<PAGE>

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


                                  FORM 10-K/A


                               (AMENDMENT NO. 1)


<Table>
<C>        <S>
   [X]     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
           SECURITIES EXCHANGE ACT OF 1934

           FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004

                                  OR


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

</Table>

                        COMMISSION FILE NUMBER: 1-31949

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

<Table>
<S>                                              <C>
                    DELAWARE                                        76-0515249
            (State of Incorporation)                             (I.R.S. Employer
                                                               Identification No.)

             6401 SOUTHWEST FREEWAY
                  HOUSTON, TX                                         77074
    (Address of principal executive offices)                        (Zip code)
</Table>


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


          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

<Table>
<Caption>
              TITLE OF EACH CLASS                   NAME OF EACH EXCHANGE ON WHICH REGISTERED
              -------------------                   -----------------------------------------
<S>                                              <C>
         Common stock, par value $0.01                       American Stock Exchange
       Warrants to purchase common stock                     American Stock Exchange
</Table>

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                                      NONE

     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, and (2) has been subject to such filing
requirements for the past 90 days.  Yes [X]     No [ ]

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  [X]

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

     The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the closing price of the common stock on June 30,
2004 as reported on the American Stock Exchange was approximately $25,196,736.

     The number of shares of common stock, $0.01 par value, outstanding as of
March 29, 2005 was 5,454,534.

                      DOCUMENTS INCORPORATED BY REFERENCE
                                      NONE
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                                     PART I

ITEM 1.  BUSINESS

SPECIAL NOTICE REGARDING FORWARD-LOOKING STATEMENTS

     This report 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 7. -- "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. -- "Risks Related to our Business", 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 for enterprises.
The network and IP telephony solutions we offer are "Cisco-centric", meaning
they are based on the products and technology of Cisco Systems, Inc. These
solutions include design, implementation and support of IP telephony, LAN/WAN
routing and switching, virtual private networks, voice over IP, network
security, and wireless networks. Because of our substantial experience and
technical expertise in the design, implementation and support of IP telephony
solutions, we believe we are well-positioned to take advantage of what we
believe to be the growing trend of implementation by enterprises of IP telephony
in general and, in particular, the pure, packet-switched IP telephony solutions
of Cisco. We also develop and market our own computer telephony integration
software and provide remote information technology services. Our operations are
managed from offices in Houston, Dallas and Austin, Texas. Our long term goal is
to become one of the leading national providers of Cisco-centric networks and IP
telephony solutions for enterprises.


     I-Sector Corporation is a holding company, and we operate each of our three
business segments through separate subsidiaries. We sometimes refer to our
business segments in this report by referring to the name of the subsidiary that
operates that business segment. We operate our IP telephony and network
infrastructure business through our subsidiary Internetwork Experts, Inc., which
we refer to in this report as "INX." Our computer telephony business is
conducted through our subsidiary Stratasoft, Inc., which we refer to in this
report as "Stratasoft." Our remote information technology management business is
operated by our subsidiary, Valerent, Inc., which we refer to as "Valerent."


     Each of our three business segments derives revenues from sales of both
products and services. Based on revenue, our largest business segment is our IP
telephony and network infrastructure business. INX provided approximately 83.1%
of our revenues in 2004 net of intercompany eliminations. Computer telephony
software provided by Stratasoft accounted for approximately 9.5% of our revenues
in 2004 net of intercompany eliminations. The third business segment is our
remote information technology management business of Valerent, which provided
approximately 7.4% of our revenues in 2004 net of intercompany eliminations.

IP TELEPHONY INDUSTRY BACKGROUND

  TERMINOLOGY

     IP telephony is a general term for an existing and rapidly expanding
technology that uses Internet Protocol, or "IP", for exchanging voice
communications, faxes, and other types of information that have traditionally
been carried by conventional private, branch exchange ("PBX") telephone systems
used by enterprises and by the public

                                        1
<PAGE>


switched telephone network ("PSTN"). The term IP telephony generally encompasses
a narrower term frequently used in our industry called "VoIP," or voice over
Internet Protocol. We refer to VoIP as including only the exchange of voice
communication by means of IP technology, while we refer to IP telephony as
including not only VoIP but also the broader range of voice and other
communications over IP-based networks, and the systems that enable those
communications.


     Internet Protocol, or IP, is a set of industry standard procedures that are
used to:

     - format large volumes of data into smaller, discrete units or "packets";

     - give each packet both the sender's and the recipient's network address;
       and

     - send those packets over the Internet or through the enterprise's own
       network to the recipient's address.


     Sometimes the packets are sent by different routes and arrive out of proper
sequence. At their destination, the multiple packets are reassembled into their
correct order by another protocol known as Transmission Control Protocol, or
"TCP," to produce a coherent communication.


     IP telephony uses "packet-switched" connections, instead of using the
conventional "circuit-switched" connections traditionally employed by PBXs and
PSTNs. Because IP telephony uses packet-switching, multiple users can share the
same path for voice, data and other communications. In contrast, conventional
circuit-switched telephony is carried over a circuit dedicated only to the use
of the specific senders and recipients that are a part of the communication then
in progress.


     IP telephony uses network infrastructure, such as a local area network, or
"LAN," or a wide area network, or "WAN," employing IP technology to either
enhance the telephony functions performed by the enterprise's existing PBX
telephone system, or to replace the existing PBX entirely. We refer to IP
telephony systems that incorporate and augment an enterprise's existing PBX as a
"hybrid" system, and to the PBX retained by the enterprise as a "legacy PBX." We
refer to a "pure" or "packet-switched" IP telephony system as one in which
network infrastructure totally supplants the enterprise's existing PBX with a
packet-switched solution.


     In addition to offering potential long-term cost savings, implementation of
IP telephony allows enterprises to reap the benefits of participating in a
growing trend in communications technology called "convergence."

  CONVERGENCE TREND

     We believe the market for enterprise communications is moving from the
"traditional model" to what industry observers sometimes term the "converged
model". IP telephony is expected to be an important part of the trend towards
convergence.

     In the traditional enterprise communications model, different types of
communication are conducted by different means:

     - data communication is performed using LAN/WAN network infrastructure,
       including the Internet;

     - telephone/voice communication is carried over traditional
       circuit-switched PBX systems and PSTNs; and

     - video communications are often accomplished using stand-alone video
       conferencing systems using either multiple circuit-switched telephone
       lines or network communications.

     In contrast, the converged communications model will enable voice, video
and data to be carried by a single, unified IP-based network. IP telephony and
data communication over IP-based network infrastructures is already being used
by many enterprises. We believe that technology to enable video teleconferencing
over IP-based networks is rapidly developing, and that it will become available
for commercial implementation in the near future.

     Today, implementation of converged IP telephony and data communications
networks can offer both significant long-term cost savings and increased
productivity to enterprises. Among the potential long-term savings that an
enterprise might experience are:

     - elimination of redundant traditional telephone line circuits and cabling
       systems as internal voice communications move to the enterprise's
       IP-based network cabling system;
                                        2
<PAGE>

     - reduced cost resulting from consolidation of PSTN circuits to a central
       location so that all external communications to and from the enterprise
       occur through fewer or only one point of interface to the PSTN;

     - more efficient support of telephone and data functions by a single
       support organization rather than multiple service providers and in-house
       support departments;

     - simplified administration and lower costs for moves, adds and changes of
       the telephone system because an IP telephony handset can be moved or
       changed within an enterprise without rewiring the PBX or re-programming
       the telephone number as is required in a conventional PBX system; and

     - elimination or reduction of long distance toll charges as enterprises
       operating a converged solution move their internal voice communications
       to the fixed-cost data network that often already exists between the
       enterprise's remote facilities.

     Later, as convergence progresses, we expect it to further improve the
productivity and cost savings of enterprises. We believe that much of these
long-term productivity enhancements and cost savings will come from yet-to-be
created software applications designed to take full advantage of convergence
technology.

  COMPETING IP TELEPHONY SOLUTIONS


     Cisco promotes the use of a network server running their call management
software, also called a "soft switch," which enables their system to perform IP
telephony functions without the use of a PBX. While other manufacturers,
including Avaya, Inc. and Nortel Networks Corp., are moving towards
packet-switched technology, we believe that Cisco has established an early
competitive advantage in the market for packet-switched, telephony solutions
that have no need to resort to older, circuit-switched PBX technology.


     IP telephony is a comparatively new communication technology that we
believe is rapidly gaining acceptance by enterprises. There are, however,
barriers to its immediate acceptance by many enterprises. We believe one of the
most common barriers is the cash expense to an enterprise of upgrading or
replacing existing network infrastructure and legacy PBX systems. We believe a
related concern of some enterprises is the non-cash expense associated with
writing off the undepreciated cost of their legacy PBX system, particularly when
substantial undepreciated costs of that system remain on an enterprise's balance
sheet. Additionally, in our experience, doubts about the perceived quality of
service offered by an IP-based telephony system, including concerns about audio
quality, reliability, privacy and security have also been barriers to adoption
of the technology by some enterprises, but in our experience, while still
existing, these concerns have decreased over the past year.

     IP telephony as implemented by most enterprises typically requires upgraded
or new network infrastructure, regardless of whether the enterprise chooses a
hybrid or pure IP telephony solution. Most networks designed solely for data
communications are inadequate to accommodate IP telephony functions featuring
the quality of telephony service demanded by most customers. For example, most
customers demand that voice communications be given priority over data
communication in the allocation of their network's available resources. To do
this, the enterprise's network infrastructure must be able to distinguish
between data communication and voice communication. It must also be capable of
prioritizing and allocating the use of system resources between voice and data
to achieve the enterprise's quality of service expectations.

     We believe that the many complexities associated with IP telephony networks
require specialized knowledge and skills not generally available to service
providers experienced only in data networks or traditional telephone systems.
The optimal design, implementation and support of IP telephony requires a
service provider that is experienced and proficient in many different
technologies, including data networking, telephony, various industry protocols,
as well as the software and hardware needed to integrate those technologies.

OUR IP TELEPHONY AND NETWORK INFRASTRUCTURE BUSINESS

     We offer a complete range of products and services for Cisco-centric IP
telephony solutions through our INX subsidiary. Until recently, most IP
telephony solutions work we did involved our customer testing the technology
rather than full-scale implementation of IP telephony. As the market for IP
telephony solutions for enterprises matures from testing to full scale
deployment, we believe that offering a comprehensive range of products and

                                        3
<PAGE>

services to our customers will be critical in differentiating us from our
competitors. Because services typically provide higher margins than the sale of
products, we plan to emphasize recurring support services in our marketing
strategy.

  NETWORK INFRASTRUCTURE PRODUCTS

     Our products consist principally of network infrastructure components
manufactured by Cisco, including routing and switching equipment, and related
Cisco software, including Cisco Call Manager IP Telephony Software. We also
offer software products to augment Cisco technology that are available from
vendors other than Cisco, including our own software products.

  DESIGN AND IMPLEMENTATION SERVICES

     We design and implement Cisco-centric IP telephony solutions. To provide
these services, we employ highly trained network engineering staff, who are
trained and experienced in both large, complex network infrastructure technology
as well as Cisco IP telephony technology. Our technical and engineering staffs
are also experienced in essential related technology such as network security.
We have developed not only expertise in the area of enterprise IP telephony
solutions and converged communications, but also methodologies for designing and
implementing large, complex, converged communications infrastructures for
enterprises.

     During 2001 and 2002, as the move towards IP telephony technology by
enterprises began to develop, the majority of our customer engagements were
limited to the installation of pilot projects in which our customers tested the
technology. These types of projects required long selling cycles, substantial
pre-sale involvement by skilled engineers and significant IP network design and
upgrade services. Our IP telephony implementation services were a comparatively
small component of the total services we provided in these pilot projects
because our customers were implementing only relatively small "test" sites.
These projects were characterized by sporadic services revenue and generally
depressed gross margins for our services. Additionally, our engineering staff
was often not fully utilized between projects. During 2003 and 2004 customers
began to adopt IP telephony technology and we began to perform full
implementations of the technology, which has resulted in our ability to more
fully employ our engineering staff. This increased demand has improved our
service revenues and our service margins.

  POST-IMPLEMENTATION SUPPORT SERVICES

     In our view, there are two main support models for IP telephony: the
current model used to support traditional PBX systems and the model used to
support computer networks. We believe that neither the traditional PBX telephone
support model nor the existing computer network support model best suits the
needs of customers operating a converged communications infrastructure. We have
created a specialized support model for supporting Cisco-centric converged
communications systems, which we have branded under the Netsurant name. These
services include remote monitoring and management of the customer's IP telephony
and related IP network infrastructure, using specialized toolsets and a network
support center with technical staff that are specifically trained and
experienced in the area of Cisco IP telephony and complex, state-of-the-art IP
network infrastructure. Customers are notified of system problems and we solve
the problems detected either remotely or onsite. Our Netsurant network support
center is staffed with technical staff that are specifically trained and
experienced in both complex network infrastructure and Cisco IP telephony
technology.

     Historically, when most customers were only testing IP telephony
technology, post-implementation support services were not a high priority for
those customers. But as customers transition to the full implementation of IP
telephony, we believe that post-implementation support will become a higher
priority. Additionally, we believe that the quality of support services is
likely to become among the more significant factors for enterprises when they
are choosing a service provider. Through our Netsurant service offering, we
believe we will be positioned to provide support services that customers desire
and require.

  WHY WE OFFER CISCO-CENTRIC IP TELEPHONY SOLUTIONS EXCLUSIVELY

     We offer only Cisco-centric network infrastructure solutions and
Cisco-centric IP telephony solutions. We choose to do this because we believe it
enables us to compete more effectively for large Cisco-centric IP telephony
                                        4
<PAGE>

projects. Our sales force works closely with Cisco's sales organization to
identify and close IP telephony projects. By deliberately refraining from
selling products that are competitive with Cisco's products, we believe our
relationship with Cisco is enhanced, and our sales staff and sales management,
as well as our engineering staff, is more focused and knowledgeable about the
products we sell.

     We believe that most sales of Cisco IP telephony systems are market share
gains by Cisco. This is because Cisco only entered the voice communications
market in 1998, and does not have a large traditional PBX telephone systems
customer base to protect against encroachment by competitors. Because sales of
IP telephony systems to enterprises will be largely systems replacing existing
traditional PBX telephone systems, the traditional PBX manufacturers will be
seeking to retain their existing customers while each system sold by Cisco will
be a new customer for Cisco at the expense of a competitor, resulting in market
shares gains by Cisco.

     The majority of the enterprise organization IP-based routing and switching
equipment installed today is manufactured by Cisco. For that reason, we believe
Cisco has a competitive advantage with respect to implementing pure,
packet-switched IP telephony solutions. According to Infotech's April, 2004
report on enterprise IP telephony titled "Enterprise Convergence -- The Race for
IP Telephony Supremacy", Cisco had over a 50% share of the installed IP
telephony handsets, but less than a 2% market share of all enterprise handsets
installed, including traditional circuit-switched systems. Because of this, we
believe Cisco has the potential to gain market share against its competitors as
the move towards full adoption of IP telephony technology by enterprises
continues. If we are able to grow to become a national rather than a regional
provider of Cisco-centric network infrastructure, and if, as we expect, Cisco
gains market share against its competitors, we believe that we will be able to
substantially increase our revenues.

     Because the IP telephony and network infrastructure solutions we offer are
based on the IP telephony products and technology of Cisco, it is critical to
our business that we maintain a good working relationship with Cisco. We believe
that because of our focus on Cisco's products, and our commitment to their
strategy, our relationship with Cisco is excellent. Cisco awarded us its
Regional Direct Value Added Reseller for its Southern Region for 2002, and its
Regional Direct Value Added Reseller for the entire United States for 2003.

     We are an authorized reseller of Cisco products and have been awarded their
"Gold" level status, which enables us to obtain the best published pricing
discounts on the Cisco products that we sell, which in turn enables us to be
competitive with other large Cisco product resellers.

  GEOGRAPHIC EXPANSION AND ACQUISITIONS

     We have grown to what we believe to be the leading regional Cisco-centric
IP telephony solutions provider for Texas, with offices in Austin, Dallas,
Houston and San Antonio, Texas. In February of 2005, we also opened an office in
Washington, D.C. Our target customers for Cisco-centric IP telephony solutions
are enterprise organizations with approximately 300 to 10,000 users. Because of
being a dominant provider of Cisco-based IP telephony solutions for our target
customers in the Texas market, without geographic expansion, our growth will
begin to slow. With full adoption of IP telephony technology by enterprises at
an early stage, we intend to expand nationally, establishing offices in other
major U.S. markets in order to create a national presence, with the goal of
eventually becoming the leading focused, national provider of Cisco-based IP
telephony solutions to our target customers. We intend to do this, when
feasible, by acquiring select Cisco-centric network infrastructure solutions
companies in major markets, and adjusting the focus of those companies, if
necessary, towards the opportunities created by the trend toward full adoption
of IP telephony technology. We were successful in entering the Austin, Texas
market by buying the operations of Digital Precision, Inc. in April 2003, and we
have since become a dominant participant in that market. We believe there are
opportunities in other markets to repeat the success we had entering Austin,
Texas.

OUR COMPUTER TELEPHONY SOFTWARE BUSINESS

     We have developed and marketed our own proprietary computer telephony
software applications through our Stratasoft subsidiary since 1995.
Traditionally, our computer-telephony software applications have primarily
consisted of products used by professional contact centers. More recently, we
have migrated our traditional contact center products to take advantage of the
trend towards the use of voice over IP technology. We have been
                                        5
<PAGE>

developing new products that we hope will allow us to take advantage of the
opportunity that we believe exists for computer telephony software applications
for enterprise organizations that use IP telephony.

  EXISTING PRODUCTS

     This software is used by professional contact centers and other complex,
high volume telephony environments and is marketed under the trade name
"Stratasoft". Our current complete contact center product offering allows our
customers to rapidly customize our software to their business applications. Our
Stratasoft products provide telephony functionality essential to contact center
operations including:

     - outbound predictive dialing;

     - automatic call distribution for processing inbound calls;

     - call blending between inbound and outbound activity;

     - voice mail and auto attendant applications;

     - text-to-speech capabilities;

     - Web-based text chatting;

     - fax on demand;

     - interactive voice response;

     - rapid application development and scripting;

     - local/remotes agent using SIP soft phone technology;

     - support for IP Telephony telephone lines.

     The open architecture design of our Stratasoft products allows for
integration with the customer's existing systems and software applications, thus
minimizing implementation expenses. Stratasoft's products have been awarded
numerous awards by industry trade journals, including Call Centers Editors
Choice award for 1998, Call Center Solutions product of the year award for 1998,
Customer Interaction Solutions product of the year awards for both 2001 and for
2002, and Communications Solutions product of the year award for 2002. Recently,
Technology Marketing Corporation's TMC Labs presented Stratasoft its Innovation
Award for 2004, the Customer Interaction Solutions product of the year award for
2004, and the IP Contact Center Technology Pioneer award for 2005.

     Stratasoft's products are currently sold and used in over 20 countries
worldwide, including contact centers in the United States, Canada, the United
Kingdom, Germany, Greece, India, Egypt, Japan, the Philippines and Grenada.

  CONVERGENCE SOFTWARE RESEARCH AND DEVELOPMENT

     We intend to use our computer telephony software development expertise to
create and market new software products that augment and enhance Cisco-centric
IP telephony solutions. We believe that IP telephony and convergence will create
an environment where there will be an opportunity to create new software
applications to integrate voice, video and data into a customer's business
processes and traditional business applications in ways that were not possible
before. These software applications are often called "convergence applications".
Therefore we believe our extensive experience in developing and marketing
complex computer telephony software applications positions us to take advantage
of this opportunity.

REMOTE INFORMATION TECHNOLOGY MANAGEMENT

     We offer a variety of services related to cost reduction and performance
improvement of information technology through Internet-based remote service and
support of information technology. These services include the following:

     - remote end user and server management;

                                        6
<PAGE>

     - data and network management; and

     - security and internet services.


     We operate this third of our three business segments through our Valerent
subsidiary.


CUSTOMERS

     We had one customer that represented 10% or more of our revenue for the
year ended December 31, 2004. Micro System Enterprise, Inc./Acclaim Professional
Services ("MSE"), an agent related to the Dallas Independent School District
E-Rate funded program, which represented approximately 16.1% of our consolidated
revenue for the year ended December 31, 2004 and approximately 49.5% of our
consolidated net accounts receivable at December 31, 2004. We had no customer
that represented 10% or more of our total consolidated revenue during the years
ended December 31, 2002 or 2003.

  IP TELEPHONY AND NETWORK INFRASTRUCTURE

     Customers for our Cisco-centric IP telephony and other network solutions
are typically medium- to larger-sized corporate organizations, schools and
governmental agencies that use large network infrastructures. Presently, a
majority of our customers are located in, or make significant network
infrastructure decisions in Texas. They include private enterprises in various
industries such as healthcare, legal, banking, energy and utilities,
hospitality, transportation, manufacturing and entertainment. In addition to its
direct sales model, INX has also provided technical consulting and project
management services as a sub-contractor for companies such as EDS, IBM and
Sprint. Although our customers are generally based in Texas, we have performed
work at their locations in other parts of the United States, and on occasion,
internationally.


     During 2004, we performed an increased amount of business with educational
and governmental customers, including schools that receive funding for network
infrastructure under a federal program, commonly referred to as the "E-Rate"
program. These customers typically pay more slowly than our commercial
customers, and to the extent a greater portion of our revenue is derived from
these customers, our business cycle and collections cycle is extended and our
working capital requirements are increased as a percent of our revenue.


  COMPUTER TELEPHONY SOFTWARE

     Customers for our computer telephony software are typically contact centers
or companies or organizations that operate a contact center, including political
and non-profit organizations. A majority of our customers have historically been
located in the United States, but we have increasingly sold and installed call
center systems internationally. In 2002, 2003 and 2004, approximately 28.2%,
42.2% and 23.7%, respectively, of Stratasoft's revenue, and 4.4%, 5.1% and 2.3%,
respectively, of our consolidated revenue, were with customers outside the
United States, including customers in India, Egypt, the United Kingdom, Canada,
Japan, Germany, Greece and the Philippines.

     We believe that Stratasoft's typical contact center customers may change in
the future due to changes in the contact industry that are occurring as a result
of the "National Do Not Call" legislation. This may occur because the new
legislation created unintended incentives for large companies or organizations
that have large numbers of customers to enter the contract contact center
industry. We believe the new legislation created these incentives because it
permits companies to contact their own customers for the purpose of marketing.
If this trend develops as we expect, our typical customer could become a larger
enterprise rather than a smaller contact center business.

     If we are successful developing and marketing new software applications for
use by enterprise customers that use IP telephony for other than contact center
operations, we expect that a higher percentage of Stratasoft's revenues will
come from enterprise customers, rather than smaller contact center businesses.

                                        7
<PAGE>

  REMOTE INFORMATION TECHNOLOGY MANAGEMENT

     Customers for our remote information technology management consist
primarily of commercial businesses as well as state and local governmental
organizations, primarily in Houston and Dallas.

SALES AND MARKETING

     We market our products and services primarily through sales personnel,
including account managers and customer service representatives. These sales
personnel are partially compensated, and in some cases are solely compensated,
based on productivity, specifically either the revenue or the profitability of
sales that they participate in developing. In addition, Stratasoft markets its
computer telephony software applications through a network of value added
resellers, who often integrate their products and services with Stratasoft's
software products. We also promote our products and services through general and
trade advertising, and participation in trade shows. INX's sales organization
works closely with the Cisco sales organization to identify opportunities for IP
telephony and network infrastructure solutions.

     Potential customers for our IP telephony and network infrastructure
business sometimes, particularly governmental and educational customers, specify
that bid and performance bonds must be provided in order to be considered for
the award of their projects, particularly in the case of larger projects. In the
past we have been unable to obtain bid bonds or performance bonds requested by
potential customers in connection with some large potential transactions. In
some cases, we have lost business because of this. In other cases, we were able
to obtain only a smaller portion of the overall project by acting as a
subcontractor, to a larger, better financed organization that was able to obtain
the necessary bonding. The proceeds from our public equity offering in May 2004
and posting several quarters of profitability, coupled with a generally
improving market for performance bonding, has improved our ability to obtain
bonding. In July 2004 we established a bonding line with SureTec Insurance
Company. However, we expect that our ability to bid and win certain larger
projects will continue to be adversely affected by our bonding capabilities,
which are defined by our financial strength and the level of, and history of,
profitability.

SUPPLY AND DISTRIBUTION

     We purchase equipment that is sold in conjunction with Stratasoft's
software products and by INX as part of network infrastructure and/or IP
telephony solutions. INX makes up the substantial majority of product purchases,
and purchases the majority of the Cisco products that it resells directly from
Cisco. We also purchase some of our products through various distribution
channels when a product is not available directly from Cisco. In addition,
Valerent and INX purchase or exchange service parts, typically with the product
manufacturer or its authorized parts distributor. Additionally, Stratasoft uses
resellers to distribute its software products. We attempt to keep minimal
inventory on hand and attempt to purchase inventory only as needed to fulfill
orders. We attempt to ship products directly from our supplier to our customer
when possible in order to shorten the business cycle and avoid handling the
product in our facility.

COMPETITION

     The market for communications systems, including network infrastructure, IP
telephony solutions and computer telephony software for contact centers is
evolving rapidly, is highly competitive and is subject to rapid technological
change. Many of our competitors are substantially larger than we are and have
significantly greater financial, sales, marketing, technical and other
resources. We expect to face increasing competitive pressures from both current
and future competitors in the markets we serve. Our competition varies by
business segment.

     Our competition for IP telephony and network infrastructure solutions is
highly fragmented, and we compete with numerous large and small competitors. In
our efforts to market Cisco-centric IP telephony solutions we compete with
manufacturers of IP telephony equipment such as Avaya, Inc. and Nortel Networks
Corporation as well as with such manufacturer's integrators and solution
providers. For Cisco-centric IP telephony solutions and network infrastructure
solutions, we compete with large, well established Cisco equipment integrators
and solution providers, including most of the major national and international
solution providers such as EDS, IBM, SBC and others.

                                        8
<PAGE>

     With regard to our computer telephony software applications for contact
centers, we compete primarily with manufacturers of specialized contact center
systems, such as Avaya, Concerto, Interactive Intelligence, and others. If we
are successful in developing other software applications to augment and enhance
Cisco-centric IP telephony solutions, we expect to face competition from
numerous early stage companies focused in this area as well as many large,
well-established software companies and telephone systems manufacturers.

     For our remote managed services business, we compete with numerous large,
well established IT services and support organizations, large IT equipment
manufacturers, and numerous smaller IT services and support organizations.

     We believe that the principal competitive factor in all segments of our
business is price. Other important factors include technical competence, the
perception of the customer regarding our financial and operational ability to
manage a project, and the quality of our relationship with Cisco. In our
computer telephony software business, the array of features offered by our
software products as compared to those of our competitors is also an important
competitive factor. Additionally, the IP telephony products we offer compete
with hybrid systems.

MANAGEMENT INFORMATION SYSTEMS

     We use an internally developed, highly customized management information
system ("MIS") to manage most aspects of our business. All of our subsidiaries
use our MIS, which is customized to their specific needs. We use our MIS to
manage accounts payable, accounts receivable and collections, general ledger,
sales order processing, purchasing, service contracts, service calls and work
orders, engineer and technician scheduling and time tracking, service parts
acquisition and manufacturer warranties, and project management. Reporting can
be generated for project profitability, contract and customer analysis, parts
and inventory tracking and employee time tracking. The system provides for
separate company accounting and also for consolidation of all subsidiary company
financial information.

EMPLOYEES

     At March 24, 2005 we employed approximately 194 people. Of these,
approximately 44 were employed in sales, marketing and customer service, 88 were
employed in engineering and technical positions and 62 were employed in
administration, finance and MIS. Approximately 38% of our network engineering
staff in our INX subsidiary hold the Cisco Certified Internetwork Engineer
certification, the highest level of Cisco technical certification. We believe
that our ability to recruit and retain highly skilled and experienced technical,
sales and management personnel has been, and will continue to be, critical to
our ability to execute our business plans. None of our employees are represented
by a labor union nor are any subject to a collective bargaining agreement. We
believe that our relations with our employees are good.

CERTAIN MILESTONES IN OUR CORPORATE DEVELOPMENT

     We started business as a computer reseller and service provider in 1983. We
added a traditional PBX telephone systems business unit in 1994, and founded
Stratasoft in 1995. We conducted an initial public offering and became a public
company in 1997. By 1999, we had grown to over $200 million in revenue,
operating from five offices in Texas, with over 500 employees.

     In 1999, we decided to sell both our computer products reselling business
and our traditional PBX telephone systems business, which together accounted for
approximately 90% of our total revenue at the time, and reposition our company
to take advantage of what we then believed would become a significant
opportunity in the area of converged communications using network
infrastructure. We closed the sale of these two business units by mid-2000 and
started the process of building our current Cisco-centric network infrastructure
solutions organization with a significant focus on PBX IP telephony technology
in the enterprise market.

GENERAL INFORMATION

     Our corporate headquarters are located at 6401 Southwest Freeway, Houston,
Texas 77074, and our telephone number is (713) 795-2000. Our annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on

                                        9
<PAGE>

Form 8-K and all amendments to those reports are available without charge from
us on our website at http://www.I-Sector.com, as reasonably practicable
following the time they are filed with or furnished to the SEC.

RISKS RELATED TO OUR BUSINESS

  WE HAVE A HISTORY OF LOSSES AND MAY CONTINUE TO INCUR LOSSES.


     We incurred a net loss in each fiscal year since 1998, except fiscal 2004.
As of December 31, 2004, our accumulated deficit was $1.7 million. During 2004
our income was $1.5 million, but we cannot assure you that profitability will
continue in upcoming quarters or years. In order to continue profitability, we
will have to maintain or increase our operating margin. Improvements in
operating margin could result from increases in revenue without comparable
increases in operating expense, from changes in the mix of products and services
we sell, or from other factors. Our profitability improved in 2004 compared to
2003 primarily due to increased gross margin percentage and the fact that our
operating expenses increased at a lower rate than revenue growth. We cannot
assure you that we will be able to continue to achieve improved operating
margins, or that operating margin will not decrease in the future. If we were
unable to increase revenue, if our gross margin decreases, or if we are unable
to control our operating expenses, our business could produce losses. We have
only recently become profitable and are in a rapidly changing industry. In
addition, our business depends upon winning new contracts with new customers,
the size of which may vary from contract to contract. Whether we are able to
remain profitable in the future will depend on many factors, but primarily upon
the commercial acceptance of IP telephony products and services, specifically
those developed and marketed by Cisco.


  OUR SUCCESS IS DEPENDENT ON MAINTAINING OUR RELATIONSHIP WITH CISCO.

     Approximately 77% of our revenue for the year ended December 31, 2004 was
derived from the sale of Cisco products, network products and related services.
We anticipate that these products and related services will account for a
significant portion of our revenue for the foreseeable future. We have a
contract with Cisco to purchase the products that we resell, and we purchase
substantially all of our Cisco products directly from Cisco. Cisco can terminate
this agreement on relatively short notice. Cisco has designated us an authorized
reseller and we receive certain benefits from this designation, including
special pricing and payment terms. We have in the past, and may in the future,
purchase Cisco-centric products from other sources. When we purchase
Cisco-centric products from sources other than Cisco, the prices are typically
higher and the payment terms are not as favorable. Accordingly, if we are unable
to purchase directly from Cisco, maintain our status as an authorized reseller
of Cisco network products and to expand our relationship with Cisco, our
business could be significantly harmed. If we are unable to purchase Cisco
products from other sources on terms that are comparable to the terms we
currently receive, our business would be harmed and our operating results and
financial condition would be materially and adversely affected.

  OUR SUCCESS DEPENDS UPON BROAD MARKET ACCEPTANCE OF IP TELEPHONY.

     The market for IP telephony products and services is relatively new and is
characterized by rapid technological change, evolving industry standards and
strong customer demand for new products, applications and services. As is
typical of a new and rapidly evolving industry, the demand for, and market
acceptance of, recently introduced IP telephony products and services are highly
uncertain. We cannot assure you that the use of IP telephony will become
widespread. The commercial acceptance of IP telephony products, including
Cisco-centric products, may be affected by a number of factors including:

     - quality of infrastructure;

     - security concerns;

     - equipment, software or other technology failures;

     - government regulation;

     - inconsistent quality of service;

                                        10
<PAGE>

     - poor voice quality over IP networks; and

     - lack of availability of cost-effective, high-speed network capacity.

     If the market for IP telephony fails to develop, develops more slowly than
we anticipate, or if IP telephony products fail to achieve market acceptance,
our business will be adversely affected.

  ALTHOUGH OUR SUCCESS IS GENERALLY DEPENDENT UPON THE MARKET ACCEPTANCE OF IP
  TELEPHONY, OUR SUCCESS ALSO DEPENDS UPON A BROAD MARKET ACCEPTANCE OF
  CISCO-CENTRIC IP TELEPHONY.

     We cannot assure you that the Cisco-centric IP telephony products we offer
will obtain broad market acceptance. Competition, technological advances and
other factors could reduce demand for, or market acceptance of, the
Cisco-centric IP telephony products and services we offer. In addition, new
products, applications or services may be developed that are better adapted to
changing technology or customer demands and that could render our Cisco-centric
products and services unmarketable or obsolete. To compete successfully, the
Cisco-centric IP telephony products we offer must achieve broad market
acceptance and we must continually enhance our related software and customer
services in a timely and cost-effective manner. If the Cisco-centric IP
telephony products we offer fail to achieve broad market acceptance, or if we do
not adapt our existing services to customer demands or evolving industry
standards, our business, financial condition and results of operation could be
significantly harmed.

  OUR BUSINESS DEPENDS ON THE LEVEL OF CAPITAL SPENDING BY ENTERPRISES FOR
  COMMUNICATIONS PRODUCTS AND SERVICES.

     As a supplier of IP telephony products, applications and services for
enterprises, our business depends on the level of capital spending for
communications products and services by enterprises in our markets. We believe
that an enterprise's investment in communications systems and related products
and services depends largely on general economic conditions that can vary
significantly as a result of changing conditions in the economy as a whole. The
market for communications products and services may continue to grow at a modest
rate or not at all. If our customers decrease their level of spending on
communications systems and the related products and services, our revenue and
operating results may be adversely affected.

  A MAJORITY OF OUR CUSTOMERS ARE BASED IN TEXAS.


     We offer our IP telephony products and services primarily to businesses in
Texas. Because a majority of the enterprises that we offer our IP telephony
products to are geographically concentrated in Texas, our customers' level of
spending on communication products may be affected by economic condition in
Texas, in addition to general economic conditions in the United States. If
demand for IP telephony products by enterprises in Texas decreases, our
business, financial condition and results of operations could be significantly
harmed.


  OUR STRATEGY CONTEMPLATES RAPID GEOGRAPHIC EXPANSION, WHICH WE MAY BE UNABLE
  TO ACHIEVE, AND WHICH IS SUBJECT TO NUMEROUS UNCERTAINTIES.

     A component of our strategy is to become one of the leading national
providers of Cisco-centric IP telephony products. To achieve this objective, we
must either acquire existing businesses or hire qualified personnel in various
locations throughout the country, fund a rapid increase in operations and
implement corporate governance and management systems that will enable us to
function efficiently on a national basis. Identifying and acquiring existing
businesses is a time-consuming process and is subject to numerous risks.
Qualified personnel are in demand, and we expect the demand to increase as the
market for IP telephony grows. We will also likely face competition from our
existing competitors and from local and regional competitors in the markets we
attempt to enter. A rapid expansion in the size and geographical scope of our
business is likely to introduce management challenges that may be difficult to
overcome. We cannot assure you that we will be successful in expanding our
operations beyond Texas or achieving our goal of becoming a national provider.
An unsuccessful expansion effort would consume capital and human resources
without achieving the desired benefit and would have an adverse affect on our
business.

                                        11
<PAGE>

  WE MAY REQUIRE ADDITIONAL FINANCING TO ACHIEVE EXPANSION OF OUR BUSINESS
  OPERATIONS, AND FAILURE TO OBTAIN FINANCING MAY PREVENT US FROM CARRYING OUT
  OUR BUSINESS PLAN.


     We may need additional capital to grow our business. Our business plan
calls for the expansion of sales of our IP telephony products to enterprises in
geographical markets where we currently do not operate, including expansion
through acquisitions. If we do not have adequate capital or are not able to
raise the capital to fund our business objectives, we may have to delay the
implementation of our business plan. We can provide no assurance that we will be
able to obtain financing if required, or if financing is available, there is no
assurance that the terms would be favorable to existing stockholders. Our
ability to obtain additional financing is subject to a number of factors,
including general market conditions, investor acceptance of our business plan,
our operating performance and financial condition, and investor sentiment. These
factors may affect the timing, amount, terms or conditions of additional
financing available to us.


  WE MAY BE UNABLE TO MANAGE OUR GROWTH EFFECTIVELY, WHICH MAY HARM OUR
  BUSINESS.

     The ability to operate our business in a rapidly evolving market requires
effective planning and management. Our efforts to grow have placed, and are
expected to continue to place, a significant strain on our personnel, management
systems, infrastructure and other resources. Our ability to manage future growth
effectively will require us to successfully attract, train, motivate and manage
new employees, to integrate new employees into our operations and to continue to
improve our operational, financial and management controls and procedures. If we
are unable to implement adequate controls or integrate new employees into our
business in an efficient and timely manner, our operations could be adversely
affected and our growth could be impaired.

  OUR OPERATING RESULTS HAVE HISTORICALLY BEEN VOLATILE, AND MAY CONTINUE TO BE
  VOLATILE, PARTICULARLY FROM QUARTER TO QUARTER.

     Our revenue for the third quarter of 2004 increased by approximately 49%
from the second quarter, and it increased over 56% from the third quarter of
2003. Our revenue for the fourth quarter of 2004 decreased by approximately 26%
from the third quarter of 2004, but increased over 59% from the fourth quarter
of 2003. Our quarterly operating results have historically depended on, and may
fluctuate in the future as a result of, many factors including:

     - volume and timing of orders received during the quarter;

     - amount and timing of supplier incentives received in any particular
       quarter, which can vary substantially;

     - gross margin fluctuations associated with the mix of products sold;

     - general economic conditions;

     - patterns of capital spending by enterprises for communications products;

     - the timing of new product announcements and releases;

     - pricing pressures;

     - the cost and effect of acquisitions;

     - the amount and timing of sales incentives we may receive from our
       suppliers, particularly Cisco; and

     - the availability and cost of products and components from our suppliers.

     As a result of these and other factors, we have historically experienced,
and may continue to experience, fluctuations in sales and operating results. In
addition, it is possible that in the future our operating results may fall below
the expectations of analysts and investors, and as a result, the price of our
securities may fall.

                                        12
<PAGE>

  WE HAVE MANY COMPETITORS AND EXPECT NEW COMPETITORS TO ENTER OUR MARKET, WHICH
  COULD INCREASE PRICE COMPETITION AND MAY AFFECT THE AMOUNT OF BUSINESS
  AVAILABLE TO US AND THE PRICES THAT WE CAN CHARGE FOR OUR PRODUCTS AND
  SERVICES.

     The markets for our all of products and services, and especially our IP
telephony products and services, are extremely competitive and subject to rapid
change. Substantial growth in demand for IP telephony solutions has been
predicted, and we expect competition to increase as existing competitors enhance
and expand their products and services and as new participants enter the IP
telephony market. IP telephony involves the application of traditional
computer-based technology to voice communication, and the hardware component of
the solution is readily available. Accordingly, there are relatively few
barriers to entry to companies with computer and network experience. A rapid
increase in competition could negatively affect the amount of business that we
get and the prices that we can charge.

     Additionally, many of our competitors and potential competitors have
substantially greater financial resources, customer support, technical and
marketing resources, larger customer bases, longer operating histories, greater
name recognition and more established relationships than we do. We cannot be
sure that we will have the resources or expertise to compete successfully.
Compared to us, our competitors may be able to:

     - develop and expand their products and services more quickly;

     - adapt faster to new or emerging technologies and changing customer needs;

     - take advantage of acquisitions and other opportunities more readily;

     - negotiate more favorable agreements with vendors;

     - devote greater resources to marketing and selling their products; and

     - address customer service issues more effectively.

     Some of our competitors may also be able to increase their market share by
providing customers with additional benefits or by reducing their prices. We
cannot be sure that we will be able to match price reductions by our
competitors. In addition, our competitors may form strategic relationships with
each other to better compete with us. These relationships may take the form of
strategic investments, joint-marketing agreements, licenses or other contractual
arrangements that could increase our competitors' ability to serve customers.


  BUSINESS ACQUISITIONS, DISPOSITIONS OR JOINT VENTURES ENTAIL NUMEROUS RISKS
  AND MAY DISRUPT OUR BUSINESS, DILUTE STOCKHOLDER VALUE OR DISTRACT MANAGEMENT
  ATTENTION.


     As part of our business strategy, we plan to consider acquisitions of, or
significant investments in, businesses that offer products, services and
technologies complementary to ours. Any acquisition could materially adversely
affect our operating results and/or the price of our securities. Acquisitions
involve numerous risks, some of which we have experienced and may continue to
experience, including:

     - unanticipated costs and liabilities;

     - difficulty of integrating the operations, products and personnel of the
       acquired business;

     - difficulty retaining key personnel of the acquired business;

     - difficulty retaining customers of the acquired businesses;

     - difficulties in managing the financial and strategic position of acquired
       or developed products, services and technologies;

     - difficulties in maintaining customer relationships, in particular where a
       substantial portion of the target's sales were derived from products that
       compete with products that we currently offer;

     - the diversion of management's attention from the core business;

     - inability to maintain uniform standards, controls, policies and
       procedures; and

                                        13
<PAGE>

     - damage to relationships with acquired employees and customers as a result
       of integration of the acquired business.

     Finally, to the extent that shares of our common stock or rights to
purchase common stock are issued in connection with any future acquisitions,
dilution to our existing stockholders will result and our earnings per share may
suffer. Any future acquisitions may not generate the anticipated level of
revenue and earnings or provide any benefit to our business, and we may not
achieve a satisfactory return on our investment in any acquired businesses.

  OUR INTERNATIONAL OPERATIONS, WHICH WE PLAN TO EXPAND, WILL SUBJECT US TO
  ADDITIONAL RISKS THAT MAY ADVERSELY AFFECT OUR OPERATING RESULTS DUE TO
  INCREASED COSTS.

     Our revenue generated outside the United States, as a percentage of our
total revenue, was 5.1% and 2.3% for the years ended December 31, 2003 and 2004,
respectively. We intend to continue to pursue international opportunities.
Pursuit of international opportunities may require us to make significant
investments for an extended period before returns on such investments, if any,
are realized. International operations are subject to a number of risks and
potential costs, including:

     - unexpected changes in regulatory requirements and telecommunication
       standards;

     - tariffs and other trade barriers;

     - risk of loss in currency exchange transactions;

     - exchange controls or other currency restrictions;

     - difficulty in collecting receivables;

     - difficulty in staffing and managing foreign operations;

     - the need to customize marketing and products;

     - inadequate protection of intellectual property in countries outside the
       United States;

     - adverse tax consequences; and

     - political and economic instability.

     Any of these factors could prevent us from increasing our revenue and
otherwise adversely affect our operating results. We may not be able to overcome
some of these barriers and may incur significant costs in addressing others.

  IF WE LOSE KEY PERSONNEL WE MAY NOT BE ABLE TO ACHIEVE OUR OBJECTIVES.


     We are dependent on the continued efforts of our senior management team,
including our Chairman and Chief Executive Officer, James H. Long, our President
and Chief Operating Officer, Mark T. Hilz, our President of Stratasoft, Bob
Hennessey, our President of Valerent, Frank Cano and our Vice President and
Chief Financial Officer, Brian Fontana. If for any reason, our senior executives
do not continue to be active in management, our business, financial condition or
results of operations could be adversely affected. We cannot assure you that we
will be able to continue to retain our senior executives or other personnel
necessary for the development of our business.


  WE MAY NOT BE ABLE TO HIRE AND RETAIN HIGHLY SKILLED TECHNICAL EMPLOYEES,
  WHICH COULD AFFECT OUR ABILITY TO COMPETE EFFECTIVELY AND COULD ADVERSELY
  AFFECT OUR OPERATING RESULTS.

     We depend on highly skilled technical personnel to research and develop and
to market and service our products. To succeed, we must hire and retain
employees who are highly skilled in rapidly changing communications
technologies. In particular, as we implement our strategy of focusing on IP
telephony, we will need to:

     - hire more employees with experience developing and providing advanced
       communications products and services;

     - retrain our current personnel to sell IP telephony products and services;
       and

     - retain personnel to service our products.
                                        14
<PAGE>

     Individuals who can perform the services we need to provide our products
and services are scarce. Because the competition for qualified employees in our
industry is intense, hiring and retaining qualified employees is both time-
consuming and expensive. We may not be able to hire enough qualified personnel
to meet our needs as our business grows or to retain the employees we currently
have. Our inability to hire and retain the individuals we need could hinder our
ability to sell our existing products, systems, software or services or to
develop and sell new ones. If we are not able to attract and retain qualified
employees, we will not be able to successfully implement our business plan and
our business will be harmed.

  IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, OUR BUSINESS MAY
  BE HARMED.

     Although we attempt to protect our intellectual property through patents,
trademarks, trade secrets, copyrights, confidentiality and non-disclosure
agreements and other measures, intellectual property is difficult to protect and
these measures may not provide adequate protection. Patent filings by third
parties, whether made before or after the date of our patent filings, could
render our intellectual property less valuable. Competitors may misappropriate
our intellectual property, disputes as to ownership of intellectual property may
arise and our intellectual property may otherwise become known or independently
developed by competitors. The failure to protect our intellectual property could
seriously harm our business because we believe that developing new products and
technology that are unique to us is important to our success. If we do not
obtain sufficient international protection for our intellectual property, our
competitiveness in international markets could be significantly impaired, which
would limit our growth and future revenue.

  WE MAY BE FOUND TO INFRINGE ON THIRD-PARTY INTELLECTUAL PROPERTY RIGHTS.

     Third parties have in the past and may in the future assert claims or
initiate litigation related to their patent, copyright, trademark and other
intellectual property rights in technology that is important to us. The asserted
claims and/or litigation could include claims against us or our suppliers
alleging infringement of intellectual property rights with respect to our
products or components of those products. Regardless of the merit of the claims,
they could be time consuming, result in costly litigation and diversion of
technical and management personnel, or require us to develop a non-infringing
technology or enter into license agreements. There can be no assurance that
licenses will be available on acceptable terms, if at all. Furthermore, because
of the potential for high court awards, which are not necessarily predictable,
it is not unusual to find even arguably unmeritorious claims resulting in large
settlements. If any infringement or other intellectual property claim made
against us by any third party is successful, or if we fail to develop
non-infringing technology or license the proprietary rights on commercially
reasonable terms and conditions, our business, operating results and financial
condition could be materially adversely affected.

  COSTS OF COMPLIANCE WITH THE SARBANES-OXLEY ACT OF 2002 AND THE RELATED SEC
  REGULATIONS MAY HARM OUR RESULTS OF OPERATIONS.

     The Sarbanes-Oxley Act of 2002 requires heightened financial disclosure and
corporate governance for all publicly traded companies. Although costs of
compliance with the Sarbanes-Oxley Act are uncertain due to several factors, we
expect that our general and administrative expenses will increase. Furthermore,
the American Stock Exchange has adopted amendments to its listing standards that
will impose additional corporate governance requirements. In the past, we met
the requirements of the "Controlled Company" exemption under Section 801 (a) of
the American Stock Exchange Company Guide (the "Guide"). However, as of May
2004, when we completed a public equity offering, we were no longer able to use
this exception and must comply with certain additional requirements under the
Guide, including the guidance requiring director independence. Failure to comply
with the Sarbanes-Oxley Act, Securities and Exchange Commission ("SEC")
regulations or American Stock Exchange listing requirements may result in
penalties, fines or delisting of our securities from the American Stock
Exchange, which could limit our ability to access the capital markets, having a
negative impact on our financial condition and results of operations.

ITEM 2.  PROPERTIES

     We do not own any real property and currently lease all of our existing
facilities. We lease the Houston office for our Corporate, INX, Stratasoft and
Valerent segments, and it is housed in a freestanding building of
                                        15
<PAGE>

approximately 48,000 square feet. On November 30, 1999, the building was
acquired by a corporation owned by our Chairman and Chief Executive Officer. A
new lease at reduced rental rates was signed on February 1, 2002, which expires
on January 31, 2007. Our Dallas office relocated during 2004. The Dallas
facility was originally a space of approximately 8,960 square feet before
occupying a newly leased facility with 23,332 square feet. The initial Dallas
facility lease term began July 2000 and expired in July 2003, but upon
expiration the lease was continued on a month to month basis until June of 2004.
During June 2004 the Dallas facility relocated to the newly leased facility
subject to a lease that expires in May 2010. The Dallas facility is leased for
our INX and Valerent segments. Our Austin office is leased for our INX segment,
and it is a space of approximately 2,845 square feet. The Austin facility lease
was acquired in conjunction with our acquisition of Digital Precision in April
2003 and expires October 31, 2006. The San Antonio office is leased for out INX
segment, and it is a space of approximately 2,040 square feet which began in
July 2004 and expires in July 2007. The Washington D. C. office is leased for
our INX segment, and it is a space of approximately 1,004 square feet which
began in February 2005 and expires in February 2006.

ITEM 3.  LEGAL PROCEEDINGS

     We are party to litigation and claims that management believes are normal
in the course of our operations; while the results of such litigation and claims
cannot be predicted with certainty, we believe the final outcome of such matters
will not have a material adverse effect on our results of operations or
financial position.

     In August 2002, Inacom Corp. 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 we owed the sum of approximately $570,000
to Inacom ("Inacom") as a result of Inacom's termination of a Vendor Purchase
Agreement between Inacom and us. We believe that the lawsuit is without merit,
and we intend to vigorously contest it.

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

     On December 30, 2004, we held our annual meeting of stockholders. The
aggregate number of shares of common stock of the Company entitled to vote at
the meeting was 5,177,154. Present at the meeting, in person and by proxy, were
the holders of 5,038,567 shares of common stock representing 97.32% of the total
number of shares entitled to vote and constituting a quorum. The holders of our
common stock elected James H. Long, Donald R. Chadwick, Cary M. Grossman and
John B. Cartwright as directors and approved an amendment to the company's
incentive stock plan to increase the number of shares of common stock reserved
for issuance under the plan from 600,000 shares to 900,000 shares as follows.

ELECTION OF DIRECTORS:

<Table>
<Caption>
                                                              NUMBER OF VOTES   NUMBER OF VOTES
NAME OF NOMINEE                                                  VOTED FOR         WITHHELD
---------------                                               ---------------   ---------------
<S>                                                           <C>               <C>
James H. Long...............................................     4,773,751          264,816
Donald R. Chadwick..........................................     4,817,151          221,416
Cary M. Grossman............................................     4,891,367          147,200
John B. Cartwright..........................................     4,778,751          259,816
</Table>

AMENDMENT TO THE INCENTIVE STOCK PLAN:

<Table>
<Caption>
                                    NUMBER OF VOTES   NUMBER OF VOTES   NUMBER OF VOTES    BROKER
                                       VOTED FOR       VOTED AGAINST       WITHHELD       NON-VOTE
                                    ---------------   ---------------   ---------------   ---------
<S>                                 <C>               <C>               <C>               <C>
Amend the Incentive Stock Plan....     2,539,959          312,282             675         2,185,651
</Table>

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     On December 29, 2003, our common stock began trading on the American Stock
Exchange under the ticker symbol "ISR". Prior to December 29, 2003 and since the
change of the corporate name on July 11, 2000, our common stock was traded on
the NASDAQ Small Cap Market under the symbol "ISEC". Prior to July 11, 2000, our
shares traded under the symbol "ALLS". As of June 8, 2004, our warrants began
trading on the American

                                        16
<PAGE>

Stock Exchange under the symbol "ISR.WS". Our units traded under the symbol
"ISR.U" for a limited period beginning on May 7, 2004 and ending on June 7,
2004.

COMMON STOCK

     The following table set forth the price range of our common stock.

<Table>
<Caption>
                                                               HIGH     LOW
                                                              ------   -----
<S>                                                           <C>      <C>
2003
  First Quarter.............................................  $ 2.06   $1.64
  Second Quarter............................................  $ 2.40   $1.75
  Third Quarter.............................................  $ 4.40   $2.60
  Fourth Quarter............................................  $15.97   $4.14
2004
  First Quarter.............................................  $15.87   $6.25
  Second Quarter............................................  $ 9.90   $7.61
  Third Quarter.............................................  $ 8.36   $6.43
  Fourth Quarter............................................  $10.12   $6.75
</Table>

WARRANTS

     The following table set forth the high and low sales prices of our warrants
as quoted by the American Stock Exchange commencing on June 8, 2004, the first
day of trading.

<Table>
<Caption>
                                                              HIGH     LOW
                                                              -----   -----
<S>                                                           <C>     <C>
2004
  Second Quarter............................................  $1.85   $1.20
  Third Quarter.............................................  $1.60   $1.00
  Fourth Quarter............................................  $2.35   $1.16
</Table>

UNITS

     The following table set forth the high and low sales prices of our units as
quoted by the American Stock Exchange during their limited 32 day trading period
beginning on May 7, 2004, and ending on June 7, 2004.

<Table>
<Caption>
                                                               HIGH     LOW
                                                              ------   ------
<S>                                                           <C>      <C>
2004
  Second Quarter............................................  $19.95   $16.15
</Table>

     As of March 18, 2005, we had 43 stockholders of record of our common stock.
On March 25, 2005, the closing sales price of our common stock and warrants as
reported by the American Stock Exchange was $5.60 per share and $0.80 per
warrant.

DIVIDEND POLICY

     We have never declared or paid any cash dividends on our common stock and
do not anticipate declaring or paying dividends on our common stock in the
foreseeable future. Any future determination as to the payment of dividends will
be made at the discretion of the Board and will depend on our operating results,
financial condition, capital requirements, general business conditions and such
other factors as the Board deems relevant.

                                        17
<PAGE>

ITEM 6.  SELECTED FINANCIAL DATA

     The following sets forth the selected data of the company for the five
years ended December 31, 2004.

<Table>
<Caption>
                                                                          YEAR ENDED DECEMBER 31
                                                              -----------------------------------------------
                                                               2000      2001      2002      2003      2004
                                                              -------   -------   -------   -------   -------
                                                               (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                           <C>       <C>       <C>       <C>       <C>
OPERATING DATA:
Revenue:
  Products..................................................  $ 1,670   $ 9,925   $29,805   $46,900   $72,680
  Services..................................................    8,757     6,477     5,647     7,725    11,393
  Custom projects...........................................    6,660     7,218     6,569     7,527     8,996
                                                              -------   -------   -------   -------   -------
    Total revenue...........................................   17,087    23,620    42,021    62,152    93,069
Cost of sales and services:
  Products..................................................    2,104     8,685    26,437    41,060    61,694
  Services..................................................    7,291     5,322     4,395     5,383     7,273
  Custom projects...........................................    3,573     3,318     2,920     2,982     4,150
                                                              -------   -------   -------   -------   -------
    Total cost of sales and services........................   12,968    17,325    33,752    49,425    73,117
Gross profit:
  Products..................................................     (434)    1,240     3,368     5,840    10,986
  Services..................................................    1,466     1,155     1,252     2,342     4,120
  Custom projects...........................................    3,087     3,900     3,649     4,545     4,846
                                                              -------   -------   -------   -------   -------
    Total gross profit......................................    4,119     6,295     8,269    12,727    19,952
Selling, general and administrative expenses................    9,479    10,573    10,625    15,061    18,254
                                                              -------   -------   -------   -------   -------
    Operating income (loss).................................   (5,360)   (4,278)   (2,356)   (2,334)    1,698
Interest and other income (expense), net....................      239       316       115       107      (108)
                                                              -------   -------   -------   -------   -------
Income (loss) from continuing operations before income tax
  benefit...................................................   (5,121)   (3,962)   (2,241)   (2,227)    1,590
Tax benefit.................................................    1,493        87     1,595       181        19
                                                              -------   -------   -------   -------   -------
Net income (loss) from continuing operations before minority
  interests.................................................   (3,628)   (3,875)     (646)   (2,046)    1,609
  Minority interests........................................       --        --        --        --      (117)
                                                              -------   -------   -------   -------   -------
Net income (loss) from continuing operations................   (3,628)   (3,875)     (646)   (2,046)    1,492
Gain on disposal of discontinued operations, net of taxes...    3,585       170       262       210        38
                                                              -------   -------   -------   -------   -------
Net income (loss)...........................................  $   (43)  $(3,705)  $  (384)  $(1,836)  $ 1,530
                                                              =======   =======   =======   =======   =======
Net income (loss) per share:
  Basic:
    Net income (loss) from continuing operations before
      minority interests....................................  $ (0.90)  $ (0.99)  $ (0.17)  $ (0.55)  $  0.35
    Minority interests......................................       --        --        --        --     (0.03)
    Gain on disposal of discontinued operations, net of
      taxes.................................................     0.89      0.04      0.07      0.06      0.01
                                                              -------   -------   -------   -------   -------
    Net income (loss) per share.............................  $ (0.01)  $ (0.95)  $ (0.10)  $ (0.49)  $  0.33
                                                              =======   =======   =======   =======   =======
  Diluted:
    Net income (loss) from continuing operations before
      minority interests....................................  $ (0.90)  $ (0.99)  $ (0.17)  $ (0.56)  $  0.32
    Minority interests......................................       --        --        --        --     (0.02)
    Gain on disposal of discontinued operations, net of
      taxes.................................................     0.89      0.04      0.07      0.06      0.01
                                                              -------   -------   -------   -------   -------
Net income (loss) per share.................................  $ (0.01)  $ (0.95)  $ (0.10)  $ (0.50)  $  0.31
                                                              =======   =======   =======   =======   =======
BALANCE SHEET DATA:
Working capital.............................................  $10,098   $ 5,983   $ 5,540   $ 3,724   $13,143
Total assets................................................   17,142    13,548    15,751    19,207    41,139
Current portion of long-term debt(1)........................       --       213       157     1,784     8,220
Long-term debt..............................................       --       410       247       229       122
Stockholders' equity........................................  $11,912   $ 8,015   $ 7,640   $ 6,619   $15,849
</Table>

---------------


(1) Excludes non-interest bearing borrowings under Textron Floorplan Loan. (See
    Note 7 of consolidated financial statements).


                                        18
<PAGE>

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

     Please read the following discussion of our financial condition and results
of operations together with "Item 6. Selected Financial Data" and our
consolidated financial statements and the notes to those statements included
elsewhere in this report. The following discussion and analysis contains
forward-looking statements that involve risks and uncertainties. Our actual
results may differ materially from those anticipated in these forward-looking
statements as a result of certain factors, including, but not limited to, those
set forth under "Item 1. Business -- Risk Factors" and elsewhere in this report.

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 improving profitability. 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 margins on INX revenue. At the same time, we will seek to limit the growth
of relatively fixed components of our selling, general and administrative
expenses relative to the growth of revenue so that those expenses become a
relatively smaller percentage of total revenues. Through a combination of
increased revenue, slightly increased gross margin and somewhat decreased growth
of selling, general and administrative expenses, relative to the growth of
revenue, we hope to be able to increase our operating margin and increase
profitability at a more rapid rate than revenue increases. We expect that
selling expenses can generally be expected to increase in proportion to our
revenues increases. For example, our sales staff earns sales commissions that
are typically calculated as a percentage of gross profit produced. Historically,
sales commissions have been approximately 22% to 24% of gross profit and we
expect sales commissions to continue to consume similar percentages of total
gross profit. However, 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 because we believe we can achieve some levels
of leverage on certain of these operating expenses.

     Our key operating strategies include:

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

     - 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;

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

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

     - developing and marketing our own computer telephony software products
       that operate with and augment Cisco-centric IP telephony products; and

     - Developing and marketing our own proprietary equipment for certain IP
       communications solutions.

     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

                                        19
<PAGE>

a substantially higher level of our services and more products than do smaller
projects. Larger projects, however, can strain our financial resources.

     Increases in the size and volume of the IP telephony projects we undertake
can also challenge our cash management. For example, larger projects can reduce
our available cash by requiring that we carry higher levels of inventory. Larger
projects can also require other investments in working capital. This is because,
in some cases, we do not receive payments from our customers for extended
periods of time. Until we invoice the customer and are paid, all of the cash
expended on labor and products on the project remains invested in
work-in-progress and accounts receivable. We expect that we will need increasing
levels of working capital 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.
In May 2004, we raised capital through a public equity offering with net
proceeds of $7.5 million. We used the net proceeds of this equity offering
primarily for working capital and to repay interest-bearing debt then
outstanding under our credit facility.

     Although over 79% of our revenue in 2004 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 2004, for example, the gross profit margin on
sales of products by INX was 15.1%, while the gross profit margin on sales of
services by INX for that year was 33.4%. 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 purchase products
directly from Cisco on a timely basis. 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. There is a risk that we may not meet the
incentive criteria in the future. In addition, we are typically reliant on Cisco
and their product pricing. The respective timing of when vendor incentives
become earned and determinable creates significant fluctuations in our gross
margin.

     We also plan to grow our business in other geographic areas through
strategic acquisitions 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
consideration paid for an acquisition exceeds the estimated fair value of the
net identified tangible and intangible assets acquired, which we expect is
likely. To the extent an acquisition results in goodwill, we will reevaluate the
value of that goodwill at least annually and adjust the value as appropriate. If
we determine that the value of the goodwill has decreased, the resulting
adjustment could result in a non-cash charge to earnings in the periods of
revaluation.

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

                                        20
<PAGE>

ELIMINATING MINORITY INTEREST IN INX

     Between April 2004 and March 18, 2005, our INX subsidiary had a minority
interest. The minority interest was eliminated through an exchange of the
minority interest for an interest in I-Sector on March 18, 2005.

     Prior to April 2004, INX had 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, Inc., 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 remained employed through
April 4, 2004, the first anniversary of the acquisition. This condition was met
and the INX stock was issued in April 2004. At the time of issuance of that INX
common stock, we 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 we recognized $162,000 of minority interest on our
balance sheet upon issuance.

     Since we owned 92.4% of INX's stock for December 31, 2004, our interest in
INX's future profits and losses have been reduced for the minority share. Under
accounting principles generally accepted in the United States of America, our
consolidated financial statements for the period through the exchange will
reflect a minority interest adjustment of the reportable profits and losses of
INX attributable to the minority ownership. For 2004, we reported income
attributable to minority interest of $117,000 in our statement of operations and
a minority interest balance of $279,000 in our balance sheet.


     On February 1, 2005, we entered into an agreement with the INX minority
shareholder group to merge INX into I-Sector, contingent upon I-Sector
stockholder approval. Upon stockholder approval on March 18, 2005, INX became a
wholly-owned subsidiary of the company. The exchange of the minority interest
resulted in a remeasurement of the stock options that were part of the minority
interest and such remeasurement resulted in a $5.7 million one-time non-cash
charge to earnings, which was equal to the intrinsic value of the stock options
on March 18, 2005. This one-time non-cash charge to earnings, which does not
impact assets or liabilities, will reduce reported net income and earnings per
share in our first quarter ending March 31, 2005. The elimination of the
minority interest will simplify our capital structure and eliminate the minority
interest on our financial statements, but will increase the shares used to
compute diluted earnings per share due to the shares of our common stock issued
in the exchange and because of the increased number of stock options resulting
from exchanging INX stock options for our stock options. Based on the closing
stock price of $6.25 on March 18, 2005, we expect shares used in computing
diluted earnings per share to increase by approximately 1,161,592 shares as a
result of the exchange of the minority interest.


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
year ended December 31, 2004, INX, Stratasoft and Valerent accounted for 83.1%,
9.5% and 7.4%, respectively, of total consolidated revenue.

     INX revenue consists of product and service revenue. Product revenue
consists of reselling Cisco products and limited amounts of complementary
products from 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 generally increased 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. 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 the number, frequency and size of INX projects has grown, INX has
achieved better utilization of its engineering resources, resulting in improved
gross margins on services. The normal sales cycle for corporate customers
typically ranges from three to six months depending on the nature, scope and
size of the project. Our experience with educational organizations utilizing
E-Rate funding, which is a federal
                                        21
<PAGE>


government funding program for schools administered by the Schools and Libraries
Division Universal Services Administrative Corporation (the "SLD"), indicates
that the sales cycle is generally about six to twelve months or longer.



     Since the latter part of 2004, INX has experienced payment delays for
amounts due from educational organization projects that are being partially
funded by the SLD. The SLD has informed us that these payment delays are due to
administrative issues within the SLD. In November 2004, pending a satisfactory
resolution of the issues causing the payment delays, or payment of a substantial
portion of the past due amounts, we temporarily suspended product shipments for
certain SLD-funded projects in November 2004. Based on communications from the
SLD that payments were being processed, limited amounts of product shipments
were made in December 2004 for a significant project that was previously
suspended. After December 31, 2004, the SLD made significant payments on past
due accounts and we resumed product shipments for the previously suspended
SLD-funded projects. At December 31, 2004, our total net accounts receivable of
$28.2 million included approximately $17.1 million of net E-Rate funded accounts
receivable, approximately $14.0 million of which were amounts related to a
single SLD-funded project that had been temporarily suspended due to a past due
balance of $11.8 million, however, as of March 23, 2005 approximately $10.7
million of the past due balance had been collected. For the year ending December
31, 2004, INX has approximately $18.7 million of revenue derived from E-Rate
funded projects included in its $77.9 million of total annual revenue. While
collections have occurred for our more significantly aged invoices, we
anticipate that we will continue to experience payment delays for SLD-funded
educational projects due to increased administration standards imposed upon the
SLD and continued changes at the SLD and the E-Rate program.


     In mid-2003, INX introduced Netsurant, its branded support service that
consists primarily of customer service personnel and a support center. This new
support service offering requires that we incur the fixed cost to operate a
network operations center to monitor customer's systems. The fixed operating
cost has resulted in negative gross margins from this new Netsurant service
offering. We recognize the support service revenue evenly over the entire
service period for the customer. Eventually, we expect that the Netsurant
support offering will improve overall services gross margins. Through December
31, 2004, Netsurant service revenue was insignificant.


     Stratasoft revenue consists primarily of custom project revenue from the
sale of proprietary computer-telephony software. Stratasoft revenue is reported
as custom project revenue in our statements of operations because it consists of
bundled products and services which cannot be accounted for separately.
Stratasoft has traditionally produced our highest gross margin since it's
revenues consists primarily of 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
utilizes the percentage of completion method of accounting to recognize the
majority of its revenue. 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 service 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 service revenue consists of remote and onsite technical assistance to
its 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. While these agreements provide somewhat predictable and stable
sources of revenue, the loss of a recurring agreement could disrupt the
stability of Valerent's revenues.

     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

                                        22
<PAGE>


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 contracts, which typically have higher gross
margin. Our gross margin percentage on product sales and services revenue has
generally improved over the past several years.



     Gross margin percentage on product sales has improved primarily due to
increased repeat business with existing customers, which are typically smaller
transactions that generate slightly higher levels of gross margin as compared to
large, competitively bid projects. In addition, we have benefited from increased
levels of vendor incentives, which lower our cost of goods sold.



     Our annual and quarterly gross profits and gross margins on INX product
sales are materially affected by vendor incentives recognized in certain
accounting periods, most of which are Cisco incentive programs initiated in
2003. The incentive programs sponsored by Cisco currently enable us to qualify
for cash rebates or product pricing discounts. The most significant incentive is
a Cisco incentive that is generally earned based on sales volumes of particular
Cisco products; sales growth and customer satisfaction levels, and beginning in
our fourth quarter ended December 31, 2004, this incentive program could be
readily monitored by us via access to the vendor's website. The amounts earned
and costs incurred under these programs are recorded as a reduction of cost of
goods sold, and the increased gross profit results in an increase in selling,
general and administrative expenses related to sales commissions. In reporting
periods prior to our fourth quarter ended December 31, 2004, we recognized the
Cisco incentives on the earlier of when payment was received or declared by the
vendor, as such amounts were not determinable by us prior to then. Prior to
2004, there had only been one incentive program measurement period, and we had
not met all of the qualification criteria for such incentive period. Cisco pays
incentives earned under this program semi-annually for the six-month measurement
periods that end one month following the end of our second and fourth quarters.
This caused significant fluctuations in gross profit and operating profits from
quarter to quarter because these incentives were recognized semi-annually in our
first and third quarters. Beginning in the fourth quarter of 2004, the
information became readily available from the vendor so that the amount of
incentive earned from the vendor was determinable. Furthermore, we determined
that collection of the incentive was probable and therefore recognizable. For
2004, the INX products cost of goods was $60.8 million (84.9% of INX product
revenue), which is net of $3.4 million of vendor incentives recognized. For
2003, the INX product cost of goods was $40.1 million (87.6% of INX product
revenue), which is net of $313,000 in vendor incentives recognized. Our product
cost and resulting gross profit can vary significantly depending upon vendor
pricing incentives and our ability to qualify for and recognize such incentives.


     Our gross margin percentage on service revenue has also generally improved
over the past several years. A significant portion of our cost of services for
each of our service businesses is comprised of labor. Our gross margin on
service 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 important 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. Several years ago, early in INX's development,
we purposely over staffed technical and engineering staff in order to have the
technical competency necessary to gain market share and create a successful
organization. Over the past several years, as INX has grown, we have been able
to better utilize our technical and engineering staff and this has helped to
improve the gross margin percentage on service revenue.


     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.

                                        23
<PAGE>

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 transaction and the mix of associated products and services with our overall
gross profit. Historically, sales commission expense has been approximately 22%
to 24% of gross profit, and we expect that it will continue to be approximately
that level in the future. 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, but will generally increase over time as the
organization grows. We believe that we can achieve some level of leverage on
these somewhat fixed operating expenses, relative to revenue growth, and if we
are successful in doing so that this will help to increase our net operating
margin.


     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 common 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.

     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 December 31, 2004, was approximately $2.0 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. 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.

                                        24
<PAGE>

     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.

<Table>
                                                                   YEAR ENDED DECEMBER 31,
                                                     ---------------------------------------------------
                                                          2002              2003              2004
                                                     ---------------   ---------------   ---------------
                                                     AMOUNT      %     AMOUNT      %     AMOUNT      %
                                                     -------   -----   -------   -----   -------   -----
                                                                   (DOLLARS IN THOUSANDS)
<S>                                                  <C>       <C>     <C>       <C>     <C>       <C>
Revenue:
  INX product......................................  $28,990    69.0   $45,749    73.6   $71,646    77.0
  INX service......................................    1,748     4.1     4,226     6.8     6,280     6.7
                                                     -------   -----   -------   -----   -------   -----
       Total INX revenue...........................   30,738    73.1    49,975    80.4    77,926    83.7
                                                     -------   -----   -------   -----   -------   -----
  Stratasoft -- custom projects....................    6,569    15.6     7,527    12.1     8,996     9.7
  Valerent product.................................    1,092     2.6     1,573     2.5     1,829     2.0
  Valerent service.................................    3,900     9.3     3,503     5.6     5,113     5.5
                                                     -------   -----   -------   -----   -------   -----
       Total Valerent revenue......................    4,992    11.9     5,076     8.2     6,942     7.5
     Eliminations revenue..........................     (278)   (0.6)     (426)   (0.7)     (795)   (0.9)
                                                     -------   -----   -------   -----   -------   -----
          Total revenue............................   42,021   100.0    62,152   100.0    93,069   100.0
Cost of sales and service:
  INX product......................................   25,659    88.5    40,060    87.6    60,802    84.9
  INX service......................................    1,658    94.9     2,976    70.4     4,183    66.6
                                                     -------   -----   -------   -----   -------   -----
       Total INX cost of sales and service.........   27,317    88.9    43,036    86.1    64,985    83.4
  Stratasoft -- custom projects....................    2,920    44.5     2,982    39.6     4,150    46.1
  Valerent product.................................    1,055    96.6     1,421    90.3     1,687    92.2
  Valerent service.................................    2,738    70.2     2,412    68.9     3,090    60.8
                                                     -------   -----   -------   -----   -------   -----
       Total Valerent cost of sales and service....    3,793    76.0     3,833    75.5     4,777    69.1
     Eliminations of cost of sales and service.....     (278)  100.0      (426)  100.0      (795)  100.0
                                                     -------   -----   -------   -----   -------   -----
          Total cost of sales and service..........   33,752    80.3    49,425    79.5    73,117    78.6
Gross profit:
     INX product...................................    3,331    11.5     5,689    12.4    10,844    15.1
     INX service...................................       90     5.1     1,250    29.6     2,097    33.4
                                                     -------   -----   -------   -----   -------   -----
       Total INX gross profit......................    3,421    11.1     6,939    13.9    12,941    16.6
  Stratasoft -- custom projects....................    3,649    55.5     4,545    60.4     4,846    53.9
  Valerent product.................................       37     3.4       152     9.7       142     7.8
  Valerent service.................................    1,162    29.8     1,091    31.1     2,023    39.2
                                                     -------   -----   -------   -----   -------   -----
       Total Valerent gross profit.................    1,199    24.0     1,243    24.5     2,165    30.9
     Eliminations gross profit.....................       --     0.0        --     0.0        --     0.0
                                                     -------   -----   -------   -----   -------   -----
          Total gross profit.......................    8,269    19.7    12,727    20.5    19,922    21.4
Selling, general and administrative expenses:
  INX..............................................    3,545    11.5     6,045    12.1    10,295    13.2
  Stratasoft. .....................................    3,922    59.7     5,888    78.2     5,100    56.7
  Valerent.........................................    2,236    44.8     1,963    38.7     1,886    27.3
  Corporate........................................      922     (NA)    1,165     (NA)      973     (NA)
  Eliminations.....................................       --     0.0        --     0.0        --     0.0
                                                     -------   -----   -------   -----   -------   -----
Total selling, general and administrative
  expenses.........................................   10,625    25.3    15,061    24.2    18,254    19.6
</Table>

                                                   (continued on following page)
                                        25
<PAGE>

<Table>
<Caption>
                                                                   YEAR ENDED DECEMBER 31,
                                                     ---------------------------------------------------
                                                          2002              2003              2004
                                                     ---------------   ---------------   ---------------
                                                     AMOUNT      %     AMOUNT      %     AMOUNT      %
                                                     -------   -----   -------   -----   -------   -----
                                                                   (DOLLARS IN THOUSANDS)
<S>                                                  <C>       <C>     <C>       <C>     <C>       <C>
Operating income (loss):
  INX..............................................     (124)   (0.4)      894     1.8     2,646     3.4
  Stratasoft. .....................................     (273)   (4.2)   (1,343)  (17.8)     (254)   (2.8)
  Valerent.........................................   (1,037)  (20.8)     (720)  (14.2)      279     3.6
  Corporate........................................     (922)    (NA)   (1,165)    (NA)     (973)    (NA)
  Eliminations.....................................       --     (NA)       --     0.0        --     0.0
                                                     -------   -----   -------   -----   -------   -----
       Total operating income (loss)...............   (2,356)   (5.6)   (2,334)   (3.8)    1,698     1.8
Interest and other income (expense), net...........      115     0.3       107     0.2      (108)   (0.1)
                                                     -------   -----   -------   -----   -------   -----
Income (loss) from continuing operations before
  benefit for income taxes.........................   (2,241)   (5.3)   (2,227)   (3.6)    1,590     1.7
Benefit for income taxes...........................    1,595     3.8       181     0.3        19     0.0
                                                     -------   -----   -------   -----   -------   -----
Net income (loss) from continuing operations before
  minority interests...............................     (646)   (1.5)   (2,046)   (3.3)    1,609     1.7
  Minority interests...............................       --     (NA)       --     (NA)     (117)   (0.1)
Net income (loss) from continuing operations.......     (646)   (1.5)   (2,046)   (3.3)    1,492     1.6
Gain (loss) on disposal, net of taxes..............      262     0.6       210     0.3        38     0.0
                                                     -------   -----   -------   -----   -------   -----
Net income (loss)..................................  $  (384)   (0.9)  $(1,836)   (3.0)  $ 1,530     1.6
                                                     =======   =====   =======   =====   =======   =====
</Table>

  YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2004

     Total Revenue.  Our total revenue, net of intercompany eliminations,
increased by $30.9 million, or 49.7%, from $62.2 million to $93.1 million.

     INX revenue increased by $27.9 million, or 55.8%, from $50.0 million to
$77.9 million. As a percentage of total revenue, INX revenue increased from
80.4% to 83.7%. Of the increase, $11.2 million was attributed to our office in
Austin, $4.6 million was attributed to government sector sales and $14.8 million
was attributed to the large project for the Dallas Independent School District.
These increases were partially offset by revenue decreases of $1.2 million in
our Houston operation and $1.5 million in our Dallas operation (excluding the
DISD project). INX's revenue grew rapidly primarily due to large sales to school
districts totaling $22.2 million. The sales to the school districts are one-time
competitive bid events fostered by the E-Rate programs that provide schools with
90% of their funding for internet related expenditures, and there can be no
assurance as to the level of revenue provided, if any, in future periods from
school districts.

     Stratasoft revenue increased by $1.5 million, or 20.0%, from $7.5 million
to $9.0 million. As a percentage of total revenue, Stratasoft revenue decreased
from 12.1% to 9.7%. Stratasoft's international sales accounted for 23.7% of
Stratasoft's revenue as compared to 42.2% in 2003. The increase in revenue is
primarily attributed to the implementation of larger VoIP projects during 2004.
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 $548,000 or 6.1% of its revenue from sales
to resellers in 2004 which compares with $929,000 or 12.3% of 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 $1.8 million, or 35.3%, from $5.1 million to
$6.9 million. As a percentage of total revenue, Valerent revenue decreased from
8.2% to 7.5%. The increase in Valerent revenue was primarily attributable to
increased product and service revenue of $256,000 and $1.6 million,
respectively.

     Gross Profit.  Our total gross profit increased by $7.2 million, or 56.7%,
from $12.7 million to $19.9 million. Gross margin increased from 20.5% to 21.4%,
primarily because of the increase in gross margin in our INX and Stratasoft
subsidiaries as discussed below.

                                        26
<PAGE>


     INX gross profit increased $6.0 million, or 87.0%, from $6.9 million to
$12.9 million. INX's gross margin increased from 13.9% to 16.6%. INX's gross
profit on its product sales increased $5.1 million, or 89.5%, from $5.7 million
to $10.8 million due to increased product sales revenue and lower product cost,
reflecting increased vendor rebates. INX's gross profit on its service component
increased $847,000, from $1.3 million to $2.1 million, and service gross margin
improved from 29.6% to 33.4%, as a result of significantly increased service
revenue of $2.1 million and improved utilization of technical personnel.


     Stratasoft gross profit increased by $301,000, or 6.7%, from $4.5 million
to $4.8 million. Stratasoft's gross margin decreased from 60.4% to 53.9%.
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 an increased "product" component of total Stratasoft
sales. Software only sales primarily relate to reseller customers and do not
require the continuing involvement of our personnel.

     Valerent gross profit increased by $922,000, or 74.2%. Valerent's gross
margin increased from 24.5% to 30.9%. Valerent improved its utilization of its
labor pool by reducing the number of technicians employed and lowering its fixed
cost, which contributed to improved gross profits.


     Selling, General and Administrative Expenses.  Selling, general and
administrative expenses increased by $3.2 million, or 21.2%, from $15.1 million
to $18.3 million. As a percentage of total revenue, these expenses decreased
4.6%, from 24.2% to 19.6%. These expenses were primarily increased by the
following:



     - Sales compensation increased $2.0 million as the result of hiring
       additional sales staff and increased sales commissions generated from the
       increase in gross profit.



     - Administrative compensation expense increased $900,000 due to bonuses of
       $321,000, settlement of an EEOC claim for $25,000, the hiring of
       additional personnel at INX in Houston and Dallas, Texas; and for the
       addition of the San Antonio, Texas office. Stratasoft hired personnel in
       Houston, Texas and Canada.


     - Payroll tax expense increased $174,000 with the increase in compensation
       expenses.

     - General office expense increased $157,000 primarily from office and
       employee relocation expenses and increased printing costs.

     - Depreciation expense increased $158,000 due to asset additions and the
       Digital Precision acquisition in April 2003.

     - Rents increased $145,000 due to additional office space in Dallas and San
       Antonio, Texas.


     - Shareholder relations expense increased $44,000, due to employing a
       shareholder relations firm, attending investor conferences and visiting
       investor groups, however, this expense was partially offset by a $199,000
       reduction related to the revaluation of the non-employee stock option
       compensation for the investor relation consultant.


     - Entertainment expense increased $70,000 due to a customer seminar
       sponsored by Stratasoft and employee's meals incurred while traveling.

     - Communication expense increased $64,000 due to growth.

     - Utilities expense increased $54,000 due to growth.

These expenses were primarily decreased by the following:

     - Bad debt expense decreased $560,000 due to recoveries of bad debt and
       decreases in allowances based on the aging of receivables and credit
       worthiness of customers.

     - Advertising and promotion decreased $73,000 with downsizing of
       promotional campaigns within Stratasoft.

     - Insurance expense decreased $66,000 because of policy and rate changes

     - Contract labor expense decreased $66,000 primarily from Stratasoft
       terminating contract labor in India offset by $55,000 for technicians and
       programmers.

                                        27
<PAGE>


     We expect our future selling, general and administrative expenses to
increase as we ensure our compliance with the provisions of the Sarbanes-Oxley
Act as well as our expected growth within our INX subsidiary.



     Operating Income.  Operating income increased $4.0 million, or 172.8%, from
a $2.3 million loss to a profit of $1.7 million, primarily due to the $7.2
million increase in gross profit, partially offset by the $3.2 million increase
in selling, general and administrative expenses. INX's operating profit
increased $1.7 million, or 190.2%, from a profit of $894,000 to a profit of $2.6
million. Stratasoft's operating loss decreased $1.0 million, or 76.9%, from a
loss of $1.3 million to a loss of $254,000. Valerent's operating income
increased $999,000, or 138.9%, from a loss of $720,000 to a profit of $279,000.
The operating loss for the Corporate Segment decreased $192,000, or 16.5%, from
a loss of $1.2 million to an operating loss of $973,000.



     Interest and Other Income (Expense), Net.  Interest and other income, net,
decreased by $215,000 or 200.9%, from income of $107,000 to expense of $108,000,
primarily due to an increase in interest expense of $134,000 or 188.7%, from
$71,000 to $205,000 which is attributable to interest expense due to increased
borrowings under our credit facility. Our borrowings under our credit facility
increased from $7.6 million to $16.0 million while the interest bearing portion
of our borrowings increased from $1.7 million at December 31, 2003 to $8.1
million at December 31, 2004. Foreign exchange gain increased $48,000 from a
loss of $13,000 to a gain of $35,000. Other income decreased $129,000, or
111.2%, from a $116,000 to $13,000 expense.



     Net Income.  The net income increased $3.3 million, or 183.3%, from a loss
of $1.8 million to a net profit of $1.5 million. The benefit for income taxes
decreased $162,000, or 89.5%, from $181,000 to $19,000. Because the Job Creation
and Worker Assistance Act of 2002 provided for the carryback of net operating
losses for any taxable year ending during 2001 or 2002 to each of the 5 tax
years preceding the loss year, we were able to use our net operating loss
carryback. The benefit in 2003 includes amounts related to additional carryback
benefits for 2002 not previously recorded. Minority interest of $117,000 was
recorded for 2004 as a reduction of our net income due to the 1,800,000 shares
of INX common stock issued to certain key employees as part of the Digital
Precision acquisition agreement. Upon issuance of stock our ownership of INX was
reduced from 100% to approximately 92.4%.



     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 year ended December
31, 2003, the gain on disposal related to these three businesses was $80,000,
$104,000 and $26,000, net of taxes of $41,000, $54,000 and $14,000, for a total
gain of $210,000. For the year ended December 31, 2004, the gain on disposal
related to these three businesses was $0, $58,000 and $(1,000), net of taxes of
$0, $19,000 and $0, for a total gain of $38,000. The gains and/or losses on
disposal related to these discontinued operations are primarily related to
collections of accounts receivables retained when these businesses were sold.


  YEAR ENDED DECEMBER 31, 2002 COMPARED TO THE YEAR ENDED DECEMBER 31, 2003

     Total Revenue.  Our total revenue, net of intercompany eliminations,
increased by $20.1 million, or 47.9%, from $42.0 million to $62.2 million.


     INX revenue increased by $19.3 million, or 62.6%, from $30.7 million to
$50.0 million. As a percentage of total revenue, INX revenue increased from
73.1% to 80.4%. Of the increase, $10.8 million was attributed to the Houston
office, $4.6 million was attributed to a new office in Austin, $1.1 million was
attributed to government sector sales and $2.8 million was attributed to the
Dallas office. The increase in revenue attributable to the Digital Precision
acquisition, including the $4.6 million of revenue of the acquired Austin
office, was $8.5 million. INX's revenue grew rapidly primarily due to large
sales to four school districts totaling $14.3 million and due to synergy of $8.5
million resulting from its acquisition of Digital Precision. The sales to the
school districts are one-time competitive bid events fostered by the E-Rate
programs that provide schools with 90% of their funding for internet related
expenditures, and there can be no assurance as to the level of revenue provided,
if any, in future periods from school districts.


     Stratasoft revenue increased by $958,000, or 14.6%, from $6.6 million to
$7.5 million. As a percentage of total revenue, Stratasoft revenue decreased
from 15.6% to 12.1%. Stratasoft's increased revenue was primarily the result

                                        28
<PAGE>


of two large international custom projects in 2003, as compared to no
individually large custom projects initiated during 2002. This was slightly
offset by deferred revenue for certain custom projects that included fees that
were determined to not be fixed and determinable in 2003. Stratasoft's
international sales accounted for 42.2% of Stratasoft's revenue as compared to
28.2% in 2002. Stratasoft has it 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 $929,000, or 12.3% of its
revenue from sales to resellers in 2003, which compares with $614,000, or 9.3%,
of revenue in 2002. 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 $84,000, or 1.7%, from $5.0 million to $5.1
million. As a percentage of total revenue, Valerent revenue decreased from 11.9%
to 8.2%. The increase in Valerent revenue was primarily attributable to
decreased service revenue of $397,000 offset by increased product sales of
$481,000. The decrease in service revenue is primarily attributable to the loss
of revenue from certain customers of $355,000, 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, and we
expect that the redirection will provide generally improved margins in the
future.


     Gross Profit.  Our total gross profit increased by $4.4 million, or 53.9%,
from $8.3 million to $12.7 million. Gross margin increased from 19.7% to 20.5%,
primarily because of the increase in gross margin in our INX and Stratasoft
subsidiaries as discussed below.


     INX gross profit increased $3.5 million, or 102.8%, from $3.4 million to
$6.9 million. INX's gross margin increased from 11.1% to 13.9%. INX's gross
profit on its product sales component increased $2.4 million, or 70.8%, from
$3.3 million to $5.7 million due to increased product sales revenue and a vendor
rebate of $313,000. INX's gross profit on its service component increased $1.2
million, from $90,000 to $1.3 million, and service gross margin improved from
5.1% to 29.6%, as a result of significantly increased service revenue of $2.5
million with a somewhat fixed cost of service component due to improved
utilization of technical personnel.


     Stratasoft gross profit increased by $896,000, or 24.6%, from $3.6 million
to $4.5 million. Stratasoft's gross margin increased from 55.5% to 60.4%.
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 increased gross
profit is primarily due to an increased "software only" component relative to
the "systems sales" component of total Stratasoft sales. Software only sales
primarily relate to reseller customers and do not require the continuing
involvement of our personnel.

     Valerent gross profit increased by $44,000, or 3.7%. Valerent's gross
margin increased from 24.0% to 24.5%. 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 and lowering its fixed cost, which contributed to
improved gross profits.


     Selling, General and Administrative Expenses.  Selling, general and
administrative expenses increased by $4.5 million, or 41.8% from $10.6 million
to $15.1 million. As a percentage of total revenue, these expenses decreased
1.1%, from 25.3% to 24.2%. Sales compensation increased $919,000 due to
corresponding increase in sales. Legal and professional fees increased $629,000
due to an EEOC claim, collection efforts, and commercial disputes in the
ordinary course of business. Administrative compensation expense increased
$580,000 due to hiring additional INX and Stratasoft personnel in Houston,
Dallas, Canada and India. Payroll tax expense increased $109,000 correspondingly
with compensation expenses. Contract labor expense increased $147,000 to
supplement technical service labor need to fulfill contractual obligations.
Travel expense increased $312,000 primarily due to Stratasoft international
travel and INX travel for technical staff and management. General office
expenses increased $354,000 due to printing and general growth. Insurance
expense increased $64,000 because of rate increases and volume increases.
Shareholder relations expense increased $209,000, due to employing a shareholder
relations firm, attending investor conferences and visiting investor groups.
Depreciation expense increased $163,000 due to asset additions and the Digital
Precision acquisition in April 2003. Rents increased $172,000 due to additional
office space in Austin and Dallas. Other corporate expenses increased $198,000
due to our overall growth.


                                        29
<PAGE>

     Operating Loss.  Operating loss decreased $22,000, or 0.9% from $2.4
million to $2.3 million, primarily due to the $4.5 million increase in gross
profit being offset by the $4.4 million increase in selling, general and
administrative expenses. INX's operating profit increased $1.0 million, or
821.0% from a loss of $124,000 to a profit of $894,000. Stratasoft's operating
loss increased $1.1 million, or 391.9% from a loss of $273,000 to a loss of $1.3
million. Valerent's operating loss decreased $317,000, or 30.6% from $1.0
million to $720,000. The operating loss for the Corporate Segment increased
$243,000, or 26.4% from a loss of $922,000 to an operating loss of $1.2 million.

     Interest and Other Income, Net.  Interest and other income, net, decreased
by $8,000 or 7.0%, from $115,000 to $107,000, primarily due to a decrease in
interest income of $102,000 or 57.6% from $177,000 to $75,000 which is
attributable to interest on the settlement of a past due customer account in
2002. The decrease in interest income was also affected by an increase in
interest expense of $41,000, or 136.6%, from $30,000 to $71,000 due to increased
borrowings used to finance inventory purchases to supply the increased business
activity. Our borrowings under the Textron credit facility increased from $3.2
million to $7.6 million while the interest bearing portion of our borrowings
increased from $0 at December 31, 2002 to $1.7 million at December 31, 2003.
Foreign exchange loss increased $13,000 from $0 to a loss of $13,000. Other
income increased $148,000 or 461.0% from a loss of $32,000 to $116,000.

     Net Loss.  The net loss increased $1.5 million, or 378.1% from $384,000 to
$1.8 million. The benefit for income taxes decreased $1.4 million or 88.7% from
$1.6 million to $181,000. Because the Job Creation and Worker Assistance Act of
2002 provided for the carryback of net operating losses for any taxable year
ending during 2001 or 2002 to each of the 5 tax years preceding the loss year,
we were able to use our net operating loss carryback. The benefit in 2003
includes amounts related to additional carryback benefits for 2002 not
previously recorded.

     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 year ended December
31, 2002, the gain on disposal related to these three businesses was $171,000,
$104,000 and $(13,000), net of taxes of $88,000, $53,000 and $(7,000), for a net
total of $262,000. For the year ended December 31, 2003 the gain on disposal
related to these three businesses was $80,000, $104,000 and $26,000, net of
taxes of $41,000, $53,000 and $14,000, for a total gain of $210,000. The gains
and/or losses on disposal related to these discontinued operations are primarily
related to collections of accounts receivables retained when these businesses
were sold.

                                        30
<PAGE>

QUARTERLY RESULTS

     The following table sets forth certain unaudited quarterly financial
information for each of our last eight quarters and, in the opinion of
management, includes all adjustments (consisting of only normal recurring
adjustments) that we consider necessary for a fair presentation of the
information set forth therein. Our quarterly results may vary significantly
depending on factors such as the timing of large customer orders, timing of new
product introductions, adequacy of product supply, variations in our product
costs, variations in our product mix, promotions, seasonal influences and
fluctuations in competitive pricing pressures. The results of any particular
quarter may not be indicative of results for the full year or any future period.

<Table>
<Caption>
                                                  2003                                                2004
                            -------------------------------------------------   -------------------------------------------------
                              FIRST        SECOND       THIRD        FOURTH       FIRST        SECOND       THIRD        FOURTH
                             QUARTER      QUARTER      QUARTER      QUARTER      QUARTER      QUARTER      QUARTER      QUARTER
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
                                                 (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<S>                         <C>          <C>          <C>          <C>          <C>          <C>          <C>          <C>
Revenue
  INX product.............  $    6,661   $   12,253   $   15,954   $   10,881   $   10,061   $   16,354   $   27,179   $   18,052
  INX service.............         477          782        1,392        1,575          913        1,625        1,516        2,226
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
Total INX revenue.........       7,138       13,035       17,346       12,456       10,974       17,979       28,695       20,278
Stratasoft custom
  project.................       2,069        1,511        2,415        1,532        2,137        2,169        2,531        2,159
  Valerent product........         193          509          515          356          334          505          288          702
  Valerent service........         812          874          877          940        1,031        1,484        1,310        1,288
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
Total Valerent revenue....       1,005        1,383        1,392        1,296        1,365        1,989        1,598        1,990
Eliminations..............        (132)         (59)        (172)         (63)        (201)        (250)        (212)        (132)
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
Total revenue.............      10,080       15,870       20,981       15,221       14,275       21,887       32,612       24,295
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
Cost of sales and
  services:
  INX product.............       5,844       10,846       13,758        9,612        8,382       14,440       23,251       14,729
  INX service.............         516          757          795          908          589        1,145        1,099        1,350
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
Total INX cost of sales
  and service.............       6,360       11,603       14,553       10,520        8,971       15,585       24,350       16,079
Stratasoft custom
  project.................         801          574          728          879          962          886        1,323          979
  Valerent product........         192          424          474          331          310          460          292          625
  Valerent service........         584          599          606          623          697          907          750          736
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
Total Valerent cost of
  sales and service.......         776        1,023        1,080          954        1,007        1,367        1,042        1,361
  Eliminations............        (132)         (59)        (171)         (64)        (201)        (250)        (212)        (132)
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
Total cost of sales and
  services................       7,805       13,141       16,190       12,289       10,739       17,588       26,503       18,287
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
Gross profit:
  INX product.............         817        1,407        2,196        1,269        1,679        1,914        3,928        3,323
  INX service.............         (39)          25          597          667          324          480          417          876
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
Total INX gross profit....         778        1,432        2,793        1,936        2,003        2,394        4,345        4,199
Stratasoft custom
  project.................       1,268          937        1,687          653        1,175        1,283        1,208        1,180
  Valerent product........           1           85           41           25           24           45           (4)          77
  Valerent service........         228          275          271          317          334          577          560          552
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
Total Valerent gross
  profit..................         229          360          312          342          358          622          556          629
  Eliminations............          --           --           (1)           1           --           --           --           --
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
Total gross profit........       2,275        2,729        4,791        2,932        3,536        4,299        6,109        6,008
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
Selling, general and
  administrative expenses:
  INX.....................         945        1,448        2,126        1,526        1,884        2,318        3,332        2,761
  Stratasoft. ............       1,596        1,344        1,754        1,194        1,020        1,131        1,419        1,530
  Valerent................         560          536          455          412          390          486          522          488
  Corporate...............         275          234          287          369          205          301          183          284
  Eliminations............          --           --           (1)           1           --           --           --           --
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
Total selling, general and
  administrative
  expenses................       3,376        3,562        4,621        3,502        3,499        4,236        5,456        5,063
</Table>

                                                   (continued on following page)
                                        31
<PAGE>

<Table>
<Caption>
                                                  2003                                                2004
                            -------------------------------------------------   -------------------------------------------------
                              FIRST        SECOND       THIRD        FOURTH       FIRST        SECOND       THIRD        FOURTH
                             QUARTER      QUARTER      QUARTER      QUARTER      QUARTER      QUARTER      QUARTER      QUARTER
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
                                                 (DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<S>                         <C>          <C>          <C>          <C>          <C>          <C>          <C>          <C>
Operating income (loss)
  INX.....................        (167)         (16)         667          410          119           76        1,013        1,438
  Stratasoft. ............        (328)        (407)         (67)        (541)         155          152         (211)        (350)
  Valerent................        (331)        (176)        (143)         (70)         (32)         136           34          141
  Corporate...............        (275)        (234)        (287)        (369)        (205)        (301)        (183)        (284)
  Eliminations............          --           --           --           --           --           --           --           --
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
  Total operating income
    (loss)................      (1,101)        (833)         170         (570)          37           63          653          945
Interest income (expense)
  and other income, net...          10           96          (11)          12           19          (26)          17         (118)
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
Income (loss) before
  benefit for income
  taxes...................      (1,091)        (737)         159         (558)          56           37          670          827
Income tax benefit
  (expense)...............          --           81           12           88           (5)           7           (2)          19
Net income (loss) from
  continuing operations
  before minority
  interest................      (1,091)        (656)         171         (470)          51           44          668          846
Minority interests........          --           --           --           --           --           (6)         (50)         (61)
Net income (loss) from
  continuing operations...      (1,091)        (656)         171         (470)          51           38          618          785
Discontinued operations
  gain (loss) on
  disposal................          --           16           23          171          (12)          13           --           37
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
Net income (loss).........  $   (1,091)  $     (640)  $      194   $     (299)  $       39   $       51   $      618   $      822
                            ==========   ==========   ==========   ==========   ==========   ==========   ==========   ==========
Net income (loss) per
  share:
  Basic:
    Net income (loss) from
      continuing
      operations before
      minority interest...  $    (0.30)  $    (0.19)  $     0.04   $    (0.12)  $     0.01   $     0.01   $     0.13   $     0.16
    Minority interests....          --           --           --           --           --           --        (0.01)       (0.01)
    Gain (loss) on
      disposal............          --         0.01         0.01         0.04           --           --           --         0.01
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
    Net income (loss) per
      share...............  $    (0.30)  $    (0.18)  $     0.05   $    (0.08)  $     0.01   $     0.01   $     0.12   $     0.16
                            ==========   ==========   ==========   ==========   ==========   ==========   ==========   ==========
  Diluted:
    Net income (loss) from
      continuing
      operations before
      minority interest...  $    (0.30)  $    (0.19)  $     0.03   $    (0.12)  $     0.01   $     0.01   $     0.12   $     0.15
    Minority interests....          --           --           --           --           --           --        (0.01)       (0.01)
    Gain (loss) on
      disposal............          --         0.01         0.01         0.04           --           --           --         0.01
                            ----------   ----------   ----------   ----------   ----------   ----------   ----------   ----------
    Net income (loss) per
      share...............  $    (0.30)  $    (0.18)  $     0.04   $    (0.08)  $     0.01   $     0.01   $     0.11   $     0.15
                            ==========   ==========   ==========   ==========   ==========   ==========   ==========   ==========
Weighted average number of
  shares outstanding:
  Basic...................   3,630,285    3,636,441    3,703,206    3,874,730    3,978,407    4,582,790    3,703,206    5,173,189
  Diluted.................   3,630,285    3,636,441    3,974,298    3,874,730    4,544,406    4,939,206    3,974,298    5,556,207
</Table>

     For the quarter ended September 30, 2004, we saw unusually strong revenue,
due to large E-Rate funded projects related to the DISD and other school
projects. For the fourth quarter ended December 31, 2004, our revenue decreased
sequentially as compared to the exceptionally strong third quarter because of
the delayed shipments pending resolution of the E-Rate funded payment delays,
but the fourth quarter revenue did increase 59% as compared to the fourth
quarter of 2003.

     Our gross profit has fluctuated between quarters primarily due to changes
in our revenue mix between services revenues in INX and Valerent and our
Stratasoft custom project revenue, which have generally generated higher
margins, and the lower margin components of our business including product sales
in INX and Stratasoft. While INX and Valerent service gross margin increased
significantly for the fiscal year ended December 31, 2004 as compared to the
fiscal year ended December 31, 2003, quarter-to-quarter gross margin levels have
varied primarily based on the level of utilization of billable technical staff
and the type of service revenues generated, which can vary from period to period
and result in varying levels of gross margin. While product gross profit also
increased for both INX and Valerent for the fiscal year ended December 31, 2004,
as compared to the fiscal year ended December 31, 2003, the levels of gross
margin have also varied between quarters based on the type of product sold and
the mix of

                                        32
<PAGE>

large revenue product contracts, which typically have lower gross margin, as
compared with smaller revenue product contracts, which typically have a higher
gross margin. The respective timing of when vendor incentives become earned and
determinable has created significant quarter to quarter gross margin
fluctuations. While we expect vendor incentives will remain earned and
determinable in future periods, we do not have any assurance that we will
continue to meet the vendor incentive criteria required to receive the incentive
or that the vendor will continue to offer incentive programs during the future.

     Our third quarter 2004 gross margin improved in comparison to both the
prior quarter and the third quarter of 2003. The improved gross margin was the
result of higher product revenue from INX and INX vendor incentives, which
produces our highest gross margin. Our fourth quarter 2004 gross margin
increased in comparison to the third and fourth quarter of 2003. The increase in
gross profit in comparison to the third quarter resulted from vendor incentives
and higher profit margin from INX services.

     In the third quarter of 2004 our selling, general and administrative
expenses increased as compared to previous quarters due to increases in sales
commissions resulting higher revenue and vendor incentives. Our selling, general
and administrative expenses for the fourth quarter of 2004 decreased as compared
to the third quarter primarily because of decreased expenses from lower sales
commissions related to the decreased level of sales and gross profits during the
quarter.

CRITICAL ACCOUNTING POLICIES

  REVENUE RECOGNITION

     We have a number of different revenue sources, which vary between our three
reportable segments. Each reportable segment has more than one revenue source,
and revenue is recognized differently for each component (or "stream") of
revenue earned by segment. The material revenue streams earned by us are:

          Products Revenue.  All three of our 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 purchased from us independent of our providing any
     material services. We recognize revenue from product shipments when there
     are binding contracts or purchase orders, the price is fixed or
     determinable, the product is shipped or delivered to the customer and
     collectibility is reasonably assured. 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 our business segments performs credit research prior to extending
     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.

          Service Revenue.  All of our operating segments earn revenue from
     providing stand-alone services. These revenues consist of billings for
     engineering and technician time, programming services, which are provided
     on either an hourly basis or a flat-fee basis, and the service component of
     maintenance and repair service ticket transactions. These services are
     contracted for separately from any product sale. Revenue is recognized when
     the service is performed, the service is expected to be completed in less
     than three months, and collection is reasonably assured. Some of our
     segments earn agency fee revenue from various sources, primarily from as a
     result of our referring customers to other organizations for which an
     agency fee is received. Revenue is recognized at the earlier of when
     payment is received or when notification of amounts being due is received
     from the entity paying the agency fee, and collectibility is reasonably
     assured.

          Certain fixed and flat fee contracts that extend over three months or
     more are accounted for using the percentage of completion method of method
     of accounting. The percentage of revenue recognized in any particular
     period is determined based 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.

                                        33
<PAGE>

          Custom Project Revenue.  One of our segments, Stratasoft, earns
     revenue from projects that are recognized using the percentage of
     completion method of accounting. The majority of Stratasoft's revenue
     consists of systems sales in which it bundles its proprietary software,
     along with third-party hardware products and software customization
     services, installation, training services, warranty services and incidental
     post contract services ("PCS") together under a single contract. PCS is
     insignificant on contracts with a term of one year or less, and therefore,
     we have determined that the value of PCS should not be unbundled from the
     project revenue as set forth in paragraph 59 of SOP 97-2 [Software Revenue
     Recognition]. Accordingly, PCS revenue recognized together with the project
     revenue, and the estimated cost to provide the PCS is accrued. 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 [Accounting for Performance of Construction-Type and
     Certain Production-Type Contracts]. 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.

          We have risk to the extent that this group of customers have not paid
     or issued contractual letters of credit up to the level of cost and
     earnings recognized. On our projects in South Asia we typically require a
     cash payment or letter of credit from the customer prior to shipping the
     product. Additionally, Stratasoft has had revenue derived from Africa, the
     United Kingdom, and Canada.

          We maintain allowances for doubtful accounts and notes receivable for
     estimated losses resulting from the inability of our customers to make
     required payments. If the financial condition of our customers were to
     deteriorate, resulting in an impairment of their ability to make payments,
     additional allowances may be required.

          Credit and Collections Policy Inherent in our revenue recognition
     policy is the determination of the collectibility of amounts due from our
     customers, which requires us to use estimates and exercise judgment. We
     routinely monitor our customer's payment history and current credit
     worthiness to determine that collectibility is reasonably assured and, then
     in some instances, require letters of credit in support of contracted
     amounts.

     This requires us to make frequent judgments and estimates in order to
     determine the appropriate period to recognize a sale to a customer and the
     amount of valuation allowances required for doubtful accounts. We record
     provisions for doubtful accounts when it becomes evident that the customer
     will not be able to make the required payments either at contractual due
     dates or in the future. Changes in the financial condition of our
     customers, either adverse or positive, could impact the amount and timing
     of any additional provision for doubtful accounts that may be required.

          We recognize vendor incentive rebates when we meet the vendor's sales
     volume and customer satisfaction levels set by the vendor. Failure to
     achieve the levels set by the vendor could result in us not receiving a
     vendor incentive and result in lower gross margins for our company.

          Vendor Incentive Recognition.  One of our segments, INX, participates
     in a significant vendor incentive program. These incentives are generally
     earned by sales volume, sales growth and customer satisfaction levels. The
     amounts earned under these programs are accrued when they are deemed
     probable and can be reasonably measured; otherwise, they are recorded when
     they are declared by the vendor or the cash is received, which ever is
     earlier. The incentives are recorded as a reduction of cost of goods.
     Selling, general and administrative expenses are increased for any
     associated commission expense and payroll tax related to the incentives.
     When vendor incentives are recognized upon vendor declaration or cash
     receipt, then their effect on cost of goods can vary significantly between
     quarterly and annual reporting periods.

                                        34
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

  SOURCES OF LIQUIDITY

     Our principal sources of liquidity are collections from our accounts and
notes receivable, and our credit facility with Textron Financial Corporation
(the "Textron Facility"). In 2004, we also received approximately $7.5 million
in net proceeds from a public offering. 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. In 2004, we experienced negative
cash flow from operating activities of $10.5 million. Our working capital was
$3.7 million and $13.1 million at December 31, 2003 and 2004, respectively.

     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
risk 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 $28.2 million at December 31, 2003 and 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 December 31, 2004, Stratasoft had net notes receivable of $928,000 and $1.4
million, respectively. The current portion of those notes receivable is
reflected on our balance sheets as current portion of notes receivable, net, and
the long-term portion of the notes receivable is reflected on our balance sheets
as notes receivable, net. The following table shows the breakdown of the total
notes receivable:

<Table>
<Caption>
                                                                   DECEMBER 31,
                                                              -----------------------
                                                                2003          2004
                                                              ---------     ---------
                                                              (DOLLARS IN THOUSANDS)
<S>                                                           <C>           <C>
Current portion of notes receivable, gross..................   $1,049        $2,103
Allowance for doubtful notes................................     (373)         (872)
                                                               ------        ------
Current portion of notes receivable, net....................      676         1,231
                                                               ------        ------
Long term portion of notes receivable, gross................      502           457
Allowance for doubtful notes................................     (250)         (250)
                                                               ------        ------
Long-term portion of notes receivable, net..................      252           207
                                                               ------        ------
Total notes receivable, net.................................   $  928        $1,438
                                                               ======        ======
</Table>

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

     Inventory.  We had inventory of $1.0 million and $1.8 million at December
31, 2003 and 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 are 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.

                                        35
<PAGE>

  CONTRACTUAL OBLIGATIONS

     The following table summarizes certain of our contractual cash obligations
and related payments due as of December 31, 2004:

<Table>
<Caption>
                                                           PAYMENTS DUE BY PERIOD
                                            -----------------------------------------------------
                                                      LESS THAN                            AFTER
CONTRACTUAL OBLIGATIONS                      TOTAL     1 YEAR     1-3 YEARS   4-5 YEARS   5 YEARS
-----------------------                     -------   ---------   ---------   ---------   -------
                                                           (DOLLARS IN THOUSANDS)
<S>                                         <C>       <C>         <C>         <C>         <C>
Lease obligations.........................  $ 2,508    $  804      $1,498       $206       $  --
Textron, interest bearing debt............    8,122     8,122          --         --          --
Other debt obligations....................      220        98         122         --          --
                                            -------    ------      ------       ----       -----
Total contractual cash obligations........  $10,850    $9,024      $1,620       $206       $  --
                                            =======    ======      ======       ====       =====
</Table>

     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.

     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 with the proceeds of our recent
public offering.

     Textron Facility.  On January 31, 2002, we entered into the Textron
Facility to provide financing for our inventory purchases. On September 30, 2004
the agreement was amended and the maximum credit available under the Textron
facility is presently $25 million and it is collateralized by substantially all
of our assets other than our patent licenses.

     As of December 31, 2004, we owed $16.0 million under the Textron Facility
and had an additional $9.0 million available subject to borrowing base
restrictions. The "unused availability" is the amount not borrowed, but eligible
to be borrowed. The "unused portion of the facility" is the amount not borrowed,
but that amount may not be eligible for borrowing because of the borrowing base
restrictions.

     The borrowing base restrictions generally restrict our borrowings under the
Textron Facility to 80% of the eligible receivables and 90% of our Floorplanned
inventory which cannot exceed the lesser of 30% of our eligible accounts
receivable or $6.0 million, however, while doing business with DISD this is
increased to 35% of our eligible accounts receivable or $9.0 million.

     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-day 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 have credit availability 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 (5.25% at
December 31, 2004) plus 2.5%. Because payment cycles of sales to school
districts under the E-Rate program often extend beyond 60 days, and because such
payment cycles have recently extended even further due to administrative issues
with the organization that makes payments to vendors for the E-Rate program, we
expect we will continue to carry extended payment balances under the Textron
Facility for at least the next several quarters. The total outstanding balance
under the Textron Facility at December 31, 2004 was $16.0 million. $7.9 million
of the outstanding balance was within the Free Finance Period and therefore is
reflected as accounts payable in our balance sheet at December 31, 2004. $8.1
million with accrued interest of $161,000 is reflected as notes payable and
accrued expense, respectively, at December 30, 2004.

                                        36
<PAGE>

     As defined in the Textron Facility there are restrictive covenants that are
measured at each quarter and year end. These covenants require us to:

     - maintain Minimum Tangible Capital Funds of $9.5 million, which is defined
       to be the sum of cash, receivables, inventory and fixed net assets, minus
       total liabilities, with total liabilities being defined as accounts
       payable, accrued expenses and short- and long-term notes payable;

     - maintain a maximum Debt to Tangible Capital Funds ratio of 4.0 to 1;

     - maintain Minimum Working Capital of not less than $8.0 million;

     - maintain Minimum Cash on Hand of not less than $2.0 million;

     - maintain a Current Ratio of not less than 1.25 to 1.0;

     - achieve Earnings Before Interest, Taxes, Depreciation and Amortization
       exceeding $100,000; and

     - enter into a Memorandum of Understanding (MOU) on December 29, 2004 with
       MSE and Textron among other members of the DISD consortium regarding
       payment procedures under the Master DISD Contract.

     At December 31, 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 (a participating
partner with Textron) 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.

     Cash Flows.  During 2004, our cash increased by $2.6 million. Operating
activities used $10.5 million, investing activities used $1.0 million and
financing activities provided $14.1 million.

     Operating Activities.  Operating activities used $10.5 million in 2004 as
compared to using cash of $2.5 million in 2003 and providing cash of $809,000 in
2002. Adjustments for non-cash-related items included a $38,000 gain on disposal
of discontinued operations, net of tax, due to collection of discontinued
receivables previously reserved against as uncollectible. An adjustment was also
made to record minority interest of $117,000, depreciation and amortization of
$918,000, current tax benefit of $19,000 and the loss on retirement of assets of
$4,000. Adjustments for non-cash expenses included bad debt expense of $1.3
million, which was attributable to increases in allowances for accounts and
notes receivable that were partially offset by decreases in the allowance for
doubtful accounts receivable due to the write off of uncollectible accounts.

     Changes in asset and liability accounts used $13.6 million. The most
significant use related to an increase in accounts receivable of $19.3 million,
which was related primarily to increased revenue and the delayed payment of
E-Rate funded accounts receivable associated with the sales to independent
school districts and the administrative delays encountered at the School and
Libraries Division (SLD) which administers the E-Rate program on their behalf.
Days sales outstanding increased 28.1 days from 46.5 days at December 31, 2003
to 74.6 days at December 31, 2004 due to these delays. Adjustment for accounts
receivable-others was $4,000 in 2004. Inventory increased $740,000 in 2004 as
compared to an increase of $257,000 in 2003 and an increase of $147,000 in 2002.
Net working capital used for contracts in progress increased $410,000 due to an
increase in cost and estimated earnings in excess of billings of $211,000, which
was primarily related to an increase in the Stratasoft custom projects in
process at year-end and a reduction in billings in excess of cost and estimated
earnings of $199,000. In addition, notes receivable increased $1.0 million due
to more notes receivables being accepted from Stratasoft customers. These uses
of cash were partially offset by an increase in accounts payable of $4.1
million, which related primarily to: increased purchases of Cisco products for
sales by our INX subsidiary; an increase in accrued expenses of $1.7 million
primarily for sales commissions; a decrease in other assets of $596,000
primarily for return of bid deposits and reduction in prepaid insurance; and an
increase of $579,000 in deferred revenue related to a sale of software to
resellers with notes in excess of twelve months.

     Investing Activities.  Investing activities used $1.0 million in 2004
compared to a use of $885,000 for 2003 and a use of $347,000 for 2002. Our
investing activities related to capital expenditures in all three years were
primarily related to purchases of computer equipment and software, and to a
lesser degree, leasehold improvements. Investing activities related to cash paid
for acquisitions increased in 2003 due to the acquisition of Digital Precision
by INX.

                                        37
<PAGE>

During the next twelve months, we do not expect to incur significant capital
expenditures requiring cash, except for acquisitions, of which we cannot predict
the certainty or magnitude.

     Financing Activities.  Financing activities provided $14.1 million in 2004
as compared to providing $2.0 million in 2003 and to using $405,000 in 2002. In
2003 and 2004, our changes in stock price resulted in stock option holders
exercising stock options, which provided $478,000 and $280,000, respectively. No
options were exercised during the previous two years. During December 2003, $1.7
million of debt under the Textron Facility became interest-bearing debt and was
classified as notes payable rather than accounts payable. During January 2004,
the company repaid $1.7 million of interest-bearing debt under the Textron
Facility. During the year ended December 31, 2004, another $1.2 million of debt
under the Textron Facility became interest-bearing in March 2004 and was repaid
in May 2004, and during September 2004 through December 2004 another $8.1
million became interest bearing.

     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 before additional offering expenses. 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 before additional offering
expenses. We paid $1.1 million of offering expenses associated with the public
offering resulting in net proceeds from the public offering of $7.5 million. We
used the net proceeds of the offering primarily for working capital and to repay
interest-bearing debt.

FUTURE TRENDS

     We expect revenue to continue to increase in 2005 for each of our three
subsidiaries. We expect INX will grow the most, but that INX's growth rate for
2005 will be less than its growth rate for 2004 excluding the impact of
acquisitions that we might make during 2005. We believe INX's growth rate will
slow somewhat from historical rates of growth primarily because we believe we
have become the dominant provider of Cisco-based IP telephony solutions for our
targeted types of customers in our current market of Texas, which are customers
with approximately 300 to 10,000 employees. We expect Cisco-based systems will
continue to gain market share, and we expect our revenue growth in 2005 will be
primarily the result of prior investments in increased sales and marketing
programs. We anticipate making one or more acquisitions during 2005, which we
expect would add additional INX revenue growth.

     While we cannot predict the economic and industry trends with certainty, we
continue to believe that the enterprise customer information and communications
technology industries are continuing to rebound from the depressed market
conditions that began in 2000, the recovery from which was somewhat delayed by
the Iraq war. We currently believe that events and circumstances point toward
this trend of improving general market conditions will continue through 2005.

     We expect to be able to contain the growth of certain selling, general and
administrative expenses somewhat, relative to revenue growth, as expected
increases in revenue are spread over a somewhat fixed corporate administration
expense base.

     We have experienced no material impact of inflation and changing prices on
net sales and income from continuing operations in the last three years.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTEREST RATE RISK

     We attempt to manage our borrowings under the Textron Facility to minimize
interest expense. The interest rate of the Textron Facility is the prime rate
plus 2.5% (see "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources"). During the year
ended December 31, 2004, the interest rates of borrowings under the Textron
Facility ranged from 6.5% to 10.0%. A one percent change in variable interest
rates will not have a material impact on our financial condition.

                                        38
<PAGE>

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                              I-SECTOR CORPORATION

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<Table>
<Caption>
                                                              PAGE
                                                              ----
<S>                                                           <C>
Report of Independent Registered Public Accounting Firm for
  the years ended December 31, 2003 and 2004................   40
Report of Independent Registered Public Accounting Firm for
  the year ended December 31, 2002..........................   41
Consolidated Balance Sheets at December 31, 2003 and 2004...   42
Consolidated Statements of Operations for the years ended
  December 31, 2002, 2003 and 2004..........................   43
Consolidated Statements of Stockholders' Equity for the
  years ended December 31, 2002, 2003 and 2004..............   44
Consolidated Statements of Cash Flows for the years ended
  December 31, 2002, 2003 and 2004..........................   45
Notes to Consolidated Financial Statements..................   46
</Table>

                                        39
<PAGE>

            REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders of I-Sector Corporation:

We have audited the accompanying consolidated balance sheets of I-Sector
Corporation (a Delaware corporation) and subsidiaries as of December 31, 2003
and 2004, and the related consolidated statements of operations, stockholders'
equity, and cash flows for the years then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over Financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of I-Sector Corporation
and subsidiaries as of December 31, 2003 and 2004, and the results of their
operations and their cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of America.

/s/ GRANT THORNTON LLP

Houston, Texas
February 28, 2005

                                        40
<PAGE>

            REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders of I-Sector Corporation:

We have audited the accompanying consolidated statements of operations,
stockholders' equity and cash flows for the year ended December 31, 2002 of
I-Sector Corporation and subsidiaries ("I-Sector"). These financial statements
are the responsibility of I-Sector's management. Our responsibility is to
express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the results of I-Sector's operations, changes in
stockholders' equity and cash flows for the year ended December 31, 2002 in
conformity with accounting principles generally accepted in the United States of
America.

/s/ DELOITTE & TOUCHE LLP

Houston, Texas
March 21, 2003

                                        41
<PAGE>

                     I-SECTOR CORPORATION AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS

<Table>
<Caption>
                                                                  DECEMBER 31,
                                                              ---------------------
                                                                2003        2004
                                                              ---------   ---------
                                                              (IN THOUSANDS, EXCEPT
                                                               SHARE AND PAR VALUE
                                                                    AMOUNTS)
<S>                                                           <C>         <C>
                                      ASSETS
Current Assets:
  Cash and cash equivalents.................................   $ 2,172     $ 4,773
  Accounts receivable -- trade, net of allowance of $612 and
     $1,274.................................................     9,757      28,236
  Accounts receivable -- affiliates.........................        16          20
  Accounts receivable -- other..............................        29          21
  Notes receivable, net of allowance of $373 and $872.......       676       1,231
  Inventory.................................................     1,038       1,778
  Cost and estimated earnings in excess of billings.........     1,452       1,663
  Other current assets......................................       943         310
                                                               -------     -------
          Total current assets..............................    16,083      38,032
Property and equipment, net of accumulated depreciation of
  $1,887 and $2,397.........................................     1,271       1,787
Notes receivable, net of allowance of $250 and $250.........       252         207
Patent license rights, net of accumulated amortization of
  $265 and $375.............................................       849         739
Other intangible assets, net of accumulated amortization of
  $335 and $630.............................................       317         374
Deferred offering costs.....................................       435          --
                                                               -------     -------
          Total Assets......................................   $19,207     $41,139
                                                               =======     =======

                       LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
  Notes payable and current portion of long-term debt.......   $ 1,784     $ 8,220
  Accounts payable..........................................     6,524      10,675
  Billings in excess of cost and estimated earnings.........       262          63
  Accrued expenses..........................................     2,676       4,171
  Net liabilities related to discontinued operations........       557         625
  Deferred revenue..........................................       556       1,135
                                                               -------     -------
          Total current liabilities.........................    12,359      24,889
                                                               -------     -------
Long-term debt..............................................       229         122
Minority interest...........................................        --         279
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 5,201,354 issued.............        48          52
  Additional paid in capital................................    10,853      17,350
  Additional paid in capital -- other.......................       337         163
  Treasury stock, at cost 811,800 and 0 shares..............    (1,373)         --
  Retained deficit..........................................    (3,246)     (1,716)
                                                               -------     -------
          Total stockholders' equity........................     6,619      15,849
                                                               -------     -------
          Total Liabilities and Stockholders' Equity........   $19,207     $41,139
                                                               =======     =======
</Table>

  The accompanying notes are an integral part of these consolidated financial
                                   statements

                                        42
<PAGE>

                     I-SECTOR CORPORATION AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<Table>
<Caption>
                                                                    YEAR ENDED DECEMBER 31,
                                                              ------------------------------------
                                                                 2002         2003         2004
                                                              ----------   ----------   ----------
                                                                (IN THOUSANDS, EXCEPT SHARE AND
                                                                       PER SHARE AMOUNTS)
<S>                                                           <C>          <C>          <C>
Revenue:
  Products..................................................  $   29,805   $   46,900   $   72,680
  Services..................................................       5,647        7,725       11,393
  Custom projects...........................................       6,569        7,527        8,996
                                                              ----------   ----------   ----------
  Total revenue.............................................      42,021       62,152       93,069
                                                              ----------   ----------   ----------
Cost of goods and services:
  Products..................................................      26,437       41,060       61,694
  Services..................................................       4,395        5,383        7,273
  Custom projects...........................................       2,920        2,982        4,150
                                                              ----------   ----------   ----------
  Total cost of goods and services..........................      33,752       49,425       73,117
                                                              ----------   ----------   ----------
     Gross profit...........................................       8,269       12,727       19,952
Selling, general and administrative expenses................      10,625       15,061       18,254
                                                              ----------   ----------   ----------
Operating income (loss).....................................      (2,356)      (2,334)       1,698
Interest and other income (expense), net....................         115          107         (108)
                                                              ----------   ----------   ----------
Income (loss) from continuing operations before income tax
  benefit...................................................      (2,241)      (2,227)       1,590
Income tax benefit..........................................       1,595          181           19
                                                              ----------   ----------   ----------
Net income (loss) from continuing operations before minority
  interest..................................................        (646)      (2,046)       1,609
Minority interest...........................................          --           --         (117)
                                                              ----------   ----------   ----------
Net income (loss) from continuing operations................        (646)      (2,046)       1,492
Gain on disposal of discontinued operations, net of taxes...         262          210           38
                                                              ----------   ----------   ----------
Net income (loss)...........................................  $     (384)  $   (1,836)  $    1,530
                                                              ==========   ==========   ==========
Net income (loss) per share
  Basic:
     Net income (loss) from continuing operations before
       minority interest....................................  $    (0.17)  $    (0.55)  $     0.35
     Minority interest......................................          --           --        (0.03)
     Gain on disposal of discontinued operations, net of
       taxes................................................        0.07         0.06        0. 01
                                                              ----------   ----------   ----------
     Net income (loss) per share............................  $    (0.10)  $    (0.49)  $     0.33
                                                              ==========   ==========   ==========
  Diluted:
     Net income (loss) from continuing operations before
       minority interest....................................  $    (0.17)  $    (0.56)  $     0.32
     Minority interest......................................          --           --        (0.02)
     Gain on disposal of discontinued operations, net of
       taxes................................................        0.07         0.06        0. 01
                                                              ----------   ----------   ----------
     Net income (loss) per share............................  $    (0.10)  $    (0.50)  $     0.31
                                                              ==========   ==========   ==========
Shares used in computing net income (loss) per share:
  Basic.....................................................   3,709,689    3,691,052    4,569,507
                                                              ==========   ==========   ==========
  Diluted...................................................   3,709,689    3,691,052    5,004,393
                                                              ==========   ==========   ==========
</Table>

  The accompanying notes are an integral part of these consolidated financial
                                   statements

                                        43
<PAGE>

                     I-SECTOR CORPORATION AND SUBSIDIARIES

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY


<Table>
<Caption>
                                        $.01 PAR VALUE
                                         COMMON STOCK      ADDITIONAL      ADDITIONAL
                                      ------------------    PAID-IN         PAID-IN        TREASURY   RETAINED
                                       SHARES     AMOUNT    CAPITAL     CAPITAL -- OTHER    STOCK     EARNINGS    TOTAL
                                      ---------   ------   ----------   ----------------   --------   --------   -------
                                                      (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<S>                                   <C>         <C>      <C>          <C>                <C>        <C>        <C>
Balance at January 1, 2002..........  4,441,325    $44      $10,184          $  --         $(1,187)   $(1,026)   $ 8,015
Purchase of treasury stock..........         --     --           --             --            (186)        --       (186)
Stock warrants expired..............         --     --          195             --              --         --        195
Net loss............................         --     --           --             --              --       (384)      (384)
                                      ---------    ---      -------          -----         -------    -------    -------
Balance at December 31, 2002........  4,441,325     44       10,379             --          (1,373)    (1,410)     7,640
Issuance of options to
  consultants.......................         --     --           --            337              --         --        337
Exercise of common stock options....    321,484      4          474             --              --         --        478
Net loss............................         --     --           --             --              --     (1,836)    (1,836)
                                      ---------    ---      -------          -----         -------    -------    -------
Balance at December 31, 2003........  4,762,809     48       10,853            337          (1,373)    (3,246)     6,619
Revaluation of consultant options...         --     --           --           (199)             --         --       (199)
Exercise of common stock options....    100,345     --          255             25              --         --        280
Proceeds from offering of units, net
  of offering costs of $1,145.......  1,150,000     12        7,536             --              --         --      7,548
Issuance of INX common stock net of
  minority interest.................         --     --           71             --              --         --         71
Retirement of treasury stock........   (811,800)    (8)      (1,365)            --           1,373         --         --
Net income..........................         --     --           --             --              --      1,530      1,530
                                      ---------    ---      -------          -----         -------    -------    -------
Balance at December 31, 2004........  5,201,354    $52      $17,350          $ 163         $    --    $(1,716)   $15,849
                                      =========    ===      =======          =====         =======    =======    =======
</Table>


  The accompanying notes are an integral part of these consolidated financial
                                   statements

                                        44
<PAGE>

                     I-SECTOR CORPORATION AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS


<Table>
<Caption>
                                                                YEAR ENDED DECEMBER 31,
                                                              ---------------------------
                                                               2002      2003      2004
                                                              -------   -------   -------
                                                                    (IN THOUSANDS)
<S>                                                           <C>       <C>       <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss).........................................  $  (384)  $(1,836)  $ 1,530
  Adjustments to reconcile net income (loss) to net cash
    provided by (used in) operating activities:
  Minority interest.........................................       --        --       117
  Net gain from discontinued operations.....................     (262)     (210)      (38)
  Tax benefit from discontinued operations..................     (136)     (108)      (19)
  Depreciation and amortization.............................      596       764       918
  (Gain) loss on retirement of assets.......................       34       (88)       (4)
  Bad debt expense..........................................    1,271       769     1,346
  Changes in assets and liabilities that provided (used)
    cash:
    Accounts receivable, net................................   (3,133)   (3,680)  (19,310)
    Accounts receivable, affiliates and other...............      115       111         4
    Inventory...............................................     (147)     (257)     (740)
    Income tax receivable...................................     (337)      488        --
    Notes receivable........................................   (1,154)     (287)   (1,025)
    Other current assets....................................      (58)     (250)      596
    Accounts payable........................................    3,072     1,676     4,151
    Cost and estimated earnings in excess of billings.......      986      (743)     (211)
    Billings in excess of cost and estimated earnings.......        3       187      (199)
    Accrued expenses........................................     (288)      556     1,656
    Deferred revenue........................................      (45)      475       579
                                                              -------   -------   -------
        Net cash provided (used) in continuing operations...      133    (2,433)  (10,649)
  Net operating activities from discontinued operations.....      676       (29)      125
                                                              -------   -------   -------
        Net cash provided (used) in operating activities....      809    (2,462)  (10,524)
                                                              -------   -------   -------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Capital expenditures......................................     (347)     (399)   (1,026)
  Proceeds of sale of fixed assets..........................       --        80        --
  Acquisition of Digital Precision, Inc (inclusive of
    acquisition costs)......................................       --      (566)       --
                                                              -------   -------   -------
        Net cash used in investing activities...............     (347)     (885)   (1,026)
                                                              -------   -------   -------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Exercise of stock options.................................       --       478       280
  Proceeds from unit offering, net..........................       --        --     7,548
  Proceeds from borrowings of interest bearing debt.........       --     1,688    10,380
  Payments of short and long-term debt......................     (219)     (138)   (4,057)
  Purchase of treasury stock................................     (186)       --        --
                                                              -------   -------   -------
        Net cash provided by (used in) in financing
        activities..........................................     (405)    2,028    14,151
                                                              -------   -------   -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........       57    (1,319)    2,601
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD............    3,434     3,491     2,172
                                                              -------   -------   -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD..................  $ 3,491   $ 2,172   $ 4,773
                                                              =======   =======   =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
  Cash paid for interest....................................  $    --   $    29   $    --
                                                              =======   =======   =======
  Cash received for income taxes............................  $(1,123)  $   (73)  $    --
                                                              =======   =======   =======
SUPPLEMENTAL NONCASH INVESTING AND FINANCING ACTIVITIES:
  Revaluation of options granted to consultants.............  $    --   $    --   $  (199)
  Recognition of additional purchase price on Digital
    Precision acquisition through issuance of INX common
    stock...................................................       --        --       234
  Recognition of minority interest for issuance of INX
    common stock............................................       --        --      (162)
  Fixed assets acquired through capital lease...............       --        63        --
  Options granted to consultants............................       --       337        --
  Offering costs accrued....................................       --       317        --
</Table>


  The accompanying notes are an integral part of these consolidated financial
                                   statements

                                        45
<PAGE>

                     I-SECTOR CORPORATION AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              FOR THE YEARS ENDED DECEMBER 31, 2002, 2003 AND 2004
               (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 computer-telephony software, and performing
remote-enabled managed services for the information and communication technology
used by their customers:

     - Internetwork Experts, Inc. ("INX") is a network professional services and
       integration organization focused on delivering comprehensive
       Cisco-centric IP telephony solutions to clients ranging from mid-size to
       large enterprises along with other communications solutions. 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.

     - 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.

     - 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.

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


     Principles of Consolidation -- The accompanying consolidated financial
statements include the accounts of I-Sector and its subsidiaries. All
significant intercompany balances and transactions have been eliminated.



     Inventory -- Inventory consists primarily of Cisco network equipment,
Stratasoft dialers, computer equipment and components and is valued at the lower
of cost or market with cost determined on the first-in first-out method.
Substantially all of I-Sector's inventory is finished goods. The Company records
write downs of its inventory to net realizable value as appropriate.



     Property and Equipment -- Property and equipment are recorded at cost.
Expenditures for repairs and maintenance are charged to expense when incurred,
while expenditures for betterments are capitalized. Disposals are removed at
cost less accumulated depreciation with the resulting gain or loss reflected in
operations in the year of disposal.



     Intangible Assets -- Intangible assets are being amortized over their
estimated useful lives of five to sixteen years (see Note 12).



     Impairment of Long-Lived Assets -- I-Sector records impairment losses on
long-lived assets used in operations when events and circumstances indicate that
the assets might be impaired and the undiscounted cash flows estimated to be
generated by those assets are less than the carrying amounts of those assets.



     Income Taxes -- I-Sector accounts for income taxes under the liability
method, which requires, among other things, recognition of deferred income tax
liabilities and assets for the expected future tax consequences of events that
have been recognized in I-Sector's consolidated financial statements or tax
returns. Under this method, deferred income tax liabilities and assets are
determined based on the temporary differences between the financial


                                        46
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)


statement carrying amounts and the tax bases of existing assets and liabilities
and the recognition of available tax carryforwards.


     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
     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 an 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 are generally completed in less than three months.
     Service revenues 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 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.

                                        47
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)


          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. 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.
     The Company follows 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,
                                                              ---------------
                                                               2003     2004
                                                              ------   ------
<S>                                                           <C>      <C>
Costs incurred on uncompleted contracts.....................  $1,019   $1,675
Estimated earnings..........................................   3,117    4,862
                                                              ------   ------
                                                               4,136    6,537
Less: Billings to date......................................   2,946    4,937
                                                              ------   ------
Total.......................................................  $1,190   $1,600
                                                              ======   ======
Included in accompanying balance sheets under the following
  captions:
  Cost and estimated earnings in excess of billings.........  $1,452   $1,663
  Billings in excess of cost and estimated earnings.........    (262)     (63)
                                                              ------   ------
Total.......................................................  $1,190   $1,600
                                                              ======   ======
</Table>

          During the quarter ended June 30, 2003, the Company recorded
     adjustments to defer revenue for certain custom projects that had more than
     one year of free PCS and certain renewals of PCS paid in advance. The
     adjustment includes approximately $152 related to years prior to 2003.
     Management determined that the effect of these adjustments was not material
     to the previously reported results or to the results expected for 2003.

          I-Sector's operating segment Stratasoft sold $408 and $125 of software
     products to a reseller for which the related revenue was deferred at
     December 31, 2003 and 2004, respectively. Revenue from the sales will be
     recognized in the accounting periods that payments from the reseller become
     due, or in the accounting period when it has been firmly established that
     the software has been re-sold to an end-user of the software and that
     collection is reasonably assured by the Company.

          During 2002, 2003 and 2004, I-Sector has recognized revenue of $614,
     $502 and $5 respectively, on the percentage-of-completion basis for several
     projects associated with one reseller in South Asia. For these projects,
     Stratasoft entered into a three-party contract between Stratasoft, the
     South Asia reseller and the end-user customers. Stratasoft was responsible
     for performing the substantial majority of the project for the end-

                                        48
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     user customer, from whom Stratasoft was directly obligated to be paid for
     such project by the end-user customer.

     Credit Risk -- The Company extends credit to its customers in the normal
course of business and generally does not require collateral or other security.
The Company performs ongoing credit evaluations of its customers' financial
condition and, in some instances, requires letters of credit or additional
guarantees in support of contracted amounts. Earnings are charged with a
provision for doubtful accounts based on a current review of the collectibility
of the accounts and using a systematic approach based on historical collections
and age of the amounts due. Accounts deemed uncollectible are applied against
the allowance for doubtful accounts.

     Vendor Incentives -- One of the segments, INX, participates in a
significant vendor incentive program. These incentives are generally earned by
sales volume, sales growth and customer satisfaction levels. The amounts earned
under these programs are accrued when they are deemed probable and can be
reasonably measured; otherwise, they are recorded when they are declared by the
vendor or the cash is received, which ever is earlier. The incentives are
recorded, as a reduction of cost of goods and services. Selling, general and
administrative expenses are increased for any associated commission expense and
payroll tax related to the incentives. When vendor incentives are not recognized
until vendor declaration or cash receipt, then their effect on cost of goods can
vary significantly among quarterly and annual reporting periods.

     Advertising Costs -- Advertising costs consist of print advertising and
trade show materials and are expensed as incurred. Advertising costs for the
year ended December 31, 2002, 2003 and 2004 were $370, $323 and $250,
respectively.

     Research and Development Costs -- Expenditures relating to the development
of new products and processes, including significant improvements and
refinements to existing products, are expensed as incurred.

     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 and services 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>
                                                              DECEMBER 31,
                                                              -------------
                                                              2003    2004
                                                              -----   -----
<S>                                                           <C>     <C>
Balance, beginning of the period............................  $ 305   $ 302
Additions to reserve........................................    348     493
Expenses offset against reserve.............................   (351)   (434)
                                                              -----   -----
Balance, end of period......................................  $ 302   $ 361
                                                              =====   =====
</Table>

                                        49
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Stock-Based Compensation -- The Company has elected to account for employee
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 years ended
December 31, 2003 and 2004, recorded $337 and $(174) of other additional paid in
capital related to compensation to the non-employees. If compensation cost for
all option issuances had been determined consistent with the fair value method,
I-Sector's net loss and net loss per share would have increased to the pro-forma
amounts indicated below.

     For purposes of estimating the fair value disclosures below, the fair value
of each stock option has been estimated on the grant date with a Black-Scholes
option pricing model using the following weighted-average assumptions for the
2002, 2003 and 2004 periods; dividend yield of 0% for all periods; expected
volatility of 82.1%, 85.7% and 79.8%, respectively; risk-free interest rate of
3.63%, 3.63% and 3.63%, respectively; and expected lives of 7.57, 8.4 and 8.0
years, respectively, from the original date of the stock option grants.


<Table>
<Caption>
                                                                       DECEMBER 31,
                                                               2002        2003        2004
                                                              ------   ------------   ------
<S>                                                           <C>      <C>            <C>
Basic:
  Net income (loss) as reported.............................  $ (384)    $(1,836)     $1,530
Deduct:
  Total stock-based employee compensation determined under
     fair value based method for all awards, net of related
     tax effects............................................    (184)       (233)        (90)
                                                              ------     -------      ------
Pro forma net income (loss).................................  $ (568)    $(2,069)     $1,440
                                                              ======     =======      ======
Diluted:
  Net income (loss) as reported.............................  $ (384)    $(1,836)     $1,530
Deduct:
  Adjustment for subsidiary dilution........................      --         (29)       (550)
  Total stock-based employee compensation determined under
     fair value based method for all awards, net of related
     tax effects............................................    (184)       (233)        (90)
                                                              ------     -------      ------
Pro forma net income (loss).................................  $ (568)    $(2,098)     $  890
                                                              ======     =======      ======
Earnings per share:
  Basic -- as reported......................................  $(0.10)    $ (0.49)     $ 0.33
  Basic -- pro forma........................................  $(0.15)    $ (0.56)     $ 0.32
  Diluted -- as reported....................................  $(0.10)    $ (0.50)     $ 0.31
  Diluted -- pro forma......................................  $(0.15)    $ (0.57)     $ 0.18
</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

                                        50
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.


     In December 2004, the FASB issued SFAS No. 123(R), which amends SFAS No.
123 and supersedes APB Opinion No. 25. SFAS No. 123(R) requires compensation
expense to be recognized for all share-based payments made to employees based on
the fair value of the award at the date of grant, eliminating the intrinsic
value alternative allowed by SFAS No. 123. Generally, the approach for
determining fair value under the original pronouncement has not changed.
However, there are revisions to the accounting guidelines established, such as
accounting for forfeitures, that will change our accounting for stock-based
awards in the future.


     SFAS No. 123(R) must be adopted in the first annual period beginning after
June 15, 2005. The statement allows companies to adopt its provisions using
either of the following transition alternatives:

     - The modified prospective method, which results in the recognition of
       compensation expense using SFAS No. 123(R) for all share-based awards
       granted after the effective date and the recognition of compensation
       expense using SFAS No. 123 for all previously granted share-based awards
       that remain unvested at the effective date; or

     - The modified retrospective method, which results in applying the modified
       prospective method and restating prior periods by recognizing the
       financial statement impact of share-based payments in a manner consistent
       with the pro forma disclosure requirements of SFAS No. 123. The modified
       retrospective method may be applied to all prior periods presented or
       previously reported interim periods of the year of adoption.


     We currently plan to adopt SFAS No. 123(R) on July 1, 2005 using the
modified prospective method. This change in accounting is not expected to
materially impact our financial position. However, because we currently account
for share-based payments to our employees using the intrinsic value method, our
results of operations have not included the recognition of compensation expense
for the issuance of stock option awards. We have not calculated the impact of
this statement on our previous or future operating results as we are still
determining the appropriate fair value method to be used.


     We will be required to recognize expense related to stock options and other
types of equity-based compensation beginning in 2005 and such cost must be
recognized over the period during which an employee is required to provide
service in exchange for the award. The requisite service period is usually the
vesting period. The standard also requires us to estimate the number of
instruments that will ultimately be issued, rather than accounting for
forfeitures as they occur. Additionally, we may be required to change our method
for determining the fair value of stock options.

     In December 2004, the FASB issued Staff Position FSP 109-2, "Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision within the
American Jobs Creation Act of 2004" (FSP 109-2), which provides guidance on
accounting for the potential impact of the repatriation provisions of the
American Jobs Creation Act of 2004 (the Jobs Act) on enterprises' income tax
expense and deferred tax liability. The Jobs Act was enacted on October 22,
2004. FSP 109-2 states that an enterprise is allowed time beyond the financial
period of

                                        51
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or
repatriation of foreign earnings for purposes of applying SFAS No. 109. Based on
our analysis to date, we are not yet in a position to decide on whether, or to
what extent, we might repatriate foreign earnings under the Jobs Act.

2.  DISCONTINUED OPERATIONS

     Prior to 2002, I-Sector sold three businesses that have contributed to
discontinued operations in subsequent periods. In 1999, I-Sector decided to sell
both its computer products reselling business and its PBX telephone systems
dealer business, which together accounted for approximately 90% of total revenue
at the time. I-Sector closed the sale of its PBX telephone systems dealer
business, its Telecom Systems division, on March 16, 2000 and closed the sale of
its computer products reselling business, its Computer Products division, on May
19, 2000. On December 31, 2001, I-Sector finalized the sale of IT Staffing, its
computer personnel staffing business.

     During the periods specified below, I-Sector recognized a gain on disposal,
net of income tax provision, of these three businesses as follows:


<Table>
<Caption>
                                                                 DECEMBER 31,
                                                              ------------------
                                                              2002   2003   2004
                                                              ----   ----   ----
<S>                                                           <C>    <C>    <C>
IT Staffing, Inc. (net of taxes of $(7), $14 and $--,
  respectively).............................................  $(13)  $ 26   $--
Computer Products Division (net of taxes of $53, 53 and $19,
  respectively).............................................   104    104    39
Telecom Division (net of taxes and taxes of $88, 41 and $--,
  respectively).............................................   171     80    (1)
                                                              ----   ----   ---
Gain on disposal of discontinued operations, net of taxes...  $262   $210   $38
                                                              ====   ====   ===
</Table>


     The balance sheet caption "Net liabilities related to discontinued
operations" contains $557 and $625 at December 31, 2003 and 2004, respectively,
of estimated future expenses related to the winding up of the IT Staffing
business, 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 2004. The Company also reduced $17 of reserves
for legal costs relating to the Computer Products division.

3.  ACCOUNTS AND NOTES RECEIVABLE

     Accounts receivable consisted of the following:

<Table>
<Caption>
                                                                DECEMBER 31,
                                                              -----------------
                                                               2003      2004
                                                              -------   -------
<S>                                                           <C>       <C>
Accounts receivable.........................................  $10,276   $29,421
Accounts receivable retained -- discontinued operations.....       93        89
Allowance for doubtful accounts.............................     (612)   (1,274)
                                                              -------   -------
Total.......................................................  $ 9,757   $28,236
                                                              =======   =======
</Table>

     Notes receivable short-term consisted of the following:

<Table>
<Caption>
                                                               DECEMBER 31,
                                                              ---------------
                                                               2003     2004
                                                              ------   ------
<S>                                                           <C>      <C>
Notes receivable, short-term................................  $1,049   $2,103
Allowance for doubtful accounts, short-term.................    (373)    (872)
                                                              ------   ------
Total.......................................................  $  676   $1,231
                                                              ======   ======
</Table>

                                        52
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Notes receivable long-term consisted of the following:

<Table>
<Caption>
                                                              DECEMBER 31,
                                                              -------------
                                                              2003    2004
                                                              -----   -----
<S>                                                           <C>     <C>
Notes receivable, long-term.................................  $ 502   $ 457
Allowance for doubtful accounts, long-term..................   (250)   (250)
                                                              -----   -----
Total.......................................................  $ 252   $ 207
                                                              =====   =====
</Table>

4.  PROPERTY AND EQUIPMENT

     Property and equipment consisted of the following:

<Table>
<Caption>
                                                                DECEMBER 31,
                                                              -----------------
                                                               2003      2004
                                                              -------   -------
<S>                                                           <C>       <C>
Equipment...................................................  $   270   $   292
Computer equipment..........................................    1,888     2,658
Furniture and fixtures......................................      330       382
Leasehold improvements......................................      623       747
Vehicles....................................................       47       105
                                                              -------   -------
                                                                3,158     4,184
Accumulated depreciation and amortization...................   (1,887)   (2,397)
                                                              -------   -------
Total.......................................................  $ 1,271   $ 1,787
                                                              =======   =======
</Table>

     Property and equipment are depreciated over their estimated useful lives
ranging from three to ten years using the straight-line method. Depreciation
expense totaled $356, $466 and $513 for 2002, 2003 and 2004, respectively.
Assets under capital leases at December 31, 2003 and 2004 totaled $63 and $63
with $1 and $6 of recorded amortization for 2003 and 2004, respectively.

                                        53
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

5.  SEGMENT INFORMATION

     I-Sector has four reportable segments: INX, Stratasoft, Valerent and
Corporate. Corporate is not an 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 views 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 following table. The tables below show the results of
the four reportable segments:

     For the year ended December 31, 2004:

<Table>
<Caption>
                                        INX     STRATASOFT   VALERENT   CORPORATE   ELIMINATIONS   CONSOLIDATED
                                      -------   ----------   --------   ---------   ------------   ------------
<S>                                   <C>       <C>          <C>        <C>         <C>            <C>
Revenue:
  Products..........................  $71,646     $   --      $1,829      $  --        $(795)        $72,680
  Services..........................    6,280         --       5,113         --           --          11,393
  Custom projects...................       --      8,996          --         --           --           8,996
                                      -------     ------      ------      -----        -----         -------
Total revenue.......................   77,926      8,996       6,942         --         (795)         93,069
                                      -------     ------      ------      -----        -----         -------
Cost of goods and services:
  Products..........................   60,802         --       1,687         --         (795)         61,694
  Services..........................    4,183         --       3,090         --           --           7,273
  Custom projects...................       --      4,150          --         --           --           4,150
                                      -------     ------      ------      -----        -----         -------
Cost of goods and services..........   64,985      4,150       4,777         --         (795)         73,117
                                      -------     ------      ------      -----        -----         -------
Gross profit........................   12,941      4,846       2,165         --           --          19,952
Selling, general and administrative
  expenses..........................   10,295      5,100       1,886        973           --          18,254
                                      -------     ------      ------      -----        -----         -------
Operating income (loss).............  $ 2,646     $ (254)     $  279      $(973)       $  --           1,698
                                      =======     ======      ======      =====        =====
Interest and other income (expense),
  net...............................                                                                    (108)
                                                                                                     -------
Income from continuing operations
  before income taxes...............                                                                   1,590
Income tax expense..................                                                                      19
                                                                                                     -------
Net income from continuing
  operations before minority
  interest..........................                                                                   1,609
Minority interest...................                                                                    (117)
Gain on disposal of discontinued
  operations, net of taxes..........                                                                      38
                                                                                                     -------
Net income..........................                                                                 $ 1,530
                                                                                                     =======
Selected Balance Sheet Information:
  Trade accounts receivable, net....  $25,847     $  803      $1,497      $  89        $  --         $28,236
                                      =======     ======      ======      =====        =====         =======
  Inventory.........................  $ 1,000     $  697      $   81      $  --        $  --         $ 1,778
                                      =======     ======      ======      =====        =====         =======
</Table>

                                        54
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     For the year ended December 31, 2003:

<Table>
<Caption>
                                        INX     STRATASOFT   VALERENT   CORPORATE   ELIMINATIONS   CONSOLIDATED
                                      -------   ----------   --------   ---------   ------------   ------------
<S>                                   <C>       <C>          <C>        <C>         <C>            <C>
Revenue:
  Products..........................  $45,749    $    --      $1,573     $    --       $(422)        $46,900
  Services..........................    4,226         --       3,503          --          (4)          7,725
  Custom projects...................       --      7,527          --          --          --           7,527
                                      -------    -------      ------     -------       -----         -------
Total revenue.......................   49,975      7,527       5,076          --        (426)         62,152
                                      -------    -------      ------     -------       -----         -------
Cost of goods and services:
  Products..........................   40,060         --       1,421          --        (421)         41,060
  Services..........................    2,976         --       2,412          --          (5)          5,383
  Custom projects...................       --      2,982          --          --          --           2,982
                                      -------    -------      ------     -------       -----         -------
Cost of goods and services..........   43,036      2,982       3,833          --        (426)         49,425
                                      -------    -------      ------     -------       -----         -------
Gross profit........................    6,939      4,545       1,243          --          --          12,727
Selling, general and administrative
  expenses..........................    6,045      5,888       1,963       1,165          --          15,061
                                      -------    -------      ------     -------       -----         -------
Operating income (loss).............  $   894    $(1,343)     $ (720)    $(1,165)      $  --          (2,334)
                                      =======    =======      ======     =======       =====
Interest and other income, net......                                                                     107
                                                                                                     -------
Loss from continuing operations
  before income taxes...............                                                                  (2,227)
Benefit from income taxes...........                                                                     181
                                                                                                     -------
Net loss from continuing
  operations........................                                                                  (2,046)
Gain on disposal of discontinued
  operations, net of taxes..........                                                                     210
                                                                                                     -------
Net loss............................                                                                 $(1,836)
                                                                                                     =======
Selected Balance Sheet Information:
  Accounts receivable, net..........  $ 7,898    $   978      $  788     $    --       $  --         $ 9,664
                                      =======    =======      ======     =======       =====
  Accounts receivable retained from
     discontinued operations, net...                                                                      93
                                                                                                     -------
  Total accounts receivable, net....                                                                 $ 9,757
                                                                                                     =======
  Inventory.........................  $   365    $   657      $   16     $    --       $  --         $ 1,038
                                      =======    =======      ======     =======       =====         =======
</Table>

                                        55
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     For the year ended December 31, 2002:

<Table>
<Caption>
                                       INX     STRATASOFT   VALERENT   CORPORATE   ELIMINATIONS   CONSOLIDATED
                                     -------   ----------   --------   ---------   ------------   ------------
<S>                                  <C>       <C>          <C>        <C>         <C>            <C>
Revenue:
  Products.........................  $28,990     $   --     $ 1,092      $  --        $(277)        $29,805
  Services.........................    1,748         --       3,900                      (1)          5,647
  Custom projects..................       --      6,569          --                      --           6,569
                                     -------     ------     -------      -----        -----         -------
Total revenue......................   30,738      6,569       4,992         --         (278)         42,021
                                     -------     ------     -------      -----        -----         -------
Cost of goods and services:
  Products.........................   25,659         --       1,055         --         (277)         26,437
  Services.........................    1,658         --       2,738         --           (1)          4,395
  Custom projects..................       --      2,920          --         --           --           2,920
                                     -------     ------     -------      -----        -----         -------
Cost of goods and services.........   27,317      2,920       3,793         --         (278)         33,752
                                     -------     ------     -------      -----        -----         -------
Gross profit.......................    3,421      3,649       1,199         --           --           8,269
Selling, general and administrative
  expenses.........................    3,545      3,922       2,236        922           --          10,625
                                     -------     ------     -------      -----        -----         -------
Operating income (loss)............  $  (124)    $ (273)    $(1,037)     $(922)       $  --          (2,356)
                                     =======     ======     =======      =====        =====
Interest and other income, net.....                                                                     115
                                                                                                    -------
Loss from continuing operations
  before income taxes..............                                                                  (2,241)
Benefit from income taxes..........                                                                   1,595
                                                                                                    -------
Net loss from continuing
  operations.......................                                                                    (646)
Gain on disposal of discontinued
  operations, net of taxes.........                                                                     262
                                                                                                    -------
Net loss...........................                                                                 $  (384)
                                                                                                    =======
</Table>

     International sales accounted for $1,851, $3,179 and $2,132 or 4.4%, 5.1%
and 2.3% of consolidated revenue in 2002, 2003 and 2004, respectively, and were
primarily in the Stratasoft segment. International sales accounted for 23.7% of
the Stratasoft segment revenue in the year ended December 31, 2004.
International sales are derived primarily from United States, Canada, the United
Kingdom, Germany, Greece, India, Egypt, The Philippines, Japan and Grenada.

     The INX segment had one customer, Micro System Enterprise, Inc./Acclaim
Professional Services ("MSE"), an agent related to the DISD E-Rate funded
program that represented 16.1% of the consolidated revenue for the year ended
December 31, 2004 and 49.5% of the net account receivables at December 31, 2004.
The Company had no single customer that represented 10% or more of our total
consolidated revenue during the years ended December 31, 2002 or 2003.

6.  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.

                                        56
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     The potentially dilutive options of 101,318 and 215,395 for the years ended
December 31, 2002 and 2003, 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. For the year ended December 31, 2004
no options were excluded in the calculation of diluted earnings.

     The potentially dilutive options of the Company's wholly-owned subsidiary,
Internetwork Experts, Inc., (see Note 14) did not impact the calculation of
I-Sector's earnings per share for 2002 since the effect would have been
antidilutive. In 2003, net loss from continuing operations for purposes of
computing the loss per share increased $29 for the assumed exercise of INX
options under the treasury method, and in 2004 the net income from continuing
operations for purposes of computing the earnings per share decreased $550 for
the assumed exercise of INX options under the treasury method.

<Table>
<Caption>
                                                                   DECEMBER 31,
                                                       ------------------------------------
                                                          2002         2003         2004
                                                       ----------   ----------   ----------
<S>                                                    <C>          <C>          <C>
Numerator for basic earnings per share:
  Net income (loss) from continuing operations before
     minority interest...............................  $     (646)  $   (2,046)  $    1,609
  Minority interest..................................          --           --         (117)
  Gain on disposal of discontinued operations, net of
     taxes...........................................         262          210           38
                                                       ----------   ----------   ----------
Net income (loss)....................................  $     (384)  $   (1,836)  $    1,530
                                                       ==========   ==========   ==========
Numerator for diluted earnings per share:
  Net income (loss) from continuing operations before
     minority interest...............................  $     (646)  $   (2,046)  $    1,609
  Minority interest..................................          --           --         (117)
  INX income attributable to potential minority
     interest net income (loss) from continuing
     operations used in computing loss per share.....          --          (29)        (550)
                                                       ----------   ----------   ----------
Net income (loss) from continuing operations used in
  computing income (loss) per share..................        (646)      (2,075)         942
Gain on disposal of discontinued operations, net of
  taxes..............................................         262          210           38
                                                       ----------   ----------   ----------
Net income (loss)....................................  $     (384)  $   (1,865)  $      980
                                                       ==========   ==========   ==========
Denominator for basic earnings per
  share -- weighted-average shares outstanding.......   3,709,689    3,691,052    4,569,507
Effect of dilutive securities:
  Shares issuable from assumed conversion of common
     stock options and restricted stock..............          --           --      434,886
                                                       ----------   ----------   ----------
Denominator for diluted earnings per share --
  weighted-average shares outstanding................   3,709,689    3,691,052    5,004,393
                                                       ==========   ==========   ==========
</Table>


     There were warrants to purchase 176,750 shares of common stock for 2002
which were not included in computing diluted earnings per share because the
inclusion would have been anti-dilutive. During the three months ended September
30, 2002 such warrants expired and the carrying value of the warrants was
recognized as additional paid in capital. For 2004 we did not include 50,000
warrants issued in 2004 to purchase units, nor did we include 635,000 warrants
issued in 2004 to purchase common stock in determination of the dilutive shares
since their exercise prices exceeded the $7.65 per share price of the common
stock on December 31, 2004.


                                        57
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

7.  DEBT

     On September 27, 2001, Stratasoft, a subsidiary of I-Sector, 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 of $30, $17 and $12 in 2002, 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 $80 and long-term debt of $103
at December 31, 2004.

     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 and $6 of interest in 2003 and 2004,
respectively. In connection with this capital lease, I-Sector has recorded
short-term debt maturing within one year of $17 and long-term debt of $19 at
December 31, 2004.

     In connection with its credit agreement for the purchase of inventory
discussed immediately below, $1,688 and $8,122 of the outstanding balance on
such credit line was interest bearing at December 31, 2003 and 2004,
respectively, and is reflected as short-term debt in the accompanying balance
sheets.

     I-Sector and Textron revised the Floorplan Loan agreement on September 30,
2004 to increase the floorplan line of credit to $25,000. Under the revised
agreement the aggregate outstanding principal amount of all Floorplan Loans
shall not, at any time, exceed the sum of (a) 80% of the aggregate net invoice
prices of all Eligible Receivable plus (b) (i) for so long as the Borrower is
discharging its undertakings in respect of the Master Dallas Independent School
District Contract (DISD) or any DISD Receivable is owing to it, 90% of the
invoice price of (1) all Floorplanned Inventory and (2) all DISD Inventory that
is Eligible Inventory, provided that the sum of the amounts in clauses (1) and
(2) above shall be limited to the lesser of $9,000 or 35% of the net invoice
prices of all outstanding Eligible Receivables and (ii) after the Borrower has
discharged its undertakings in respect of the Master DISD Contract and all DISD
Receivables owing to it have been paid, the least of (1) 90% of the invoice
price of all Floorplanned Inventory, (2) 30% of the net invoice prices of all
outstanding Eligible Receivables and (3) $6,000. Borrower shall, within two (2)
Business Days of the aggregate outstanding principal amount of the Floorplan
Loans exceeding at any time the aforesaid sum, prepay the Floorplan Loans in an
aggregate principal amount sufficient so that this covenant shall not be
violated. Inventory floor plan borrowings are reflected in accounts payable in
the accompanying consolidated balance sheets, except for $1,688 and $8,122 that
is interest bearing and is reflected in short term debt in the accompanying
consolidated balance sheets at December 31, 2003 and December 31, 2004,
respectively. Borrowings accrue interest at the prime rate (5.25% at December
31, 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 indebtedness to
tangible capital funds ratio; minimum working capital; minimum cash on hand;
minimum current ratio; and minimum earnings before interest, taxes, depreciation
and amortization (EBITDA). On December 29, 2004 I-Sector as stipulated in the
revised agreement entered into a Memorandum of Understanding (MOU) with Micro
System Enterprise, Inc. (MSE) and Textron among other members of the DISD
consortium regarding the payment procedures under the Master DISD Contract when
such agreement has been finalized among such parties. At December 31, 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 (a participating
partner with Textron) for those events, which, if not obtained, could accelerate
repayment and require I-Sector to seek other sources of finance. At December 31,
2004, I-Sector had $16,024 outstanding on inventory floor plan finance
borrowings, and the remaining credit availability was $8,976, subject to
borrowing limitations as described above.

                                        58
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)


     The weighted-average interest rate for borrowings under all credit line
arrangements in effect during, 2002, 2003 and 2004 was 0%, 6.73% and 7.37%,
respectively. Interest expense on all credit lines was $0, $29 and $189 for the
years ended December 31, 2002, 2003 and 2004, respectively. Maturities of the
debt at December 31, 2004 are as follows:


<Table>
<S>                                                            <C>
2005........................................................   $8,220
2006........................................................      115
2007........................................................        7
                                                               ------
Total.......................................................   $8,342
                                                               ======
</Table>

8.  INCOME TAXES

     The provision for income taxes consisted of the following:

<Table>
<Caption>
                                                               YEAR ENDED DECEMBER 31,
                                                              -------------------------
                                                                2002      2003    2004
                                                              --------   ------   -----
<S>                                                           <C>        <C>      <C>
Current provision (benefit):
  Federal...................................................  $(1,595)   $(181)   $(19)
  State.....................................................       --       --      --
                                                              -------    -----    ----
Total current provision (benefit)...........................   (1,595)    (181)    (19)
Deferred provision (benefit)................................       --       --      --
                                                              -------    -----    ----
Total benefit form continuing operations....................   (1,595)    (181)    (19)
Total benefit from discontinued operations..................       --       --      --
                                                              -------    -----    ----
Total provision for gain on disposal........................      136      108      19
                                                              -------    -----    ----
Total.......................................................  $(1,459)   $ (73)   $ --
                                                              =======    =====    ====
</Table>

     The total provision for income taxes for continuing operations during the
years ended December 31, 2002, 2003 and 2004 varied from the U.S. federal
statutory rate due to the following:

<Table>
<Caption>
                                                              YEAR ENDED DECEMBER 31,
                                                              -----------------------
                                                               2002     2003    2004
                                                              -------   -----   -----
<S>                                                           <C>       <C>     <C>
Federal income tax at statutory rate........................  $  (762)  $(757)  $ 541
Tax benefit of non-qualified options........................       --      --    (568)
Non-deductible expenses.....................................       18      20      67
Other.......................................................       --      (2)    182
Valuation allowance.........................................     (851)    558    (241)
                                                              -------   -----   -----
  Total benefit from continuing operations..................  $(1,595)  $(181)  $ (19)
                                                              =======   =====   =====
</Table>

                                        59
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Net deferred tax assets computed at the statutory rate related to temporary
differences were as follows:


<Table>
<Caption>
                                                                DECEMBER 31,
                                                              -----------------
                                                               2003      2004
                                                              -------   -------
<S>                                                           <C>       <C>
Net deferred tax assets (liabilities):
  Accounts and notes receivable.............................  $   458   $   598
  Closing and severance costs...............................      189       212
  Deferred service revenue..................................      (35)     (344)
  Inventory.................................................       13        17
  Amortization of intangibles...............................      (17)       (9)
  Depreciation..............................................      (63)      (27)
  Net operating loss carryforward...........................      806       663
                                                              -------   -------
     Total..................................................    1,351     1,110
Less: Valuation allowance...................................   (1,351)   (1,110)
                                                              -------   -------
     Total..................................................  $    --   $    --
                                                              =======   =======
</Table>


     Due to the company's recurring losses, a valuation allowance was
established to fully offset the net deferred tax assets at December 31, 2003 and
2004.

     At December 31, 2004, I-Sector has a net operating loss (NOL) carryforward
for federal income tax reporting purposes of approximately $1,950. Since United
States tax laws limit the time during which an NOL may be applied against future
taxable income and tax liabilities, I-Sector may not be able to take full
advantage of its NOL carryforward for federal income tax purposes. The
carryforward will expire in 2023 if not otherwise used. A change in ownership,
as defined by federal income tax regulations, could significantly limit
I-Sector's ability to utilize its carryforward.

     During 2003 and 2004, a significant number of non-qualified options were
exercised creating an excess income tax benefit for I-Sector. This benefit will
be utilized to the extent that I-Sector has tax basis income that was not offset
by net operating loss (NOL) carryforwards. At December 31, 2004, approximately
$243 of the valuation allowance has been attributed to "excess benefit due to
options." The company will use this portion only when the valuation allowance
has been reduced by approximately $420. Any tax benefit that is realized in
subsequent years from the reduction of the valuation allowance established
related to these options will be recorded as an expense and additional paid-in
capital.

     On March 9, 2002, President Bush signed into law the Job Creation and
Worker Assistance Act of 2002. The law provides for the carryback of net
operating losses for any taxable year ending during 2001 and 2002 to each of the
5 tax years preceding the loss year. Previously, a net operating loss was only
eligible to be carried back to the 2 years preceding the year of loss. As a
result of the change in the carryback period, I-Sector recognized a tax benefit
of $73 and $ -- in the years ended December 31, 2003 and 2004, respectively.
Additionally, on July 24, 2003 the Company received $561 in tax refunds.

                                        60
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

9.  ACCRUED EXPENSES

     Accrued expenses consisted of the following:

<Table>
<Caption>
                                                               DECEMBER 31,
                                                              ---------------
                                                               2003     2004
                                                              ------   ------
<S>                                                           <C>      <C>
Sales tax payable...........................................  $  374   $  336
Accrued employee benefits, payroll and other related
  costs.....................................................   1,359    2,279
Accrued property taxes......................................       4        8
Accrued offering costs......................................     317       --
Accrued warranty costs......................................     302      361
Other.......................................................     320    1,187
                                                              ------   ------
  Total.....................................................  $2,676   $4,171
                                                              ======   ======
</Table>

10.  COMMITMENTS AND CONTINGENCIES

     Litigation -- 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.

     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.

     Leases -- I-Sector leases office space from Allstar Equities, Inc. Rental
expense under this agreement amounted to approximately $446, $446, and $446
during years ended December 31, 2002, 2003 and 2004, respectively. Additionally,
future minimum rentals on other operating leases amount to approximately $358 in
2005, $341 in 2006, $228 in 2007 and $206 in 2008. Amounts paid during the years
ended December 31, 2002, 2003 and 2004, under such agreements totaled
approximately $131, $295 and $270, respectively.

     401(k) Plan -- I-Sector maintains a 401(k) savings plan wherein I-Sector
matches a portion of the employee contribution. In addition, I-Sector has a
discretionary matching fund based on the net profitability of I-Sector. All
full-time employees who have completed 90 days of service with I-Sector are
eligible to participate in the plan. Declaration of the discretionary portion of
the matching fund is the decision of the Board. I-Sector has made no additional
contributions to the plan for the years ended December 31, 2002, 2003 or 2004.
Under the standard I-Sector matching program, I-Sector's match was $27, $31 and
$39 for the years ended December 31, 2002, 2003 and 2004, respectively.

11.  RELATED PARTY TRANSACTIONS

     The Company leases office space from Allstar Equities, Inc., a Texas
corporation ("Equities"), a company wholly owned by the CEO. 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.

                                        61
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     From time to time, I-Sector makes short-term loans and travel advances to
its non-executive employees. The balance of approximately $17 relating to these
loans and advances is included in the Company's balance sheet and reported as
part of Accounts receivable -- other at December 31, 2004.

12.  INTANGIBLE ASSETS

<Table>
<Caption>
                                         DECEMBER 31, 2003         DECEMBER 31, 2004
                                      -----------------------   -----------------------
                                       GROSS                     GROSS                      WEIGHTED
                                      CARRYING   ACCUMULATED    CARRYING   ACCUMULATED    AMORTIZATION
                                       AMOUNT    AMORTIZATION    AMOUNT    AMORTIZATION      YEARS
                                      --------   ------------   --------   ------------   ------------
<S>                                   <C>        <C>            <C>        <C>            <C>
Amortized intangible assets
  Patent licenses right.............   $1,114        $265        $1,114       $  375          6.71
  Customer list.....................      602         231           836          492          1.31
  Other.............................      168         104           168          138          0.90
                                       ------        ----        ------       ------
Total...............................   $1,884        $600        $2,118       $1,005
                                       ======        ====        ======       ======
</Table>

     The estimated aggregate amortization expense for each of the next five
years and thereafter is as follows:

<Table>
<S>                                                            <C>
2005........................................................   $  418
2006........................................................      175
2007........................................................      110
2008........................................................      110
2009........................................................      110
Thereafter..................................................      190
                                                               ------
  Total.....................................................   $1,113
                                                               ======
</Table>

     On April 7, 2003, I-Sector's subsidiary, INX, acquired certain assets and
liabilities of one of its competitors, Digital Precision, Inc. ("Digital").
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 of Digital
valued at $376, as well as assumed certain operating leases of equipment and
office space 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. That contingency
was resolved in April 2004 when INX issued 1,800,000 shares to the certain key
employees, and I-Sector recognized a minority interest of $162 in its
consolidated balance sheet related to the issuance of INX's common stock (see
Note 14). No goodwill was recognized in the acquisition. The results of
operations subsequent to April 2003 and prior to April 2004 are included in
I-Sector's consolidated statement of operations. At December 31, 2004 I-Sector
recognized minority interest of $117 in its consolidated statement of operations
related to the INX operating income subsequent to April 7, 2004 and $279 in its
consolidated balance sheet.

13.  STOCKHOLDERS' EQUITY

  STOCK OPTION PLANS

     Under the 1996 Incentive Stock Plan (the "1996 Incentive Plan") and the
1996 Non-Employee Director Stock Option Plan (the "Director Plan") as approved
by the shareholders, I-Sector's Compensation Committee may grant up to 417,500
shares of common stock, which have been reserved for issuance to certain
employees of I-Sector. At December 31, 2004, 5,150 shares were available for
future grant under the 1996 Incentive Plan. The 1996 Incentive Plan provides for
the granting of incentive awards in the form of stock options, restricted stock,

                                        62
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

phantom stock, stock bonuses and cash bonuses in accordance with the provisions
of the plan. Additionally, no shares may be granted after the tenth anniversary
of the 1996 Incentive Plan's adoption. I-Sector has reserved for issuance, under
the Director Plan, 100,000 shares of common stock, subject to certain
anti-dilution adjustments, of which no shares were available for future grants
at December 31, 2004. The Director Plan provides for a one-time option by newly
elected directors to purchase up to 5,000 common shares, after which each
director is entitled to receive an option to purchase up to 5,000 common shares
upon each date of re-election to I-Sector's Board of Directors. Options granted
under the Director Plan and the 1996 Incentive Plan have an exercise price equal
to the fair market value on the date of grant and generally expire ten years
after the grant date.

     In May 2000, I-Sector adopted the 2000 Stock Incentive Plan (the "2000
Incentive Plan") as approved at the annual shareholder's meeting. At the August
20, 2003 shareholder's meeting, the 2000 Incentive Plan was amended and
restated, including a change in the name of the plan to I-Sector Corporation
Incentive Plan ("I-Sector Incentive Plan") and amendments to make it compliant
with both the Sarbanes-Oxley Act of 2002 and with Section 162(m) and other
sections of the Internal Revenue Code. Additionally, the plan was amended to
increase the number of shares of common stock available for granting stock
options to 600,000 in 2003. At the December 30, 2004 shareholder's meeting
I-Sector Incentive Plan was amended to increase the number of shares of common
stock available for stock option grants to 900,000. The I-Sector Incentive Plan
provides for the granting of incentive awards in the form of stock-based awards
and cash bonuses in accordance with the provisions of the plan. All employees,
including officers, and consultants and non-employee directors are eligible to
participate in the I-Sector Incentive Plan. Generally, the Compensation
Committee has the discretion to determine the exercise price of each stock
option under the I-Sector Incentive Plan, and they must be exercised within ten
years of the grant date, except those classified as Incentive Stock Option
("ISO") grants to a 10% or greater stockholder. ISO options grants to a 10% or
greater stockholder must be exercised within five years of the grant date. The
exercise price of each ISO option grant may not be less than 100% of the fair
market value of a share of common stock on the date of grant (110% in the case
of a 10% or greater stockholder). At December 31, 2004, 339,500 shares were
available for future option grants under the I-Sector Incentive Plan.

                                        63
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     The activity of employees in all plans is summarized below:

<Table>
<Caption>
                                                           YEAR ENDED DECEMBER 31,
                                       ---------------------------------------------------------------
                                              2002                  2003                  2004
                                       -------------------   -------------------   -------------------
                                                  WEIGHTED              WEIGHTED              WEIGHTED
                                                  AVERAGE               AVERAGE               AVERAGE
                                                  EXERCISE              EXERCISE              EXERCISE
                                        SHARES     PRICE      SHARES     PRICE      SHARES     PRICE
                                       --------   --------   --------   --------   --------   --------
<S>                                    <C>        <C>        <C>        <C>        <C>        <C>
Options outstanding at beginning of
  the period.........................   399,812    $1.48      396,042    $1.47      501,966    $2.85
Granted during the period............    25,000     1.20      338,760     3.58       95,000     7.52
Exercised during the period..........        --       --     (222,736)    1.44      (58,665)    3.47
Transfers to non-employees...........   (11,330)     .99           --       --
Canceled during the period...........   (17,440)    1.66      (10,100)    1.36      (21,480)    2.13
                                       --------              --------              --------
Options outstanding at end of
  period.............................   396,042    $1.47      501,966    $2.85      516,821    $3.70
                                       ========              ========              ========
Options exercisable at end of
  period.............................   369,312    $1.46      259,406    $1.81      357,287    $2.83
                                       ========              ========              ========
Options outstanding price range......     $0.82                 $0.82                 $0.82
                                       to $7.62              to $8.06              to $8.06
Weighted average fair value of
  options granted during the
  period.............................     $1.20                 $2.55                 $7.52
Options weighted average remaining
  life...............................      6.29                  8.39                  7.77
                                          Years                 Years                 Years
</Table>

<Table>
<Caption>
                                                                   EMPLOYEE AND DIRECTOR
                                               -------------------------------------------------------------
                                                           OUTSTANDING                     EXERCISABLE
                                               ------------------------------------   ----------------------
                                                              WEIGHTED
                                                               AVERAGE     WEIGHTED                 WEIGHTED
                                                              REMAINING    AVERAGE                  AVERAGE
                                               OUTSTANDING   CONTRACTUAL   EXERCISE   EXERCISABLE   EXERCISE
                                                 SHARES         LIFE        PRICE       SHARES       PRICE
                                               -----------   -----------   --------   -----------   --------
<S>                                            <C>           <C>           <C>        <C>           <C>
$0.82 to $1.99...............................    164,421        5.29        $1.41       143,855      $1.37
$2.00 to $2.99...............................     90,600        8.28         2.63        90,430       2.63
$3.00 to $3.99...............................         --          --           --            --         --
$4.00 to $4.99...............................    156,800        8.76         4.14       104,668       4.14
$5.00 to $8.06...............................    105,000        9.72         7.57        18,334       7.72
                                                 -------                                -------
  Total......................................    516,821        7.77        $3.70       357,287      $2.83
                                                 =======                                =======
</Table>

     Employees affected by the sale of the Telecom Division on March 16, 2000
and of the Computer Products Division on May 19, 2000 (See Note 2) retained
their respective stock option grants received prior to I-Sector's disposal of
these divisions. In addition, certain affected employees were eligible and
received stock options awards subsequent to their termination dates. The
affected employees' awards will vest or continue to vest according to the
periods specified in their respective stock option agreements, generally five
years, contingent upon the employment with the respective division's acquirer.

                                        64
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     The activity of options to the non-employee group is summarized below:

<Table>
<Caption>
                                                           YEAR ENDED DECEMBER 31,
                                       ---------------------------------------------------------------
                                              2002                  2003                  2004
                                       -------------------   -------------------   -------------------
                                                  WEIGHTED              WEIGHTED              WEIGHTED
                                                  AVERAGE               AVERAGE               AVERAGE
                                                  EXERCISE              EXERCISE              EXERCISE
                                        SHARES     PRICE      SHARES     PRICE      SHARES     PRICE
                                       --------   --------   --------   --------   --------   --------
<S>                                    <C>        <C>        <C>        <C>        <C>        <C>
Options outstanding at beginning of
  the period.........................   181,483    $1.45      168,280    $1.43      187,532    $1.92
Transferred from employee plan.......    10,200     0.99           --       --
Exercised during the period..........        --       --      (98,748)    1.56      (41,680)    1.83
Grants during the period.............        --       --      118,000     2.32
Canceled during the period...........   (23,403)    1.72           --       --       (9,752)    1.54
                                       --------              --------              --------
Options outstanding at end of
  period.............................   168,280    $1.43      187,532    $1.92      136,100     2.11
                                       ========              ========              ========
Options exercisable at end of
  period.............................   151,859    $1.42      165,492    $1.62      136,100     2.11
                                       ========              ========              ========
Options outstanding price range......     $1.06                 $1.06                 $1.06
                                       to $2.31              to $4.14              to $4.14
Options weighted average remaining
  life...............................      3.13                  5.33                  7.59
                                          Years                 Years                 Years
</Table>

<Table>
<Caption>
                                                                       NON-EMPLOYEE
                                               -------------------------------------------------------------
                                                           OUTSTANDING                     EXERCISABLE
                                               ------------------------------------   ----------------------
                                                              WEIGHTED
                                                               AVERAGE     WEIGHTED                 WEIGHTED
                                                              REMAINING    AVERAGE                  AVERAGE
                                               OUTSTANDING   CONTRACTUAL   EXERCISE   EXERCISABLE   EXERCISE
                                                 SHARES         LIFE        PRICE       SHARES       PRICE
                                               -----------   -----------   --------   -----------   --------
<S>                                            <C>           <C>           <C>        <C>           <C>
$0.82 to $1.99...............................    113,500        7.55        $1.82       113,500      $1.82
$2.00 to $2.99...............................      6,600        5.33         2.25         6,600       2.25
$3.00 to $3.99...............................         --          --           --            --         --
$4.00 to $4.99...............................     16,000        8.76         4.14        16,000         --
$5.00 to $6.00...............................         --          --           --            --         --
                                                 -------                                -------
  Total......................................    136,100        7.59        $2.11       136,100      $2.11
                                                 =======                                =======
</Table>

     Capital Stock -- Holders of I-Sector's common stock are entitled to one
vote per share on all matters to be voted on by shareholders and are entitled to
receive dividends, if any, as may be declared from time to time by the Board of
Directors of I-Sector (the "Board"). Upon any liquidation or dissolution of
I-Sector, the holders of common stock are entitled, subject to any preferential
rights of the holders of preferred stock, to receive a pro rata share of all of
the assets remaining available for distribution to shareholders after payment of
all liabilities. There are no shares of preferred stock issued or outstanding.

     Restricted Stock -- At December 31, 2002, I-Sector had 1,200 shares of
restricted stock with a par value of $0.01 per share outstanding. The 1,200
shares, valued at $1.563 per share, vested ratably at the end of each one year
period over a five year period from the date of issuance. At December 31, 2003,
all restrictions on these shares have lapsed.

                                        65
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

14.  SUBSIDIARY STOCK OPTION PLAN

     Each of I-Sector's three primary subsidiaries had an incentive stock option
plan in place, but all of the subsidiary plans except for INX were terminated in
December 2003. The INX plan has not been presented to the shareholders 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 vest typically 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 one
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. 5,431,500 of the options contain an
exercise restriction which only allows 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 8,255,038 options granted and
outstanding, of which 4,260,183 are vested and 1,476,182 are exercisable at
December 31, 2004. The outstanding options have exercise prices ranging from
$0.01 to $0.25 per share with a weighted average of $0.16 per share. There are
no shares in INX's plan available to be issued at December 31, 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
December 31, 2004 and summarize the potential dilutive effect on I-Sector's
ownership in INX if all options granted at December 31, 2004 were fully vested
and option grants were exercised, and include the effects of the issuance of
stock in 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        PERCENT OF
                                                              COMMON STOCK     TOTAL
                                                              ------------   ----------
<S>                                                           <C>            <C>
Ownership of INX shares at December 31, 2004:
  Common Stock owned by I-Sector............................   21,834,333       92.4%
  Common Stock owned by others(5)...........................    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 December 31, 2004.......   21,834,333       68.5%
  Common Stock owned by others at December 31, 2004(5)......    1,800,000        5.6%
  Options granted and outstanding at December 31,
     2004(1)(2)(3)(4)(5)....................................    8,255,038       25.9%
                                                               ----------      ------
  Total at December 31, 2004................................   31,889,371      100.0%
                                                               ==========      ======
</Table>

---------------

(1) Options granted and outstanding at December 31, 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 December 31, 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 year ended December 31, 2003, INX granted fully vested options to
    purchase 1,200,000 shares of INX at an exercise price of $0.25 per share to
    the CEO and Chairman of the Board of I-Sector Corporation.

                                        66
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

    Such option grant was voluntarily canceled by the CEO and Chairman of the
    Board of I-Sector Corporation in February 2004 concurrent 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 at an exercise price of $0.25 per share 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.

(4) The remainder of the shares included in INX option grants outstanding at
    December 31, 2003 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.

(5) On December 29, 2004, I-Sector's Board of Directors authorized an exchange
    of the minority interest and potential minority interest in INX for an
    interest in I-Sector, subject to negotiating and entering into a definitive
    agreement with the security holders of the minority interest and subject to
    I-Sector shareholder approval. (See Note 18)

15.  WARRANTS


     Included in the units issued by I-Sector on May 7, 2004 were 575,000
warrants to purchase common stock at an exercise price of $12.45 per share.
These warrants are exercisable through May 7, 2009 and are subject to redemption
by I-Sector at a price of $0.25 per warrant upon 30 days notice to the holders;
however, we may only redeem the warrants if the closing price for our stock, as
reported on the principal exchange on which our stock trades, for any five
consecutive days has equaled or exceeded $16.60.


     On May 7, 2004 I-Sector issued warrants to the underwriters to purchase up
to 50,000 units at an exercise price equal to $19.92 per unit. These warrants
are exercisable during the four-year period beginning May 7, 2005 which is one
year from the date of the prospectus. Pursuant to NASD Rule 2710(g), these
warrants cannot be sold, transferred, assigned, pledged or hypothecated by any
person for a period of one year following the effective date of the offering,
except to any NASD member participating in the offering, to bona fide officers,
by operation of law or if we are reorganized, so long as the securities so
transferred remain subject to the same transfer restriction for the remainder of
the one-year period. The holder of the representative's warrant will have, in
that capacity, no voting, dividend or other stockholder rights.

     In May 2004 I-Sector issued warrants to an investor relations firm, in
return for services, to purchase up to 60,000 shares of common stock at an
exercise price equal to $14.00 per share. These warrants are exercisable during
the 12 month period beginning May 20, 2005.

16.  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 common 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 the issuance of INX stock occurred, I-Sector's ownership percentage
of INX's common stock declined to 92.38% and I-Sector recognized $162 of
minority interest in its balance sheet at that time.

17.  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

                                        67
<PAGE>
                     I-SECTOR CORPORATION AND SUBSIDIARIES

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 before additional offering expenses. 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 before additional offering expenses. The Company
paid approximately $1,145 of additional offering expenses associated with the
public offering as of December 31, 2004. Net proceeds after all discounts and
expenses were approximately $7,548.

18.  SUBSEQUENT EVENTS (UNAUDITED)

     On March 18, 2005, the Company's stockholders approved the merger of INX
into I-Sector and INX became a wholly-owned subsidiary of the Company. The
exchange of the minority interest resulted in a remeasurement of the stock
options that were part of the minority interest and such remeasurement resulted
in a $5.7 million one-time non-cash charge to earnings, which was equal to the
intrinsic value of the stock options on March 18, 2005. Based on the closing
stock price of $6.25 on March 18, 2005, we expect diluted shares to increase by
approximately 1,161,592 shares as a result of the exchange of the minority
interest.

                                        68
<PAGE>

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

     None.

ITEM 9A.  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, our disclosure controls and procedures at December 31, 2004
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 the
fourth quarter of 2004, there has been no change in our internal control over
financial reporting that has materially affected, or is reasonably likely to
affect, our internal control over financial reporting.

     We will consider further actions and continue to evaluate the effectiveness
of our disclosure controls and internal controls and procedures on an ongoing
basis, taking corrective action as appropriate. Our management does not expect
that disclosure controls and procedures or internal controls can prevent all
error and all fraud. A control system, no matter how well conceived and
operated, can provide only reasonable and not absolute assurance that the
objectives of the control system are met. Further, the design of a control
system must reflect the fact that there are resource constraints, and the
benefits of controls must be considered relative to their costs. While our
management believes that its disclosure controls and procedures provide
reasonable assurance that fraud can be detected and prevented, because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, have been detected.

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS

DIRECTORS

     James H. Long -- Director and Chief Executive Officer, April 1983 to
present.

     James H. Long, age 46, is our founder and has served as our Chairman of the
Board and Chief Executive Officer since our inception in 1983. Mr. Long also
served as our president through December of 2003. Prior to founding I-Sector,
Mr. Long served with the United States Navy in a technical position and was then
employed by IBM in a technical position.

     Donald R. Chadwick -- Director, September 12, 1996 to present.

     Donald R. Chadwick, age 61, served as Secretary from February, 1992 to
August, 2002 and served as our Chief Financial Officer of the Company from
February 1992 until December, 1999. As Chief Financial Officer, his duties
included supervision of finance, accounting and controller functions.

     John B. Cartwright -- Director, August 8, 2001 to present.

     John B. Cartwright, age 58, has been the owner of John B. Cartwright &
Associates, a Certified Public Accounting firm, since 1990. From 1973 to 1990,
Mr. Cartwright was the managing partner or managing shareholder of Cartwright,
Matthews, Gonsoulin & Bradley, PC, Cartwright, Matthews & Gonsoulin, a
Partnership and Cartwright & Matthews, a Partnership. From 1969 to 1973 Mr.
Cartwright was an Audit Supervisor of Touche Ross & Co., (now Deloitte & Touche
LLP) in Houston. Mr. Cartwright is a member of the American Institute of
Certified Public Accountants, Texas Society of Certified Public Accountants,
Houston Chapter of the Texas Society of Certified Public Accountants, and the
past President of the Houston Chapter of the Community Associations Institute.

                                        69
<PAGE>

     Cary M. Grossman -- Director, December 30, 2004 to present.

     Cary M. Grossman, age 50, has served as the Executive Vice President and
Chief Financial Officer of Gentium, S.p.A. since August 2004. He has also served
as the Chairman and Co-Chief Executive Officer of Coastal Bancshares Acquisition
Corp., a special purpose acquisition company, since May 2004. Mr. Grossman is a
Director of Sand Hill IT Security Acquisition Corp., a special purpose
acquisition company, and I-Sector Corporation, which provides network
infrastructure and Internet protocol telephony solutions. From 2002 until 2003
he served as the Executive Vice President and Chief Financial Officer of U S
Liquids, Inc, an American Stock Exchange listed environmental services company.
Mr. Grossman left U S Liquids, Inc. in 2003 as a result of the acquisition of
three of its businesses by a private equity firm and was President and Chief
Executive Officer of the acquiring company, ERP Environmental Services until
November 2003. From 1997 until 2002, Mr. Grossman served Pentacon, Inc., a
provider of inventory management services and distributor of components to
Fortune 50 original equipment manufacturers, as a board member and in several
senior executive positions including: Chairman of the Board of Directors
(2001-2002), Acting Chief Financial Officer (2001-2002) and Lead Director
(1998-2001). Pentacon and substantially all of its subsidiaries filed a Joint
Chapter 11 Plan of Debtors in 2002. From 1991 until 2002, Mr. Grossman was the
Managing Partner of McFarland, Grossman & Company, Inc., an investment banking
and financial advisory firm he co-founded in 1991. Prior to that, Mr. Grossman
practiced public accounting for 15 years. He earned a Bachelor of Business
Administration in Accounting from The University of Texas, and is a Certified
Public Accountant.

BOARD COMMITTEES

     The Board has no nominating committee or any committee performing similar
functions. All of the members of the Board participate in the consideration of
nominations for the election of directors. The Board has an audit committee. The
audit committee is currently composed of Messrs. Chadwick, Cartwright and
Grossman. The Board has determined that Mr. Grossman is qualified as an audit
committee financial expert within the meaning of SEC regulations and has
accounting and related financial management expertise within the meaning of the
listing standards of the American Stock Exchange.

EXECUTIVE OFFICERS

     Our executive officers serve until resignation or removal by the Board. Set
forth below is certain information about our Executive Officers, other than
James H. Long.

     Mark T. Hilz -- President and Chief Operating Officer of I-Sector
Corporation, December 2003 to present; and President, Internetwork Experts,
Inc., July 2000 to present.

     Mark Hilz, age 46, was appointed as our President and Chief Operating
Officer in December 2003. Mr. Hilz' responsibilities include management of our
operations including the operations of our subsidiaries, INX, Stratasoft and
Valerent. Mr. Hilz has also served as the President of INX since its founding in
July 2000. Mr. Hilz served as a director of our company from April 1999 until
June 2001. From January 1999 to June 2000, Mr. Hilz was Vice President of
Project Development at Mathews Southwest, LLC, Inc., a real estate investment
and development firm headquartered in Dallas. From 1998 to July 2000, Mr. Hilz
was one of our directors and the Chief Executive Officer of Nichecast, Inc., a
privately held internet services company. From July 1990 to July 1998 Mr. Hilz
was the founder, President and Chief Executive Officer of PC Service Source,
Inc., a publicly held distributor of personal computer hardware for the repair
industry. Before that, Mr. Hilz was founder, President and Chief Executive
Officer of Hilz Computer Products, Inc., a privately held wholesale computer
products distributor.

     William R. Hennessy -- President, Stratasoft, Inc., September 1996 to
present.

     William R. Hennessy, age 46, has served as the President of Stratasoft
since January 1996. Mr. Hennessy's responsibilities include the general
management of the operations of Stratasoft. From July 1991 to January 1996, Mr.
Hennessy was employed by Inter-Tel, Incorporated, a publicly held telephone
systems manufacturer and sales and service company, where he served as the
Director of MIS and the Director of Voice and Data Integration for the central
region.

                                        70
<PAGE>

     Frank Cano -- President, Valerent, Inc., November 2002 to present.

     Frank Cano, age 40, has served as the President of Valerent since November
2002. Mr. Cano's responsibilities include the general management of the
operations of Valerent. From May 2000 to May 2002, Mr. Cano served as a Division
President of Amherst Southwest, LLP. Prior to that, Mr. Cano held various
positions in our company including serving as the President of our former
computer products division, as our Senior Vice President, Branch Operations and
as our Branch Manager for the Dallas-Fort Worth office. Mr. Cano is the
brother-in-law of Mr. Long.


     Brian Fontana -- Vice President and Chief Financial Officer January 2005 to
present.


     Brian Fontana, age 47, has served as the Chief Financial Officer since
January 2005. Mr. Fontana has an extensive financial management background that
includes the management of the accounting, finance, investor relations, internal
information systems and legal functions for large, complex organizations,
including organizations that were executing strategies for rapid expansion
through acquisitions. As CFO, he has managed multiple initial public offerings,
follow-on equity offerings, private equity offerings, public debt placements and
syndicated bank financings. He previously held the position of CFO at three NYSE
listed public companies, one Nasdaq listed company and two privately held
companies. His prior experience includes serving as Chief Financial Officer of
Talent Tree, Inc., a privately-held workforce outsourcing organization;
PerformanceRetail, Inc., an early-stage venture-capital funded software company;
Drypers Corporation, a NASDAQ listed multinational diaper manufacturing company;
Pentacon, Inc., a NYSE listed fastener distribution company; Prime Service,
Inc., a NYSE listed equipment rental company; and National Convenience Stores,
Inc., a NYSE listed operator of convenience stores. Mr. Fontana is a 1981
graduate of the University of Texas, where he earned a BBA in Finance.


     Larry Lawhorn -- Vice President and Controller, April 2005 to present.



     Larry Lawhorn, age 52, was appointed as our Controller and Chief Accounting
Officer in April 2005 and is responsible for our accounting and reporting
functions. From August 2001 to April 2005, Mr. Lawhorn was the Vice
President -- Corporate Controller for Talent Tree, Inc., a privately-held
workforce outsourcing organization headquartered in Houston, Texas. From March
1987 to July 2001, Mr. Lawhorn served with Corporate Express, Inc. headquartered
in Broomfield, Colorado as regional controller and division president in
Houston, Texas and Baton Rouge, Louisiana, respectively. Previously, Mr. Lawhorn
served with Coopers & Lybrand (now PriceWaterhouseCoopers) for eleven years. Mr.
Lawhorn is a Certified Public Accountant and he is a member of the American
Institute of Certified Public Accountants and the Texas Society of Certified
Public Accountants.


     Timothy J. Grothues -- Treasurer, November, 2003 to present.

     Timothy Grothues, age 56, has been our Treasurer since November 2003. From
November, 2001 to November, 2003, he was our Assistant Controller. His
responsibilities include the treasury and risk management functions. From
January 1998 to November 2001, Mr. Grothues was a private investor. For the
eighteen years prior to that, Mr. Grothues was the Chief Financial Officer of
Blackburn Group, Inc., a privately held industrial construction company
specializing in the petroleum and petrochemical industries.

     Paul Klotz -- Vice President and Chief Operating Officer of Internetwork
Experts, Inc., August 2000 to present.

     Paul Klotz, age 43, has served as the Vice President and Chief Operating
Officer of Internetwork Experts since August 2000. Mr. Klotz' responsibilities
include the operations management of Internetwork Experts. From 1997 to July
2000, Mr. Klotz was the Vice President of Marketing of PC Service Source. Before
that, Mr. Klotz served as the Vice President of Acme Keystone, a privately held
consumer products manufacturing company.


     Jeffrey A. Sylvester served as our Controller and Secretary from December
2003 until his departure in March 2005.


FAMILY RELATIONSHIPS

     James H. Long and Frank Cano are brothers-in-law. There are no other family
relationships among any of our directors and executive officers.

                                        71
<PAGE>

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

     Pursuant to Section 16(a) of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), our directors, executive officers, and
stockholders who own more than 10% of the common stock (the "Reporting Persons")
are required to file reports of stock ownership and changes in ownership of
common stock with the SEC and to furnish us with copies of all such reports they
file. We believe that, for fiscal year 2004, all the Reporting Persons complied
with all applicable filing requirements.

CODE OF ETHICS FOR SENIOR FINANCIAL OFFICERS

     We have adopted a code of ethics that applies to the Chief Executive
Officer, the Chief Financial Officer, the Controller and persons performing
similar functions. We have also adopted a code of ethics applicable to all
employees. We have posted a copy of the codes on our Internet website at
Internet address: http://www.I-Sector.com. Copies of the codes may be obtained
free of charge from the Company's website at the above Internet address. We
intend to disclose any amendments to, or waivers from, a provision of the code
of ethics that applies to the Chief Executive Officer, the Chief Financial
Officer or the Controller by posting such information on our website at the
above address.

ITEM 11.  EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

     The following table sets forth information about compensation we paid or
awarded for services rendered during the fiscal years ended December 31, 2004,
2003 and 2002 to our (i) Chief Executive Officer and (ii) the three most highly
compensated executive officers who were serving as executive officers at the end
of 2004 and whose total annual salary and bonus exceeded $100,000 (the "Named
Executive Officers").

<Table>
<Caption>
                                                                                             LONG-TERM
                                                                                            COMPENSATION
                                                                                               AWARDS
                                                      ANNUAL COMPENSATION                   ------------
                                       --------------------------------------------------    SECURITIES
                                                                         OTHER ANNUAL        UNDERLYING
NAME AND PRINCIPAL POSITION             YEAR      SALARY     BONUS    COMPENSATION ($)(1)    OPTIONS(2)
---------------------------            -------   --------   -------   -------------------   ------------
<S>                                    <C>       <C>        <C>       <C>                   <C>
James H. Long........................     2004   $114,750   $    --          $  --                 --
  Chairman and Chief Executive
  Officer                                 2003    121,636        --             --                 --
                                          2002    127,690        --             --                 --
Mark T. Hilz.........................     2004    200,000    71,250             --                 --
  President and Chief Operating
  Officer                                 2003    200,000    55,120             --             72,816
                                          2002    185,190        --             --            462,582
William R. Hennessy..................     2004    125,000    17,188             --                 --
  President of Stratasoft Inc.            2003    125,000    19,063             --             80,000
                                          2002    133,167    59,028             --                 --
Paul Klotz...........................     2004    150,000    48,438             --                 --
  Vice President of                       2003    150,000    41,370             --             48,809
  Internetwork Experts, Inc.              2002    144,252     7,500             --             95,236
</Table>

---------------

(1) Amounts exclude the value of perquisites and personal benefits because the
    aggregate amount thereof did not exceed the lesser of $50,000 or 10% of the
    Named Executive Officer's total annual salary and bonus.

(2) Amounts for Mark T. Hilz and Paul Klotz include option grants during 2002
    and 2003 in INX which were subsequently converted to options in the Company
    on March 18, 2005.

I-SECTOR STOCK OPTIONS

     We have issued stock options to purchase our common stock to our officers,
directors and employees.

     Options to purchase shares of our common stock may be granted to executive
officers, directors and other employees under our 1996 Incentive Stock Option
Plan (the "1996 Incentive Plan"), the 1996 Non-Employee

                                        72
<PAGE>

Director Stock Option Plan "the Director Plan" and the I-Sector Corp. Incentive
Stock Plan (the "I-Sector Incentive Plan"). As of March 18, 2005, 1,844,774
shares were reserved for issuance upon exercise of outstanding options under all
Plans and 269,650 were reserved and remained available for future grants
pursuant to all Plans. No options under the plans were granted to officers or
other employees during 2001 and 2002, except that options to purchase 15,000
shares were issued to the non-employee directors during each year. During 2003
and 2004, options to purchase 445,500 and 95,000 shares, respectfully, were
granted to officers, directors, consultants and other employees under the Plans.
On March 18, 2005, options to purchase 1,123,103 shares where exchanged for all
of the previously granted options in INX.

OPTIONS GRANTED IN LAST FISCAL YEAR

     We did not grant any stock options to our Named Executive Officers during
the fiscal year ended December 31, 2004. We did not grant any stock appreciation
rights in the fiscal year ended December 31, 2004.

AGGREGATED OPTION EXERCISES AND YEAR-END OPTION VALUES

     The following table sets forth information regarding option exercises
during the fiscal year ended December 31, 2004, as well as the number and total
of in-the-money options at December 31, 2004 for each of the Named Executive
Officers:

<Table>
<Caption>
                                                         NUMBER OF SECURITIES           VALUE OF UNEXERCISED
                                                        UNDERLYING UNEXERCISED          IN-THE-MONEY OPTIONS
                              SHARES                 OPTIONS AT DECEMBER 31, 2004       AT DECEMBER 31, 2004
                            ACQUIRED ON    VALUE     ----------------------------   ----------------------------
NAME                         EXERCISE     REALIZED   EXERCISABLE    UNEXERCISABLE   EXERCISABLE    UNEXERCISABLE
----                        -----------   --------   -----------    -------------   -----------    -------------
<S>                         <C>           <C>        <C>            <C>             <C>            <C>
James H. Long.............        --      $     --       2,400            --        $   18,360         $  --
William R. Hennessy.......        --            --      98,000            --           749,700            --
Mark T. Hilz..............        --            --     630,635(1)         --         4,824,358            --
Paul Klotz................    15,800       116,707     155,455(2)         --         1,189,231            --
</Table>

---------------

(1) Amount includes 598,635 Company options that were exchanged for INX options
    on March 18, 2005.

(2) Amount includes 146,255 Company options that were exchanged for INX options
    on March 18, 2005.

EMPLOYMENT AGREEMENTS

     We have entered into employment agreements with each of the Named Executive
Officers (collectively, the "Executive Employment Agreements"). Under the terms
of the respective agreements, Messrs. Long, Hennessy, Hilz, Klotz and Fontana
are entitled to an annual base salary of $150,000, $125,000, $200,000, $150,000
and $190,000 respectively, plus other bonuses, the amounts and payment of which
are within the discretion of our compensation committee. Beginning in the
quarter ended June 30, 2001, Messrs. Long, Hilz and Klotz took voluntarily pay
reductions as compared to the base salary set in their respective employment
agreements. The voluntary pay reductions were terminated for Messrs. Hilz and
Klotz after certain financial performance goals were attained. Mr. Long has
extended his voluntary pay reduction through the current pay period. The
agreements with Messrs. Hilz, Cano, Hennessy and Klotz also include special
bonus plan provisions that may be changed or eliminated at our sole discretion.
These four executives each currently have an opportunity to receive two bonuses
on a quarterly basis, which two bonuses are tied to each of gross profits per
share compared to plan and earnings per share compared to plan for the pertinent
subsidiary. The bonus amounts that may be earned range from zero to as much as
70% of their quarterly salary based upon performance attained. These bonus
arrangements may be modified at any time at the sole discretion of our
compensation committee. All Executive Employment Agreements may be terminated by
us or by the officer named therein at any time by giving proper notice. The
Executive Employment Agreements generally provide that the executive officer
will not, for the term of his employment and for a period of either twelve or
eighteen months, whichever the case may be, following the end of such executive
officer's employment with us, compete with us, disclose any of our confidential
information, solicit any of our employees or customers or otherwise interfere
with the our business relations. The non-compete provision with Mr. Long does
not apply if we elect to terminate Mr. Long's employment without cause; except
that, we may elect to continue the non-compete restrictions in that event by
paying Mr. Long a severance amount during the restricted period. The

                                        73
<PAGE>

severance amount payable to Mr. Long is based upon the greater of 75% of his
salary at the time of termination or 75% of his average monthly salary and
bonus, calculated based on his compensation during the 12 months period prior to
his termination.

DIRECTORS' COMPENSATION

     From January 1, 2004 through November 3, 2004, each director who was not an
employee of the Company was paid $1,000 for each Board and Audit Committee
meeting they attended and $500 for each Compensation Committee meeting they
attended, plus reasonable out-of-pocket expenses incurred to attend the
meetings. The chairperson of the Audit Committee was paid $2,000 for each
meeting attended. In addition, each non-employee director was entitled to
receive stock options pursuant to the Company's Non-Employee Director Stock
Option Plan (the "Director Plan"). Upon election to the Board, each independent
director received options to purchase 5,000 shares of Common Stock. Upon
re-election to the Board, each independent director received options to purchase
5,000 shares of Common Stock. All options granted to directors during 2003
vested immediately. All options granted to directors had an exercise price equal
to the fair market value of a share of Common Stock on the date of grant and
expire ten years after the date of grant (subject to earlier termination).
Options granted to directors are subject to early termination on the occurrence
of certain events, including ceasing to be a member of the Board of Directors
(other than by death). During 2004, options to acquire 15,000 shares of Common
Stock were granted to independent directors.

     Effective November 3, 2004, the Company increased the cash component of
compensation for independent board members. This increase was made due to the
increased size and complexity of the Company, increased requirements of Board
members following and related to the Sarbanes-Oxley Act of 2002
("Sarbanes-Oxley") and in order to attract the best possible talent to the Board
of Directors. Beginning on November 3, 2004, each non-employee director receives
a quarterly retainer of $3,000, plus $1,000 for each Board and Audit Committee
meeting they physically attend and $500 for each Compensation Committee meeting
they attend, as well as reasonable out-of-pocket expenses incurred to attend the
meetings. In addition, the chairperson of the Audit Committee receives an
additional $4,000 quarterly retainer. For telephonic board meetings lasting more
than one hour, each board member in attendance receives $500, and for telephonic
board meetings lasting less than one hour, each board member is paid $300. An
additional $1,000 per special committee meeting is paid to any director that is
serving as the chairperson of such special committee.

                                        74
<PAGE>

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
          RELATED STOCKHOLDER MATTERS

SECURITY OWNERSHIP OF MANAGEMENT OF I-SECTOR COMMON STOCK

     The following table sets forth, as of March 28, 2005 the number of shares
of common stock owned by each director, each Named Executive Officer, as defined
in "Item 11. Executive Compensation," and all directors and executive officers
as a group.

<Table>
<Caption>
                                                               AMOUNT AND NATURE OF     PERCENT
NAME OF BENEFICIAL OWNER                                      BENEFICIAL OWNERSHIP(1)   OF CLASS
------------------------                                      -----------------------   --------
<S>                                                           <C>                       <C>
James H. Long...............................................         1,997,430(2)         28.2%
Donald R. Chadwick..........................................            37,386(3)            *
Cary M. Grossman............................................            15,000(4)            *
William R. Hennessey........................................           115,000(5)          1.6%
John B. Cartwright..........................................            20,200(6)            *
Mark T. Hilz................................................           630,635(7)          8.9%
Paul Klotz..................................................           155,455(8)          2.2%
All officers and directors..................................         3,105,935(9)        43.89%
</Table>

---------------

 *  Less than 1%

(1) Beneficially owned shares include shares over which the named person
    exercises either sole or shared voting power or sole or shared investment
    power. It also includes shares the named person has the right to acquire
    within 60 days by the exercise of any right or option. Unless otherwise
    noted, all shares are owned of record and beneficially by the named person.

(2) Includes 2,400 shares that may be acquired upon exercise of currently
    exercisable options.

(3) Includes 17,686 shares that may be acquired upon exercise of currently
    exercisable options and 200 shares owned by his minor children for which Mr.
    Chadwick disclaims beneficial ownership.

(4) Includes 5,000 shares that may be acquired upon exercise of currently
    exercisable options and 2,000 shares that may be acquired upon exercise of
    warrants.

(5) Includes 98,000 shares that may be acquired upon exercise of currently
    exercisable options and 2,000 shares owned by his children, one of which is
    a minor, for which Mr. Hennessey disclaims beneficial ownership.

(6) Includes 20,000 shares that may be acquired upon exercise of currently
    exercisable options.

(7) Includes 630,635 shares that may be acquired upon exercise of currently
    exercisable options.

(8) Includes 155,455 shares that may be acquired upon exercise of currently
    exercisable options.

(9) Includes 1,000,445 shares that may be acquired upon exercise of currently
    exercisable options.

SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS

     The table presented below contains certain information about our equity
compensation plans, as of March 18, 2005, which consists of the 1996 Incentive
Plan, the Director Plan and the I-Sector Incentive Plan. All of our equity
compensation plans have been previously approved by its stockholders.


<Table>
<Caption>
                                                                                                     NUMBER OF
                                                         NUMBER OF                                   SECURITIES
                                                      SECURITIES TO BE                          REMAINING AVAILABLE
                                                        ISSUED UPON                             FOR FUTURE ISSUANCE
                                                        EXERCISE OF                                 UNDER EQUITY
                                                        OUTSTANDING        WEIGHTED-AVERAGE      COMPENSATION PLANS
                                                          OPTIONS,        EXERCISE PRICE OF          (EXCLUDING
                                                        WARRANTS AND     OUTSTANDING OPTIONS,   SECURITIES REFLECTED
                                                           RIGHTS        WARRANTS AND RIGHTS       IN COLUMN (A))
PLAN CATEGORY                                               (A)                  (B)                    (C)
-------------                                         ----------------   --------------------   --------------------
<S>                                                   <C>                <C>                    <C>
Equity compensation plans approved by security
  holders...........................................     1,844,774              $ 2.60                269,650
Equity compensation plans not approved by security
  holders...........................................        60,000              $14.00                   None
</Table>


                                        75
<PAGE>

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     We lease office space from Allstar Equities, Inc. a Texas corporation
("Equities"), which is wholly-owned by James H. Long, our Chairman and Chief
Executive Officer. On December 1, 1999, Equities purchased the building where
our principal office is located and we executed a direct lease with Equities
with an expiration date of December 31, 2004. In conjunction with Equities
obtaining new financing on the building, we executed a new lease with Equities
on February 1, 2002 with an expiration date of January 31, 2007. Under the new
lease, our rental rate was reduced from $37,692 per month to $37,192 per month.

ITEM 14.  PRINCIPAL ACCOUNTING FEES AND SERVICES

     The following information sets forth the aggregate fees billed or to be
billed by Grant Thornton LLP ("Grant Thornton") for services performed for the
fiscal year 2004. The audit committee has reviewed the audit and non-audit fees
that we paid to the independent accountants for purposes of considering whether
such fees are compatible with maintaining the auditor's independence. Under the
SEC's new rule on auditor independence, which is effective for the first fiscal
years ending after December 15, 2003 and was adopted as a result of implementing
the Sarbanes-Oxley Act of 2002, fees would be categorized as follows:

          Audit Fees.  Estimated fees billed for services rendered by Grant
     Thornton for the audit of our financial statements included in our annual
     report and the reviews of financial statements included in our quarterly
     reports were $225,000 for 2003 and $180,075 for 2004.

          Audit-Related Fees.  We did not retain Grant Thornton for any audit
     related services in 2003 and 2004 and there were no fees for audit-related
     services during those years.

          Tax Fees.  Aggregate fees billed for tax services related to the
     preparation of our annual corporate tax returns rendered by Grant Thornton
     was $ -- and $17,700 for 2003 and 2004, respectively.

          All Other Fees.  Aggregate fees billed for all other services rendered
     by Grant Thornton to us consisted of $825 relating to research and
     discussions of the accounting for certain employee benefit matters in 2003
     and $185,000 in 2004 which consisted of $1,500 for program training costs
     and $183,500 related to the secondary offering.

     Our audit committee must now pre-approve all audit and non-audit services
that we receive from our independent accountants. This pre-approval authority
may be delegated to a single member of the audit committee and then reviewed by
the entire audit committee at the committee's next meeting. Approvals of
non-audit services will be publicly disclosed in our periodic reports filed with
the SEC. For 2004, the audit committee pre-approved 100% of the 2004 audit and
non-audit services we received from our independent accountants.

                                    PART IV

ITEM 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES

     (a)(1) Consolidated Financial Statements -- See Index to Consolidated
Financial Statements on Page 42

     (2) Consolidated Financial Statements Schedule II Valuation and Qualifying
Accounts filed herewith as Exhibit 99.1

     (3) Exhibits: See index to exhibit table below.

                                        76
<PAGE>

                                   SIGNATURES


     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, April 11, 2005.


                                         I-SECTOR CORPORATION
                                          (Registrant)

                                         By:       /s/ JAMES H. LONG
                                          --------------------------------------
                                                      James H. Long
                                                 Chief Executive Officer

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.


<Table>
<Caption>
              SIGNATURE                                 CAPACITY                        DATE
              ---------                                 --------                        ----
<S>     <C>                              <C>                                       <C>

          /s/ JAMES H. LONG              Chief Executive Officer and Chairman of   April 11, 2005
--------------------------------------           the Board of Directors
            James H. Long


          /s/ BRIAN FONTANA                Vice President and Chief Financial      April 11, 2005
--------------------------------------                   Officer
            Brian Fontana


          /s/ LARRY LAWHORN                   Vice President and Controller        April 11, 2005
--------------------------------------
            Larry Lawhorn


        /s/ DONALD R. CHADWICK                          Director                   April 11, 2005
--------------------------------------
          Donald R. Chadwick


          /s/ CARY GROSSMAN                             Director                   April 11, 2005
--------------------------------------
            Cary Grossman


        /s/ JOHN B. CARTWRIGHT                          Director                   April 11, 2005
--------------------------------------
          John B. Cartwright
</Table>


                                        77
<PAGE>

                                 EXHIBIT INDEX

<Table>
<Caption>
EXHIBIT
  NO.                        DESCRIPTION                       FILED HEREWITH OR INCORPORATED BY REFERENCE FROM:
-------                      -----------                       -------------------------------------------------
<S>       <C>                                                  <C>
 3.1      Bylaws of the Company.                               Exhibit 3.1 to Form S-1, Registration No.
                                                               333-09789, filed August 8, 1996
 3.2      Certificate of Incorporation of the Company.         Exhibit 3.2 to Amendment 1 to Form S-1,
                                                               Registration No. 333-09789, filed August 8, 1996
 3.3      Certificate of Amendment to Certificate of           Exhibit 3.4 to Amendment 5 to Form S-1,
          Incorporation of Allstar Systems, Inc., dated June   Registration No. 333-09789, filed August 8, 1996
          24, 1997.
 3.4      Certificate of Amendment to Certificate of           Exhibit 3.3 to Form 8-A, Registration No.
          Incorporation of Allstar Systems, Inc., dated        001-31949, filed December 29, 2003
          March 5, 1999.
 3.5      Certificate of Amendment to Certificate of           Exhibit 3.4 to Form 8-A, Registration No.
          Incorporation of Allstar Systems, Inc. dated July    001-31949, filed December 29, 2003
          10, 2000.
 4.1      Specimen Common Stock Certificate.                   Exhibit 4.1 to Amendment 2 to Form S-1,
                                                               Registration No. 333-09789, filed August 8, 1996
10.1      Form of Employment Agreement by and between the      Exhibit 10.5 to Amendment 1 to Form S-1,
          Company and certain members of management.           Registration No. 333-09789, filed August 8, 1996
10.2      Employment Agreement by and between Stratasoft,      Exhibit 10.6 to Form S-1, Registration No.
          Inc. and William R. Hennessy, dated September 7,     333-09789, filed August 8, 1996
          1995.
10.3      Employment Agreement by and between Allstar          Exhibit 10.3 to Form 10-K Registration No.
          Systems, Inc. and James H. Long, dated August 15,    001-31949, filed March 12, 2004
          1996.
10.4      Assignment of Certain Software by International      Exhibit 10.7 to Form S-1, Registration No.
          Lan and Communications, Inc. and Aspen System        333-09789, filed August 8, 1996
          Technologies, Inc. to Stratasoft, Inc., dated
          September 7, 1995.
10.5      Systems Integrator Agreement by and between Cisco    Exhibit 10.5 to Form 10-K Registration No.
          Systems, Inc. and Internetwork Experts, Inc.,        001-31949, filed March 12, 2004
          dated November 13, 2000.
10.6      Amendment One, dated January 28, 2002, to Systems    Exhibit 10.6 to Form 10-K Registration No.
          Integrator Agreement by and between Cisco Systems,   001-31949, filed March 12, 2004
          Inc. and Internetwork Experts, Inc., dated
          November 13, 2000.
10.7      Amendment Two, dated November 21, 2002, to Systems   Exhibit 10.6 to Form 10-K Registration No.
          Integrator Agreement by and between Cisco Systems,   001-31949, filed March 12, 2004
          Inc. and Internetwork Experts, Inc., dated
          November 13, 2000.
10.8      Amendment Three, dated January 20, 2003, to          Exhibit 10.8 to Form 10-K Registration No.
          Systems Integrator Agreement by and between Cisco    001-31949, filed March 12, 2004
          Systems, Inc. and Internetwork Experts, Inc.,
          dated November 13, 2000.
10.9      Amendment Four, dated January 16, 2004, to Systems   Exhibit 10.9 to Form 10-K Registration No.
          Integrator Agreement by and between Cisco Systems,   001-31949, filed March 12, 2004
          Inc. and Internetwork Expert's, Inc, dated
          November 13, 2000
10.10     Amended & Restated Allstar Systems, Inc. 1996        Exhibit 10.10 to Form 10-K Registration No.
          Incentive Stock Plan, dated effective July 1,        001-31949, filed March 12, 2004
          1997.
</Table>

                                        78
<PAGE>

<Table>
<Caption>
EXHIBIT
  NO.                        DESCRIPTION                       FILED HEREWITH OR INCORPORATED BY REFERENCE FROM:
-------                      -----------                       -------------------------------------------------
<S>       <C>                                                  <C>
10.11     Amended & Restated I-Sector Corp. Stock Incentive    Exhibit 10.11 to Form 10-K Registration No.
          Plan, dated effective July 28, 2003.                 001-31949, filed March 12, 2004
10.12     Amended & Restated Internetwork Experts, Inc.,       Exhibit 10.12 to Form 10-K Registration No.
          Stock Incentive Plan dated effective August 1,       001-31949, filed March 12, 2004
          2003.
10.13     Resale Agreement, by and between Ingram Micro Inc.   Exhibit 10.14 to Amendment 1 to Form S-1,
          and Allstar Systems, Inc., dated December 14,        Registration No. 333-09789, filed August 8, 1996
          1995.
10.14     Volume Purchase Agreement, by and between Tech       Exhibit 10.15 to Amendment 1 to Form S-1,
          Data Corporation and Allstar Systems, Inc., dated    Registration No. 333-09789, filed August 8, 1996
          October 31, 1995.
10.15     Lease Agreement by and between Allstar Equities,     Exhibit 10.32 to Form 10-K, Registration No.
          Inc. and I-Sector Corporation, dated February 1,     000-21479, filed March 28, 2002
          2002.
10.16     Asset Purchase Agreement between Amherst Computer    Exhibit 2.1 to Form 8-K, Registration No.
          Products Southwest, L.P., Amherst Technologies,      000-21479, filed March 22, 2000
          L.L.C. and Allstar Systems, Inc., dated March 16,
          2000.
10.17     Asset Purchase Agreement, by and between Digital     Exhibit 10.17 to Form 10-K Registration No.
          Precision, Inc. and Internetwork Experts, Inc.,      001-31949, filed March 12, 2004
          dated April 4, 2003.
10.18     Promissory Note between James H. Long and Allstar    Exhibit 10.35 to Form 10-K, Registration No.
          Systems, Inc. dated December 1, 1999.                000-21479, filed March 28, 2000
10.19     Asset Purchase Agreement by and between              Exhibit 10.36 to Form 10-K, Registration No.
          Internetworking Sciences Corporation and             000-21479, filed March 24, 2001
          Internetwork Experts, Inc. dated October 27, 2000.
10.20     Lease Agreement by and between Whitehall-Midway      Exhibit 10.37 to Form 10-K, Registration No.
          Park North, Ltd. and Allstar Systems, Inc. dated     000-21479, filed March 24, 2001
          July 31, 2000.
10.21     Dealer Loan and Security Agreement by and between    Exhibit 10.38 to Form 10-K, Registration No.
          Textron Financial Corporation and I-Sector           000-21479, filed March 28, 2002
          Corporation, dated January 31, 2002.
10.22     Limited Fraud Guarantee, by and between James H.     Exhibit 10.17 to Form 10-K Registration No.
          Long and Textron Financial Corporation, dated        001-31949 filed March 12, 2004
          September 3, 2003.
10.23     Loan and Securities Agreement dated September 30,    Exhibit 10.1 to Form 10-Q Registration No.
          2004 among Textron, I-Sector and its subsidiaries.   001-31949 filed November 15, 2004
10.24     Employment Agreement by and between I-Sector         Exhibit 10.1 to Form 8-K Registration No.
          Corporation and Brian Fontana, dated December 20,    001-31949 filed December 20, 2004
          2004.
10.25     Confidentiality Agreement by and between I-Sector    Exhibit 10.2 to Form 8-K Registration No.
          Corporation and Brian Fontana, dated December 20,    001-31949 filed December 20, 2004
          2004.
</Table>

                                        79
<PAGE>


<Table>
<Caption>
EXHIBIT
  NO.                        DESCRIPTION                       FILED HEREWITH OR INCORPORATED BY REFERENCE FROM:
-------                      -----------                       -------------------------------------------------
<S>       <C>                                                  <C>
10.26     Memorandum of Understanding Regarding Purchases,     Previously filed
          Invoicing and Payments Under Master Agreement For
          Products and Services for the Dallas Independent
          School District by and between I-Sector
          Corporation, Micro System Enterprises, Inc. and
          Textron Financial Corporation.
16.1      Letter from Deloitte & Touche LLP dated June 17,     Exhibit 16.1 to Form 8-K, Registration No.
          2003.                                                000-21479, filed June 5, 2003
21.1      List of Subsidiaries of the Company                  Exhibit 21.1 to Form 10-K, Registration No.
                                                               000-21479, filed March 31, 2003
23.1      Consent of Grant Thornton LLP                        Filed herewith
23.2      Consent of Deloitte & Touche LLP, Independent        Filed herewith
          Registered Public Accounting Firm
31.1      Rule 13a-14(a)/15d-14(a) Certification of Chairman   Filed herewith
          and Chief Executive Officer
31.2      Rule 13a-14(a)/15d-14(a) Certification of Chief      Filed herewith
          Financial Officer
32.1      Section 1350 Certification of Chief Executive        Filed herewith
          Officer and Chief Financial Officer
99.1      Report of Independent Certified Public Accountants   Previously filed
</Table>


                                        80