EPICEDGE INC - 10-Q Quarterly Report

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

Form 10-Q

[X] QUARTERLY REPORT UNDER 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: 001-15493

EPICEDGE, INC.
Formerly Known as Design Automation Systems, Inc.
(Exact name of Registrant as specified in its charter)

TEXAS 75-1657943
(State or other jurisdiction of (IRS Employer
Incorporation or organization) Identification Number)

5508 Two Ninety West, Suite 300
Austin, TX 78735
512-261-3346
(Address and telephone number of principal executive offices)

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 filing
requirements for the past 90 days.

X Yes No
--- ---

The number of shares of common stock of the Registrant outstanding at August 9,
2002 was 18,200,336.

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EPICEDGE, INC.
FORM 10-Q
FOR THE QUARTER ENDED June 30, 2002

INDEX

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

EPICEDGE, INC.
CONDENSED BALANCE SHEETS

See notes to condensed financial statements.

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EPICEDGE, INC.
CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

See notes to condensed financial statements.

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EPICEDGE, INC.
CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

See notes to condensed financial statements.

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EPICEDGE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The accompanying unaudited condensed financial statements have been
prepared by EpicEdge, Inc. (the "Company" or "EpicEdge") 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 financial statements and notes thereto for
the year ended December 31, 2001 included in the Company's Annual
Report on Form 10-K. The accompanying condensed financial statements
reflect all adjustments (consisting solely of normal, recurring
adjustments) that 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 months ended June 30, 2002
are not necessarily indicative of the results to be expected for any
future period or the full fiscal year.

2. Amortization of Goodwill and Other Purchased Intangible Assets

Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets" ("SFAS 142"), which revises the accounting for
purchased goodwill and intangible assets, became effective for the
Company on January 1, 2002. Under SFAS No. 142, goodwill, with balances
of $460,000 at June 30, 2002, and December 31, 2001, and intangibles
with indefinite lives will no longer be amortized, but will be tested
for impairment annually and also in the event of an impairment
indicator.

The Company assessed the carrying value of its goodwill in the second
quarter of 2002 to determine the complete impact of the adoption of
SFAS No. 142. No further impairment was required at June 30, 2002.

The Company's net loss on a pro forma basis, assuming the cessation of
goodwill amortization as required under SFAS No. 142 had been in effect
from January 1, 2001 is as follows:

3. Notes Payable and Financial Restructuring

In February 2001, the Company adopted a strategy and a plan of
execution to reduce its workforce and other costs in order to stabilize
the organization.

In February 2001, the Company hired a consulting group to assist in
designing and executing a repayment plan (the "Plan") with its
unsecured creditors. This Plan, which was executed in June 2001, after
achieving an acceptable percentage of consents from the unsecured
creditors, was designed to repay this group over time either in-full
for those creditors whose balance was $5,000 or less, or who were
willing to accept $5,000 as full payment, or up to 60% of $3,094,000,
which represented the original unsecured accounts payable amount as of
February 1, 2001. The Plan further provided that, if sufficient cash
was available, the Company could pay a total of 30% of the original
unsecured accounts payable amount by December 31, 2001, and this total
amount would fully and completely

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satisfy the Company's obligations to the unsecured creditors.
Substantial payments were made to the unsecured creditors of the
Company during 2001 in accordance with the Plan. The then remaining
balance of $1,049,000 would be paid quarterly at four (4%) percent of
the original balance through June 2004, unless the remaining unsecured
creditors agree to a lesser amount over a shorter time. Based upon the
payables satisfied by payments made under the Plan, the Company
recognized an extraordinary gain from this restructuring of $18,000 and
$45,000 in the three and six months ended June 30, 2002, respectively.

In June 2001, the Company began negotiations with certain existing
stockholders and convertible debt holders for additional funding to
provide the ability to execute on the unsecured creditor payment plan
(see above), pay or renegotiate legacy expenses, and provide working
capital to execute on the current operating plan of the Company.
Although the final documents were not executed until 2002, the Company
received $1,050,000 as of December 31, 2001 as interim bridge financing
in the form of convertible promissory notes ("June Convertible
Notes")(see Note 4). The Company received additional funding of
$860,000 under the June Convertible Notes in February and early March
2002. In addition, in April and May 2002, the Company received an
additional $1,240,000 under the June Convertible Notes. On April 16,
2002, the terms were finalized on these convertible notes, subject to
stockholder approval, which was granted at the 2002 Annual Meeting held
in July 2002 (see Note 4). The total amount to be received under these
new convertible notes is a minimum of $2,650,000 up to a maximum of
$4,500,000 ($3,150,000 of which has been received as of June 2002). The
entire amount received under the new convertible notes is secured by
all of the Company's assets. Upon receiving shareholder approval of the
amendment to the Articles of Incorporation, which was granted at the
2002 Annual Meeting held in July 2002, all but $1,100,000 of the
outstanding balance on these new convertible notes, including any
accrued but unpaid interest of $109,000 at June 30, 2002, were to be
converted into shares of Series B Preferred Stock. The additional
$1,100,000 may be converted at the sole election of the holder,
Edgewater. These notes, consisting of the outstanding balance, plus any
accrued interest, are to be exchanged into shares of Series B
Convertible Preferred Stock. On July 31, 2002, the Company and the
noteholders agreed to delay the conversion of the June Convertible
Notes until all of the closing conditions have been satisfied (see Note
4). Until converted, these June Convertible Notes are for a term of one
year and are due April 2003, and have a stated interest rate of 8%.

Additional features of the June Convertible Notes are that they are
secured, until converted, by all investments, accounts receivable,
inventory and property, subject only to a first lien (see Note 4) and
they carry with them demand registration rights.

Also on April 16, 2002, the terms of $5,000,000 July Convertible Notes
with Edgewater Private Equity Fund III, L.P. and Fleck T.I.M.E. Fund,
L.P. were renegotiated, subject to stockholder approval, which was
granted at the 2002 Annual Meeting held in July 2002 (see Note 4).
Under the new terms of the $5,000,000 July Convertible Notes, the
principal and accrued interest are to be exchanged into Series A
Convertible Preferred Stock (see Note 4) with a stated par value of
approximately $5.9 million at June 30, 2002, and a maturity date of
August 1, 2002. As a result of the delay of the pending conversion (see
Note 4), on August 1, 2002 these notes were amended to mature on April
16, 2003.

Additionally, on April 16, 2002, the principal and accrued interest
($128,000 at June 30, 2002) on $1,000,000 of the December Convertible
Notes (see Note 4) are also to be converted into Series A Preferred
Stock, and 2,000,000 of the warrants issued along with the December
Convertible Notes are to be relinquished. Also the holders of the
$1,000,000 of the December Convertible Notes waive any defaults and all
events of default under that agreement.

In conjunction with and as part of the conditions prior to executing
the final documents, the June Convertible Notes required that terms of
the November Convertible Note be renegotiated. On April 16, 2002, the
Company renegotiated the November Convertible Note, as amended,
($958,000 at June 30, 2002) such that the new terms are that the
November Convertible Note bears an annual interest at the rate of 8%,
are convertible at the lender's option into the Company's common stock
at $.25 per share and matures on December 1, 2004. In addition, the
promissory notes required that the note holder relinquish the 2,000,000
warrants that were issued along with the November Convertible Note and
that the Company enter into a share return agreement with three
original stockholders, one of which is the former Chairman, major
stockholder, and a November Convertible Note holder, for the return of
a total of 10,295,210 shares. Both of these additional requirements
were completed as of December 31, 2001.

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Also on April 16, 2002, of the remaining $500,000 under the December
Convertible Notes, $300,000 was due and was paid in April 2002 and the
remaining $221,000, consisting of remaining principle and accrued and
unpaid interest as of April 2002, plus any additional accrued and
unpaid interest is to be paid by January 10, 2003. The remaining
1,000,000 warrants for common stock at $0.01 per share that we issued
in conjunction with this portion of the December Convertible Notes are
not relinquished and therefore remain in effect.

As discussed above, as part of the transactions on April 16, 2002,
certain convertible notes are to be exchanged for Series A and Series B
Convertible Preferred Stock subject to stockholder approval, which was
granted at the 2002 Annual Meeting held in July 2002 (see Note 4) and
certain other closing conditions.

The following table summarizes the convertible notes payable at June
30, 2002 and the estimated pro-forma effects of the pending conversion
(see Note 4). These convertible notes are described and classified as
current or long-term based upon contractual maturities, as amended in
April 2002.

4. Pending Preferred Stock Transactions and related Pro-forma Effects

In April 2002, the Company entered into a Note and Preferred Stock
Purchase Agreement with Edgewater, Fleck T.I.M.E., DeJoria and Loche
(the "Note Agreement"). In accordance with a Note Agreement, the Board
of Directors has approved and the Company currently anticipates issuing
approximately 9,443,000 shares of Series A Preferred Stock, par value
$0.01 per share, and approximately 2,886,000 shares of Series B
Preferred Stock, par value $0.01 per share (the "Equity Closing"). An
amendment to the Company's Articles of Incorporation was approved by
the shareholders at the Company's Annual Meeting held in July 2002 that
increased the number of shares of authorized Preferred Stock to
30,000,000 shares to permit the conversion of the notes covered by the
Note Agreement. At the Annual Meeting the shareholders also approved an
increase in common shares to 100,000,000. The table below depicts, as
of July 12, 2002, the preferred stock estimated to be issued in
exchange for the convertible notes discussed in Note 3 above.

The Series A Preferred Stock has the following terms: a conversion rate
equal to one share of common stock for each $.75 of stated value or a
liquidation preference such that in the event of any liquidation,
dissolution or winding up of EpicEdge, the holders thereof shall be
entitled to receive, at their option, either: (a) in preference to the
holders of the common stock and on a pro-rated pari passu basis with
the Series B Preferred Stock, an amount equal to 2.75 times the stated
value, (b) a ratable share of the distribution of assets and property
with the holders of the common stock, participating on an as converted
basis, if a liquidation event occurs within 24 months. If, however, a
liquidation event occurs after 24 months, the preference multiple
becomes 3 times the stated value. A merger or sale of capital stock in
which the Company's current shareholders do not own a majority of the
outstanding shares of the surviving corporation or sale of all or
substantially all of our assets shall be deemed to be a liquidation.

The Series B Preferred Stock has the following terms: a conversion rate
equal to one share of common stock for each $.25 of stated value or a
liquidation preference such that in the event of any liquidation,
dissolution or winding up

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of EpicEdge, the holders thereof shall be entitled to receive, at their
option, either: (a) in preference to the holders of the common stock
and on a pro-rated pari passu basis with the Series A Preferred Stock,
an amount equal to 2.75 times the stated value if a liquidation event
occurs within 24 months. If, however, a liquidation event occurs after
24 months, the preference multiple becomes 3 times the stated value. In
addition, if the holders of the Series B Preferred Stock choose upon a
liquidation event to receive the liquidation preference multiple in
effect at the time of the event and there still remains undistributed
new equity value after any debt obligations and Series A Preferred
Stock liquidating preference payments, then the Series B Preferred
Stock will participate in that additional distribution on an as
converted basis at a conversion rate equal to one share of common stock
for each $.75 of stated value. A merger or sale of capital stock in
which the Company's current shareholders do not own a majority of the
outstanding shares of the surviving corporation or sale of all or
substantially all of the Company's assets shall be deemed to be a
liquidation.

According to a covenant in the Note Agreement, the Company may not
redeem or repurchase any shares of company capital stock other than
pursuant to equity incentive agreements with employees and service
providers, the Articles of Incorporation and the Note Agreement.

On July 12, 2002, the Company held the 2002 Annual Meeting of
shareholders. In addition to the election of the members of the Board
of Directors and the appointment of the independent auditors for the
2002 fiscal year, several proposals were voted on that allowed for the
approval and conversion of the Note Agreement. The shareholders
approved all proposals.

The accompanying unaudited balance sheet as of June 30, 2002, does not
reflect any effects of these shareholder approvals. The pro-forma
effects of the impending debt conversion had it occurred as of June 30,
2002 or, where appropriate, as of the date of the Annual Meeting, at
which the various transactions surrounding the conversion were approved
by the shareholders, would be additional preferred stock of $9,973,000
which would be a result of the following:

a) the conversion of current debt of $8,050,000 to
preferred equity,

b) the conversion of accrued and unpaid interest on the
converted debt of $1,196,000,

c) the elimination of the $1,000,000 common stock
warrants that will be relinquished upon the
conversion of the December Convertible Notes, and

d) reduction for legal and professional fees of $273,000
relating to the Note Agreement.

On July 31, 2002, the parties to the Note Agreement agreed to delay the
conversion of the debt until (1) the approval of the Additional Listing
Application filed with the AMEX in July 2002 for the purpose of listing
the shares of conversion stock issuable under the Note Agreement and
July Convertible Notes, and (2) the Company and The Edgewater Funds
shall have mutually agreed that either (a) the Securities and Exchange
Commission ("SEC") investigation (see Note 7) has been resolved in a
manner that does not have a material adverse effect (as that term is
defined in the Note Agreement) on the Company, or (b) the SEC
investigation has progressed or is progressing such that its likely
outcome and its effects on the Company are not likely to have a
material adverse effect on the Company and should no longer delay the
debt conversion.

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The following table summarizes the convertible notes payable at June
30, 2002 and the pro-forma equivalent of both the convertible preferred
stock to be issued, pending the Equity Closing, and the potential
additional common stock outstanding that would result from the
conversion of the convertible preferred stock:

(A) Includes the shares related to the anticipated accrued and unpaid interest
on these notes through July 12, 2002 which amount will also convert into
the respective preferred and common shares. The notes will continue to
accrue interest until converted and, therefore, will actually convert in
more shares than shown in the table above.

(B) This note is convertible into shares of the Company's common stock at the
option of the holder at $.25 per share.

(C) This note is convertible into shares of the Company's common stock at the
option of the holder at $.50 per share.

5. Earnings (Loss) Per Share

Earnings (loss) per basic share is calculated by dividing net income
(loss) available to common stockholders by the weighted average shares
of common stock outstanding during the period. Diluted earnings per
share is calculated by dividing net income available to common
stockholders by the weighted average number of common shares used in
the basic earnings per share calculation plus the number of common
shares that would be issued assuming conversion of all potentially
dilutive shares outstanding. Stock options, warrants, and convertible
notes were excluded from the calculation of the loss per share because
the effect would have been anti-dilutive. The antidilutive effects
excluded from net loss per share computation at June 30 were as
follows:

A includes 2,000,000 warrants associated with convertible notes payable which,
when converted, will be relinquished.

B includes shares related to the accrued and unpaid interest on these notes
through July 12, 2002 which amounts are convertible into common shares.

6. Other New Accounting Pronouncements

In August 2001, SFAS No. 144 ("SFAS 144"), "Accounting for the
Impairment or Disposal of Long-Lived Assets", was issued, which
addresses the financial accounting and reporting for the impairment of
long-lived assets. This statement supersedes SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of" and the accounting and

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reporting provisions of APB 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
Company adopted SFAS No. 144 on January 1, 2002 and does not believe
that the adoption of SFAS 144 will have a significant impact on its
financial statements.

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections, which rescinds FASB Statement No. 4, Reporting
Gains and Losses from Extinguishment of Debt, and an amendment of that
Statement, FASB Statement No. 64, Extinguishments of Debt Made to
Satisfy Sinking-Fund Requirements. The Statement also rescinds FASB
Statement No. 44, Accounting for Intangible Assets of Motor Carriers.
The Statement amends FASB Statement No. 13, Accounting for Leases, to
eliminate an inconsistency between the required accounting for
sale-leaseback transactions and the required accounting for certain
lease modifications that have economic effects that are similar to
sale-leaseback transactions. The Company will adopt SFAS No. 145 in
January 2003 and is currently assessing the impact of SFAS #145 on its
financial statements.

7. Legal Proceedings

The Company has been notified by the SEC Staff that the SEC is
conducting an investigation into (1) the trading activity of certain
individuals and entities in the Company's securities and the securities
of other companies during the period between 1999 and 2000, and (2)
certain actions of the Company during that same period. The Company
intends to fully cooperate with the SEC to the extent it requests
information. At this time, management is unable to predict the outcome
of this investigation with certainty. The Company could become subject
to an order enjoining the Company from unlawful conduct and incur civil
monetary penalties as a result of the investigation. Such penalties
could have a material adverse effect on the Company and its operations
or financial condition.

The Company has several lawsuits pending against it, one of which
involves a former employee who alleges damages in the amount of
approximately $2,700,000. The Company believes it has good and
meritorious defenses against these claims and plans to defend itself
vigorously. While the outcome of this litigation cannot be predicted
with certainty, Management believes that it will not have a material
adverse effect on the Company's financial statements. However, an
unfavorable outcome of this litigation could have a material adverse
effect.

8. 2002 Stock Option Plan

The Board of Directors adopted the 2002 Option Plan on April 16, 2002,
subject to its approval by shareholders, which was granted at the 2002
Annual Meeting held in July 2002. The 2002 Option Plan is intended to
supplement the 1999 Stock Option Plan. A total of 10,371,311 shares are
reserved under the 2002 Stock Option Plan. Although it is the intention
of both the shareholders and the Board of Directors that current
executive officers and key employees in the company will receive the
options under the 2002 Stock Option Plan, no individual grants have
been issued.

The Board of Directors believes that EpicEdge must offer a competitive
equity incentive program if it is to continue to successfully attract
and retain the best possible candidates for positions of responsibility
within EpicEdge. The Board expects that the 2002 Option Plan will be an
important factor in attracting and retaining the high caliber members
of management and key employees essential to the Company's success and
in motivating these individuals to strive to enhance the Company's
growth and profitability. The Board intends to grant options under the
2002 Option Plan to current executive officers and key employees in the
Company.

9. Bonus Plan

In April 2002, the Board voted to establish the EpicEdge, Inc. Bonus
Plan ("Bonus Pool") for the benefit of the Company's management and
employees. From the proceeds of a liquidation event, as defined in the
bonus pool document, the bonus pool payment will be equal to 10% of the
aggregate proceeds if the proceeds equal or exceed $12 million (the
"Measurement Base"), increasing by 1.25% for every additional million
dollars of aggregate proceeds, up to $20 million (such percentage is
referred to as the "Applicable Percentage") of proceeds available for
distribution to the preferred and common shareholders (the "Proceeds
Available"), only upon a liquidation event and if the available

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proceeds for distribution exceeds $12 million, otherwise the Applicable
Percentage equals 0%. The proceeds available for distribution to the
common and preferred shareholders are equal to the value of the
consideration allocated to the holders of preferred and common stock,
only upon a liquidity event. The Applicable Percentage shall increase
as the aggregate amount of proceeds available for distribution to the
preferred and common shareholders increases, but shall not exceed 20%.
In addition, the Bonus Pool shall increase by $200,000 for every $1
million of aggregate proceeds available for distribution in excess of
$20 million until the amount available for distribution to preferred
and common shareholders is greater than $42 million. After such amount
available for distribution exceeds $42 million, the Bonus Pool shall be
reduced by $150,000 for every $1 million of aggregate proceeds
available for distribution until the Bonus Pool is reduced to zero. An
individual who is awarded participation in the Bonus Pool vests 30% on
the date of the award and the remainder vests upon a liquidity event if
the individual is employed by the Company immediately prior to such
liquidity event. Provided, that, if an individual voluntarily resigns
or is terminated for cause, all interests in the Bonus Pool granted to
such individual will expire and be forfeited. Similarly, if the
individual is terminated for anything other than cause, all unvested
interests in the Bonus Pool will terminate and be forfeited.
Percentages of the Bonus Pool will be allocated from time to time to
management and employees of the Company at the discretion of the Chief
Executive Officer as approved by the Board of Directors. The entire
Bonus Pool will be allocated in full upon a liquidity event. Management
has determined that this Bonus Plan has a potential compensation
component in that it contains a contingent obligation of the Company
that will be recognized when and if 1) the estimated Proceeds Available
exceeds the Measurement Base, as defined above, and 2) a liquidity
event, as defined in the bonus pool document, is judged to be probable.
Management has concluded that neither of these two events has occurred
and therefore no compensation adjustment is required as of June 30,
2002 under this Bonus Plan.

10. AMEX Notice

On May 28, 2002, the Company received notice from the AMEX indicating
that it was not in compliance with certain of the Exchange's continued
listing standards with its shareholders' equity below $2 million and
due to losses from continuing operations and/or net losses in the two
of its three most recent fiscal years, as set forth in Section
1003(a)(i) of the AMEX Company Guide. The Company was afforded an
opportunity to submit a plan of compliance to the Exchange and on June
26, 2002 it presented its plan to the Exchange. On July 30, 2002 the
Exchange notified the Company that the Exchange had accepted the
Company's plan of compliance and granted the Company an extension of
time to regain compliance with the continued listing standards until
March 31, 2003. The Company will be subject to periodic reviews by the
Exchange during the extension period. Failure to make progress
consistent with the plan or to regain compliance with the continued
listing standards by the end of the extension period could result in
the Company being delisted from the American Stock Exchange.

* * *

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

Overview

The following analysis of the results of operations and financial condition of
the Company should be read in conjunction with the condensed financial
statements, including the notes thereto, contained elsewhere in this Form 10-Q.

This discussion contains forward-looking statements reflecting management's
current forecast of certain aspects of our future. It is based on current
information that we have assessed but which by its nature is dynamic and subject
to rapid and even abrupt changes. Forward looking statements include statements
regarding future operating results, liquidity, capital expenditures, product
development and enhancements, numbers of personnel, strategic relationships with
third parties, and strategy. The forward-looking statements are generally
accompanied by words such as "plan," "estimate," "expect," "intend," "believe,"
"should," "would," "could," "anticipate" or other words that convey uncertainty
of future events or outcomes. Our actual results could differ materially from
those stated or implied by our forward-looking statements due to risks and
uncertainties associated with our business. These risks are described throughout
this Form 10-Q, which you should read carefully and in conjunction with our
other filings with the SEC. We would particularly refer you to the section of
this Form 10-Q under the heading "Investment Considerations" for an extended
discussion of the risks confronting our business. The forward-looking statements
in this Form 10-Q should be considered in the context of these risk factors.

EpicEdge, Inc. is a publicly held Texas corporation listed on the American Stock
Exchange under the symbol "EDG." We were originally incorporated under the name
Loch Exploration, Inc. in June 1979. In April 1989, Loch Exploration filed for
Chapter 11 bankruptcy, and was reorganized in connection with its Plan of
Reorganization, effective November 17, 1989. In December 1998, Loch Exploration,
Inc. transferred all of its assets and liabilities to Loch Energy, Inc., in
exchange for shares of Loch Energy, Inc. common stock, whereby Loch Energy
became a subsidiary of Loch Exploration. In January 1999, Loch Exploration
acquired all of the issued and outstanding capital stock of Design Automation
Systems, Inc., a private company, in exchange for shares of common stock. In
April 1999, Design Automation was merged into Loch Exploration, and Loch
Exploration changed its name to Design Automation Systems Incorporated. In March
2000, we changed our name to EpicEdge, Inc. During the quarter ended September
30, 2000, we irrevocably transferred all of the shares of Loch Energy to a
designated trustee.

In 2001 and 2002, we engaged in the business of providing professional services
in enabling our clients to meet their business goals through implementation and
support of client/server ERP financial and human resource systems, custom web
application development of object oriented Internet applications, and
implementing strategic marketing plans.

Our services currently include assisting clients in dealing with issues during
the entire software development life cycle of their projects, including the
following: strategic planning, business process evaluation, integrated marketing
and communications, brand structure and design, system architecture and design,
product acquisition, application hosting, configuration and implementation,
ongoing operational support, and evolutions in technology. Our goal is to
provide solutions to complex information technology problems focusing on
enabling our clients to take advantage of the evolving Internet economy. The
majority of our revenues were and are expected to be associated with providing
project management, consulting services, and software implementation to state
and local governments, including the States of Texas, New York and Washington.

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RESULTS OF OPERATIONS

The following table sets forth certain condensed statement of operations data
expressed as a percentage of total revenues for the periods indicated:

REVENUES

For the three months ended June 30, 2002, as compared to the three months ended
June 30, 2001, total revenues increased $414,000 or 10.6%, to $4,337,000 from
$3,923,000. For the six months ended June 30, 2002, as compared to the six
months ended June 30, 2001, total revenues increased $703,000 or 10.0%, to
$7,764,000 from $7,061,000. The increase in revenue is due primarily to the
implementation of new contracts with existing clients. Two customers represented
56% and 59% of total revenues in the three and six months ended June 30, 2002,
respectively; and the same two customers represented 57% and 56% in the three
and six months ended June 30, 2001, respectively. Although there was a decrease
in concentration of 6%, from 62% to 56% on a quarter-to-quarter basis in the
current year, there was an increase in concentration for the six months
comparison on a year-to-year basis. This increase is primarily the result of
expanded business within these two customers and the quarterly decrease in the
current year is a result of additional business with other customers.

COST OF REVENUES and GROSS PROFIT

For the three months ended June 30, 2002, total gross profit decreased to
$1,394,000, or 2.0%, as compared to the three months ended June 30, 2001 of
$1,422,000, however for the six months ended June 30, 2002, total gross profit
increased to $2,552,000, or 19.4%, as compared to the six months ended June 30,
2001 of $2,137,000. The quarterly decrease in gross margin is a result of
increased billable consultants to accommodate the increasing revenues and new
contracts.

The gross margin percent from professional services decreased 11.6% for the
three months ended June 30 from 36.3% in 2001 to 32.1% in 2002. This decrease is
the result of an increase in revenue from governmental agencies, which typically
carry lower gross margins, and the increase in the utilization of subcontractors
on these increasing revenues. The comparable gross margin percent for the six
months ended June 30 increased 8.6% from 30.3% in 2001 to 32.9% in 2002. The
higher gross margin for the six months in 2002 was the result of the planned
expansion of additional "milestone" projects from our eSolutions group.
Milestone projects are those that must meet certain contractual milestones
before revenue recognition can occur either on an interim phase or the final
phase. Depending on the timing of the acceptance by the customer, the final
phase of these contracts can provide higher gross margins than those realized
over the entire contract.

OPERATING EXPENSES

Selling, general and administrative expenses decreased $384,000, or 33.8%, to
$753,000 from $1,137,000 for the three months ended June 30, 2002, and 2001,

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Page 14

respectively. For the six months ended June 30, 2002, as compared to the six
months ended June 30, 2001, selling, general and administrative expenses
decreased $718,000, or 34.0%, from $2,114,000 to $1,396,000. In the first
quarter 2001, a strategy and plan of execution was adopted to attempt to
stabilize the organization and return to cash flow positive and eventually
profitability. This strategy included a strict line-by-line review and
evaluation of non-compensation expenses. This strategy was closely monitored
throughout 2001 and continues into 2002.

Compensation and benefit expenses decreased $346,000, or 33.2%, to $696,000 from
$1,042,000 for the three months ended June 30, 2002, and 2001, respectively. We
are continuously evaluating and analyzing various aspects of the business for
either current or potential future profitability. As a result of this review
process, during the third quarter 2001, we made the strategic decision to
eliminate certain ancillary activities, most notably our training division which
further eliminated non-productive compensation and associated overhead expenses.
This third quarter 2001 reduction eliminated an additional 16 full-time
positions, or 14% of our workforce at that time. The effect of this staff
elimination is part of the reduction in compensation and benefits experienced in
the second quarter 2002 over the comparable period in 2001. For the six months
ended June 30, 2002, as compared to the six months ended June 30, 2001,
compensation and benefit expenses decreased $1,647,000, or 54.7%, to $1,364,000
from $3,011,000. This decrease is a result of effects of our stabilization and
reduction strategy that began in October 2000 with a reduction in our workforce
by 43 full-time positions, or 14% of our workforce at that time, as well as
another 15% reduction in our workforce in the Creative, Research and Sales
departments in the first quarter of 2001 and the 15% reduction in our workforce
in the third quarter 2001 discussed above coupled with controlled growth in
staff to maintain high utilization rates among our consulting staff and
effective use of our non-billable resources. Due to these eventual reductions in
compensation and benefits along with the results of our continuing line-by-line
review and evaluation of non-compensation expenses, we may begin to be cash flow
positive by the end of 2002; however, no assurances can be made that these
expense reductions will have the effect we expect or occur in the timeframe we
anticipate.

Depreciation and Amortization

Depreciation for the three and six months ended June 30, 2002 was $270,000 and
$540,000, respectively compared to $234,000 and $469,000 for the same three and
six months periods ended June 30, 2001. This increase is from the depreciation
on replacement computer technology for our billable staff.

Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"), which revises the accounting for purchased
goodwill and intangible assets, became effective for the on January 1, 2002.
Under SFAS No. 142, goodwill, with balances of $460,000 at June 30, 2002, with
indefinite lives will no longer be amortized, but will be tested for impairment
annually and also in the event of an impairment indicator.

We assessed the carrying value of our goodwill in the second quarter of 2002 to
determine the complete impact of the adoption of SFAS No. 142. No further
impairment was required at June 30, 2002.

Debt Discount Amortization

In November 2000, our former Chairman and major stockholder provided a
$1,000,000 line of credit to us in the form of a convertible note (the "November
Convertible Note"). We were able to draw upon the line of credit from time to
time as needed. As of June 30, 2001, we had drawn $900,000 on the line of
credit. The November Convertible Note has an annual interest at the rate of 8%,
was originally convertible at the lenders' option at $.50 per share and was
scheduled to mature on December 31, 2001. The lender had the option to demand
repayment of the November Convertible Note within 30 days after the IPS sale;
however, the lender made no such demand. In connection with the November
Convertible Note, the lender was issued five-year warrants to purchase an
aggregate of 2,000,000 shares of our common stock at $.01 per share. We recorded
debt discount of $900,000 in connection with the issuance of the warrants, which
resulted in a net carrying value of zero for the November Convertible Note. This
discount was amortized into interest expense over the life of the November
Convertible Note. Debt discount amortization of $225,000 and $450,000 was
recorded for the three and six months ended June 30, 2001, respectively. This
November Convertible Note was amended as of April 16, 2002 (see LIQUIDITY AND
CAPITAL RESOURCES).

In December 2000, we issued $1,500,000 in convertible notes to two of our
stockholders (the "December Convertible Notes"), both of which formerly served
on

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Page 15

our Board of Directors. The December Convertible Notes were originally
convertible at the lenders' option at $.50 per share. The December Convertible
Notes bear interest at 8% per annum and originally matured on December 31, 2001.
The lenders had the option to demand repayment of the December Convertible Notes
within 30 days after the IPS sale. In connection with the December Convertible
Notes, the lenders were issued five-year warrants to purchase an aggregate
3,000,000 shares of our common stock at $.01 per share. We recorded debt
discount of $1,500,000 in connection with the issuance of the warrants, which
resulted in a net carrying value of zero for the December Convertible Notes.
This discount was amortized into interest expense over the life of the December
Convertible Notes. Debt discount amortization of $375,000 and $750,000 was
recorded for the three and six months ended June 30, 2001, respectively. On
April 16, 2002, these December Convertible Notes were amended or renegotiated
(see LIQUIDITY AND CAPITAL RESOURCES).

Interest Expense

Interest expense for the three and six months ended June 30, 2002 was $267,000
and $513,000, respectively compared to $222,000 and $303,000 for the three and
six months ended June 30, 2001, respectively. Although this is an increase of
$210,000 of the six months in 2002 over 2001, in 2001 there was $2.4 million of
debt that had warrants issued in conjunction with them and this caused the debt
to be recorded at a net carrying value of zero (see above). As a result, the
interest that would have normally been associated with these debt instruments
was reflected in the debt discount amortization.

In addition, as a result of the impending debt conversion (see LIQUIDITY AND
CAPITAL RESOURCES), the majority of debt that generates this interest expense
will convert into equity. However, the debt conversion has been delayed until
certain additional closing conditions occur or are achieved as described in Note
4 to the financial statements included in this report. In future quarters, the
remaining, non-converted debt is expected to generate approximately $85,000 in
interest expense until the debt matures.

LIQUIDITY AND CAPITAL RESOURCES

As of June 30, 2002, our primary sources of liquidity were cash and cash
equivalents of $282,000 and net accounts receivable of $2,737,000.

As of December 31, 2001, our primary sources of liquidity were cash and cash
equivalents of $256,000 and net accounts receivable of $1,803,000.

Net cash used in operating activities was $1,294,000 for the six months ended
June 30, 2002, as compared to $4,545,000 at June 30, 2001. The difference was
primarily due to a reduction in losses from operations and the decrease non-cash
items for amortization and debt discount partially offset by the increase in
accounts payable and accrued liabilities.

Net cash used in investing activities was $79,000 for the six months ended June
30, 2002, as compared to net cash provided by investing activities of $5,418,000
for the six months ended June 30, 2001. This was primarily due to the proceeds
received with the sale of IPS in the first quarter of 2001.

Net cash provided by financing activities was $1,399,000 for the six months
ended June 30, 2002, as compared to net cash used in financing activities of
$1,507,000 for the six months ended June 30, 2001. This difference was primarily
a result of the $2,100,000 of convertible debt funding in the first and second
quarter of 2002, net of scheduled payments of notes payable as compared to the
repayment of the line of credit debt in the first quarter 2001 from the proceeds
of the IPS transaction.

In April 2002, we entered into Note and Preferred Stock Purchase Agreement with
Edgewater, Fleck T.I.M.E., DeJoria and Loche (the "Note Agreement"). In
accordance with a Note Agreement, the Board of Directors has approved and we
currently anticipate issuing approximately 9,443,000 shares of Series A
Preferred Stock, par value $0.01 per share, and approximately 2,886,000 shares
of Series B Preferred Stock, par value $0.01 per share (the "Equity Closing").
An amendment to our Articles of Incorporation was approved by the shareholders
at our Annual Meeting held in July 2002 that increased the number of authorized
Preferred Stock to permit the conversion of the notes referred to in the Note
Agreement.

In June 2001, we began negotiations with certain existing stockholders and
convertible debt holders for additional funding to provide the ability to
execute on the unsecured creditor payment plan (see RESTRUCTURING PLAN below),
pay or renegotiate legacy expenses, and provide working capital to execute on
our current operating plan. Although the final documents were not executed until
April 2002, we

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Page 16

received $1,050,000 as of December 31, 2001 as interim bridge financing in the
form of convertible promissory notes (the "June Convertible Notes"). We received
additional funding of $860,000 under the June Convertible Notes in February and
early March 2002. In addition, in April and May 2002, we received an additional
$1,240,000 under the June Convertible Notes. On April 16, 2002, the terms were
finalized on these convertible notes, subject to stockholder approval, which was
granted at the 2002 Annual Meeting held in July 2002. The total amount to be
received under these new convertible notes is a minimum of $2,650,000 up to a
maximum of $4,500,000 ($3,150,000 of which has been received as of June 2002).
Until converted, these June Convertible Notes are for a term of one year and are
due April 2003, and have a stated interest rate of 8%. At the Equity Closing,
these notes, consisting of the outstanding balance, plus any accrued interest,
are to be exchanged into shares of Series B Convertible Preferred Stock. The
Series B Preferred Stock has the following terms: a conversion rate equal to one
share of common stock for each $.25 of stated value or a liquidation preference
such that in the event of any liquidation, dissolution or winding up of
EpicEdge, the holders thereof shall be entitled to receive, at their option,
either: (a) in preference to the holders of the common stock and on a pro-rated
pari passu basis with the Series A Preferred Stock, an amount equal to 2.75
times the stated value if a liquidation event occurs within 24 months. If,
however, a liquidation event occurs after 24 months, the preference multiple
becomes 3 times the stated value. In addition, if the holders of the Series B
Preferred Stock choose upon a liquidation event to receive the liquidation
preference multiple in effect at the time of the event and there still remains
undistributed new equity value after any debt obligations and Series A Preferred
Stock liquidating preference payments, then the Series B Preferred Stock will
participate in that additional distribution on an as converted basis at a
conversion rate equal to one share of common stock for each $.75 of stated
value. A merger or sale of capital stock in which our shareholders do not own a
majority of the outstanding shares of the surviving corporation or sale of all
or substantially all of our assets shall be deemed to be a liquidation.

In July 2000, we completed a $5 million convertible debt offering with Edgewater
and Fleck T.I.M.E. In December 2000, we issued $1.5 million in convertible notes
to Fleck T.I.M.E. and Bahram Nour-Omid. Upon the Equity Closing, the principal
and accrued interest underlying the notes issued in July 2000 and the note in
the principal amount of $1,000,000 and accrued interest thereon issued to Fleck
T.I.M.E. in December 2000 will convert into shares of Series A Preferred Stock,
par value $0.01. The Series A Preferred Stock has the following terms: a
conversion rate equal to one share of common stock for each $.75 of stated value
or a liquidation preference such that in the event of any liquidation,
dissolution or winding up of EpicEdge, the holders thereof shall be entitled to
receive, at their option, either: (a) in preference to the holders of the common
stock and on a pro-rated pari passu basis with the Series B Preferred Stock, an
amount equal to 2.75 times the stated value, (b) a ratable share of the
distribution of assets and property with the holders of the common stock,
participating on an as converted basis, if a liquidation event occurs within 24
months. If, however, a liquidation event occurs after 24 months, the preference
multiple becomes 3 times the stated value. A merger or sale of capital stock in
which our shareholders do not own a majority of the outstanding shares of the
surviving corporation or sale of all or substantially all of our assets shall be
deemed to be a liquidation.

In November 2000, our former Chairman and major stockholder provided a
$1,000,000 line of credit to us in the form of a convertible note (the "November
Convertible Note"). We could draw upon the line of credit from time to time as
needed and had drawn $900,000 at June 30, 2002 and December 31, 2001. The
November Convertible Note bore annual interest at the rate of 8%, was
convertible at the lenders' option at $.50 per share and was scheduled to mature
on December 31, 2001. The lender had the option to demand repayment of the
November Convertible Note within 30 days after the IPS sale; however, the lender
made no such demand. In August 2001, we renegotiated the terms of the November
Convertible Note (the "Amended November Convertible Note") that extended the
maturity date and increased the conversion feature to $1.00 per share,
convertible at the lender's option. In exchange, we agreed to commence interest
only payments to the lender based upon the principal and accrued interest as of
September 1, 2001. In September 2001, the $100,000 unused balance of the
November Convertible Note was cancelled. On April 16, 2002, in conjunction with
the Convertible Notes discussed above, the Amended November Convertible Notes
were renegotiated. The new terms are that the Amended November Convertible Notes
still bear an annual interest rate of 8%, are convertible at the lenders' option
into shares of our common stock at $.25 per share and mature on December 1,
2004.

In connection with the November Convertible Note, the lender was issued in 2000
five-year warrants to purchase an aggregate of 2,000,000 shares of our common
stock

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Page 17

at $.01 per share. We recorded debt discount of $900,000 in connection with the
issuance of the warrants, which resulted in an initial net carrying value of
zero for the November Convertible Note. This discount was being amortized into
interest expense over the life of the November Convertible Note. In connection
with the renegotiation of the November Convertible Notes in 2001, the
stockholder forfeited his rights to the 2,000,000 warrants to purchase common
stock. Upon forfeiture of these warrants the debt was brought to its full value
of $900,000 with the remaining unamortized portion of the debt discount of
$225,000 being offset to additional paid in capital. Debt discount amortization
totaling $600,000 was recorded as interest expense related to these warrants in
2001.

In December 2000, we issued $1,500,000 in convertible notes to two of its
stockholders (the "December Convertible Notes'), both of which formerly served
on the Company's Board of Directors. The December Convertible Notes are
convertible at the lenders' option at $.50 per share. The December Convertible
Notes bear interest at 8% per annum and matured on December 31, 2001. In
connection with the December Convertible Notes, the lenders were issued
five-year warrants to purchase an aggregate of 3,000,000 shares of our common
stock at $.01 per share. We recorded debt discount of $1,500,000 in connection
with the issuance of the warrants, which resulted in a net carrying value of
zero for the December Convertible Notes. This discount was to be amortized into
interest expense over the original life of the December Convertible Notes. This
debt discount was fully amortized as of December 31, 2001 and amortization of
$1,300,000 was recorded as interest expense in 2001. Of these convertible notes,
the holder of $1,000,000 agreed in December 2001 to extend the maturity date to
January 31, 2003. On April 16, 2002, we renegotiated this portion of the
December Convertible Notes, plus accrued interest ($128,000 at June 30, 2002),
which is to be exchanged into Series A Preferred Stock upon the Equity Closing.
The Holder of the remaining $500,000 had demanded payment and on April 16, 2002,
the Company negotiated with this individual to repay this note over an
installment period. In April 2002, $300,000 was paid on this remaining December
Convertible Note and the balance plus accrued interest is due in January 2003.

In October 2000, we reduced our workforce by 43 full-time positions, or 14% of
our workforce at that time. In the first quarter 2001, a strategy and plan of
execution was adopted to attempt to stabilize the organization and return to
cash flow positive and eventually profitability. This strategy included a strict
line-by-line review and evaluation of non-compensation expenses as well as
another 15% reduction in our workforce in the Creative, Research and Sales
departments. In the fourth quarter 2000 and in the first quarter 2001, there
were continuing additional non-recurring expenses associated with these
reductions in force. Due to the eventual reductions in compensation and benefits
along with the results of the line-by-line review and evaluation of
non-compensation expenses, we expect to be cash flow positive by the end of
2002; however, no assurances can be made that these expense reductions will have
the expected effect or occur in the anticipated timeframe.

At June 30, 2002, we had a working capital deficit of $11,514,000. However, had
the impending debt conversions as approved by the shareholders occurred as of
June 30, 2002 (see pro-forma effects discussed in Note 4 of the financial
statements), we would have had a working capital deficit of $2,570,000.
Additionally, over the preceding two years we have completed several
acquisitions that have placed an additional strain on our cash resources as the
operations of the acquired businesses were integrated with our operations.
Management can raise an additional $1,350,000 under the current financing
agreements in place at June 30, 2002 at the discretion of the investors. In
addition, on April 16, 2002, we received a commitment (the "Commitment") in the
form of a letter agreement with Edgewater Private Equity Fund III, L.P.
("Edgewater") to invest up to an additional $1,360,000 pursuant to a new
agreement for the purchase of secured promissory notes that are convertible into
a new series of preferred stock. This Commitment is valid through October 16,
2003. This new series of preferred stock would have a liquidation preference
equal to 3 times its purchase price and would be senior with respect to
liquidation preference to the Series A and Series B Preferred Stock. Any
additional financing pursuant to the Commitment which is described above is
contingent upon the following: (a) there being (i) no material adverse change in
our financial condition, business, operating results, operations, business
prospects or property, as measured against our Board of Directors' current
operating plan (a "Material Adverse Change"), or (ii) no default or event of
default under the Purchase Agreement (a "Default"), to the extent that there is
a Material Adverse Change or a Default, prior to the financing described above,
Edgewater shall not be obligated to provide us with any of the amounts described
above; (b) Board approval in advance of the financing; and (c) the execution of
definitive documents, which shall contain in detail the terms described above
and shall also contain other rights, including, without limitation, registration
rights, protective provisions, information rights and events of defaults and
remedies on essentially the same terms described in the Purchase Agreement. In
the event we are not able to execute on our

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Page 18

current operating plan or a Material Adverse Change occurs as described in the
Commitment, we may not be able to get any additional funding from Edgewater.

Management expects that our current available funds, funds provided from current
operations and additional amounts to be funded by Edgewater under the Commitment
will be sufficient to satisfy our cash requirements through the end of 2002.
However, based on our current forecasts, we believe that we may need to obtain
addition capital in early 2003. If our operating cash flows are inadequate or if
we are unable to raise sufficient financing through the Commitment or otherwise,
we may not be able to continue successfully funding our operations. We believe
that our success in obtaining the necessary financing will depend upon, among
other factors, successfully executing on our current operating plan. If we fail
to execute on our current operating plan or a Material Adverse Change occurs as
described in the Commitment, we may not be able to obtain any additional funds
from Edgewater under the Commitment. In that event, we may need to raise
additional funding from other sources. Sources of additional funding may include
bank debt or the public or private sale of equity or debt securities. However,
there can be no assurance that we will be successful in arranging such
additional financing at all or on terms commercially acceptable to us. In
addition, the issuance of debt may require us to agree to restrictive covenants
that could hamper our business and operations. These uncertainties could have a
material adverse affect on us.

In view of the renegotiations of debt terms and subsequent financings discussed
above, management believes that we will continue as a going concern through the
remainder of 2002. However, there can be no assurance that these events will
provide the necessary working capital to fulfill our needs; therefore,
additional cost reductions or additional sources of funds may be necessary in
early 2003.

RESTRUCTURING PLAN

Effective January 1, 2001, with a closing date of February 5, 2001, we sold all
of the issued and outstanding stock of IPS to Red & Blue, Inc., a Delaware
corporation, and to the IPS Associates, Inc. Stock Ownership Plan. The
consideration for the sale was (1) the return of an aggregate 740,260 shares of
our common stock, including ESOP shares, (2) $5,700,000 in net proceeds and (3)
the transfer of the IPS ESOP plan, along with the note payable to a financial
institution for the ESOP financing of $4,861,000. The stock purchase agreement
provided that 143,323 shares of the 740,260 shares of our common stock be held
in escrow until the earlier of (1) the completion of audited financial
statements of IPS for the year ended December 31, 2000, or (2) six months from
the date of closing. In the event that the net equity, revenues or net earnings
of IPS differed by more than $500,000 from the financial statements disclosed in
the purchase agreement, Red & Blue, Inc. had the right to setoff the difference
against the shares held in escrow at a value based upon the closing price of our
common stock on the day before the setoff. In the event of a setoff, we had
agreed to immediately register the setoff shares. Based on audited financial
results of IPS, no such setoff occurred. As discussed in Note 2, the goodwill
related to IPS was written down as of December 31, 2000, to the amount
recoverable in the sale.

In the first quarter of 2001, we received the above-described proceeds,
cancellation of the inter-company payable and receivables with IPS, along with
the return of 740,260 shares now in treasury stock, in exchange for the transfer
of assets of $6,085,000 and liabilities of $8,028,000. In addition, with the
return of the shares held by the ESOP, a reduction in unearned compensation of
$8,979,000 associated with these unreleased ESOP shares was recorded as a charge
against the additional paid in capital arising from the IPS acquisition. The net
proceeds from the sale of IPS were used to pay off the secured debt for
$2,275,000 and the balance was used to fund working capital needs such as
payroll and current accounts payable.

In February 2001, we adopted a strategy and a plan of execution to reduce our
workforce and other costs in order to stabilize the organization.

In February 2001, we hired a consulting group to assist in designing and
executing a repayment plan (the "Plan") with its unsecured creditors. This Plan,
which was executed in June 2001, after achieving an acceptable percentage of
consents from the unsecured creditors, was designed to repay this group over
time either in-full for those creditors whose balance was $5,000 or less, or who
were willing to accept $5,000 as full payment, or up to 60% of $3,094,000, which
represented the original unsecured accounts payable amount as of February 1,
2001. The Plan further provided that, if sufficient cash was available, we could
pay a total of 30% of the original unsecured accounts payable amount by December
31, 2001, and this total amount would fully and completely satisfy our
obligations to the unsecured creditors. In June 2001, in accordance with the
Plan, we paid the initial installment to consenting unsecured creditors under
the Plan representing 18% of the original obligation. In December 2001, we made
a second installment of 12% of the original obligation to fully satisfy its
obligations under the Plan as it relates to $2,045,000 of the original unsecured
accounts payable. The remaining balance of $1,049,000 will be paid quarterly at
four (4%) percent of the original balance over the next two and one-half (2 1/2)
years, unless they agree to a lesser amount over a shorter time. Based upon the
payables satisfied by payments made under the Plan, we recognized an
extraordinary gain from this restructuring of $27,000 in the first quarter 2002
and $18,000 in the second quarter 2002.

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Page 19

In March 2001, we negotiated new terms for $1,933,000 of other notes payable,
which extended repayment terms into 2002.

In October 2000, we reduced our workforce by 43 full-time positions, or 14% of
our workforce at that time. In the spring of 2001, a strategy and plan of
execution was adopted to stabilize the organization and return to cash flow
positive and eventually profitability. This strategy includes a strict
line-by-line review and evaluation of non-compensation expenses as well as
another 15% reduction in our workforce in the Creative, Research and Sales
departments. In the fourth quarter 2000 and in the first quarter 2001, there
were continuing additional non-recurring expenses associated with these
reductions in force. However, because of the eventual reductions in compensation
and benefits along with the results of the line-by-line review and evaluation of
non-compensation expenses, we expect to be cash flow positive by the end of
2002; however, no assurances can be made that these expense reductions will have
the effect we expect or occur in the timeframe we anticipate.

INVESTMENT CONSIDERATIONS

The following important factors could cause actual results to differ materially
from those contained in forward-looking statements made in this Quarterly Report
on Form 10-Q or presented elsewhere by management from time to time.

OUR CLIENTS MAY CANCEL OR DELAY SPENDING ON BUSINESS AND TECHNOLOGY INITIATIVES
BECAUSE OF THE CURRENT ECONOMIC CLIMATE.

Since the second half of 2000, many companies have experienced
financial difficulties or uncertainty, and have cancelled or delayed spending on
business and technology consulting initiatives. Additionally, the severe
financial difficulties that many start-up Internet companies have experienced
have reduced or eliminated competition and have further reduced the perceived
urgency by larger companies to begin or continue technology initiatives. Since
some of our revenues are derived from large companies, if large companies
continue to cancel or delay their business and technology consulting initiatives
because of the current economic climate, or for other reasons, our business,
financial condition and results of operations could be materially adversely
affected.

OUR REVENUES AND OPERATING RESULTS ARE VOLATILE AND DIFFICULT TO FORECAST, WHICH
MAY CAUSE THE MARKET PRICE OF OUR COMMON STOCK TO DECLINE.

Our revenues and operating results are subject to significant variation
from quarter to quarter due to a number of factors, including:

o the number, size and scope of projects in which we are
engaged;

o demand for our services generated by strategic relationships
and certain prime contractors;

o economic conditions in the vertical and geographic markets we
serve;

o our employee utilization rates and the number of billable days
in a particular quarter;

o the contractual terms and degree of completion of projects;

o any delays or costs incurred in connection with project; or
early termination of, a project;

o the accuracy of estimates of resources required to complete
ongoing projects;

o our ability to staff projects with salaried employees versus
hourly employees, hourly independent contractors and
subcontractors;

o start-up costs including software license fees incurred in
connection with the initiation of large projects;

o the adequacy of provisions for losses.

The timing and realization of opportunities in our sales pipeline make the
timing and variability of revenues difficult to forecast. Because of the
variability of our quarterly operating results, we believe that period-to-period
comparisons of our operating results are not necessarily meaningful, should not
be relied upon as

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Page 20

indications of future performance and may result in volatility and declines in
the price of our common stock. In addition, our operating results may from time
to time be below the expectations of analysts and investors. If so, the market
price of our common stock may decline significantly.

WE MAY REPORT AN OPERATING LOSS IN 2002 AND MAY NOT ACHIEVE OR SUSTAIN FUTURE
PROFITABILITY.

Although our core business is providing information technology
services, our business strategy continues to evolve. We have reported an
operating loss in each of the previous three fiscal years, and again in the
first two quarters of 2002. Although our revenues have generally been increasing
since the third quarter of fiscal 2000 at an annualized rate of over 9% and this
trend has continued into at least the first portion of 2002, it is possible that
we will continue to incur operating losses, and that our revenues may decline
for the remainder of 2002. During the course of 2001, we fundamentally
restructured our business by consolidating office space, reducing our workforce
and reshaping our service offerings. To the extent that our restructuring plan
does not generate the cost savings or revenues that we anticipate, our results
of operations and liquidity could be materially and adversely affected. If we
are unable to maintain the historical increase in our revenues, or if our
operating expenses exceed our expectations, we may continue to incur losses and
may not achieve profitability. If we achieve profitability in the future, we may
not be able to sustain it.

WE MAY NEED TO RAISE ADDITIONAL CAPITAL, WHICH MAY NOT BE AVAILABLE.

On April 16, 2002, the terms were finalized on an initial funding under
the Purchase Agreement (see Liquidity and Capital Resources). The total amount
to be received under the Purchase Agreement is a minimum of $2,650,000, up to a
maximum of $4,500,000 at their discretion ($3,150,000 of which has been received
as of June 2002). We have also received a commitment from one of our current
shareholders, Edgewater, pursuant to which they have agreed to fund up to an
additional $1,360,000 through October 2003 subject to certain conditions (see
LIQUIDITY AND CAPITAL RESOURCES). Management expects that our current available
funds, funds provided from current operations and the additional amounts to be
funded by Edgewater will be sufficient to satisfy our cash requirements through
the end of 2002. However, based on our current forecasts, we believe that we may
need to obtain additional capital in early 2003. If our operating cash flows are
inadequate or if we are unable to raise sufficient financing through the
Commitment or otherwise, we may not be able to continue successfully funding our
operations. We believe that our success in obtaining the necessary financing
will depend upon, among other factors, successfully executing on our current
operating plan. If we fail to execute on our current operating plan or a
Material Adverse Change occurs as described under the Commitment, we may not be
able to obtain any additional funds from Edgewater under the Commitment. In that
event, we may need to raise additional funding from other sources. Sources of
additional financing may include bank debt or the public or private sale of
equity or debt securities. However, there can be no assurance that we will be
successful in arranging such additional financing at all or on terms
commercially acceptable to us. In addition, the issuance of debt may require us
to agree to restrictive covenants that could hamper our business and operations.
These uncertainties could have a material adverse affect on us.

WE DEPEND ON GOVERNMENT AGENCIES FOR A MAJORITY OF OUR REVENUES AND THE LOSS OR
DECLINE OF EXISTING OR FUTURE GOVERNMENT AGENCY FUNDING WOULD ADVERSELY AFFECT
OUR REVENUES AND CASH FLOWS.

For the quarter ended June 30, 2002, approximately 88% of our revenues
were either directly or indirectly, as a subcontractor, derived from services
provided to government agencies. These government agencies may be subject to
budget cuts, budgetary constraints, a reduction or discontinuation of funding or
changes in the political or regulatory environment that may cause government
agencies to divert funds. A significant reduction in funds available for
government agencies to purchase professional services would significantly reduce
our revenues and cash flows. In addition, the loss of a major government client,
or any significant reduction or delay in orders by that client, would also
significantly reduce our revenues and cash flows.

BUSINESSES MAY DECREASE OR DELAY THEIR USE OF ADVANCED TECHNOLOGIES AS A MEANS
FOR CONDUCTING COMMERCE.

Our future success depends heavily on the increased acceptance and use
of advanced technologies as a means for conducting commerce and streamlining
operations. We focus our services on the development and implementation of
advanced technology strategies and solutions. If use of these advanced

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technologies does not continue to grow, or grows more slowly than expected, our
revenue growth could slow or decline and our business, financial condition and
results of operations could be materially adversely affected. Consumers and
businesses may delay adoption of advanced technologies for a number of reasons,
including:

o inability to implement and sustain profitable business models
using advanced technologies;

o inadequate network infrastructure or bandwidth;

o delays in the development or adoption of new technical
standards and protocols required to handle increased levels of
usage;

o delays in the development of security and authentication
technology necessary to effect secure transmission of
confidential information; and

o failure of companies to meet their clients' expectations in
delivering goods and services using advanced technologies.

IF OUR MARKETING RELATIONSHIPS WITH SOFTWARE VENDORS DETERIORATE, WE WOULD LOSE
THEIR POTENTIAL CLIENT REFERRALS.

We currently have marketing relationships with software vendors,
including PeopleSoft, iPlanet, Siebel, and Sun Microsystems. We estimate that we
derive nearly all of our revenues directly or indirectly from these
relationships. Although we have historically received a number of business leads
from these software vendors to implement their products, they are not required
to refer business to us, may cease referring business to us and may further
terminate these relationships at any time. If our relationships with these
software vendors deteriorate, we may lose their client leads and our ability to
develop new clients could be negatively impacted. Any decrease in our ability to
obtain new clients may cause a reduction in our revenue growth.

OUR BUSINESS IS DEPENDENT ON OUR ABILITY TO KEEP PACE WITH THE LATEST
TECHNOLOGICAL CHANGES.

Our market and the enabling technologies used by our clients are
characterized by rapid technological change. Failure to respond successfully to
these technological developments, or to respond in a timely or cost-effective
way, will result in serious harm to our business and operating results. We
expect to derive a substantial portion of our revenues from creating e-business
systems that are based upon today's leading technologies and that are capable of
adapting to future technologies. As a result, our success will depend, in part,
on our ability to offer services that keep pace with continuing changes in
technology, evolving industry standards and changing client preferences as well
as being first to market new services in this market. There can be no assurance
that we will be successful in addressing these developments on a timely basis or
that if addressed we will be successful in the marketplace. Our failure to
address these developments could have a material adverse effect on our business,
financial condition and results of operations.

IF WE DO NOT ATTRACT AND RETAIN QUALIFIED PROFESSIONAL STAFF, WE MAY NOT BE ABLE
TO ADEQUATELY PERFORM OUR CLIENT ENGAGEMENTS AND COULD BE LIMITED IN ACCEPTING
NEW CLIENT ENGAGEMENTS.

Our business is labor intensive and our success will depend upon our
ability to attract, retain, train and motivate highly skilled employees.
Although many specialized e-business and other business and technology companies
have reduced their workforces or slowed their hiring efforts, and we reduced our
workforce in October 2000 and March 2001, intense competition still exists for
certain employees who have specialized skills or significant experience in
business and technology consulting. We may not be successful in attracting a
sufficient number of these highly skilled employees in the future. Additionally,
the industry attrition rates for these types of employees are high, and we may
not be successful in retaining, training and motivating the employees we are
able to attract. Any inability to attract, retain, train and motivate employees
could impair our ability to adequately manage and complete existing projects and
to bid for or accept new client engagements.

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THE TRADING PRICE OF OUR STOCK HAS BEEN, AND IS EXPECTED TO BE, HIGHLY VOLATILE.
THE PRICE OF OUR COMMON STOCK IS SUBJECT TO SIGNIFICANT FLUCTUATION.

In addition, the trading price of our common stock could be subject to
wide fluctuations in response to:

o general economic or stock market conditions unrelated to our
operating performance;

o quarterly variations in operating results;

o changes in earnings estimates by analysts;

o any differences between reported results and analysts'
published or unpublished expectations;

o announcements of new contracts or service offerings by us or
our competitors; and

o other events or factors.

WE DEPEND HEAVILY ON OUR PRINCIPAL CLIENTS.

We have derived, and believe that we will continue to derive, a
significant portion of our revenues from a limited number of large clients. In
the second quarter of 2002, our two largest clients, the Texas Department of
Health and Northrup Grumman, accounted for approximately 57% of our revenues.
The volume of work performed for specific clients is likely to vary from year to
year, and a major client in one year may not use our services in a subsequent
year. In addition, revenues from a large client may constitute a significant
portion of our total revenues in a particular quarter. Most of our contracts are
terminable by the client following limited notice and without significant
penalty to the client. The loss of any large client could have a material
adverse effect on our business, financial condition and results of operations.

WE HAVE SIGNIFICANT FIXED OPERATING COSTS AND OUR OPERATING RESULTS ARE SUBJECT
TO FLUCTUATION.

A high percentage of our operating expenses, approximately 40%,
particularly personnel and rent, are fixed in advance of any particular quarter.
As a result, unanticipated variations in the number, or progress toward
completion, of our projects or in employee utilization rates may cause
significant variations in operating results in any particular quarter and could
result in losses for such quarter.

An unanticipated termination of a major project, a client's decision
not to proceed to the subsequent stage of a project, or the completion during a
quarter of several major client projects could require us to maintain
underutilized employees and could therefore have a material adverse effect on
our business, financial condition and results of operations. Our revenues and
earnings may also fluctuate from quarter to quarter based on such factors as the
contractual terms and degree of completion of such projects, any delays incurred
in connection with projects, the accuracy of estimates of resources required to
complete ongoing projects, and general economic conditions.

WE SOMETIMES ENTER INTO FIXED-PRICE CONTRACTS.

Some of our projects are based on fixed-price, fixed-timeframe
contracts, rather than contracts in which payment to us is determined on a time
and materials basis. We recognize revenues as defined milestones are reached.
For the three months ended June 30, 2002, approximately 29% of our projects were
fixed-price, fixed time frame contracts. Our failure to accurately estimate the
resources required for a project or our failure to complete our contractual
obligations in a manner consistent with the project plan upon which our
fixed-price, fixed-timeframe contract was based would adversely affect our
overall profitability and could have a material adverse effect on our business,
financial condition and results of operations. We have at times been required to
commit unanticipated additional resources to complete certain projects, which
has resulted in losses on certain contracts. We recognize that we may experience
similar situations in the future. In addition, for certain projects we may fix
the price before the design specifications are finalized, which could result in
a fixed price that turns out to be less than our expenses on the project and
therefore adversely affects our profitability.

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WE FACE SIGNIFICANT COMPETITION IN MARKETS THAT ARE NEW, INTENSELY COMPETITIVE
AND RAPIDLY CHANGING.

The markets for the services we provide are highly competitive. We
believe that we currently compete principally with large accounting firms,
strategy consulting firms, Internet and e-business professional services
providers, software integration firms, application software vendors, and
internal information systems groups. Some of our competitors are Accenture Ltd.,
Braun Consulting, Inc., CACI International, Inc., Maximus, Inc., Lante
Corporation, and KPMG Consulting, Inc. Many of the companies that provide such
services have significantly greater financial, technical and marketing resources
than we do and generate greater revenues and have greater name recognition than
we do. These firms may attempt to gain a competitive advantage by offering large
pricing concessions. In addition, there are relatively low barriers to entry
into our markets and we have faced, and expect to continue to face, additional
competition from new entrants into our markets. We believe that the principal
competitive factors in our markets include:

o Internet expertise and talent;

o quality of service, price and speed of delivery;

o ability to integrate strategy, technology and creative design
services;

o vertical industry knowledge; and

o project management capability.

We believe that our ability to compete also depends in part on a number
of competitive factors outside our control, including:

o the ability of our competitors to hire, retain and motivate
their senior staff;

o the development by others of Internet solutions or software
that is competitive with our products and services; and

o the extent of our competitors' responsiveness to client needs.

There can be no assurance that we will be able to compete successfully with our
competitors.

INCREASING GOVERNMENT REGULATION COULD AFFECT OUR BUSINESS.

We are subject not only to regulations applicable to businesses
generally, but also laws and regulations directly applicable to electronic
commerce. Although there are currently few such laws and regulations, state,
federal and foreign governments may adopt a number of these laws and
regulations. Any such legislation or regulation could dampen the growth of the
Internet and decrease its acceptance as a communications and commercial medium.
If such a decline occurs, companies may decide in the future not to use our
services to create an electronic business channel. This decrease in the demand
for our services would seriously harm our business and operating results.

LEGISLATIVE ACTIONS, HIGHER INSURANCE COST AND POTENTIAL NEW ACCOUNTING
PRONOUNCEMENTS ARE LIKELY TO IMPACT OUR FUTURE FINANCIAL POSITION AND RESULTS
OF OPERATIONS.

There have been regulatory changes, including the Sarbanes-Oxley Act of
2002, and there may be potential new accounting pronouncements or regulatory
rulings which will have an impact on our future financial position and results
of operations. The Sarbanes-Oxley Act of 2002 and other rule changes and
proposed legislative initiatives following the Enron bankruptcy are likely to
increase general and administrative costs. In addition, insurers are likely to
increase rates as a result of high claims rates over the past year and our rates
for our various insurance policies are likely to increase. Further, proposed
initiatives result in changes in accounting rules, including legislative and
other proposals to account for employee stock options as an expense. These and
other potential changes could materially increase the expenses we report under
generally accepted accounting principles, and adversely affect our operating
results.

OUR BUSINESS COULD BE ADVERSELY AFFECTED IF WE ARE UNABLE TO PROTECT OUR
PROPRIETARY TECHNOLOGY.

Our success depends, in part, upon our proprietary methodologies and
other intellectual property rights. We rely upon a combination of trade secret,
nondisclosure and other contractual arrangements to protect our proprietary
rights. We enter into confidentiality agreements with our employees; generally
require that our consultants and clients enter into such agreements, and limit
access to and distribution of our proprietary information. We currently do not
have any trademark or copyright protection on any of our intellectual property.
There can be no assurance that the steps taken by us in this regard will be
adequate to deter misappropriation of our proprietary information or that we
will be able to detect unauthorized use and take appropriate steps to enforce
our intellectual property rights. In addition, although we believe that our
services and products do not infringe on the intellectual property rights of
others, there can be no assurance that such a claim will not be asserted against
us in the future, or that if asserted any such claim will be successfully
defended. A successful claim against us could have material adverse affect on
our business, financial condition and results of operations.

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WE MAY NOT HAVE THE RIGHT TO RESELL OR REUSE APPLICATIONS DEVELOPED FOR SPECIFIC
CLIENTS.

A portion of our business involves the development of Internet and
software applications for specific client engagements. Ownership of such
software is the subject of negotiation and is frequently assigned to the client,
although we may retain a license for certain uses. Issues relating to the
ownership of and rights to use software applications can be complicated and
there can be no assurances that disputes will not arise that affect our ability
to resell or reuse such applications. Any limitation on our ability to resell or
reuse an application could require us to incur additional expenses to develop
new applications for future projects.

WE ARE DEPENDENT ON A NUMBER OF KEY PERSONNEL.

Our success will depend in large part upon the continued services of
a number of key employees, including our CEO, key consultants and practice
leaders. The loss of the services of any of these individuals or of one or more
of our other key personnel could have a material adverse effect on us. In
addition, if one or more of our key employees resigns to join a competitor or to
form a competing company, the loss of such personnel and any resulting loss of
existing or potential clients to any such competitor could have a material
adverse effect on our business, financial condition and results of operations.
In the event of the loss of any such personnel, there can be no assurance that
we would be able to prevent the unauthorized disclosure or use of our technical
knowledge, practices or procedures by such personnel.

OUR BUSINESS WILL SUFFER IF WE ARE UNABLE TO ATTRACT, SUCCESSFULLY INTEGRATE AND
RETAIN QUALIFIED PERSONNEL AND KEY EMPLOYEES.

A critical component of our business is the level of experience and
technical proficiency of our employees. If we are unable to attract, retain,
train, manage and motivate skilled employees, particularly project managers and
other senior technical personnel, our ability to adequately manage and staff our
existing projects and to bid for or obtain new projects could be impaired, which
would adversely affect our business and its growth. The failure of our employees
to achieve expected levels of performance could adversely affect our business.
There is significant competition for employees with the skills required to
perform the services we offer. In particular, qualified project managers and
senior technical and professional staff are in great demand worldwide. In
addition, we require that many of our employees travel to client sites to
perform services on our behalf, which may make a position with us less
attractive to potential employees.

OUR FAILURE TO DELIVER ERROR-FREE PRODUCTS AND SERVICES COULD RESULT IN REDUCED
PAYMENTS, SIGNIFICANT FINANCIAL LIABILITY OR ADDITIONAL COSTS TO US, AS WELL AS
NEGATIVE PUBLICITY.

Many of our engagements involve projects that are critical to the
operations of our clients' businesses and provide benefits that may be difficult
to quantify. The failure by us to meet a client's expectations in the
performance of the engagement could damage our reputation and adversely affect
our ability to attract new business. We have undertaken, and may in the future
undertake, projects in which we guarantee performance based upon defined
operating specifications or guaranteed delivery dates. Unsatisfactory
performance or unanticipated difficulties or delays in completing such projects
may result in client dissatisfaction and a reduction in payment to us, payment
of penalties or damages by us as a result of litigation or otherwise. In
addition, unanticipated delays could necessitate the use of more resources than
we initially budgeted for a particular project, which could increase our costs
for that project.

WE COULD BECOME SUBJECT TO LAWSUITS OR INVESTIGATIONS THAT COULD RESULT IN
MATERIAL LIABILITIES TO US OR CAUSE US TO INCUR MATERIAL COSTS.

We have been notified by the SEC Staff that the SEC is conducting an
investigation into (1) the trading activity of certain individuals and entities
in our securities and the securities of other companies during the period
between 1999 and 2000, and (2) certain of our actions during that same period.
We intend to fully cooperate with the SEC to the extent it requests information.
As a result of the investigation, we could become subject to an order enjoining
us from unlawful conduct and incur civil monetary penalties. Such penalties
could have a material adverse effect on our operations or financial condition.

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We have several lawsuits pending against us, one of which alleges
damages in the amount of approximately $2,700,000. We believe we have good and
meritorious defenses against these claims and plan to defend ourselves
vigorously. While the outcome of this litigation cannot be predicted with
certainty, we believe that it will not have a material adverse effect on our
financial statements. However, an unfavorable outcome of this litigation could
have a material adverse effect. In addition, any failure in a client's system
could result in a claim against us for substantial damages, regardless of our
responsibility for such failure. We cannot guarantee that the limitations of
liability set forth in our service contracts will be enforceable or will
otherwise protect us from liability for damages. Our general liability insurance
coverage, which includes coverage for errors or omissions, may not continue to
be available on reasonable terms or in sufficient amounts to cover one or more
claims, and the insurer may disclaim coverage as to any future claim. The
successful assertion of one or more claims against us that exceed available
insurance coverage or changes in insurance policies, including premium increases
or the imposition of large deductible or co-insurance requirements, would
adversely affect our business.

OUR COMMON STOCK MAY BE DELISTED FROM THE AMERICAN STOCK EXCHANGE. IF IT IS
DELISTED, THE MARKET PRICE OF THE COMMON STOCK COULD DECLINE POTENTIALLY TO ZERO
AND YOU COULD LOSE YOUR INVESTMENT.

As a result of our delay in filing Form 10-KSB for 2000 and the
first and second quarter 10-Q of 2001, AMEX suspended the trading of our stock
on the AMEX. Upon review of these items once they were filed, they reinstated
trading in our stock. Currently, however we are not in compliance with several
AMEX rules.

On May 28, 2002, we received notice from the AMEX indicating that we
are not in compliance with certain of the Exchange's continued listing standards
with our shareholders' equity below $2 million and due to losses from continuing
operations and/or net losses in the two of our three most recent fiscal years,
as set forth in Section 1003(a)(i) of the AMEX Company Guide. We were afforded
an opportunity to submit a plan of compliance to the Exchange and on June 26,
2002 we presented our plan to the Exchange. On July 30, 2002 the Exchange
notified us that it accepted our plan of compliance and granted us an extension
of time to regain compliance with the continued listing standards until March
31, 2003. We will be subject to periodic reviews by the Exchange during the
extension period. Failure to make progress consistent with the plan or to regain
compliance with the continued listing standards by the end of the extension
period could result in our being delisted from the American Stock Exchange.

Not withstanding the terms of the July 30, 2002 letter from the
AMEX, the Exchange has advised us that consistent with its obligations and
responsibilities as a self-regulatory organization, it is authorized to initiate
immediate delisting proceedings as appropriate in the public interest.
Therefore, despite compliance with the submitted plan, the AMEX may decide to
delist our common stock based on our non-compliance with AMEX rules or our
financial condition. Although we intend to take steps to maintain our listing,
we can give no assurances that our securities will not be delisted from trading
by AMEX. If we lose our AMEX listing status, our common stock would most likely
trade in the over-the-counter market, which is viewed by most investors as a
less desirable and less liquid marketplace. In that event, trading in shares of
our common stock would likely decrease substantially or cease altogether, and
the market price of the common stock would likely decline further, potentially
to zero.

WE COULD SUFFER MATERIAL LOSSES IF OUR SYSTEMS OR OPERATIONS FAIL OR ARE
DISRUPTED.

Any system failure, including network, software or hardware failure,
whether caused by us, a third party service provider, unauthorized intruders and
hackers, computer viruses, natural disasters, power shortage or terrorist
attacks, could cause interruptions or delays in our business or loss of data. In
addition, if our mail, communications or utilities are disrupted or fail, our
operations, including our transaction processing, could be suspended or
interrupted and our business could be harmed. Our property insurance and
business interruption insurance may not be adequate to compensate us for all
losses that may occur as a result of any system failure or disruption.

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CERTAIN SHAREHOLDERS CAN CONTROL MATTERS REQUIRING SHAREHOLDER APPROVAL BECAUSE
THEY OWN A LARGE PERCENTAGE OF OUR COMMON STOCK, AND THEY MAY VOTE THIS COMMON
STOCK IN A WAY WITH WHICH OTHER SHAREHOLDERS MAY NOT AGREE.

Certain shareholders Edgewater Private Equity Fund III and Fleck
T.I.M.E. Fund, LP and affiliates of Fleck own approximately 36% and 15%,
respectively, of the outstanding shares of our common stock. In addition, with
the impending conversion of the various convertible debt into voting Preferred
Stock, Edgewater and Fleck will have greatly increased their voting control over
our affairs. As a result, if these persons act together, they will have the
ability to exercise substantial control over our affairs and corporate actions
requiring shareholder approval, including the election of directors, a sale of
substantially all our asserts, a merger with another entity or an amendment our
certificate of incorporation. The ownership position of these shareholders could
delay, deter or prevent a change in control and could adversely affect the price
that investors might be willing to pay in the future for shares of our common
stock.

OUR ISSUANCE OF PREFERRED STOCK COULD MAKE IT DIFFICULT FOR ANOTHER COMPANY TO
ACQUIRE US, WHICH COULD DEPRESS THE PRICE OF OUR COMMON STOCK.

Our board of directors has the authority and, pursuant to the Note
and Preferred Stock Purchase Agreement, is obligated to issue preferred stock
upon receiving the requisite shareholder approval, such approval was granted at
our 2002 Annual Meeting held in July 2002. The preferred stock, when issued,
will be issued with voting, liquidation, and other rights superior to the rights
of our common stock. The potential issuance of preferred stock may delay or
prevent a change in control of us, discourage bids for the common stock at a
premium over the market price and adversely affect the market price and the
voting and other rights of the holders of our common stock.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We do not believe there is any material market risk exposure with respect to
derivative or other financial instruments, which would require disclosure under
this item. However, we have obligations that have fixed interest rates and,
therefore, contain market rate risk.

Convertible Notes Payable - On June 21, 2001 we executed letter agreements and
promissory notes (the "June Notes") with certain existing stockholders. As of
December 31, 2001 we had received $1,050,000 relating to these June Notes. As
of June 30, 2002, we had received an additional $2,100,000 for a total of
$3,150,000 relating to these June Notes. The June Notes originally were for a
term of one year and have a stated interest rate of 8%. On April 16, 2002, the
June Notes were replaced with a substitute convertible secured promissory note
(the "June Convertible Notes") that has a maturity date of April 2003. Subject
to stockholder approval, which was granted at our 2002 Annual Meeting held in
July 2002, the outstanding balance, plus any accrued interest ($129,000 at June
30, 2002), of the June Convertible Notes are to be exchanged into shares of
Series B Convertible Preferred Stock. The terms of these June Convertible Notes
were finalized on April 16, 2002. On July 31, 2002, the parties to the Note
Agreement agreed to delay the conversion of this debt (see Note 4 to the
financial statements included in this report).

In July 2000, we completed a $5,000,000 convertible debt offering ("July
Convertible Notes") with Edgewater Private Equity Fund III, L.P. and Fleck
T.I.M.E. Fund, L.P. The July Convertible Notes bear annual interest at 9.5%.
Originally, the principal and accrued and unpaid interest was convertible at the
option of the holder into shares of our common stock at a conversion price of
$5.00 per share. We recorded an imputed debt discount of $5,000,000 related to
the beneficial conversion feature and based on the quoted market price of our
common stock of $19.50 per share on the date of issuance. At December 31, 2000,
this debt was due on demand, and the imputed discount was fully amortized to
expense. On July 20, 2001, we reached an agreement related to the July
Convertible Notes, under which the maturity date was extended to August 1, 2002.
Originally the conversion terms were to be renegotiated by August 15, 2001;
otherwise, a penalty of $500,000 would have been assessed and payable in
February 2002. On April 16, 2002, we completed these renegotiations. Under the
new terms, subject to stockholder approval, which was granted at our 2002 Annual
Meeting held in July 2002, the principal and accrued interest ($937,000 at June
30, 2002) underlying the July Convertible Notes are to be exchanged into Series
A Convertible Preferred Stock. As a result of the delay of the pending
conversion (see Note 4 to the financial statements), on August 1, 2002 these
notes were amended to mature on April 16, 2003.

In November 2000, our then Chairman and major stockholder provided a $1,000,000
line of credit to us in the form of a convertible note (the "November
Convertible Note"). We could draw upon the line of credit from time to time as
needed and had drawn $900,000 at December 31, 2001 and 2000. The November
Convertible Note bore annual interest at the rate of 8%, was convertible at the
lenders' option at $.50 per share and was scheduled to mature on December 31,
2001. The lender had the

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option to demand repayment of the November Convertible Note within 30 days after
the IPS sale; however, the lender made no such demand. In August 2001, we
renegotiated the terms of the November Convertible Note (the "Amended November
Convertible Note") that extended the maturity date to December 1, 2002 and
increased the conversion feature to $1.00 per share, convertible at the lender's
option. Furthermore, if the Amended November Convertible Note was not paid at
the new maturity date, the lender, at his sole discretion, could have converted
the note at $0.50 per share, demanded payment or further extended the maturity
date until December 1, 2003. Finally, if the Amended November Convertible Note
was not paid at the new extended maturity date, the lender, at his sole
discretion, could have converted the note at $0.25 per share, demanded payment
or further extended the maturity date until December 1, 2004. In exchange, we
agreed to commence interest only payments to the lender based upon the principal
and accrued interest as of September 1, 2001. In September 2001, the $100,000
unused balance of the November Convertible Note was cancelled. On April 16,
2002, in conjunction with the Notes discussed above, the new terms are that the
Amended November Convertible Note still bears an annual interest at the rate of
8%, is convertible at the lenders' option into shares of our common stock at
$.25 per share and matures on December 1, 2004.

In December 2000, we issued $1,500,000 in convertible notes to two of its
stockholders (the "December Convertible Notes'), both of which formerly served
on our Board of Directors. The December Convertible Notes are convertible at the
lenders' option at $.50 per share. The December Convertible Notes bear interest
at 8% per annum and matured on December 31, 2001. In connection with the
December Convertible Notes, the lenders were issued five-year warrants to
purchase an aggregate of 3,000,000 shares of our common stock at $.01 per share.
We recorded debt discount of $1,500,000 in connection with the issuance of the
warrants, which resulted in a net carrying value of zero for the December
Convertible Notes. This discount was to be amortized into interest expense over
the original life of the December Convertible Notes. This debt discount is fully
amortized as of December 31, 2001 and amortization of $1,300,000 was recorded as
interest expense in 2001. Of these convertible notes, the holders of $1,000,000
agreed in December 2001 to extend the maturity date to January 31, 2003. On
April 16, 2002, we renegotiated this portion of the December Convertible Notes,
plus accrued interest ($128,000 at June 30, 2002), which is to be exchanged into
Series A Preferred Stock, subject to stockholder approval, which was granted at
the 2002 Annual Meeting held in July 2002. The Holder of the remaining $500,000
had demanded payment and on April 16, 2002, we negotiated with this individual
to repay this note over an installment period. In April 2002, $300,000 was paid
on this remaining December Convertible Note and the balance plus accrued
interest is due in January 2003.

Notes Payable - Other - In March 2001, we negotiated new terms for $1,933,000 of
other notes payable. Under these new terms, we are required to make equal
monthly payments, which represent principal and interest at 10%, of $25,000
through January 2002 and $75,000 per month from January 2002 until a balloon
payment is due in October 2002.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We have been notified by the SEC Staff that the SEC is conducting an
investigation into (1) the trading activity of certain individuals and entities
in our securities and the securities of other companies during the period
between 1999 and 2000, and (2) certain of our actions during that same period.
We intend to fully cooperate with the SEC to the extent it requests information.
As a result of the investigation, we could become subject to an order enjoining
us from unlawful conduct and incur civil monetary penalties. Such penalties
could have a material adverse effect on our operations or financial condition.

We have several lawsuits pending against us, one of which alleges damages in the
amount of approximately $2,700,000. We believe we have good and meritorious
defenses against these claims and plan to defend ourselves vigorously. While the
outcome of this litigation cannot be predicted with certainty, we believe that
it will not have a material adverse effect on our financial statements. However,
an unfavorable outcome of this litigation could have a material adverse effect.

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

Our 2002 Annual Meeting of Shareholders was held on July 12, 2002 at our
principal executive officers at 5508 Two Ninety West, Suite 300, Austin, TX
78735. Eleven

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proposals were voted on at the Annual Meeting and the results of the voting are
as follows:

Proposal 1: Election of five members to our Board of Directors for one-year
terms. Each of the below director nominees received the number
and type of votes set forth opposite each of their names below:

Proposal 2: Amendment and restatement of our Articles of Incorporation to
increase the number of shares of common stock authorized from
50,000,000 to 100,000,000. Proposal 2 received the following votes:
For - 12,217,986; Against - 197,328; Abstain - 9,173; Broker
non-votes - 4,853,963.

Proposal 3: Amendment and restatement of our Articles of Incorporation to
increase the number of shares of preferred stock from 5,000,000 to
30,000,000, to designate 10,000,000 shares of our capital stock as
Series A Preferred Stock, to designate 10,000,000 shares of our
capital stock as Series B Preferred Stock and to authorize
10,000,000 shares of our capital stock as blank check preferred
stock. Proposal 3 received the following votes: For - 12,158,465;
Against - 253,223; Abstain - 12,789; Broker non-votes - 4,853,973.

Proposal 4: Amendment and restatement of our Articles of Incorporation to
change the stated purpose of our business. Proposal 4 received the
following votes: For - 12,355,704; Against - 53,481; Abstain -
15,302; Broker non-votes - 4,853,963.

Proposal 5: Ratification of the September 2000 sale of 2,000,000 shares of
our common stock to certain private investors for $2 million.
Proposal 5 received the following votes: For - 10,266,491; Against -
151,524; Abstain - 6,472; Broker non-votes - 4,853,963.

Proposal 6: Approval of the November 2000 convertible debt financing in the
amount of $900,000 to our then Chairman, Carl Rose. Proposal 6
received the following votes: For - 10,164,151; Against - 249,248;
Abstain - 11,086; Broker non-votes - 4,853,965.

Proposal 7: Approval of the December 2000 convertible debt financing in the
amount of $1.5 million to two of our shareholders. Proposal 7
received the following votes: For - 10,181,383; Against - 232,860;
Abstain - 10,244; Broker non-votes - 4,853,963.

Proposal 8: Approval of an April 2002 financing in which we agreed to convert
debt issued in July 2000 and certain debt issued in December 2000
into shares of Series A Preferred Stock upon receiving shareholder
approval, issued substitute notes to replace convertible notes
issued in June 2001, February 2002 and March 2002, and issued
additional notes in April and May 2002 which substitute and new
notes are convertible into shares of Series B Preferred Stock upon
receiving shareholder approval. Proposal 8 received the following
votes: For - 10,189,238; Against - 224,810; Abstain - 10,435; Broker
non-votes - 4,853,967.

Proposal 9: Establishment of a management bonus pool for the benefit of
certain members of management. Proposal 9 received the following
votes: For - 12,118,660; Against - 287,725; Abstain - 18,102; Broker
non-votes - 4,853,963.

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Proposal 10: Adoption of the EpicEdge, Inc. 2002 Stock Option Plan and
reservation an aggregate of up to 10,317,311 shares of the common
stock for issuance under the plan. Proposal 10 received the
following votes: For - 12,154,250; Against - 263,905; Abstain -
6,332; Broker non-votes - 4,853,963.

Proposal 11: Ratification of the Appointment of Deloitte & Touche as our
independent public accountant. Proposal 11 received the following
votes: For - 17,251,328; Against - 27,000; Abstain - 122.

Item 6. Exhibits and Reports on Form 8-K

(a) The following exhibits are filed as part of, or incorporated by reference
into, this Form 10-Q:

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(1) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on January 15, 1999 and incorporated
herein by reference.

(2) Filed as an exhibit to our Annual Report on Form 10-KSB for the year
ended December 31, 1998 and incorporated herein by reference.

(3) Filed as an exhibit to the Company's Registration Statement on Form S-1
filed with the Securities and Exchange Commission on September 7, 1979
and incorporated herein by reference.

(4) Filed as an exhibit to our Definitive Proxy Statement on Schedule 14C
filed with the Securities and Exchange Commission on March 9, 1999 and
incorporated herein by reference.

(5) Filed as an exhibit to our Quarterly Report on Form 10-QSB for the
quarter ended March 31, 1999 filed with the Securities and Exchange
Commission on May 17, 1999 and incorporated herein by reference.

(6) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on June 14, 1999 and incorporated
herein by reference.

(7) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on August 11, 1999 and incorporated
herein by reference.

(8) Filed as an exhibit to our Quarterly Report on Form 10-QSB for the
quarter ended June 30, 1999 filed with the Securities and Exchange
Commission on August 16, 1999 and incorporated herein by reference.

(9) Filed as an exhibit to our Quarterly Report on Form 10-QSB for the
quarter ended September 30, 1999 filed with the Securities and Exchange
Commission on November 15, 1999 and incorporated herein by reference.

(10) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on March 15, 2000 and incorporated
herein by reference.

(11) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on October 16, 2000 and incorporated
herein by reference.

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(12) Filed as an exhibit to our Annual Report on Form 10-KSB for the year
ended December 31, 1999 filed with the Securities and Exchange
Commission on March 30, 2000 and incorporated herein by reference.

(13) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on July 14, 2000 and incorporated
herein by reference.

(14) Filed as an exhibit to our Quarterly Report on Form 10-QSB for the
quarter ended September 30,2000 filed with the Securities and Exchange
Commission on November 21, 2000 and incorporated herein by reference.

(15) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on March 5, 2001 and incorporated
herein by reference.

(16) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on January 27, 1999 and incorporated
herein by reference.

(17) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on December 14, 1999 and
incorporated herein by reference.

(18) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on February 28, 2000 and
incorporated herein by reference.

(19) Filed as an exhibit to our Definitive Proxy Statement on Schedule 14A
filed with the Securities and Exchange Commission on April 28, 2000 and
incorporated herein by reference.

(20) Filed as an exhibit to our Annual Report on Form 10-KSB for the year
ended December 31, 2000 filed with the Securities and Exchange
Commission on July 23, 2001 and incorporated herein by reference.

(21) Filed as an exhibit to our Quarterly Report on Form 10-Q for the
quarter ended June 30,2001 filed with the Securities and Exchange
Commission on August 28, 2001 and incorporated herein by reference.

(22) Filed as an exhibit to our Quarterly Report on Form 10-Q for the
quarter ended September 30,2001 filed with the Securities and Exchange
Commission on November 19, 2001 and incorporated herein by reference.

(23) Filed as an exhibit to our Annual Report on Form 10-K for the year
ended December 31, 2001 filed with the Securities and Exchange
Commission and incorporated herein by reference.

(24) Filed as an exhibit to Amendment No. 1 to our Annual Report on Form
10-K for the year ended December 31, 2001 filed with the Securities and
Exchange Commission on April 30, 2002 and incorporated herein by
reference.

(25) Filed as an exhibit to our Quarterly Report on Form 10-Q for the
quarter ended March 31, 2002 filed with the Securities and Exchange
Commission on May 20, 2002 and incorporated herein by reference.

(#) Filed herewith.

A copy of any exhibit will be furnished (at a reasonable cost) to any
of our shareholders upon receipt of a written request. Such request should be
sent to EpicEdge, Inc. 5508 Two Ninety West, Suite 300 Austin, Texas 78735
Attention: Robert A. Jensen, Chief Operating Officer/Chief Financial Officer.

(b) Reports on Form 8-K

During the quarter ended June 30, 2002 and subsequently to date,
EpicEdge has filed the following Current Reports on Form 8-K with the Securities
and Exchange Commission:

A Current Report on Form 8-K was filed on April 16, 2002 announcing the
resignation of one of the members of our board of directors.

A Current Report on Form 8-K was filed on April 29, 2002 announcing
another round of financing with both new and existing shareholders and
investors.

A Current Report on Form 8-K was filed on July 29, 2002 announcing the
resignation of our chairman of the board of directors.

A Current Report on Form 8-K was filed on August 8, 2002 announcing the
notification by the AMEX of our failure to meet the Exchange's listing
standards and the acceptance of our plan for compliance.

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SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

EpicEdge, Inc.

Date: August 14, 2002 By /s/ Peter B. Covert
-----------------------------
Peter B. Covert
Vice President of Finance, and
Principal Accounting Officer

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EXHIBIT INDEX

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(1) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on January 15, 1999 and incorporated
herein by reference.

(2) Filed as an exhibit to our Annual Report on Form 10-KSB for the year
ended December 31, 1998 and incorporated herein by reference.

(3) Filed as an exhibit to the Company's Registration Statement on Form S-1
filed with the Securities and Exchange Commission on September 7, 1979
and incorporated herein by reference.

(4) Filed as an exhibit to our Definitive Proxy Statement on Schedule 14C
filed with the Securities and Exchange Commission on March 9, 1999 and
incorporated herein by reference.

(5) Filed as an exhibit to our Quarterly Report on Form 10-QSB for the
quarter ended March 31, 1999 filed with the Securities and Exchange
Commission on May 17, 1999 and incorporated herein by reference.

(6) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on June 14, 1999 and incorporated
herein by reference.

(7) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on August 11, 1999 and incorporated
herein by reference.

(8) Filed as an exhibit to our Quarterly Report on Form 10-QSB for the
quarter ended June 30, 1999 filed with the Securities and Exchange
Commission on August 16, 1999 and incorporated herein by reference.

(9) Filed as an exhibit to our Quarterly Report on Form 10-QSB for the
quarter ended September 30, 1999 filed with the Securities and Exchange
Commission on November 15, 1999 and incorporated herein by reference.

(10) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on March 15, 2000 and incorporated
herein by reference.

(11) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on October 16, 2000 and incorporated
herein by reference.

(12) Filed as an exhibit to our Annual Report on Form 10-KSB for the year
ended December 31, 1999 filed with the Securities and Exchange
Commission on March 30, 2000 and incorporated herein by reference.

(13) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on July 14, 2000 and incorporated
herein by reference.

(14) Filed as an exhibit to our Quarterly Report on Form 10-QSB for the
quarter ended September 30,2000 filed with the Securities and Exchange
Commission on November 21, 2000 and incorporated herein by reference.

(15) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on March 5, 2001 and incorporated
herein by reference.

(16) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on January 27, 1999 and incorporated
herein by reference.

(17) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on December 14, 1999 and
incorporated herein by reference.

(18) Filed as an exhibit to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on February 28, 2000 and
incorporated herein by reference.

(19) Filed as an exhibit to our Definitive Proxy Statement on Schedule 14A
filed with the Securities and Exchange Commission on April 28, 2000 and
incorporated herein by reference.

(20) Filed as an exhibit to our Annual Report on Form 10-KSB for the year
ended December 31, 2000 filed with the Securities and Exchange
Commission on July 23, 2001 and incorporated herein by reference.

(21) Filed as an exhibit to our Quarterly Report on Form 10-Q for the
quarter ended June 30,2001 filed with the Securities and Exchange
Commission on August 28, 2001 and incorporated herein by reference.

(22) Filed as an exhibit to our Quarterly Report on Form 10-Q for the
quarter ended September 30,2001 filed with the Securities and Exchange
Commission on November 19, 2001 and incorporated herein by reference.

(23) Filed as an exhibit to our Annual Report on Form 10-K for the year
ended December 31, 2001 filed with the Securities and Exchange
Commission and incorporated herein by reference.

(24) Filed as an exhibit to Amendment No. 1 to our Annual Report on Form
10-K for the year ended December 31, 2001 filed with the Securities and
Exchange Commission on April 30, 2002 and incorporated herein by
reference.

(25) Filed as an exhibit to our Quarterly Report on Form 10-Q for the
quarter ended March 31, 2002 filed with the Securities and Exchange
Commission on May 20, 2002 and incorporated herein by reference.

(#) Filed herewith.