<PAGE>



                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q



(Mark One)
    X         Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
              Exchange Act of 1934

                  FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

                                       or

       Transition Report Pursuant to Section 13 or 15(d) of the Securities
                              Exchange Act of 1934


                          COMMISSION FILE NUMBER 29947

                      INTEGRATED INFORMATION SYSTEMS, INC.
             (Exact name of registrant as specified in its charter)

         DELAWARE                                        86-0624332
  (State of Incorporation)                          (IRS Employer I.D. No.)

                            1480 SOUTH HOHOKAM DRIVE
                              TEMPE, ARIZONA 85281
                    (Address of principal executive offices)

                                 (480) 317-8000
                         (Registrant's telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

                                 YES [X] NO [ ]

The registrant has not been subject to the filing requirements of Sections 13 or
15(d) of the Securities Exchange Act of 1934 for the past 90 days.

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, not including shares held in treasury:

        AS OF AUGUST 9, 2002, THERE WERE 16,550,688 SHARES OF COMMON STOCK,
$0.001 PAR VALUE, OUTSTANDING.



<PAGE>


               INTEGRATED INFORMATION SYSTEMS, INC. AND SUBSIDIARY

                                TABLE OF CONTENTS


<TABLE>
<CAPTION>
                                                                                                              PAGE
                                                                                                              ----

<S>   <C>                                                                                                        <C>
PART I       FINANCIAL INFORMATION........................................................................       3

      ITEM 1     UNAUDITED FINANCIAL STATEMENTS...........................................................       3

                 Condensed Consolidated Balance Sheets as of June 30, 2002
                 and December 31, 2001....................................................................       3
`
                 Condensed Consolidated Statements of Operations for the Three and Six
                 Months Ended June 30, 2002 and 2001......................................................       4

                 Condensed Consolidated Statements of Cash Flows for the Six
                 Months Ended June, 2002 and 2001.........................................................       5

                 Notes to Condensed Consolidated Financial Statements.....................................       6

      ITEM 2     MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                 CONDITION AND RESULTS OF OPERATIONS......................................................      13

      ITEM 3     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
                 MARKET RISK..............................................................................      20


PART II      OTHER INFORMATION............................................................................      27


      ITEM 1     LEGAL PROCEEDINGS........................................................................      27

      ITEM 6     EXHIBITS AND REPORTS ON FORM 8-K.........................................................      28


SIGNATURES  ..............................................................................................      28


</TABLE>




                                       2
<PAGE>

PART I.    FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS


               INTEGRATED INFORMATION SYSTEMS, INC. AND SUBSIDIARY

                      CONDENSED CONSOLIDATED BALANCE SHEETS
                      (In thousands, except share amounts)

<TABLE>
<CAPTION>
                                                                       JUNE 30,        DECEMBER 31,
                                                                         2002             2001
                                                                     ------------     --------------
                                                                     (Unaudited)
<S>                                                                      <C>                <C>
ASSETS

Current assets:
  Cash and cash equivalents                                            $    629          $  5,235
  Restricted cash                                                           433             1,125
  Accounts receivable, net of allowance of $1,664 and $6,830,
       at June 30, 2002 and December 31, 2001, respectively               4,041             4,688
  Unbilled revenues on contracts                                            105               174
  Prepaid expenses and other current assets                                 758               550
                                                                       --------          --------
           Total current assets                                           5,966            11,772
Property and equipment, net                                               5,536             8,018
Goodwill                                                                  4,745             3,187
Other assets                                                              1,262             1,402
                                                                       --------          --------
                                                                       $ 17,509          $ 24,379
                                                                       ========          ========

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Current liabilities:
  Accounts payable and accrued expenses                                $  8,895          $  7,476
  Current installments of capital lease obligations                       3,093             3,253
  Deferred revenues on contracts                                            239               750
                                                                       --------          --------
           Total current liabilities                                     12,227            11,479

Note payable to bank                                                      4,695              --
Other non-current liabilities                                             1,218              --
Capital lease obligations, less current installments                        522               902
                                                                       --------          --------
           Total liabilities                                             18,662            12,381

Commitments and contingencies
Stockholders' equity (deficit):
   Common stock, $.001 par value, authorized 100,000,000
      shares; issued and outstanding 16,550,688
      shares at June 30, 2002 and December 31, 2001                          16                16
   Additional paid-in capital                                            94,154            94,154
   Accumulated deficit                                                  (89,990)          (76,836)
   Accumulated other comprehensive loss                                     (51)              (54)
                                                                       --------          --------
                                                                          4,129            17,280
    Treasury stock, at cost, 4,951,800 shares at June 30, 2002
       and December 31, 2001                                             (5,282)           (5,282)
                                                                       --------          --------
           Total stockholders' equity (deficit)                          (1,153)           11,998
                                                                       --------          --------

                                                                       $ 17,509          $ 24,379
                                                                       ========          ========
</TABLE>



     See accompanying notes to condensed consolidated financial statements.


                                       3
<PAGE>



               INTEGRATED INFORMATION SYSTEMS, INC. AND SUBSIDIARY

                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                    (In thousands, except per share amounts)


<TABLE>
<CAPTION>

                                                        THREE MONTHS ENDED                 SIX MONTHS ENDED
                                                             JUNE 30,                          JUNE 30,
                                                     2002              2001             2002              2001
                                                  --------          --------          --------          --------
                                                           (Unaudited)                        (Unaudited)
<S>                                               <C>               <C>               <C>               <C>
Revenues ................................         $  7,129          $  8,699          $ 15,396          $ 19,206
Cost of revenues ........................            5,409             8,693            11,641            18,074
Other charges ...........................             --               2,162              --               2,162
                                                  --------          --------          --------          --------

       Gross profit (loss) ..............            1,720            (2,156)            3,755            (1,030)
                                                  --------          --------          --------          --------

Operating Expenses
     Selling and marketing ..............              716             1,484             1,770             2,935
     General and administrative .........            3,247             7,379             8,892            15,657
     Asset impairment and restructuring
       charges ..........................              133             9,144             2,884             9,144
                                                  --------          --------          --------          --------

       Total operating expenses .........            4,096            18,007            13,546            27,736
                                                  --------          --------          --------          --------

       Loss from operations .............           (2,376)          (20,163)           (9,791)          (28,766)
Interest income (expense), net ..........             (106)              210              (176)              594
                                                  --------          --------          --------          --------
       Loss before income taxes and
         cumulative effect of a change
         in accounting principle ........           (2,482)          (19,953)           (9,967)          (28,172)
Provision for income taxes ..............             --                --                --                --
                                                  --------          --------          --------          --------
       Loss before cumulative effect of a
         change in accounting principle .           (2,482)          (19,953)           (9,967)          (28,172)
 Cumulative effect of a change in
    accounting principle ................             --                --              (3,187)             --
                                                  --------          --------          --------          --------

       Net loss .........................         $ (2,482)         $(19,953)         $(13,154)         $(28,172)
                                                  ========          ========          ========          ========

Loss per share:
Loss before cumulative effect of change
    in accounting principle .............         $  (0.15)         $  (1.05)         $  (0.60)         $  (1.42)
Cumulative effect of a change in
    accounting principle ................             --                --            $  (0.19)             --
                                                  --------          --------          --------          --------

       Net loss per share, basic
        and diluted .....................         $  (0.15)         $  (1.05)         $  (0.79)         $  (1.42)
                                                  ========          ========          ========          ========

Weighted average common shares
    outstanding .........................           16,551            19,087            16,551            19,792
                                                  ========          ========          ========          ========

</TABLE>





     See accompanying notes to condensed consolidated financial statements.



                                       4
<PAGE>




               INTEGRATED INFORMATION SYSTEMS, INC. AND SUBSIDIARY

                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

                                 (In thousands)

<TABLE>
<CAPTION>

                                                                          SIX MONTHS ENDED
                                                                              JUNE 30,

                                                                      2002              2001
                                                                    --------          --------
                                                                           (Unaudited)
<S>                                                                 <C>               <C>
Cash flows from operating activities:
    Net loss ..............................................         $(13,154)         $(28,172)
    Adjustments to reconcile net loss to net cash
      used in operating activities:
      Cumulative effect of a change in accounting principle            3,187              --
      Depreciation and amortization .......................            2,480             4,917
      Asset impairments, restructuring and other charges ..            2,884            11,306
      Provision for doubtful accounts .....................              332              (251)
      Change in assets and liabilities, net of acquisition:
        Accounts receivable ...............................            1,206             1,914
        Income tax receivable .............................             --                  94
        Unbilled revenues on contracts ....................               69               282
        Prepaid expenses and other current assets .........             (208)              (70)
        Other assets ......................................              (48)             (167)
        Accounts payable and accrued expenses .............              (69)           (1,747)
        Deferred revenues on contracts ....................             (589)             (184)
                                                                    --------          --------

           Net cash used in operating activities ..........           (3,910)          (12,078)
                                                                    --------          --------

Cash flows from investing activities:
    Capital expenditures ..................................             (162)           (1,248)
    Proceeds from disposition of assets ...................               73              --
    Cash paid for acquisition .............................             (400)             --
                                                                    --------          --------

           Net cash used in investing activities ..........             (489)           (1,248)
                                                                    --------          --------

Cash flows from financing activities:
    Restricted cash .......................................              692            (2,707)
    Repayments of capital lease obligations ...............             (902)           (2,178)
    Issuance of common stock and exercise of stock options              --                 147
    Repurchase of common stock ............................             --              (2,819)
                                                                    --------          --------

        Net cash used in financing activities .............             (210)           (7,557)
                                                                    --------          --------

Effect of exchange rate on cash ...........................                3                (4)
                                                                    --------          --------

Decrease in cash and cash equivalents .....................           (4,606)          (20,887)
Cash and cash equivalents, at beginning of period .........            5,235            46,541
                                                                    --------          --------

Cash and cash equivalents, at end of period ...............         $    629          $ 25,654
                                                                    ========          ========
</TABLE>



     See accompanying notes to condensed consolidated financial statements.


                                       5
<PAGE>



               INTEGRATED INFORMATION SYSTEMS, INC. AND SUBSIDIARY
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

                                   (UNAUDITED)


1. BASIS OF PRESENTATION

We have prepared the accompanying unaudited condensed consolidated financial
statements pursuant to the rules and regulations of the Securities and Exchange
Commission regarding interim financial reporting. (In this report, "we" or "the
Company" means Integrated Information Systems, Inc.) Accordingly, they do not
include all of the information and notes required by accounting principles
generally accepted in the United States of America for complete financial
statements and should be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's Annual Report on Form
10-K for the year ended December 31, 2001. The accompanying condensed
consolidated financial statements reflect all adjustments (consisting solely of
normal, recurring adjustments), which are, in the opinion of management,
necessary for a fair presentation of results for the interim periods presented.
The results of operations for the three and six month periods ended June 30,
2002 are not necessarily indicative of the results to be expected for any future
period or the full fiscal year.

We operate in a highly competitive, consolidating market. The information
technology services industry has experienced rapid growth followed by rapid and
significant contraction over a relatively short economic cycle. Our rapid growth
phase required significant investments in infrastructure, facilities, computer
and office equipment, human resources and working capital in order to meet
perceived demand. Since the third quarter of 2000, the market for our services
has changed and declined significantly.

Our condensed consolidated financial statements are prepared using accounting
principles generally accepted in the United States of America applicable to a
going concern, which contemplate the realization of assets and satisfaction of
liabilities in the normal course of business. However, the Company's auditors
issued their independent auditors' report dated February 15, 2001 stating the
company has suffered negative cash flows from operations and has an accumulated
deficit, that raise substantial doubt about our ability to continue as a going
concern. We incurred negative cash flows from operations for each of the three
years ended December 31, 2001 and for the six months ended June 30, 2002. The
Company also has an accumulated deficit of $89,990,000 through June 30, 2002.
Management has responded to these changes by closing unprofitable offices and
reducing staff in remaining offices. We continue to closely monitor staff
utilization and other operating expenses in order to improve cash flow from
operations and have undertaken an effort to settle obligations for vacated
facilities, excess equipment leases and accounts payable related to those
facilities and types of services we are no longer offering to clients. We have
recorded expenses and charges associated with impairments on assets and idle
facilities. Our management believes that cash receipts may be accelerated
through accounts receivable-backed financing to pay settlements, support growth
opportunities, support working capital needs and address unanticipated
contingencies. Additional needed financing may not be available on terms
favorable to us, if at all. If we are unable to raise additional capital and
significantly reduce operating losses, our business activities may be
significantly curtailed. The condensed consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.

2. USE OF ESTIMATES

The preparation of these financial statements in accordance with accounting
principles generally accepted in the United States of America requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate estimates, including those
related to long-term service contracts, intangible assets, income taxes, bad
debts, restructuring, contingencies and litigation. We base our estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that may
not be readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.

We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our condensed
consolidated financial statements. We recognize revenue and profit as work
progresses on long-term, fixed price contracts using the
percentage-of-completion method, which relies on estimates of total expected
contract revenues and costs. We follow this method because reasonably dependable
estimates of the revenues and costs



                                       6
<PAGE>

applicable to various stages of a contract can be made. Recognized revenues and
profit are subject to revisions as the contracts progress to completion.

Revisions in profit estimates are charged to income in the period in which the
facts that give rise to the revision become known. We maintain allowances for
doubtful accounts for estimated losses resulting from the inability of our
customers to make required payments. If the financial condition of our customers
were to deteriorate, resulting in an impairment of their ability to make
payments, additional allowances may be required.

We recorded goodwill and other intangible assets from acquisitions during 2001
and 2002. Future adverse changes in market conditions or poor operating results
could result in an inability to recover the carrying value of the investment,
thereby possibly requiring an impairment charge in the future as required by
recently issued financial standards.

We record a valuation allowance to reduce our deferred tax assets to the amount
that is more likely than not to be realized. In the event we were to determine
that we would be able to realize our deferred tax assets in the future in excess
of our net recorded amount, an adjustment to the deferred tax asset would
increase net income in the period such determination was made.

We recorded accruals for the estimated future cash expenditures required from
closing vacated offices and disposal of leases for unused equipment. The
accruals include estimates of future rent payments and settlements until the
obligations are canceled. Should actual cash expenditures differ from our
estimates, revisions to the estimated liability for closing vacated offices and
terminating leases would be required.

We evaluate the requirement for future cash expenditures resulting from
contingencies and litigation. We record an accrual for contingencies and
litigation when exposures can be reasonably estimated and are considered
probable. Should the actual results differ from our estimates, revisions to the
estimated liability for contingencies and litigation would be required.

3. REVENUE RECOGNITION

We recognize revenue when each of the following four criteria are met:

         o    Persuasive evidence of an arrangement exists;
         o    Delivery has occurred or services have been rendered;
         o    The seller's price to the buyer is fixed or determinable; and
         o    Collectibility is reasonably assured.

Subject to the above listed criteria, revenues for time-and-material contracts
are recognized as the services are rendered. Revenues pursuant to fixed fee
contracts are recognized as services are rendered on the
percentage-of-completion method of accounting (based on the ratio of labor hours
incurred to total estimated labor hours). Revenues from maintenance or
post-contract support agreements are recognized as earned over the terms of the
agreements. Revenues from recurring services such as application management and
hosting operations are recognized as services are provided each month. Revenues
for services rendered are not recognized until collectibility is reasonably
assured.

Provisions for estimated losses on uncompleted contracts are made on a
contract-by-contract basis and are recognized in the period in which such losses
are determined. Unbilled revenues on contracts are comprised of earnings on
certain contracts in excess of contractual billings on such contracts. Billings
in excess of earnings are classified as deferred revenues on contracts.

In 2001, the Emerging Issues Task Force of the Financial Accounting Standards
Board (FASB) concluded that reimbursements for "out of pocket" expenses should
be classified as revenue and, correspondingly, cost of services, in the income
statement. The new accounting treatment is applicable to us in 2002 and requires
that comparative financial statements for prior periods be reclassified in order
to ensure consistency for all periods presented. Accordingly, in our condensed
consolidated statements of operations, we included revenues and cost of sales
from the reimbursements of expenses incurred of $215,000 and $44,000 for the
quarters ended June 30, 2002 and 2001, respectively and $421,000 and $114,000
for the six month periods ended June 30, 2002 and 2001, respectively.




                                       7
<PAGE>



4. ACQUISITIONS

In order to more effectively address the general economic business climate and
the slowdown in the IT professional services market, in 2001 we developed and
began implementing an aggressive growth strategy focused on acquiring
like-minded peer consultancies. The acquisition target companies ideally have
leading competitive positions in regional and vertical markets, a proven track
record of providing Microsoft-based solutions, a booked backlog of project work
for premier clients, managers in place who are capable of leading a regional
division for the Company, a working culture and ethic similar to ours and are
owned by consultants who remain active in the business.

On August 20, 2001, we completed a series of transactions with K2 Digital, Inc.
("K2"), a publicly held digital services firm based in New York City. In that
transaction, 24 management and consulting employees of K2 were hired, certain
related fixed assets were acquired and the leased office space of K2 in New York
City was assumed. The total purchase price consisted of cash payments of
$544,000 for certain K2 assets and $709,000 for the assumption of liabilities.
In the purchase price allocation, $927,000 was recorded as goodwill. Due to
continuing weak economic conditions subsequent to September 11, 2001, generally
weak demand for IT services and other factors in the New York market, management
closed the New York K2 operations in July 2002.

On September 28, 2001, a similar series of transactions were completed with STEP
Technology, Inc. ("STEP"), a Portland, Oregon-based information technology
consulting firm. In that transaction, 54 management and consulting personnel of
STEP were hired, certain related assets were acquired and a portion of STEP's
office space in Portland was assumed. The total purchase price consisted of cash
payments of $1,140,000 for certain STEP assets and $1,041,000 for the assumption
of liabilities. In the purchase price allocation, $1,433,000 was recorded as
goodwill. In addition to the cash consideration, under the purchase agreement,
if in 2002, 2003, and 2004 annual earnings from STEP operations are positive,
STEP is entitled to additional consideration from this transaction based on a
percentage of the revenues generated and limited to an agreed upon percentage of
earnings.

On October 31, 2001, a series of transactions were completed with INTEFLUX, Inc.
("INTEFLUX"), a privately-owned international technology consulting firm based
in Phoenix, Arizona, with operations in New York City and London, England. In
that transaction, 19 management and consulting employees of INTEFLUX were hired,
certain related assets were acquired and INTEFLUX's office space in Phoenix and
London was assumed. The total purchase price consisted of cash payments of
$50,000 and the issuance of common stock totaling $187,000 for certain INTEFLUX
assets and $319,000 for the assumption of liabilities. In the purchase price
allocation, $346,000 was recorded as goodwill. In addition to the cash and
common stock consideration, under the purchase agreement, if in 2002, 2003 and
2004 annual earnings from INTEFLUX operations are positive, INTEFLUX is entitled
additional consideration from this transaction based on a percentage of the
revenues generated and limited to an agreed upon percentage of earnings or
dollar amount.

On November 16, 2001, a series of transactions were completed with Winfield
Allen, Inc. ("Winfield Allen"), a Denver, Colorado-based information technology
consulting firm. In that transaction, 24 management and consulting personnel of
Winfield Allen were hired, certain related assets were acquired and Winfield
Allen's leased office space in Colorado was assumed. The total purchase price
consisted of cash payments of $84,000 and the issuance of common stock totaling
$136,000 for certain Winfield Allen assets, the assumption of a note payable for
$103,000 and $173,000 for the assumption of liabilities. In the purchase price
allocation, $358,000 was recorded as goodwill. In addition to the cash and
common stock consideration, under the purchase agreement, if in 2002, 2003, and
2004 annual earnings from Winfield Allen operations are positive, Winfield Allen
is entitled to additional consideration from this transaction based on a
percentage of the revenues generated and limited to an agreed upon percentage of
earnings or dollar amount.

In connection with a recently issued accounting standard, we were required to
assess the impairment of our recorded goodwill relating to the above
acquisitions. As discussed in Note 9, all of the above goodwill and acquisition
costs of $123,000, totaling $3,187,000, were written off as a non-cash,
cumulative effect of a change in accounting principle.

On January 25, 2002, we completed a series of transactions with Goliath
Networks, Inc. ("Goliath"), a Madison, Wisconsin-based information technology
consultancy. In that transaction, 81 management and consulting personnel of
Goliath were hired, certain related assets acquired and the leased office space
of Goliath in Madison and Milwaukee, Wisconsin was assumed. In the preliminary
purchase price allocation, $4,745,000 was recorded as goodwill and intangibles.
The transaction was paid for with a combination of cash payments totaling
$400,000, the issuance of a note payable for $4,250,000 to a bank and the
assumption of $567,000 of liabilities. The amount of the note increased
approximately $445,000, as we purchased some of Goliath's accounts receivables.
The note payable bears interest at 7% per



                                       8
<PAGE>

year. Payments on the note are interest only for the first year. Principal and
interest payments for the second, third and fourth years will be based on a
ten-year amortization schedule. The unpaid principal will be paid in full at the
end of the fourth year. The note payable is collateralized by computer equipment
and office equipment owned by the Company.

As part of these acquisitions, intangible assets totaling $607,000 were acquired
consisting of non-compete agreements of $250,000 and employee agreements of
$357,000. The intangible assets originating from employee agreements will be
amortized over their contractual lives, which are generally five years. The
intangible assets arising from the non-compete agreements will be amortized over
their contractual lives, which are generally less than one year. It is estimated
that most of the goodwill will be deductible for tax purposes, subject to the
utilization of the Company's net operating losses.

In connection with these acquisitions, we acquired accounts receivable of
$1,305,000 and fixed assets of $471,000. The Company issued 507,108 shares of
common stock valued at $365,000.

Our condensed consolidated financial statements reflect the results of
operations for each acquisition from the transaction date. The following
summary, prepared on a pro forma basis, presents the results of operations as if
the acquisitions of K2, STEP, INTEFLUX, Winfield Allen and Goliath had been
completed as of January 1, 2001 (amounts in thousands, except per share
amounts):

                                          SIX MONTHS ENDED
                                              JUNE 30,
                                       2002              2001
                                     --------          --------
                                              (Unaudited)
Revenues ..........................  $ 16,162          $ 39,901
Operating losses ..................    (9,728)          (35,296)
Net loss ..........................   (13,144)          (38,423)
Net loss per share ................     (0.79)            (1.89)

The pro forma results are not indicative of what actually would have occurred if
the transactions had been completed as of January 1, 2001. In addition, they are
not intended to be a projection of future results and do not reflect any
synergies that might be achieved from combined operations.

5. ASSET IMPAIRMENT, RESTRUCTURING AND OTHER CHARGES

During 2001, we recorded asset impairments and restructuring charges totaling
$14,882,000. These charges were attributable to a $9,144,000 charge in the
second quarter of 2001, related to underutilized computer equipment and
leasehold improvements at our data center used for application outsourcing
services and a $5,691,000 charge in the fourth quarter of 2001 for expenses
incurred in connection with the closing and consolidating of six office
locations and abandoned leasehold improvements in an unoccupied seventh
location. The charge for closing and consolidating offices consisted of an
impairment charge totaling $3,556,000 and an accrual for future cash
expenditures, primarily rent-related obligations net of estimated future
sublease income, totaling $2,135,000. Additionally, in the second quarter of
2001, we recorded other charges of $2,162,000 related to the impairment of
inventoried software licenses.

During the first quarter of 2002, commercial real estate markets in some areas
continued to be weaker than anticipated. As a result, we did not anticipate
subleasing certain closed office locations as quickly or at rates as high as
originally anticipated. Accordingly, we re-evaluated our accrual for future cash
expenditures for closed office locations. In addition, we executed a series of
cost control initiatives to close and consolidate three additional office
locations. These activities resulted in asset impairments and restructuring
charges totaling $2,751,000 for the first quarter of 2002. The charges consisted
of an increase in the accrual to terminate and exit closed facilities totaling
$1,108,000, an accrual totaling $1,039,000 for future cash expenditures
attributable to closing and consolidating three office locations, impairment
charges to fixed assets totaling $482,000 and impairment charges to rent
deposits totaling $122,000. In the second quarter of 2002, the Company recorded
additional asset impairment charges totaling $133,000 relating to the closure of
an office.

As of June 30, 2002, we had accrued liabilities for the future cash expenditures
attributable to these restructuring charges totaling $3,739,000. Of this
obligation, $2,521,000 is classified as current accounts payable and accrued
liabilities and $1,218,000 is classified as other non-current liabilities.



                                       9
<PAGE>

6. RECLASSIFICATIONS

Certain reclassifications have been made to the prior periods' condensed
consolidated financial statement amounts to conform to the current period
presentations. See Note 3, Revenue Recognition, regarding reclassification of
out-of-pocket expenses reimbursed by client.

7. RESTRICTED CASH

In October 1999, we signed a lease for a new 71,000 square foot headquarters
facility to be constructed as part of a multi-tenant, mixed-use property in
Tempe, Arizona. In March and May 2001, we deposited a total of $2,500,000 into a
construction escrow account. Through December 31, 2001 and June 30, 2002,
$2,091,000 of the restricted cash had been used to fund the build-out of tenant
improvements at the new facility. In December 2001, in accordance with
provisions of the lease, we terminated our lease for this facility based on
construction delays. See additional information under the caption "Legal
Proceedings" in Part II, Item 1. No additional amounts are expected to be
authorized to be spent from the escrow account, and we are currently attempting
to recover costs invested in this facility and the construction escrow account
balance of approximately $414,000. A liability was recorded in the fourth
quarter of 2001 for the escrow account balance, and the leasehold expenditures
were written off in December 2001 as part of the asset impairment charges.

In June 2001, we deposited approximately $1,000,000 into a restricted
certificate of deposit account. The funds in this account served as collateral
against various letters of credit totaling $1,000,000. During the fourth quarter
of 2001, the first quarter of 2002, and the second quarter of 2002, $300,000,
$227,000 and $465,000, respectively, was used in connection with our closure of
excess office space and other obligations.

At June 30, 2002, $414,000 of the restricted cash was on deposit in the
construction escrow account and $19,000 was remaining in support of a letter of
credit, which $19,000 was drawn down subsequent to June 30, 2002.

8. NET LOSS PER SHARE

The following table sets forth the computation of shares used in computing basic
and diluted net loss per share (in thousands, except per share amounts):

<TABLE>
<CAPTION>
                                                    THREE MONTHS ENDED                    SIX MONTHS ENDED
                                                          JUNE 30,                             JUNE 30,
                                                  2002               2001               2002              2001
                                               --------           --------           --------           --------
<S>                                            <C>                <C>                <C>                <C>
Net loss ...................................   $ (2,482)          $(19,953)          $(13,154)          $(28,172)
                                               ========           ========           ========           ========
Weighted average outstanding
common shares ..............................     16,551             19,087             16,551             19,792
Effect of dilutive securities:
    Stock options and warrants .............          6                148                  6                177
    Antidilutive effect of securities ......         (6)              (148)                (6)              (177)
                                               --------           --------           --------           --------
Weighted average and common
equivalent shares outstanding ..............     16,551             19,087             16,551             19,792
                                               ========           ========           ========           ========

Net loss per share:
    Basic and diluted ......................   $  (0.15)          $  (1.05)          $  (0.79)          $  (1.42)
                                               ========           ========           ========           ========
</TABLE>

9. GOODWILL

In June 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets
(SFAS 142). SFAS 142 became effective for us on January 1, 2002 and requires,
among other things, the cessation of the amortization of goodwill. In addition,
the standard includes provisions for the reassessment of the useful lives of
existing recognized intangibles, a new method of measuring reported goodwill for
impairment and the identification of reporting units for purposes of assessing
potential future impairments of goodwill. We had recorded $7,932,000 of goodwill
relating to the five acquisitions completed after the effective date of SFAS
141, and



                                       10
<PAGE>

there has been no amortization expense recorded in the accompanying financial
statements. Among other requirements, SFAS 142 required us to complete a
transitional goodwill impairment test on or before June 30, 2002.

In connection with SFAS 142's transitional goodwill impairment evaluation, the
Statement required the Company to perform an assessment of whether there was an
indication that goodwill is impaired as of the date of the Company's adoption.
To accomplish this, the Company was required to identify its reporting units and
determine the carrying value of each reporting unit by assigning the assets and
liabilities, including the existing goodwill and intangible assets, to those
reporting units as of January 1, 2002. Using the guidance provided in SFAS 142,
management determined that it has only one reporting unit. The Company was
required to determine the fair value of its reporting unit at and compare it to
the carrying amount of the reporting unit within six months of, January 1, 2002.
To the extent the carrying amount of a reporting unit exceeded the fair value of
the reporting unit, an indication existed that the reporting unit's goodwill may
be impaired and the Company would be required to perform the second step of the
transitional impairment test. In this step, the Company is required to compare
the implied fair value of the reporting unit goodwill with the carrying amount
of the reporting unit goodwill, both of which must be measured as of the date of
adoption. The implied fair value of goodwill is determined by allocating the
fair value of the reporting unit to all of the assets (recognized and
unrecognized) and liabilities of the reporting unit in a manner similar to a
purchase price allocation, in accordance with SFAS 141. The residual fair value
after this allocation will be the implied fair value of the reporting unit
goodwill. If the implied fair value of this reporting unit exceeds the carrying
amount, the Company is required to recognize an impairment loss.

The fair value of our reporting unit and the related implied fair value of its
respective goodwill was established using a market capitalization approach
supported by a discount cash flow approach.

In June 2002, the Company completed the transitional goodwill impairment test in
accordance with SFAS 142, which resulted in a non-cash charge of $3,187,000 and
is reported in the caption "Cumulative effect of a change in accounting
principle" in the Company's condensed consolidated statements of operations. All
of the charge was related to the Company's acquisitions completed in 2001. The
primary factors that resulted in the impairment charge were the difficult
economic environment in the IT professional services sector and the doubt about
the Company's ability to continue as a going concern.

In accordance with SFAS 142, the fair value and carrying value of the remaining
goodwill of $4,745,000, relating to the acquisition we completed in the first
quarter of 2002, will be tested on the company's annual measurement date in the
fourth quarter of 2002.

10. RECENTLY ISSUED FINANCIAL STANDARDS

In June 2001, the FASB issued Statement of Financial Accounting Standard No.
141, Business Combinations (SFAS 141). SFAS 141 became effective for us as of
July 1, 2001. It establishes new standards for accounting and reporting
requirements for business combinations and requires the purchase method of
accounting be used for all business combinations initiated after June 30, 2001.
The adoption of SFAS 141 did not have a material impact on our condensed
consolidated financial statement.

In August 2001, the FASB issued Statement of Financial Accounting Standard No.
143, Accounting for Asset Retirement Obligations (SFAS 143), which addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and for the associated asset retirement
costs. SFAS 143 requires an enterprise to record the fair value of an asset
retirement obligation as a liability in the period in which it incurs a legal
obligation associated with the retirement of tangible long-lived assets that
result from the acquisition, construction, development and/or normal use of the
assets. The enterprise also is to record a corresponding increase to the
carrying amount of the related long-lived assets and to depreciate that cost
over the life of the asset. The liability is changed at the end of each period
to reflect the passage of time (i.e., accretion expense) and changes in the
estimated future cash flows underlying the initial fair value measurement. The
provisions of SFAS 143 were effective for us on January 1, 2002 and are to be
applied prospectively. The adoption of SFAS 143 did not have a material impact
on our condensed consolidated financial statements.

In August 2001, the FASB issued Statement of Financial Accounting Standard No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144)
that addresses financial accounting and reporting for the impairment or disposal
of long-lived assets, including discontinued operations. While SFAS 144
supercedes Statement of Financial Accounting



                                       11
<PAGE>

Standard No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of, it retains many of the fundamental
provisions of that Statement. SFAS 144 also supercedes certain provisions of ABP
Opinion No. 30, Reporting the Results of Operations-Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions, for the disposal of a segment of a business.
The provisions of SFAS 144 were effective for us on January 1, 2002 and are to
be applied prospectively. The adoption of SFAS 144 did not have a material
impact on our condensed consolidated financial statements.

In November 2001, the Emerging Issues Task Force of the FASB concluded that
reimbursements for "out of pocket" expenses should be classified as revenue and,
correspondingly, cost of services, in the income statement. The new accounting
treatment is applicable to IIS in the first quarter 2002 and requires that
comparative financial statements for prior periods be reclassified in order to
ensure consistency for all periods presented. Accordingly, in the attached
statements of operations, we included revenues from the reimbursements of
expenses incurred of $215,000 and $44,000 for the quarters ended June 30, 2002
and 2001, respectively, and $421,000 and $114,000 for the six month periods
ended June 30, 2002 and 2001, respectively.

In April 2002, the FASB issued Statement of Financial Accounting Standard No.
145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections (SFAS 145), which addresses
financial accounting and reporting for reporting gains and losses from
extinguishment of debt, accounting for intangible assets of motor carriers and
accounting for leases. SFAS 145 requires that gains and losses from the early
extinguishment of debt should not be classified as extraordinary, as previously
required. SFAS 145 also rescinds Statement 44, which was issued to establish
accounting requirements for the effects of transition to the provisions of the
Motor Carrier Act of 1980 (Public Law 96-296, 96th Congress, July 1, 1980).
Those transitions are completed; therefore, Statement 44 is no longer necessary.
Statement 145 also amends Statement 13 to require sale-leaseback accounting for
certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. Statement 145 also makes various technical
corrections to existing pronouncements. Those corrections are not substantive in
nature. The provisions of this statement relating to Statement 4 are applicable
in fiscal years beginning after May 15, 2002. The provisions of this Statement
related to Statement 13 are effective for transactions occurring after May 15,
2002. All other provisions of this Statement are effective for financial
statements issued on or after May 15, 2002. The adoption of SFAS 145 is not
expected to have a material impact on our condensed consolidated financial
statements.

In June 2002, the FASB issued Statement of Financial Accounting Standards SFAS
No. 146, Accounting for Exit or Disposal Activities (SFAS 146). SFAS 146
addresses the recognition, measurement and reporting of costs associated with
exit and disposal activities, including restructuring activities. SFAS 146 also
addresses recognition of certain costs related to terminating a contract that is
not a capital lease, costs to consolidate facilities or relocate employees and
termination of benefits provided to employees that are involuntarily terminated
under the terms of a one-time benefit arrangement that is not an ongoing benefit
arrangement or an individual deferred compensation contract. SFAS 146 is
effective for exit or disposal activities that are initiated after December 31,
2002. The Company is in the process of evaluating the adoption of SFAS 146 and
its impact on the financial position or results of operations of the Company.

11. SUBSEQUENT EVENTS

Due to continuing weak economic conditions subsequent to September 11, 2001,
generally weak demand for IT services and other factors in the New York market,
management closed the New York K2 operations in July 2002.





                                       12
<PAGE>



ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

FORWARD-LOOKING STATEMENTS

The following discussion contains forward-looking statements based on current
expectations, and we assume no obligation to update these statements. Because
actual results may differ materially from expectations, we caution readers not
to place undue reliance on these statements. These statements are based on our
estimates, projections, beliefs, and assumptions, and are not guarantees of
future performance. A number of factors could cause future results to differ
materially from historical results, or from results or outcomes currently
expected or sought by us. These factors include: a reduced demand for
Information Technology (IT) services; the loss of one or more of our significant
clients; an inability to increase our market share; difficulties in maintaining
our technology alliances; and a continued downturn in economic conditions.

These factors and the other matters discussed below under the heading "Factors
That May Affect Future Results and Our Stock Price" may cause future results to
differ materially from historical results, or from results or outcomes we
currently expect or seek.

OVERVIEW

Since the third quarter of 2000, the market for IT services has changed
dramatically and the demand has declined significantly. As part of our effort to
adjust our structure to better address the general economic business climate and
the slowdown in the IT professional services market, we have closed
underperforming or vacant regional offices, reduced staff in remaining offices,
recorded material charges related to underutilized data center facility computer
equipment and leasehold improvements and developed and began implementing an
aggressive growth strategy through acquiring like-minded peer consultancies. We
completed four such acquisitions in 2001, a fifth such transaction during
January 2002 and anticipate additional, similar transactions, in future periods.
Due to continuing weak economic conditions, management closed the New York K2
operations in July 2002.

We have operated at a loss for each of the last four years and those losses
continue into the third quarter of the current year. The losses, combined with
the current market for IT services, have raised substantial doubt about our
ability to continue as a going concern. We continue to reduce our operating
expenses in order to improve cash flow from operations. We are in default of
certain operating and capital lease provisions for failure to make timely
payment, have received several default notices during 2002 and have been named
in a number of related lawsuits. Our management believes that cash receipts may
be accelerated through accounts receivable-backed financing to fund settlements
of the operating and capital leases, support growth opportunities, support
working capital needs and address unanticipated contingencies. However, such
financing and additional needed financing may not be available on terms
favorable to us, if at all. If we are unable to raise additional capital and
significantly reduce operating losses, our business activities may be
significantly curtailed.

We derive our revenues primarily from the delivery of professional services. We
offer our services to clients under time and materials contracts or under fixed
fee contracts. For time and material projects, we recognize revenues based on
the number of hours worked by consultants at a rate per hour agreed upon with
our clients. We recognize revenues from fixed-price contracts on a
percentage-of-completion method based on project hours worked. The percentage of
our revenues from fixed-price contracts was approximately 22.7% and 28.7% in the
three and six months ended June 30, 2002 and 13.3% and 7.5% in the corresponding
periods of 2001. We provide our application outsourcing services for a minimum
monthly fee and charge extra fees for services that exceed agreed-upon
parameters. Revenues from these services are recognized as services are
provided. Revenues for services rendered are not recognized until collectibility
is reasonably assured.

Our cost of revenues consists primarily of employee compensation, outside
consulting services and benefits. Selling and marketing expenses consist
primarily of compensation and benefits. General and administrative expenses
consist primarily of compensation and benefits for our executive management and
our finance, administration, legal, information technology, and human resources
personnel. General and administrative expenses also include research and
development expense, depreciation, bad debt expense and operating expenses such
as rent, insurance, telephones, office supplies, travel, outside professional
services, training, and facilities costs.

We have historically derived and believe that we may continue to derive a
significant portion of our revenues from a limited number of clients who may
change from period to period (see related discussion below in "Results of
Operations"). Any cancellation, deferral, or significant reduction in work
performed for our principal clients could harm our business and cause



                                       13
<PAGE>

our operating results to fluctuate significantly from period to period. While
the Company's overall reliance on a small number of clients has decreased,
during the six months ended June 30, 2002, revenues from two separate clients
represented, when added together, approximately 15% of our revenues. We
anticipate that revenues from each of these clients will decline significantly,
starting in the third quarter of 2002, due to the completion of current
engagements. As a result of our investments in infrastructure and increase in
operating expenses, we incurred a net loss in each of the last four years. Our
quarterly revenue, cost of revenues, and operating results have varied in the
past due to fluctuations in the utilization of project personnel and are likely
to vary significantly in the future. Therefore, we believe that period-to-period
comparisons of our operating results may not be indicative of future performance
and should not necessarily be relied upon.

RECENT ACQUISITIONS

As part of our effort to adjust our structure to better address a rapidly
changing and declining IT services market, we developed and began implementing
an aggressive growth strategy through acquiring like-minded peer consultancies.
The acquisition target companies ideally have leading competitive positions in
regional and vertical markets, a proven track record of providing
Microsoft-based solutions, a booked backlog of project work for premier clients,
managers in place who are capable of leading a regional division for the
Company, a working culture and ethic similar to our own and are owned by
consultants who remain active in the business. We completed the acquisition of
four such consultancies in 2001, a fifth consultancy during January 2002 and
anticipate additional, similar transactions in the fourth quarter of 2002.

On August 20, 2001, we completed a series of transactions with K2 Digital, Inc.
("K2"), a publicly held digital services firm based in New York City. In that
transaction, we hired 24 management and consulting employees of K2, acquired
certain related fixed assets and assumed certain of the leased office space of
K2 in New York City. The transactions were paid for with cash and the assumption
of certain operating expenses of K2. Due to continuing weak economic conditions
subsequent to September 11, 2001, generally weak demand for IT services and
other factors in the New York market, management closed the New York K2
operations in July 2002.

On September 28, 2001, we completed a similar series of transactions with STEP
Technology, Inc. ("STEP"), a Portland, Oregon-based information technology
consulting firm. In that transaction, we hired 54 management and consulting
personnel of STEP, acquired certain related assets and assumed a portion of
STEP's office space in Portland. The transaction was paid for with cash and the
assumption of certain liabilities of STEP.

On October 31, 2001, we completed a similar series of transactions with
INTEFLUX, Inc. ("INTEFLUX"), a Phoenix, Arizona-based information technology
consultancy with international operations in London, England. In that
transaction, we hired 19 management and consulting personnel of INTEFLUX,
acquired certain related assets and assumed the leased office space of INTEFLUX
in Phoenix and London. The transaction was paid for with a combination of cash
and restricted shares of our common stock, as well as the assumption of certain
liabilities of INTEFLUX.

On November 16, 2001, we completed a similar series of transactions with
Winfield Allen, Inc. ("Winfield Allen"), a Denver, Colorado-based information
technology consultancy. In that transaction, we hired 24 management and
consulting personnel of Winfield Allen, acquired certain related assets, and
assumed the leased office space of Winfield Allen. The transaction was paid for
with a combination of cash, a promissory note and restricted shares of our
common stock, as well as the assumption of certain liabilities of Winfield
Allen.

On January 25, 2002, we completed a series of transactions to hire the executive
management and key professional staff and acquire certain related assets of
Goliath Networks, Inc. ("Goliath"), a Madison, Wisconsin-based information
consulting and services firm. In that transaction, we hired 81 management and
consulting personnel of Goliath, acquired certain related assets, and assumed
the leased office space of Goliath in Madison and Milwaukee, Wisconsin. The
transaction was paid for with a combination of cash and issuance of a note
payable to a bank.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Company's discussion and analysis of its financial condition and results of
operations are based upon the Company's condensed consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires the Company to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an on-going basis, the
Company evaluates its estimates, including those related to long-term service
contracts, bad debts, intangible assets, income taxes, restructuring, and
contingencies and litigation. The Company bases its


                                       14
<PAGE>

estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.

The Company believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its condensed
consolidated financial statements. The Company recognizes revenue and profit as
work progresses on long-term, fixed price contracts using the
percentage-of-completion method, which relies on estimates of total expected
contract revenue and costs. The Company follows this method because reasonably
dependable estimates of the revenue and costs applicable to various stages of a
contract can be made. Recognized revenues and profit are subject to revisions as
the contract progresses to completion. Revisions in profit estimates are charged
to income in the period in which the facts that give rise to the revision become
known. The Company maintains allowances for doubtful accounts for estimated
losses resulting from the inability of its customers to make required payments.
If the financial condition of the Company's customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required. The Company reviews acquired businesses on a
periodic basis to determine that the fair value is deemed adequate to support
the carrying value of goodwill and other intangible assets. Future adverse
changes in market conditions or poor operating results could result in an
inability to recover the carrying value of the investments, thereby possibly
requiring an impairment charge in the future. The Company records a valuation
allowance to reduce its deferred tax assets to the amount that is more likely
than not to be realized. In the event the Company were to determine that it
would be able to realize its deferred tax assets in the future in excess of its
net recorded amount, an adjustment to the deferred tax asset would increase
income in the period such determination was made. The Company records accruals
for the estimated future cash expenditures required from closing its vacated
offices. The accruals include estimates of future rent payments and settlements
until the obligation is canceled. Should actual cash expenditures differ from
the Company's estimates, revisions to the estimated liability for closing
vacated offices would be required. The Company evaluates the requirement for
future cash expenditures resulting from its contingencies and litigation. The
Company records an accrual for contingencies and litigation when exposures can
be reasonably estimated and are considered probable. Should the actual results
differ from the Company's estimates, revisions to the estimated liability for
contingencies and litigation would be required.

RESULTS OF OPERATIONS

REVENUES. For the three months ended June 30, 2002, revenues decreased 18.4% to
$7.1 million compared to $8.7 million in the corresponding period of 2001. For
the first six months ended June 30, 2002, revenues decreased 19.8% to $15.4
million compared to $19.2 million in the corresponding period of 2001. The
decrease in revenues for the second quarter primarily resulted from a decrease
in billed hours of 24.4% to 62,000 hours compared to 82,000 hours for the
corresponding quarter in 2001. This decrease in revenues for the second quarter
was partially offset by an increase in our average hourly bill rate of 12.6% to
$107 compared to $95 in the corresponding quarter in 2001. The increase in our
bill rate has resulted from the decline in lower-end service consulting. The
decrease in revenues for the six months ended June 30, 2002 resulted primarily
from a decrease in billed hours of 16.6% to 136,000 hours compared to 163,000
hours for the corresponding quarter in 2001, while our average hourly bill rate
remained relatively constant for the six month period. The Company has
substantially reduced its dependency for revenues on a few clients. For the
three months ended June 30, 2002, revenue from our largest client was only 6.0%
compared to 20.0% during the corresponding period of 2001. For the three months
ended June 30, 2002, revenue was generated from 351 clients compared to 139
during the corresponding period of 2001. For the six months ended June 30, 2002
revenue from our largest client was only 7.7% compared to 25.2% during the
corresponding period of 2001. For the six months ended June 30, 2002 revenue was
generated from 461 clients compared to 171 during the corresponding period of
2001.

COST OF REVENUES. Cost of revenues decreased 37.9% to $5.4 million for the three
months ended June 30, 2002 compared to $8.7 million for the corresponding period
of 2001. Cost of revenues decreased 35.9% to $11.6 million for the six months
ended June 30, 2002 compared to $18.1 million for the corresponding period of
2001. The decrease in cost of revenues for the second quarter resulted from a
decrease in overall firm staffing, improved utilization and implementation of
hourly and variable pay plans in certain offices. Utilization of consultants
increased 41.3% to 65.0%, compared to 46.0% for the corresponding quarter in
2001. The decrease in cost of revenues for the six months ended June 30, 2002
resulted from a decrease in overall firm staffing, improved utilization of 31.9%
to 62.0% compared to 47.0% for the corresponding quarter in 2001 and
implementation of hourly and variable pay plans in certain offices. We also
incurred less depreciation expense for our data center during the six months
ended June 30, 2002 as compared to the corresponding 2001 period due to the $9.2
million charge in the second quarter of 2001 related to underutilized computer
equipment and leasehold improvements. This data center was closed during the
second quarter of 2002.



                                       15
<PAGE>

OTHER CHARGES. During the second quarter of 2001, we recorded a $2.2 million
non-cash charge due to the impairment of inventoried software licenses.

SELLING AND MARKETING EXPENSES. Selling and marketing expenses decreased 52.3%
to $716,000 for the three months ended June 30, 2002, compared to $1.5 million
for the corresponding period of 2001. Selling and marketing expenses decreased
37.9% to $1.8 million for the six months ended June 30, 2002 compared to $2.9
million for the corresponding period of 2001. The decrease was due primarily to
reductions of dedicated sales and marketing personnel and to a lesser extent,
decreases in spending for advertising and promotion in the three and six months
ended June 30, 2002.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased 56.8% to $3.2 million for the three months ended June 30, 2002,
compared to $7.4 million for the corresponding period of 2001. General and
administrative expenses decreased 43.3% to $8.9 million for the six months ended
June 30, 2002 compared to $15.7 million for the corresponding period of 2001.
These decreases were primarily attributable to reductions in general and
administrative personnel, facility rent expense and depreciation expense from
closed offices and $350,000 of insurance proceeds related to a litigation
settlement. Non cash charges included $1.2 million and $2.3 million of
depreciation expense in the three and six month periods ended June 30, 2002,
respectively, compared with $2.5 million and $4.9 million for the three and six
month periods ended June 30, 2001, respectively.

ASSET IMPAIRMENT AND RESTRUCTURING CHARGES. During the second quarter of 2001,
we recorded asset impairment and restructuring charges totaling $9,144,000,
related to underutilized computer equipment and leasehold improvements at our
data center used for application outsourcing services and a $5,691,000 charge in
the fourth quarter of 2001 for expenses incurred in connection with the closing
and consolidating of six office locations and abandoned leasehold improvements
in an unoccupied seventh location. The charge for closing and consolidating
offices consisted of an impairment charge totaling $3,556,000 and an accrual for
future cash expenditures, primarily rent-related obligations net of estimated
future sublease income, totaling $2,135,000.

During the first quarter of 2002, commercial real estate markets in some areas
continued to be weaker than anticipated. As a result, we did not anticipate
subleasing certain closed office locations as quickly or at rates as high as
originally anticipated. Accordingly, we re-evaluated our accrual for future cash
expenditures for closed office locations. In addition, we executed a series of
cost control initiatives to close and consolidate three additional office
locations. These activities resulted in asset impairments and restructuring
charges totaling $2,751,000 for the first quarter of 2002. The charges consisted
of an increase in the accrual to terminate and exit closed facilities totaling
$1,108,000, an accrual totaling $1,039,000 for future cash expenditures
attributable to closing and consolidating three office locations, impairment
charges to fixed assets totaling $482,000 and impairment charges to rent
deposits totaling $122,000. In the second quarter of 2002, the Company recorded
additional asset impairment charges totaling $133,000 relating to the closure of
an office.

INTEREST INCOME (EXPENSE), NET. We incurred interest expense, net of interest
income totaling $106,000 for the three months ended June 30, 2002 compared to
earning interest income, net of interest expense, of $210,000 for the
corresponding period of 2001. We incurred interest expense, net of interest
income totaling, $176,000 for the six months ended June 30, 2002 compared to
earning interest income, net of interest expense, of $594,000 for the
corresponding period of 2001. These changes were primarily attributable to less
cash available for investment during the first and second quarter of 2002 as
compared to the corresponding period in 2001.

LIQUIDITY AND CAPITAL RESOURCES

Since inception, we have funded our operations and investments in property and
equipment through capital lease financing arrangements, bank borrowings, and
equity financings. In January 2000, we raised $20.2 million, before expenses of
$800,000 through a private placement of Series C preferred stock to
institutional and other accredited investors. In March and April 2000, we raised
an additional $67.5 million (net of underwriting discounts and other offering
expenses) through an initial public offering of 4,945,000 shares of the
Company's common stock.

We operate in a highly competitive market. The information technology services
industry has experienced rapid growth followed by rapid and significant
contraction over a relatively short economic cycle. Our rapid growth phase
required significant investments in infrastructure, facilities, computer and
office equipment, human resources and working capital in order to meet perceived
demand. Since the third quarter of 2000, the market for our services has changed
and declined



                                       16
<PAGE>

significantly. We incurred negative cash flows from operations for each of the
three years ended December 31, 2001 and for the six months ended June 30, 2002.
The Company's auditors issued their independent auditors' report dated February
15, 2001 stating the Company has suffered negative cash flows from operations
and has an accumulated deficit, that raise substantial doubt about our ability
to continue as a going concern.

Our management is currently pursuing various options in order to provide
necessary financing for future operations. Potential means of resolving near
term cash flow issues include the following:

         o    Restructuring the terms and payments of facility and equipment
              leases;
         o    Negotiating a new line of credit through accounts receivable
              backed financing;
         o    A private placement of equity financing;
         o    Projected improvement of operating results;
         o    Improved collections of accounts receivable; or
         o    Regulatory reorganization of the Company.

We continue to reduce operating expenses by closing unprofitable offices that
could not become profitable in the near term and reducing staff in remaining
offices and believe that these actions taken will improve cash flow from
operations.

We believe if we can finalize the restructuring of terms and payments of
facility and equipment leases, conclude financing alternatives that we are
pursuing, together with projected improvement in operating results for 2002, we
will generate sufficient resources to ensure uninterrupted performance of our
operating obligations. Our continuance as a going concern is dependent upon our
ability to generate sufficient cash flow to meet obligations in a timely manner,
to obtain additional financing as required and ultimately to attain
profitability. There can be no assurance, however, that these sources will be
available to us on acceptable terms or when necessary, or that we will be
successful in our efforts to improve our operating results.

We incurred negative cash flows from operations in 2001 and continue to do so in
2002. We are in default of certain operating and capital lease provisions for
failure to make timely payment, have received several default notices during
2002 and have been named in a number of related lawsuits. The notices and
lawsuits relate primarily to facility lease commitments for closed offices and
capital lease commitments for computer equipment, office equipment and office
furniture. We are in the process of trying to settle our operating and capital
lease obligations on terms as favorable as possible to the Company and have
reached settlements with several landlords and lessors. The settlements are, in
many instances, subject to us reaching agreement with other landlords and
lessors and obtaining financing to fund the settlements. If we are unable to
obtain financing on terms acceptable to us, or at all, we may choose or be
required to limit or reduce our scope of operations, cease looking for
consultancies to consolidate with the Company, or, under the worst of
circumstances, pursue strategic alternatives such as a sale, merger or
recapitalization of the Company or seek protection under reorganization,
insolvency or similar laws. We continue to pursue sources of additional funds in
order to take advantage of acquisition or expansion opportunities, develop new
services and address unanticipated contingencies. If the best available
financing is raising additional capital through the sale of equity securities or
through taking on debt with an equity component, whether for funding settlements
and working capital needs or for growing through acquisitions, your investment
in us would be diluted. The inability to settle obligations on favorable terms,
raise financing for the settlements or for working capital or other needs would
materially and adversely affect the Company and would likely cause our stock
price to further decline.

At June 30, 2002, we had approximately $629,000 in cash and cash equivalents and
a deficiency of working capital of approximately $6.3 million, as compared to
$5.2 million in cash and cash equivalents and $293,000 in working capital at
December 31, 2001.

For the six months ended June 30, 2002 and 2001, net cash used in operating
activities was $3.9 million and $12.1 million, respectively. Cash used in
operating activities in each of these periods was the result of net losses,
adjusted for non-cash items primarily related to depreciation and amortization,
non-cash asset impairment and restructuring charges and fluctuations in accounts
receivable, prepaid expenses and other current assets, and accounts payable and
accrued expenses. Our collections of accounts receivable improved in the second
quarter of 2002 with trade receivables averaging 49 days sales outstanding,
compared to 52 days sales outstanding for the corresponding period of 2001.
Additionally, the percentage of receivables over 90 days as of June 30, 2002 was
reduced to 32.8% compared to 69.9% as of June 30, 2001.



                                       17
<PAGE>

For the six months ended June 30, 2002 and 2001, net cash used in investing
activities was $489,000 and $1.2 million, respectively. During the first quarter
of 2002, the Company paid $400,000 in cash as part of the price to acquire the
assets of another company. Cash used for the purchases of computer equipment,
furniture and leasehold improvements to support growth in our infrastructure
during the six months ended June 30, 2002 and 2001 totaled $162,000 and $1.2
million, respectively.

For the six months ended June 30, 2002, net cash used in financing activities
was $210,000, compared to net cash used in financing activities for the six
months ended June 30, 2001 of $7.6 million. During the first six months of 2002,
net repayments of capital lease obligations totaled approximately $902,000. We
also used $692,000 of our restricted cash during the first six months of 2002 in
connection with the Company's closure of excess office space. For the six months
ended June 30, 2001, we repurchased 2,739,800 shares of our common stock for
approximately $2.8 million and allocated $2.7 million to restricted cash. Our
net repayments of capital lease obligations during the six months ended June 30,
2001 totaled approximately $2.2 million.

Non-cash investing and financing activities for the six months ended June 30,
2002 consisted of the issuance of a note payable to a bank of approximately $4.7
million, in conjunction with the acquisition of Goliath and $362,000 of new
capital lease obligations for property and equipment, resulting from a renewal
of an expired lease. Non-cash investing and financing activities for the six
months ended June 30, 2001 consisted of new capital lease obligations for
property and equipment of $150,000.

As of June 30, 2002, we had a note payable to a bank for approximately $4.7
million issued in connection with an acquisition. The note payable bears
interest at 7% per year. Payments on the note are interest only for the first
year. Principal and interest payments for the second, third and fourth years
will be based on a ten-year amortization schedule. The unpaid principal will be
paid in full at the end of the fourth year. The note payable is collateralized
by computer equipment and office equipment owned by the Company.

As of June 30, 2002, we had a master lease agreement to finance computer
equipment with Comerica Bank - California and/or Comerica Leasing Corporation,
as successor to Imperial Bank Equipment Leasing, a division of Imperial Bank.
The master lease agreement has an implied interest rate of approximately 10.5%.
As of June 30, 2002, approximately $544,000 was outstanding under this master
lease agreement. The five equipment schedules under the master lease agreement
expire on various dates through July 2003, and three of the five schedules have
expired. During the first quarter of 2002, we began negotiating a settlement of
one schedule nearing completion and began delaying payments on the other
equipment schedule under the master lease agreement. Concurrently, as part of
our company-wide efforts to restructure the terms and payments of facility and
equipment leases and reduce our overall operating cost structure, we initiated
efforts to renegotiate or settle all of the remaining lease payments. During
June 2002, Comerica applied to past due lease payments approximately $277,000 of
our funds on deposit at Comerica, most of which had secured equipment leases and
letters of credit. In the end of July 2002, Comerica took possession of the
leased equipment in order to sell the equipment and apply the proceeds to
amounts claimed. The net book value of the returned equipment was approximately
$272,000 as of June 30, 2002. By letter dated August 7, 2002, Comerica stated
that we owe Comerica approximately $1.4 million for casualty value, late
payments and other fees and expenses (with the proceeds from the sale of the
leased equipment to be applied to that amount) and demanded that we provide a
list of our accounts by August 16, 2002 so that Comerica could direct payment on
our accounts directly to Comerica, in satisfaction of amounts claimed. On August
13, 2002, we filed an action in Superior Court in Arizona against Comerica Bank
- California and Comerica Leasing Corporation and asked the court for an order
declaring that Comerica does not have a security interest giving it the right to
collect our accounts receivable and that Comerica is not entitled under its
leases to recover from us the casualty value of the leased equipment. We have
also asked the court for an order restraining Comerica from intercepting or
attempting to intercept payment on our accounts from our customers. We believe
that Comerica does not have the interest of a secured party in our accounts or
other assets and we intend to pursue this action vigorously. We will also
continue our efforts to renegotiate or settle past and future equipment lease
payments, but no assurance can be given that we will be successful in reducing
the amount of the equipment lease payments by negotiation, that we will prevail
in setting aside Comerica's claimed security interest in our assets or that
Comerica will not be determined to have the right to collect the casualty value
under its leases. There would be a material adverse affect on the Company if
Comerica were successful in its efforts to intercept payment on our accounts
receivables.

In June 2001, we deposited approximately $1.0 million into a restricted
certificate of deposit account. The funds in this account served as collateral
against various letters of credit. During the fourth quarter of 2001, the first
quarter of 2002, and the second quarter of 2002, $300,000, $227,000 and
$465,000, respectively, was used in connection with our closure of excess office
space and other obligations. At June 30, 2002, $414,000 of the restricted cash
was on deposit in the construction escrow account established for tenant
improvements at the headquarters facility and $19,000 was remaining in support
of a letter of credit, which $19,000 was drawn down subsequent to June 30, 2002.

                                       18
<PAGE>

RECENTLY ISSUED FINANCIAL STANDARDS

In June 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard No. 141, Business Combinations (SFAS 141), and
Statement of Financial Accounting Standard No. 142, Goodwill and Other
Intangible Assets (SFAS 142). SFAS 141 became effective for us as of July 1,
2001. It establishes new standards for accounting and reporting requirements for
business combinations and requires the purchase method of accounting be used for
all business combinations initiated after June 30, 2001. SFAS 142 became
effective for us on January 1, 2002 and requires, among other things, the
cessation of the amortization of goodwill. In addition, the standard includes
provisions for the reassessment of the useful lives of existing recognized
intangibles, a new method of measuring reported goodwill for impairment and the
identification of reporting units for purposes of assessing potential future
impairments of goodwill.

We have recorded $7.9 million of goodwill relating to the five acquisitions
completed after the effective date of SFAS 141, and there has been no
amortization expense recorded in the accompanying financial statements. As
discussed in Note 9 to our condensed consolidated financial statements, in
connection with SFAS 142's transitional goodwill impairment evaluation, the
Company recorded a non-cash charge of $3.2 million, relating to all of the
goodwill recorded in connection with the four acquisitions completed during
2001, and is reported in the caption "Cumulative effect of a change in
accounting principle." All of the charge was related to the Company's
acquisitions completed in 2001. The primary factors that resulted in the
impairment charge were the difficult economic environment in the IT professional
services sector and the doubt about the Company's ability to continue as going
concern. In accordance with SFAS 142, the fair value and carrying value of the
remaining goodwill of $4.7 million, relating to our acquisition, which we
completed in the first quarter of 2002, will be tested on the Company's annual
measurement date in the fourth quarter of 2002.

In August 2001, the FASB issued Statement of Financial Accounting Standard No.
143, Accounting for Asset Retirement Obligations (SFAS 143), which addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and for the associated asset retirement
costs. SFAS 143 requires an enterprise to record the fair value of an asset
retirement obligation as a liability in the period in which it incurs a legal
obligation associated with the retirement of tangible long-lived assets that
result from the acquisition, construction, development and/or normal use of the
assets. The enterprise also is to record a corresponding increase to the
carrying amount of the related long-lived assets and to depreciate that cost
over the life of the asset. The liability is changed at the end of each period
to reflect the passage of time (i.e., accretion expense) and changes in the
estimated future cash flows underlying the initial fair value measurement. The
provisions of SFAS 143 were effective for us on January 1, 2002 and are to be
applied prospectively. The adoption of SFAS 143 did not have a material impact
on our consolidated financial statements.

In August 2001, the FASB issued Statement of Financial Accounting Standard No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144)
that addresses financial accounting and reporting for the impairment or disposal
of long-lived assets, including discontinued operations. While SFAS 144
supercedes Statement of Financial Accounting Standard No. 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,
it retains many of the fundamental provisions of that Statement. SFAS 144 also
supercedes certain provisions of ABP Opinion No. 30, Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for
the disposal of a segment of a business. The provisions of SFAS 144 were
effective for us on January 1, 2002 and are to be applied prospectively. The
adoption of SFAS 144 did not have a material impact on our consolidated
financial statements.

In November 2001, the Emerging Issues Task Force of the FASB concluded that
reimbursements for "out of pocket" expenses should be classified as revenue and,
correspondingly, cost of services, in the income statement. The new accounting
treatment is applicable to us in the first quarter of 2002 and requires that
comparative financial statements for prior periods be reclassified in order to
ensure consistency for all periods presented. Accordingly, in the attached
statements of operations, we included revenues and cost of sales from the
reimbursements of expenses incurred of $215,000 and $44,000 for the quarters
ended June 30, 2002 and 2001, respectively and $421,000 and $114,000 for the six
month periods ended June 30, 2002 and 2001, respectively.

In April 2002, the FASB issued Statement of Financial Accounting Standard No.
145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections (SFAS 145), which addresses
financial accounting and reporting for reporting gains and losses from
extinguishment of debt, accounting for intangible assets of motor carriers and
accounting for leases. SFAS 145 requires that gains and losses from the early
extinguishment of debt



                                       19
<PAGE>

should not be classified as extraordinary, as previously required. SFAS 145 also
rescinds Statement 44, which was issued to establish accounting requirements for
the effects of transition to the provisions of the Motor Carrier Act of 1980
(Public Law 96-296, 96th Congress, July 1, 1980). Those transitions are
completed; therefore, Statement 44 is no longer necessary. Statement 145 also
amends Statement 13 to require sale-leaseback accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. Statement 145 also makes various technical corrections to existing
pronouncements. Those corrections are not substantive in nature. The provisions
of this statement relating to Statement 4 are applicable in fiscal years
beginning after May 15, 2002. The provisions of this Statement related to
Statement 13 are effective for transactions occurring after May 15, 2002. All
other provisions of this Statement are effective for financial statements issued
on or after May 15, 2002. The adoption of SFAS 145 is not expected to have a
material impact on our consolidated financial statements.

In June 2002, the FASB issued Statement of Financial Accounting Standards issued
SFAS No. 146, Accounting for Exit or Disposal Activities (SFAS 146). SFAS 146
addresses the recognition, measurement and reporting of costs associated with
exit and disposal activities, including restructuring activities. SFAS 146 also
addresses recognition of certain costs related to terminating a contract that is
not a capital lease, costs to consolidate facilities or relocate employees and
termination of benefits provided to employees that are involuntarily terminated
under the terms of a one-time benefit arrangement that is not an ongoing benefit
arrangement or an individual deferred compensation contract. SFAS 146 is
effective for exit or disposal activities that are initiated after December 31,
2002. The Company is in the process of evaluating the adoption of SFAS 146 and
its impact on the financial position and results of operations of the Company.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

To date, we have not utilized derivative financial instruments or derivative
commodity instruments. We do not expect to employ these or other strategies to
hedge market risk in 2002. We invest our cash in money market funds, which are
subject to minimal credit and market risk. We believe that the market risks
associated with these financial instruments are immaterial.

All of our revenues are realized currently in U.S. dollars and are from
customers primarily in the United States. Therefore, we do not believe that we
currently have any significant direct foreign currency exchange rate risk.



                                       20
<PAGE>

FACTORS THAT MAY AFFECT FUTURE RESULTS AND OUR STOCK PRICE

This Quarterly Report on Form 10-Q includes forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Act of 1934. Forward-looking statements give our current expectations
or forecasts of future events. Words such as "expect," "may," "anticipate,"
"intend," "would," "will," "plan," "believe," "estimate," "should," and similar
expressions identify forward-looking statements. Forward-looking statements in
this Form 10-Q include express or implied statements concerning our future
revenues, expenditures, capital or other funding requirements, the adequacy of
our current cash and working capital balances to fund our present and planned
operations and financing needs, expansion of and demand for our service
offerings, and the growth of our business and operations, as well as future
economic and other conditions both generally and in our specific geographic and
product and services markets. These statements are based on our estimates,
projections, beliefs, and assumptions and are not guarantees of future
performance. From time to time, we also may provide oral or written
forward-looking statements in other materials we release to the public.

We caution that the following important factors, among others, could cause our
actual results to differ materially from those expressed in forward-looking
statements made by or on behalf of us in filings with the Securities and
Exchange Commission, press releases, communications with investors, and oral
statements. Any of these factors, among others, could also negatively impact our
operating results and financial condition and cause the trading price of our
common stock to decline or fluctuate significantly. We undertake no obligation
to publicly update any forward-looking statements, whether as a result of new
information, future events or otherwise. You are advised, however, to consult
any further disclosures we make in our reports filed with the Securities and
Exchange Commission and in future public statements and press releases.

THE COMPANY IS SEEKING ADDITIONAL FINANCING WHICH, IF NOT AVAILABLE TO US, COULD
JEOPARDIZE OUR ONGOING OPERATIONS AND WHICH, IF AVAILABLE AND RAISED, COULD
DILUTE YOUR OWNERSHIP INTEREST IN US.

We incurred negative cash flows from operations in 2001 and continue to do so in
2002. We are in default of certain operating and capital lease provisions for
failure to make timely payment, have received several default notices during
2002 and have been named in a number of related lawsuits. The notices and
lawsuits relate primarily to facility lease commitments for closed offices and
capital lease commitments for computer equipment, office equipment and office
furniture. We are in the process of trying to settle these obligations on terms
as favorable as possible to the Company and have reached settlements with
several landlords and lessors. The settlements are, in many instances, subject
to us reaching agreement with other landlords and lessors and obtaining
financing to fund the settlements. If we are unable to obtain financing on terms
acceptable to us, or at all, we may choose or be required to limit or reduce our
scope of operations, cease looking for consultancies to consolidate with the
Company, or, under the worst of circumstances, pursue strategic alternatives
such as a sale, merger or recapitalization of the Company or seek protection
under reorganization, insolvency or similar laws. We are also pursuing sources
of additional funds in order to take advantage of acquisition or expansion
opportunities, develop new services and address unanticipated contingencies. If
the best available financing is raising additional capital through the sale of
equity securities or through taking on debt with an equity component, whether
for funding settlements and working capital needs or for growth through
acquisitions, your investment in us would be diluted. The inability to settle
obligations on favorable terms, raise financing for the settlements or for
working capital or other needs would materially and adversely affect the Company
and would likely cause our stock price to further decline.

WE HAVE RECEIVED A DELISTING NOTICE FROM NASDAQ; IF WE ARE UNABLE TO MAINTAIN A
NASDAQ SMALLCAP MARKET LISTING, OUR COMMON STOCK MAY BECOME EVEN MORE ILLIQUID
AND THE VALUE OF OUR SECURITIES MAY DECLINE FURTHER.

On June 6, 2002, on our application, the listing of our common stock was
transferred from The Nasdaq National Market to The Nasdaq SmallCap Market. On
August 13, 2002, the 180-day grace period for meeting the $1.00 minimum bid
price requirement expired, and on August 14, 2002, we received a delisting
notice from Nasdaq. The delisting notice states that our common stock will be
delisted at the opening of business on August 22, 2002 because we have not
regained compliance with the minimum $1.00 bid price per share requirement of
Marketplace Rule 4310(c)(8)(D). The company is not eligible for an additional
180 day grace period to regain compliance with that Marketplace Rule because we
do not meet the initial inclusion requirements of The Nasdaq SmallCap Market
under Marketplace Rule 4310(c)(2)(A). We will appeal the decision to a Listing
Qualifications Panel on or before August 21, 2002. If the appeal is not
successful, Nasdaq will delist our common stock. If this occurs, our common
stock will likely trade in the over-the-counter market on the National
Association of Securities Dealers' OTC Bulletin Board or in the so-called "pink
sheets" maintained by Pink Sheets LLC. Such alternative trading markets are
generally considered less liquid and efficient than Nasdaq, and although trading
in our stock is already relatively thin and sporadic, the liquidity of our
common stock may decline further because smaller quantities of shares would
likely be bought and sold, transactions could be delayed and news media coverage
of us

                                       21
<PAGE>

would diminish. These factors could result in lower prices and larger spreads in
the bid and ask prices for our common stock. Reduced liquidity may reduce the
value of our common stock and our ability to generate additional funding.

WE HAVE EXPERIENCED OPERATING LOSSES AND MAY INCUR OPERATING LOSSES IN FUTURE
PERIODS, WHICH COULD CAUSE THE PRICE OF OUR COMMON STOCK TO DECLINE FURTHER.

We had a net loss of approximately $2.5 million in the second quarter of 2002, a
net loss of approximately $13.2 million for the first six months of 2002, a net
loss of approximately $49.4 million for the year ended December 31, 2001, a net
loss of $25.4 million for the year ended December 31, 2000 and a net loss of
approximately $1.4 million for the year ended December 31, 1999. We expect to
continue to incur losses during 2002. The Company's auditors issued their
independent auditors' report dated February 15, 2001 stating the Company has
suffered negative cash flows from operations and has an accumulated deficit,
that raise substantial doubt about our ability to continue as a going concern.
If we do not achieve revenue growth, and are not able to reduce our obligations
for equipment and facilities that we no longer need or use, we could experience
operating losses greater than already anticipated in 2002 or for periods after
2002. These losses or any fluctuation in our operating results could cause the
market value of our common stock to decline further.

WE MAY INCUR EXPENDITURES RELATING TO CLOSED OFFICE LEASES WHICH ARE GREATER
THAN WE HAVE ANTICIPATED, WHICH EXPENDITURES WOULD REQUIRE US TO USE LIMITED
FINANCIAL RESOURCES AND WOULD ADVERSELY IMPACT OUR LIQUIDITY.

Through the second quarter of 2002, we have accrued approximately $4.7 million
for future cash expenditures relating to closing and consolidating offices. The
actual future expenditures related to these closed and consolidated offices may
be greater than our accrual, and, in that event, the additional expenses will
reduce earnings and cash in future periods. Any such reduction will adversely
impact our liquidity, operating results and the price for our common stock.

WE ANTICIPATE ACQUIRING MORE BUSINESSES, AND WE MAY INCUR INCREASED OPERATING
EXPENSES WITHOUT CORRESPONDING INCREASED REVENUES, WHICH MAY LIMIT OUR ABILITY
TO ACHIEVE OR MAINTAIN PROFITABILITY AND CAUSE THE PRICE OF OUR COMMON STOCK TO
DECLINE.

A key component of our current business strategy is to acquire like-minded peer
consultancies in geographic areas where we do not have a strong presence. We
also look for acquisition opportunities, without focusing on increasing our
geographic diversity, if there is an opportunity to strengthen a current service
offering or add a service offering which complements our current service
offerings. The risks of acquisitions include retaining clients, retaining key
employees, incurring higher than anticipated transaction expenses and other
unexpected expenses and diverting management's attention from daily operations
of our business. Acquiring businesses, especially in markets in which we have
limited prior experience, is risky. If we do not implement this strategy
successfully, we may incur increased operating expenses without increased
revenues, which could materially harm our operating results and stock price.

WE RELY ON A SMALL NUMBER OF CLIENTS FOR MOST OF OUR REVENUES AND OUR REVENUES
WILL DECLINE SIGNIFICANTLY IF WE CANNOT RETAIN OR REPLACE, OR IF WE EXPERIENCE
COLLECTION PROBLEMS FROM, THESE CLIENTS.

We derive, and expect to continue to derive, a significant portion of our
revenues from a limited number of clients. Virtually all of our client contracts
may be canceled by the client after a short notice period and without economic
penalty. Clients remain responsible to us for fees we earn through the date of
contract termination unless a valid offset exists. Revenues from specific
clients are likely to vary from period to period. A major client in one year may
not use our services in a subsequent year. The loss of a large client or project
in any period could result in a decline in our revenues and profitability from
period to period and cause significant and sudden declines or fluctuations in
the market value of our common stock. In addition, because a large portion of
our receivables relate to a limited number of clients and large projects,
write-offs attributable to one or a few of these clients or projects could
seriously deplete our allowance for doubtful accounts and significantly harm our
operating results.

BECAUSE THE MARKET FOR OUR SERVICES MAY NOT GROW DURING 2002, WE MAY BE UNABLE
TO BECOME PROFITABLE.

We offer services in the IT services market. The IT services market began
contracting in the second half of 2000 and has not rebounded. We do not
anticipate any meaningful growth in the IT services market in 2002. During 2000,
in anticipation of a continued increase in demand for IT services, we made
substantial infrastructure investments to support the anticipated demand. While
we have taken steps to reduce our costs and are making efforts to settle
obligations on vacated offices and


                                       22
<PAGE>

equipment leases, if demand for our services does not grow in the future, or if
we do not capture sufficient market share for these services, we may be unable
to achieve profitability.

OUR RESULTS OF OPERATIONS MAY VARY FROM QUARTER TO QUARTER IN FUTURE PERIODS
AND, AS A RESULT, WE MAY NOT MEET THE EXPECTATIONS OF OUR INVESTORS AND
ANALYSTS, WHICH COULD CAUSE OUR STOCK PRICE TO FLUCTUATE OR DECLINE.

Our revenues and results of operations have fluctuated significantly in the past
and could fluctuate significantly in the future. We incurred a net loss of $2.5
million in the second quarter of 2002, a net loss of $10.7 million in the first
quarter of 2002 and net losses of $8.2 million, $20.0 million, $8.8 million and
$12.5 million in the first, second, third, and fourth quarters of 2001,
respectively.

Our results may fluctuate due to the factors described in this Form 10-Q, as
well as: the loss of or failure to replace any significant clients; variation in
demand for our services; higher than expected bad debt write-offs; changes in
the mix of services that we offer; and variation in our operating expenses.

A substantial portion of our operating expense is related to personnel costs and
overhead, which cannot be adjusted quickly and is, therefore, relatively fixed
in the short term. Our operating expenses are based, in significant part, on our
expectations of future revenues. If actual revenues are below our expectations,
we may not achieve our anticipated operating results. Moreover, it is possible
that in some future periods our results of operations may be below the
expectations of investors and analysts. In this event, the market price of our
common stock is likely to decline.

IF WE FAIL TO KEEP PACE WITH THE RAPID TECHNOLOGICAL CHANGES THAT CHARACTERIZE
OUR INDUSTRY, OUR COMPETITIVENESS WOULD SUFFER, CAUSING US TO LOSE PROJECTS OR
CLIENTS AND CONSEQUENTLY REDUCING OUR REVENUES AND THE PRICE OF OUR COMMON
STOCK.

Our market and the enabling technologies used by our clients are characterized
by rapid, frequent, and significant technological changes. If we fail to respond
in a timely or cost-effective way to these technological developments, we may
not be able to meet the demands of our clients, which would affect our ability
to generate revenues and achieve profitability. We have derived, and expect to
continue to derive, a large portion of our revenues from creating solutions that
are based upon today's leading and developing technologies and which are capable
of adapting to future technologies. Our historical results of operations may not
reflect our new service offerings and may not give you an accurate indication of
our ability to adapt to these future technologies.

OUR FAILURE TO MEET CLIENT EXPECTATIONS OR DELIVER ERROR-FREE SERVICES COULD
DAMAGE OUR REPUTATION AND HARM OUR ABILITY TO COMPETE FOR NEW BUSINESS OR RETAIN
OUR EXISTING CLIENTS, WHICH MAY LIMIT OUR ABILITY TO GENERATE REVENUES AND
ACHIEVE OR MAINTAIN PROFITABILITY.

Many of our engagements involve the delivery of information technology services
that are critical to our clients' businesses. Any defects or errors in these
services or failure to meet clients' specifications or expectations could result
in: delayed or lost revenues due to adverse client reaction; requirements to
provide additional services to a client at no or a limited charge; refunds of
fees for failure to meet obligations; negative publicity about us and our
services; and claims for substantial damages against us.

In addition, we sometimes implement critical functions for high profile clients
or for projects that have high visibility and widespread usage in the
marketplace. If these functions experience difficulties, whether or not as a
result of errors in our services, our name could be associated with these
difficulties and our reputation could be damaged, which would harm our business.

WE MAY LOSE MONEY ON FIXED-PRICE CONTRACTS BECAUSE WE MAY FAIL TO ACCURATELY
ESTIMATE AT THE BEGINNING OF PROJECTS THE TIME AND RESOURCES REQUIRED TO FULFILL
OUR OBLIGATIONS UNDER OUR CONTRACTS; THE ADDITIONAL EXPENDITURES THAT WE MUST
MAKE TO FULFILL THESE CONTRACT OBLIGATIONS MAY CAUSE OUR PROFITABILITY TO
DECLINE OR PREVENT US FROM ACHIEVING PROFITABILITY AND COULD REDUCE THE PRICE OF
OUR COMMON STOCK.

Although we provide consulting services primarily on a time and materials
compensation basis, approximately 22% of our consulting revenue was derived from
fixed-price, fixed-time engagements during the three months ended June 30, 2002,
32% of our consulting revenue was derived from fixed-price, fixed-time
engagements for the first quarter of 2002, 14% of our consulting revenue was
derived from fixed-price, fixed-time engagements in 2001, and approximately 5%
of revenues



                                       23
<PAGE>

were derived from fixed-price, fixed-time engagements in 2000. The percentage of
our revenues derived from fixed-price, fixed time engagements will fluctuate and
may increase in the future, as influenced by changes in demand and market
conditions. Our failure to accurately estimate the resources required for a
fixed-price, fixed-time engagement or our failure to complete our contractual
obligations in a manner consistent with our projections or contractual
commitments could harm our overall profitability and our business. From time to
time, we have been required to commit unanticipated additional resources to
complete some fixed-price, fixed-time engagements, resulting in losses on these
engagements. We believe that we may experience similar situations in the future.
In addition, we may negotiate a fixed price for some projects before the design
specifications are finalized, resulting in a fixed price that is too low and
causing a decline in our operating results.

OUR LACK OF LONG-TERM CONTRACTS WITH CLIENTS AND OUR CLIENTS' ABILITY TO
TERMINATE CONTRACTS WITH LITTLE OR NO NOTICE REDUCES THE PREDICTABILITY OF OUR
REVENUES AND INCREASES THE POTENTIAL VOLATILITY OF OUR STOCK PRICE.

Our clients generally retain us on an engagement-by-engagement basis, rather
than under long-term contracts. In addition, our current clients can generally
reduce the scope of or cancel their use of our services without penalty and with
little or no notice. As a result, our revenues are difficult to predict. Because
we incur costs based on our expectations of future revenues, our failure to
predict our revenues accurately may cause our expenses to exceed our revenues,
which could cause us to incur increased operating losses. Although we try to
design and build complete integrated information systems for our clients, we are
sometimes retained to design and build discrete segments of the overall system
on an engagement-by-engagement basis. Since the projects of our large clients
can involve multiple engagements or stages, there is a risk that a client may
choose not to retain us for additional stages of a project or that the client
will cancel or delay additional planned projects. These cancellations or delays
could result from factors related or unrelated to our work product or the
progress of the project, including changing client objectives or strategies, as
well as general business or financial considerations of the client. If a client
defers, modifies, or cancels an engagement or chooses not to retain us for
additional phases of a project, we may not be able to rapidly re-deploy our
employees to other engagements and may suffer underutilization of employees and
the resulting harm to our operating results. Our operating expenses are
relatively fixed and cannot be reduced on short notice to compensate for
unanticipated variations in the number or size of engagements in progress. The
slowing in spending on business and IT consulting initiatives that began in the
second half of 2000 continues, and if current or potential clients cancel or
delay their IT initiatives, our business and results of operations could be
materially adversely affected.

WE MAY NOT BE SUCCESSFUL IN RETAINING OUR CURRENT TECHNOLOGY ALLIANCES OR
ENTERING INTO NEW ALLIANCES, WHICH COULD HAMPER OUR ABILITY TO MARKET OR DELIVER
SOLUTIONS, NEEDED OR DESIRED BY OUR CLIENTS AND LIMIT OUR ABILITY TO INCREASE OR
SUSTAIN OUR REVENUES AND ACHIEVE OR MAINTAIN PROFITABILITY.

We rely on vendor alliances for client referral and marketing opportunities,
access to advanced technology and training as well as other important benefits.
These relationships are non-exclusive and the vendors are free to enter into
similar or more favorable relationships with our competitors. Whether written or
oral, many of the agreements underlying our relationships are general in nature,
do not legally bind the parties to transact business with each other or to
provide specific client referrals, cross-marketing opportunities, or other
intended benefits to each other, have indefinite terms, and may be ended at the
will of either party. We may not be able to maintain our existing strategic
relationships and may fail to enter into new relationships. If we are unable to
maintain these relationships, the benefits that we derive from these
relationships, including the receipt of important sales leads, cross-marketing
opportunities, access to emerging technology training and certifications, and
other benefits, may be lost. Consequently, we may not be able to offer desired
solutions to clients, which would result in a loss of revenues and our inability
to effectively compete for clients seeking emerging or leading technologies
offered by these vendors.

BECAUSE WE OPERATE IN A HIGHLY COMPETITIVE AND RAPIDLY CHANGING INDUSTRY,
COMPETITORS COULD CAUSE US TO LOSE BUSINESS OPPORTUNITIES AND LIMIT OUR ABILITY
TO INCREASE OR SUSTAIN REVENUE LEVELS.

Although our industry experienced significant consolidation in 2001 and
continues to do so in 2002, the business areas in which we compete remain
intensely competitive and subject to rapid change. We expect competition to
continue and to intensify. Our competitors currently fall into several
categories and include a range of entities providing both general management and
information technology consulting services and Internet services. Many of our
competitors have longer operating histories, larger client bases, and greater
brand or name recognition, as well as greater financial, technical, marketing,
and public relations resources. Our competitors may be able to respond more
quickly to technological developments and changes in clients' needs. Further, as
a result of the low barriers to entry, we may face additional competition from
new entrants into our markets. We do not own any technologies that preclude or
inhibit competitors from


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<PAGE>

entering the general business areas in which we compete. Existing or future
competitors may independently develop and patent or copyright technologies that
are superior or substantially similar to our technologies, which may place us at
a competitive disadvantage. All of these factors could lead to competitors
winning new client engagements for which we compete. If this occurs, our ability
to generate increased revenues may be limited and we may not achieve
profitability.

WE MAY NOT BE ABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS AND, AS A RESULT,
WE COULD LOSE COMPETITIVE ADVANTAGES WHICH DIFFERENTIATE OUR SOLUTIONS AND OUR
ABILITY TO ATTRACT AND RETAIN CLIENTS.

Our success is dependent, in part, upon our intellectual property rights. We
rely upon a combination of trade secrets, confidentiality and nondisclosure
agreements, and other contractual arrangements, as well as copyright and
trademark laws to protect our proprietary rights. We have no significant patents
and no pending patent applications. We enter into confidentiality agreements
with our employees, we generally require that our consultants and clients enter
into these agreements, and we attempt to limit access to and distribution of our
proprietary information. Nevertheless, we may be unable to deter
misappropriation of our proprietary information or to detect unauthorized use
and take appropriate steps to enforce our intellectual property rights or
proprietary information.

We attempt to retain significant ownership or rights to use our internally
developed software applications which we can market and adapt through further
customization for other client projects. Under some of our client contracts, all
of our project developments are the property of the client and we have no right
or only limited rights to reuse or provide these developments in other client
projects. To the extent that we are unable to negotiate contracts, which permit
us to reuse code and methodologies, or to the extent that we have conflicts with
our clients regarding our ability to do so, we may be unable to provide services
to some of our clients within price and timeframes acceptable to these clients.

Although we believe that our services, trade or service names, and products do
not infringe upon the intellectual property rights of others, claims could be
asserted against us in the future. If asserted, we may be unable to successfully
defend these claims, which could cause us to cease providing some services or
products and limit any competitive advantage we derive from our trademarks or
names.

If any of these events occur, our ability to differentiate ourselves and compete
effectively could be limited and we may lose revenue opportunities.

WE OCCASIONALLY AGREE NOT TO PERFORM SERVICES FOR OUR CLIENTS' COMPETITORS,
WHICH MAY LIMIT OUR ABILITY TO GENERATE FUTURE REVENUES AND INHIBIT OUR BUSINESS
STRATEGY.

In order to secure particularly large engagements or engagements with industry
leading clients, we have agreed on limited occasions not to perform services, or
not to utilize some of our intellectual property rights developed for clients,
for competitors of those clients for limited periods of time ranging from one to
three years. In our agreement with American Express, our largest client in 2001
and 2000, we have agreed not to perform services for competitors of American
Express for one year after each project completion date and not to assign
consultants who have worked on American Express projects to other clients'
competitive projects for nine months after completing work for American Express.
These non-compete provisions reduce the number of our prospective clients and
our potential sources of revenue. These agreements also may limit our ability to
execute a part of our business strategy of leveraging our business expertise in
discreet industry segments by attracting multiple clients competing in those
industries. In addition, these agreements increase the significance of our
client selection process because some of our clients compete in markets where
only a limited number of companies gain meaningful market share. If we agree not
to perform services or to utilize intellectual property rights for a particular
client's competitors or competitive projects, we are unlikely to receive
significant future revenues in that particular market.

THE LOSS OF MR. JAMES G. GARVEY, JR., OUR FOUNDER, CHAIRMAN, CHIEF EXECUTIVE
OFFICER AND PRESIDENT, MAY HARM OUR ABILITY TO OBTAIN AND RETAIN CLIENT
ENGAGEMENTS, MAINTAIN A COHESIVE CULTURE, OR COMPETE EFFECTIVELY.

Our success will depend in large part upon the continued services of James G.
Garvey, Jr., our founder, Chairman, Chief Executive Officer and President. We
have an employment contract with Mr. Garvey. Mr. Garvey is precluded under his
agreement from competing against us for one year should he leave us. The loss of
Mr. Garvey's services could harm us and cause a loss of investor confidence in
our business, which could cause the trading price of our stock to decline. In
addition, if Mr. Garvey resigns to join a competitor or to form a competing
company, the loss of Mr. Garvey and any resulting loss of existing or potential
clients to any competitor could harm our business. If we lose Mr. Garvey, we may
be unable to prevent


                                       25
<PAGE>

the unauthorized disclosure or use by other companies of our technical
knowledge, practices, or procedures. In addition, due to the substantial number
of shares of our common stock owned by Mr. Garvey, the loss of Mr. Garvey's
services could cause investor or analyst concern that Mr. Garvey may sell a
large portion of his shares, which could cause a rapid and substantial decline
in the trading price of our common stock.

THE SALE OF A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON STOCK IN THE PUBLIC
MARKET COULD ADVERSELY AFFECT THEIR MARKET PRICE, NEGATIVELY IMPACTING YOUR
INVESTMENT.

There are a substantial number of shares of our common stock potentially
available for sale in the public market. The sale of a substantial number of
shares in the public market could depress the market price of our common stock
and could impair our ability to raise capital through the sale of additional
equity securities.

THE HOLDINGS OF MR. GARVEY MAY LIMIT YOUR ABILITY TO INFLUENCE THE OUTCOME OF
DIRECTOR ELECTIONS AND OTHER MATTERS SUBJECT TO A STOCKHOLDER VOTE, INCLUDING A
SALE OF OUR COMPANY ON TERMS THAT MAY BE ATTRACTIVE TO YOU.

James G. Garvey, Jr., our founder, Chairman, Chief Executive Officer and
President, currently owns approximately 64% of our outstanding common stock. Mr.
Garvey's stock ownership and management positions enable him to exert
considerable influence over our Company, including the election of directors and
the approval of other actions submitted to our stockholders. In addition,
without the consent of Mr. Garvey, we may be prevented from entering into
transactions that could be viewed as beneficial to other stockholders, including
a sale of the Company. This could prevent you from selling your stock to a
potential acquirer at prices that exceed the market price of our stock, or could
cause the market price of our common stock to decline.

OUR CHARTER DOCUMENTS COULD MAKE IT MORE DIFFICULT FOR A THIRD PARTY TO ACQUIRE
US, WHICH COULD LIMIT YOUR ABILITY TO SELL YOUR STOCK TO AN ACQUIRER AT A
PREMIUM PRICE OR COULD CAUSE OUR STOCK PRICE TO DECLINE.

Our certificate of incorporation and by-laws may make it difficult for a third
party to acquire control of us, even if a change in control would be beneficial
to stockholders. Our certificate of incorporation authorizes our board of
directors to issue up to 5,000,000 shares of "blank check" preferred stock.
Without stockholder approval, the board of directors has the authority to attach
special rights, including voting and dividend rights, to this preferred stock.
With these rights, preferred stockholders could make it more difficult for a
third party to acquire our Company.

Our by-laws do not permit any person other than at least three members of our
board of directors, our President, the Chairman of the Board, or holders of at
least a majority of our stock to call special meetings of the stockholders. In
addition, a stockholder's proposal for an annual meeting must be received within
a specified period in order to be placed on the agenda. Because stockholders
have limited power to call meetings and are subject to timing requirements in
submitting stockholder proposals for consideration at meetings, any third-party
takeover or other matter that stockholders wish to vote on that is not supported
by the board of directors could be subject to significant delays and
difficulties.

If a third party finds it more difficult to acquire us because of these
provisions, you may not be able to sell your stock at a premium price that may
have been offered by the acquirer, and the trading price of our stock may be
lower than it otherwise would be if these provisions were not in effect.

OUR STOCK REPURCHASE PLAN MAY ADVERSELY AFFECT THE TRADING VOLUME AND LIQUIDITY
OF OUR COMMON STOCK AND COULD CAUSE OUR STOCK PRICE TO DECLINE.

In December 2000, our board authorized a stock repurchase plan which authorized
us to purchase up to $2 million of our common stock on the open market in
compliance with applicable SEC regulations. In August 2001, our board authorized
an increase in the maximum amount from $2 million to $7 million. During 2001, we
repurchased 4,951,800 shares of our common stock at a cost of approximately $5.3
million. We currently have no plan to repurchase additional shares of our common
stock. However, if we do repurchase more shares of our common stock under this
plan, the number of shares of our common stock outstanding will decrease. This
decrease would likely reduce the trading volume of our common stock and could
adversely impact the liquidity and value of our common stock.





                                       26
<PAGE>

PART II.  OTHER INFORMATION

ITEM 1.   LEGAL PROCEEDINGS

During July and August 2001, four purported class action lawsuits were filed in
the United States District Court for the Southern District of New York against
us, certain of our current and former officers and directors (the "Individual
Defendants") and the members of the underwriting syndicate involved in our
initial public offering (the "Underwriter Defendants"). All four lawsuits have
been transferred to Judge Scheindlin for coordination with more than 300 similar
cases. The suits generally allege that: (1) the Underwriter Defendants allocated
shares of our initial public offering to their customers in exchange for higher
than standard commissions on transactions in other securities; (2) the
Underwriter Defendants allocated shares of our initial public offering to their
customers in exchange for the customers' agreement to purchase additional shares
of our common stock in the after-market at pre-determined prices; (3) we and the
Individual Defendants violated section 10(b) of the Securities Exchange Act of
1934 and/or section 11 of the Securities Act of 1933; and (4) the Individual
Defendants violated section 20 of the Securities Exchange Act of 1934 and/or
section 15 of the Securities Act of 1933. The plaintiffs seek unspecified
compensatory damages and other relief. We have sought indemnification from the
underwriters of our initial public offering. The plaintiffs filed a consolidated
amended complaint in April 2002. In July 2002, we, as part of the group of
issuers of shares named in the consolidated litigation and the Individual
Defendants, filed a motion to dismiss the consolidated amended complaints. Also
in July 2002, the plaintiffs offered to dismiss the Individual Defendants,
without prejudice, in exchange for a Reservation of Rights and Tolling Agreement
from each Individual Defendant. All of the Individual Defendants in our four
lawsuits have indicated that they will accept this offer. We believe that the
claims against us are unfounded and without merit and intend to vigorously
defend this matter.

In December 2001, we terminated a lease with MCW Brickyard Commercial, L.L.C.
("MCW") for new office space at 699 South Mill Avenue in Tempe, Arizona as a
result of MCW's failure to deliver the leased premises in a timely manner and
filed suit against MCW in Superior Court in Maricopa County, Arizona to recover
damages we incurred in preparing to move to the premises and approximately
$414,000 remaining in a construction escrow account. MCW filed an answer,
denying all liability and alleging that we caused delays in delivery of the
leased premises. During March 2002, MCW filed an amended answer and supplemental
counterclaim for lost rent, lost parking income, lost expense income,
commissions and unpaid construction costs. MCW also asks for indemnity for
construction costs and its attorneys' fees and interest. We believe that the
counterclaims are without merit, intend vigorously to prosecute our claim
against MCW and to defend against MCW's counterclaim.

In February 2002, we filed suit against Oracle Corporation ("Oracle") in
Superior Court in Maricopa County, Arizona for breach of contract, breach of
implied covenant of good faith and fair dealing, negligent misrepresentation and
fraud. We have joined Fleet Business Credit, L.L.C. ("Fleet") as a necessary
party. Based upon representations of Oracle, we entered into a lease schedule
for software licenses, a payment plan agreement for payments of approximately
$2.6 million and a related ordering schedule. The payment plan agreement was
purportedly assigned to Fleet. Oracle filed, and in June 2002 the court granted,
a motion to dismiss the suit for improper venue, but the court left the action
pending as against Fleet. We have reached a conditional settlement with Fleet
that calls for payment to Fleet of $100,000 on or before August 31, 2002. If we
do not pay Fleet by that date, there is no binding settlement and Fleet would
likely pursue a final payment of approximately $500,000 under the payment plan
agreement, interest and its fees and expenses.

In connection with offices which have been closed and vacated, there are five
pieces of litigation pending against the Company, all of which have been brought
as actions for past rent and eviction or unlawful detainer. Of these five, one
is presently on appeal of our successful motion to vacate a landlord's judgment,
one is subject to a conditional settlement (subject to us making an initial
payment of approximately $35,000 on or before September 15, 2002) and three
others remain pending before the courts. The aggregate amount claimed in the
three pending matters is approximately $735,000. The Company is actively
pursuing settlements with the four landlords with which we have not settled. In
the event we are unable to reach acceptable settlements, the Company intends to
defend itself in these lawsuits.

On August 13, 2002, we filed an action in Superior Court in Arizona against
Comerica Bank - California and Comerica Leasing Corporation. In July 2002,
Comerica took possession of the equipment we had leased from Comerica, and, by
letter dated August 7, 2002, Comerica Bank - California asserted that we owe
Comerica approximately $1.4 million for casualty value, late payments and other
fees and expenses (with the proceeds from the sale of the leased equipment to be
applied to that amount). In its letter, Comerica also claimed that it has a
security interest giving it the right to recover that amount by collecting our
accounts receivable. In our complaint, we asked the court for an order declaring
that Comerica does not have a security interest or the right to collect our
accounts and that Comerica is not entitled under its leases to


                                       27
<PAGE>

recover from us the casualty value of the leased equipment. We have also asked
the court for an order restraining Comerica from intercepting or attempting to
intercept payment on our accounts from our customers. We believe that Comerica
does not have the interest of a secured party in our accounts and we intend to
pursue this action vigorously. No assurance can be given that the Court will
grant the relief requested.

Additionally, we are, from time to time, party to various legal proceedings
arising in the ordinary course of business. We evaluate such claims on a
case-by-case basis, and our policy is to vigorously contest any such claims
which we believe are without merit.


ITEM 3. DEFAULTS UPON SENIOR SECURITIES

We are in default on a master lease agreement to finance computer equipment with
Comerica Bank - California and/or Comerica Leasing Corporation, as successor to
Imperial Bank Equipment Leasing, a division of Imperial Bank. As of June 30,
2002, approximately $544,000 was outstanding under this master lease agreement.
By letter dated August 7, 2002, Comerica stated that we owe Comerica
approximately $1.4 million for casualty value, late payments and other fees and
expenses (with the proceeds from the sale of the leased equipment to be applied
to that amount) and demanded that we provide a list of our accounts by August
16, 2002 so that Comerica could direct payment on our accounts directly to
Comerica, in satisfaction of amounts claimed. On August 13, 2002, we filed an
action in Superior Court in Arizona against Comerica Bank - California and
Comerica Leasing Corporation and asked the court for an order declaring that
Comerica does not have a security interest giving it the right to collect our
accounts receivable and that Comerica is not entitled under its leases to
recover from IIS the casualty value of the leased equipment. We have also asked
the court for an order restraining Comerica from intercepting or attempting to
intercept payment on our accounts from our customers. Please see "Liquidity and
Capital Resources," "Factors that May Affect Future Results and Our Stock Price"
and "Legal Proceedings" for additional information.


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

On May 22, 2001, the Company held its annual meeting of stockholders. At the
annual meeting, the Company's stockholders elected James G. Garvey, Jr., John M.
Blair, Stephen W. Brown, R. Nicholas Loope and Richard M. Gardner as directors
of the Company and ratified the appointment of KPMG LLP as the Company's
independent public accountants for the fiscal year ending December 31, 2002.
With respect to the ratification of KPMG's appointment, 14,876,176 votes were
cast in favor, 22,209 were cast against and 18,648 were withheld. With respect
to the election of Directors, votes were cast as follows:

   ----------------------- --------------- ---------------- ----------------
    NOMINEE                   VOTES FOR     VOTES AGAINST    VOTES WITHHELD
   ----------------------- --------------- ---------------- ----------------
    James G. Garvey, Jr.     14,791,758          --             125,275
   ----------------------- --------------- ---------------- ----------------
    John M. Blair            14,811,963          --             105,070
   ----------------------- --------------- ---------------- ----------------
    Stephen W. Brown         14,814,038          --             102,995
   ----------------------- --------------- ---------------- ----------------
    R. Nicholas Loope        14,813,838          --             103,195
   ----------------------- --------------- ---------------- ----------------
    Richard M. Gardner       14,812,063          --             104,970
   ----------------------- --------------- ---------------- ----------------


ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

    (a)  Exhibits

         10.47  Employment Agreement between the Company and Randall Eckel

         10.48  Employment Agreement between the Company and Kenneth J. Biehl

         99.1   Certification of James G. Garvey, Jr., Chairman, Chief Executive
                Officer and President

         99.2   Certification of William A. Mahan, EVP, Chief Financial Officer
                and Treasurer

    (b)  Reports on Form 8-K

         o  Form 8-K filed June 4, 2002, to file as exhibit 99.1 a press release
            titled "IIS Common Stock to Trade on the NASDAQ Small Cap Market."




                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(D) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.


                            INTEGRATED INFORMATION SYSTEMS, INC.

Dated:  August 14, 2002

                            /s/ William A. Mahan
                            ------------------------------
                            William A. Mahan
                            Executive Vice President, Chief Financial Officer
                            and Treasurer


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