<PAGE>
                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

                                   FORM 10-Q/A

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
    EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2004
                                       OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
    EXCHANGE ACT OF 1934

For the transition period from

Commission file number: 0-21479

                              I-SECTOR CORPORATION
             (Exact name of Registrant as specified in its charter)


                 DELAWARE                                 76-0515249
        (State of incorporation)            (I.R.S. Employer Identification No.)
         6401 SOUTHWEST FREEWAY
             HOUSTON, TEXAS                                  77074
(Address of principal executive offices)                   (Zip code)

        REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE: (713) 795-2000


              (Former name, former address, and former fiscal year,
                         if changed since last report)

         Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

         Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]

         Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.

         As of October 5, 2004, there were 5,013,954 shares of common stock,
$.01 par value per share, outstanding.


                                       1
<PAGE>
                          Part I. Financial Information

Item 1.  Condensed Consolidated Financial Statements - I-Sector Corporation
         (Unaudited):

         Condensed Consolidated Balance Sheets at December 31, 2003 and June 30,
         2004

         Condensed Consolidated Statements of Income for the three months ended
         June 30, 2003 and 2004

         Condensed Consolidated Statements of Income for the six months ended
         June 30, 2003 and 2004

         Condensed Consolidated Statement of Stockholders' Equity for the six
         months ended June 30, 2004

         Condensed Consolidated Statements of Cash Flows for the six months
         ended June 30, 2003 and 2004

         Notes to Condensed Consolidated Financial Statements

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

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Item 4.  Controls and Procedures

                           Part II. Other Information

Item 1.  Legal Proceedings

Item 5.  Other Information

Item 6.  Exhibits and Reports on Form 8-K


         Signatures

<PAGE>

                          PART 1. FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

                      I-SECTOR CORPORATION AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS
               (In thousands, except share and par value amounts)

<TABLE>
<CAPTION>
                                                                                               December 31,         June 30,
                                                                                                  2003               2004
                                                                                               ------------         --------
                                                                                                                  (Unaudited)
<S>                                                                                              <C>               <C>
                                    ASSETS
Current Assets:
     Cash and cash equivalents .........................................................         $  2,172          $  7,220
     Accounts receivable - trade, net of allowance of $612 and $635 ....................            9,757            13,215
     Accounts receivable - affiliates ..................................................               16                13
     Accounts receivable - other .......................................................               29                25
     Notes receivable, net of allowance of $373 and $549 ...............................              676             1,253
     Inventory .........................................................................            1,038             1,949
     Cost and estimated earnings in excess of billings .................................            1,452             1,714
     Other current assets ..............................................................              943               490
                                                                                                 --------          --------
         Total current assets ..........................................................           16,083            25,879
                                                                                                 --------          --------

Property and equipment, net of accumulated depreciation of $1,887 and $2,129 ...........            1,271             1,448
Notes receivable, long-term, net of allowance of $250 and $250 .........................              252               253
Patent license rights, net of accumulated amortization of $265 and $320 ................              849               794
Other intangible assets,  net of accumulated amortization of $335 and $438 .............              435               537
Deferred offering costs ................................................................              317                --
                                                                                                 --------          --------
         Total Assets ..................................................................         $ 19,207          $ 28,911
                                                                                                 ========          ========


                        LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
     Notes payable and current portion of long-term debt ...............................         $  1,784          $     94
     Accounts payable ..................................................................            6,524             9,801
     Billings in excess of cost and estimated earnings .................................              262               132
     Accrued expenses ..................................................................            2,676             2,828
     Net liabilities related to discontinued operations ................................              557               642
     Deferred revenue ..................................................................              556               733
                                                                                                 --------          --------
         Total current liabilities .....................................................           12,359            14,230
                                                                                                 --------          --------

Long-term debt .........................................................................              229               178

Minority interest ......................................................................               --               168

Commitments and Contingencies

Stockholders' Equity:
     Preferred stock, $.01 par value, 5,000,000 shares authorized,
         no shares issued ..............................................................               --                --
     Common stock, $.01 par value, 15,000,000 shares authorized,
         4,762,809 and 5,960,354 issued ................................................               48                60
     Additional paid in capital ........................................................           10,853            18,601
     Additional paid in capital - other ................................................              337               202
     Treasury stock, at cost 811,800 and 811,800 shares ................................           (1,373)           (1,373)
     Retained deficit ..................................................................           (3,246)           (3,155)
                                                                                                 --------          --------
         Total stockholders' equity ....................................................            6,619            14,335
                                                                                                 --------          --------
              Total Liabilities and Stockholders' Equity ...............................         $ 19,207          $ 28,911
                                                                                                 ========          ========

</Table>

            See notes to condensed consolidated financial statements


                                       3
<PAGE>
                      I-SECTOR CORPORATION AND SUBSIDIARIES
                   CONDENSED CONSOLIDATED STATEMENTS OF INCOME
               (In thousands, except share and per share amounts)
                                  (Unaudited)

<Table>
<Caption>
                                                                                                     Three months ended June 30,
                                                                                                  ---------------------------------
                                                                                                     2003                  2004
                                                                                                  -----------           -----------
<S>                                                                                               <C>                   <C>
Revenue:
       Products ........................................................................          $    12,703           $    16,609
       Services ........................................................................                1,656                 3,109
       Custom projects .................................................................                1,511                 2,169
                                                                                                  -----------           -----------
             Total revenue .............................................................               15,870                21,887
                                                                                                  -----------           -----------

Cost of goods and services:
       Products ........................................................................               11,211                14,650
       Services ........................................................................                1,356                 2,052
       Custom projects .................................................................                  574                   886
                                                                                                  -----------           -----------
             Total cost of goods and services ..........................................               13,141                17,588
                                                                                                  -----------           -----------
                 Gross profit ..........................................................                2,729                 4,299
Selling, general and administrative expenses ...........................................                3,562                 4,236
                                                                                                  -----------           -----------
Operating income (loss) ................................................................                 (833)                   63
Interest and other income (expense), net ...............................................                   96                   (26)
                                                                                                  -----------           -----------
Income (loss) from continuing operations before income tax benefit .....................                 (737)                   37
Income tax benefit .....................................................................                  (81)                   (7)
                                                                                                  -----------           -----------
Net income (loss) from continuing operations before minority interest ..................                 (656)                   44
Minority interest ......................................................................                   --                    (6)
Discontinued operations:
Gain on disposal of discontinued operations, net of taxes ..............................                   16                    13
                                                                                                  -----------           -----------
Net income (loss) ......................................................................          $      (640)          $        51
                                                                                                  ===========           ===========
Net income (loss) per share Basic:
Net income (loss) from continuing operations before minority interest ..................          $     (0.19)          $      0.01
Minority interest ......................................................................                   --                    --
Gain on disposal of discontinued operations, net of taxes ..............................                 0.01                    --
                                                                                                  -----------           -----------
Net income (loss) per share ............................................................          $     (0.18)          $      0.01
                                                                                                  ===========           ===========
Diluted:
Net income (loss) from continuing operations before minority interest ..................          $     (0.19)          $      0.01
Minority interest ......................................................................                   --                    --
Gain on disposal of discontinued operations, net of taxes ..............................                 0.01                    --
                                                                                                  -----------           -----------
Net income (loss) per share ............................................................          $     (0.18)          $      0.01
                                                                                                  ===========           ===========
Shares used in computing net income (loss) per share:
Basic ..................................................................................            3,636,441             4,582,790
                                                                                                  -----------           -----------
Diluted ................................................................................            3,636,441             4,939,206
                                                                                                  -----------           -----------
</TABLE>


            See notes to condensed consolidated financial statements


                                       4
<PAGE>


                      I-SECTOR CORPORATION AND SUBSIDIARIES
                   CONDENSED CONSOLIDATED STATEMENTS OF INCOME
               (In thousands, except share and per share amounts)
                                  (Unaudited)

<Table>
<Caption>
                                                                                                       Six months ended June 30,
                                                                                                  ---------------------------------
                                                                                                      2003                  2004
                                                                                                  -----------           -----------
<S>                                                                                               <C>                   <C>
Revenue:
       Products ........................................................................          $    19,427           $    26,803
       Services ........................................................................                2,944                 5,053
       Custom projects .................................................................                3,580                 4,306
                                                                                                  -----------           -----------
       Total revenue ...................................................................               25,951                36,162
                                                                                                  -----------           -----------
Cost of goods and services:
       Products ........................................................................               17,114                23,142
       Services ........................................................................                2,458                 3,338
       Custom projects .................................................................                1,374                 1,848
                                                                                                  -----------           -----------
       Total cost of goods and services ................................................               20,946                28,328
                                                                                                  -----------           -----------
                 Gross profit ..........................................................                5,005                 7,834
Selling, general and administrative expenses ...........................................                6,939                 7,734
                                                                                                  -----------           -----------
Operating income (loss) ................................................................               (1,934)                  100
Interest and other income (expense), net ...............................................                  106                    (6)
                                                                                                  -----------           -----------
Income (loss) from continuing operations before income tax benefit .....................               (1,828)                   94
Income tax benefit .....................................................................                  (81)                   (1)
                                                                                                  -----------           -----------
Net income (loss) from continuing operations before minority interest ..................               (1,747)                   95
Minority interest ......................................................................                   --                    (6)
Discontinued operations:
Gain on disposal of discontinued operations, net of taxes ..............................                   16                     2
                                                                                                  -----------           -----------
Net income (loss) ......................................................................          $    (1,731)          $        91
                                                                                                  ===========           ===========
Net income (loss) per share Basic:
Net income (loss) from continuing operations before minority interest ..................          $     (0.48)          $      0.02
Minority interest ......................................................................                   --                    --
Gain (loss) on disposal of discontinued operations, net of taxes .......................                   --                    --
                                                                                                  -----------           -----------
Net income (loss) per share ............................................................          $     (0.48)          $      0.02
                                                                                                  ===========           ===========
Diluted:
Net income (loss) from continuing operations before minority interest ..................          $     (0.48)          $      0.02
Minority interest ......................................................................                   --                    --
Gain (loss) on disposal of discontinued operations, net of taxes .......................                   --                    --
                                                                                                  -----------           -----------
Net income (loss) per share ............................................................          $     (0.48)               4 0.02
                                                                                                  ===========           ===========

Shares used in computing net income (loss) per share:
Basic ..................................................................................            3,632,978             4,280,599
                                                                                                  -----------           -----------
Diluted ................................................................................            3,632,978             4,658,296
                                                                                                  -----------           -----------
</TABLE>

            See notes to condensed consolidated financial statements


                                       5
<PAGE>


                      I-SECTOR CORPORATION AND SUBSIDIARIES

            CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

                      (In thousands, except share amounts)
                                   (Unaudited)

<Table>
<Caption>

                                                  $.01 par value                   Additional
                                                   Common Stock        Additional   Paid-In
                                                -------------------     Paid-In    Capital -    Treasury      Retained
                                                Shares       Amount     Capital      Other        Stock       Deficit       Total
                                               ---------   ---------   ----------  ---------    ---------    ---------    ---------
<S>                                            <C>         <C>         <C>         <C>          <C>          <C>          <C>
Balance at December 31, 2003 ...............   4,762,809   $      48   $  10,853   $     337    $  (1,373)   $  (3,246)   $   6,619
Revaluation of consultant options ..........          --          --          --        (163)          --           --         (163)
Exercise of common stock options ...........      47,545          --          60          25           --           --           85
Proceeds from offering of Units,
  net of offering costs of $1,046 ..........   1,150,000          12       7,620          --           --           --        7,632
Issuance of INX common stock
  net of minority interest .................          --          --          71          --           --           --           71
Net income .................................          --          --          --          --           --           91           91
                                               ---------   ---------   ---------   ---------    ---------    ---------    ---------
Balance at June 30, 2004 ...................   5,960,354   $      60   $  18,604   $     199    $  (1,373)   $  (3,155)   $  14,335
                                               =========   =========   =========   =========    =========    =========    =========
</TABLE>


                   The accompanying notes are an integral part
               of this condensed consolidated financial statement


                                       6
<PAGE>
                      I-SECTOR CORPORATION AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)
                                   (Unaudited)


<Table>
<Caption>
                                                                                                           Six Months Ended June 30,
                                                                                                           -------------------------
                                                                                                             2003             2004
                                                                                                           -------          -------
<S>                                                                                                        <C>              <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
       Net income (loss) .........................................................................         $(1,731)         $    91
       Adjustments to reconcile net income (loss) to net cash provided by (used in)
         operating activities:
            Minority interest ....................................................................              --                6
            Net gain (loss) from discontinued operations .........................................             (16)               3
            Tax benefit (expense) from discontinued operations ...................................              (8)              (1)
            Depreciation and amortization ........................................................             359              444
            (Gain) loss on retirement of assets ..................................................             (89)              23
            Bad debt expense .....................................................................             578              193
       Changes in assets and liabilities that provided (used) cash:
            Accounts receivable, net .............................................................          (1,856)          (3,453)
            Accounts receivable, affiliates and other ............................................              57                7
            Inventory ............................................................................          (1,029)            (911)
            Income tax receivable ................................................................             (73)              --
            Notes receivable .....................................................................            (300)            (776)
            Other current assets .................................................................              14              453
            Accounts payable .....................................................................           3,390            3,277
            Cost and estimated earnings in excess of billings ....................................            (191)            (262)
            Billings in excess of cost and estimated earnings ....................................             198             (130)
            Other assets .........................................................................            (250)              --
            Accrued expenses .....................................................................             158              305
            Deferred revenue .....................................................................             115              177
                                                                                                           -------          -------
                          Net cash used in continuing operations .................................            (674)            (554)

       Net operating activities from discontinued operations .....................................           ((255)              83
                                                                                                           -------          -------
                          Net cash used in operating activities ..................................            (929)            (471)
                                                                                                           -------          -------
CASH FLOWS FROM INVESTING ACTIVITIES:
       Proceeds of sale of fixed assets ..........................................................              80               --
       Acquisition of Digital Precision, Inc (inclusive of acquisition costs) ....................            (566)              --
       Capital expenditures ......................................................................            (220)            (457)
                                                                                                           -------          -------
                          Net cash used in investing activities ..................................            (706)            (457)
                                                                                                           -------          -------
CASH FLOWS FROM FINANCING ACTIVITIES:
       Exercise of stock options .................................................................              14               85
       Proceeds from Unit offering ...............................................................              --            7,632
       Proceeds from borrowings of interest bearing debt .........................................              --            1,204
       Payments of long-term debt ...............................................................             (104)          (2,945)
                                                                                                           -------          -------
                          Net cash provided by (used in) in financing activities .................             (90)           5,976
                                                                                                           -------          -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .............................................          (1,725)           5,048

CASH AND CASH EQUIVALENTS AT BEGINNING OF  PERIOD ................................................           3,491            2,172
                                                                                                           -------          -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD .......................................................         $ 1,766          $ 7,220
                                                                                                           =======          =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

       Cash paid for interest ....................................................................         $     9          $    10

SUPPLEMENTAL NONCASH INVESTING AND FINANCING ACTIVITIES:
       Revaluation of options granted to consultants .............................................         $    78          $  (163)
       Other receivable for proceeds of sale of fixed assets .....................................              30               --
       Recognition of additional purchase price on Digital Precision acquisition
         through issuance of INX common stock ....................................................              --              234
</TABLE>

            See notes to condensed consolidated financial statements


                                       7
<PAGE>

                      I-SECTOR CORPORATION AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
               (In thousands, except share and per share amounts)

1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         I-Sector Corporation and subsidiaries ("I-Sector" or the "Company") is
engaged in selling and supporting IP telephony solutions as well as related
network infrastructure, their proprietary computer-telephony software, and
performing remote-enabled managed services for the information and communication
technology used by their customers:

              o  Internetwork Experts, Inc. ("INX") is a network professional
                 services and integration organization focused on delivering
                 comprehensive Cisco-centric IP communications solutions to
                 clients ranging from mid-size to large enterprises. IP
                 communications solutions include design and implementation,
                 ongoing support and applications enablement. Supporting
                 practice areas include network architecture, security, and
                 wireless. To provide these services, INX employs highly trained
                 IP communications consultants and network engineering staff who
                 are trained and experienced in both large, complex network
                 infrastructure technology and IP communications technology.

              o  Stratasoft, Inc. ("Stratasoft") creates and markets software
                 related to the integration of computer and telephone
                 technologies. This software is used by professional contact
                 centers and other complex, high-volume telephony environments
                 and is marketed under the trade name "Stratasoft". Stratasoft
                 intends to use its computer telephony software development
                 expertise to create and market new software products that
                 enhance Cisco-centric IP telephony solutions.

              o  Valerent, Inc. ("Valerent") provides information technology
                 solutions that lower its client's expense by utilizing
                 centralized, remote enabled computing management tools which
                 predict, announce and manage service interruptions.
                 Additionally, Valerent provides customers with traditional
                 computer services such as on-site and carry-in computer repair,
                 application support, operating system and network migration
                 services, turn-key outsourced IT helpdesk solutions, technical
                 staff augmentation for IT helpdesk operations, and helpdesk
                 solutions consulting services.

         The condensed consolidated financial statements presented herein as of
and for the three-month and six-month periods ended June 30, 2003 and 2004 are
unaudited; however, all adjustments which are, in the opinion of management,
necessary for a fair presentation of the financial position, results of
operations, and cash flows for the periods covered have been made and are of a
normal, recurring nature. The results of the interim periods are not necessarily
indicative of results for the full year. The consolidated balance sheet as of
December 31, 2003 is derived from audited consolidated financial statements but
does not include all disclosures required by accounting principles generally
accepted in the United States of America. Although management believes the
disclosures are adequate, certain information and disclosures normally included
in the notes to the financial statements have been condensed or omitted as
permitted by the rules and regulations of the Securities and Exchange
Commission. These interim statements should be read in conjunction with the
consolidated financial statements and notes thereto included in I-Sector's 2003
annual report on Form 10-K.

         I-Sector's significant accounting policies are as follows:

         USE OF ESTIMATES - The preparation of the financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amount
of revenue and expense during the reporting period. Actual results could differ
from these estimates.

         REVENUE RECOGNITION - I-Sector has a number of different revenue
components, which vary between its reportable operating segments. Each
reportable operating segment has more than one revenue component, and revenue is
recognized differently for each component (or "stream") of revenue earned by
operating segment. The material revenue streams earned by I-Sector, some of
which are earned by more than one operating segment, and some by only one
operating segment, are:

         Products Revenue. Three of I-Sector's operating segments earn revenue
         from product shipments. Product shipment revenue occurs when products
         manufactured by other parties are purchased and resold to a customer
         and such products are contracted for independently of material
         services. I-Sector recognizes revenue from product shipments when the
         product is shipped or delivered to the customer. In all three segments,
         the four criteria for revenue recognition have been met because: (1)
         there are written, executed contracts, or in the case of INX and
         Valerent, in some situations there are binding purchase orders; (2)
         delivery has occurred or services have been rendered; (Stratasoft,
         however, recognizes revenue on the percentage of completion method, as
         described below.) (3) the price is fixed or determinable, and (4)
         collectibility is reasonably assured. Each of I-Sector's business
         segments performs credit research prior to extending


                                       8
<PAGE>
         credit. In Stratasoft's business segment, a substantial portion of the
         total contract price is received in cash or letter of credit when the
         unit is installed.

         Services Revenue. All of I-Sector's operating segments earn revenue
         from providing stand-alone services revenue. This revenue consists of
         billings for engineering and technician time, programming services,
         which are provided on either a hourly basis or a flat-fee basis,
         support contracts and the service component of maintenance and repair
         service ticket transactions. These services are contracted for
         separately from any product sale, and generally for contracts of short
         duration, are recognized when the service is performed and when
         collection is reasonably assured. Two of I-Sector's segments sometimes
         earn agency fee revenue from various sources, the primary source of
         which is referring customers to other organizations for which an agency
         fee is received. This revenue is recognized at the earlier of when
         payment is received or when notification of amounts being due is
         received from the entity paying such agency fee and collectibility is
         reasonably assured.

         One of I-Sector's segments, INX, has certain fixed and flat fee
         services contracts that extend over three months or more, and are
         accounted for on the percentage of completion method of accounting. The
         percentage of revenue recognized in any particular period is determined
         on the basis of the relationship of the actual hours worked to
         estimated total hours to complete the contract. Revisions of the
         estimated hours to complete are reflected in the period in which the
         facts necessitating the revisions become known. When a contract
         indicates a loss, a provision is made for the total anticipated loss.

         Custom Project Revenue. One of I-Sector's segments, Stratasoft, earns
         revenue from projects that are recognized using the percentage of
         completion method of accounting for such revenue. The majority of
         Stratasoft's revenue consists of system sales in which it bundles its
         proprietary software, along with third-party hardware products and
         material related software customization services, installation,
         training services, warranty services and incidental post contract
         support ("PCS") together under a single contract with the customer. PCS
         is insignificant on such contracts for one year or less, and therefore,
         we have determined that the value of such PCS should not be unbundled
         from the project revenue as set forth in paragraph 59 of SOP 97-2.
         Accordingly, such PCS revenue is recognized together with the project
         revenue, and the estimated cost to provide the PCS is accrued. The
         value of the PCS is determinable within the contract, which defines the
         period that the PCS is granted and offers renewals at stated amounts,
         thereby defining the value of the PCS. The software customization,
         together with the hardware customization and integration, represent a
         significant modification, customization and/or production of the
         product and, therefore, the entire arrangement is required to be
         accounted for using the percentage of completion method of accounting
         pursuant to SOP 81-1. The percentage of revenue recognized in any
         particular period is determined principally on the basis of the
         relationship of the cost of work performed on the contract to estimated
         total costs. The percentage-of-completion method relies on estimates of
         total expected contract revenue and costs. We follow this method since
         reasonably dependable estimates of the revenue and costs applicable to
         various stages of a contract can be made. Revisions of estimates are
         reflected in the period in which the facts necessitating the revisions
         become known. When a contract indicates a loss, a provision is made for
         the total anticipated loss. The following reflects the amounts relating
         to uncompleted contracts at:

<Table>
<Caption>
                                                  December 31,    June 30,
                                                      2003          2004
                                                  ------------    --------
<S>                                                 <C>           <C>
Costs incurred on uncompleted contracts .........   $ 1,019       $ 1,685
Estimated earnings ..............................     3,117         4,341
                                                    -------       -------
                                                      4,136         6,026
Less: Billings to date ..........................    (2,946)       (4,444)
                                                    -------       -------

Total ...........................................   $ 1,190       $ 1,582
                                                    =======       =======
Included in accompanying balance sheets
  under the following captions:
Cost and estimated earnings in excess of billings   $ 1,452       $ 1,714
Billings in excess of cost and estimated earnings      (262)         (132)
                                                    -------       -------
Total ...........................................   $ 1,190       $ 1,582
                                                    =======       =======
</TABLE>

         During the six months ending June 30, 2004, I-Sector's operating
         segment Stratasoft deferred $520 of revenue for software products sold
         on notes that are not due within twelve months of their note
         origination and revenue to resellers of $37. Also during the second
         quarter of 2004, the company reversed deferred revenue of $398 due to
         cancellation of a reseller transaction that was originally deferred in
         full at December 31, 2003. Revenue from resellers and notes in excess
         of twelve months is recognized in the accounting periods that payments
         from the customer are received.

                                       9
<PAGE>

         VENDOR INCENTIVES - From time to time, the Company participates in
programs provided by suppliers that enable it to earn incentives. These
incentives are generally earned based upon sales volume, sales growth and
customer satisfaction levels. The amounts earned under these programs are
recorded as a reduction of cost of goods when earned and determinable. The
amount of vendor incentives recognized can vary significantly between quarterly
and annual periods. During the three-month period ended June 30, 2004, the
Company did not recognize any vendor incentives. During the six-month period
ended June 30, 2004, the Company recognized $622 in vendor incentives that
related to the six-month measurement period ended January 31, 2004.

         WARRANTY RESERVE - I-Sector records a warranty reserve related to
certain software products sold by its Stratasoft subsidiary. That reserve is
classified in accrued expenses and is amortized over the life of the warranty,
which is generally twelve months, against actual warranty expenditures. This
warranty reserve relates to the estimate of warranty obligations from sales of
Stratasoft's call center telephony systems, which consist of Stratasoft's
software, configured hardware components as well as telephone support relating
to Stratasoft's software products. This liability amount has been consistently
recorded within each period as a charge to cost of goods based upon five percent
of period revenue. This percentage was based upon a review of the costs of
providing the warranty work, which was initially performed in connection with
the acquisition of the Stratasoft technology. Stratasoft incurs numerous types
of costs related to the warranty work, which includes labor cost of technicians
and programmers, hardware cost, the cost of developing and uploading software
patches related to "bug fixes", telephone support, and hardware parts cost
related to defective hardware sold as a part of a complete Stratasoft system.
The majority of these costs are individually insignificant amounts for which the
cost/benefit relationship does not warrant tracking, but which we periodically
assess and continue to estimate at approximately five percent of Stratasoft
sales. As the actual costs are not tracked, Stratasoft amortizes the recorded
amounts to cost of goods over the average life of the contractual warranty
period as costs are believed to be incurred ratably over the warranty period.
The difference between the actual warranty costs incurred and the amount of
amortization is not considered to be materially different. The following table
depicts the activity in the warranty reserve:

<Table>
<Caption>
                                      Six Months Ended
                                          June 30,
                                      ----------------
                                           2004
                                      ----------------
<S>                                      <C>
Balance, beginning of the period          $ 302
Additions to reserve .................      227
Expenses offset against reserve.......     (195)
                                          -----
Balance, end of period ...............    $ 334
                                          =====
</TABLE>


         STOCK-BASED COMPENSATION - The Company has elected to account for
stock-based compensation using the intrinsic value method of accounting in
accordance with Accounting Principles Bulletin ("APB") No. 25 "Accounting for
Stock Issued to Employees". Under this method no compensation expense is
recognized when the number of shares granted is known and the exercise price of
the stock option is equal to or greater than the fair value of the common stock
on the grant date. The Company has recorded no stock-based compensation
associated with stock options granted to employees and directors in its
consolidated statement of operations. I-Sector and its subsidiaries apply the
fair value method as prescribed by SFAS No. 123, as interpreted and amended, for
stock and stock options issued to non-employees and during the three and six
month periods ended June 30, 2004, recorded a $25 expense and a $39 benefit,
respectively. If compensation cost for all option issuances had been determined
consistent with the fair value method, I-Sector's per share profitability would
have changed to the pro-forma amounts indicated below for the three and six
month periods ended June 30, 2003 and 2004.


                                       10
<PAGE>

<Table>
<Caption>
                                                                                     Three Months Ended         Six Months Ended
                                                                                          June 30,                   June 30,
                                                                                  -----------------------    -----------------------
                                                                                    2003           2004         2003          2004
                                                                                  ---------     ---------    ---------     ---------
<S>                                                                               <C>           <C>          <C>           <C>
Basic and diluted:
Net income (loss) as reported ................................................    $    (640)    $      51    $  (1,731)    $      91
Deduct: Total stock-based employee
  compensation determined under fair value
  based method for all awards, net of related tax effects ....................           14            23           24            45
                                                                                  ---------     ---------    ---------     ---------
Pro forma net income (loss) ..................................................    $    (654)    $      28    $  (1,755)    $      46
                                                                                  =========     =========    =========     =========

Earnings per share:
Basic - as reported ..........................................................    $   (0.18)    $    0.01    $   (0.48)    $    0.01
Basic - pro forma ............................................................    $   (0.18)    $    0.01    $   (0.48)    $    0.01

Diluted - as reported ........................................................    $   (0.18)    $    0.01    $   (0.48)    $    0.01
Diluted - pro forma ..........................................................    $   (0.18)    $    0.01    $   (0.48)    $    0.01
</Table>

         EARNINGS PER SHARE - Basic net income per share is computed on the
basis of the weighted-average number of common shares outstanding during the
periods. Diluted net income per share is computed based upon the
weighted-average number of common shares plus the assumed issuance of common
shares for all potentially dilutive securities using the treasury stock method
(See Note 4).

         FAIR VALUE OF FINANCIAL INSTRUMENTS - I-Sector's financial instruments
consist of cash and cash equivalents, accounts receivable and accounts payable
for which the carrying values approximate fair values given the short-term
maturity of the instruments. The carrying value of the Company's debt
instruments approximate their fair value based on estimates of rates offered to
the Company for instruments with the same maturity dates and security
structures.

         ACCOUNTING PRONOUNCEMENTS - In January 2003, the FASB issued FASB
Interpretation 46 ("FIN 46"), "Consolidation of Variable Interest Entities - An
Interpretation of ARB No. 51". FIN 46 addresses consolidation by business
enterprises of variable interest entities. This Interpretation applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after that
date. It applies in the first fiscal year or interim period beginning after June
15, 2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. On December 17, 2003, the
FASB issued FIN 46(R), providing a deferral of the application of FIN 46 for
interests held by public entities in a variable interest entity or potential
variable interest entity until fiscal periods ending after March 15, 2004. The
Company has assessed the impact of FIN 46 on its financial statements,
particularly its relationship with Allstar Equities, Inc., and adoption of this
statement did not have an impact on the Company's financial statements.

2. DISCONTINUED OPERATIONS

         In 1999, I-Sector decided to sell both its computer products reselling
business and its PBX telephone systems dealer business. During the quarter and
six months specified below, I-Sector recognized a gain (loss) on disposal, net
of income tax provision, of these three businesses as follows:

<Table>
<Caption>
                                                                         Three Months             Six Months
                                                                        Ended June 30,          Ended June 30,
                                                                      ------------------      ------------------
                                                                      2003         2004       2003          2004
                                                                      -----        -----      -----        -----
<S>                                                                   <C>          <C>        <C>          <C>
IT Staffing, Inc. (net of taxes of $14 and $-,
  respectively for quarter ended) and ($14
  and $ -, respectively for six months ended)....................     $  26        $  --      $  26        $  --
Computer Products Division (net of taxes
  of $(5) and $(2), respectively for quarter
  ended) and ($(7) and $2, respectively for
  six months ended)..............................................        (9)          12        (14)           3
Telecom Division (net of taxes and taxes
  of - and $-, respectively for quarter ended)
  and ($2 and $(1), respectively for six
  smonths ended).................................................        (1)           1          4           (1)
                                                                      -----        -----      -----        -----
Gain on disposal of discontinued operations,
  net of taxes...................................................     $  16        $  13      $  16        $   2
                                                                      =====        =====      =====        =====
</Table>

         The balance sheet caption "Net liabilities related to discontinued
operations" contains $557 and $642 at December 31, 2003 and June 30, 2004,
respectively, of estimated future expenses related to the winding up of the
Telecom Division and the Computer Products Division, and includes amounts
related to settlement of pending litigation and to Telecom warranties. An
additional $85 relating to the rebate repayment claims from a former vendor was
reclassified from accrued liabilities to net liabilities related to discontinued
operations during the six month period ending June 30, 2004.


                                       11
<PAGE>
3. SEGMENT INFORMATION

         I-Sector has four reportable segments: INX, Stratasoft, Valerent and
Corporate. Corporate is not a revenue generating operating segment. The
accounting policies of the business segments are the same as those for I-Sector.
I-Sector evaluates performance of each segment based on operating income.
Management considers trade accounts receivable and inventory and not total
assets in their decision-making. Inter-segment sales and transfers are not
significant and are shown in the Eliminations column in the table below. The
following tables show the results of the four reportable segments:

         For the quarter ended June 30, 2004:

<Table>
<Caption>
                           INX     STRATASOFT   VALERENT   CORPORATE   ELIMINATIONS   CONSOLIDATED
                         -------   ----------   --------   ---------   ------------   ------------
<S>                      <C>       <C>          <C>        <C>         <C>            <C>
Revenue:
     Products..........  $16,354     $   --      $  505      $  --        $(250)        $16,609
     Services..........    1,625         --       1,484         --           --           3,109
     Custom projects...       --      2,169          --         --           --           2,169
                         -------     ------      ------      -----        -----         -------
Total revenue..........   17,979      2,169       1,989         --         (250)         21,887
                         -------     ------      ------      -----        -----         -------
Cost of goods and
  Services:
     Products..........   14,440         --         460         --         (250)         14,650
     Services..........    1,145         --         907         --           --           2,052
     Custom projects...       --        886          --         --           --             886
                         -------     ------      ------      -----        -----         -------
  Cost of goods and
     Services..........   15,585        886       1,367         --         (250)         17,588
                         -------     ------      ------      -----        -----         -------
Gross profit...........    2,394      1,283         622         --           --           4,299

Selling, general and
  administrative
  expenses.............    2,318      1,131         486        301           --           4,236
                         -------     ------      ------      -----        -----         -------
Operating income
  (loss)...............  $    76     $  152      $  136      $(301)       $  --              63
                         -------     ------      ------      -----        -----
Interest and other income, net.....................................................         (26)
                                                                                        -------
Income from continuing operations before income taxes..............................          37
Income tax benefit.................................................................          (7)
                                                                                        -------
Net income from continuing operations before minority interest.....................          44
Minority interest..................................................................          (6)
Gain on disposal of discontinued operations, net of taxes..........................          13
                                                                                        -------
Net income.........................................................................     $    51
                                                                                        =======
Selected Balance Sheet Information:
Trade accounts
  Receivable, net......  $11,455     $  706      $  961      $  --        $  --         $13,122
                         -------     ------      ------      -----        -----         -------
Accounts receivable retained from discontinued operations, net.....................          93
                                                                                        -------
Total accounts receivable, net.....................................................     $13,215
                                                                                        =======
Inventory..............  $ 1,222     $  681      $   46      $  --        $  --         $ 1,949
                         -------     ------      ------      -----        -----         -------
</Table>


                                       12
<PAGE>
         For the quarter ended June 30, 2003:

<Table>
<Caption>
                           INX     STRATASOFT   VALERENT   CORPORATE   ELIMINATIONS   CONSOLIDATED
                         -------   ----------   --------   ---------   ------------   ------------
<S>                      <C>       <C>          <C>        <C>         <C>            <C>
Revenue:
     Products..........  $12,253     $   --      $  509      $  --         $(59)        $12,703
     Services..........      782         --         874         --           --           1,656
     Custom projects...       --      1,511          --         --           --           1,511
                         -------     ------      ------      -----         ----         -------
Total revenue..........   13,035      1,511       1,383         --          (59)         15,870
                         -------     ------      ------      -----         ----         -------
Cost of goods and
  Services:
     Products..........   10,846         --         424         --          (59)         11,211
     Services..........      757         --         599         --           --           1,356
     Custom projects...       --        574                     --           --             574
                         -------     ------      ------      -----         ----         -------
  Cost of goods and
     Services..........   11,603        574       1,023         --          (59)         13,141
                         -------     ------      ------      -----         ----         -------
Gross profit...........    1,432        937         360         --           --           2,729

Selling, general and
  administrative
  expenses.............    1,448      1,344         536        234           --           3,562
                         -------     ------      ------      -----         ----         -------
Operating loss.........  $   (16)    $ (407)     $ (176)     $(234)        $ --            (833)
                         -------     ------      ------      -----         ----
Interest and other income, net.....................................................          96
                                                                                        -------
Loss from continuing operations before income taxes................................        (737)
Income taxes.......................................................................         (81)
                                                                                        -------
Net loss from continuing operations................................................        (656)
Gain on disposal of discontinued operations, net of taxes..........................          16
                                                                                        -------
Net loss...........................................................................     $  (640)
                                                                                        =======
Selected Balance Sheet Information:
Trade accounts
  receivable, net......  $ 6,231     $1,231      $  747      $  15         $ --         $ 8,224
                         -------     ------      ------      -----         ----
Accounts receivable retained from discontinued operations, net.....................         100
                                                                                        -------
Total accounts receivable, net.....................................................     $ 8,324
                                                                                        =======
Inventory..............  $ 1,434     $  448      $   29      $  --         $ --         $ 1,911
                         -------     ------      ------      -----         ----         -------
</Table>


                                       13
<PAGE>
         For the six months ended June 30, 2004:

<Table>
<Caption>
                           INX     STRATASOFT   VALERENT   CORPORATE   ELIMINATIONS   CONSOLIDATED
                         -------   ----------   --------   ---------   ------------   ------------
<S>                      <C>       <C>          <C>        <C>         <C>            <C>
Revenue:
     Products..........  $26,415     $   --      $  839      $  --        $(451)        $26,803
     Services..........    2,538         --       2,515         --           --           5,053
     Custom projects...       --      4,306          --         --           --           4,306
                         -------     ------      ------      -----        -----         -------
Total revenue..........   28,953      4,306       3,354         --         (451)         36,162
                         -------     ------      ------      -----        -----         -------
Cost of goods and
  Services:
     Products..........   22,822         --         771         --         (451)         23,142
     Services..........    1,735         --       1,603         --           --           3,338
     Custom projects...       --      1,848          --         --           --           1,848
                         -------     ------      ------      -----        -----         -------
  Cost of goods and
     Services..........   24,557      1,848       2,374         --         (451)         28,328
                         -------     ------      ------      -----        -----         -------
Gross profit...........    4,396      2,458         980         --           --           7,834

Selling, general and
  administrative
  expenses.............    4,202      2,150         876        506           --           7,734
                         -------     ------      ------      -----        -----         -------
Operating income
  (loss)...............  $   194     $  308      $  104      $(506)       $  --             100
                         -------     ------      ------      -----        -----
Interest and other income, net.....................................................          (6)
                                                                                        -------
Income from continuing operations before income taxes..............................          94
Income tax benefit.................................................................          (1)
                                                                                        -------
Net income from continuing operations before minority interest.....................          95
Minority interest..................................................................          (6)
Gain on disposal of discontinued operations, net of taxes..........................           2
                                                                                        -------
Net income.........................................................................     $    91
                                                                                        =======
</Table>

         For the six months ended June 30, 2003:

<Table>
<Caption>
                           INX     STRATASOFT   VALERENT   CORPORATE   ELIMINATIONS   CONSOLIDATED
                         -------   ----------   --------   ---------   ------------   ------------
<S>                      <C>       <C>          <C>        <C>         <C>            <C>
Revenue:
     Products..........  $18,915     $   --      $  703      $  --        $(191)        $19,427
     Services..........    1,259         --       1,685         --           --           2,944
     Custom projects...       --      3,580          --         --           --           3,580
                         -------     ------      ------      -----        -----         -------
Total revenue..........   20,174      3,580       2,388         --         (191)         25,951
                         -------     ------      ------      -----        -----         -------
Cost of goods and
  Services:
     Products..........   16,690         --         615         --         (191)         17,114
     Services..........    1,274         --       1,184         --           --           2,458
     Custom projects...       --      1,374          --         --           --           1,374
                         -------     ------      ------      -----        -----         -------
  Cost of goods and
     Services..........   17,964      1,374       1,799         --         (191)         20,946
                         -------     ------      ------      -----        -----         -------
Gross profit...........    2,210      2,206         589         --           --           5,005

Selling, general and
  administrative
  expenses.............    2,393      2,941       1,096        509           --           6,939
                         -------     ------      ------      -----        -----         -------
Operating loss.........  $  (183)    $ (735)     $ (507)     $(509)       $  --          (1,934)
                         -------     ------      ------      -----        -----
Interest and other income, net.....................................................         106
                                                                                        -------
Loss from continuing operations before income taxes................................      (1,828)
Income taxes.......................................................................         (81)
                                                                                        -------
Net loss from continuing operations................................................      (1,747)
Gain on disposal of discontinued operations, net of taxes..........................          16
                                                                                        -------
Net loss...........................................................................     $(1,731)
                                                                                        =======
</Table>


         International sales accounted for $1,591 or 10.0% and $565 or 2.6% of
consolidated revenues and 105.3% and 26.0% of the Stratasoft segment revenues in
the three months ended June 30, 2003 and 2004, respectively. In the six months
ended June 30, 2003 and 2004, international sales accounted for $1,946 or 7.5%
and $1,219 or 3.4% of consolidated revenues and 50.8% and 28.3% of the
Stratasoft segment sales, respectively. International sales are derived
primarily from Canada, the United Kingdom, Germany, Greece, India, Egypt, The
Philippines, Caribbean and Japan.


                                       14
<PAGE>
4. EARNINGS PER SHARE

         Basic EPS is computed by dividing net income (loss) by the
weighted-average number of common shares outstanding for the period. Diluted EPS
is based on the weighted-average number of shares outstanding during each period
and the assumed exercise of dilutive stock options and warrants less the number
of treasury shares assumed to be purchased from the proceeds using the average
market price of the Company's common stock for each of the periods presented.

         For the quarter and six months ended June 30, 2003, I-Sector's
potentially dilutive options of 219,494 and 186,507, respectively, were not used
in the calculation of diluted earnings since the effect of potentially dilutive
securities in computing a loss per share is antidilutive.

         The potentially dilutive options of the Company's wholly-owned
subsidiary, INX, (see Note 9) did not impact the calculation of I-Sector's
earnings per share for the quarter and six months ended June 30, 2003 since the
effect would have been antidilutive. In the quarter and six months ended June
30, 2004, net income from continuing operations for purposes of computing the
income per share decreased $- and $5 , respectively, for the assumed exercise of
INX options under the treasury method.

<Table>
<Caption>
                                                                           Three Months Ended June 30,    Six Months Ended June 30,
                                                                           ---------------------------   --------------------------
                                                                               2003           2004          2003           2004
                                                                           -----------    -----------    -----------    -----------
<S>                                                                        <C>            <C>            <C>            <C>
Numerator for basic earnings per share:
Net income (loss) from continuing operations before minority interest ..   $      (656)   $        44    $    (1,747)   $        95
Minority interest ......................................................            --             (6)            --             (6)
Gain (loss) on disposal of discontinued operations, net of taxes .......            16             13             16              2
Net income (loss) ......................................................   $      (640)   $        51    $    (1,731)   $        91
                                                                           -----------    -----------    -----------    -----------

Numerator for diluted earnings per share:
Net income (loss) from continuing operations ...........................   $      (656)   $        44    $    (1,747)   $        95
Minority interest ......................................................            --             (6)            --             (6)
INX income attributable to potential minority interest net income (loss)
 from continuing operations used in computing loss per share ...........            16             --             16             (5)
Loss on disposal of discontinued operations, net of taxes ..............            --             13             --              2
                                                                           -----------    -----------    -----------    -----------
Net income (loss) ......................................................   $      (640)   $        51    $    (1,731)   $        86
                                                                           ===========    ===========    ===========    ===========


Denominator for basic earnings per share - weighted-average shares
 outstanding ...........................................................     3,636,441      4,582,790      3,632,978      4,280,599
Effect of dilutive securities:
Shares issuable from assumed conversion of common stock options and
 restricted stock ......................................................            --        356,416             --        377,697
Denominator for diluted earnings per share - weighted-average shares
 outstanding ...........................................................     3,636,441      4,939,206      3,632.978      4,658,296
</Table>

5. DEBT

         On September 27, 2001, Stratasoft signed a note payable to a third
party for $725, payable in monthly installments through February 2007. The note
does not bear interest and I-Sector has imputed interest at 5.5% to record the
debt and related patent license asset and has recorded interest expense of $4
and $3 in the three month periods and $9 and $7 in the six month periods ended
June 30, 2003 and 2004, respectively. This note is collateralized by
Stratasoft's patent license assets and Stratasoft has granted a security
interest in its pending patent application and the next two patent applications
filed by Stratasoft. In connection with this note payable, I-Sector has
short-term debt maturing within one year of $68 and $74 at December 31, 2003 and
June 30, 2004, respectively; and long-term debt of $184 and $146 at December 31,
2003 and June 30, 2004, respectively.

         In October 2001, I-Sector signed a non-interest bearing note payable
for $39 payable in monthly installments through October 2004. In connection with
this note payable, I-Sector has short-term debt maturing within one year of $10
and $3 at December 31, 2003 and June 30, 2004, respectively.


                                       15
<PAGE>
         In December 2003, I-Sector signed a 36-month non-cancelable capital
lease for the purchase of equipment. I-Sector imputed interest at 10% to record
the debt on which I-Sector has recorded $0 interest expense for the three month
period ending June 30, 2004. In connection with this capital lease, I-Sector has
recorded short-term debt maturing within one year of $18 and $17 at December 31,
2003 and June 30, 2004, respectively; and long-term debt of $45 and $32 at
December 31, 2003 and June 30, 2004, respectively.

         The borrowing base amount under the Textron facility is generally the
sum of 80% of eligible accounts receivable (the "Accounts Advance Amount") plus
the lesser of: (a) 90% of eligible inventory purchased by I-Sector from
manufacturers with whom Textron has acceptable repurchase agreements, plus 40%
of other eligible inventory; (b) $4,000,000; or (c) 30% of the Accounts Advance
Amount. An account receivable will not qualify as an eligible accounts
receivable if, among other things, it is not paid within 90 days after
I-Sector's invoice date, the customer has failed to pay more than 25% of all
accounts receivable owed by the customer to I-Sector within 90 days after the
invoice date, or to the extent that the customer's total accounts receivable
exceed 15% of all I-Sector's eligible accounts receivable. In February 2004, the
syndication loan documents were executed and the credit line increased from
$10,000 to $15,000. Inventory floor plan borrowings are reflected in accounts
payable in the accompanying consolidated balance sheets, except for $1,688 and
$0 that is interest bearing and is reflected in short term debt in the
accompanying consolidated balance sheets at December 31, 2003 and June 30, 2004,
respectively. Borrowings accrue interest at the prime rate (4.25% at June 30,
2004) plus 2.5% on outstanding balances that extend beyond the vendor approved
free interest period. This agreement is collateralized by substantially all of
I-Sector's assets except its patent license assets. The loan agreement contains
restrictive covenants measured at each quarter end and requires I-Sector to
maintain minimum tangible capital funds, maintain minimum debt to tangible
capital funds ratio, and achieve a fixed charge coverage ratio. At June 30,
2004, I-Sector was in compliance with those loan covenants effective at that
date and anticipates that it will be able to comply with its loan covenants for
the next twelve months. In the event I-Sector does not maintain compliance, it
would be required to seek waivers from Textron and Silicon Valley Bank for those
events, which, if not obtained, could accelerate repayment and require I-Sector
to seek other sources of finance. At June 30, 2004, I-Sector had $7,799
outstanding on inventory floor plan finance borrowings, and the remaining credit
availability was $246, subject to borrowing limitations as described above.


6. COMMITMENTS AND CONTINGENCIES

         In August 2002, Inacom Corp. ("Inacom") filed a lawsuit in the District
Court of Douglas County, Nebraska styled Inacom Corp v. I-Sector Corporation,
f/k/a Allstar Systems, Inc., claiming that I-Sector owed the sum of
approximately $570 to Inacom as a result of Inacom's termination of a Vendor
Purchase Agreement between Inacom and I-Sector. I-Sector believes that the claim
is without merit and intends to vigorously contest the demand.

         In March 2003, I-Sector and other parties were notified of a demand for
return of payments relating to the business activities of a call center
customer. In March 2004, I-Sector was informed by the claimant that claims will
not be pursued at this time. I-Sector believes that the claims against it, if
re-initiated, are without merit and intends to vigorously contest any demands
related to this matter.

         I-Sector is also party to other litigation and claims which management
believes are normal in the course of its operations. While the results of such
litigation and claims cannot be predicted with certainty, I-Sector believes the
final outcome of such matters will not have a materially adverse effect on its
results of operations or financial position.

7. RELATED PARTY TRANSACTIONS

         The Company leases office space from Allstar Equities, Inc., a Texas
corporation ("Equities"), a company wholly owned by I-Sector's Chief Executive
Officer. On December 1, 1999, Equities purchased the Company's corporate office
building and executed a direct lease with us with an expiration date of December
31, 2004. In conjunction with Equities obtaining new financing on the building,
a new lease was executed with the Company on February 1, 2002 with an expiration
date of January 31, 2007. The lease has rental rates of $37 per month.

         From time to time, I-Sector makes short-term loans and travel advances
to its non-executive employees. The balance of approximately $16 and $11
relating to these loans and advances is included in the Company's consolidated
balance sheets and reported as part of accounts receivable - other at December
31, 2003 and June 30, 2004, respectively.

8. INTANGIBLE ASSETS

         On April 7, 2003, I-Sector's subsidiary, INX, acquired certain assets
and liabilities of one of its competitors, Digital Precision, Inc. ("Digital
Precision"). Under the terms of the purchase, INX acquired fixed assets valued
at $63, inventory valued at $101 and intellectual property, customer lists,
trademarks, trade names and service marks, contract rights and other intangibles


                                       16
<PAGE>
of Digital Precision valued at $376, as well as assumed certain operating leases
of equipment and office space in Austin, Texas and Dallas, Texas with a net
future obligation of $548. The office space in Dallas, TX was subleased with
future rentals of $234. The intangibles are subject to amortization and have a
three year expected life. The purchase price was $540 in cash and, contingent
upon the retention of certain key employees, the obligation to issue 1,800,000
shares of INX common stock in April 2004. The contingency was resolved in April
2004, and I-Sector recognized a minority interest related to the issuance of
INX's common stock (see Note 9) resulting in additional paid-in capital net of
intangible assets of $71. The results of operations of Digital Precision
subsequent to April 7, 2003 are included in I-Sector's consolidated statements
of operations.

9. STOCK OPTION PLANS

         The company has three stock-based option plans, the 1996 Incentive
Stock Plan, the 1996 Non-Employee Director Stock Option Plan and the Incentive
Plan. Under the Incentive Plan, all I-Sector employees, including officers,
consultants and non-employees directors are eligible to participate.

         INX is the only I-Sector subsidiary with an incentive stock option plan
in place. All other subsidiary plans except for INX were terminated in December
2003. The INX plan has not been presented to the stockholders of I-Sector for
approval. INX has granted incentive awards under its incentive plan, and such
awards have been granted to certain employees and to management of INX. Under
INX's plan such options typically vest ratably over three to five years. In
December 2003, the Company amended option agreements with INX's two most senior
executives to convert to a fixed 5-year vesting schedule from a vesting schedule
that was determined based on the percentage of attainment of predefined
financial goals by INX. No stock-based compensation was recorded as the exercise
price equaled or exceeded management's estimated fair value of the INX common
stock. Any unvested INX stock options may vest immediately upon the occurrence
of a liquidity event for that subsidiary. Of the options, 5,434,000 contain an
exercise restriction which allows only vested options to be exercised upon the
occurrence of a liquidity event or one month prior to the option's expiration
date. The INX options expire ten years after the grant date if they are not
exercised. The INX stock option grants are subject to dilution when I-Sector
purchases additional shares of the subsidiary stock in order to keep the
subsidiary sufficiently capitalized. INX has 8,261,038 options granted and
outstanding, of which 3,955,097 are vested and 1,364,598 are exercisable at June
30, 2004. The outstanding options have exercise prices ranging from $0.01 to
$0.25 per share with a weighted average of $0.17 per share. There are no shares
in INX's plan available to be issued at June 30, 2004, and INX's plan has been
amended, effective December 31, 2003, so that no further options may be granted
under the plan. The tables below reflect the ownership of INX at June 30, 2004
and summarize the potential dilutive effect on I-Sector's ownership in INX if
all options granted at June 30, 2004 were fully vested and option grants were
exercised, and include the effects of the issuance of stock in April 2004
relating to INX's acquisition of certain assets and liabilities of Digital
Precision, Inc. The table does not assume any repurchase of shares with proceeds
from option exercises.

<Table>
<Caption>
                                                                         INX Common    Percent
                                                                           Stock       of Total
                                                                         ----------   ----------
<S>                                                                      <C>          <C>
Ownership of INX shares at June 30, 2004:
     Common Stock owned by I-Sector ..................................   21,834,333         92.4%
     Common Stock owned by others ....................................    1,800,000          7.6%
                                                                         ----------   ----------
     Total Common Stock Outstanding ..................................   23,634,333        100.0%
                                                                         ==========   ==========

Potential Future I-Sector Dilution of Ownership:
    Common Stock owned by I-Sector at June 30, 2004 ..................   21,834,333         68.5%
    Common Stock owned by others at June 30,2004 .....................    1,800,000          5.6%
    Options granted and outstanding  at June 30, 2004  (1) (2) (3) (4)    8,261,038         25.9%
                                                                         ----------   ----------
    Total at June 30, 2004 ...........................................   31,895,371        100.0%
                                                                         ==========   ==========
</Table>

(1)  Options granted and outstanding at June 30, 2004 include option grants for
     4,100,000 shares of INX granted to the two senior executives of INX and
     vesting of these option grants was performance-based relating to the
     percentage of predefined financial goals attained by INX while these two
     senior executives remain employed. In December 2003, these option
     agreements were amended to convert to a fixed 5-year vesting schedule.
(2)  Included in the option grants outstanding at June 30, 2004 are grants for
     1,881,692 shares granted to key employees related to the acquisition
     Digital Precision, Inc. Grants for 500,000 of these shares vested April
     2003. The balance of the grants for 1,381,692 shares, which were granted in
     November 2003, vest over three years, starting in April 2004
(3)  During the quarter ended December 31, 2003, INX granted fully vested
     options to purchase 1,200,000 shares of INX to the CEO and Chairman of the
     Board of I-Sector Corporation. Such option grant was voluntarily canceled
     by the CEO and Chairman of the Board of I-Sector Corporation in February,
     2004 in connection with the issuance of a warrant for 1.2 million shares to
     I-Sector on similar terms. During the year ended December 31, 2003, INX
     granted fully vested options to purchase 300,000 shares to the President
     and CEO of INX. In addition, INX granted options vesting over three years
     to various other employees during the year ended December 31, 2003.


                                       17
<PAGE>
(4)  The remainder of the shares included in INX option grants outstanding at
     March 31, 2004 vest over either three or five years based upon continued
     employment by INX of the individuals to whom such grants have been made.
     All options granted by INX expire in ten years if unexercised.

10. MINORITY INTEREST

         During April 2004, INX ceased to be a wholly-owned subsidiary as the
result of the issuance of INX common stock to the former owners of Digital
Precision, which INX acquired in April 2003. In connection with that
acquisition, INX agreed to issue to the seller 1.8 million shares of INX common
stock as additional purchase consideration for their business if certain
employees remain employed through April 4, 2004, the first anniversary of the
acquisition. These conditions were met and the INX stock was issued in April
2004. At the time of issuance of INX common stock I-Sector recognized an
additional customer list value of $234 determined by using the valuation model
of INX common stock that yielded a per share value of $0.13 and is amortizing
this amount over two years. When issuance of INX occurred, I Sector's ownership
percentage of INX's common stock declined to 92.38% and I Sector recognized
$162,000 of minority interest in its balance sheet at that time.

11. COMPLETION OF PUBLIC OFFERING

         On May 12, 2004, the Company closed a public offering of 500,000 Units.
The Units began trading on May 7, 2004, on the American Stock Exchange under the
symbol ISR.U. Each Unit consists of two shares of common stock and one warrant
to purchase one share of common stock at a price of $12.45. The Units were
offered at a public offering price of $16.60 per Unit resulting in $8,300 of
proceeds less 9% underwriter discount of $747 and underwriter expenses of $9 for
a net amount of $7,544. On June 2, 2004 the underwriters exercised their option
to purchase 75,000 additional Units to cover over-allotments resulting in $1,245
of proceeds less 9% underwriter discount of $112 for a net amount of $1,133. The
Company paid approximately $1,046 of additional costs associated with the public
offering as of June 30, 2004. Net proceeds after all discounts and expenses were
approximately $7,632.


                                       18
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

         The following discussion is qualified in its entirety by, and should be
read in conjunction with, our consolidated financial statements, including the
notes thereto included elsewhere in this Form 10-Q and our annual report on Form
10-K for the fiscal year ended December 31, 2003 previously filed with the
Securities and Exchange Commission.

SPECIAL NOTICE REGARDING FORWARD-LOOKING STATEMENTS

         This quarterly report on Form 10-Q contains forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995
relating to future events or our future financial performance including, but not
limited to, statements contained in Item 2. - "Management's Discussion and
Analysis of Financial Condition and Results of Operations." Readers are
cautioned that any statement that is not a statement of historical fact,
including but not limited to, statements which may be identified by words
including, but not limited to, "anticipate," "appear," "believe," "could,"
"estimate," "expect," "hope," "indicate," "intend," "likely," "may," "might,"
"plan," "potential," "seek," "should," "will," "would," and other variations or
negative expressions thereof, are predictions or estimations and are subject to
known and unknown risks and uncertainties. Numerous factors, including factors
that we have little or no control over, may affect I-Sector's actual results and
may cause actual results to differ materially from those expressed in the
forward-looking statements contained herein. In evaluating such statements,
readers should consider the various factors identified in I-Sector's annual
report on Form 10-K, as filed with the Securities and Exchange Commission
including the matters set forth in Item 1. - "Factors Which May Affect The
Future Results Of Operations," which could cause actual events, performance or
results to differ materially from those indicated by such statements.

GENERAL

         We are a leading regional provider of IP telephony and other network
infrastructure and related implementation and support services. The IP telephony
industry is characterized by rapidly evolving and competing technologies. We
compete with larger and better financed entities. Our three principal offices
are located in Texas, and we primarily market to potential customers
headquartered in, or making purchasing decisions from, Texas. Our long-term
goal, however, is to become one of the leading national providers of
Cisco-centric network and IP telephony solutions to enterprises.

         We begin Management's Discussion and Analysis of Financial Condition
and Results of Operations with an overview of our strategies for achieving this
goal and becoming profitable. From a financial perspective, these operating
strategies have a number of important implications for our results of operations
and financial condition.

STRATEGY

         We plan to improve profitability by implementing the strategies
discussed below. We believe that our strategies will allow us to continue to
increase total revenues. We also believe our strategies will enable us to
improve our gross profit in 2004 by improving our gross margins on INX revenue.
At the same time, we will seek to contain the growth of relatively fixed
components of our selling, general and administrative expenses relative to the
growth of revenue so that those components become a relatively smaller
percentage of total revenues. Although selling expenses can generally be
expected to increase in proportion as our revenues increase, we believe that if
we are successful in implementing our strategies, many general and
administrative expenses (such as management salaries, administrative wages and
professional expenses) will decrease as a percentage of our total revenues.
Initially, however, these expenses are increasing more rapidly than revenue as
personnel are hired in anticipation of expected demand.

         Our key operating strategies are as follows:

            o  seeking larger, full scale IP telephony implementation projects,
               as opposed to smaller pilot projects;

            o  increasing the gross revenues from our higher gross margin
               operations, such as services and Stratasoft custom projects, as
               opposed to product sales, which typically produce smaller gross
               margins;

            o  aligning ourselves with Cisco as our exclusive supplier for the
               network and IP telephony equipment and technology that we offer;

            o  expanding geographically by acquiring complementary businesses
               and by opening our own offices; and

            o  developing and marketing our own computer telephony software that
               operates with and augments Cisco-centric IP telephony products.


                                       19
<PAGE>
         If we are successful in obtaining larger, full scale IP telephony
implementation projects, we expect that our gross revenues from both products
and services will increase because these projects, by their nature, typically
require a substantially higher level of our services and more products than do
smaller projects. Larger projects, however, can strain our financial resources.
For example, as often occurs on competitive bids, a potential customer for a
major IP telephony project may require that we post a bid bond or performance
bond in order for us to be awarded the project. Bonding companies typically
require that we provide security to collateralize the issuance of its bond. We
have been financially unable to provide sufficient collateral in some instances,
and as a result have not been able to obtain the bond. We believe we have
occasionally lost business that we might have otherwise been awarded because we
were unable to obtain the bond required by the potential customer.

         Increases in the size and volume of IP telephony projects we undertake
can also challenge our cash management. For example, larger projects can reduce
our available cash by causing us to carry higher levels of inventory. Larger
projects can also require us to invest our available cash in labor costs. This
is because, in some cases, we do not receive payments from our customers for
extended periods of time. Until customers pay us, all the cash we previously
expended in labor and products on the project remains invested. We expect that
greater amounts of our cash will become invested in accounts receivable in the
future if we are successful in growing our business as we intend.

         To meet our cash requirements to support planned growth, we expect to
rely on capital provided from our operations and our credit facility, which is
collateralized by our accounts receivable and substantially all of our assets.
During May 2004, we raised capital through a public offering with net proceeds
of $7.6 million. We used the net proceeds of this offering primarily for working
capital and to repay interest-bearing debt.Although over 75% of our revenue in
2003 was attributable to product sales, the gross profit margins on sales of our
services have been substantially higher than those for sales of products, with
the exception of sales of our proprietary Stratasoft software products. In 2003,
for example, the gross profit margin on sales of products by INX was 12.4%,
while the gross profit margin on sales of services by INX for that year was
29.6%. We plan to increase revenue from services, particularly our
post-implementation services for IP Telephony. The success of this aspect of our
strategy largely depends on our ability to attract and retain highly skilled and
experienced employees.

         For the last three years, the largest component of our total cost of
sales and service has been purchases of Cisco-centric IP telephony products by
INX. The majority of those purchases were directly from Cisco. We typically
purchase from various wholesale distributors only when we cannot timely purchase
products directly from Cisco. Our reliance on Cisco as the primary supplier for
the network and IP telephony equipment and technology we offer means that our
results of operations from period to period depend substantially on the terms
upon which we are able to purchase these products from Cisco and, to a much
lesser extent, from wholesale distributors of Cisco's products. Therefore, our
ability to manage the largest component of our cost of sales and service is very
limited and depends to a large degree on maintaining and growing our
relationship with Cisco. Our cost of products purchased from Cisco can be
substantially influenced by whether Cisco sponsors sales incentive programs and
whether we qualify for such incentives.

         We plan to also grow our business in other geographic areas through
strategic acquisition of similar businesses or by opening our own offices. This
aspect of our strategy can affect our financial condition and results of
operations in many ways. The purchase price for business acquisitions and the
costs of opening offices may require substantial cash and may require us to
incur long term debt. The expenses of a geographic expansion in an area may well
exceed the revenues attributable to a new business or office for some time, even
if it performs as we expect. Additionally, it is possible that our acquisition
activities may require that we record substantial amounts of goodwill if the
purchase consideration paid for an acquisition exceeds the estimated fair value
of the net identified tangible and intangible assets acquired. To the extent an
acquisition results in goodwill, we will reevaluate the realization of that
goodwill at least annually and adjust it as appropriate. The resulting
adjustment could result in significant charges to earnings in future periods.

         Developing new or substantially improved computer telephony software
products will likely require us to expend cash and record software development
expenses. Software development costs will likely be expensed because we expect
to incur substantially all costs prior to achieving technological feasibility in
developing a new or substantially improved software product.

MINORITY INTEREST IN INX

         Since its formation in 2000 and until April 2004, INX has been our
wholly-owned subsidiary. In April 2004, INX ceased to be a wholly-owned
subsidiary as the result of the issuance of INX common stock to the former
owners of Digital Precision, which INX acquired in April 2003. In connection
with that acquisition, we agreed to issue to the seller 1.8 million shares of
INX common stock as additional purchase consideration for their business if
certain employees remain employed through April 4, 2004, the first anniversary
of the acquisition. These conditions were met and the INX stock was issued in
April 2004. At the time of issuance of that INX common stock, I-Sector
recognized additional customer list value of $234,000 as an intangible asset to
be amortized over a two year period. When that issuance occurred, our ownership
percentage of INX's common stock declined to approximately 92.4% and I Sector
recognized $162,000 of minority interest in its balance sheet upon issuance.


                                       20
<PAGE>
         INX has also granted stock options to employees of INX to acquire INX
common stock pursuant to a stock option plan for INX employees. Additionally, we
were granted a warrant that entitles us to acquire an additional 1.2 million
shares of INX common stock. The exercise prices for the INX options and our
warrant range from $0.01 to $0.25 with a weighted average of $0.17. We estimate
that I-Sector's ownership in INX could be reduced to 69.5%, assuming that all of
the INX options are exercised, we exercise our warrant and there are no other
changes in INX's equity.

         While the existence of the unexercised INX options and the contingent
obligation to issue INX stock did not result in a minority interest for
accounting purposes through March 2004, the actual issuance of INX stock in
April 2004 and the exercise of INX employee options in May 2004 resulted in a
minority interest. Since I-Sector owns 92.4% of INX's stock at June 30, 2004,
its interest in INX's future profits and losses have been reduced during April,
May and June 2004 for the minority share. Under accounting principles generally
accepted in the United States of America, I-Sector's consolidated financial
statements in future periods will reflect a minority interest adjustment of the
otherwise reportable profits and losses of INX by the percentage of minority
ownership in INX. I-Sector's percentage share of any cash dividends or other
distributions paid by INX to its stockholders will likewise be reduced by the
percentage of minority ownership in INX. Additionally, if the percentage of
minority ownership of INX's stock grows as a result of future exercises of INX
options, that increase will cause a corresponding decrease in the reportable
share of INX's profits and losses included in our consolidated financial
statements, and our share of cash dividends and other distributions from INX. At
June 30, 2004, we reflect income attributable to minority interest of $6,000 in
our income statement and a minority interest balance of $168,000 in our balance
sheet.

         Unlike the boards of directors of our wholly-owned subsidiaries, the
board of directors of INX is required to be mindful of the interests of INX's
minority stockholders, in addition to our interests, when considering whether to
approve business and financing transactions involving INX. For example, we may
be unable to cause the assets of INX to be pledged as collateral for
indebtedness if the proceeds of that indebtedness disproportionately benefit us
or our other wholly-owned subsidiaries in relation to INX. Conflicts of interest
may reduce our flexibility in structuring business and financing transactions
beneficial to us and our wholly-owned subsidiaries.

         Contributions of capital to INX by us, in the form of stock purchases,
which may be necessary to fund INX's growth, could increase our percentage
ownership of INX, but would require capital resources that could be used in
other parts of our business. Because of the minority interest and the potential
increase in the minority interest in INX, we will be required to make capital
contributions to INX on a basis that is, in the good faith judgment of our board
of directors, fair to us and the holders of the minority interest.

         Minority stock ownership in INX could also subject us to lawsuits from
its minority stockholders complaining of our actions with respect to INX and its
minority stockholders, even if the actions complained of are ultimately
determined to have been proper. For example, if we choose to cause INX to merge
with, or sell all or substantially all of its assets to, another entity, the
minority stockholders of INX may bring lawsuits seeking to block the transaction
or seeking to exercise statutory dissenters' rights with respect to the
transaction. Whether or not successful, any such actions would cause us to incur
litigation costs and potentially reduce the benefit of any such transaction to
us.

         The common stock of INX is not publicly-traded. Accordingly, any shares
of INX common stock issued, including those issued to the former owners of
Digital Precision upon exercise of INX options, are, and will be for the
foreseeable future, relatively illiquid. For this reason, and to eliminate the
other consequences of having a minority interest in a subsidiary, we believe
that in the future we will offer to exchange INX common stock and stock options
for our common stock or options to acquire our common stock. If we conclude such
a transaction, the aggregate ownership percentage of our common stock by our
stockholders immediately before the conversion or exchange transaction will be
reduced by the percentage of post-transaction ownership acquired by the former
minority stockholders of INX through such exchange transaction. Their
post-transaction ownership may be further reduced by subsequent exercises of
I-Sector stock options that we may choose to exchange for INX stock options.

         We cannot predict the percentage of ownership reduction to our
stockholders that may result from any future exchange or conversion of INX stock
and INX options. The ownership reduction resulting from any such transaction
may, however, be significant. We believe this may be the case principally
because:

            o  we expect that the total number of shares of our common stock
               that we would be required to issue in any such transaction would
               be approximately equivalent in value, as determined at a future
               date, to the value of the INX stock and INX options to be
               exchanged at such future date;

            o  the historical financial effect of INX on our business is
               significant, as compared with our other subsidiaries; and

            o  we expect INX will continue to generate most of our revenue.

         If in the future we propose to exchange or convert INX stock and INX
options into I-Sector common stock or options, we intend to utilize a special
committee of our independent directors to negotiate any exchange ratio for the
transaction with the


                                       21
<PAGE>
principal INX minority stockholders and option holders. The facts and
circumstances that the special committee may choose to consider and the relative
weights to be accorded them in negotiating the relative values of our common
stock and INX stock and in negotiating the exchange ratio for any future
transaction are matters that we intend to delegate to the discretion of the
special committee. Accordingly, presently we cannot quantify the amount of any
future ownership reduction that our stockholders may experience in an exchange
transaction with INX stockholders and option holders.

         Under some circumstances, we may be required by accounting principles
generally accepted in the United States of America to record substantial
non-cash expenses if we choose to exchange INX stock or INX options into our
common stock or options. We are not now able to determine the amount or timing
of any such charges. This is because those matters will largely depend upon the
timing and terms on which any future exchange would occur, particularly the
exchange ratio negotiated at the time. Because most of our revenues in 2003 were
generated by INX and our expectation is that this will continue for the
foreseeable future, we believe that any resulting non-cash expense charges could
be substantial. Any such future non-cash expenses charges could materially and
adversely affect our financial results of operations.

         If we determine to undertake a transaction to exchange INX stock or INX
options into our common stock or stock options, we also plan to submit any such
transaction to our stockholders for their approval, even if not required by
Delaware law or the rules of the American Stock Exchange. Even if we believe
that such transaction is in our best interest, our stockholders may refuse to
approve it. If that were to occur, it could disappoint the expectations of those
INX minority stockholders and INX option holders in favor of the transaction,
some of who are currently, and are expected to remain, key employees. This could
cause employee morale and retention problems for us.

RESULTS OF OPERATIONS

         Overview

         Sources of Revenue. Our revenue is derived from three segments
represented by our three operating subsidiaries, INX, Stratasoft and Valerent.
During the quarter ended June 30, 2004, INX, Stratasoft and Valerent accounted
for 82.1%, 9.9% and 9.1%, respectively, of total consolidated revenue, and 1.1%
of subsidiary revenue was eliminated in consolidation due to inter-company
transactions. During the six months ended June 30, 2004, INX, Stratasoft and
Valerent accounted for 80.0%, 11.9% and 9.3%, respectively, of total
consolidated revenue, and 1.2% of subsidiary revenue was eliminated in
consolidation due to inter-company transactions.

         INX revenue consists of product and service revenue. Product revenue
consists of reselling Cisco products and limited amounts of complementary
products by other manufacturers. Service revenue is generated by fees from a
variety of implementation and support services. Product prices for INX are set
by the market for Cisco products, and provide our lowest gross margins. Service
revenue for INX has recently provided a higher gross margin that has generally
improved over the past several years as the cost of INX's technical resources,
which are reflected as a cost of service, has decreased as a percentage of
services revenue. Also, certain fixed and flat fee service contracts that extend
over three months or more are accounted for on the percentage of completion
method of accounting. Historically, the majority of INX's services revenue has
been generated from implementation services, which is project oriented and tends
to be volatile as projects are completed and new projects commence. As the
number, frequency and size of INX projects has grown, INX has achieved better
utilization of its engineering resources resulting in improved gross margins or
services. The normal sales cycles for corporate customers typically ranges from
three to six months depending on the nature, scope and size of the deal
involved. But our direct experience with school districts involved in eRate
funding (a governmental funding program for schools) indicates that the sales
lead time is generally about six to twelve months. In mid-2003, INX introduced
Netsurant, its branded support service that consists primarily of customer
service personnel and a support center that we believe could further improve
overall services gross margins. Through June 30, 2004, Netsurant service revenue
was not significant.

         Stratasoft revenue consists primarily of custom project revenue from
the sale of proprietary computer-telephony software. Our Stratasoft revenue is
reported as custom project revenue in our financial statements, because it
consists of product and services which cannot be accounted for separately.
Stratasoft has traditionally provided our highest gross margin since it is
primarily sales of our proprietary computer-telephony software. Our cost of
goods sold for Stratasoft's custom project revenue includes the costs of
developing our computer-telephony software products, installation costs, and the
cost of hardware and other equipment bundled with our software applications and
included in a sale to a customer. Stratasoft revenue also includes sales to
resellers. The sales to resellers are recorded when the sale becomes fixed or
determinable; otherwise revenue from resellers is recorded when payments become
due.

         Valerent revenue consists of both product revenue and services revenue.
Product revenue consists of reselling primarily software products, and to a
lesser degree, hardware products, that facilitate Valerent's managed services,
including remote management software products from Altiris, Inc., and security
software products from Network Associates, Inc. Product sales prices for
Valerent are set by the market for these products, and Valerent's product sales
have typically provided lower gross profit margins than its services revenue.
Valerent's services revenue consists of remote and onsite technical assistance
to its


                                       22
<PAGE>
customers. Valerent's gross margin on service revenue, much like INX's
implementation services revenue, is subject to variability based upon the
utilization of Valerent's billable technical resources. Recurring service
agreements exist with some customers, but usually with varying terms and
conditions that conform to their year over year business changes and their
specific needs, and while these agreements provide predictable and stable
sources of revenue, the loss of a recurring agreement could disrupt the
stability of that revenue stream for Valerent.

         Gross Profit and Gross Profit Margin. The mix of our various revenue
components, each of which has substantially different levels of gross margin,
materially influences our overall gross profit and gross margin in any
particular quarter. In periods in which service revenue or Stratasoft custom
project revenue are high, as compared to INX and Valerent product sales, our
gross margin generally improves as compared to periods in which we have higher
levels of product sales. Our gross margin for product sales also varies
depending on the type of product sold, the mix of large revenue product
contracts, which typically have lower gross margin, as compared to smaller
revenue product contacts, which typically have higher gross margin.

         In addition, our quarterly gross profit and gross margin can be
materially affected by vendor incentives received in certain quarterly periods,
most of which are Cisco incentives received by INX. The incentive programs
sponsored by Cisco currently enable us to qualify for cash rebates or product
pricing discounts. These incentives are generally earned based on sales volume,
sales growth and customer satisfaction levels. The amounts earned under these
programs are recorded as a reduction of cost of goods and can vary significantly
between periods. Currently, incentives by Cisco are paid semiannually, and are
typically paid in the first and third quarters of each calendar year. Incentives
are recognized when we receive payment from the supplier or when we have earned
and can reasonably estimate the amount due from the supplier. During the three
months ended June 30, 2004, we did not recognize any vendor incentives, and we
did not accrue any commission expense related to the vendor incentives earned by
sales personnel in association with this vendor incentive program for the
quarter. During the six months ended June 30, 2004, we recognized $622,000 in
vendor incentives, and approximately $100,000 in commission expense earned by
sales personnel in association with this vendor incentive program.

         A significant portion of our cost of services for each of our service
businesses is comprised of labor. Labor cost related to permanent employees is
generally fixed in the short-term so that higher levels of service revenue
produce higher gross margins while lower levels of service revenue produce lower
gross margins. Our gross margin on services revenue fluctuates from period to
period depending not only upon the prices charged to customers for our services,
but also upon the level of utilization of our technical staff. Management of
labor cost is therefore important in order to maximize gross margin. Our gross
margin is also impacted by such factors as contract size, time and material
pricing versus fixed fee pricing, discounting, vendor incentives and other
business and marketing factors normally incurred during the conduct of business.

         Selling, General and Administrative Expenses. Our selling, general and
administrative expenses include both fixed and variable expenses. Relatively
fixed expenses in selling, general and administrative expenses include rent,
utilities, promotion and advertising, and administrative wages. Variable
expenses in selling, general and administrative expenses include sales
commissions and travel, which will usually vary based on our sales and gross
profit. Selling, general and administrative expenses also include expenses which
vary significantly from period to period but not in proportion to sales or gross
profit. These include legal expenses and bad debt expense both of which vary
based on factors that are difficult to predict.

         A significant portion of our selling, general and administrative
expenses relate to personnel costs, some of which are variable and others that
are relatively fixed. Our variable personnel costs consist primarily of sales
commissions. Sales commissions are typically calculated based upon our gross
profit on a particular sales transaction and thus generally fluctuate because of
the size of the deal and the mix of associated products and services with our
overall gross profit. Bad debt expense generally fluctuates somewhat in
proportion to sales levels, although not always in the same periods as increases
or decreases in sales. Legal expense varies based on legal issue activity, which
can vary substantially from period to period. The remainder of selling, general
and administrative expenses are relatively fixed and do not vary in direct
proportion to increases in revenue.

         Acquisition and Disposition. In the second quarter of 2003, INX
acquired the fixed assets, inventory, intellectual property, customer lists,
trademarks, trade names, service marks, contract rights and other intangibles of
Digital Precision. In connection with that acquisition we also assumed leases
for equipment and office space. Our results of operations include those
attributable to Digital Precision on and after April 7, 2003. The initial
purchase price for Digital Precision was $540,000 in cash and contingent
consideration of 1.8 million shares of INX common stock which we agreed to issue
if certain employees remained employed through April 4, 2004, the first
anniversary of the acquisition. In April 2004, we recorded $234,000 of
additional intangible assets in connection with the 1.8 million shares of INX
stock we issued to satisfy the contingent purchase price obligation.

         The sale of our computer reselling and PBX telephone systems reselling
business in early 2000 and the sale of our IT Staffing business in 2001 resulted
in a gain on disposal. Since the sale of these businesses, we have realized, in
various periods, income and expense from discontinued operations that has been
primarily a result of litigation expenses and settlement of litigation related
to our discontinued operations. We expect the income and expense from
discontinued operations to decrease over time and to eventually be eliminated
after these matters are fully resolved.


                                       23
<PAGE>
         Tax Loss Carryforward. Because of our operating losses in 2003, we have
accumulated a net operating loss carryforward for federal income tax purposes
that, as of June 30, 2004, was approximately $2.4 million and is available to
offset future federal and state taxable income. This carryforward expires in
2023. In addition to potential expiration, there are several factors that could
limit or eliminate our ability to use these carryforwards. For example, under
Section 382 of the Internal Revenue Code of 1986, as amended, use of prior net
operating loss carryforwards is limited after an ownership change. This type of
change could result from the offering we completed during May 2004, either alone
or in combination with other prior or subsequent offerings of equity securities.
If we achieve sustained profitability, which may not happen, the use of net
operating loss carryforwards would reduce our tax liability and increase our net
income and available cash resources. When all operating loss carryforwards have
been used or have expired, we would again be subject to increased tax expense
and reduced earnings due to such tax expense.

         Period Comparisons. The following tables set forth, for the periods
indicated, certain financial data derived from our consolidated statements of
operations. Percentages shown in the table below are percentages of total
revenue, except for each individual segment's cost of sales and services, gross
profit, selling, general and administrative expenses, and operating income,
which are percentages of the respective segment's revenue, and the product and
service components of the INX and Valerent segments' cost of goods sold and
gross profit, which are percentages of such segment's respective product and
service revenue.


                                       24
<PAGE>
<TABLE>
<CAPTION>
                                                                         QUARTER ENDED JUNE 30,
                                                           --------------------------------------------------
                                                                    2003                        2004
                                                           ----------------------      ----------------------
                                                            AMOUNT          %           AMOUNT           %
                                                           --------      --------      --------      --------
                                                                       (DOLLARS IN THOUSANDS)
<S>                                                        <C>           <C>           <C>           <C>
Revenue:
    INX product ......................................     $ 12,253          77.2      $ 16,354          74.7
    INX service ......................................          782           4.9         1,625           7.4
                                                           --------      --------      --------      --------
            Total INX revenue ........................       13,035          82.1        17,979          82.1
                                                           --------      --------      --------      --------
    Stratasoft - Custom projects .....................        1,511           9.5         2,169           9.9
                                                           --------      --------      --------      --------
    Valerent product .................................          509           3.2           505           2.3
    Valerent service .................................          874           5.5         1,484           6.8
                                                           --------      --------      --------      --------
            Total Valerent revenue ...................        1,383           8.7         1,989           9.1
      Eliminations revenue ...........................          (59)         (0.3)         (250)         (1.1)
                                                           --------      --------      --------      --------
                Total revenue ........................       15,870         100.0        21,887         100.0
Cost of sales and service:
    INX product ......................................       10,846          88.5        14,440          88.3
    INX service ......................................          757          96.8         1,145          70.5
                                                           --------      --------      --------      --------
           Total INX cost of sales and service .......       11,603          89.0        15,585          86.7
    Stratasoft - Custom projects .....................          574          49.9           886          40.8
                                                           --------      --------      --------      --------
    Valerent product .................................          424          83.3           460          91.1
    Valerent service .................................          599          68.5           907          61.1
                                                           --------      --------      --------      --------
            Total Valerent cost of sales and service .        1,023          74.0         1,367          68.7
      Eliminations of cost of sales and service ......          (59)        100.0          (250)        100.0
                                                           --------      --------      --------      --------
                Total cost of sales and service ......       13,141          82.8        17,588          80.4
Gross profit:
      INX product ....................................        1,407          11.5         1,914          11.7
      INX service ....................................           25           3.2           480          29.5
                                                           --------      --------      --------      --------
           Total INX gross profit ....................        1,432          11.0         2,394          13.3
    Stratasoft - Custom projects .....................          937          62.0         1,283          59.2
                                                           --------      --------      --------      --------
    Valerent product .................................           85          16.7            45           8.9
    Valerent service .................................          275          31.5           577          38.9
                                                           --------      --------      --------      --------
           Total Valerent gross profit ...............          360          26.0           622          31.3
                                                           --------      --------      --------      --------
                 Total gross profit ..................        2,729          17.2         4,299          19.6
Selling, general and administrative expenses:
    INX ..............................................        1,448          11.1         2,318          12.9
    Stratasoft .......................................        1,344          88.9         1,131          52.1
    Valerent .........................................          536          38.8           486          24.4
    Corporate ........................................          234           N/A           301           N/A
                                                           --------      --------      --------      --------
Total selling, general and administrative expenses ...        3,562          22.4         4,236          19.4
Operating income (loss):
    INX ..............................................          (16)         (0.1)           76           0.4
    Stratasoft .......................................         (407)        (26.9)          152           7.0
    Valerent .........................................         (176)        (12.7)          136           6.8
    Corporate ........................................         (234)          N/A          (301)          N/A
                                                           --------      --------      --------      --------
           Total operating income (loss) .............         (833)         (5.2)           63           0.3
Interest and other income, net .......................           96           0.6           (26)         (0.1)
                                                           --------      --------      --------      --------
Income (loss) from continuing operations before income
         Taxes........................................         (737)         (4.6)           37           0.2
Income tax benefit ...................................          (81)         (0.5)           (7)          0.0
                                                           --------      --------      --------      --------
Net income (loss) from continuing operations before
         minority interest............................         (656)         (4.1)           44           0.2
Minority interest ....................................           --           0.0            (6)          0.0
Discontinued operations:
Gain (loss) on disposal, net of taxes ................           16           0.1            13           0.0
                                                           --------      --------      --------      --------
Net income (loss) ....................................     $   (640)         (4.0)     $     51           0.2
                                                           ========      ========      ========      ========
</Table>


                                       25
<PAGE>
QUARTER ENDED JUNE 30, 2003 COMPARED TO THE QUARTER ENDED JUNE 30, 2004

         Total Revenue. Our total revenue, net of intercompany eliminations,
increased by $6.0 million, or 37.9%, from $15.9 million to $21.9 million.

         INX revenue increased by $5.0 million, or 37.9%, from $13.0 million to
$18.0 million. As a percentage of total revenue, INX revenue remained at 82.1%.
Product revenue increased $4.2 million, or 34.4% from $12.2 million to $16.4
million. INX service revenue increased $843,000, or 108.0% from $782,000 to $1.6
million. The increase in services is attributed to an increase in the number of
IP Telephony projects which have higher service content than traditional network
infrastructure projects, as well as the IP telephony service contract in Iraq.
The increase in product sales is attributed to the adoption of IP telephony
technology by our customers requiring equipment upgrades for implementation.

         Stratasoft revenue increased by $658,000, or 43.5%. As a percentage of
total revenue, Stratasoft revenue increased from 9.5% to 9.9%. Stratasoft's
international sales accounted for 26.0% of Stratasoft's revenue as compared to
100.0% in 2003. Stratasoft has its own internally managed sales force, but it
also utilizes dealer agreements from time to time with certain established
resellers in domestic and international markets that do not require the
continued involvement of our personnel. Stratasoft derived $5,000 or 0.2% of its
revenue from sales to resellers during the quarter which compares with $446,000
or 29.5% of its revenue in 2003. Sales to resellers are included in revenue when
the fees are fixed and determinable; otherwise revenue from resellers is
deferred and recognized when the payment becomes due.

         Valerent revenue increased by $606,000, or 43.8%, from $1.4 million to
$2.0 million. As a percentage of total revenue, Valerent revenue increased from
8.7% to 9.1%. The increase in Valerent revenue was primarily attributable to
increased service revenue of $610,000 and offset by a decrease in product sales
of $4,000. The increase in service revenue is primarily attributable to
development of remote services to be operated by clients , the sale of the
underlying technology to support remote management, and the delivery by Valerent
of remote managed services for clients, which was primarily related to Valerent
making changes to its business model so that it no longer pursued certain
non-strategic sources of services revenue. Valerent's business model now focuses
on identifying and developing markets with enterprise customers.

         Gross Profit. Our total gross profit increased by $1.6 million, or
57.5%, from $2.7 million to $4.3 million. Gross margin increased from 17.2% to
19.6%, primarily because of the increase in gross margin in our INX subsidiary
discussed below.

         INX gross profit increased $1.0 million, or 67.2%, from $1.4 million to
$2.4 million. INX's gross margin increased from 11.0% to 13.3%. INX's gross
profit on its product sales component increased $507,000 or 36.0%, from $1.4
million to $1.9 million due to increased product sales revenue. INX's gross
profit on its service component increased $455,000, from $25,000 to $480,000,
and service gross margin improved from 3.2% to 29.5%, as a result of increased
service revenue of $843,000 with a somewhat fixed cost of service component due
to improved utilization of technical personnel.

         Stratasoft gross profit increased by $346,000, or 36.9%, from $937,000
to $1.3 million. Stratasoft's gross margin decreased from 62.0% to 59.2%.
Stratasoft gross profit was impacted by the mix of sales between "systems
sales", which include a hardware component, as compared to "software only"
sales, which do not have a hardware component. Stratasoft's decreased gross
profit is primarily due to a decreased "software only" component relative to the
"systems sales" component of total Stratasoft sales. Software only sales include
sales to reseller customers and do not require the continuing involvement of our
personnel.

         Valerent gross profit increased by $262,000, or 72.8%, from $360,000 to
$622,000. Valerent's gross margin increased from 26.0% to 31.3%. Valerent's cost
of service consists primarily of fixed labor cost that does not fluctuate
directly with changes in revenue. Valerent improved its utilization of its labor
pool by reducing the number of technicians employed, relative to revenue, and
lowered its fixed cost, which contributed to improved gross profits.


                                       26
<PAGE>
         Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased by $674,000, or 18.9% from $3.6 million to
$4.2 million. As a percentage of total revenue, these expenses decreased 3.0%,
from 22.4% to 19.4%.

These expenses were primarily increased by the following:

            o  Administrative compensation expense increased $374,000 due to
               bonuses of $190,000, settlement of an EEOC claim for $26,000 and
               the hiring of additional INX and Stratasoft personnel in Houston,
               Texas; Dallas, Texas; Canada and the addition of our Austin,
               Texas office resulting from the Digital Precision acquisition of
               April 2003.
            o  Sales compensation increased $326,000 due to additional personnel
               as the result of the Digital Precision acquisition in April 2003
               and increased commissions generated from the increase in gross
               profit.
            o  Payroll tax expense increased $80,000 in line with the increase
               in compensation expenses.
            o  Legal and professional fees increased $49,000 primarily from the
               amortization of prepaid consultant expenses of $91,000 and the
               revaluation and amortization of non-employee stock consultant
               options of $23,000 which was offset by a $65,000 reduction in
               legal fees and accounting fees.
            o  Depreciation and amortization expense increased $49,000 due to
               asset additions and the Digital Precision acquisition in April
               2003 and the additional purchase value for the Digital Precision
               intangible of April 2004.
            o  Shareholder relations expense increased $37,000, due to employing
               a shareholder relations firm, attending investor conferences and
               visiting investor groups.
            o  Telephone and communication expenses increased $19,000 primarily
               due to INX office growth and relocation.

These expenses were primarily decreased by the following:

            o  Contract labor expense decreased $69,000 primarily from
               Stratasoft terminating contract labor in India.
            o  General office expenses decreased $69,000 due to decreased
               employee recruiting fees and sales tax recapture.
            o  Insurance expense decreased $49,000 because of policy and rate
               changes.
            o  Employee benefits decreased $34,000 as a result of additional
               personnel and policy rate changes.
            o  Bad debt expense decreased $32,000 due to recoveries of bad debt
               and decreases in allowances based on the aging of receivables and
               credit worthiness of customers.
            o  Travel expense decreased $30,000 due to reduced Stratasoft
               international travel and INX travel for technical staff and
               management.

         Operating Profit. Operating profit increased $896,000 or 107.6% from a
loss of $833,000 to a profit of $63,000, primarily due to the $1.6 million
increase in gross profit being offset by the $674,000 increase in selling,
general and administrative expenses. INX's operating profit increased $92,000,
or 575.0% from a loss of $16,000 to a profit of $76,000. Stratasoft's operating
profit increased $559,000, or 137.3% from a loss of $407,000 to a profit of
$152,000. Valerent's operating profit increased $312,000 or 177.3%, from a loss
of $176,000 to a profit of $136,000. The operating loss for the Corporate
Segment increased $67,000, from a loss of $234,000 to a loss of $301,000.

         Interest and Other Income, Net. Interest and other income, net,
decreased by $122,000, from $96,000 of other income to $26,000 of other expense,
primarily due to the sale of an internet domain in 2003 for $80,000. Our total
borrowings under the Textron credit facility increased from $6.9 million to $7.8
million however the interest bearing portion of our borrowings decreased from
$1.2 million at March 31, 2004 to zero at June 30, 2004.

         Minority interest. Income attributable to minority interest increased
from $0 to $6,000. During April 2004 the company issued 1,800,000 shares of INX
common stock pursuant to the Digital Precision purchase agreement of April 2003.
Approximately 7.6% of INX's net income is deducted from the consolidated net
income of I-Sector as a result of their minority interest in INX.

         Net income. Net income increased $691,000, or 108.0% from a $640,000
net loss to a $51,000 net income. The income tax benefit for the period was
$7,000, and there is a net operating tax loss carryforward of approximately $2.4
million as of June 30, 2004.

         Discontinued Operations. During 1999, we discontinued our Telecom
Systems business. On March 16, 2000, we entered into an agreement to sell
certain assets of, and the ongoing operation of, our Computer Products Division.
The sale transaction closed on May 19, 2000. On December 31, 2000, we sold our
IT Staffing business. As a consequence of these events, the operations of these
businesses are reported as discontinued operations. For the quarter ended June
30, 2003, the gain (loss) on disposal related to these three businesses was
$4,000, ($14,000) and $26,000, net of taxes and tax benefits of $2,000, ($7,000)
and $14,000 for a net total of $16,000. For the quarter ended June 30, 2004 the
gain on disposal related to these three businesses was $0, $20,000 and $0, net
of taxes of $0, $7,000 and $0 for a net total of $13,000. The gains and/or
losses on disposal in 2003


                                       27
<PAGE>
and 2004 related to these discontinued operations are primarily related to
collections of accounts receivables retained when these businesses were sold.

<Table>
<Caption>
                                                                        SIX MONTHS ENDED JUNE 30,
                                                           --------------------------------------------------
                                                                    2003                        2004
                                                           ----------------------      ----------------------
                                                            AMOUNT          %           AMOUNT          %
                                                           --------      --------      --------      --------
                                                                         (DOLLARS IN THOUSANDS)
<S>                                                        <C>           <C>           <C>           <C>
Revenue:
    INX product ......................................     $ 18,915          72.9      $ 26,415          73.0
    INX service ......................................        1,259           4.9         2,538           7.0
                                                           --------      --------      --------      --------
            Total INX revenue ........................       20,174          77.7        28,953          80.0
                                                           --------      --------      --------      --------
    Stratasoft - Custom projects .....................        3,580          13.8         4,306          11.9
                                                           --------      --------      --------      --------
    Valerent product .................................          703           2.7           839           2.3
    Valerent service .................................        1,685           6.5         2,515           7.0
                                                           --------      --------      --------      --------
            Total Valerent revenue ...................        2,388           9.2         3,354           9.3
      Eliminations revenue ...........................         (191)         (0.7)         (451)         (1.2)
                                                           --------      --------      --------      --------
                Total revenue ........................       25,951         100.0        36,162         100.0
Cost of sales and service:
    INX product ......................................       16,690          88.6        22,822          86.4
    INX service ......................................        1,274         101.2         1,735          68.4
                                                           --------      --------      --------      --------
           Total INX cost of sales and service .......       17,964          89.0        24,557          84.8
    Stratasoft - Custom projects .....................        1,374          38.4         1,848          42.9
                                                           --------      --------      --------      --------
    Valerent product .................................          615          87.5           771          91.9
    Valerent service .................................        1,184          70.3         1,603          63.7
                                                           --------      --------      --------      --------
            Total Valerent cost of sales and service .        1,799          75.3         2,374          70.8
      Eliminations of cost of sales and service ......         (191)        100.0          (451)        100.0
                                                           --------      --------      --------      --------
                Total cost of sales and service ......       20,946          80.7        28,328          78.3
Gross profit:
      INX product ....................................        2,225          11.8         3,593          13.6
      INX service ....................................          (15)         (1.2)          803          31.6
                                                           --------      --------      --------      --------
           Total INX gross profit ....................        2,210          11.0         4,396          15.2
    Stratasoft - Custom projects .....................        2,206          61.6         2,458          57.1
                                                           --------      --------      --------      --------
    Valerent product .................................           88          12.5            68           8.1
    Valerent service .................................          501          29.7           912          36.3
                                                           --------      --------      --------      --------
           Total Valerent gross profit ...............          589          24.7           980          29.2
                                                           --------      --------      --------      --------
                 Total gross profit ..................        5,005          19.3         7,834          21.7
Selling, general and administrative expenses:
    INX ..............................................        2,393          11.9         4,202          14.5
    Stratasoft .......................................        2,941          82.2         2,150          49.9
    Valerent .........................................        1,096          45.9           876          26.1
    Corporate ........................................          509           N/A           506           N/A
                                                           --------      --------      --------      --------
Total selling, general and administrative expenses ...        6,939          26.7         7,734          21.4
Operating income (loss):
    INX ..............................................         (183)         (0.9)          194           0.7
    Stratasoft .......................................         (735)        (20.5)          308           7.2
    Valerent .........................................         (507)        (21.2)          104           3.1
    Corporate ........................................         (509)          N/A          (506)          N/A
                                                           --------      --------      --------      --------
           Total operating income (loss) .............       (1,934)         (7.4)          100           0.3
Interest and other income, net .......................          106           0.4            (6)          0.0
                                                           --------      --------      --------      --------
Income (loss) from continuing operations before income
           taxes .....................................       (1,828)         (7.0)           94           0.3
Income tax benefit ...................................          (81)         (0.3)           (1)          0.0
                                                           --------      --------      --------      --------
Net income (loss) from continuing operations before
            minority interest.........................       (1,747)         (6.7)           95           0.3
Minority interest ....................................           --           0.0            (6)          0.0
Discontinued operations:
Gain on disposal, net of taxes .......................           16           0.0             2           0.0
                                                           --------      --------      --------      --------
Net income (loss) ....................................     $ (1,731)         (6.7)     $     91           0.3
                                                           ========      ========      ========      ========
</Table>


                                       28
<PAGE>
SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2004

         Total Revenue. Our total revenue, net of intercompany eliminations,
increased by $10.2 million, or 39.3%, from $26.0 million to $36.2 million.

         INX revenue increased by $8.8 million, or 43.5%, from $20.2 million to
$29.0 million. As a percentage of total revenue, INX revenue increased from
77.7% to 80.0%. Product revenue increased $7.5 million, or 39.7% from $18.9
million to $26.4 million. INX service revenue increased $1.2 million, or 101.6%
from $1.3 million to $2.5 million. The increase in services is attributed to an
increase in the number of IP Telephony projects which have higher service
content than traditional network infrastructure projects, as well as the IP
telephony service contract in Iraq. The increase in product sales is attributed
to the adoption of IP telephony technology by our customers requiring equipment
upgrades for implementation, and the addition of the Austin, Texas office
resulting from the Digital Precision acquisition of April 2003.

         Stratasoft revenue increased by $726,000, or 20.3%. As a percentage of
total revenue, Stratasoft revenue decreased from 13.8% to 11.9%. Stratasoft's
international sales accounted for 28% of Stratasoft's revenue as compared to
51.4% in 2003. Stratasoft has its own internally managed sales force, but it
also utilizes dealer agreements from time to time with certain established
resellers in domestic and international markets that do not require the
continued involvement of our personnel. Stratasoft derived $322,000 or 7.5% of
its revenue from sales to resellers during the six months of 2004 which compares
with $679,000 or 19.0% of its revenue in 2003. Sales to resellers are included
in revenue when the fees are fixed and determinable; otherwise revenue from
resellers is deferred and recognized when the payment becomes due.

         Valerent revenue increased by $966,000, or 40.5%, from $2.4 million to
$3.4 million. As a percentage of total revenue, Valerent revenue increased from
9.2% to 9.3%. The increase in Valerent revenue was primarily attributable to
increased service revenue of $830,000 and increased product sales of $136,000.
The increase in service revenue is primarily attributable to development of
remote services for clients to operate themselves, the sale of the underlying
technology to support remote management, and Valerent delivered remote managed
services on behalf of clients, which was primarily related to Valerent making
changes to its business model so that it no longer pursued certain non-strategic
sources of services revenue. Valerent's business model now focuses on
identifying and developing markets with enterprise customers.

         Gross Profit. Our total gross profit increased by $2.8 million, or
56.5%, from $5.0 million to $7.8 million. Gross margin increased from 19.3% to
21.7%, primarily because of the increase in gross margin in our INX subsidiary
discussed below.

         INX gross profit increased $2.2 million, or 98.9%, from $2.2 million to
$4.4 million. INX's gross margin increased from 11.0% to 15.2%. INX's gross
profit on its product sales component increased $1.4 million or 63.6%, from $2.2
million to $3.6 million due to increased product sales revenue and a vendor
rebate of $622,000. INX's gross profit on its service component increased
$818,000, from ($15,000) to $803,000, and service gross margin improved from
(1.2%) to 31.6%, as a result of increased service revenue of $1.3 million with a
somewhat fixed cost of service component due to improved utilization of
technical personnel.

         Stratasoft gross profit increased by $252,000, or 11.4%, from $2.2
million to $2.5 million. Stratasoft's gross margin decreased from 61.6% to
57.1%. Stratasoft gross profit was impacted by the mix of sales between "systems
sales", which include a hardware component, as compared to "software only"
sales, which do not have a hardware component. Stratasoft's decreased gross
profit is primarily due to a decreased "software only" component relative to the
"systems sales" component of total Stratasoft sales. Software only sales include
sales to reseller customers and do not require the continuing involvement of our
personnel.

         Valerent gross profit increased by $391,000, or 66.4%, from $589,000 to
$980,000. Valerent's gross margin increased from 24.7% to 29.2%. Valerent's cost
of service consists primarily of fixed labor cost that does not fluctuate
directly with changes in revenue. Valerent improved its utilization of its labor
pool by reducing the number of technicians employed, relative to revenue, and
lowered its fixed cost, which contributed to improved gross profits.


                                       29
<PAGE>
         Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased by $795,000, or 11.5% from $6.9 million to
$7.7 million. As a percentage of total revenue, these expenses decreased 5.3%,
from 26.7% to 21.4%.

These expenses were primarily increased by the following:

            o  Sales compensation increased $787,000 due to additional personnel
               as the result of the Digital Precision acquisition in April 2003
               and increased commissions generated from the increase in gross
               profit, and it also includes approximately $100,000 in earned
               commissions by sales personnel in association with the Cisco
               vendor incentive program.
            o  Administrative compensation expense increased $542,000 due to
               bonuses of $163,000, settlement of an EEOC claim for $26,000 and
               due to hiring additional INX and Stratasoft personnel in Houston,
               Texas, Dallas, Texas, Canada and the addition of Austin, Texas
               office resulting from the Digital Precision acquisition of April
               2003.
            o  Legal and professional fees increased $117,000 primarily from the
               amortization of prepaid consultant expenses of $185,000, which
               was offset by a $29,000 decrease in various attorney fees for
               collection matters and a $39,000 decrease for accounting fees.
            o  Payroll tax expense increased $114,000 in line with the increase
               in compensation expenses.
            o  Depreciation expense increased $85,000 due to asset additions and
               the Digital Precision acquisition in April 2003.
            o  Rents increased $54,000 due to additional office space in Austin,
               Texas and Dallas, Texas resulting from the Digital Precision
               acquisition in April 2003
            o  Shareholder relations expense increased $50,000, due to employing
               a shareholder relations firm, attending investor conferences and
               visiting investor groups, however this expense was partially
               offset by a $43,000 reduction related to the revaluation of the
               non-employee stock option compensation for the investor relation
               consultant.

These expenses were primarily decreased by the following:

            o  Bad debt expense decreased $697,000 due to recoveries of bad debt
               and decreases in allowances based on the aging of receivables and
               credit worthiness of customers.
            o  Contract labor expense decreased $113,000 primarily from
               Stratasoft terminating contract labor in India.
            o  Insurance expense decreased $100,000 because of policy and rate
               changes
            o  Travel expense decreased $45,000 due to reduced Stratasoft
               international travel and INX travel for technical staff and
               management.


         Operating Profit. Operating profit increased $2.0 million, or 105.2%
from a $1.9 million loss to a $100,000 profit, primarily due to the $2.8 million
increase in gross profit being offset by the $795,000 increase in selling,
general and administrative expenses. INX's operating profit increased $377,000,
or 206.0% from a loss of $183,000 to a profit of $194,000. Stratasoft's
operating profit increased $1.0 million, or 141.9% from a loss of $735,000 to a
profit of $308,000. Valerent's operating profit increased $611,000 or 120.5%,
from a loss of $507,000 to a profit of $104,000. The operating loss for the
Corporate Segment decreased $3,000, from a loss of $509,000 to a loss of
$506,000.

         Interest and Other Income, Net. Interest and other income, net,
decreased by $112,000, from income of $106,000 to expense of $6,000, primarily
due to the 2003 sale for $80,000 of an internet domain. Our borrowings under the
Textron credit facility increased from $7.6 million to $7.8 million while the
interest bearing portion of our borrowings decreased from $1.7 million at
December 31, 2003 to $0 at June 30, 2004.

         Minority interest. Income attributable to minority interest increased
from $0 to $6,000. During April 2004 the company issued 1,800,000 shares of INX
common stock pursuant to the Digital Precision purchase agreement of April 2003.
Approximately 7.6% of INX's net income is deducted from the consolidated net
income of I-Sector as a result of their minority interest in INX.

         Net income. Net income increased $1.8 million, or 105.3% from a $1.7
million net loss to a $91,000 net income. The income tax benefit for the period
was $1,000, and there is a net operating tax loss carryforward of approximately
$2.4 million as of June 30, 2004.

         Discontinued Operations. During 1999, we discontinued our Telecom
Systems business. On March 16, 2000, we entered into an agreement to sell
certain assets of, and the ongoing operation of, our Computer Products Division.
The sale transaction closed on May 19, 2000. On December 31, 2000, we sold our
IT Staffing business. As a consequence of these events, the operations of these
businesses are reported as discontinued operations. For the six months ended
June 30, 2003, the gain (loss) on disposal related to these three businesses was
$4,000, ($14,000) and $26,000, net of taxes and tax benefits of $2,000,


                                       30
<PAGE>
($7,000) and $14,000, for a net total of $16,000. For the six months ended June
30, 2004 the gain (loss) on disposal related to these three businesses was
($1,000), $4,000 and $0, net of taxes and tax benefits of ($1,000), $2,000 and
$0, for a net total of $2,000. The gains and/or losses on disposal in 2003 and
2004 related to these discontinued operations are primarily related to
collections of accounts receivables retained when these businesses were sold.


                                       31
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES

         Sources of Liquidity

         Our principal sources of working capital are collections from our
accounts and notes receivable, and our credit facility with Textron Financial
Corporation (the "Textron Facility"). We use the Textron Facility to finance the
majority of our purchases of inventory, and to provide working capital when our
cash flow from operations is insufficient. During the six month period ending
June 30, 2004, we experienced negative cash flow from operating activities of
$471,000 as compared to negative cash flow of $929,000 for the six months ended
June 30, 2003. Our working capital was $3.7 million and $11.6 million at
December 31, 2003 and June 30, 2004, respectively.

         During May 2004, we closed a public offering of 500,000 Units. The
Units began trading on May 7, 2004, on the American Stock Exchange under the
symbol ISR.U. Each Unit consists of two shares of common stock and one warrant
to purchase one share of common stock at a price of $12.45. The Units were
offered at a public offering price of $16.60 per Unit resulting in $8.3 million
of proceeds less 9% underwriter discount of $747,000 and underwriter expenses of
$9,000 for a net amount of $7.5 million.

         During June 2004 the underwriters exercised their option to purchase
75,000 additional Units to cover over-allotments resulting in $1.2 million of
proceeds less 9% underwriter discount of $112,000 for a net amount of $1.1
million. We paid approximately $1.0 million of additional costs associated with
the public offering as of June 30, 2004. Net proceeds after all discounts and
expenses were approximately $7.6 million.

         Accounts and Notes Receivable. The timing of our collection of accounts
and notes receivable and payments of our accounts payable is one of the
principal influences on our cash flow from operations. We typically sell our
products and services on short-term credit terms. We try to minimize our credit
losses by performing credit checks, obtaining letters of credit in certain
instances, and conducting our own collection efforts.

         We had accounts receivable, net of allowance for doubtful accounts, of
$9.8 million and $13.2 million at December 31, 2003 and June 30, 2004,
respectively.

         Our Stratasoft subsidiary has accepted customer notes receivable as
part of its consideration for certain of its custom projects sales. At December
31, 2003 and June 30, 2004, Stratasoft had net notes receivable of $928,000 and
$1.5 million, respectively. The following table shows the breakdown of the total
notes receivable:

<Table>
<Caption>
                                                                 DECEMBER 31      JUNE 30
                                                                    2003            2004
                                                                 --------------------------
                                                                   (DOLLARS IN THOUSANDS)
                                                                   -------        -------
<S>                                                              <C>              <C>
            Current portion of notes receivable, gross .......     $ 1,049        $ 1,802
            Allowance for doubtful notes .....................        (373)          (549)
                                                                   -------        -------
            Current portion of notes receivable, net .........         676          1,253
                                                                   -------        -------
            Long term portion of notes receivable, gross .....         502            503
            Allowance for doubtful notes .....................        (250)          (250)
                                                                   -------        -------
            Long-term portion of notes receivable, net .......         252            253
                                                                   -------        -------
            Total notes receivable, net ......................     $   928        $ 1,506
                                                                   =======        =======
</Table>

         Alternatively, our Stratasoft subsidiary also has other sales that
require payment to occur after more than 90 days but less than twelve months
from the date of the sale. Those outstanding balances are classified as accounts
receivable in the accompanying balance sheets.

         Inventory. We had inventory of $1.0 million and $1.9 million at
December 31, 2003 and June 30, 2004, respectively. We try to minimize the amount
of inventory on hand to reduce the risk that the inventory will become obsolete
or decline in value. We have been able to do this by relying on the ready
availability of products from our principal suppliers. As noted above, we rely
principally on our Textron Facility to finance our inventory purchases.

         Textron Facility. On January 31, 2002, we entered into the Textron
Facility to provide financing for our inventory purchases. The maximum credit
available under the Textron facility, as amended, is $15 million and it is
collateralized by substantially all of our assets other than our patent
licenses.

         As of June 30, 2004, we owed $7.8 million under the Textron Facility
and had an additional $246,000 available subject to borrowing base restrictions.
The borrowing base amount under the Textron facility is generally the sum of 80%
of eligible accounts receivable (the "Accounts Advance Amount") plus the lesser
of: (a) 90% of eligible inventory purchased by us from manufactures with whom
Textron has acceptable repurchase agreements, plus 40% of other eligible
inventory; (b) $4,000,000; or (c) 30% of the Accounts Advance Amount. An account
receivable will not qualify as an eligible accounts receivable if, among other
things, it is not paid within 90 days after our invoice date, the customer has
failed to pay more than 25% of all accounts


                                       32
<PAGE>
receivable owed by the customer to us within 90 days after the invoice date, or
to the extent that the customer's total accounts receivable exceed 15% of all of
our eligible accounts receivable.

         We use the Textron Facility to finance purchases of Cisco products from
Cisco and from certain wholesale distributors. Cisco provides 60-day terms, and
other wholesale distributors typically provide 30-day terms. Balances under the
Textron Facility that are within those respective 60- and 30-day periods (the
"Free Finance Period") do not accrue interest and are classified as accounts
payable in our balance sheet. We refer to non-interest bearing balances as
"inventory floor plan borrowings."

         To the extent that we can borrow under the Textron Facility, it gives
us the ability to extend the payment terms past the Free Finance Period. Amounts
extended past the Free Finance Period accrue interest and are classified as
notes payable on our balance sheet. These extended payment balances under the
Textron Facility accrue interest at the prime rate (4.25% at June 30, 2004) plus
2.5%. Working capital advances under the Textron Facility accrue interest at the
same rate as extended payment balances. Because payment cycles of sales to
school districts under the eRate program extend beyond 60 days, we expect we
will continue to carry extended payment balances under the Textron Facility
during 2004. The total outstanding balance under the Textron Facility at June
30, 2004 was $7.8 million, all of it was within the Free Finance Period and
therefore is reflected as accounts payable in our balance sheet at June 30,
2004.

         The Textron Facility contains restrictive covenants that are measured
at each quarter end. These covenants require us to:

            o  maintain Minimum Tangible Capital Funds of $2.2 million, which is
               defined to be the sum of cash, trade accounts receivable,
               inventory and fixed net assets, minus subordinated liabilities
               minus total liabilities, with total liabilities being defined as
               accounts payable, accrued expenses and short- and long-term notes
               payable;

            o  maintain a maximum Debt to Tangible Capital Funds ratio of 6.0 to
               1; and

            o  to achieve a fixed charge coverage ratio of no less than 1.1 to
               1.0, the fixed charge coverage ratio being defined as (a)
               quarterly net income plus interest expense, taxes, and lease and
               rental expense divided by (b) the sum of (1) quarterly interest
               expense, lease and rental expense, and (2) quarterly current
               maturities of long-term debt divided by [1.0 minus the tax rate].

         At June 30, 2004, we were in compliance with the loan covenants, and we
anticipate that we will be able to comply with the loan covenants during the
next twelve months. If we violate any of the loan covenants, we would be
required to seek waivers from Textron and Silicon Valley Bank for those
non-compliance events. If Textron or Silicon Valley Bank refused to provide
waivers, the amount due under the Textron Facility could be accelerated and we
could be required to seek other sources of financing.

         During July 2004 we began re-negotiating the Textron credit facility.
The maximum credit available was temporarily increased from $15.0 million to
$22.0 million during the re-negotiation period, and we anticipate that we will
be able to complete the re-negotiation of the Tex ton credit facility sometime
during our third quarter of 2004.

         Contractual Obligations

         The following table summarizes certain of our contractual cash
obligations and related payments due as of June 30, 2004:

<Table>
<Caption>
                                                            PAYMENTS DUE BY PERIOD
                                             ----------------------------------------------------
                                                            (DOLLARS IN THOUSANDS)
                                                       LESS THAN    1-3        4-5      MORE THAN
CONTRACTUAL OBLIGATIONS                      TOTAL      1 YEAR     YEARS      YEARS      5 YEARS
----------------------------------------     ------     ------     ------     ------    ---------
<S>                                          <C>        <C>        <C>        <C>       <C>
Lease obligations ......................     $2,704     $  386     $1,804     $  411     $  103
Textron, interest bearing debt .........         --         --         --         --         --
Other debt obligations .................        272         94        178         --         --
                                             ------     ------     ------     ------     ------
Total contractual cash obligations .....     $2,976     $  480     $1,982     $  411     $  103
                                             ======     ======     ======     ======     ======
</Table>

         During the second quarter of 2004 the INX and Valerent Dallas, Texas
offices occupied new office space under a six year lease obligation. Expected
payments for base lease obligation are approximately $ - for 2004, $157,000 for
2005, $205,000 for 2006, $241,000 for 2007, $255,000 for 2008, $264,000 for 2009
and $110,000 for 2010. The approximate previous annual lease payment for the INX
was $108,000. During the third quarter INX intends to open and occupy an office
in San Antonio, Texas. Expected payments for the base lease obligation are
approximately $17,000 for 2004, $34,000 for 2005, $34,000 for 2006 and $17,000
for 2007. These amounts are reflected in the contractual obligations schedule
shown above.

         We do not have any material contractual purchase obligations. We
purchase inventory to fulfill in-hand orders from customers and we try to
minimize the amount of inventory on hand to reduce risk that the inventory will
become obsolete or decline in value. We are able to do this by relying on the
ready availability of products from our principal suppliers.


                                       33
<PAGE>
         We expect to be able to meet our contractual cash payment obligations
by their due dates through cash generated from operations, augmented, if needed,
by borrowings under the Textron Facility, and through the proceeds from our
public offering.

         Cash Flows. During the six months ended June 30, 2004, our cash
increased by $5.0 million. Operating activities used $471,000, investing
activities used $457,000 and financing activities provided $6.0 million.

         Operating Activities. Operating activities used $471,000 in the six
months ended June 30, 2004 as compared to using cash of $929,000 in 2003. The
cash used in 2004 was primarily related to the $1.3 million net growth of assets
over the net growth in liabilities which was offset by $662,000 of non-cash
expenses and net income of $91,000.

         Changes in asset and liability accounts used $1.3 million. The most
significant use related to a $3.5 million increase in accounts receivable. Days
in sales outstanding decreased by 10 days from 57 days at December 31, 2003 to
47 days at June 30, 2004 primarily due to completion of INX eRate funded
projects relating to school districts. Net working capital used for contracts in
progress increased $392,000 due to an increase in cost and estimated earnings in
excess of billings of $262,000, which was primarily related to an increase in
the Stratasoft custom projects in process at period-end. Inventory increased
$911,000 primarily due INX staging Cisco products for upcoming projects and
Stratasoft purchasing dial logic cards for upcoming projects. Notes receivables
increased $776,000 due to Stratasoft accepting two notes as consideration from
two of its customers. These uses of cash were partially offset by an increase in
accounts payable of $3.3 million, which related primarily to increased purchases
of Cisco products for sales by INX and inventory by Stratasoft. The decrease in
other current assets of $453,000 primarily related to the return of bid deposits
for INX bids on school projects and the amortization of prepaid consultant fees.
In addition, deferred revenue increased $177,000 primarily from $529,000 for
software products sold on notes that are not due within twelve months of the
note origination, a $9,000 net increase in unused service revenue, and $37,000
of sales to resellers offset by $398,000 credit to a reseller in May 2004.
Revenue from deferred sales will be recognized in the accounting periods that
payments from the customer are received. The $147,000 increase in accrued
expense is primarily related to accruing for wages and bonuses.

         Investing Activities. Investing activities used $457,000 in 2004
compared to a use of $706,000 for 2003. Our investing activities related to
capital expenditures used $457,000 in 2004. Capital expenditures during both
periods were primarily related to purchases of computer equipment and software,
and to a lesser degree, leasehold improvements. During the next twelve months,
we do not expect to incur significant capital expenditures requiring cash,
except possibly for acquisitions, of which we cannot predict the certainty or
magnitude.

         Financing Activities. Financing activities provide $6.0 million in 2004
as compared to using $90,000 in 2003. In 2003, our stock price increased
substantially, resulting in stock option holders exercising stock options, which
provided $85,000 in 2004. During January 2004, the company repaid $1.7 million
of interest-bearing debt under the Textron Facility. During the six months ended
June 30, 2004, another $1.2 million of debt under the Textron Facility become
interest-bearing in March 2004 and was repaid in May 2004.

         On May 12, 2004 we closed a public offering of 500,000 Units. The Units
began trading on May 7, 2004, on the American Stock Exchange under the symbol
ISR.U. Each Unit consists of two shares of common stock and one warrant to
purchase one share of common stock at a price of $12.45. The Units were offered
at a public offering price of $16.60 per Unit resulting in $7.5 million of
proceeds. On June 2, 2004 the underwriters exercised their option to purchase
75,000 additional Units to cover over-allotments resulting in $1.1 million of
proceeds. We paid $1.0 million of costs associated with the public offering as
of June 30, 2004 resulting in net proceeds from the public offering of $7.6
million. We intend to use the net proceeds of this offering primarily for
working capital and to repay interest-bearing debt.

RELATED PARTY TRANSACTIONS

         We lease office space from Allstar Equities, Inc., a Texas corporation
("Equities"), a company wholly owned by James H. Long, our chief executive
officer. On December 1, 1999 Equities purchased our corporate office building
and executed a direct lease with us with an expiration date of December 31,
2004. In conjunction with Equities obtaining new financing on the building, a
new lease was executed with us on February 1, 2002 with an expiration date of
January 31, 2007. The new lease has a rental rate of $37,192 per month.

         From time to time we make short-term loans and travel advances to our
employees. The balance of approximately $16,000 and $11,000 relating to these
loans and advances is included in the Company's balance sheet and reported as
part of Accounts receivable - affiliates at December 31, 2003 and June 30, 2004,
respectively.


                                       34
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         We incur certain market risks related to interest rate variations
because we hold floating rate debt. Based upon the average amount of debt
outstanding during the six months ended June 30, 2004, a one-percent increase in
interest rates paid by us on our floating rate debt would have resulted in a
$1,000 increase in interest for the period.

         Our business depends upon our ability to obtain an adequate supply of
products and parts at competitive prices and on reasonable terms. Our suppliers
are not obligated to have product on hand for timely delivery to us nor can they
guarantee product availability in sufficient quantities to meet our demands.
INX's business is Cisco centric. Any material disruption in our supply of
products could have a material adverse effect on our financial condition and
results of operations.

ITEM 4. CONTROLS AND PROCEDURES

         Under the supervision and with the participation of certain members of
our management, including our Chairman of the Board, Chief Executive Officer and
principal financial officer, we completed an evaluation of the effectiveness of
the design and operation of our disclosure controls and procedures (as defined
in Rules 13a-15(e) and 15d-15(e) to the Securities Exchange Act of 1934, as
amended (the "Exchange Act")). Based on that evaluation, we and our management
have concluded that, except as discussed in the following paragraph, our
disclosure controls and procedures at the end of the period covered by this
report were effective to ensure that information required to be disclosed by us
in the reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
rules and forms of the SEC, and are designed to ensure that information required
to be disclosed by us in these reports is accumulated and communicated to our
management, as appropriate to allow timely decisions regarding required
disclosures.

         In connection with their audit of the consolidated financial statements
for the year ended December 31, 2003, Grant Thornton LLP ("Grant Thornton"), our
independent accountants, identified and reported to the audit committee of the
board of directors certain internal control deficiencies that Grant Thornton
considered to be significant deficiencies under the standards established by the
American Institute of Certified Public Accountants and the SEC. The identified
internal control deficiencies relate to (i) a material weakness involving
contemporaneous documentation of all terms related to revenue transactions and
conclusions regarding customer creditworthiness and (ii) a significant
deficiency with respect to the review of significant agreements by our
accounting personnel in order to monitor compliance with their terms.

         We have taken corrective actions to address these internal control
deficiencies, by implementing the following measures:

         o  established improved procedures for the review of revenue
            recognition policies and contract management polices and procedures;

         o  held formalized training of finance and sales staff; and

         o  hired an additional person in our accounting department.

         In the six months of 2004, there have been no other changes in our
internal control over financial reporting that have materially affected, or are
likely to affect, our internal control over financial reporting.


                                       35
<PAGE>
                           PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

         In August 2002, Inacom Corp. ("Inacom") filed a lawsuit in the District
Court of Douglas County, Nebraska styled Inacom Corp v. I-Sector Corporation,
f/k/a Allstar Systems, Inc., claiming that I-Sector owed the sum of
approximately $570,000 to Inacom as a result of Inacom's termination of a Vendor
Purchase Agreement between Inacom and I-Sector. I-Sector believes that the claim
is without merit and intends to vigorously contest the demand.

         In March 2003, I-Sector and other parties were notified of a demand for
return of payments relating to the business activities of a call center
customer. In March 2004, I-Sector was informed by the claimant that claims will
not be pursued at this time. I-Sector believes that the claims against it, if
re-initiated, are without merit and intends to vigorously contest any demands
related to this matter.

         I-Sector is also party to other litigation and claims which management
believes are normal in the course of its operations. While the results of such
litigation and claims cannot be predicted with certainty, I-Sector believes the
final outcome of such matters will not have a materially adverse effect on its
results of operations or financial position.


                                       36
<PAGE>
ITEM 5. OTHER INFORMATION

         None

ITEM 6. EXHIBITS AND REPORTS FORM 8-K

         (a) Exhibits

            Exhibit 31.0 Certificate of Incorporation, By laws and Warrant
            Agreement. (may be incorporated by reference)

            Exhibit 31.1 Certification of CEO and CFO pursuant to Rule 13a-14(a)

            Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350 as
            adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002 of
            James H. Long

         (b) Reports on Form 8-K

            Filed June 2, 2004, regarding the exercise of the over-allotment
            option in connection with its recent public offering

            Filed May 17, 2004, regarding the pricing of units of equity
            offering and trading of units.

         Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

                                        I-Sector Corporation.

October 5, 2004                         By: /s/ JAMES H. LONG
                                           -------------------------------------
Date                                    James H. Long, Chief Executive Officer,
                                        Chief Financial Officer, and Chairman of
                                        the Board


                                        By: /s/ JEFFREY A. SYLVESTER
                                           -------------------------------------
                                        Jeffrey A. Sylvester, Secretary and
                                        Controller


                                       37
<PAGE>
                                 Exhibit Index

Exhibit
Number          Description
-------         -----------
 31.0           Certificate of Incorporation, By laws and Warrant Agreement.
                (may be incorporated by reference)

 31.1           Certification of CEO and CFO pursuant to Rule 13a-14(a)

 32.1           Certification pursuant to 18 U.S.C. Section 1350 as adopted
                pursuant to Section 906 of the Sarbanes Oxley Act of 2002 of
                James H. Long