<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, 2001

                                       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 10, 2001, THERE WERE 16,553,625 SHARES OF COMMON
                     STOCK, $0.001 PAR VALUE, OUTSTANDING
<PAGE>

              INTEGRATED INFORMATION SYSTEMS, INC. AND SUBSIDIARY



                               TABLE OF CONTENTS
                               -----------------

<TABLE>
<CAPTION>

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

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

             Condensed Consolidated Balance Sheets as of June 30, 2001 and
             December 31, 2000..................................................................................        3
`
             Condensed Consolidated Statements of Operations for Three and Six
             Months Ended June 30, 2001 and 2000................................................................        4

             Condensed Consolidated Statements of Cash Flows for Six
             Months Ended June 30, 2001 and 2000................................................................        5

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

     ITEM 2  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
             CONDITION AND RESULTS OF OPERATIONS................................................................        7

     ITEM 3  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
             MARKET RISK........................................................................................       10

PART II  OTHER INFORMATION......................................................................................       18

     ITEM 1  LEGAL PROCEEDINGS..................................................................................       18

     ITEM 2  CHANGES IN SECURITIES AND USE OF PROCEEDS..........................................................       18

     ITEM 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                       18

     ITEM 6  EXHIBITS AND REPORTS ON FORM 8-K...................................................................       18

SIGNATURES......................................................................................................       19

SIGNATURE PAGE..................................................................................................       19
</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,
                                                                                                 2001         2000
                                                                                             (UNAUDITED)
<S>                                                                                           <C>           <C>
ASSETS
Current assets:
  Cash and cash equivalents                                                                      $ 25,654       $ 46,541
  Restricted cash                                                                                   2,707             --
  Accounts receivable, net of allowance of $6,543 and $6,794, respectively                          4,909          6,572
  Income tax receivable                                                                                17            111
  Unbilled revenues on contracts                                                                      190            472
  Prepaid expenses and other current assets                                                         1,017          3,109
                                                                                                 --------       --------
          Total current assets                                                                     34,494         56,805
Property and equipment, net                                                                        10,985         23,647
Other assets                                                                                        1,039            872
                                                                                                 --------       --------
                                                                                                 $ 46,518       $ 81,324
                                                                                                 ========       ========
LIABILITIES, CONVERTIBLE PREFERRED
STOCK AND STOCKHOLDERS'  EQUITY
Current liabilities:
  Accounts payable and accrued expenses                                                          $  4,747       $  6,494
  Current installments of capital lease obligations                                                 4,061          4,322
  Deferred revenues on contracts                                                                      265            449
                                                                                                 --------       --------
          Total current liabilities                                                                 9,073         11,265
Capital lease obligations, less current installments                                                2,143          3,909
                                                                                                 --------       --------
          Total liabilities                                                                        11,216         15,174
Series A Convertible Preferred Stock, $.001 par value;
  5,000,000 shares authorized; zero shares issued
  and outstanding at June 30, 2001 and December 31, 2000                                               --             --
Series B Convertible Preferred Stock, $.001 par value;
  5,000,000 shares authorized; zero shares issued
  and outstanding at June 30, 2001 and December 31, 2000                                               --             --
Series C Convertible Preferred Stock, $.001 par value;
  5,000,000 shares authorized; zero shares issued
  and outstanding at June 30, 2001 and December 31, 2000                                               --             --
Stockholders' equity:
  Common stock, $.001 par value, authorized 100,000,000
    shares, issued and outstanding 18,198,775 and
    20,683,922 shares at June 30, 2001
    and December 31, 2000, respectively                                                                18             21
  Additional paid-in capital                                                                       93,763         93,613
  Accumulated deficit                                                                             (55,613)       (27,441)
  Accumulated other comprehensive loss:
        Foreign currency translation                                                                  (47)           (43)
                                                                                                 --------       --------
                                                                                                   38,121         66,150
  Treasury stock, at cost, 2,739,800 shares at June 30, 2001                                       (2,819)            --
                                                                                                 --------       --------
          Total stockholders' equity                                                               35,302         66,150
                                                                                                 --------       --------
                                                                                                 $ 46,518       $ 81,324
                                                                                                 ========       ========
</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)
                                  (UNAUDITED)

<TABLE>
<CAPTION>
                                                                                  THREE MONTHS ENDED      SIX MONTHS ENDED
                                                                                        JUNE 30,               JUNE 30,
                                                                                    2001       2000        2001       2000
                                                                                  --------   --------    --------    -------
<S>                                                                               <C>        <C>         <C>         <C>
 Revenues......................................................................   $  8,655   $ 15,381    $ 19,092    $25,835
 Cost of revenues..............................................................      8,649      8,782      17,960     14,328
 Other charges.................................................................     11,306         --      11,306         --
                                                                                  --------   --------    --------    -------
           Gross profit (loss).................................................    (11,300)     6,599     (10,174)    11,507
 Operating expenses:
   Selling and marketing.......................................................      1,484      2,722       2,935      4,955
   General and administrative..................................................      7,379      7,912      15,657     13,013
                                                                                  --------   --------    --------    -------
           Total operating expenses............................................      8,863     10,634      18,592     17,968
                                                                                  --------   --------    --------    -------
 Loss from operations..........................................................    (20,163)    (4,035)    (28,766)    (6,461)
 Interest income, net..........................................................        210        818         594        977
                                                                                  --------   --------    --------    -------
 Loss before income taxes......................................................    (19,953)    (3,217)    (28,172)    (5,484)
 Provision for income taxes....................................................         --         --          --         --
                                                                                  --------   --------    --------    -------
       Net loss................................................................   $(19,953)  $ (3,217)   $(28,172)   $(5,484)
                                                                                  ========   ========    ========    =======
 Loss per share:
    Basic and diluted..........................................................   $  (1.05)  $   (.16)   $  (1.42)   $  (.30)
                                                                                  ========   ========    ========    =======

                                                                                    19,087     20,395      19,792     18,084
    Weighted average number of common shares outstanding.......................   ========   ========    ========    =======
</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
                                                                                                   2001        2000
                                                                                                 --------    --------
                                                                                                     (UNAUDITED)
<S>                                                                                             <C>          <C>
  Cash flows from operating activities:
    Net loss..................................................................................   $(28,172)   $(5,484)
    Adjustments to reconcile net loss to net cash
       used in operating activities:
       Depreciation and amortization..........................................................      4,917      2,337
       Other charges..........................................................................     11,306         --
       Change in allowance for doubtful accounts..............................................       (251)     1,287
       Increase (decrease) in cash resulting from changes in:
         Accounts receivable..................................................................      1,914     (6,947)
         Income tax receivable................................................................         94        428
         Unbilled revenues on contracts.......................................................        282        (77)
         Prepaid expenses and other current assets............................................        (70)    (1,199)
         Other assets.........................................................................       (167)    (2,086)
         Accounts payable and accrued expenses................................................     (1,747)     1,953
         Deferred revenues on contracts.......................................................       (184)      (136)
                                                                                                 --------    -------
            Net cash used in operating activities.............................................    (12,078)    (9,924)
                                                                                                 --------    -------
  Cash flows from investing activities:
    Capital expenditures......................................................................     (1,248)    (9,458)
                                                                                                 --------    -------
            Net cash used in investing activities.............................................     (1,248)    (9,458)
                                                                                                 --------    -------
  Cash flows from financing activities:
    Restricted cash...........................................................................     (2,707)        --
    Net repayments on lines of credit.........................................................         --     (1,015)
    Long-term debt repayments.................................................................         --       (885)
    Repayment of capital lease obligations....................................................     (2,178)    (1,003)
    Proceeds of initial public offering, net of expenses......................................         --     67,516
    Issuance of Series C Convertible Preferred Stock, net of expenses                                  --     19,411
    Issuance of common stock and exercise of stock options....................................        147        159
    Repurchase of common stock................................................................     (2,819)        --
                                                                                                 --------    -------
            Net cash provided by (used in) financing activities...............................     (7,557)    84,183
                                                                                                 --------    -------
  Effect of exchange rate on cash.............................................................         (4)       (13)
                                                                                                 --------    -------
  Increase (decrease) in cash and cash equivalents............................................    (20,887)    64,788
  Cash and cash equivalents, at beginning of period...........................................     46,541        863
                                                                                                 --------    -------
    Cash and cash equivalents, at end of period...............................................   $ 25,654    $65,651
                                                                                                 ========    =======
  Acquisition of property and equipment and assumption of
     capital lease obligations................................................................   $    150    $ 9,211
                                                                                                 ========    =======
</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

     The accompanying unaudited condensed consolidated financial statements have
been prepared by Integrated Information Systems, Inc. (the "Company") pursuant
to the rules and regulations of the Securities and Exchange Commission regarding
interim financial reporting. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
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, 2000. 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, 2001 are not necessarily indicative of the results to be expected
for any future period or the full fiscal year.

2. Use of Estimates

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

3. Revenue Recognition

     Revenues for time-and-material contracts are recognized as the services are
rendered. Revenues pursuant to fixed fee contracts are generally 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.

4. Restricted Cash

     In March and May 2001, the Company deposited $1,806,000 into a construction
escrow account.  The funds in this account are being used to fund the build-out
of tenant improvements at the Company's new 71,000 square foot facility in
Tempe, Arizona.

     In June 2001, the Company deposited $1,000,000 into a restricted
certificate of deposit account.  The funds in this account serve as collateral
against various letters of credit totaling $1,000,000.

5. Repurchase of Common Stock

     During the six months ended June 30, 2001, the Company repurchased
2,739,800 shares of its Common Stock at a cost of approximately $2,822,000.
These shares are reflected as treasury stock in the accompanying financial
statements.

                                       6
<PAGE>

6.   Other Charges

     During the second quarter of 2001, the Company recorded a charge of
approximately $11.3 million related to certain underutilized data center
facility computer equipment and leasehold improvements of $9.1 million, and
related inventoried software licenses of $2.2 million. During this quarter,
management determined that the future revenues to be generated from the
Company's application outsourcing services would not be sufficient to recover
the cost of the assets utilized in such operations, and, accordingly, performed
an analysis for impairment under the guidance of FASB Statement No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of.

     Based on this analysis, management determined that the fair market values
of the computer equipment and leasehold improvements related to the data center
were less than the net book value of these assets, and, therefore, recorded an
asset impairment charge of $9.1 million to reduce the book value of the assets
to their estimated fair market value, which was determined to be zero.
Additionally, management determined during the second quarter of 2001 that the
software licenses to be utilized to serve certain application outsourcing
services customers also had a fair value less than their book value, and,
therefore, recorded a charge of $2.2 million to write the licenses down to their
estimated fair value, which was determined to be zero.

     These assets and software licenses are utilized solely for the purpose of
generating application outsourcing revenues, therefore, the charges have been
recorded as costs of revenues.

7. 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 JUNE 30,   SIX MONTHS ENDED JUNE 30,
                                                                   2001           2000           2001          2000
                                                                 --------        -------       --------       -------
                                                                        (UNAUDITED)                  (UNAUDITED)
<S>                                                              <C>             <C>           <C>            <C>
 Net loss.................................................       $(19,953)       $(3,217)      $(28,172)      $(5,484)
                                                                 ========        =======       ========       =======

 Weighted average outstanding common shares...............         19,087         20,395         19,792        18,084
 Effect of dilutive securities:
      Stock options and warrants..........................            148          1,667            177         1,839
      Antidilutive effect of securities...................           (148)        (1,667)          (177)       (1,839)
                                                                 --------        -------       --------       -------
 Weighted average common equivalent shares
   outstanding............................................         19,087         20,395         19,792        18,084
                                                                 ========        =======       ========       =======
  Loss per share:
      Basic and diluted...................................       $  (1.05)       $  (.16)      $  (1.42)      $  (.30)
                                                                 ========        =======       ========       =======
</TABLE>

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

OVERVIEW

     Since our inception in 1989, we have been a leader in applying emerging
technologies by building and operating integrated information systems that allow
our clients to digitally transform their business processes.  Our success in
assisting clients has been accompanied by growth in revenue, personnel, and
infrastructure over our twelve-year history.

     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 fee contracts was approximately 5% in 2000
and 11% in 1999.  We provide our application outsourcing services at 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 and
benefits and depreciation of hosting facility property and equipment.  Sales and
marketing expenses consist primarily of compensation and benefits, and the costs
of marketing programs.  General and administrative expenses consist primarily of
compensation and benefits for our executive management and our finance,
administration, 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 will continue to derive a
significant portion of our revenues from a limited number of clients who may
change from year to year.  Any cancellation, deferral, or significant reduction
in work performed for our principal clients could harm our business and cause
our operating results to fluctuate significantly from period to period.  As a
result of our investments in infrastructure and increase in operating expenses
in 1999 and 2000, we incurred a net loss in 2000 and during the first six months
of 2001.  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 necessarily be
meaningful and should not be relied upon as indications of future performance.

RESULTS OF OPERATIONS

REVENUES. Revenues decreased 44% to $8.7 million for the three months ended June
30, 2001, compared to $15.4 million in the same period of 2000. For the first
six months of 2001, revenues decreased 26% to $19.1 million compared to $25.8
million in same period of 2000. Revenues from our largest customer decreased to
$1.7 million and $4.7 million for the three and six months ended June 30, 2001
compared to $2.9 million and $5.2 million

                                       7
<PAGE>

for the same periods of 2000. Declines in billed hours and new engagements
resulted in decreases of approximately $4.5 million and $6.0 million in revenues
for the three and six months ended June 30, 2001 compared to the same periods in
2000. Declines in average hourly bill rates resulted in decreases of
approximately $1.1 million and $800,000 in revenues for the three and six months
ended June 30, 2001 compared to the same periods of 2000. During the first six
months of 2001, $1.7 million of services were provided to customers for which no
revenue was recognized due to the fact that collectibility was not reasonably
assured.

COST OF REVENUES. Cost of revenues increased 127% to $20.0 million for the three
months ended June 30, 2001, compared to $8.8 million for the same period of
2000. For the first six months 2001, cost of revenues increased 105% to $29.3
million compared to $14.3 million for the same period of 2000.  These increases
were due primarily to a non-cash charge of approximately $11.3 million that was
recorded in the three months ended June 30, 2001.  This charge related to
certain underutilized data center facility computer equipment and leasehold
improvements of $9.1 million and related inventoried software licenses of $2.2
million. The remaining increase for the six months ended June 30, 2001, was
attributable to increases of approximately $2.0 million in personnel cost and
$1.7 million in depreciation. Project personnel were 285 at June 30, 2001
compared to 405 at June 30, 2000.

     During the quarter ended June 30, 2001, management determined that the
future revenues to be generated from the Company's application outsourcing
services would not be sufficient to recover the cost of the assets utilized in
such operations, and accordingly, performed an analysis for impairment under the
guidance of FASB Statement No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of.

     Based on this analysis, management determined that the fair market values
of the computer equipment and leasehold improvements related to the data center
were less than the net book value of these assets, and, therefore, recorded an
asset impairment charge of $9.1 million to reduce the book value of the assets
to their estimated fair market value, which was determined to be zero.
Additionally, management determined during the second quarter of 2001 that the
software licenses to be utilized to serve certain application outsourcing
services customers also had a fair value less than their book value, and,
therefore, recorded a charge of $2.2 million to write the licenses down to their
estimated fair value, which was determined to be zero.

     These assets and software licenses are utilized solely for the purpose of
generating application outsourcing revenues, therefore, the charges have been
recorded as cost of revenues.

SELLING AND MARKETING EXPENSES. Selling and marketing expenses decreased 45% to
$1.5 million for the three months ended June 30, 2001, compared to $2.7 million
for the same period of 2000. For the first six months of 2001, selling and
marketing expenses decreased 42% to $2.9 million compared to $5.0 million for
the same period of 2000.  The decreases are due primarily to reductions of
dedicated sales and marketing personnel and decreases in spending for
advertising and promotion for the first six months of 2001 compared to the same
period of 2000. As a percentage of revenues, selling and marketing expenses
decreased to 17% and 15% for the three and six months ended June 30, 2001, from
18% and 19% for the same periods of 2000.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased 6% to $7.4 million for the three months ended June 30, 2001, compared
to $7.9 million for the same period of 2000. For the first six months of 2001,
general and administrative expenses increased 21% to $15.7 million compared to
$13.0 million for the same period of 2000. The decrease for the three months
ended June 30, 2001 was primarily attributable to reductions of general and
administrative personnel and facility rent expense. The increase for the six
months ended June 30, 2001 was attributable to approximately $1.4 million
additional facility rent expense due to regional office expansion that occurred
in the second quarter of 2000, approximately $900,000 of additional
depreciation expense, and approximately $1.2 million to additional compensation
and benefits paid to administrative personnel. These increases were offset by a
reduction of approximately $600,000 of bad debt expense. The balance of the
increase was related to increases in other expenses such as telecommunications,
professional services, and office administration. As a percentage of revenues,
general and administrative expenses increased to 85% and 82% for the three and
six months ended June 30, 2001, from 51% and 50% for the same periods of 2000.

INTEREST INCOME, NET. Interest income, net of interest expenses, decreased to
$210,000 for the three months ended June 30, 2001, compared to $818,000 for the
same period of 2000. For the first six months of 2001, interest income, net of
interest expenses, decreased to $594,000 compared to $1.0 million for the same
period of 2000.  The decreases are due primarily to the use of invested proceeds
from both our preferred stock financing in January 2000 and our initial public
offering in March and April 2000 during the first six months of 2001.

LIQUIDITY AND CAPITAL RESOURCES

     Since inception, we have funded our operations and investments in property
and equipment through cash generated from operations, 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 our initial public offering of
4,945,000 shares of our common stock.

     At June 30, 2001, we had approximately $25.7 million in cash and cash
equivalents and $25.4 million in working capital, as compared to $46.5 million
and $45.5 million at December 31, 2000.

     For the six months ended June 30, 2001 and 2000, net cash used in operating
activities was $12.1 million and $9.9 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, amortization and
asset impairment, and fluctuations in accounts receivable, prepaid expenses and
other current assets, and accounts payable and accrued expenses.

     For the six months ended June 30, 2001 and 2000, net cash used in investing
activities was $1.2 million and $9.5 million, respectively.  Cash used in
investing activities in each period consisted primarily of purchases of computer
equipment, furniture and leasehold improvements to support growth in our
infrastructure. During 2000 we invested approximately $7 million, net of leased

                                       8
<PAGE>

furniture and equipment, in our application outsourcing services data center. We
also invested in geographical expansion during 2000.  We anticipate additional
capital expenditures of approximately $3 million in 2001.

     For the six months ended June 30, 2001, net cash used in financing
activities was $7.6 million, compared to net cash provided by financing
activities of $84.2 million for the six months ended June 30, 2000.  During the
first six months of 2001, we repurchased 2,739,800 shares of our common stock
for approximately $2.8 million.  Net repayments of capital lease obligations
were approximately $2.2 million for the same period.  We allocated $2.8 million
to restricted cash and used $100,000 during the first six months of 2001.  Cash
provided by financing activities in 2000 related to the sale of our preferred
stock in a private placement and our common stock in our initial public
offering, partially offset by debt repayment.

     Non-cash investing and financing activities for the six months ended June
30, 2001 and 2000 consisted of new capital lease obligations for property and
equipment of $150,000 and $9.2 million, respectively.

     As of June 30, 2001, we had a master lease agreement to finance up to $3.0
million of computer equipment with Imperial Bank.  The master lease agreement
has an implied interest rate of approximately 10.5%.  As of June 30, 2001,
approximately $1.7 million was outstanding under the master lease agreement.
The master lease agreement expires on various dates through June 2002.

     We believe that current cash balances will be sufficient to meet our
working capital and capital expenditure requirements for the remainder of 2001.
We may need additional financing to fund our cash requirements beyond 2001.  In
this regard, we expect to continue to invest in our business in an effort to
grow revenues.  Such additional financing, if needed, may not be available on
terms acceptable to us, if at all.  In June 2001, the Company deposited
$1,000,000 into a restricted certificate of deposit account.  The funds in this
account serve as collateral against various letters of credit totaling
$1,000,000.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

     In July 2001, the FASB issued Statement No. 141, Business Combinations, and
Statement No. 142, Goodwill and Other Intangible Assets.  Statement 141 requires
that the purchase method of accounting be used for all business combinations
initiated after June 30, 2001 as well as all purchase method business
combinations completed after June 30, 2001.  Statement 141 also specifies
criteria intangible assets acquired in a purchase method business combination
must meet to be recognized and reported apart from goodwill, noting that any
purchase price allocable to an assembled workforce may not be accounted for
separately.  Statement 142 will require that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of Statement 142.
Statement 142 will also require that intangible assets with definite useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with SFAS
No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of.

     The Company is required to adopt the provisions of Statement 141 as of July
1, 2001, and Statement 142 effective January 1, 2002. Furthermore, any goodwill
and any intangible asset determined to have an indefinite useful life that are
acquired in a purchase business combination completed after June 30, 2001 will
not be amortized, but will continue to be evaluated for impairment in accordance
with the appropriate pre-Statement 142 accounting literature. The Company has
not recorded any goodwill or intangible assets acquired in business combinations
completed before July 1, 2001.

     Statement 141 will require upon adoption of Statement 142, that the Company
evaluate its existing intangible assets and goodwill that were acquired in a
prior purchase business combination, and to make any necessary reclassifications
in order to conform with the new criteria in Statement 141 for recognition apart
from goodwill.  Upon adoption of Statement 142, the Company will be required to
reassess the useful lives and residual values of all intangible assets acquired
in purchase business combinations, and make any necessary amortization period
adjustments by the end of the first interim period after adoption.  In addition,
to the extent an intangible asset is identified as having an indefinite useful
life, the Company will be required to test the intangible asset for impairment
in accordance with the provisions of Statement 142 within the first interim
period.  Any impairment loss will be measured as of the date of adoption and
recognized as the cumulative effect of a change in accounting principle in the
first interim period.

     In connection with the transitional goodwill impairment evaluation,
Statement 142 will require the Company to perform an assessment of whether there
is an indication that goodwill is impaired as of the date of adoption.  To
accomplish this the Company must identify its reporting units and determine the
carrying value of each reporting unit by assigning the assets and liabilities,
including

                                       9
<PAGE>

the existing goodwill and intangible assets, to those reporting units as of the
date of adoption. The Company will then have up to six months from the date of
adoption to determine the fair value of each reporting unit and compare it to
the reporting unit's carrying amount. To the extent a reporting unit's carrying
amount exceeds its fair value, an indication exists that the reporting unit's
goodwill may be impaired and the Company must perform the second step of the
transitional impairment test. In the second step, the Company must compare the
implied fair value of the reporting unit's goodwill, determined by allocating
the reporting unit's fair value to all of it assets (recognized and
unrecognized) and liabilities in a manner similar to a purchase price allocation
in accordance with Statement 141, to its carrying amount, both of which would be
measured as of the date of adoption. This second step is required to be
completed as soon as possible, but no later than the end of the year of
adoption. Any transitional impairment loss will be recognized as the cumulative
effect of a change in accounting principle in the Company's statement of
operations.

     Finally, any unamortized negative goodwill existing at the date Statement
142 is adopted must be written off as the cumulative effect of a change in
accounting principle.

     As of July 1, 2001, the date of adoption of Statement 141, the Company had
no unamortized goodwill and no unamortized identifiable intangible assets
subject to the transition provisions of Statement 141. The Company has recorded
no amortization expense related to goodwill for the year ended December 31, 2000
and the six months ended June 30, 2001. The adoption of Statement 142 on January
1, 2002, is not expected to have a material effect on our consolidated financial
statements.

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 2001. 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.


           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 "expects," "may," "anticipates,"
"intends," "would," "will," "plans," "believes," "estimates," "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
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, in the
future 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.

                                      10
<PAGE>

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

     We had a net loss of approximately $25.4 million for the year ended
December 31, 2000 and a net loss of approximately $28.2 million for the six
months ended June 30, 2001.  We expect to continue to incur losses in 2001. If
we do not achieve revenue growth or reduce expenses we could experience
operating losses greater than already anticipated or for periods after 2001.
These losses or any fluctuation in our operating results could cause the market
value of our common stock to decline further.

IF OUR COMMON STOCK PRICE REMAINS BELOW $1.00 IN 2001, WE MAY BE DELISTED FROM
NASDAQ, REDUCING THE LIQUIDITY AND VALUE OF OUR COMMON STOCK.

     At various times since January 2001, our common stock has traded for less
than $1.00 per share on the Nasdaq National Market.  If a security listed on
Nasdaq trades for less than $1.00 for thirty consecutive days, Nasdaq begins a
process pursuant to which the issuer's securities may be delisted from the
Nasdaq.  Any delisting of our common stock on Nasdaq would adversely affect the
liquidity of our common stock and further depress the common 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.  Our two largest clients accounted
for 41% and 34% of our revenues during the first six months of 2001 and in
fiscal 2000, respectively.

     Virtually all of our client contracts may be canceled by the client
following limited notice and without economic penalty; however, the client is
responsible for fees earned through the date of contract termination unless a
valid offset exists. The revenues derived from specific clients are likely to
vary from period to period, and 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 exceed our
allowance for doubtful accounts and significantly harm our operating results.

     In the first six months of 2001 and in fiscal 2000, we recorded bad debt
expense of $611,000 and $11.8 million , respectively.  Of the $11.8 million in
bad debt expense incurred in 2000, approximately $7.4 million was attributable
to development stage and dot-com clients that have not been able to pay as a
result of the slow-down in funding for start up ventures in 2000.  The remaining
$4.4 million in bad debt expense was attributable to disputes with clients.  We
are currently in arbitration with these clients to resolve these disputes.
Certain of these clients have asserted counter-claims against us.

SOME OF OUR CLIENTS ARE EMERGING COMPANIES THAT HAVE LITTLE OR NO OPERATING
HISTORY AND MAY LACK THE RESOURCES TO PAY OUR FEES, WHICH COULD CAUSE US TO
INCUR LOSSES ON THESE ACCOUNTS.

     We provide services to many small emerging companies that have limited
operating histories and resources to pay our fees. Occasionally, we provide
services to select start-up companies in exchange for equity in those clients.
These companies often have little or no earnings or cash flow and their business
is generally at greater risk of failing than more established, traditional
businesses. As a result, these clients may be unable to pay for our services in
a timely manner, or at all. This would reduce our cash flow, making it difficult
to carry on our business without additional funds, and could lead to the
inefficient allocation of our professional and other resources. In addition, if
the equities we receive from these companies decline in value, we may be
required to reduce the value of these equity investments. We have not accepted
any equity from our customers for services rendered during the first six months
of 2001.

THE MARKET FOR OUR SERVICES MAY NOT GROW AS ANTICIPATED AND HURT OUR ABILITY TO
BECOME PROFITABLE.

     While the IT services market in which we compete with our consulting and
application outsourcing services steadily grew in 2000, this growth was lower
than anticipated.  In anticipation of a continued increase in demand for
consulting and application

                                      11
<PAGE>

outsourcing services, we made substantial infrastructure investments to support
these demands. If demand for either of these types of services does not grow as
was anticipated , or if we do not capture sufficient market share for these
services, we may not be able to achieve profitability.

THE VALUATION MODEL FOR COMPANIES SUCH AS OURS HAS CHANGED AND OUR INABILITY TO
ACHIEVE PROFITABILITY WOULD MATERIALLY ADVERSELY AFFECT OUR STOCK PRICE.

     When our stock became publicly traded in 2000, companies in our sector were
valued generally upon revenue growth, with little regard for profitability.
Over the past few periods, companies in our sector have been increasingly
measured based on cash flows and profits.  If we are unable to achieve
profitability and positive cash flow, our stock price will continue to suffer
and could further decline, and the liquidity for our stock could deteriorate
further as well.

IF WE ARE UNABLE TO ATTRACT AND RETAIN PROFESSIONAL STAFF, WE WILL BE UNABLE TO
PROVIDE OUR SERVICES EFFECTIVELY AND CONSEQUENTLY MAY BE UNABLE TO INCREASE OR
MAINTAIN CURRENT REVENUE LEVELS OR ACHIEVE OR MAINTAIN PROFITABILITY, WHICH
WOULD CAUSE THE PRICE OF OUR COMMON STOCK TO DECLINE.

     We derive substantially all of our revenue from the billings of our
professional services personnel on projects. If we fail to attract and retain
professionals, we may not be able to successfully compete for new projects,
timely finish existing projects, or generally carry out our business plan. The
continuing evolution of new technology requires integrated solutions implemented
by professionals qualified in leading and emerging technologies. There is
competition for professionals with the skills required to provide these
solutions. We may lose prospective qualified employees to clients or
competitors. We may not attract a sufficient number of highly skilled
professionals, or retain, train, and motivate the professionals that we do
attract. Failure to do so could impair our ability to adequately manage and
complete our existing projects or obtain new projects. In addition, declines in
the trading price of our common stock could materially and adversely affect
employee morale and retention and other aspects of our business.

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 net losses of
$25.4 million and $28.2 million for 2000 and the first six months of 2001,
respectively. In 2000, our quarterly net losses ranged from $2.3 million in the
first quarter to $16.3 in the fourth quarter. You should not rely on period-to-
period comparisons of operations as an indication of future performance.

     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;
          .  variati0n in demand for our services;
          .  higher than expected bad debt write-offs;
          .  changes in the mix of services that we offer; and
          .  increases 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 analysts and investors. In this event, the market price of
our common stock is likely to decline.

                                      12
<PAGE>

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 5% of our consulting revenue was derived from
fixed-price, fixed-time engagements in 2000, and approximately 7% of revenues
were derived from fixed-price, fixed-time engagements for the six months ended
June 30, 2001. The percentage of our revenues derived from fixed-price, fixed
time engagements may increase in the future, as influenced by changes in demand
and market conditions. While we believe we have the ability to estimate the
expected cost to be incurred under any given contract, 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

                                      13
<PAGE>

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.

     Since the second half of 2000, many companies have experienced financial
difficulties or uncertainty and have begun to cancel or delay spending on
business and IT consulting initiatives.  The financial difficulties of many dot-
com companies may reduce the urgency of larger companies' IT initiatives.  If
current or potential clients continue to 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.

IF WE ARE UNABLE TO SUCCESSFULLY OPERATE OUR REGIONAL OFFICES, 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 business strategy is to increase revenues delivered
from our offices in Atlanta, Boston, Denver, Las Vegas, Los Angeles, Irvine,
Jacksonville, and San Francisco as well as our solutions development center in
India.  We may not be able to operate our regional offices profitably or
successfully expand these offices. If we do not implement this strategy
successfully, we may incur increased operating expenses without increased
revenues, which would harm our operating results and our stock price.

IF OUR EFFORTS TO DEVELOP BRAND AWARENESS ARE NOT SUCCESSFUL, WE MAY NOT BE ABLE
TO INCREASE OUR REVENUES SUFFICIENTLY TO OFFSET THE MARKETING COSTS THAT WE WILL
INCUR IN THESE EFFORTS.

     Because the information technology professional service industry recently
experienced a decline in demand, an element of our business strategy is to
develop and maintain widespread awareness of our brand name in our target
markets. If our marketing efforts are not successful, we may not experience
increases in revenues.

                                      14
<PAGE>

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

     The business areas in which we compete are intensely competitive and
subject to rapid change. Consequently, we expect competition to continue and to
intensify.  Competitors could hire professionals or win new client engagements
that we are competing for. If this occurs, our ability to generate increased
revenues may be limited and we may not achieve profitability. Our competitors
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 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.

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 secret, confidentiality and nondisclosure
agreements, and other contractual arrangements, as well as copyright and
trademark laws to protect our proprietary rights. We have no patents or 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 or
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, 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

                                      15
<PAGE>

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.

OUR LONG SALES CYCLES MAKE OUR REVENUES DIFFICULT TO PREDICT, WHICH COULD CAUSE
OUR REVENUES OR PROFITABILITY TO BE BELOW ANALYST OR INVESTOR EXPECTATIONS,
CAUSING OUR STOCK PRICE TO FLUCTUATE AND DECLINE SIGNIFICANTLY.

     The timing of our revenues is difficult to predict because of the length
and variance of the time required to complete a sale. Our sales cycle typically
ranges in length from three months to nine months and is sometimes longer. Prior
to retaining us for a project, our clients often undertake an extensive review
of their systems, needs, and budgets and may require approval at various levels
within their organization. The length or unpredictability of our sales cycle
could cause our revenues or profitability to be below the expectations of
analysts or investors and our stock price to fluctuate significantly.

IF WE ARE UNABLE TO SUCCESSFULLY POSITION AND SELL OUR APPLICATION OUTSOURCING
SERVICES, OUR PROFITABILITY AND THE PRICE OF OUR COMMON STOCK MAY DECLINE.

     Our ability to increase revenues and profitability depends in part on the
adoption and acceptance of third-party application hosting services by our
clients. We have expended significant resources and expect to continue to invest
to increase our data center capacity to accommodate our hosting services. To
date, these services have not been profitable and we have not been able to
attract and retain a significant number of clients. If we do not achieve
profitability from these services, our operating results and stock price will
continue to be negatively affected. In June 2001, we recorded a non-cash charge
of $11.3 million relating to certain under-utilized data center assets.

THE LOSS OF MR. JAMES G. GARVEY, JR., OUR FOUNDER, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, 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 President, Chief Executive Officer, and founder. 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 services
of Mr. Garvey 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 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.

WE MAY NEED ADDITIONAL CAPITAL WHICH, IF NOT AVAILABLE TO US, MAY ALTER OUR
BUSINESS PLAN OR LIMIT OUR ABILITY TO ACHIEVE GROWTH IN REVENUES AND WHICH, IF
AVAILABLE AND RAISED, WOULD DILUTE YOUR OWNERSHIP INTEREST IN US.

     We incurred negative cash flows from operations in 2000, and continue to do
so in 2001.  Although we believe that we have sufficient cash to sustain
negative cash flows from operations for the balance of the year, thereafter we
may need to raise additional funds through public or private equity or debt
financings in order to:

          .    support capital expenditures;
          .    take advantage of acquisition or expansion opportunities;
          .    develop new services;
          .    address working capital needs; or
          .    address unanticipated contingencies.

     Our inability to obtain financing on terms acceptable to us, or at all, may
limit our ability to increase revenues or to achieve profitability. Our stock
price, like the stock price of many competitors in our industry, has been
depressed in recent periods, which could limit our ability to obtain any needed
financing on acceptable terms, or at all. In addition, if we are able to raise
additional

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<PAGE>

capital through the sale of equity securities, your investment in us would be
diluted, which could cause our stock price to further decline.

THE VOLUME OF TRADING OF OUR COMMON STOCK COULD FLUCTUATE SIGNIFICANTLY,
ADVERSELY AFFECTING OUR STOCK PRICE.

     The stock prices of many technology companies, such as ours, have declined
significantly in recent periods. If investor interest in these stocks continues
to decline generally or does not increase, the price of our common stock could
continue to decline suddenly and significantly.

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 currently available for sale in
the public market. The sales of a substantial number of shares of our common
stock 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., a director, executive officer, and our founder,
currently owns approximately 64% of our outstanding common stock. Mr. Garvey's
stock ownership and management positions enable him to exert considerable
influence over us, including in 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 Integrated
Information Systems. 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 CURRENT STOCK REPURCHASE PLAN MAY ADVERSELY AFFECT THE TRADING VOLUME AND
LIQUIDITY OF OUR COMMON STOCK AND COULD CAUSE OUR STOCK PRICE TO DECLINE.

     In May 2001, our board authorized a stock repurchase plan, which authorizes
us to purchase up to $5 million of our common stock on the open market in
compliance with applicable SEC regulations. If we continue to repurchase our
common stock under this

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<PAGE>

plan, the number of shares of our common stock outstanding will decrease. This
decrease could reduce the trading volume of our common stock, which may
adversely impact the liquidity and value of our common stock. As of August 10,
2001, we have repurchased 4,390,700 shares of our common stock at a cost of
                          ---------
approximately $4.7 million.

PART II.  OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

     Beginning on or about July 10, 2001, a number of purported class action
lawsuits have been filed in the United States District Court for the Southern
District of New York against the Company, certain of its current and former
officers and directors, and the members of the underwriting syndicate involved
in the Company's initial public offering.  The lawsuits are essentially
identical, and purport to bring suit on behalf of those who purchased the
Company's publicly traded securities between March 17, 2000 and June 27, 2001.
Plaintiffs allege that defendants made false and misleading statements, purport
to assert claims for violations of the federal securities laws, and seek
unspecified compensatory damages and other relief.  The Company believes the
claims are without merit and intends to defend the actions vigorously.

ITEM 2.   CHANGES IN SECURITIES AND USE OF PROCEEDS

     On March 16, 2000, the Securities and Exchange Commission declared
effective our Registration Statement on Form S-1 (File No. 333-94861) for our
initial public offering. On March 22, 2000, IIS closed its offering for
4,600,000 shares of Common Stock at a public offering price of $15.00 per share.
On April 19, 2000, IIS closed an offering of an additional 690,000 shares at the
same public offering price pursuant to exercise of the underwriters' over-
allotment option, 345,000 of which shares were sold by IIS, and 345,000 were
sold by James G. Garvey, Jr., the founder, Chairman, CEO, and President of IIS.

     Through June 30, 2001, approximately $40.0 million of IIS' proceeds from
the offering have been applied to working capital, to capital improvements to
our facilities, and to repurchase shares of our common stock. The remaining net
proceeds are being maintained in a portfolio of money market funds and
investment grade securities.

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

     On May 24, 2001, the Company held its annual meeting of stockholders. At
the annual meeting, the Company's stockholders voted to amend the Company's 1997
Long-Term Incentive Plan to increase the aggressive number of shares in respect
of which awards may be granted under the plan to 6,000,000 and to quality
options granted under the plan as "performance-based compensation" under Section
162(m) of the Internal Revenue. The stockholders approved these amendments with
10,837,655 votes in favor of this amendment, 1,089,417 votes opposed, and zero
votes abstaining. Stockholders also approved an amendment to the Employee Stock
Purchase Plan to increase the aggregate number of shares available under the
plan to 700,000 with 11,741,637 votes in favor of this amendment, 223,645 votes
opposed, and zero votes abstaining.

ITEM 6.   EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits

     3.1     Amended and Restated Certificate of Incorporation (incorporated by
             reference to Exhibit 3.3 of the Company's Quarterly Report on Form
             10-Q (File No. 333-94861) for the period ending June 30, 2000).

     3.2     Amended and Restated Bylaws (incorporated by reference to Exhibit
             3.2 of the Company's Annual Report on Form 10-K (File No. 333-
             94861) for the period ending December 31, 2000).

     10.30   Lease Agreement between the Company and Regency Tower LLC dated
             February 22, 2001.

     10.31   Assignment and Assumption of Lease between the Company, The CIT
             Group/Equipment Financing, Inc., and Birtcher Arizona, LLC Manager
             for AmberJack, Ltd. dated July 10, 2001.

     10.32   Assignment and Assumption of Lease between the Company, The CIT
             Group/Equipment Financing, Inc., and Birtcher Arizona, LLC Manager
             for AmberJack, Ltd. dated July 10, 2001.

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<PAGE>

(b)  Reports on Form 8-K

     The Company filed a Current Report on Form 8-K on July 18, 2001, relating
     to a class action lawsuit filed against the Company and certain of its
     current and former directors.


SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities and
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.
                                            Registrant


                                            /s/ David A. Wirthlin
                                            ---------------------
                                            David A. Wirthlin
                                            Chief Financial and Principal
                                            Accounting Officer
Date: August 14, 2001

                                      19
<PAGE>

                                 Exhibit Index

   3.1  Amended and Restated Certificate of Incorporation (incorporated by
        reference to Exhibit 3.3 of the Company's Quarterly Report on Form 10-Q
        (File No. 333-94861) for the period ending June 30, 2000).

   3.2  Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 of
        the Company's Annual Report on Form 10-K (File No. 333-94861) for the
        period ending December 31, 2000).

  10.30 Lease Agreement between the Company and Regency Tower LLC dated
        February 22, 2001.

  10.31 Assignment and Assumption of Lease between the Company, The CIT Group/
        Equipment Financing, Inc., and Birtcher Arizona, LLC Manager for
        AmberJack, Ltd. dated July 10, 2000.

  10.32 Assignment and Assumption of Lease between the Company, The CIT Group/
        Equipment Financing, Inc., and Birtcher Arizona, LLC Manager for Amber-
        Jack, Ltd. dated July 10, 2001.

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