I SECTOR CORP - 10-Q Quarterly Report

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FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

(Mark One)

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

For the quarterly period ended June 30, 2003

OR

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

For the transition period from ________ to ___________

Commission file number: 0-21479

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

DELAWARE 76-0515249
(State of incorporation) (I.R.S. Employer Identification No.)

6401 SOUTHWEST FREEWAY
HOUSTON, TEXAS 77074
Address of principal executive offices) (Zip code)

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

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

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

APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [ ] No [ ]

APPLICABLE ONLY TO CORPORATE REGISTRANTS:

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

Title Outstanding

Common Stock, $.01 par value per share As of August 19, 2003
3,640,925 shares outstanding

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

I-SECTOR CORPORATION
FORM 10-Q
QUARTER ENDED JUNE 30, 2003

Part I. Financial Information

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

Condensed Consolidated Balance Sheets at June 30, 2003 and December 31,
2002

Condensed Consolidated Statements of Income for the three months ended
June 30, 2003 and 2002

Condensed Consolidated Statements of Income for the six months ended
June 30, 2003 and 2002

Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 2003 and 2002

Notes to Condensed Consolidated Financial Statements

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

Item 3. Quantative and Qualitative Disclosures about Market Risk

Item 4. Controls and Procedures

Part II. Other Information

Item 1. Legal Proceedings

Item 2. Other Information

Item 6. Exhibits

Exhibit 31 Certification

Exhibit 32 Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002

Signatures

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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

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

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

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

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

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

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

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

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I-SECTOR CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

I-Sector Corporation and subsidiaries ("I-Sector") is engaged in the
business of providing network integration services and certain managed IT
services and of selling associated network hardware and telephony software
products. I-Sector's operations are conducted through three segments:

o Valerent, Inc. ("Valerent"), a wholly owned subsidiary,
provides information technology solutions that lowers 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
application support, operating system and network migration
services, turnkey outsourced IT helpdesk solutions, technical
staff augmentation for IT helpdesk operations and helpdesk
solutions consulting services.

o Internetwork Experts, Inc. ("INX"), a wholly-owned subsidiary,
is a network professional services and integration
organization with areas of practice that include large-scale
enterprise network engineering consulting, network security,
network management, wireless networking, and IP Telephony.

o Stratasoft, Inc. ("Stratasoft"), a wholly-owned subsidiary,
creates and markets software related to the integration of
computer and telephone technologies.

A substantial portion of I-Sector's sales and services are authorized
under arrangements with product manufacturers. I-Sector's operations are
dependent upon maintaining its approved status with such manufacturers. Should
I-Sector's approved status lapse, revenues and gross profit could be adversely
affected.

The condensed consolidated financial statements presented herein as of
and for the three-month and six-month periods ended June 30, 2003 and 2002 are
unaudited; however, all adjustments which are, in the opinion of management,
necessary for a fair presentation of the financial position, results of
operations, and cash flows for the periods covered have been made and are of a
normal, recurring nature. The results of the interim periods are not necessarily
indicative of results for the full year. The consolidated balance sheet at
December 31, 2002 is derived from audited consolidated financial statements but
does not include all disclosures required by accounting principles generally
accepted in the United States of America. Although management believes the
disclosures are adequate, certain information and disclosures normally included
in the notes to the financial statements have been condensed or omitted as
permitted by the rules and regulations of the Securities and Exchange
Commission. These interim financial statements should be read in conjunction
with the consolidated financial statements and notes thereto included in
I-Sector's 2002 Annual Report on Form 10-K.

RECLASSIFICATIONS - Certain amounts in the consolidated financial
statements presented herein have been reclassified to conform to current period
presentation.

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

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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 three reportable segments. Each reportable
segment has more than one revenue component, and revenue is recognized
differently for each component (or "stream") of revenue earned by segment. The
material revenue streams earned by I-Sector, some of which are earned by more
than one segment, and some by only one segment, are:

Product Revenue. All three of I-Sector's 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.

Custom Project Revenue. One of I-Sector's segments,
Stratasoft, earns revenues from projects that are recognized using the
percentage of completion method of accounting for such revenues. The
majority of Stratasoft's revenues consist 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 PCS
together under a single contract with the customer. PCS is
insignificant on 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 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. 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 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. The following
reflects the amounts relating to uncompleted contracts at June 30, 2003
and December 31, 2002:

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 $152,000 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.

During 2002 and 2003 I-Sector has recognized revenues 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-user customer, from
whom Stratasoft was directly obligated to be paid for such project.

Services Revenue. All of I-Sector's segments earn revenue from
providing stand-alone services revenues. 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, and are recognized when the service is performed and when
collection is reasonably assured. One of I-Sector's segments sometimes
earns agency fee revenue from

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various sources, the primary source of which is referring customers to
other organizations for which an agency fee is received. These revenues
are recognized at the earlier of when payment is received or when
notification of amounts being due is received from the entity paying
such agency fee and collectiblity is reasonably assured.

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 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. Accounts deemed
uncollectible are applied against the allowance for doubtful accounts.

WARRANTY RESERVE - I-Sector records a warranty reserve related to
certain software products sold by its Stratasoft subsidiary. This 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
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 sales based upon 5% 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 sales 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
composition of the warranty reserve at June 30, 2003 and December 31, 2002:

STOCK-BASED COMPENSATION - The Company has elected to account for
stock-based compensation using the intrinsic value method of accounting in
accordance with Accounting Principles Bulletin ("APB") Number 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 market price of the Company's
common stock on the grant date. The Company has recorded no stock-based
compensation associated with stock options granted to employees and directors in
its consolidated statement of operations. I-Sector and its subsidiaries apply
the fair value method as prescribed by SFAS No. 123, as interpreted and amended,
for stock and stock options issued to non-employees and during the three and
six-month period ended June 30, 2003, recorded $4 and $4 of expense,
respectively. 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 the
quarters and six months ended June 30, 2003 and 2002, respectively.

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

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

ACCOUNTING PRONOUNCEMENTS -

In April 2002, the FASB issued Statement of Financial Accounting
Standards No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment
of FASB Statement No. 13, and Technical Corrections." SFAS No. 145, among other
things, amends SFAS No. 4 and SFAS No. 64, to require that gains and losses from
the extinguishments of debt generally be classified within continuing
operations. The provisions of SFAS No. 145 are effective for fiscal years
beginning after May 15, 2002 and early application is encouraged. The Company
adopted SFAS No. 145 on January 1, 2003. The adoption of this statement had no
impact on the financial statements.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 replaces Emerging
Issues Task Force (EITF Issue 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity". This standard
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. The Company adopted SFAS No. 146 on January 1, 2003. The
adoption of this statement had no impact on the financial statements.

In February 2003, the FASB issued SFAS No. 148, "Accounting for Stock
Based Compensation: A Comparison of FASB Statement No. 123, Accounting for
Stock-Based Compensation and Its Related Interpretations, and IASB Proposed
IFRS, Share-based Payments." SFAS No. 148 amends SFAS 123 to provide alternative
methods of transition for an entity that voluntarily changes to the fair value
based method of accounting for stock-based employee compensation. It also amends
the disclosure provisions of that Statement to require prominent disclosure
about the effects on reported net income of an entity's accounting policy
decisions with respect to stock-based compensation. The statement also amends
APB Opinion No. 28, "Interim Financial Reporting", to require disclosure about
those effects in interim financial information. The Company has chosen not to
voluntarily change to the fair value based methods of accounting for stock-based
employee compensation but has adopted the disclosure rules of SFAS 148.

In April 2003 The FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies when a derivative contains a financing component that warrants special
reporting in the statement of cash flows and amends certain other existing
pronouncements, resulting in more consistent reporting of contracts that are
derivatives in their entirety or that contain embedded derivatives that warrant

10

separate accounting. SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003. The Company does not believe that the adoption of
SFAS No. 149 will have a significant impact on its financial statements.

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. The Company has not fully assessed the impact of FIN 46
on its financial statements, particularly its relationship with Allstar
Equities, Inc., but the adoption of this statement in the third quarter is not
expected to have a material impact on the Company's financial statements.

In November 2002, the Emerging Issues Task Force ("EITF") reached a
consensus on EITF Issue 00-21, "Revenue Arrangements with Multiple
Deliverables". EITF 00-21 addresses certain aspects of the accounting by a
vendor for arrangements under which it will perform multiple revenue-generating
activities. Issue 00-21 is effective for revenue arrangements entered into in
fiscal periods beginning after June 15, 2003. The Company does not expect that
the adoption of EITF 00-21 will have a significant impact on the Company's
financial statements.

2. DISCONTINUED OPERATIONS

On November 6, 2001, I-Sector approved a plan to sell or close its IT
Staffing business. A sale was finalized on December 31, 2001. Under the terms of
the sale I-Sector received a note receivable for $52. The note receivable bears
interest at 5% per annum and is collectible in installments based on the total
monthly revenue of the buyer over 24 months beginning in March, 2002.
Previously, on March 16, 2000, I-Sector entered into an agreement to sell
certain assets of and the ongoing operations of its Computer Products Division.
The sale transaction closed on May 19, 2000 after shareholder and other required
consents were obtained. Additionally on November 2, 1999, I-Sector approved a
plan to sell or close its Telecom Division and that business was sold on March
16, 2000.

During the six months ended June 30, 2003 and 2002, I-Sector recognized
a net gain (loss) on disposal of these three businesses as follows:

The balance sheet caption "Net Liabilities related to discontinued
operations" contains $625 and $904 at June 30, 2003 and December 31, 2002,
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.

3. SEGMENT INFORMATION

I-Sector has four reportable segments: Valerent, INX, Stratasoft 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
Elimination column in the following table. The tables below show the results of
the four reportable segments:

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For the quarter ended June 30, 2003:

For the quarter ended June 30, 2002:

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For the six months ended June 30, 2003:

For the six months ended June 30, 2002:

International sales accounted for $1,591 or 10.0% and $716 or 7.0% of
consolidated revenues and 105.3% and 43.2% of the Stratasoft segment revenues in
the three months ended June 30, 2003 and 2002, respectively. In the six months
ended June 30, 2003 and 2002, international sales accounted for $1,946 or 7.5 %
and $1,458 or 7.5% of consolidated revenues and 50.8% and 45.7% of the
Stratasoft segment sales, respectively. International sales are derived from
Southern Asia, Africa, United Kingdom, Greece, Japan and Canada.

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The following table represents the reconciliation of products and services
included in total revenues:

4. EARNINGS PER SHARE

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

The potentially dilutive options of 219,494 and 34,204 for the three
months ended June 30, 2003 and 2002, respectively, and the potentially dilutive
options of 186,507 for the six months ended June 30, 2003 were not used in the
calculation of diluted earnings since the effect of potentially dilutive
securities in computing a loss per share is antidilutive. The potentially
dilutive options totaling 3,381 for the six months ended June 30, 2002 were
calculated under the treasury stock method.

The potentially dilutive options of the Company's wholly-owned
subsidiary, Internetwork Experts, Inc., (see Note 9) did not impact the
calculation of I-Sector's earnings per share in the quarter ended June 30, 2003.
The potentially dilutive options of Internetwork Experts, Inc. were not used in
the calculation of diluted earnings attributable to the Company for the three
months ended June 30, 2002, and for the six months ended June 30, 2003 and 2002,
respectively, since the effect would have been antidilutive.

There were warrants to purchase 176,750 shares of common stock for the
six months ended June 30, 2002 which were not included in computing diluted
earnings per share because the inclusion would have been antidilutive. 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.

5. CURRENT DEBT OBLIGATIONS

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 $4 and $8 in the three months and $9 and $16 in the six months ended
June 30, 2003 and 2002, respectively. This note is collateralized by
Stratasoft's patent license assets and Stratasoft has granted a security
interest to 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 $63 and $144 and long-term debt of
$221 and $236 at June 30, 2003 and December 31, 2002, respectively.

In October 2001, I-Sector signed a non-interest bearing note payable
for $39 payable in monthly installments through October 2004. In connection with
this note payable, I-Sector has short-term debt maturing within one year of $13
and $13 and long-term debt of $3 and $11 at June 30, 2003 and December 31, 2002,
respectively.

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On January 31, 2002 I-Sector entered into a credit agreement with
Textron Financial Corporation ("Textron") for a revolving line of credit (the
"Textron Facility"). The initial total credit available under the Textron
facility was $2,500 subject to borrowing base limitations that are generally
computed as 80% of eligible accounts receivable, and 90% of identifiable
inventory purchased under this agreement and 40% of all other inventory. In
December 2002, Textron increased the credit line on a temporary basis to $5,500
and in April 2003 Textron increased the total credit available temporarily under
the Textron facility to $7,500. The temporary increase was made permanent in
August 2003. In connection with the increase in the credit line, a modification
was made to the borrowing base limitations that restricted the eligibility of
accounts receivable for collateralization by disallowing as eligible any
customer's receivables in their entirety that have balances over 90 days old and
that exceed 25% of their total balance. I-Sector may use up to $500 of the line
for working capital advances under approved conditions. Borrowings accrue
interest at the prime rate plus 2.5% on outstanding balances that extend beyond
the vendor approved free interest period and on working capital advances from
date of advance. This agreement is collateralized by substantially all of
I-Sector's assets except its patent license assets. The agreement contains
restrictive covenants measured at each quarter end, which require us to maintain
minimum tangible capital funds and a minimum debt to tangible capital funds
ratio. At June 30, 2003 I-Sector was not in compliance with all of the loan
covenants, however the Company subsequently received a waiver on such
non-compliance for that date. I-Sector is in negotiation with Textron to modify
the loan covenant and believes it will be able to comply with the applicable
covenants in future reporting periods. In the event I-Sector does not maintain
compliance, it would be required to seek waivers from Textron for those events,
which, if not obtained, could accelerate repayment and require I-Sector to seek
other sources of finance. At June 30, 2003, I-Sector had $6,845 outstanding on
inventory floor plan finance borrowings, $0 outstanding on working capital
advances and had total credit availability of $655 based upon the temporary line
increase to $7,500.

6. LITIGATION

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 I-Sector owed the sum of approximately
$570 to Inacom Corp. ("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.

The Equal Employment Opportunity Commission ("EEOC") filed a Charge of
Discrimination against Stratasoft on behalf of Jennifer R. Bond on August 1,
2002 in the EEOC Minneapolis, Minnesota office. Stratasoft believes that the
charge is without merit and intends to vigorously contest the charge.

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

7. INCOME TAX BENEFIT

On March 9, 2002, President Bush signed into law the Job Creation and
Worker Assistance Act of 2002. The new 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 $1,179 in the six months ended June 30, 2003 and 2002, respectively.
On July 26, 2002 the Company received $1,123 in tax refunds. Additionally, on
July 24, 2003 the Company received $561 in tax refunds.

8. RELATED PARTY TRANSACTIONS

I-Sector has from time to time made payments on behalf of Allstar
Equities, Inc., a Texas corporation ("Equities"), which is wholly-owned by its
President and Chief Executive Officer, on his behalf personally, for taxes,
property and equipment. Effective on December 1, 1999 a note payable by Equities
was signed for $336 for 60 monthly installments of $7. The note bears interest
at 9% per year. At June 30, 2003 and December 31, 2002, the Company's
receivables from Equities amounted to approximately $46 and $87, respectively.
Additionally, from time to time the Company has made payments to unrelated
parties, primarily for use of a credit card, for transactions that either wholly
or partially benefit the Company's President and Chief Executive Officer and
which therefore are accounted for as indebtedness from him to the Company and on
which he paid interest of 6% per annum on the average outstanding balance.
During August 2002, in order to comply with the Sarbanes-Oxley Act of 2002, the
Company made a demand for repayment of the outstanding balance at that time of
$94 related

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to the President and CEO's personal credit card usage. The President and CEO
paid the entire balance in December 2002 and there is no balance due at June 30,
2003 or at December 31, 2002.

The Company leases office space from Equities. On December 1, 1999
Equities purchased the Company's corporate office building and executed a direct
lease with us with an expiration date of December 31, 2004. In conjunction with
Equities obtaining new financing on the building, a new lease was executed with
the Company on February 1, 2002 with an expiration date of January 31, 2007. The
new lease has rental rates of $37,192 per month.

From time to time I-Sector has obtained an independent survey of real
estate rental rates and has consulted with real estate consulting firms to
determine market rates of facilities that are comparable to the Houston
headquarters facility. The Company believes that the rental rate and other terms
of our lease from Equities are at least as favorable as those that could be
obtained in an arms-length transaction with an unaffiliated third party.

From time to time I-Sector makes short-term loans and travel advances
to its employees. The balance of approximately $23 and $12 relating to these
loans and advances is included in the Company's balance sheet and reported as
part of Accounts receivable - other at June 30, 2003 and December 31, 2002,
respectively.

9. STOCK OPTION PLANS

The Company has three stock-based option plans, the 1996 Incentive
Stock Plan, the 1996 Non-Employee Director Stock Option Plan and the 2000 Stock
Incentive Plan. Under the 2000 Incentive Plan, all of I-Sector employees,
including officers, consultants and non-employee directors are eligible to
participate.

Additionally, each of I-Sector's subsidiaries has an incentive stock
option plan in place. The subsidiary plans have not been presented to the
shareholders of I-Sector for approval. The only subsidiary with options granted
under its plan incurred a net loss for each of the periods presented, and as a
result I-Sector's share of subsidiary net loss does not change for purposes of
computation of I-Sector's net income.

Only one of I-Sector's subsidiaries, 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 ratably over three
to five years. The quantity of incentive options that are eligible to vest each
year for INX's two most senior executives is determined based on the percentage
of attainment of predefined financial goals by INX. Any unvested stock options
vest immediately upon the occurrence of a liquidity event for that subsidiary.
The subsidiary options expire ten years after the grant date if they are not
exercised. The subsidiary 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 5,884,275 options granted and
outstanding, of which 1,910,275 are vested at June 30, 2003. There are 3,115,725
shares in INX's plan available to be issued at June 30, 2003. The tables below
reflect the ownership INX at June 30, 2003 and summarize the potential dilutive
effect on I-Sector's ownership in INX if all options granted at June 30, 2003
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. (See note 10).

Ownership of INX at June 30, 2003:

16

(1) Options granted and outstanding at June 30, 2003 include option grants
for 4,100,000 shares of INX granted to the two senior executives of INX
and vesting of these option grants is performance-based relating to the
percentage of predefined financial goals attained by INX while these
two senior executives remain employed. Any of the shares associated
with this group of option grants that become eligible for vesting, but
do not vest due to financial performance, as compared to predefined
goals, are forfeited and will no longer be eligible for vesting unless
there is a liquidity event that returns a pre-defined return on
investment to I-Sector. Additionally, included in the option grants
outstanding at June 30, 2003 are grants for 500,000 shares granted to
key employees related to an acquisition (see Note 10), and this group
of option grants vested immediately upon grant. The remainder of the
shares included in option grants outstanding at June 30, 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.

(2) In connection with the acquisition of certain assets and liabilities of
Digital Precision, Inc. (see note 10), a portion of the consideration
given by INX was the contingent obligation to issue 1,800,000 shares of
INX Common Stock to Digital Precision, Inc. when and if three key
employees complete one year of employment with INX. If any of such key
employees terminates employment without cause before completion of one
year of employment, the number of shares of Common Stock to be issued
is decreased by scheduled and agreed upon percentages.

(3) INX entered into employment agreements with certain of the former
owners and employees of Digital Precision, Inc. that set forth that if
they met certain performance goals during the first two calendar
quarters following the completion Digital Precision transaction and for
the twelve months subsequent to the acquisition, that certain option
grants would be made. As of June 30, 2003, there is the potential that
options for 900,000 shares of INX will be granted to them on or after
April 4, 2004 at fair value at that date.

10. ACQUISITION

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, inventory,
intellectual property, customer lists, trademarks, tradenames and service marks,
contract rights and other intangibles of Digital, as well as assumed certain
operating leases of equipment and office space. 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. When that
contingency is resolved in April 2004, I-Sector could recognize a minority
interest related to the issuance of INX's common stock (see Note 9). No goodwill
was recognized in the acquisition. The results of operations subsequent to April
7, 2003 are included in I-Sector's consolidated statement of income for the
three months ended June 30, 2003.

17

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

I-SECTOR CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is qualified in its entirety by, and should be
read in conjunction with, our consolidated financial statements, including the
notes thereto included elsewhere in this Form 10-Q and our Form 10-K, previously
filed with the Securities and Exchange Commission. All monetary amounts
discussed in Items 2 through 5 are in thousands.

OVERVIEW

Our revenue is derived from three segments. Valerent, Inc. ("Valerent")
provides information technology solutions that lower the client's expense by
utilizing centralized, remote enabled computing management tools which predict,
announce and manage service interruptions. Additionally Valerent sells computer
products and provides customers with certain managed IT services such as
application support, operating system and network migration services, turnkey
outsourced IT helpdesk solutions, technical staff augmentation for IT helpdesk
operations and helpdesk solutions consulting services. Internetwork Experts,
Inc. ("INX") focuses on the design, deployment and support of networking
infrastructure. INX provides professional services for customers that have
large-scale network infrastructure requirements that are Cisco centric. The
areas of practice for INX include network design, implementation, turnkey
support, security audits and firewall design, network infrastructure management
and network infrastructure consulting services. Stratasoft, Inc. ("Stratasoft")
develops and markets proprietary software that integrates business telephone
systems and networked computer systems. Stratasoft's basic products are
sometimes customized to suit a customer's particular needs and are sometimes
bundled with computer hardware supplied by Stratasoft at the customer's request.
Stratasoft products include software for call center management, both in-bound
and out-bound, as well as interactive voice response software.

Valerent and INX market their services to businesses in Texas from
locations in the Houston and Dallas-Fort Worth metropolitan areas. Stratasoft
markets its products worldwide through a direct sales force and an authorized
dealer network. During the six months ended June 30, 2003, Valerent and INX
produced 9.1 % and 77.1 % of total revenues, while Stratasoft produced 14.5 % of
total revenues. Gross margin varies substantially between each of these business
segments.

Our ability to attract and retain qualified professional and technical
personnel is critical to the success of all of our services operations. The most
significant portion of the costs associated with the delivery of services is
personnel costs. Therefore, in order to be successful, our billable rates must
be in excess of the personnel costs and our margin is dependent upon maintaining
high utilization of our service personnel. In addition, the competition for high
quality personnel has generally intensified, causing both our and other service
provider's personnel costs to increase. In markets where we do not maintain
branch offices, we often subcontract for necessary technical personnel.

A significant portion of our cost of services for each of our service
businesses is comprised of labor. Labor cost related to permanent employees has
a somewhat fixed nature such that higher levels of service revenue produces
higher gross margin while lower levels of service revenue produces less gross
margin. Management of labor cost is important in order to prevent erosion of
gross margin.

A significant portion of our selling, general and administrative
expenses in all of our businesses relate to personnel costs, some of which are
variable and others of which are relatively fixed. Our variable personnel costs
are substantially comprised of sales commissions, which are typically calculated
based upon our gross profit on a particular sales transaction and thus generally
fluctuate with our overall gross profit. The remainder of selling, general and
administrative expenses are relatively fixed and does not vary in proportion to
increases in revenue as directly.

SPECIAL NOTICE REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q contains forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995
relating to future events or our future financial performance including, but not
limited to, statements contained in Item 2. - "Management's Discussion and
Analysis of Financial Condition and Results of Operations." Readers are
cautioned that any statement that is not a statement of historical fact,
including but not limited to, statements which may be identified by words
including, but not limited to, "anticipate," "appear," "believe," "could,"

18

"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 the 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 the I-Sector's annual
report on Form 10-K, as filed with the Securities and Exchange Commission
including the matters set forth in Item 1.- "Factors Which May Affect The Future
Results Of Operations," which could cause actual events, performance or results
to differ materially from those indicated by such statements.

19

THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002

The following table sets forth, for the periods indicated, certain
financial data derived from our unaudited consolidated statements of operations
for the three months ended June 30, 2003 and 2002. The discussion below relates
only to our continuing operations, unless otherwise noted.

TOTAL REVENUE. Total revenue, net of intercompany eliminations,
increased by $5,610 (54.7%) to $15,870 in 2003 from $10,260 in 2002.

Valerent revenue increased by $156 (12.7%) to $1,383 in 2003 from
$1,227 in 2002. As a percentage of total revenue Valerent revenue decreased to
8.5 % in 2003 from 12.0% in 2002. The increase in Valerent revenue was primarily
attributable to increased product sales of $245 offset by decreased service
revenues of $89 in the quarter ended June 30, 2003. The increase in revenue is
attributable to sales efforts beginning to come to fruition in the area of
specialized information technology solutions involving managed services and
internet security.

INX revenue increased by $5,605 (75.4 %) to $13,035 in 2003 from $7,430
in 2002. As a percentage of total revenue, INX revenue increased to 81.1 % in
2003 from 72.4% in 2002. Of the increase in revenues, $4,751 was attributed to
the Houston office, $118 was attributed to an increase in the federal government
sector, and $927 was attributed to a new office in Austin, Texas, formerly a
Digital Precision office. The total increase in revenues

20

attributable to the Digital Precision acquisition and including the revenues of
the Austin office is $1,982. These increases were offset by a decrease of $191
attributed to the Dallas office. The significant increase in the Houston office
revenues is attributed to three large projects involving both product and
service. These projects will carry over into the third quarter ending September
30, 2003.

Stratasoft revenue decreased by $146 (8.8%) to $1,511 in 2003 from
$1,657 in 2002. Stratasoft revenue, as a percentage of total revenue, decreased
to 10.5% in 2003 from 16.1% in 2002. 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 $152,000 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. The
decrease in revenues related to the Adjustment was offset by a $58 increase
resulting from an increase of 21 in the number of custom projects in process at
June 30, 2003 as compared to June 30, 2002 offset by the recognition on eight
large international custom projects that were in process during the second
quarter of 2002. Stratasoft's international sales accounted for 105.3% of
Stratasoft's revenues in the quarter ended June 30, 2003 as compared to 43.2% in
the same quarter of 2002.

GROSS PROFIT. Gross profit increased by $1,022 (59.9%) to $2,729 in
2003 from $1,707 in 2002. Gross margin increased to 17.2% in 2003 from 16.6% in
2002, primarily because a greater portion of the INX revenues were from its
service component, which has higher margins and because Stratasoft experienced
higher margins in the 2003 quarter.

Valerent gross profit increased by $47 (15.0%) to $360 in 2003 from
$313 in 2002. Gross margin for Valerent increased to 26.0% in 2003 from 25.5% in
2002. Valerent's cost of service consists primarily of labor cost that has a
fixed component. The fixed component of labor causes gross profit and gross
margin not to fluctuate directly with the change in revenues.

INX gross profit increased $824 (135.5%) to $1,432 in 2003 from $608 in
2002. Gross margin for INX increased to 11.0 % in 2003 from 8.2% in 2002. INX's
product gross profit has increased $702 to $1,408 in 2003 from $706 in 2002 due
to both sales volume increase and due to improved gross margin rates. INX's
gross profit on its service component increased to $24 in 2003 as compared to a
gross loss of $98 in 2002 due to better utilization of personnel.

Stratasoft gross profit increased by $151 (43.0%) to $937 in 2003 from
$786 in 2002 as revenue decreased by 8.8%. Gross margin for Stratasoft increased
to 62.0% in 2003 from 47.4% in 2002. Gross margin is impacted by the mix of
sales between custom systems sales, which include a hardware component, as
compared to software only sales, which do not have a hardware cost of goods
component. Stratasoft's increased gross margin rate is primarily due to changing
the mix of components included in their custom system sales to include a reduced
hardware component.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $1,548 (76.9%) to $3,562 in 2003 from
$2,014 in 2002. As a percentage of revenue, these expenses increased by 3.0%, to
22.6% of revenue in 2003 from 19.6% of revenue in 2002. Sales compensation
increased by $243, primarily due to the increased revenue volume of INX. Bad
debt expense increased by $441 and legal and accounting expense increased by
$178. Administrative compensation and related payroll taxes were higher by $94
in 2003, primarily due to an acquisition by INX, as compared to 2002. Contract
labor was higher by $76, primarily due to Stratasoft's opening of an office in
Calcutta, India. Travel increased $107 in 2003 as compared to the same period in
2002, primarily in Stratasoft due to international travel. General office
expenses increased $153 in 2003 as compared to 2002. Rent was higher in 2003 as
compared to 2002, primarily because of new offices related to the INX
acquisition and the Stratasoft India office. Other expenses increased $252 in
2003 as compared to 2002.

INTEREST AND OTHER INCOME (NET). We had interest income of $16 in 2003
compared to interest income of $15 in 2002, primarily due to interest on notes
receivable. Additionally, we had interest expense of $8 and a gain on
disposition of assets of $88 in 2003 as compared to interest expense of $8 and a
loss on disposition of assets of $15 in 2002.

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. As a consequence of these events, the
operations of these businesses are

21

reported as discontinued operations. At December 31, 2000 we sold our IT
Staffing business. For the quarters ended June 30, 2003 and 2002, respectively,
the gain (loss) on disposal related to these business was $4, $(14), and $26,
net of taxes of $2, $(7) and $14 and $5, $(1) and $7 (net of taxes of $3, $4 and
$(1)). The gains and/or losses on disposal related to these discontinued
operations is primarily related to collections of accounts receivables retained
when these businesses were sold.

NET LOSS. Net loss in the quarters ended June 30, 2003 and 2002 was
$640 and $295, respectively. No tax benefit had been recorded for the loss in
the three months ended June 30, 2002 because, due to our recurring losses, a
valuation allowance was recorded. A benefit for income taxes of $81 was recorded
in the quarter ended June 30, 2003 because, due to the Job Creation and Worker
Assistance Act of 2002 which 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 utilize our net operating loss
carryback. Previously, a net operating loss was only eligible to be carried back
to the 2 years preceding the year of loss.

SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO SIX MONTHS ENDED JUNE 30, 2002

The following table sets forth, for the periods indicated, certain
financial data derived from our unaudited consolidated statements of operations
for the six months ended June 30, 2003 and 2002. The discussion below relates
only to our continuing operations, unless otherwise noted.

TOTAL REVENUE. Total revenue, net of intercompany eliminations,
increased by $6,483 (33.3%) to $25,951 in 2003 from $19,468 in 2002.

22

Valerent revenue decreased by $304 (11.3%) to $2,388 in 2003 from
$2,692 in 2002. As a percentage of total revenue Valerent revenue decreased to
9.0% in 2003 from 13.8% in 2002. The decrease in Valerent revenue was primarily
attributable to decreased service revenues of $370 offset by increased product
sales of $66 in the six months ended June 30, 2003. The decrease in revenue is
primarily attributable to the loss of revenue from certain customers of $268 and
a loss of revenues of $26 due to a decision to not participate in the National
Service Network, a network of information technology organizations that provide
service and support for regional and national customers through the certified
services professionals employed by its participants.

INX revenue increased by $7,031 (53.5%) to $20,174 in 2003 from $13,143
in 2002. As a percentage of total revenue, INX revenue increased to 77.1 % in
2003 from 67.5% in 2002. Of the increase in revenues, $5,230 was attributed to
the Houston office, $927 was attributed to a new office in Austin, $118 was
attributed to sales in the government sector and $756 was attributed to the
Dallas office. The total increase in revenues attributable to the Digital
Precision acquisition, including the revenues of the acquired Austin office is
$1,982. INX's revenues grew rapidly in the six months ended June 30 2003
primarily due to large sales to two school districts totaling $5,234 and due to
synergy of $1,982 resulting from its acquisition of Digital Precision, Inc.

Stratasoft revenue decreased by $248 (6.5%) to $3,580 in 2003 from
$3,828 in 2002. Stratasoft revenue, as a percentage of total revenue, decreased
to 14.3% in 2003 from 19.7% in 2002. 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 $152,000 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. The
decrease in revenues related to the adjustments was offset by a $58 increase
resulting from an increase of 21 in the number of custom projects in process at
June 30, 2003 as compared to June 30, 2002 offset by the recognition on eight
large international custom projects that were in process during the second
quarter of 2002. Stratasoft's international sales accounted for 105.3% of
Stratasoft's revenues in the quarter ended June 30, 2003 as compared to 43.2% in
the same quarter of 2002. Additionally, Stratasoft's decreased revenues were
primarily the result of eight large international custom projects that were in
process during the first six months of 2002 and as compared to six large
international custom projects in process during the first six months of 2003.
Stratasoft's international sales accounted for 51.4% of Stratasoft's revenues in
the six months ended June 30, 2003 as compared to 38.1% in the same period of
2002.

GROSS PROFIT. Gross profit increased by $1,064 (27.0%) to $5,005 in
2003 from $3,941 in 2002. Gross margin decreased to 19.3 % in 2003 from 20.2% in
2002, primarily because a greater portion of the revenues were contributed by
INX, which has lower margins.

Valerent gross profit decreased by $39 (6.2%) to $589 in 2003 from $628
in 2002. Gross margin for Valerent increased to 24.7% in 2003 from 23.3% in
2002. Valerent cost of service consists primarily of labor cost that has a fixed
component. The fixed component of labor causes gross profit and gross margin not
to fluctuate directly with the decrease in revenues. During the six months ended
June 30, 2003, Valerent improved its utilization of its labor pool by reducing
the number of technicians employed, which contributed to improved gross margin.

INX gross profit increased $1,017 (85.2%) to $2,210 in 2003 from $1,193
in 2002. Gross margin for INX increased to 11.0 % in 2003 from 9.1% in 2002.
INX's product gross profit has increased $828 to $2,224 in 2003 from $1,396 in
2002 due to both the sales volume increase and the improved gross margin rates.
INX's gross loss on its service component improved to $14 in 2003 as compared to
a gross loss of $203 in 2002 as a result of better utilization of technical
personnel.

Stratasoft gross profit increased by $86 (4.1%) to $2,206 in 2003 from
$2,120 in 2002 as revenue decreased by 6.5%. Gross margin for Stratasoft
increased to 63.2% in 2003 from 55.4% in 2002. Gross margin is 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 cost of goods
component. Stratasoft's increased gross margin rate is primarily due to changing
the mix of system sales to include a reduced hardware component.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $2,303 (49.7%) to $6,939 in 2003 from
$4,636 in 2002. As a percentage of revenue, these expenses increased by 2.9%, to
26.7% of revenue in 2003 from 23.8% of revenue in 2002. Sales compensation
increased by $151 in 2003 as

23

compared to 2002. Bad debt expense increased by $873 and legal and accounting
expense increased by $204 in 2003 as compared to 2002. Administrative
compensation increased by $88 in 2003 as compared to 2002. Contract labor
increased $130 in 2003 as compared to 2002. Travel increased $176 in 2003 as
compared to 2002, primarily in Stratasoft due to international travel. General
office expenses increased $226 in 2003 as compared to 2002 and general insurance
expense increased $93 in 2003 as compared to 2002. Employee benefits,
depreciation and rents increased $62, $60 and $60, respectively, in 2003 as
compared to 2002. Other Corporate expenses increased $165 in 2003 as compared to
2002.

INTEREST AND OTHER INCOME (NET). Interest income increased by $7 to $34
in 2003 compared to interest income of $27 in 2002, primarily due to interest on
notes receivable. Interest income was offset by interest expense of $14 in 2003
as compared to $15 in 2002. Additionally, a gain on disposition of assets of $85
was recorded in 2003 as compared to a loss of $16 in 2002.

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. As a consequence of these events, the
operations of these businesses are reported as discontinued operations. At
December 31, 2000 we sold our IT Staffing business. For the six months ended
June 30, 2003 the gain (loss) on disposal related to these businesses was $8,
$(19) and $26, net of taxes of $4, $(10) and $14. For the six months ended June
30, 2002, the gain (loss) on disposal related to these businesses was $8, $3 and
$6, net of taxes of $4, $1 and $3. The gains and/or losses on disposal related
to these discontinued operations is primarily related to collections of accounts
receivables retained when these businesses were sold.

NET LOSS. Net loss (income) in the six months ended June 30, 2003 and
2002 was $(1,731) and $510. A benefit for income taxes of $81 and $1,189 was
recorded in the six months ended June 30, 2003 and 2002 because, due to the Job
Creation and Worker Assistance Act of 2002 which 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 utilize our net
operating loss carryback. Previously, a net operating loss was only eligible to
be carried back to the 2 years preceding the year of loss.

ASSET MANAGEMENT

Our cash flow from operations has been affected primarily by the timing
of our collection of accounts and notes receivable. We have typically sold our
products and services on short-term credit terms and seek 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 $8,324 and $6,525 at June
30, 2003 and December 31, 2002, respectively. At June 30, 2003 and December 31,
2002, Stratasoft had notes receivable of $765 and $898, respectively.

CRITICAL ACCOUNTING POLICIES

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

Product Revenue. All three of I-Sector's 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.

Custom Project Revenue. One of I-Sector's segments,
Stratasoft, earns revenues from projects that are recognized using the
percentage of completion method of accounting for such revenues. The
majority of Stratasoft's revenues consist 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 services ("PCS") together under a single contract with the
customer. PCS is insignificant on 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 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. The percentage of revenue
recognized in any particular period is

24

determined principally on the basis of the relationship of the cost of
work performed on the contract to estimated total costs. 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
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.

During the quarters ended June 30, 2003 and 2002 our subsidiary,
Stratasoft, recognized revenues on the percentage-of-completion basis
for several projects associated with 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-user customer, from whom Stratasoft was directly obligated to
be paid for such project.

I-Sector has 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 revenues derived
from Africa, the United Kingdom, and Canada.

Services Revenue. All of I-Sector's segments earn revenue from
providing stand-alone services revenues. 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, and are recognized when the service is performed and when
collection is reasonably assured. . Some of I-Sector's segments
sometime 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. These revenues are recognized at the earlier
of when payment is received or when notification of amounts being due
is received from the entity paying such agency fee and collectiblity is
reasonably assured.

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 the Company's revenue
recognition policy is the determination of the collectibility of amounts due
from its customers, which requires the Company to use estimates and exercise
judgment. The Company routinely monitors its customer's payment history and
current credit worthiness to determine that collectibility is reasonably assured
and, in some instances, requires letters of credit in support of contracted
amounts. This requires the Company 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. The Company
records 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 the Company's
customers, either adverse or positive, could impact the amount and timing of any
additional provision for doubtful accounts that may be required.

LIQUIDITY AND CAPITAL RESOURCES

Our working capital was $3,382 and $5,539 at June 30, 2003 and December
31, 2002, respectively. As of June 30, 2003, we had outstanding inventory floor
plan financings of $6,845 and an available borrowing base of $655 under our
Textron Finance Division credit facility. Cash used in continuing operating
activities decreased from $1,118 in the first six months of 2002 to $674 for the
comparable period in 2003. As further explained below, cash used in investing
activities increased from $223 in 2002 to $706 in 2003 due to the acquisition of
Digital Precision discussed in Note 10 to the Condensed Consolidated Financial
Statements. Cash used for financing activities decreased from $266 in 2002 to
$104 in 2003, primarily due to decreased purchases of treasury stock.

On January 31, 2002 we entered into a credit agreement with Textron
Financial Corporation ("Textron") for a revolving line of credit (the "Textron
Facility"). The total credit available under the Textron facility was $4,000,
however In December 2002, Textron increased the credit available on a temporary
basis to $5,500 and in April 2003 increased the credit available again on a
temporary basis to $7,500. The temporary increase was made permanent in August
2003. The Textron facility is subject to borrowing base limitations that are
generally computed as 80% eligible accounts receivable and 90% of identifiable
inventory purchased under this agreement and 40% of all other inventory. In
connection with the increase in the credit line, a modification was made to the
borrowing base limitations that restricted the eligibility of accounts
receivable for collateralization by disallowing as eligible any customer's
receivables in their entirety that have balances over 90 days old that

25

exceed 25% of their total balance. We may use up to $500 of the line for working
capital advances under approved conditions. Borrowings under the Textron
facility accrue interest at the prime rate plus 2.5% on outstanding balances
that extend beyond the vendor approved free interest period and on working
capital advances from date of advance. Inventory floor plan borrowings are
reflected in accounts payable on the accompanying balance sheets. At, June 30,
2003, we had $6,845 outstanding on inventory floor plan finance borrowings, $0
outstanding on working capital advances and had total credit availability of
$655 based upon the temporary line increase to $7,500.

This agreement is collateralized by substantially all of our assets
except our patent license assets. The agreement contains restrictive covenants,
which require us to maintain minimum tangible capital funds of $4,000,000 and a
minimum debt to tangible capital funds ratio of 2 to 1. At June 30, 2003 we were
not in compliance with all of the loan covenants; however. The Company
subsequently received a waiver on such non-compliance for that date. We are in
negotiations with Textron to modify the loan covenant agreement and we believe
we will be able to comply with these covenants in future reporting periods. In
the event we do not maintain compliance, we would be required to seek waivers
from Textron for those events, which, if not obtained, could accelerate
repayment and require us to seek other sources of finance.

Operating activities used net cash totaling $929 during the six months
ended June 30, 2003, including $255 related to discontinued operations.
Operating activities used net cash during the period primarily due to a net loss
of $1,731, an increase in accounts receivable of $1,856 and an increase in
inventory of $1,029, offset by a increase in accounts payable of $3,390.
Additionally, the uses of cash were offset by cash produced from increased
billings in excess of cost and estimated earnings of $198 and an increase in
accrued expenses of $158, and increased by an increase in cost and estimated
earnings in excess of billings of $191. The increase in accounts receivable of
$1,856 (28.4%) offset by bad debt write-offs of $58 7to $8,324 at June 30, 2003
from $6,525 at December 31, 2003 was primarily due to an increase in INX
receivables of $1,777 (39.9%) to $6,231 from $4,454, which was due to the
significant growth in its revenues. Our Stratasoft accounts receivables
increased by $107 (9.5%) to $1,231 from $1,124 due to increased revenues of $970
for the quarter ended June 30, 2003 over our quarter ended December 31, 2002.
Our Valerent accounts receivables increased by $347 (86.8%) to $747 from $400
due to increased revenues of $374 over revenues for our quarter ended December
31, 2002. Additionally, our receivables from discontinued operations decreased
by $332 (76.9%) to $100 from $432 at December 31, 2002. This is primarily
attributed to settlements with customers of our discontinued Computer Products
Division and our Telecom Division late in 2002 of which some was paid in 2003.
These receivables had previously been fully reserved, but were reversed when the
settlements, were reached.

The increase in inventory of $1,029 (144.7%) to $1,911 at June 30, 2003
from $781 at December 31, 2003 was primarily due to growth of inventory in our
INX subsidiary. Such growth in inventory was primarily attributable to increases
in INX transactions that occurred just prior to June 30, 2003, which created an
increase in inventory that was in the process of being prepared for delivery to
customers by INX at June 30, 2003.

The increase in accounts payable of $3,389 (70.0%) to $8,234 at June
30, 2003 from 4,844 at December 31, 2003 was primarily due to growth of INX,
which resells Cisco Systems and purchases such products either directly from
Cisco Systems, in which case accounts payable are outstanding under our Textron
credit facility, or through various suppliers, in which case such accounts
payable are outstanding under either our Textron credit facility or credit
facilities established directly with such suppliers. Under our Textron credit
facility the Company is typically obligated to pay for purchases within 60 days
following such purchases. Under credit facilities established with distribution
channel suppliers, we are typically obligated to pay for purchases within 30
days of such purchases. We expect INX revenue to continue to grow. Such INX
revenue growth impacts our cash flow if the growth exceeds increases in
available credit under our available credit facilities utilized to finance our
product purchases and this could cause the Company to seek other sources of
financing such as through the sale of stock.

Our negative cash flows from operations have been in large part due to
discretionary ongoing expenditures in the areas of sales and marketing related
to attempts to produce rapid growth, which we believe is a key to our business
strategy. These negative cash flows from operations have been balanced by cash
flows generated from financing activities, as we have utilized our growing
short-term asset base of accounts receivables and inventory to securitize a
growing credit facility with Textron, our primary provider of operational
financing.

We believe our working capital needs during the remainder of 2003 can
be met from our existing cash balances, cash generated by our operations and
borrowings under our credit facilities. Continued revenue growth is likely to
create a need for increased debt and/or equity capital financing resources.
There can be no assurance that we will be able to obtain such resources,
however, while we have not engaged an investment bank, we have maintained dialog
with a number of sources of both equity and debt financing, and we believe that,
so long as we produce reasonably improving results from

26

this point forward, we will be successful in obtaining at least the minimal
required debt and/or equity capital necessary to sustain continued growth until
we reach profitability, at which time we expect profits to mitigate the need for
equity financing, as we should be able to leverage our growing asset base to
obtain additional required debt financing necessary to finance continued growth
as necessary.

We are aware of no other substantial changes in trends, or other
events, that will materially change our liquidity situation other than those
that are normal as a part of growth, such as increasing assets and liabilities
associated directly with such growth, such as growth in accounts receivables and
inventory and settlement of litigation. We have no substantial short-term
balloon payments, planned significant capital expenditures, or any other
out-of-the-ordinary substantial known requirements to be satisfied.

RELATED PARTY TRANSACTIONS

We have from time to time made payments on behalf of Allstar Equities,
Inc., a Texas corporation ("Equities"), which is wholly-owned by our President
and Chief Executive Officer, on his behalf personally, for taxes, property and
equipment. Effective on December 1, 1999 a note payable by Equities was signed
for $336 for 60 monthly installments of $7. The note bears interest at 9% per
year. At June 30, 2003 and December 31, 2002, the Company's receivables from
Equities amounted to approximately $46 and $87, respectively. Additionally, from
time to time the Company has made payments to unrelated parties, primarily for
use of a credit card, for transactions that either wholly or partially benefit
our President and Chief Executive Officer and which therefore are accounted for
as indebtedness from him to the Company and on which he paid interest of 6% per
annum on the average outstanding balance. During August 2002, in order to be in
complete compliance with the Sarbanes-Oxley Act of 2002, the Company made a
demand for repayment of the outstanding balance at that time of $94 related to
the President and CEO's personal credit card usage. The President and CEO paid
the entire balance in December 2002 and there is no balance due at June 30, 2003
or at December 31, 2002.

We lease office space from Equities. On December 1, 1999 Equities
purchased our building and executed a direct lease with us with an expiration
date of December 31, 2004. In conjunction with Equities obtaining new financing
on the building, a new lease was executed with us on February 1, 2002 with an
expiration date of January 31, 2007. The new lease has rental rates of $37,192
per month.

From time to time we have obtained an independent survey of real estate
rental rates and have consulted with real estate consulting firms to determine
market rates of facilities that are comparable to our Houston headquarters
facility. We believe that the rental rate and other terms of our lease from
Equities are at least as favorable as those that could be obtained in an
arms-length transaction with an unaffiliated third party.

From time to time we make short-term loans and travel advances to our
employees. The balance of approximately $23 and $12 relating to these loans and
advances is included in the Company's balance sheet and reported as part of
Accounts receivable -other at June 30, 2003 and December 31, 2002, respectively.

We have three stock-based option plans, the 1996 Incentive Stock Plan,
the 1996 Non-Employee Director Stock Option Plan and the 2000 Stock Incentive
Plan. Under the 2000 Incentive Plan, all of our employees, including officers,
consultants and non-employee directors are eligible to participate.

Additionally, each of our subsidiaries has an incentive stock option
plan in place. The subsidiary plans have not been presented to the shareholders
of I-Sector for approval. The only subsidiary with options granted under its
plan incurred a net loss for each of the periods presented, and as a result our
share of subsidiary net loss does not change for purposes of computation of
I-Sector's net income.

Only one of our subsidiaries, 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 ratably over three to
five years. The quantity of incentive options that are eligible to vest each
year for INX's two most senior executives is determined based on the percentage
of attainment of predefined financial goals by INX. Any unvested stock options
vest immediately upon the occurrence of a liquidity event for that subsidiary.
The subsidiary options expire ten years after the grant date if they are not
exercised. The subsidiary 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 5,884,275 options granted and
outstanding, of which 1,910,275 are vested at June 30, 2003. There are 3,115,725
shares in INX's plan available to be issued at June 30, 2003. The tables below
reflect the ownership INX at June 30, 2003 and summarize the potential dilutive
effect on I-Sector's ownership in INX if all options granted at June 30, 2003
were fully vested and

27

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. (See note 10.)

Ownership of INX at June 30, 2003:

(1) Options granted and outstanding at June 30, 2003 include option grants
for 4,100,000 shares of INX granted to the two senior executives of INX
and vesting of these option grants is performance-based relating to the
percentage of predefined financial goals attained by INX while these
two senior executives remain employed. Any of the shares associated
with this group of option grants that become eligible for vesting, but
do not vest due to financial performance, as compared to predefined
goals, are forfeited and will no longer be eligible for vesting unless
there is a liquidity event that returns a pre-defined return on
investment to I-Sector. Additionally, included in the option grants
outstanding at June 30, 2003 are grants for 500,000 shares granted to
key employees related to an acquisition (see Note 10), and this group
of option grants vested immediately upon grant. The remainder of the
shares included in option grants outstanding at June 30, 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.

(2) In connection with the acquisition of certain assets and liabilities of
Digital Precision, Inc. (see note 10), a portion of the consideration
given by INX was the contingent obligation to issue 1,800,000 shares of
INX Common Stock to Digital Precision, Inc. when and if three key
employees complete one year of employment with INX. If any of such key
employees terminates employment without cause before completion of one
year of employment, the number of shares of Common Stock to be issued
is decreased by scheduled and agreed upon percentages.

(3) INX entered into employment agreements with certain of the former
owners and employees of Digital Precision, Inc. that set forth that if
they met certain performance goals during the first two calendar
quarters following the completion Digital Precision transaction and for
the twelve months subsequent to the acquisition, that certain option
grants would be made. As of June 30, 2003, there is the potential that
options for 900,000 shares of INX will be granted to them on or after
April 4, 2004 at fair value at that date.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We incur certain market risks related to interest rate variations
because we hold floating rate debt. Based upon the average amount of debt
outstanding during the three months ended June 30, 2003, a one-percent increase
in interest rates paid by us on our floating rate debt would not have resulted
in an increase in interest for the period.

Our business depends upon our ability to obtain an adequate supply of
products and parts at competitive prices and on reasonable terms. Our suppliers
are not obligated to have product on hand for timely delivery to us nor can they

28

guarantee product availability in sufficient quantities to meet our demands.
INX's business is Cisco centric. Any material disruption in our supply of
products could have a material adverse effect on our financial condition and
results of operations.

ITEM 4. CONTROLS AND PROCEDURES

Under the supervision and with the participation of our management,
including our Chief Executive Officer, Chief Financial Officer, President and
Chairman of the Board, we conducted an evaluation of our disclosure controls and
procedures, as such term is defined under Rule 13a-14(c) promulgated under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), within 90 days
of the filing date of this report. Based on their evaluation, our Chief
Executive Officer, Chief Financial Officer, President and Chairman of the Board
concluded that I-Sector's disclosure controls and procedures are effective.

There have been no significant changes (including corrective actions
with regard to significant deficiencies or material weaknesses) in our internal
controls or in other factors that could significantly affect these controls
subsequent to the date of the evaluation referenced in the immediate paragraph
above.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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 to
Inacom as a result of termination of a Vendor Purchase Agreement between Inacom
and us. We believe that the demand is without merit and intend to vigorously
contest the demand.

The Equal Employment Opportunity Commission ("EEOC") filed a Charge of
Discrimination against Stratasoft on behalf of Jennifer R. Bond on August 1,
2002 in the EEOC Minneapolis, Minnesota office. Stratasoft believes that the
charge is without merit and intends to vigorously contest the charge.

We are 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. We believe the final outcome of
such matters will not have a materially adverse effect on its results of
operations or financial position.

ITEM 2. OTHER INFORMATION

We disclosed in our Proxy Statement and Notice of Annual Meeting of
Stockholders to be held August 20, 2003, that our Secretary of the Board, our
retired former Chief Financial Officer, Mr. Donald R. Chadwick, is serving as a
member of our Audit Committee. Mr. Chadwick does not yet meet the three years of
non-employee status requirement for independence. We are relying on the
Marketplace Rule 4350D2B for his appointment to the Audit Committee since he is
not a current employee.

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

I-Sector Corporation.

August 19, 2003 By: /s/ JAMES H. LONG
Date ------------------
James H. Long, Chief Executive Officer, Chief
Financial Officer, President and Chairman of the Board

By: /s/ PATRICIA L. WINSTEAD
-------------------------
Patricia L. Winstead, Vice President and
Controller, Chief Accounting Officer

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ITEM 6. EXHIBITS

Exhibit 31 - Certification

Exhibit 32 - Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002

30