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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K/A
CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
JANUARY 20, 2000
(DATE OF REPORT - DATE OF EARLIEST EVENT REPORTED)
APPLIEDTHEORY CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 000-25759 16-1491253
(STATE OR OTHER JURISDICTION OF (COMMISSION (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) FILE NUMBER) IDENTIFICATION NO.)
1500 BROADWAY - 3RD FLOOR 10036
NEW YORK, NEW YORK (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 398-7070
NOT APPLICABLE
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE
LAST REPORT DATE)
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APPLIEDTHEORY CORPORATION
TABLE OF CONTENTS
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Page
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Item 2. Acquisition or Disposition of Assets 4
Item 7A. Financial Statements of CRL Network Services, Inc. and Subsidiary 7
Report of Independent Certified Public Accountants as of and
for the year ended December 31, 1999 9
Independent Auditors' Report as of December 31, 1998 and for
each of the two years ended December 31, 1998 10
Financial Statements
Consolidated Balance Sheets - December 31, 1998 and 1999 11
Consolidated Statements of Operations for the Years Ended
December 31, 1997, 1998 and 1999 12
Consolidated Statement of Stockholders' Equity (Deficit) for the
Years Ended December 31, 1997, 1998 and 1999 13
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1998 and 1999 14
Notes to the Consolidated Financial Statements 15 - 24
Item 7B. Pro Forma Financial Information 25 - 30
Item 7C. Exhibits 31
Signatures 33
Exhibit Index 34
Financial Statements of AppliedTheory Corporation
Report of Independent Certified Public Accountants F-2
Financial Statements
Balance Sheets - December 31, 1998 and 1999 F-3
Statements of Operations for the Years Ended
December 31, 1997, 1998 and 1999 F-4
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Statement of Stockholders' Equity (Deficit) and Comprehensive
Loss for the Years Ended December 31, 1997, 1998
and 1999 F-5
Statements of Cash Flows for the Years Ended
December 31, 1997, 1998 and 1999 F-6 - F-7
Notes to Financial Statements F-8 - F-31
</TABLE>
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ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS
As previously reported, on December 3, 1999, AppliedTheory Corporation
("AppliedTheory") entered into an agreement and plan of merger (the "Merger
Agreement") with CRL Network Services, Inc. ("CRL"), AppliedTheory Reef
Acquisition Corp., ("Merger Sub") a Delaware corporation wholly owned by
AppliedTheory, and certain stockholders of CRL. Pursuant to the Merger
Agreement, AppliedTheory agreed to acquire, through Merger Sub, all of the
capital stock of CRL for up to $10 million in cash and up to 2,031,250 shares
of in AppliedTheory common stock. For additional information regarding this
event, please see our Current Report on Form 8-K, filed January 20, 2000.
On January 5, 2000, CRL and Merger Sub successfully completed the merger
(the "Merger") contemplated by the Merger Agreement and the surviving
corporation, Merger Sub, changed its name to AppliedTheory California
Corporation. All of the capital stock of AppliedTheory California Corporation is
owned by AppliedTheory. For additional information regarding this event, please
see our Current Report on Form 8-K filed January 20, 2000.
This Form 8-K/Amendment is filed to amend and restate both of the
Current Reports on Form 8-K that were filed with respect to AppliedTheory's
acquisition of CRL and to provide the financial information required under
items 7(a) and 7(b) of those reports.
The total consideration to be delivered by AppliedTheory in connection
with the closing of the merger was adjusted pursuant to the Merger Agreement.
Accordingly, in connection with the closing of the merger AppliedTheory will
deliver up to approximately $9.9 million in cash and up to approximately
2,022,287 shares of common stock, par value $.01 per share, of AppliedTheory.
CRL provides high speed Internet access and data networking solutions to
businesses across the United States. CRL owns and operates a national, Tier 1
network backbone with services including connectivity, data networking, hosting,
high-bandwidth intranet and Internet connectivity services, email services and
domain name registration services.
The purchase price for AppliedTheory's acquisition of CRL was determined
through arm's-length negotiations between AppliedTheory, CRL and the other
parties to the Merger Agreement. During these negotiations, the parties
considered, among other things, the market for CRL's services, CRL's Internet
access and data networking solutions businesses, the present stage of
development of CRL's business and operations, CRL's financial condition, CRL's
future business prospects, and the estimated value of the synergies to be
realized between AppliedTheory and CRL following the closing of the Merger.
In connection with the closing of the Merger, CRL's former President and
CEO, James G. Couch executed a non-disclosure and non-competition agreement in
favor of AppliedTheory and the Merger Sub. In connection with that closing,
AppliedTheory also entered into an escrow agreement (the "Escrow Agreement")
with James G. Couch, the Merger Sub and an escrow agreement whereby 265,625
shares of AppliedTheory common stock from the total merger consideration to
which Mr. Couch could be entitled in respect of his shares of CRL common stock
will be held in an escrow account (the "Escrow Account") for a period of one
year following the closing of the Merger. Following the closing of the Merger,
the shares of AppliedTheory common stock held in
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the Escrow Account will be available as a fund against which AppliedTheory may
seek indemnification from Mr. Couch pursuant to the Merger Agreement. Also, upon
the closing of the Merger AppliedTheory entered into an escrow agreement (the
"Tax Escrow Agreement") with CRL, Merger Sub and an escrow agent whereby
approximately $97,882 in cash and approximately 19,882 shares of AppliedTheory
common stock (collectively, the "Tax Escrow Fund") will be held in escrow. The
Tax Escrow Fund will be released after AppliedTheory or Merger Sub shall have
received any tax refund (the "Tax Refund") to which either of them may be
entitled as a result of CRL's prior payment of taxes for the fiscal year ending
December 31, 1997. Upon release of the Tax Escrow Fund, the stockholders of CRL,
on the one hand, and AppliedTheory or Merger Sub, on the other hand, will
receive shares of the Tax Escrow Fund reflecting the size of the Tax Refund. In
connection with the closing of the Merger, AppliedTheory also entered into a put
option agreement (the "Put Option Agreement") with James G. Couch and other
former CRL stockholders whereby those parties will be able to require that
AppliedTheory re-purchase up to Five Million Dollars ($5,000,000) worth of
AppliedTheory common stock on the first anniversary of the closing of the Merger
(the "First Put"), and up to another Five Million Dollars ($5,000,000) worth of
AppliedTheory common stock on the second anniversary of the closing of the
Merger (the "Second Put) of the Merger. The First Put will terminate in the
event that the average closing price for AppliedTheory common stock as reported
on the Nasdaq National Market for any period of at least 30 consecutive days
beginning 180 days after the closing of the Merger shall exceed $20.00. The
Second Put will terminate in the event that the average closing price for
AppliedTheory common stock as reported on the Nasdaq National Market for any
period of at least 30 consecutive days beginning 180 days after the closing of
the Merger shall exceed $24.00. Additional terms governing the termination of
the First Put and the Second Put are described in the Put Option Agreement.
Finally, in connection with the Merger, AppliedTheory entered into a
registration rights agreement (the "Registration Rights Agreement") with James
G. Couch and other former CRL stockholders whereby those parties will have (1)
the right to "piggyback" the registration of any number of the shares of
AppliedTheory common stock delivered pursuant to the Merger, for the period
beginning on the closing of the Merger and ending on the first anniversary of
the closing of the Merger and (2) the right to demand the filing of one
registration statement for up to 50 % of the AppliedTheory common stock
delivered pursuant to the Merger, for the period beginning six months from the
closing of the Merger and ending on the first anniversary of the closing of the
Merger.
The Merger Agreement, Escrow Agreement, Put Option Agreement,
Registration Rights Agreement and Tax Escrow Agreement are included as Exhibits
2.1, 2.2, 2.3, 2.4 and 2.5 to this Current Report on Form 8-K/A. Incorporated
by reference from the Current Report on Form 8-K, SEC File No. 000-25759, filed
by AppliedTheory Corporation on January 20, 2000. Please review these documents
for additional information regarding the terms of these agreements.
AppliedTheory applied a portion the funds raised through its initial
public offering (SEC File No. 333-72133) for the cash portion of the purchase
price paid to the stockholders of CRL.
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AppliedTheory intends to operate CRL as a wholly-owned subsidiary
which will be known as AppliedTheory California Corporation. CRL will continue
to operate its business in the same manner as before the acquisition.
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ITEM 7. FINANCIAL STATEMENTS, PROFORMA FINANCIAL
INFORMATION AND EXHIBITS
(a.) Financial Statements of CRL Network Services, Inc. and Subsidiary
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CONTENTS TO FINANCIAL STATEMENTS OF
CRL NETWORK SERVICES, INC.
AND SUBSIDIARY
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PAGE
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Reports of Independent Certified Public Accountants 9-10
Financial Statements
Consolidated Balance Sheets - December 31, 1998 and 1999 11
Consolidated Statements of Operations for the Years
Ended December 31, 1997, 1998 and 1999 12
Consolidated Statement of Stockholders' Equity (Deficit)
for the Years Ended December 31, 1997, 1998 and 1999 13
Consolidated Statements of Cash Flow for the Years Ended
December 31, 1997, 1998 and 1999 14
Notes to the Consolidated Financial Statements 15-24
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REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Shareholders
CRL Network Services, Inc.
We have audited the accompanying consolidated balance sheet of CRL Network
Services, Inc., and subsidiary as of December 31, 1999, and the related
consolidated statements of operations, stockholders' equity (deficit), and cash
flows for the year then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of CRL Network
Services, Inc. and subsidiary as of December 31, 1999, and the consolidated
results of their operations and their cash flows for the year then ended, in
conformity with accounting principles generally accepted in the United States.
/s/ Grant Thornton LLP
San Francisco, California
March 9, 2000
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INDEPENDENT AUDITORS' REPORT
To the Stockholders and Board of Directors of
CRL Network Services, Inc.:
We have audited the accompanying consolidated balance sheet of CRL Network
Services, Inc. and subsidiary as of December 31, 1998, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the years ended December 31, 1997 and 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of CRL Network Services, Inc. and
subsidiary as of December 31, 1998, and the results of their operations and
their cash flows for each of the years ended December 31, 1997 and 1998, in
conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
San Francisco, California
March 18, 1999
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CRL NETWORK SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 and 1999 (In thousands, except share amounts)
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<CAPTION>
1998 1999
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ASSETS
CURRENT ASSETS:
Cash and equivalents $ 840 $ 633
Accounts receivable, net of allowances for doubtful accounts of $484 and $527
in 1998 and 1999, respectively 1,309 627
Refundable income taxes 414
Deferred tax assets 85
Other 131 155
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Total current assets 2,365 1,829
PROPERTY AND EQUIPMENT, net 2,445 1,997
OTHER ASSETS 45 77
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TOTAL ASSETS $4,855 $3,903
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LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable $ 892 $1,197
Deferred revenue 594 217
Accrued liabilities 170 1,149
Current portion of long-term obligations 270 1,563
Related party note payable 225
Other 9 60
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Total current liabilities 1,935 4,411
DEFERRED TAX LIABILITIES 313
LONG-TERM OBLIGATIONS 847
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Total liabilities 3,095 4,411
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $0.01 par value, 5,000,000 shares authorized; none issued and outstanding
Common stock, $0.0001 par value 70,000,000 shares authorized; 18,978,832 and 19,038,832 shares
issued and outstanding in 1998 and 1999, repectively 6 6
Additional paid in capital 109
Common stock options 948 1,046
Deferred stock compensation (792) (739)
Retained earnings (accumulated deficit) 1,598 (930)
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Total stockholders' equity (deficit) 1,760 (508)
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $4,855 $3,903
====== ======
</TABLE>
See notes to the consolidated financial statements.
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CRL NETWORK SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
(In thousands)
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<CAPTION>
1997 1998 1999
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REVENUES:
Colocation and Internet connectivity $ 8,873 $ 9,681 $ 8,887
Systems integration and services 1,502 2,011 1,376
---------- --------- ---------
Total revenues 10,375 11,692 10,263
---------- --------- ---------
COSTS AND EXPENSES:
Cost of colocation and Internet connectivity 3,631 4,871 5,022
Cost of systems integration and services 1,009 1,295 958
Selling and marketing 522 371 267
General and administrative 2,997 4,124 6,047
Depreciation expense 745 909 853
Stock-based compensation expense 156 151
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Total costs and expenses 8,904 11,726 13,298
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OPERATING INCOME (LOSS) 1,471 (34) (3,035)
NET INTEREST INCOME (EXPENSE) 5 (30) (122)
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INCOME (LOSS) BEFORE INCOME TAXES 1,476 (64) (3,157)
INCOME TAX PROVISION (BENEFIT) 591 87 (629)
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NET INCOME (LOSS) $ 885 $ (151) $ (2,528)
========== =========== ==========
</TABLE>
See notes to the consolidated financial statements.
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CRL NETWORK SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
(In thousands, except share amounts)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL COMMON DEFERRED RETAINED TOTAL
------------ PAID-IN STOCK STOCK EARNINGS STOCKHOLDERS'
SHARES AMOUNT CAPITAL OPTIONS COMPENSATION (DEFICIT) EQUITY (DEFICIT)
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Balance, January 1, 1997 18,978,832 $ 6 $ $ $ $ 864 $ 870
Net income 885 885
---------- ----- ------- --------- --------- ------- ------
Balance, December 31, 1997 18,978,832 6 1,749 1,755
Compensatory stock
arrangements 948 (948)
Amortization of deferred
stock compensation 156 156
Net loss (151) (151)
---------- ----- ------- --------- --------- ------- ------
Balance, December 31, 1998 18,978,832 $ 6 $ 948 $ (792) $ 1,598 $ 1,760
Compensatory stock
arrangements 98 (98)
Amortization of deferred
stock compensation 151 151
Exercise of stock options 60,000 109 109
Net loss (2,528) (2,528)
---------- ----- ------- --------- --------- ------- ------
Balance, December 31, 1999 19,038,832 $ 6 $ 109 $ 1,046 $ (739) $ (930) $ (508)
========== ===== ======= ========= ========= ======= ======
</TABLE>
See notes to the consolidated financial statements.
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CRL NETWORK SERVICES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999 (IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1998 1999
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 885 $ (151) $(2,528)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation 745 909 853
Stock-based compensation expense 156 151
Loss on disposal of fixed assets 13
Provision for bad debts 624 508 383
Deferred taxes 50 89 (228)
Changes in assets and liabilities:
Accounts receivable (1,212) (588) 299
Income taxes (414)
Other assets (64) 9 (51)
Accounts payable, deferred revenue and accrued expenses 535 (209) 907
Other liabilities 170 (18) 51
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Net cash provided by (used in) operating activities 1,746 705 (577)
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (1,336) (1,553) (415)
Proceeds from sale of property and equipment 143 10
Increase (decrease) in notes receivable from related parties, net 11 24 (5)
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Net cash used in investing activities (1,182) (1,529) (410)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Credit line borrowings 358 703 1,032
Related party borrowings 225
Principal payments on borrowings (42) (154) (586)
Issuance of common stock 109
------- ------- -------
Net cash provided by financing activities 316 549 780
------- ------- -------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS 880 (275) (207)
CASH AND EQUIVALENTS AT BEGINNING OF YEAR 235 1,115 840
------- ------- -------
CASH AND EQUIVALENTS AT END OF YEAR $ 1,115 $ 840 $ 633
======= ======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for interest $ 23 $ 70 $ 108
Cash paid for taxes 166 577 107
SUPPLEMENTAL DISCLOSURE OF NONCASH
FINANCING ACTIVITIES:
Equipment acquired under capital lease $ 133 $ -- $ --
</TABLE>
See notes to the consolidated financial statements.
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CRL NETWORK SERVICES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
(IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE INFORMATION)
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1. SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY - CRL Network Services, Inc. and subsidiary ("CRL" or the
"Company") was incorporated in the state of California in 1993 and
reincorporated in Delaware in 1999. CRL is a Tier 1 Internet service
provider focussed on offering tailored Internet and network management
solutions to small and medium-sized businesses across the United States
through a national fiber-optic data network.
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements
include the accounts of CRL and its wholly owned subsidiary. All
intercompany balances and transactions have been eliminated.
USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
CASH AND EQUIVALENTS - The Company considers all highly liquid monetary
instruments with an original maturity of three months or less from the
date of purchase to be cash equivalents.
PROPERTY AND EQUIPMENT - Property and equipment are recorded at cost and
depreciated using the straight-line method over their useful lives.
Equipment held under capital leases is amortized on the straight-line
method over the shorter of the lease term or the estimated useful life
of the asset.
Estimated useful lives are as follows:
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Machinery, equipment and software 3 to 5
Furniture and fixtures 5 to 7
Airplane 10
</TABLE>
REVENUE RECOGNITION - Revenues from colocation and Internet connectivity
include Internet and secure private network connectivity, remote
management services and hosting services. Revenues from these services
are generally earned from fixed term contracts lasting from 12 to 36
months. Revenues are recognized on a pro rata basis when the services
are performed. Deferred revenue represents amounts billed in advance of
services not yet provided. Revenues from systems integration and
hardware sales result from short term contracts and revenue is
recognized when hardware is shipped and the installation and integration
is complete.
ADVERTISING EXPENSES - All costs related to marketing and advertising
the Company's products are expensed in the periods incurred. Advertising
expenses were $27, $60 and $18 for 1997, 1998 and 1999, respectively.
INCOME TAXES - The Company accounts for income taxes using the asset and
liability method in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 109 ("SFAS 109"), Accounting for Income Taxes.
Under this
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method, deferred tax liabilities and assets are determined based on the
difference between the financial statement and tax bases of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse.
STOCK-BASED COMPENSATION - The Company accounts for stock-based awards
to employees using the intrinsic value method in accordance with
Accounting Principles Board ("APB") No. 25, Accounting for Stock Issued
to Employees. Accordingly, no accounting recognition is given to stock
options granted at fair market value until they are exercised.
Compensation expense related to employee stock options is recorded if,
on the date of grant, the fair value of the underlying stock exceeds the
exercise price.
CONCENTRATION OF CREDIT RISK - Financial instruments that potentially
subject the Company to concentration of credit risk consist of trade
receivables. The Company's receivables are subject to geographic
concentrations of credit risk. This risk is mitigated by the Company's
credit evaluation process and the reasonably short collection terms. The
Company does not require collateral or other security to support
accounts receivable and maintains reserves for potential credit losses.
FINANCIAL INSTRUMENTS - The Company's financial instruments include cash
and equivalents, accounts receivable, accounts payable and debt. At
December 31, 1998 and 1999, the carrying amounts of these instruments
approximates their fair values based on the short-term nature of such
instruments. The fair value of the related party note payable is not
determinable because of the related party nature of the instrument.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
- The Company evaluates its long-lived assets for impairment whenever
events or changes in circumstances indicate that the carrying amount of
such assets or intangibles may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying
amount of an asset to future undiscounted net cash flows expected to be
generated by the asset. If such assets are considered to be impaired,
the impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceeds the fair value of the assets.
Assets to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell.
STOCKHOLDERS' EQUITY - In August 1997, the Company's Board of Directors
authorized a 2,318 for 1 stock split. The stock split was effective and
distributed to the sole stockholder of record on August 8, 1997. In
December 1998, the Company's Board of Directors authorized a 20 for 1
stock split. The stock split was effective and distributed to the sole
stockholder of record on December 2, 1998. In December 1998, the Board
also authorized an increase in the number of authorized shares of common
stock to 200,000,000.
On March 18, 1999, the Board of Directors authorized the reincorporation
of CRL in the State of Delaware and the associated exchange of one share
of common stock of CRL for every three shares of common stock of CRL's
California predecessor and the number of shares authorized was set at
70,000,000. All share and per share information in these financial
statements have been adjusted to give effect to the reincorporation and
the stock splits. In addition, upon reincorporation in the State of
Delaware, the Board of Directors is authorized to issue up to 5,000,000
shares of preferred stock in one or more series.
During 1999 the Company incurred approximately $968 in expenses
associated with an unsuccessful initial public offering of CRL Network
Services, Inc. stock. These expenses are included in general and
administrative expenses in the consolidated statement of operations.
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COMPREHENSIVE INCOME - There are no significant differences between
comprehensive income and net income as reported in the Company's
statements of operations.
SEGMENT AND RELATED INFORMATION - The Company operates in a single
segment encompassing Internet access and related managed data services
and equipment sales and follows the requirements of Statement of
Financial Accounting Standards No. 131, Disclosures About Segments of an
Enterprise and Related Information. The Company's revenues from its
major service offerings are included in the accompanying statement of
operations. Due to the way the Company manages its operations, it does
not account for or report operating expenses by product/service
offering.
RECLASSIFICATIONS - Certain prior year amounts have been reclassified to
conform to the current year presentation. Such reclassifications had no
effect on stockholders' equity (deficit) or net income (loss).
2. MERGER
On December 21, 1998, the merger of Integral Systems, Inc. ("Integral")
was completed. Under the terms of the Integral merger, which was
accounted for as a pooling-of-interests, 434,832 shares of CRL common
stock were exchanged for all of the outstanding Integral common shares
at an exchange ratio of 5.80 shares of CRL for each share of Integral.
The financial information for all prior periods presented has been
restated to present the combined financial condition and results of
operations for both companies as if the Integral merger had been in
effect for all periods presented.
The following table presents a reconciliation of net sales and net
income (loss) previously reported by the Company to those presented in
the accompanying consolidated financial statements.
<TABLE>
<CAPTION>
1997 1998
<S> <C> <C>
Net sales:
CRL $ 9,340 $ 9,929
Integral 1,035 1,763
---------- ----------
Combined $ 10,375 $ 11,692
========== ==========
Net income (loss):
CRL $ 891 $ (123)
Integral (6) (28)
---------- ----------
Combined $ 885 $ (151)
========== ==========
</TABLE>
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3. ALLOWANCES FOR DOUBTFUL ACCOUNTS
Allowances for doubtful accounts are estimated and established based on
historical experience and specific circumstances of each customer.
Additions to the allowance are charged to general and administrative
expenses. Accounts receivable are written off against the allowance for
doubtful accounts when an account is deemed uncollectible. Recoveries on
accounts receivable previously charged off as uncollectible are credited
to the allowance for doubtful accounts. Changes in the allowance for
doubtful accounts were as follows:
<TABLE>
<CAPTION>
1997 1998 1999
<S> <C> <C> <C>
Balance, beginning of year $ 96 $ 162 $ 484
Additions 624 508 383
Writeoffs (558) (186) (340)
------- ------ ------
Balance, end of year $ 162 $ 484 $ 527
======= ====== ======
</TABLE>
4. PROPERTY AND EQUIPMENT, NET
Property and equipment at December 31 are as follows:
<TABLE>
<CAPTION>
1998 1999
<S> <C> <C>
Machinery, equipment and purchased software $ 4,208 $ 4,520
Furniture and equipment held under capital lease 135 135
Furniture and fixtures 558 637
Airplane 40 40
------- -------
Total 4,941 5,332
Less accumulated depreciation (2,496) (3,335)
------- -------
Total $ 2,445 $ 1,997
======= =======
</TABLE>
The accumulated depreciation associated with furniture and equipment
held under capital lease was $67 and $112 at December 31, 1998 and 1999,
respectively.
Effective January 1, 1998, the Company changed the estimated service
lives of certain equipment from three to five years. The effect of this
change in estimate increased 1998 operating income by $237 and increased
net income by $142.
5. LONG-TERM DEBT AND BANK CREDIT LINES
The Company has several lines of credit totaling $1,842 with a bank. As
of December 31, 1999 the lines have $556 of available credit and have
variable interest rates that are 1.25% to 1.75% above the prime rate
(9.75% - 10.25% at December 31, 1999). All borrowings are personally
guaranteed by the Chief Executive Officer and are to be repaid over a
period of no more than eight years. The Company had $978 and $1,390
outstanding against these lines at December 31, 1998 and 1999,
respectively.
The Company also had a line of credit for $50 with a bank. As of
December 31, 1999 the line has no available credit and has a variable
interest rate that is 2.50% above the prime rate (10.50% at
- 18 -
<PAGE> 19
December 31, 1999). All borrowings are to be repaid over a period of no
more than five years. The Company had $45 and $39 outstanding against
the line at December 31, 1998 and 1999, respectively.
Amounts borrowed under these agreements are secured by substantially all
of the Company's assets. At December 31, 1999, amounts outstanding
under these credit agreements are classified as current liabilities due
to the acquisition of CRL by AppliedTheory Corporation.
6. INCOME TAXES
Income taxes consist of the following at December 31:
<TABLE>
<CAPTION>
1997 1998 1999
<S> <C> <C> <C>
Current:
Federal $ 412 $ 21 $ (431)
State 129 (23) 30
-------- -------- --------
Total current 541 (2) (401)
-------- -------- --------
Deferred:
Federal 49 41 (178)
State 1 48 (50)
-------- -------- --------
Total deferred 50 89 (228)
-------- -------- --------
Total provision (benefit) $ 591 $ 87 $ (629)
======== ======== ========
</TABLE>
The primary components of the deferred tax accounts as of December 31
are as follows:
<TABLE>
<CAPTION>
1997 1998
<S> <C> <C> 1999
Current deferred tax assets (liabilities):
Allowance for bad debts $ 111 $ 120 $ 226
Other (10) (36) (28)
Valuation allowance (198)
-------- -------- --------
Total current net deferred tax assets $ 101 $ 85 $ --
======== ======== ========
Noncurrent deferred tax assets (liabilities):
Deferred rent $ 8 $ 10 $
Depreciation (215) (386) (548)
Net operating loss 89 951
Cash to accrual adjustment (33) (25)
Other (6)
Valuation allowance (403)
-------- -------- --------
Total noncurrent net deferred tax liabilities $ (246) $ (313) $ --
======== ======== ========
</TABLE>
- 19 -
<PAGE> 20
The Company's effective tax rate differs from the federal statutory tax
rate as follows:
<TABLE>
<CAPTION>
1997 1998 1999
<S> <C> <C> <C>
Federal statutory tax rate 34% (34)% (34)%
State taxes, net of federal benefit 6 (6) (6)
Tax effect of permanent items 72
50% disallowance of state tax net
operating loss 7
Nondeductible compensation expense 97 5
Valuation allowance 19
Other (1) (4)
--- --- ---
Effective tax rate 39% 136% (20)%
=== === ===
</TABLE>
The Company has net operating loss carryforwards of approximately $2,218
expiring in years 2018 through 2019. At December 31, 1999 the Company
has provided a valuation allowance for net deferred tax assets since
realization of these benefits cannot be reasonably assured following the
acquisition of the Company by AppliedTheory Corporation.
7. STOCK OPTION AND OTHER EMPLOYEE BENEFIT PLANS
401(k) PLAN - In September 1997, the Company implemented a 401(k) plan
covering all employees who have met certain eligibility requirements.
Under the 401(k) plan, employees may elect to contribute up to 15% of
their eligible compensation (to a maximum of $10) to the 401(k) plan,
subject to limitations. The Company may make matching contributions at
its discretion. As of December 31, 1997, 1998 and 1999, the Company had
not made any contributions to the 401(k) plan.
STOCK BASED COMPENSATION PLAN - In August 1997, the Board of Directors
approved and the Company adopted the 1997 Equity Incentive Plan (the
"Plan"). Under the Plan, the Company may grant options to purchase
1,812,107 shares of common stock to officers and employees. These
options generally expire 10 years from the date of grant and vest over a
period of five years.
Option activity under the plans is as follows:
<TABLE>
<CAPTION>
Number of Weighted-Average
Options Exercise Price
<S> <C> <C>
Balance, January 1, 1997 - $ -
Granted 647,547 1.83
Canceled (66,667) 1.83
-------- --------
Balance, December 31, 1997
(no shares vested) 580,880 1.83
Granted 468,773 2.40
Canceled (96,666) 1.83
-------- --------
Balance, December 31, 1998 952,987 2.11
Granted 123,333 2.29
Exercised (60,000) 1.82
Canceled (621,548) 2.60
-------- --------
Balance, December 31, 1999 394,772 $ 2.13
======== ========
</TABLE>
- 20 -
<PAGE> 21
At December 31, 1999, 126,176 shares were exercisable and 1,417,335 were
available for grant under the 1997 stock option plan. On January 5, 2000
all of the Company's outstanding stock options were canceled in
connection with the acquisition by AppliedTheory.
During the year ended December 31, 1998, deferred compensation of $948
was recorded for options granted of which $156 was amortized to
compensation expense. During the year ended December 31, 1999, deferred
compensation of $98 was recorded for options granted. A total of $151
was amortized to compensation expense during the year ended December 31,
1999.
The following table summarizes information about outstanding and vested
stock options at December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Vested
--------------------------------- ------------------------
Weighted
Outstanding Average Weighted Weighted
at Remaining Average Vested at Average
Exercise December 31, Contractual Exercise December 31, Exercise
Price 1999 Life Price 1999 Price
<S> <C> <C> <C> <C> <C>
$1.83 292,107 7.69 $ 1.83 116,843 $ 1.83
2.28 82,666 9.29 2.28 9,333 2.28
2.73 10,000 9.08 2.73
9.21 9,999 9.50 9.21
------- ------ ------- ------
394,772 $ 2.13 126,176 $ 1.86
======= ====== ======= ======
</TABLE>
On March 18, 1999, the Board of Directors adopted, subject to
stockholder approval, the 1999 Stock Incentive Plan. A total of
1,000,000 shares of common stock have initially been reserved for
issuance under the 1999 Stock Incentive Plan. There has been no activity
in the 1999 Stock Incentive Plan since inception.
ADDITIONAL STOCK PLAN INFORMATION - As discussed in Note 1, the Company
accounts for its stock-based awards to employees using the intrinsic
value method in accordance with APB No. 25, Accounting for Stock Issued
to Employees, and its related interpretations.
SFAS No. 123, Accounting for Stock-Based Compensation, requires the
disclosure of pro forma net income (loss) had the Company adopted the
fair value method. Under SFAS No. 123, the fair value of stock-based
awards to employees is calculated through the use of option pricing
models, even though such models were developed to estimate the fair
value of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option
awards.
- 21 -
<PAGE> 22
The Company's calculations for employee grants were made using the
minimum option pricing model with the following weighted
average assumptions:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
-----------------------------
1997 1998 1999
<S> <C> <C> <C>
Dividend yield None None None
Risk free interest rate 5.70% 4.40% 5.70%
Expected term, in years 5.5 3.0 3.0
</TABLE>
The weighted average minimum value per option as of the date of grant
for options granted during 1997, 1998 and 1999 was $0.48, $2.13 and
$2.39, respectively.
If the computed minimum values of the Company's stock-based awards to
employees had been amortized to expense over the vesting period of the
awards as specified under SFAS No. 123, the Company's net income (loss)
on a pro forma basis (as compared to such items as reported) would have
been:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
----------------------------------
1997 1998 1999
<S> <C> <C> <C>
Net income (loss):
As reported $ 885 $ (156) $ (2,528)
Pro forma 828 (192) (2,461)
</TABLE>
8. RELATED PARTY TRANSACTIONS
In August 1995, the Company received a 7.50% promissory note for $106
from its sole stockholder for cash. The note specified that the entire
principal plus accrued interest were to be paid by July 10, 2000. During
1998, the stockholder repaid the remaining amount outstanding.
In April 1996, the Company received an 8.00% promissory note for $25
from an employee. The note specified that payment of principal and
interest is to be paid annually in the amount of $5 plus accrued
interest until fully paid. At December 31, 1999, the remaining balance
on this note was $10.
In 1997 CRL entered into an agreement with FBN Holding Co. ("FBN") to
lease aircraft time. The sole owner of FBN is also the President and
Chief Executive Officer of CRL. This agreement may be canceled at any
time by either party with 30-day notice. The amount paid to FBN for
travel services under the agreement amounted to $104, $144 and $18 for
the years ended December 31, 1997, 1998 and 1999, respectively. On March
11, 1999, the Company terminated its relationship with FBN effective
April 30, 1999.
In November 1999 the Company issued a 7.00% promissory note for $225 to
the majority stockholder. The note specified that the entire principal
plus accrued interest were to be paid upon demand. At December 31, 1999,
no payments had been made on this note.
- 22 -
<PAGE> 23
9. GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS
The Company operates in a single segment encompassing Internet access
and related managed data services and equipment sales. All of the
Company's revenues in each year is received from customers based in the
United States. Approximately $8,181, $8,950 and $8,006 of the Company's
revenues was received from customers in the thirteen Western U.S. states
including $7,653, $8,174 and $7,285 received from customers in
California for 1997, 1998 and 1999, respectively.
No single customer accounted for 10% or more of the Company's net
revenue in any year.
10. ACCRUED EXPENSES
Accrued expenses consisted of the following at December 31:
<TABLE>
<CAPTION>
1998 1999
<S> <C> <C>
Initial public offering costs $ $ 477
Network costs 289
Other 170 383
-------- --------
Total $ 170 $ 1,149
======== ========
</TABLE>
11. COMMITMENTS AND CONTINGENCIES
LEASES - The Company leases office and storage space under operating
leases that expire at various times through 2005. Rent expense under all
leases was $224, $377 and $558 for 1997, 1998 and 1999, respectively.
Future minimum lease payments for capital lease obligations and net
lease payments under noncancelable operating leases with remaining terms
in excess of one year at December 31, 1999 are as follows:
<TABLE>
<CAPTION>
CAPITAL LEASE OPERATING
OBLIGATIONS LEASES
<S> <C> <C>
Year ending December 31:
2000 $ 40 $ 546
2001 470
2002 419
2003 319
2004 128
Thereafter 80
-------- --------
Total minimum lease payments 40 $ 1,962
========
Less amount representing interest (2)
--------
Capital lease obligations 38
Less current portion (38)
--------
Long-term portion $ --
========
</TABLE>
- 23 -
<PAGE> 24
TELECOMMUNICATIONS AND PEERING ARRANGEMENTS - CRL enters into
telecommunications agreements with telephone companies who provide local
access for dial-up customers to CRL's Internet backbone. The terms of
the service agreements vary from one to two years and provide the
Company with preferred rates. If the Company prematurely cancels one of
these service contracts, the service provider, at their discretion, can
charge the difference between their regular rates and the preferred rate
over the term of the service. Accordingly, the financial commitment
under these agreements would be the cancellation fee. In the past, no
service provider has exercised this option. Management believes that
potential additional charges, if any, from early cancellation of vendor
service contracts would not have a material effect on the financial
statements.
CRL is party to numerous peering arrangements with other Internet
providers to allow for the exchange of Internet traffic. The Company
does not record any revenue or expense associated with these non-cash
transactions as such transactions do not represent the culmination of
the earnings process and the fair value of such transactions are not
reasonably determinable. There are no financial commitments under these
peering arrangements.
Subject to few exceptions, CRL's peering relationships are not subject
to any written agreements and could be terminated at any time. For those
peering arrangements subject to contracts, there are no minimum fixed
charges for data exchange. Such agreements generally do impose minimum
usage requirements at levels which CRL has in the past always exceeded.
LEGAL MATTERS - CRL is involved in a limited number of claims and legal
actions arising out of the normal course of business. Management does
not expect that the outcome of these cases will have a material effect
on CRL's financial position, results of operations or cash flow.
Coincident with the acquisition of the Company by AppliedTheory all
legal matters were assigned to the former stockholder of CRL and the
Company has been indemnified against any adverse results of these
matters.
QWEST CONTRACT - Under a private line service agreement originating in
1997 Qwest Communications Corporation (Qwest) alleged the Company owed
them $361. During 1999, CRL entered into a settlement agreement and
issued a non-interest bearing promissory note payable to Qwest for $140
and recorded prepaid expenses for future service credits expiring in
October 2000. These credits will be amortized over the credit period and
the promissory note payable has an outstanding balance of $77 at
December 31, 1999.
12. SUBSEQUENT EVENTS
PURCHASE OF CRL NETWORK SERVICES, INC. BY APPLIEDTHEORY CORPORATION - On
January 5, 2000, AppliedTheory Reef Acquisition Corp., ("Merger Sub"), a
Delaware corporation and wholly owned subsidiary of AppliedTheory
Corporation, purchased all of the capital stock of the Company for up to
approximately $9.9 million in cash and up to approximately 2,022,287
shares of AppliedTheory common stock, par value $.01 per share. Also the
Merger Sub changed its name to AppliedTheory California Corporation. At
December 31, 1999, amounts outstanding under the Company's line of
credit agreements credit aggrements are classified as current
liabilities due to this acquisition.
******
- 24 -
<PAGE> 25
ITEM 7. FINANCIAL STATEMENTS, PROFORMA FINANCIAL
INFORMATION AND EXHIBITS (CONTINUED)
(b.) Pro Forma Financial Information.
25
<PAGE> 26
APPLIEDTHEORY CORPORATION AND CRL NETWORK SERVICES, INC. AND SUBSIDIARY
PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION
(UNAUDITED)
- --------------------------------------------------------------------------------
The unaudited pro forma condensed consolidated financial information give
effect, on a purchase accounting basis, to the Agreement and Plan of Merger (the
"Merger Agreement") dated December 3, 1999 and consummated January 5, 2000,
between AppliedTheory Corporation ("AppliedTheory"), CRL Network Services, Inc.
and Subsidiary ("CRL"), AppliedTheory Reef Acquisition Corp., ("Merger Sub") a
Delaware corporation wholly owned by AppliedTheory, and certain stockholders of
CRL.
The unaudited pro forma condensed consolidated balance sheet at December 31,
1999 is based on the individual balance sheets of CRL and AppliedTheory and
assumes that the acquisition of CRL occurred on December 31, 1999. The purchase
price consisted of up to approximately $9.9 million in cash and up to
approximately 2,022,287 shares of AppliedTheory common stock $.01 par value per
share. The source of cash used to fund the purchase price was provided by funds
raised through AppliedTheory's initial public offering on April 30, 1999. The
unaudited pro forma condensed consolidated statement of operations for the year
ended December 31, 1999 is based on the individual statements of operations of
CRL and AppliedTheory and combines their results as if the acquisition of CRL
occurred on January 1, 1999.
The Company has retained a portion of the purchase price under escrow provisions
of the Merger Agreement to cover various contingencies. Such amounts will be
recorded as additional cost of the acquired company when the amount to be paid,
if any, becomes probable. At December 31, 1999, no amount has been accrued since
the final outcome of the contingencies was not determinable. The unaudited pro
forma adjustments are based on preliminary assumptions of the allocation of the
purchase price 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. Actual purchase
accounting adjustments may differ from the pro forma adjustments presented
herein.
The unaudited pro forma condensed consolidated financial information is not
necessarily indicative of the actual results that would have been reported if
the transaction described above had occurred as of January 1, 1999 nor do they
purport to be indicative of the results of future operations. In the opinion of
management all adjustments necessary to present fairly such proforma condensed
consolidated financial information have been made. AppliedTheory's future
financial statements will reflect the acquisition of CRL as of the acquisition's
consummation date on January 5, 2000.
The pro forma condensed consolidated financial statements should be read in
conjunction with the financial statements of AppliedTheory as of December 31,
1998 and 1999 and for the three years ended December 31, 1999 included as
Exhibit 2.6 to this Current Report on Form 8-K/A.
26
<PAGE> 27
APPLIEDTHEORY CORPORATION AND CRL NETWORK SERVICES, INC. AND SUBSIDIARY
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1999
(IN THOUSANDS)
<TABLE>
<CAPTION>
Historic Pro Forma
---------------------------- -------------------------------------
AppliedTheory CRL Adjustments Consolidated
ASSETS
<S> <C> <C> <C> <C>
CURRENT ASSETS:
Cash and equivalents $ 14,834 $ 633 $ (9,589) A $ 4,353
(1,525) B
Marketable securities 32,727 32,727
Accounts receivable, net 6,714 627 7,341
Refundable income taxes 414 414
Due from related parties 59 59
Other 2,133 155 2,288
----------- ---------- ------------ -----------
Total current assets 56,467 1,829 (11,114) 47,182
Property and equipment, net 13,881 1,997 15,878
Investment, at cost 5,000 5,000
Goodwill, net 44,468 A,H 44,468
Other assets 1,587 77 1,664
----------- ---------- ------------ -----------
TOTAL ASSETS $ 76,935 $ 3,903 $ 33,354 $ 114,192
=========== ========== ============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable $ 5,025 $ 1,197 $ $ 6,222
Deferred revenue 2,476 217 2,693
Accrued liabilities 6,806 1,149 1,074 F 9,029
Current portion of long-term obligations 1,215 1,563 (1,525) B 1,253
Related party borrowings 225 (225) G 0
Other 60 252 E 312
----------- ---------- ------------ -----------
Total current liabilities 15,522 4,411 (424) 19,509
Long-term obligations 6,783 6,783
Other 421 421
----------- ---------- ------------ -----------
Total liabilities 22,726 4,411 (424) 26,713
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock 214 6 17 A 231
(6) C
Additional paid in capital 84,052 109 33,253 A 117,305
(109) C
Common stock options 1,046 (1,046) D 0
Deferred stock compensation (739) 739 D 0
Accumulated other comprehensive loss (251) (251)
Accumulated deficit (29,806) (930) 930 C (29,806)
----------- ---------- ------------ -----------
Total stockholders' equity (deficit) 54,209 (508) 33,778 87,479
----------- ---------- ------------ -----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY (DEFICIT) $ 76,935 $ 3,903 $ 33,354 $ 114,192
=========== ========== ============ ===========
</TABLE>
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
27
<PAGE> 28
APPLIEDTHEORY CORPORATION AND CRL NETWORK SERVICES, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1999
- --------------------------------------------------------------------------------
The unaudited balance sheets as of December 31, 1999 have been consolidated
to reflect the pro forma impact of the acquisition of CRL by AppliedTheory
as if the transaction had occurred on December 31, 1999.
The following is a summary of the adjustments reflected in the pro forma
condensed consolidated balance sheet:
A - The purchase price, exclusive of related fees and expenses, of $42.9 million
based on the terms and conditions of the Agreement and Plan of Merger dated
as of December 3, 1999 between AppliedTheory, CRL, Merger Sub, and certain
stockholders of CRL. The purchase price consisted of $33.3 million
(1,736,780 shares) of AppliedTheory common stock, $.01 par value and
approximately $9.6 million of cash provided by the proceeds of
AppliedTheory's initial public offering.
The purchase price has been allocated as follows:
<TABLE>
<S> <C>
Cash paid $ 9,589
Common stock issued 33,270
--------
Purchase price 42,859
Less: Assets acquired (3,903)
Liabilities not assumed (225)
Plus: Liabilities assumed 4,411
Transaction costs 1,074
Undistributed cash purchase consideration 252
--------
Goodwill $ 44,468
========
</TABLE>
B - In connection with the acquisition of CRL, AppliedTheory assumed CRL's
outstanding bank debt. Immediately after the closing of the transaction,
CRL's banks called the lines of credit and other debt and AppliedTheory will
be required to pay off the outstanding balances. Proceeds from the initial
public offering of AppliedTheory common stock on April 30, 1999 will be used
to pay down CRL's line of credit facilities and other debt. Current debt has
been adjusted to give effect to these transactions, as if such transactions
had occurred on December 31, 1999.
C - Eliminate the net equity of CRL.
D - Based on the terms and conditions of the Agreement and Plan of Merger all
outstanding CRL common stock options were cancelled on January 5, 2000 and
related deferred stock compensation was reversed. Common stock options and
deferred stock compensation have been adjusted to give effect to these
transactions, as if such transactions had occurred on December 31, 1999.
E - Record liability to a stockholder for undistributed cash purchase
consideration.
F - To record estimated transaction costs.
G - Adjustment for liabilities not assumed.
H - To record the amount by which the purchase price exceeds the fair market
value of assets acquired, less liabilities assumed and transaction costs
associated with the acquisition of CRL.
28
<PAGE> 29
APPLIEDTHOERY CORPORATION AND CRL NETWORK SERVICES, INC. AND SUBSIDIARY
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1999
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNT)
<TABLE>
<CAPTION>
Historic Pro Forma
---------------------------- -------------------------------
AppliedTheory CRL Adjustments Consolidated
<S> <C> <C> <C> <C>
REVENUES:
Third-party customers $ 27,328 $ 10,263 $ $ 37,591
Related parties 10,317 10,317
------------- ------------- ------------- --------------
Total revenues 37,645 10,263 47,908
COSTS AND EXPENSES: ------------- ------------- ------------- --------------
Cost of revenues 24,988 5,980 30,968
Selling and marketing 14,124 267 14,391
General and administrative 10,180 6,198 (151) C 16,227
Research and development 321 321
Depreciation and amortization 3,403 853 8,894 A 13,150
------------- ------------- ------------- --------------
Total costs and expenses 53,016 13,298 8,743 75,057
------------- ------------- ------------- --------------
OPERATING LOSS (15,371) (3,035) (8,743) (27,149)
NET INTEREST INCOME (EXPENSE) 1,377 (122) 122 B 1,377
------------- ------------- ------------- --------------
LOSS BEFORE INCOME TAXES (13,994) (3,157) (8,621) (25,772)
INCOME TAX PROVISION (BENEFIT) (629) (629)
------------- ------------- ------------- --------------
NET LOSS $ (13,994) $ (2,528) $ (8,621) $ (25,143)
============= ============= ============= ==============
Preferred stock dividends 73 73
------------- ------------- -------------- --------------
Net loss attributable to common stockholders $ (14,067) $ (2,528) $ (8,621) $ (25,216)
============= ============= ============= ==============
NET LOSS PER COMMON SHARE -
Basic and diluted $ (0.72) $ (1.10) D
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING:
Basic and diluted 19,491,711 22,953,491 D
</TABLE>
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
29
<PAGE> 30
APPLIEDTHEORY CORPORATION AND CRL NETWORK SERVICES, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1999
- --------------------------------------------------------------------------------
The following is a summary of the adjustments reflected in the unaudited pro
forma condensed consolidated statement of operations:
A - Earnings effect of CRL goodwill amortization using a 5 year recovery period.
B - In connection with the acquisition of CRL, AppliedTheory assumed CRL's
outstanding bank debt. After the closing AppliedTheory paid off the
outstanding balance on the lines of credit and other debt. The completion of
the initial public offering of 5,175,000 shares of AppliedTheory's common
stock, $.01 par value per share, which closed on April 30, 1999, was the
source of funds for the acquisition of CRL and the retirement of debt
assumed in the CRL acquisition. Interest expense has been adjusted to give
effect to the retirement of this debt, as if such transactions had occurred
on January 1, 1999.
C - Based on the terms and conditions of the Agreement and Plan of Merger all
outstanding CRL common stock options were cancelled on January 5, 2000 and
related deferred stock compensation was reversed. Stock based compensation
expense has been adjusted to give effect to these transactions, as if such
transactions had occurred on January 1, 1999.
D - Effective April 30, 1999, 5,175,000 shares of AppliedTheory common stock
were issued during the initial public offering. This transaction was assumed
to have occurred on January 1, 1999 as a portion of the IPO proceeds were
used to purchase CRL. Based on this, pro forma earnings per share and
weighted average common shares and share equivalents outstanding assume
issuance of 5,175,000 common shares from the IPO and 1,736,780 common shares
(2,022,287 less 285,507 shares held in escrow) for CRL's acquisition on
January 1, 1999.
30
<PAGE> 31
ITEM 7. FINANCIAL STATEMENTS, PROFORMA FINANCIAL
INFORMATION AND EXHIBITS (CONTINUED)
(c.) Exhibits.
Following is the Index of Exhibits furnished in accordance with Item 601
of Regulation S-K, filed as part of this Current Report on Form 8-K/A or
incorporated by reference herewith:
2.1 Merger Agreement, dated December 3, 1999, by and among
AppliedTheory Corporation a Delaware corporation, AppliedTheory
Reef Acquisition Corp., Delaware Corporation, CRL Network
Services, Inc., a Delaware Corporation, and James G. Couch.
Incorporated by reference from the Current Report on Form 8-K, SEC
File No. 000-25754, filed by AppliedTheory Corporation on
December 20, 1999.
2.2 Escrow Agreement, dated January 5, 2000, by and among,
AppliedTheory Corporation, AppliedTheory Reef Acquisition Corp.,
United States Trust Company of New York, and James G. Couch.
Incorporated by reference from the Current Report on Form 8-K,
SEC File No. 000-25759, filed by AppliedTheory Corporation on
January 20, 2000.
2.3 Put Option Agreement dated January 5, 2000, by and between,
AppliedTheory Corporation, James G. Couch and other holders of
capital stock of CRL Network Services, Inc. Incorporated by
reference from the Current Report on Form 8-K, SEC File No.
000-25759, filed by AppliedTheory Corporation on January 20,
2000.
2.4 Registration Rights Agreement dated January 5, 2000, by and
between AppliedTheory Corporation, James G. Couch and any other
holders of registerable stock of CRL Network Services, Inc. who
may join the agreement. Incorporated by reference from the Current
Report on Form 8-K, SEC File No. 000-25759, filed by
AppliedTheory Corporation on January 20, 2000.
2.5 Tax Escrow Agreement dated January 5, 2000, by and among
AppliedTheory Corporation, AppliedTheory Reef Acquisition Corp.,
CRL Network Services, Inc. and United States Trust Company of
New York. Incorporated by reference from the Current
Report on Form 8-K, SEC File No. 000-25759, filed by
AppliedTheory Corporation on January 20, 2000.
2.6 Audited Financial Statements of AppliedTheory Corporation as of
December 31, 1998 and 1999 and for the three years ended December
31, 1999.
99.1 Press release issued by AppliedTheory Corporation on December 6,
1999. Incorporated by reference from the Current Report on Form
8-K, SEC File No. 000-25759, filed by AppliedTheory Corporation
on December 20, 1999.
99.2 Press release issued by AppliedTheory Corporation on January 6,
2000.
31
<PAGE> 32
Incorporated by reference from the Current Report on Form 8-K,
SEC File No. 000-25759, filed by AppliedTheory Corporation on
January 20, 2000.
32
<PAGE> 33
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 hereunto duly authorized.
AppliedTheory Corporation
Date: March 20, 2000 by: /s/ Richard Mandelbaum
-------------------------
Richard Mandelbaum
Chairman of the Board,
Chief Executive Officer, and
Director (Principal Executive Officer)
33
<PAGE> 34
EXHIBIT INDEX
Exhibit No. Description
2.1 Merger Agreement, dated December 3, 1999, by and among
AppliedTheory Corporation a Delaware corporation, AppliedTheory
Reef Acquisition Corp., Delaware Corporation, CRL Network
Services, Inc., a Delaware Corporation, and James G. Couch.
Incorporated by reference from the Current Report on Form 8-K, SEC
File No. 000-25754, filed by AppliedTheory Corporation on
December 20, 1999.
2.2 Escrow Agreement, dated January 5, 2000, by and among,
AppliedTheory Corporation, AppliedTheory Reef Acquisition Corp.,
United States Trust Company of New York, and James G. Couch.
Incorporated by reference from the Current Report on Form 8-K,
SEC File No. 000-25759, filed by AppliedTheory Corporation on
January 20, 2000.
2.3 Put Option Agreement dated January 5, 2000, by and between,
AppliedTheory Corporation, James G. Couch and other holders of
capital stock of CRL Network Services, Inc. Incorporated by
reference from the Current Report on Form 8-K, SEC File No.
000-25759, filed by AppliedTheory Corporation on January 20,
2000.
2.4 Registration Rights Agreement dated January 5, 2000, by and
between AppliedTheory Corporation, James G. Couch and any other
holders of registerable stock of CRL Network Services, Inc. who
may join the agreement. Incorporated by reference from the Current
Report on Form 8-K, SEC File No. 000-25759, filed by
AppliedTheory Corporation on January 20, 2000.
2.5 Tax Escrow Agreement dated January 5, 2000, by and among
AppliedTheory Corporation, AppliedTheory Reef Acquisition Corp.,
CRL Network Services, Inc. and United States Trust Company of
New York. Incorporated by reference from the Current
Report on Form 8-K, SEC File No. 000-25759, filed by
AppliedTheory Corporation on January 20, 2000.
2.6 Audited Financial Statements of AppliedTheory Corporation as of
December 31, 1998 and 1999 and for the three years ended December
31, 1999.
99.1 Press release issued by AppliedTheory Corporation on December 6,
1999. Incorporated by reference from the Current Report on Form
8-K, SEC File No. 000-25759, filed by AppliedTheory Corporation
on December 20, 1999.
99.2 Press release issued by AppliedTheory Corporation on January 6,
2000. Incorporated by reference from the Current
Report on Form 8-K, SEC File No. 000-25759, filed by
AppliedTheory Corporation on January 20, 2000.
34
<PAGE> 1
Exhibit 2.6
CONTENTS TO FINANCIAL STATEMENTS OF
APPLIEDTHEORY CORPORATION
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Certified Public Accountants F-2
Financial Statements
Balance Sheets - December 31, 1998 and 1999 F-3
Statements of Operations for the Years Ended
December 31, 1997, 1998 and 1999 F-4
Statement of Stockholders' Equity (Deficit) and Comprehensive Loss
for the Years Ended December 31, 1997, 1998 and 1999 F-5
Statements of Cash Flows for the Years Ended
December 31, 1997, 1998 and 1999 F-6 - F-7
Notes to Financial Statements F-8 - F-31
</TABLE>
F-1
<PAGE> 2
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
APPLIEDTHEORY CORPORATION
We have audited the balance sheets of AppliedTheory Corporation as of December
31, 1998 and 1999 and the related statements of operations, stockholders' equity
(deficit) and comprehensive loss and cash flows for each of the three years in
the period ended December 31, 1999. These financial statements are the
responsibility of AppliedTheory Corporation's management. Our responsibility is
to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of AppliedTheory Corporation as of
December 31, 1998 and 1999, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1999 in conformity
with accounting principles generally accepted in the United States.
/s/ GRANT THORNTON LLP
New York, New York
February 4, 2000
F-2
<PAGE> 3
AppliedTheory Corporation
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-----------------------------------
ASSETS 1998 1999
----------- ---------
(in thousands)
<S> <C> <C>
Current assets
Cash and cash equivalents $ 1,786 $ 14,834
Marketable securities 32,727
Accounts receivable, net of allowance of $157
and $231 in 1998 and 1999, respectively 3,584 6,714
Due from related parties 59
Prepaid expenses and other current assets 255 2,133
--------- --------
Total current assets 5,625 56,467
Property and equipment, net 4,203 13,881
Investment, at cost 5,000
Other assets 690 1,587
--------- --------
Total assets $ 10,518 $ 76,935
========= ========
LIABILITIES AND
STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities
Accounts payable $ 2,149 $ 5,025
Accrued payroll 582 2,012
Accrued expenses 2,473 4,794
Deferred revenue 1,849 2,476
Current portion of long-term debt and capital lease obligations 551 1,215
Preferred stock dividends payable 420
Due to related parties 850
--------- --------
Total current liabilities 8,874 15,522
Long-term debt and capital lease obligations 5,979 6,783
Borrowings from NYSERNet.net, Inc. 2,957
Other liabilities 215 421
Redeemable preferred stock - cumulative 14% dividend; $100 per share liquidation
value; 1,000,000 shares authorized; 15,000 shares issued
and outstanding in 1998 1,500
Stockholders' equity (deficit):
Common stock, $.01 par value; 90,000,000 shares authorized; issued and
outstanding, 15,039,488 voting and 54,848 nonvoting
shares in 1998 and 21,413,362 voting shares in 1999 151 214
Additional paid-in capital 6,581 84,052
Accumulated deficit (15,739) (29,806)
Accumulated other comprehensive loss (251)
--------- --------
Total stockholders' equity (deficit) (9,007) 54,209
--------- --------
Total liabilities and stockholders' equity (deficit) $ 10,518 $ 76,935
========= ========
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE> 4
AppliedTheory Corporation
STATEMENTS OF OPERATIONS
Year ended December 31,
<TABLE>
<CAPTION>
1997 1998 1999
------------ ------------ ------------
(in thousands, except per share and share amounts)
<S> <C> <C> <C>
Net revenues
Third-party customers $ 8,023 $ 14,236 $ 27,328
NYSERNet.org, Inc. customers and services 7,149 8,327 10,317
------------ ------------ ------------
Total net revenues 15,172 22,563 37,645
------------ ------------ ------------
Costs and expenses
Cost of revenues 10,796 13,316 24,988
Sales and marketing 3,706 6,400 14,124
General and administrative 4,283 6,349 10,180
Research and development 680 243 321
Depreciation and amortization 1,095 1,672 3,403
Other expenses 112 900
------------ ------------ ------------
Total costs and expenses 20,672 28,880 53,016
------------ ------------ ------------
Loss from operations (5,500) (6,317) (15,371)
Interest income (42) (1,938)
Interest expense 347 608 561
------------ ------------ ------------
NET LOSS (5,847) (6,883) (13,994)
Preferred stock dividends 210 210 73
------------ ------------ ------------
Net loss attributable to common stockholders $ (6,057) $ (7,093) $ (14,067)
============ ============ ============
Basic and diluted loss per common share $ (.62) $ (.56) $ (.72)
============ ============ ============
Shares used in computing basic and
diluted loss per share 9,756,248 12,665,940 19,491,711
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE> 5
AppliedTheory Corporation
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
AND COMPREHENSIVE LOSS
Years ended December 31, 1997, 1998, 1999
(in thousands, except share amounts)
<TABLE>
<CAPTION>
Common stock Nonvoting common stock
------------------------ -------------------------
Shares Amount Shares Amount
---------- ------ -------- ------
<S> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1997 9,750,000 $ 13
Issuance of common stock pursuant to
exercise of stock options 60,000
Preferred stock dividends
Net loss
---------- -----
Comprehensive loss
BALANCE, DECEMBER 31, 1997 9,810,000 13
Issuance of common stock, net of issuance costs of $81 1,725,000 2
Issuance of common stock pursuant to exercise of
stock options 3,504,488 5 54,848
Compensation expense related to stock option plan
Conversion of stock appreciation rights to nonstatutory
stock options
Effect of stock splits 130 $ 1
Preferred stock dividends
Net loss
---------- ----- -------- ----
Comprehensive loss
BALANCE, DECEMBER 31, 1998 15,039,488 150 54,848 1
Issuance of common stock, net of issuance costs
of $7,620 5,175,000 52
Issuance of common stock pursuant to exercise of
stock options 1,049,193 11 66,625
Issuance of common stock pursuant to Employee
Stock Purchase Plan 28,208
Compensation expense related to stock option plan
Conversion of nonvoting common stock to
voting common stock 121,473 1 (121,473) (1)
Preferred stock dividends
Unrealized loss on marketable securities
Net loss
---------- ----- ---------- ----
Comprehensive loss
BALANCE, DECEMBER 31, 1999 21,413,362 $214 $ -- $ --
========== ===== ========== ====
</TABLE>
<TABLE>
<CAPTION>
Accumu-
lated
other
Additional Accumu- compre- Compre-
paid-in lated hensive hensive
capital deficit loss Total loss
----------- ---------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1997 $ (2,589) $ (2,576)
Issuance of common stock pursuant to
exercise of stock options $ 8 8
Preferred stock dividends (210) (210)
Net loss (5,847) (5,847) $ (5,847)
----------- ---------- ---------- ----------
Comprehensive loss $ (5,847)
==========
BALANCE, DECEMBER 31, 1997 8 (8,646) (8,625)
Issuance of common stock, net of issuance costs of $81 4,983 4,985
Issuance of common stock pursuant to exercise of
stock options 264 269
Compensation expense related to stock option plan 117 117
Conversion of stock appreciation rights to nonstatutory
stock options 1,340 1,340
Effect of stock splits (131)
Preferred stock dividends (210) (210)
Net loss (6,883) (6,883) $ (6,883)
----------- ---------- ---------- ----------
Comprehensive loss $ (6,883)
==========
BALANCE, DECEMBER 31, 1998 6,581 (15,739) (9,007)
Issuance of common stock, net of issuance costs
of $7,620 75,180 75,232
Issuance of common stock pursuant to exercise of
stock options 616 627
Issuance of common stock pursuant to Employee
Stock Purchase Plan 304 304
Compensation expense related to stock option plan 1,371 1,371
Conversion of nonvoting common stock to
voting common stock
Preferred stock dividends (73) (73)
Unrealized loss on marketable securities $ (251) (251) $ (251)
Net loss (13,994) (13,994) (13,994)
----------- ---------- ------- ---------- ----------
Comprehensive loss $ (14,245)
==========
BALANCE, DECEMBER 31, 1999 $84,052 $(29,806) $ (251) $ 54,209
=========== ========== ======= ==========
</TABLE>
The accompanying notes are an integral part of this statement.
F-5
<PAGE> 6
AppliedTheory Corporation
STATEMENTS OF CASH FLOWS
Year ended December 31,
<TABLE>
<CAPTION>
1997 1998 1999
----------- ------------ ----------
(in thousands)
<S> <C> <C> <C>
Cash flows from operating activities
Net loss $(5,847) $(6,883) $(13,994)
Adjustments to reconcile net loss to net cash used in
operating activities
Depreciation and amortization 1,095 1,672 3,403
Provision for bad debts 119 60 90
Deferred payment of interest expense to NYSERNet.net, Inc. 59 211 (270)
Loss on sale of property and equipment 111 21 3
Realized loss on sale of marketable securities 26
Loss from assets not usable in operations 900
Conversion of stock appreciation rights to nonstatutory
stock options 1,340
Compensation expense related to stock option plans 117 1,371
Changes in assets and liabilities
Accounts receivable 66 (2,433) (3,220)
Due to (from) related parties (1,229) 450 (909)
Prepaid expenses, other current assets and other assets (61) (68) (3,074)
Accounts payable 577 142 2,876
Accrued payroll 229 214 1,430
Accrued expenses and other liabilities (373) 612 2,527
Deferred revenue 69 941 627
-------- ------- ---------
Net cash used in operating activities (5,185) (2,704) (9,114)
-------- ------- ---------
Cash flows from investing activities
Purchases of property and equipment (1,270) (2,480) (11,643)
Issuance of notes receivable (309)
Purchase of marketable securities (80,724)
Proceeds from sales of marketable securities 47,720
Investment in certain businesses (5,000)
Payments received on notes receivable 2 299
Proceeds from sale of property and equipment 4 8 8
-------- ------- ---------
Net cash used in investing activities (1,266) (2,779) (49,340)
-------- ------- ---------
Cash flows from financing activities
Issuance of common stock, net of issuance costs 8 5,254 76,163
Payment of deferred stock dividends (493)
Redemption of preferred stock (1,500)
Borrowings from NYSERNet.net, Inc. 2,385 301 800
Repayment of borrowings from NYSERNet.net, Inc. (3,487)
Proceeds from line of credit borrowings, net 4,144 1,286 70
Principal payments on capital leases (124) (350) (1,072)
Proceeds received from long-term debt 1,025 1,021
Security deposit on equipment financing (382)
-------- ------- ---------
Net cash provided by financing activities 6,413 7,134 71,502
-------- ------- ---------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS (38) 1,651 13,048
Cash and cash equivalents, beginning of year 173 135 1,786
-------- ------- ---------
Cash and cash equivalents, end of year $ 135 $ 1,786 $ 14,834
======== ======= =========
</TABLE>
F-6
<PAGE> 7
AppliedTheory Corporation
STATEMENTS OF CASH FLOWS (CONTINUED)
Year ended December 31,
<TABLE>
<CAPTION>
1997 1998 1999
------------ ------------ -----------
(in thousands)
<S> <C> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the period for
Interest $ 288 $ 396 $ 831
Noncash investing and financing transactions:
Fixed asset acquisitions financed through capitalized lease
obligations 551 1,448
Dividends payable 210 210
Advances from NYSERNet.org, Inc. to purchase fixed assets 2,129
Issuance of preferred stock in settlement of advances
due NYSERNet.net, Inc. 1,500
</TABLE>
The accompanying notes are an integral part of these statements.
F-7
<PAGE> 8
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS
For the years ended December 31, 1997, 1998 and 1999
NOTE A - NATURE OF OPERATIONS AND BASIS OF PRESENTATION
AppliedTheory Corporation (formerly AppliedTheory Communications, Inc.)
was incorporated in the State of New York in November 1995 as a
wholly-owned subsidiary of NYSERNet.net, Inc. ("NET"), a not-for-profit
corporation. For purposes of these financial statements and notes thereto,
AppliedTheory Corporation and AppliedTheory Communications, Inc. are used
interchangeably and referred to as the "Company" (Note K). 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, NET's direct
sale of 4,875,000 shares it owned in AppliedTheory) and the effect of the
Company's initial public offering ("IPO") in April 1999, NET's ownership
percentage in AppliedTheory declined to less than 50% (Note K).
In conjunction with its IPO, AppliedTheory Communications, Inc.
reorganized as a Delaware corporation. On January 28, 1999, the Company
established its wholly-owned subsidiary, AppliedTheory Corporation. The
Company merged into AppliedTheory Corporation, which is the surviving
entity.
The Company is a provider of Internet solutions for businesses with
critical Internet operations. The Company's solutions include: (i)
Internet connectivity, (ii) Internet integration and enterprise portal
development and (iii) Web hosting.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of the Company's significant accounting
policies.
1. Revenue Recognition
Revenue from Internet connectivity and Web hosting services is
recognized ratably over the period of the agreement as services are
provided. Internet connectivity agreements range from one to five
years and contain automatic renewal clauses unless either party
cancels the agreement. Web hosting agreements are typically for
periods of one year and automatically renew unless either party
cancels the agreement.
Revenue from Internet integration and enterprise portal development
represents professional services that are recognized principally on
a time-and-materials basis as the services are performed.
F-8
<PAGE> 9
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE B (CONTINUED)
2. Deferred Revenue
Deferred revenue consists principally of billings in advance of
services not yet provided.
3. Research and Development
The Company charges all costs incurred to establish the
technological feasibility of a product or product enhancement to
research and development expense.
4. Advertising
Advertising costs, charged to operations when incurred, were
approximately $435,000, $1,363,000 and $1,337,000 for the years
ended December 31, 1997, 1998 and 1999, respectively.
5. Income Taxes
The Company records income taxes using the asset and liability
method, which requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of temporary
differences between the financial reporting basis and tax basis of
assets and liabilities. A valuation allowance is recognized to the
extent a portion or all of a deferred tax asset may not be
realizable.
6. Loss Per Share
Basic loss per share is computed using the weighted average number
of shares of common stock outstanding during the period. Diluted
loss per share is computed using the weighted average number of
shares of common stock, adjusted for the dilutive effect of
potential common shares issued or issuable pursuant to stock options
and stock appreciation rights. Potential common shares issued are
calculated using the treasury stock method. All potential common
shares have been excluded from the computation of diluted loss per
share as their effect would be antidilutive and, accordingly, there
is no reconciliation of basic and diluted loss per share for each of
the periods presented. Potential common shares that were excluded
from the computation of diluted loss per share consisted of stock
options and stock appreciation rights outstanding of 5,837,708,
3,998,333 and 3,348,837 for the years ended December 31, 1997, 1998
and 1999, respectively.
F-9
<PAGE> 10
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE B (CONTINUED)
7. Cash and Cash Equivalents
The Company considers all highly liquid investments, which
principally consist of money market funds and time deposits, with an
original maturity of three months or less at the date of acquisition
to be cash equivalents.
8. Marketable Securities
Investments classified as marketable securities represent fixed
maturity instruments (corporate bonds and notes) which are reported
at their fair values. Unrealized gains and losses on these
securities, net of related tax effects, are included in
stockholders' equity as a component of accumulated other
comprehensive loss. The Company considers all marketable securities
as available for sale. Investment income is recognized when earned.
Realized gains and losses on sales and maturities of investments are
determined on a specific identification basis. The amortization of
premiums and accretion of discounts are computed on the
straight-line basis. Fair values are based on quoted market prices.
9. Property and Equipment
Property, equipment and leasehold improvements are recorded at cost.
Depreciation is recorded on a straight-line basis over the estimated
useful lives of the assets, which range from three to five years.
Leasehold improvements are amortized over the term of the lease or
the service lives of the improvements, whichever is shorter.
Leased property meeting certain criteria is capitalized and the
present value of the related lease payments is recorded as a
liability. Depreciation of capitalized leased assets is recorded on
the straight-line method over the shorter of the term of the lease
or the estimated useful life.
10. Impairment of Long-Lived Assets and Long-Lived Assets To Be Disposed
Of
The Company evaluates its long-lived assets and certain identifiable
intangibles for impairment whenever events or changes in
circumstances indicate that the carrying amount of such assets or
intangibles may not be recoverable. Recoverability of assets to be
held and used is measured by a comparison of the carrying amount of
an asset to future net cash flows expected to be generated by the
asset. If such an asset is considered to be impaired, the impairment
to be recognized is measured by the amount by which the carrying
amount of the asset exceeds the fair value of the assets. Assets to
be disposed of are reported at the lower of the carrying amount or
fair value less costs to sell.
F-10
<PAGE> 11
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE B (CONTINUED)
11. Lease and Contractual Commitments
The Company recognizes expense under operating leases and
contractual agreements on a straight-line basis over the terms of
the lease or agreement. The difference between the amounts computed
on a straight-line basis and the amounts paid or payable is included
in accrued expenses and other liabilities.
12. Concentration of Credit Risk
Financial instruments that potentially subject the Company to
concentration of credit risk consist primarily of cash, cash
equivalents, accounts receivable and marketable securities.
Concentrations of credit risk with respect to trade receivables are
limited due to the large number of customers comprising the
Company's customer base. However, these customers are concentrated
in New York State. The Company's revenues from ORG customers and
services to ORG accounted for approximately 47%, 37% and 27% of
total net revenues for the years ended December 31, 1997, 1998 and
1999, respectively (Note L). One third-party customer accounted for
16%, 28% and 39% of total net revenues for the years ended December
31, 1997, 1998 and 1999, respectively. Accounts receivable at
December 31, 1999 include approximately $3,584,000 from this third
party customer.
13. Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, accounts
receivable, marketable securities, accounts payable, accrued
expenses, long-term debt and capital lease obligations approximate
fair value because of the short maturity of these items.
The carrying amount of the debt issued pursuant to the Company's
bank credit agreement approximates fair value because the interest
rates change with market interest rates.
14. Segment and Related Information
The Company operates as one business segment, as a provider of
Internet solutions, and follows the requirements of Statement of
Financial Accounting Standards ("SFAS") No. 131, "Disclosures About
Segments of an Enterprise and Related Information."
F-11
<PAGE> 12
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE B (CONTINUED)
The Company had revenues from its major service offerings as
follows:
<TABLE>
<CAPTION>
1997 1998 1999
-------------- -------------- ---------
(in thousands)
<S> <C> <C> <C>
Net revenues
Internet connectivity $12,249 $15,077 $19,573
Internet integration and
enterprise portal
development 1,915 5,940 14,871
Web hosting 1,008 1,546 3,201
------ ------ ------
$15,172 $22,563 $37,645
====== ====== ======
</TABLE>
Due to the way the Company manages its operations, it does not
account for or report operating expenses by product/service
offering.
15. Use of Estimates
In preparing the financial statements in conformity with generally
accepted accounting principles, management is required to make
estimates and assumptions that affect the reported amounts of assets
and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results may differ from those estimates.
16. Effects of Recently Issued Accounting Pronouncements
In September 1998, the Financial Accounting Standards Board issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," which requires entities to recognize all derivatives in
their financial statements as either assets or liabilities measured
at fair value. SFAS No. 133 also specifies new methods of accounting
for hedging transactions, prescribes the items and transactions that
may be hedged and specifies detailed criteria to be met to qualify
for hedge accounting. SFAS No. 133, as amended by SFAS No. 137, is
effective for fiscal years beginning after September 15, 2000. The
Company currently does not use derivative instruments as defined by
SFAS No. 133. If the Company continues to not use these derivative
instruments by the effective date of SFAS No. 133, the adoption of
this statement will have no effect on the Company's results of
operations or financial position.
F-12
<PAGE> 13
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE B (CONTINUED)
17. Reclassifications
Certain prior period amounts have been reclassified to conform to
the current year presentation.
NOTE C - COMPREHENSIVE LOSS
Comprehensive loss for the years ended December 31, 1997, 1998 and 1999,
was as follows:
<TABLE>
<CAPTION>
1997 1998 1999
---------- ----------- ---------
(in thousands)
<S> <C> <C> <C>
Net loss $(5,847) $(6,883) $(13,994)
Other comprehensive income (loss):
Unrealized loss on marketable
securities, net of income
tax effect of $0 (251)
------- ------- --------
Comprehensive loss $(5,847) $(6,883) $(14,245)
======= ======= ========
</TABLE>
NOTE D - MARKETABLE SECURITIES
Marketable securities at December 31, 1999 consist of the following:
<TABLE>
<CAPTION>
Amortized Fair Unrealized
cost value loss
--------- ----- ----------
(in thousands)
<S> <C> <C> <C>
Available-for-sale securities
(carried on the balance
sheet at fair value)
Debt securities with maturities:
Less than one year $31,096 $30,875 $(221)
Due in 1 - 2 years 1,882 1,852 (30)
------ ------ ----
$32,978 $32,727 $(251)
====== ====== ====
</TABLE>
F-13
<PAGE> 14
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE E - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
1998 1999
-------- --------
(in thousands)
<S> <C> <C>
Computer equipment $ 5,468 $ 14,168
Office furniture and equipment 440 1,080
Equipment under capital leases 551 2,000
Leasehold improvements 353 2,634
-------- --------
6,812 19,882
Less accumulated depreciation
and amortization (2,609) (6,001)
-------- --------
$ 4,203 $ 13,881
======== ========
</TABLE>
The accumulated depreciation associated with equipment under capital
leases was $113,082 and $675,847 in 1998 and 1999, respectively.
On December 21, 1998, the Company adopted a plan, which was approved by
the 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 the ability to generate sufficient revenues. In connection with
the plan of abandonment, the Company has 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 - other" in 1998 and 1999, relating to equipment
leases and a facility operating lease (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" (Note
H). 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 in which they are
incurred. The plan calls for the Web hosting customer base served from
this facility and the related revenues, which are not significant, to be
transitioned to another facility. As of December 31, 1999, no amounts have
been charged against this liability. The closure date has been delayed
pending completion of additional data centers.
F-14
<PAGE> 15
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE F - INVESTMENT IN PLANNING TECHNOLOGIES, INC.
On June 22, 1999, the Company entered into a stock purchase agreement (the
"Stock Purchase Agreement") with Planning Technologies, Inc. ("PTI"), a
Georgia corporation, which provides consulting and network engineering
services, along with Grumman Hill Investments III, L.P., ("Grumman Hill")
(Note K) and certain shareholders of PTI. Pursuant to the Stock Purchase
Agreement, the Company acquired approximately 10% of the capital stock of
PTI on a fully diluted basis, as defined in the Stock Purchase Agreement,
for $5 million. The Company's 10% ownership interest in PTI is represented
by 2,976,190 shares of PTI's Convertible Preferred Stock, which represent
approximately 50% of PTI's outstanding Convertible Preferred Stock. The
investment is being accounted for under the cost method.
The Stock Purchase Agreement provides a definition of service revenues for
PTI for the year ended December 31, 1999. In the event that PTI's service
revenues for that period are below thresholds which are described in the
Stock Purchase Agreement, the Company will receive additional shares of
PTI Convertible Preferred Stock representing up to 5% of the fully diluted
capital stock of PTI.
As a result of its investment in PTI, so long as the Company continues to
hold at least 25% of the total outstanding Convertible Preferred Stock of
PTI, the Company will be entitled to designate and elect one director out
of a total of six seats on the Board of Directors. Pursuant to the terms
of its investment, during the period beginning June 30, 2000 and ending
December 31, 2000, the Company will have the option to purchase all the
outstanding capital stock of PTI at a price, which at that time is
determined to be fair market value.
During 1999, the Company paid PTI approximately $26,000 in network
operation related consulting fees.
F-15
<PAGE> 16
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE G - LONG-TERM DEBT, BORROWINGS FROM NET
AND CAPITAL LEASE OBLIGATIONS
Long-term debt, borrowings from NET and capital lease obligations consist
of the following:
<TABLE>
<CAPTION>
December 31,
----------------------------------
1998 1999
------- ------
(in thousands)
<S> <C> <C>
Line of credit $5,430 $ 5,500
Borrowings from NYSERNet.net, Inc. 2,957
Equipment financing 897 1,408
Capital lease obligations (net interest of $23,400
and $78,200 in 1998 and 1999, respectively) 203 1,090
------ ------
9,487 7,998
Less current portion (551) (1,215)
------ ------
$8,936 $6,783
===== =====
</TABLE>
Line of Credit
On January 20, 1998, the Company entered into a credit agreement with a
bank for an aggregate amount of $7,500,000, which expires on January 19,
2001. The agreement provides for the payment on January 19, 2001 of the
unpaid principal balance of all amounts advanced on and outstanding at
that time. Interest is charged and payable on a monthly basis as
determined by the Company, either on a LIBOR plus 50 basis points or a
prime rate basis less 200 basis points. The credit facility is
collateralized by substantially all assets of the Company and by a maximum
of $5,500,000 of cash and cash equivalents, government securities,
corporate securities or corporate equities pledged by NET.
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.
At December 31, 1999, the Company had $5,500,000, outstanding under the
line of credit and, as a result of certain restrictions, has no additional
availability at December 31, 1999. The average interest rate on
outstanding borrowings was 6.1% and 5.7% at December 31, 1998 and 1999,
respectively.
F-16
<PAGE> 17
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE G (CONTINUED)
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 (Note J), for working capital requirements. Interest on the
loans accrues at the prime rate (7.75% and 8.5% at December 31, 1998 and
1999, respectively) 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 outstanding under this facility as
of December 31, 1999. Amounts charged to interest expense on the
borrowings under this related party debt facility amounted to $58,915,
$211,323 and $69,414 for the years ended December 31, 1997, 1998 and 1999,
respectively.
Equipment Financing
During 1998 and 1999, the Company entered into equipment financing
agreements with a secured lender. Borrowings under these agreements are
repayable in thirty-six (36) varying monthly installments of approximately
$33,000 with interest at a fixed rate of 10.3% through September 2002. In
connection with the equipment financing, the Company was required to place
on deposit $382,000 as additional collateral. The security deposit, which
is included in "Other assets" at December 31, 1998 and 1999, earns
interest at a rate of 5.0% per annum and one-half is refundable on
September 1, 2001, and beginning May 1, 2002, the monthly payments will be
deducted from the outstanding security deposit.
Capital Lease Obligations
The Company leases certain equipment under agreements accounted for as
capital leases. The obligations for the equipment require the Company to
make monthly payments through September 2001, with implicit interest rates
ranging from 10.0% to 16.6%. In connection with the financing in 1999, the
Company was required to deliver a security deposit by placing on deposit
$782,000 as additional collateral. The security deposit was fully refunded
to the Company in June 1999.
F-17
<PAGE> 18
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE G (CONTINUED)
The following is a summary of the aggregate annual maturities of long-term
debt, borrowings from NET and capital lease obligations as of December 31,
1999:
<TABLE>
<CAPTION>
Year ending December 31,
------------------------
(in thousands)
<S> <C> <C>
2000 $1,215
2001 6,471
2002 312
------
$7,998
------
</TABLE>
NOTE H - ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued expenses consisted of the following:
<TABLE>
<CAPTION>
1998 1999
----- -----
(in thousands)
<S> <C> <C>
Network costs $1,020 $2,511
Lease and contractual commitments 185 1,035
Other 1,268 1,248
----- -----
$2,473 $4,794
===== =====
</TABLE>
OTHER LIABILITIES CONSISTED OF THE FOLLOWING:
<TABLE>
1998 1999
----- -----
<S> <C> <C>
Lease and contractual commitments $215 $421
===== =====
</TABLE>
F-18
<PAGE> 19
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE I - COMMITMENTS AND CONTINGENCIES
1. Telecommunications
The Company is committed to minimum annual and cumulative purchase
commitments to two telecommunications vendors for various products
and services as follows: (1) an aggregate minimum cumulative
purchase commitment, beginning in November 1999, over the three-year
term of the agreement of $9 million, with minimum annual commitments
of $1,000,000 in 2000, 2001 and 2002 and (2) an aggregate minimum
cumulative purchase commitment, beginning in December 1999, over the
three-year term of the agreement of $25 million, as defined, with
minimum annual commitments of $4,000,000 in 2000, $8,000,000 in 2001
and $10,000,000 in 2002.
In 1999, the Company satisfied the purchase commitment under a
previous arrangement with one of the aforementioned
telecommunications vendors.
The Company has also entered into contracts expiring at various
times through the year 2002 with various communications vendors to
provide services consisting of aggregating, routing and transporting
data communications over the Company's network. Such contracts
contain no minimum purchase commitments and are cancelable by either
party.
The Company had purchase commitments at December 31, 1999 totaling
approximately $5,000,000 for various network equipment.
2. Facilities and Equipment Leases
The Company leases office facilities, data centers and certain
equipment with expiration dates through November 2009. Certain
operating leases for the office facilities include rent holidays and
scheduled base rent increases over the term of the lease. The total
amount of base rent is being charged to expense by the straight-line
method over the terms of the lease.
F-19
<PAGE> 20
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE I (CONTINUED)
Future minimum lease payments under noncancelable operating leases
as of December 31, 1999 are as follows:
<TABLE>
<CAPTION>
Year ending December 31,
------------------------
(in thousands)
<S> <C>
2000 $ 2,400
2001 2,336
2002 2,164
2003 2,209
2004 2,257
Thereafter 7,917
-------
$19,283
=======
</TABLE>
Total rent expense for operating leases amounted to $862,000,
$898,000 and $1,736,000 for the years ended December 31, 1997, 1998
and 1999, respectively.
3. Employment Agreements
The Board of Directors has provided for severance payments upon
termination of employment or change in control, as defined, for
certain executive officers of the Company. Under this provision, the
maximum aggregate commitment at December 31, 1999, excluding
benefits, was approximately $1,276,000.
4. Litigation Matters
The Company is involved in various litigation, which arises through
the normal course of business. Management believes that the
resolution of these matters will not have a material adverse effect
on the Company's financial position or results of operations.
F-20
<PAGE> 21
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE J - REDEEMABLE PREFERRED STOCK
Effective January 1, 1997, the Company issued 15,000 shares of redeemable
preferred stock at $100 per share liquidation value to NET in
satisfaction of the $1,500,000 advance (Note L(1)). Holders of shares of
the redeemable preferred stock are entitled to receive payment for
cumulative dividends at the annual rate of $14.00 per share (14%)
beginning January 1, 1999, based upon a liquidation value of $100 per
share, payable quarterly. At December 31, 1998, the amount of dividends
payable on the 14% redeemable preferred stock was $420,000. On May 5,
1999, the Company paid approximately $1,993,000 to fully redeem all
outstanding preferred stock and accrued dividends with a portion of the
proceeds from the Company's IPO.
NOTE K - STOCKHOLDERS' EQUITY (DEFICIT)
AND STOCK OPTION PLANS
Capitalization
On January 29, 1999, the Company's Board of Directors authorized an
increase in the number of common stock and preferred stock authorized to
90,000,000 and 1,000,000, respectively. Further all non-voting common
shares are converted into voting common shares.
On May 5, 1999, the Company completed its IPO. Through the IPO, 5,175,000
shares of the Company's common stock were issued for net proceeds of
approximately $75.2 million after deduction of the underwriting discount,
commissions and other offering costs of approximately $7.6 million.
Private Placement
On August 4, 1998, the Company completed a private placement of 1,725,000
shares of its voting common stock for proceeds of $4,985,719, net of
issuance costs of $80,951. In connection with the private placement, NET
sold a portion of its holdings in the Company. The stock purchase
agreement also gives the investors the right of first refusal to purchase
any equity securities of the Company at the same price, and on the same
terms and conditions offered until such time that any class of the
Company's equity securities is registered under the Securities Act. In
addition, NET granted an irrevocable proxy to vote and to execute and
deliver written consents or otherwise act with respect to 1,890,000 shares
of its current holdings of 4,875,000 shares to the investors of the
private placement. The proxy was granted to allow the investors to have
voting
F-21
<PAGE> 22
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE K (CONTINUED)
power over a majority of the shares then outstanding which were entitled to
vote at stockholders' meetings. The granting of the proxy was a condition
to Broadwing Communication Services, Inc.'s ("Broadwing"), formerly IXC
Internet Services, Inc., and Grumman Hill's agreement to purchase shares
from NET and the Company. The number of shares covered by the proxy will
reduce by that number of shares of the Company's common stock which the
investors acquire from the Company or from stockholders under option
agreements between such stockholders and the investors during the period
between September 4, 1999 and October 28, 2000. As of December 31, 1999,
the number of shares covered by the proxy is 389,723.
Stock Splits
On October 14, 1998 and April 12, 1999, the Board of Directors approved a
five-for-one stock split and a one and one half-for-one stock split,
respectively. All share and per share amounts in the accompanying
financial statements have been retroactively restated to give effect to
the stock split. The par value was maintained at $.01 per share.
Employee Stock Purchase Plan
In March 1999, the Board of Directors adopted an Employee Stock Purchase
Plan, which permits eligible employees to purchase shares of the Company's
common stock at a discounted price of 85% of the market value of the
shares at the date of purchase, as defined. A total of 2,250,000 shares of
the Company's common stock may be purchased under the employee plan.
During 1999, employees purchased 28,208 shares, at $10.78 per share. Total
proceeds received by the Company were approximately $304,000. The Plan
conforms with Section 423 of the Internal Revenue Code of 1986 and is
considered to be non-compensatory for financial reporting purposes.
Stock Option Plans
The Company's 1996 Incentive Stock Option Plan had authorized the grant of
options to key employees, directors, advisors and consultants for up to
12,000,000 shares of the Company's common stock with an exercise price of
not less than the fair market value of the shares at the date of grant.
All options granted have ten-year terms and vest over one to five years
following the date of grant. The Board of Directors may exercise the right
to accelerate the vesting provisions of the option grants upon the
occurrence of certain conditions, as defined. This plan was frozen on
January 1, 1999 and accordingly no options were granted under the plan in
1999.
F-22
<PAGE> 23
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE K (CONTINUED)
On March 12, 1999, the Board of Directors approved its 1999 Stock Option
Plan. The Plan has authorized the grant of options to employees and
directors for up to 2,400,000 shares of the Company's common stock with an
exercise price of not less than the fair market value of the shares at the
date of grant. This plan allows for the granting of incentive stock
options qualified under Section 422 of the Internal Revenue Code and also
non-qualified options. All options granted have ten-year terms and vest
immediately or over a period of one to five years following the date of
grant. The Board of Directors may exercise the right to accelerate the
vesting provisions of the option grants upon the occurrence of certain
conditions, as defined.
As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation,"
the Company has elected to follow Accounting Principles Board Opinion No.
25 (APB 25), "Accounting for Stock Issued to Employees," method of
determining compensation cost. Under APB 25, if the exercise price of the
Company's employee stock options equals or exceeds the market price of the
underlying stock on the date of grant, no compensation expense is
recognized.
Pro forma information regarding net income is required by SFAS No. 123, and
has been determined as if the Company had accounted for its employee stock
options granted and shares purchased through the employee stock purchase
plan under the fair value method of that Statement. The fair value for
these options and shares was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions:
<TABLE>
<CAPTION>
December 31,
----------------------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Risk-free interest rate 5.40% 4.80% 5.70%
Volatility factor .001 .001 .80
Expected life of options 5 years 5 years 4 years
</TABLE>
F-23
<PAGE> 24
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE K (CONTINUED)
Had the Company determined compensation cost in accordance with SFAS
No. 123, the Company's pro forma net loss attributable to common
stockholders and pro forma basic and diluted loss per common share would
have been as follows:
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------------------
1997 1998 1999
---------- ---------- ---------
(in thousands, except per share amounts)
<S> <C> <C> <C>
Pro forma net loss attributable
to common stockholders $(6,070) $(7,288) $(15,098)
Pro forma basic and diluted
loss per common share $(.62) $(.58) $(.77)
</TABLE>
A summary of the Company's stock option activity and related information
under the plans for the years ended December 31, 1997, 1998 and 1999,
follows:
<TABLE>
<CAPTION>
Weighted
Price average
Options per share exercise price
--------- --------------- ---------------
<S> <C> <C> <C>
Balance, January 1, 1997 4,907,250 $.056 - $.133 $ .072
Granted 879,833 .40 .40
Exercised (60,000) .133 .133
Forfeited (16,875) .263 .263
------------ ---------------- ------
Balance, December 31, 1997 5,710,208 $.056 - $.40 $ .121
Granted 2,211,773 .133 - 2.93 2.736
Exercised (3,559,335) .056 - .40 .076
Forfeited (364,313) .056 - .40 .292
---------- ---------------- ------
Balance, December 31, 1998 3,998,333 $.056 - $2.93 $1.59
Granted 674,850 11.18 - 20.38 14.68
Exercised (1,115,818) .056 - 2.93 .57
Forfeited (208,528) .056 - 16.00 2.65
---------- ----------------
Balance, December 31, 1999 3,348,837 $.056 - $20.38 $4.50
========== ===============
Exercisable, December 31, 1997 1,378,470 $.056 - $.40 $.103
========== =============== ====
Exercisable, December 31, 1998 1,760,858 $.056 - $2.93 $.473
========== =============== ====
</TABLE>
F-24
<PAGE> 25
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE K (CONTINUED)
The weighted average fair values of options granted were $.00, $3.02 and
$9.24 for the years ended December 31, 1997, 1998 and 1999, respectively.
Certain options were granted in 1998 and 1999 at exercise prices below the
fair market value of the Company's stock, resulting in aggregate total
compensation of $5,059,000, of which a non-cash compensation expense of
$117,000 and $1,371,000 was recorded for the years ended December 31, 1998
and 1999, respectively, with the remaining charge of $3,571,000 at
December 31, 1999 to be recognized over the remaining vesting period of
approximately three years.
Information, at date of issuance, regarding stock option grants during the
year ended December 31, 1999 is summarized as follows:
<TABLE>
<CAPTION>
Weighted- Weighted-
average average
exercise fair
Shares price value
--------- ----------- ------------
<S> <C> <C> <C>
Exercise price exceeds market price 135,900 $16.00 $8.90
Exercise price equals market price 278,450 14.89 9.28
Exercise price is less than market price 260,500 13.70 9.36
</TABLE>
F-25
<PAGE> 26
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE K (CONTINUED)
The following table summarizes information about the shares outstanding
and exercisable for options at December 31, 1999:
<TABLE>
<CAPTION>
Outstanding Exercisable
------------------------------ --------------------------
Weighted
average Weighted Weighted
Range of remaining average average
exercise Number contractual life exercise Number exercise
prices outstanding in years price exercisable price
---------------- ----------- ---------------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$.056 - .056 77,622 7.0 $ .056 15,390 $ .056
.13 - .13 585,000 7.0 .13 585,000 .13
.40 - .40 280,585 7.5 .40 67,939 .40
2.93 - 2.93 1,738,030 8.9 2.93 595,487 2.93
11.19 - 16.00 612,350 9.7 14.20 6,250 16.00
17.50 - 20.38 55,250 9.8 19.60
----------- ---------
$.056 - 20.38 3,348,837 8.5 4.50 1,270,066 $1.54
========= =========
</TABLE>
Common Stock Reserved
At December 31, 1999, the Company reserved for issuance 7,295,779 shares
of its common stock as follows: (a) 5,073,987 shares pursuant to the
Company's stock option plans and (b) 2,221,792 shares issuable under the
Employee Stock Purchase Plan.
Stock Appreciation Rights
During 1997, the Board of Directors authorized the issuance of 127,500
Stock Appreciation Rights ("SARs") to certain executives at an exercise
price varying from $.133 to $.40. The SARs vest ratably over a four-year
period or upon occurrence of certain events. At the option of the Company,
the SARs can be converted into nonstatutory stock options at their
exercise price. As the Company determined that the exercise price exceeded
the fair value of the underlying stock as of December 31, 1997, no
compensation expense was recorded for the year then ended. The Company
recognized $1,340,000 of compensation expense relating to SARs for the
year ended December 31, 1998. In December 1998, pursuant to the original
terms of the SARs, the Company converted the SARs into nonstatutory stock
options, with the same terms and conditions as the SARs.
F-26
<PAGE> 27
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE L - RELATED PARTY TRANSACTIONS
1. Transactions With NET and ORG
The Company has entered into a resale agreement with ORG to serve as
ORG's sole source provider for Internet system and network management
solutions to ORG's customer base under contractual arrangements. ORG's
customers consist of (i) unrelated customers for which ORG serves as a
conduit to the sales transactions between the Company and these
customers and (ii) member institutions of ORG for which ORG provides
pricing terms below those charged by the Company to ORG. In addition,
the Company provides services to ORG principally related to network
development. The Company's revenues from ORG's customer base and
services to ORG for the following periods are:
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------------------------------
1997 1998 1999
----------- ----------- ---------
(in thousands)
<S> <C> <C> <C>
Unrelated customers $3,705 $3,052 $ 3,000
Member institutions 2,891 4,477 4,885
Services to ORG 553 798 2,432
----- ----- ------
$7,149 $8,327 $10,317
===== ===== ======
</TABLE>
The excess of the Company's revenues over amounts charged by ORG to
its member institutions was approximately $1,490,000, $2,814,000 and
$3,037,000 for the years ended December 31, 1997, 1998 and 1999,
respectively. Such revenues recognized by the Company from ORG are
based on standard pricing terms for similar services offered to
unrelated parties.
The Company has also entered into a resource sharing agreement with
both NET and ORG. During the years ended December 31, 1997, 1998 and
1999, the Company charged NET approximately $91,500, $100,000 and
$100,000 and ORG approximately $210,000, $300,000 and $300,000,
respectively, in management fees.
During the year ended December 31, 1997, the Company purchased from
ORG fixed assets previously leased from ORG with a book value of
$2,129,000. In addition, the Company issued 15,000 shares of $100 per
share liquidation value preferred stock in settlement of the advances
due to NET (Note J).
F-27
<PAGE> 28
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE L (CONTINUED)
2. Other
In 1998, two officers/stockholders of the Company borrowed a total of
$294,000 under term note agreements. The total principal amount plus
accrued interest was due in 2001. Interest was being accrued at a rate
of 5.56%. Upon demand by the Company, the officers/stockholders were
required to pledge common stock of the Company as collateral on these
borrowings. These term notes and accrued interest were repaid in full
during 1999.
In December 1998, the Board authorized the Company to make available a
$2.5 million credit line, effective January 1, 1999, to its
Chairman/CEO to be used exclusively for purchasing the Company's
common stock, under certain circumstances. In the event any borrowings
are drawn against this credit line, the Board of Directors will
establish payment terms, interest rates and collateral provisions.
This line of credit agreement terminated upon consummation of the
initial public offering transaction described in Note K.
3. Consulting and Service Agreements
In October 1996, the Company entered into a consulting agreement with
a director/stockholder, which agreement expires in October 2000. The
agreement, which is automatically renewable annually after the initial
term, is cancelable by either party with notice, as defined. Under
this agreement, the director/stockholder receives $5,000 per month in
consulting fees. In addition, the director/stockholder received
750,000 stock options in October 1996 with an exercise price of $.13
per share, of which 187,500 options vested on October 1, 1997, with
the balance vesting upon occurrence of certain events. The
compensation charge pertaining to the stock options was nominal based
on the fair value of the common stock at the date of grant. These
stock options became fully exercisable in 1998 as a result of the
August 4, 1998 private placement transaction described in Note K. The
Company incurred consulting fees of $60,000 in each of the years ended
December 31, 1997, 1998 and 1999.
During the years ended December 31, 1998 and 1999, the Company
incurred $25,000 and $90,000, respectively, in consulting fees to one
of its principal stockholders.
During 1999, the Company and Broadwing, a principal stockholder,
signed a Joint Marketing and Services Agreement. Under the agreement,
each party can resell the services of the other party. During 1999,
the Company purchased network access services under contract from
Broadwing totaling approximately $840,000.
F-28
<PAGE> 29
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE M - INCOME TAXES
The Company generated losses for income tax purposes of approximately
$5,526,000, $4,800,000 and $12,078,000 for the years ended December 31,
1997, 1998 and 1999, respectively.
Significant components of the Company's deferred tax assets are as follows:
<TABLE>
<CAPTION>
Year ended December 31,
------------------------------------------------------
1997 1998 1999
----------- -------------- ------------
(in thousands)
<S> <C> <C> <C>
Expenses not currently deductible $ 375 $ 766 $ 515
Net operating loss carryforwards 2,711 4,607 9,477
Amortization of intangible and fixed assets 504 471 556
Deferred compensation 447
--------- --------- ---------
Total deferred tax assets 3,590 5,844 10,995
Valuation allowance (3,590) (5,844) (10,995)
------ ------ -------
$ - $ - $ -
========== ========== ===========
</TABLE>
A reconciliation between the Company's effective tax rate and the Federal
income tax rate is as follows:
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------------------------
1997 1998 1999
----------- -------------- ------------
<S> <C> <C> <C>
Statutory Federal income tax rate 34% 34% 34%
Valuation allowance on net operating loss (32)% (32)% (28)%
Valuation allowance on temporary differences (1)% (1)% (3)%
Expenses not deductible for income
tax purposes (1)% (1)% (3)%
----- ----- -----
Effective income tax rate 0% 0% 0%
==== ==== ====
</TABLE>
F-29
<PAGE> 30
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE M (CONTINUED)
The Company has provided a net deferred tax asset valuation allowance for
net deferred tax assets since realization of these benefits cannot be
reasonably assured.
At December 31, 1998 and 1999, the Company had net operating loss
carryforwards of approximately $11,611,000 and $23,689,000, respectively,
for income tax purposes. These net operating losses expire through year
2019. Utilization of the net operating loss arising prior to August 4,
1998 will be subject to an annual limitation due to the change in
ownership on such date. Further limitations may occur in the event of
significant changes in the Company's ownership. In addition, their use is
limited to future earnings of the Company.
NOTE N - RETIREMENT SAVINGS PLANS
As of January 1, 1997, all employees covered under a former plan were
transferred to The AppliedTheory Communications, Inc. 401(k) Profit
Sharing Plan (the "401(k) Plan") and the Money Purchase Pension Plan and
the former plan was terminated and all participants were fully vested in
their account balances.
The 401(k) Plan covers substantially all employees. In addition to
employee contributions, the Company matches a percentage of the employee's
elective salary deferral into the Plan and contributes a percentage of
each eligible employee's salary to the Money Purchase Plan Pension.
Effective October 1, 1997, the Company terminated the Money Purchase
Pension Plan. All employees in the Plan were vested, and all assets were
transferred into the 401(k) Plan. The total contributions made by the
Company under both Plans totaled approximately $587,000, $373,000 and
$688,000 for the years ended December 31, 1997, 1998 and 1999,
respectively.
NOTE O - SUBSEQUENT EVENT
1. Purchase of CRL Network Services, Inc.
On January 5, 2000, the Company's newly formed wholly-owned subsidiary,
AppliedTheory Reef Acquisition Corp., ("the Merger Sub"), a Delaware
corporation, purchased all of the capital stock of CRL Network
Services, Inc. ("CRL") for up to approximately $9.9 million in cash and
up to approximately 2,022,287 shares of common stock of the Company.
Also the Merger Sub changed its name to AppliedTheory California
Corporation. The Company owns all capital stock of AppliedTheory
California Corporation. CRL provides high-speed Internet access and
data networking solutions across the United States and owns and
operates a Tier 1 network backbone.
F-30
<PAGE> 31
AppliedTheory Corporation
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
For the years ended December 31, 1997, 1998 and 1999
NOTE O (CONTINUED)
The acquisition will be accounted for using the purchase method of
accounting. Accordingly, a portion of the purchase price will be
allocated to the identifiable net assets acquired based on the
estimated fair values. The balance of the purchase price will be
recorded as goodwill.
F-31
