Notes to Consolidated Financial Statements

(In thousands)

1. Nature of Business, Basis of Presentation and Summary of Significant Accounting Policies

The Company

Communication Intelligence Corporation and its Joint Venture (the "Company" or "CIC") develops and markets natural input and biometric electronic signature solutions aimed at the emerging markets such as, e-commerce, wireless Internet/information devices, and corporate security. These emerging markets for CIC's products include all areas of personal computing, as well as electronic commerce and communications.

The Company's research and development activities have given rise to numerous technologies and products. The Company's core technologies are classified into two broad categories: "natural input technologies" and "transaction and communication enabling technologies". CIC's natural input technologies are designed to allow users to interact with a computer or handheld device through the use of an electronic pen or "stylus". Such products include the Company's multi-lingual Handwriter(R) Recognition System, and its Handwriter(R) for Windows(R) family of desktop computing products. CIC's transaction and communication enabling technologies provide a means for protecting electronic transactions and discretionary communications. CIC has developed products for dynamic signature verification, electronic ink data compression and encryption and a suite of development tools and applications which the Company believes could increase the functionality of its core products and facilitate their integration into original equipment manufacturers' ("OEM") hardware products and computer systems and networks.

Through its 90% owned joint venture, Communication Intelligence Computer Corporation, in China (the "Joint Venture"), the Company provides system integration services and markets its pen-based business computer systems to Chinese businesses, government users and other joint ventures.

For the five-year period ended December 31, 2003, the Company incurred aggregate losses of $12,600 and, at December 31, 2003, the Company's accumulated deficit was approximately $82,164 and its current liabilities exceeded its current assets by $2,908. In addition, the Company had negative cash flows from operations of $1,995, $2,087 and $2,159 for the years ended December 31, 2003, 2002 and 2001, respectively. These factors raise substantial doubt about the Company's ability to continue as a going concern. The Company has primarily funded these losses through the sale of debt and equity securities.

Going Concern

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The Company has suffered recurring losses from operations that raise a doubt about its ability to continue as a going concern.

The Company filed a registration statement with the Securities and Exchange Commission in February 2003 in order to obtain funding from equity financing. However, there can be no assurance that the Company will have adequate capital resources to fund planned operations or that any additional funds will be available to the Company when needed, or if available, will be available on favorable terms or in amounts required by the Company. If the Company is unable to obtain adequate capital resources to fund operations, it may be required to delay, scale back or eliminate some or all of its operations, which may have a material adverse effect on the Company's business, results of operations and ability to operate as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Basis of Consolidation

The accompanying consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States of America, and include the accounts of CIC and its 90% owned Joint Venture in the People's Republic of China. All inter-company accounts and transactions have been eliminated. All amounts shown in the accompanying consolidated financial statement are in thousands of dollars except per share amounts.

Communication Intelligence Corporation Notes to Consolidated Financial Statements

(In thousands)

Nature of Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenue recognition, allowance for doubtful accounts, long lived assets impairment, inventory, and disclosure of contingent assets and liabilities, at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

Fair Value of Financial Instruments

The carrying amounts of the Company's financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, short-term debt and long-term debt approximate fair value due to their short maturities.

        The Company's cash and cash equivalents, at December 31, consisted of
the following:

                                                          2003        2002
                                                     ----------- ------------

Cash in bank.......................................    $    110    $    260
Money market funds.................................         929         451
                                                     ----------- ------------

  Cash and cash equivalents............... ........    $  1,039    $    711
                                                     =========== ============

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash, cash equivalents, and accounts receivable. The Company maintains its cash and cash equivalents with various financial institutions. This diversification of risk is consistent with Company policy to maintain liquidity, and mitigate against risk of loss as to principal. Although such amounts may exceed the F. D. I. C. limits, the Company limits the amount of credit exposure with any one financial institution and believes that no significant concentration of credit risk exists with respect to cash and cash equivalents.

At December 31, 2003, the Joint Venture had approximately $92 in cash accounts held by a financial institution in the People's Republic of China. The Joint Venture deposits are not covered by any federal deposit insurance program that is comparable to the programs applicable to U.S. deposits.

To date, accounts receivable have been derived principally from revenues earned from end users, manufacturers, retailers and distributors of computer products in North America, Europe and the Pacific Rim. The Company performs periodic credit evaluations of its customers, and does not require collateral. The Company maintains reserves for potential credit losses; historically, such losses have been insignificant and within management's expectations.

The allowance for doubtful accounts is based on the Company's assessment of the collectibility of specific customer accounts and an assessment of international, political and economic risk as well as the aging of the accounts receivable. If there is a change in actual defaults from the Company's historical experience, the Company's estimates of recoverability of amounts due it could be affected and the Company will adjust the allowance accordingly.

Communication Intelligence Corporation Notes to Consolidated Financial Statements

(In thousands)

1. Nature of Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

Inventories

Inventories are stated at the lower of cost or market, cost being determined using the first-in first-out ("FIFO") method. Cost principally includes direct materials. At December 31, 2003 and 2002, inventories consisted of finished goods. At December 31, 2003 the Company recorded a provision of $38 to System Integration Cost of Sales for older obsolete inventory.

Property and Equipment, Net

Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, ranging from three to five years. Leasehold improvements are amortized over their estimated useful lives, not to exceed the term of the related lease. The cost of additions and improvements is capitalized, while maintenance and repairs are charged to expense as incurred. Depreciation expense was $63, $75 and $163 for the year ended December 31, 2003, 2002 and 2001, respectively. The Chinese Joint Venture disposed of certain assets at cost of $76 and $36 in 2003 and 2002, respectively.

Property and equipment, net at December 31, consists of the following:

                                                       2003         2002
                                                    ------------ ------------

Machinery and equipment.............................  $1,247       $1,273
Office furniture and fixtures.......................     432          432
Leasehold improvements..............................      84           84
Purchased software..................................     218          216
                                                    ------------ ------------

                                                       1,981        2,005
Less accumulated depreciation and amortization......  (1,843)      (1,846)
                                                    ------------ ------------

                                                     $   138      $   159
                                                    ============ ============

Included in property and equipment, as of December 31, 2003 and 2002, are $82 and $82, respectively, of assets acquired under capital leases. Accumulated depreciation on such assets totaled $52 and $44 at December 31, 2003 and 2002, respectively.

Patents

On October 6, 2000, the Company acquired certain assets of PenOp Limited ("PenOp") and its subsidiary PenOp Inc. pursuant to an asset purchase agreement dated as of September 29, 2000. Patents are stated at cost less accumulated amortization which in Management's opinion represents fair value. Amortization is computed using the straight-line method over the estimated lives of the related assets, ranging from five to seventeen years. Amortization expense was $379, $378 and $440 for the years ended December 31, 2003, 2002 and 2001, respectively.

The nature of the underlying technology of each material patent is as follows:

o Patent numbers 5544255, 5647017, 5818955 and 6064751 involve (a) the electronic capture of a handwritten signature utilizing an electronic tablet device on a standard computer system within an electronic document,
(b) the verification of the identity of the person providing the electronic signature through comparison of stored signature measurements, and (c) a system to determine whether an electronic document has been modified after signature.

Communication Intelligence Corporation Notes to Consolidated Financial Statements

(In thousands)

1. Nature of Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

                                 Expiration     Life       2003         2002
                                 ----------     ----   ------------ ------------

Patent (Various)................  Various         5   $      9    $       9
Patent (Various)................  Various         7        476          476
5544255.........................   2013          13         93           93
5647017.........................   2014          14        187          187
5818955........................    2015          15        373          373
6064751........................    2017          17      1,213        1,213
6091835........................    2017          17      4,394        4,394
                                                       ------------ ------------
                                                         6,745        6,745
Less accumulated amortization..                         (1,703)      (1,324)
                                                       ------------ ------------
                                                     $   5,042    $   5,421
                                                       ============ ============

Amortization expense for the years ending December 31, 2004, 2005, 2006, 2007, and 2008 are estimated to be $379, $379, $379, $379 and $379, respectively. The patents identified, as "various" are technically narrow or dated patents that the company believes are not material.

The useful lives assigned to the patents are based upon the following assumptions and conclusions:

o The estimated cash flow from products based upon each patent are expected to exceed the value assigned to each patent;

o There are no legal, regulatory or contractual provisions known to the Company that limit the useful life of each patent to less than the assigned useful life;

o No additional material costs need to be incurred or modifications made in order for the Company to continue to be able to realize the protection afforded by the patents, and

o The Company does not foresee any effects of obsolescence or significant competitive pressure on its current or future products, anticipates increasing demand for products utilizing the patented technology, and believes that the current markets for its products based on the patented technology will remain constant or will grow over the useful lives assigned to the patents because of a legal, regulatory and business environment encouraging the use of electronic signatures.

The Company performs intangible asset impairment analyses on a quarterly basis in accordance with the guidance in Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142") and Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long Lived Assets" ("SFAS 144"). The Company uses SFAS 144 in response to changes in industry and market conditions that affects its patents; the Company then determines if an impairment of its assets has occurred. The Company reassesses the lives of its patents and test for impairment quarterly in order to determine whether the book value of each patent exceeds the fair value of each patent. Fair value is determined by estimating future cash flows from the products that are and will be protected by the patents and considering the additional factors listed in Critical Accounting Policies in Item 7 of this Form 10-K.

Communication Intelligence Corporation Notes to Consolidated Financial Statements

(In thousands)

1. Nature of Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

Long-Lived Assets

The Company evaluates the recoverability of its long-lived assets whenever circumstances or events indicate such assets might be impaired. The Company would recognize an impairment reserve in the event the net book value of such assets exceeded the future undiscounted cash flows attributable to such assets. No such reserves have been recorded in the three years ended December 31, 2003.

Software Development Costs

Software development costs are accounted for in accordance with Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed" ("SFAS 86"). Under SFAS 86, capitalization of software development costs begins upon the establishment of technological feasibility, subject to net realizable value considerations. The costs capitalized include the coding and testing of the product after the technological feasibility has been established and ends upon the release of the product. The capitalized costs are amortized to cost of sales on a straight-line basis over the estimated life of the product, generally three years. As of December 31, 2003, 2002, and 2001, such costs were insignificant.

Stock-Based Compensation

Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). The Company has elected to continue to use the intrinsic value based method of Accounting Principles Board Opinion No. 25,"Accounting for Stock Issued to Employees", as allowed under SFAS 123, to account for its employee stock-based compensation plans. The Company complies with the disclosure provisions of SFAS 123.

Revenue Recognition

Revenue is recognized when earned in accordance with applicable accounting standards, including AICPA Statement of Position ("SOP") No. 97-2, "Software Revenue Recognition", as amended, Staff Accounting Bulletins 101, "Revenue Recognition in Financial Statements" ("SAB 101"), and the interpretive guidance issued by the Securities and Exchange Commission and EITF issue number 00-21, "Accounting for Revenue Arrangements with Multiple Elements", of the FASB's Emerging Issues Task Force. The Company recognizes revenues from sales of software products upon shipment, provided that persuasive evidence of an arrangement exists, collection is determined to be probable, all non-recurring engineering work necessary to enable the Company's product to function within the customer's application has been completed and the Company's product has been delivered according to specifications. Revenue from service subscriptions is recognized as costs are incurred or over the service period which-ever is longer.

Software license agreements may contain multiple elements, including upgrades and enhancements, products deliverable on a when and if available basis and post contract support. Revenue from software license agreements is recognized upon delivery of the software, provided that persuasive evidence of an arrangement exists, collection is determined to be probable, all nonrecurring engineering work necessary to enable the Company's products to function within the customer's application has been completed, and the Company has delivered its product according to specifications. Deferred revenue is recorded for upgrades, enhancements and post contract support, which is paid for in addition to license fees, and is recognized as costs are incurred or over the support period which-ever is longer. Vendor specific objective evidence of the fair value for multiple element software license agreements is determined by the price charged for the same element when sold separately or the price determined by management having the relevant authority when an element is not yet sold separately. The price established by management for the element not yet sold separately will not change prior to separate introduction of that element into the marketplace.

Revenue from system integration activities, which represents the sale and installation of third party computer equipment and limited related consulting

Communication Intelligence Corporation Notes to Consolidated Financial Statements

(In thousands)

1. Nature of Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

Revenue Recognition (continued)

services which requires little modification or customization to the software, is recognized upon installation as projects are short term in nature, provided persuasive evidence of an arrangement exists, collection of the resulting receivable is probable and the system is functioning according to specifications. Service subscription revenues associated with the system integration activities are recognized as costs are incurred or over the service period which-ever is longer.

The online/retail sales category includes sales of software made directly from the Company's website, which are downloaded either directly by a reseller or to a customer of such reseller. In both cases, the reseller reports the number of units sold each month by submitting payment and a royalty report. The reseller receives a percentage of each sale. The Company allows the on-line resellers a right of return or right of offset. The number of units reported is net of any product returns from prior months. The Company recognizes revenues on the net amount reported by the resellers each month. The Company has a limited number of resellers for its software available through the Company's website.

The online/retail sales category also includes sales made through retail establishments under the Elibrium agreement. Revenue from software product sales through retail are recognized upon notification from Elibrium of the number of units sold through Elibrium's retail customers provided collection of the resulting receivable is reasonably assured.

Major Customers

Handwriting Recognition Segment. Historically, the Company's handwriting recognition segment revenues have been derived from a limited number of customers. One customer, a major insurance company, accounted for 19% of total segment revenue for the year ended December 31, 2003. One customer, Nationwide Building Society, accounted for 11% of total segment revenues for the year ended December 31, 2002. One customer, The Prudential Insurance Company of America accounted for 16% of total segment revenues for the year ended December 31, 2001.

Systems Integration Segment. One customer, Fujitsu Ltd., accounted for 21% of total system integration revenue for the year ended December 31, 2003. This same customer accounted for 30%, and 16% of total segment revenues for the years ended December 31, 2002 and 2001, respectively.

One customer accounted for 14% of total revenues for the year ended December 31, 2003. One customer accounted for 10% of total revenues for the year ended December 31, 2002. One customer accounted for 13% of total revenues for the year ended December 31, 2001.

Research and Development

Research and development costs are charged to expense as incurred.

Advertising

The Company expenses advertising costs as incurred. Advertising expense for the years ended December 31, 2003, 2002, and 2001 was $0, $112 and $203, respectively.

Communication Intelligence Corporation Notes to Consolidated Financial Statements

(In thousands)

1. Nature of Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

Net Loss Per Share

The Company calculates earnings per share under the provisions of Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). SFAS 128 requires the disclosure of both basic earnings per share, which is based on the weighted average number of shares outstanding, and diluted earnings per share, which is based on the weighted average number of shares and dilutive potential shares outstanding. For the years ended December 31, 2003, 2002 and 2001, potential equivalent shares excluded from the calculation of diluted earnings per share, as their effect is not dilutive, include stock options of 5,911, 6,452 and 7,027 of equivalent shares. There were no warrants outstanding at December 31, 2003 or 2002. Warrants excluded from the calculation in 2001 were 237 equivalent shares.

Foreign Currency Translation

The Company considers the functional currency of the Joint Venture to be the local currency and, accordingly, gains and losses from the translation of the local foreign currency financial statements are included as a component of "accumulated other comprehensive loss" in the accompanying consolidated balance sheets. Foreign currency assets and liabilities are translated into U.S. dollars at the end-of-period exchange rates except for long-term assets and liabilities, which are translated at historical exchange rates. Revenues and expenses are translated at the average exchange rates in effect during each period except for those expenses related to balance sheet amounts which are translated at historical exchange rates.

Net foreign currency transaction gains and losses are included in "Interest income and other income (expense), net" in the accompanying consolidated statements of operations. Foreign currency transaction gains in 2003, 2002 and 2001 were insignificant.

Income Taxes

Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their financial statement reported amounts and for tax loss and credit carryforwards. A valuation allowance is provided against deferred tax assets when it is determined to be more likely than not that the deferred tax asset will not be realized.

Acquisition of Assets From PenOp

On October 6, 2000, a wholly-owned subsidiary of the Company, (the "Buyer"), acquired certain assets of PenOp Limited ("PenOp") and its subsidiary PenOp Inc., (collectively, the "Sellers") pursuant to an asset purchase agreement dated as of September 29, 2000, by and among Buyer and the Sellers for 4.7 million shares of common stock (the "Transaction Shares") of the Company (the "Acquisition"). The Company ascribed a value of $5,728 to the assets, which will be charged to income over the estimated lives of the assets, five to seventeen years.

Pursuant to the asset purchase agreement, the Company agreed to use reasonable efforts to file a registration statement under the Securities Act of 1933, as amended (the "Act"), covering the sale of the Transaction Shares no later than thirty (30) days from closing and to use reasonable efforts to have the registration statement declared effective as soon as practicable thereafter. The registration statement was declared effective on November 22, 2000.

Subsequent to the closing, an officer and Chairman of the Board of the Company at that time, and his designees, purchased in a private transaction an aggregate of 1,713,728 shares of common stock received by Sellers in connection with the Acquisition for $3.3 million.

Communication Intelligence Corporation Notes to Consolidated Financial Statements

(In thousands)

1. Nature of Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

Equity Line of Credit Agreement

In July 2002, the Company negotiated a Line of Credit agreement with Cornell Capital Partners, LP expiring two years from the effective date of the related registration statement (i.e. February 14, 2005). The Company may periodically issue and sell shares of its common stock and/or borrow funds up to an aggregate amount of $15,000, subject to the number of shares available for issuance and the purchase price of such shares. As of December 31, 2003, the Company had received $2,000 gross ($1,589 net of related costs) for approximately 8,621 shares. There is approximately 16,000 shares available for issuance against the Line of Credit at December 31, 2003. In addition, in 2003 the Company borrowed $750 pursuant to the Line of Credit agreement (See Note 4).

When the Company requests an advance under the Line of Credit, Cornell Capital Partners, L.P. will purchase shares of common stock of the Company for 100% of the "Market Price" of its stock (less a 6.5% advance fee). Market Price is defined as the lowest volume weighted average price of the Company's common stock as reported by Bloomberg, LP, calculated over four of the five trading days after the Company requests an advance. The maximum amount of each advance may not exceed $1 million in any 30-day period. In addition, in no event shall the number of shares issuable to Cornell Capital Partners, LP cause Cornell to own in excess of 9.9% of the then outstanding shares of the Company's common stock. On each advance date, the Company must pay to Cornell Capital Partners, L.P. an advance fee equal to 6.5% of the amount of each advance. Closing is held six (6) trading days after such written notice, at which time the Company delivers shares of common stock and Cornell Capital Partners, L.P. pays the advance amount. Cornell Capital Partners, L.P. cannot transfer its interest in the Line of Credit to any other person and cannot engage in short sales of shares of common stock acquired under the Line of Credit.

Recent Pronouncements

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46). FIN 46 changes the criteria by which one company includes another entity in its consolidated financial statements. Previously, the criteria were based on control through voting interest. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. A company that consolidates a variable interest entity is called the primary beneficiary of that entity. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established.

During October 2003, the FASB deferred the effective date for applying the provisions of FIN 46 until the end of the first interim or annual period ending after December 31, 2003 if the variable interest was created prior to February 1, 2003 and the public entity has not issued financial statements reporting that variable interest entity in accordance with FIN 46.

On December 24, 2003, the FASB issued FASB Interpretation No. 46 (Revised December 2003), "Consolidation of Variable Interest Entities," (FIN-46R) primarily to clarify the required accounting for interests in variable interest entities. FIN-46R replaces FIN-46 that was issued in January 2003. FIN-46R exempts certain entities from its requirements and provides for special effective dates for entities that have fully or partially applied FIN-46 as of December 24, 2003. In certain situations, entities have the option of applying or continuing to apply FIN-46 for a short period of time before applying FIN-46R. While FIN-46R modifies or clarifies various provisions of FIN-46, it also incorporates many FASB Staff Positions previously issued by the FASB. Management is currently assessing the impact, if any, FIN 46 may have on the Company; however, management does not believe there will be any material impact to the Company's financial position, results of operations or liquidity resulting from the adoption of this interpretation.

Communication Intelligence Corporation Notes to Consolidated Financial Statements

(In thousands)

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS 149 amends and clarifies financial accounting and reporting of derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement is effective for contracts entered into or modified after June 30, 2003, except for certain hedging relationships designated after June 30, 2003. The adoption of this Statement did not have a material impact on the Company's financial position, results of operations, or cash flows.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that issuers classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). With certain exceptions, this Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this Statement did not have a material impact on the Company's financial position, results of operations, or cash flows.

In December 2003, the FASB issued SFAS No. 132 (Revised 2003) "Employers' Disclosures about Pensions and Other Postretirement Benefits" (SFAS 132R). This standard replaces SFAS 132 of the same title which was previously issued in February 1998. SFAS 132R was issued in response to concerns expressed by financial statement users about their need for more transparency of pension information. The revised standard increases the existing GAAP disclosures for defined benefit pension plans and other defined benefit postretirement plans. However, it does not change the measurement or recognition of those plans as required under: SFAS 87, "Employers' Accounting for Pensions"; SFAS 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits"; and SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." Specifically, the revised standard requires companies to provide additional disclosures about pension plan assets, benefit obligations, cash flows, and benefit costs of defined benefit pension plans and other defined benefit postretirement plans. Also, for the first time, companies are required to provide a breakdown of plan assets by category, such as debt, equity and real estate, and to provide certain expected rates of return and target allocation percentages for these asset categories. The revised SFAS132R is effective for financial statements with fiscal years ending after December 15, 2003 and for interim periods beginning after December 15, 2003. The adoption of this Statement did not have a material impact on the Company's financial position, results of operations, or cash flows.

In December 2003, the Staff of the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition," which supersedes SAB No. 101, "Revenue Recognition in Financial Statements." The primary purpose of SAB No. 104 is to rescind accounting guidance contained in SAB No. 101 and the SEC's "Revenue Recognition in Financial Statements Frequently Asked Questions and Answers" related to multiple element revenue arrangements. The Company does not expect the issuance of SAB No. 104 to significantly impact its current revenue recognition policies.

2. Chinese Joint Venture

The Company currently owns 90% of a joint venture (the "Joint Venture") with the Jiangsu Hongtu Electronics Group, a provincial agency of the People's Republic of China (the "Agency"). In June 1998, the registered capital of the Joint Venture was reduced from $10,000 to $2,550. As of December 31, 2003, the Company had contributed an aggregate of $1,800 in cash to the Joint Venture and provided it with non-exclusive licenses to technologies and certain distribution rights and the Agency had contributed certain land use rights. Following the reduction in registered capital of the Joint Venture, neither the Company nor the Agency is required to make further contributions to the Joint Venture. Prior to the reduction in the amount of registered capital, the Joint Venture was subject to the annual licensing requirements of the Chinese government. Concurrent with the reduction in registered capital, the Joint Venture's business license has been renewed through October 18, 2043.

Communication Intelligence Corporation Notes to Consolidated Financial Statements

(In thousands)

3. Comprehensive Income

In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). The Company adopted SFAS 130 effective January 1, 1998. SFAS 130 requires that all items recognized under accounting standards as components of comprehensive earnings be reported in an annual statement that is displayed with the same prominence as other annual financial statements. SFAS 130 also requires that an entity classify items as other comprehensive earnings by their nature in an annual financial statement. For example, other comprehensive earnings may include foreign currency translation adjustments, minimum pension liability adjustments, and unrealized gains and losses on marketable securities classified as available-for-sale.

The accumulated other comprehensive loss at December 31, 2003 and 2002 consisted of cumulative foreign currency translation adjustments.

4. Short-term Debt - other

On December 19, 2003, the Company borrowed $750 from Cornell Capital Partners, LP. The proceeds of the loan were used for working capital purposes. The loan is secured by 4,621 shares of the Company's common stock held in escrow. The promissory note is due and payable in seven installments, commencing January 19, 2004 and ending on March 1, 2004, and may be paid in cash or shares of the company's common stock. The Company has the option to delay the commencement of the installment payments for an unlimited number of 30 day periods for an amount equal to 2% of the principal amount owed on or before the beginning of the current option period. The 2% payment may be made in cash or shares of common stock. Any delay in the commencement date will result in an equal delay in the due date of the note. If the note is not paid in full when due, the outstanding principal owed shall be due and payable in full together with interest at the rate of 2% per annum commencing from the due date.

Subsequent to December 31, 2003, the Company exercised its right to delay the commencement of the installment payments by paying the 2% fee discussed above. Such fees aggregated $38 were paid in cash and expensed. The company intends to repay the loan by issuing shares of its Common stock.

5. Short-term and Long-term Debt - related party

Short-term debt - related party

On June 19, 2001, the Company consummated a three-year $3,000 financing (the "Loan") with a charitable remainder annuity trust, a trustee of which was then a director and officer of the Company (the "Trust"). The proceeds of the Loan were used to refinance $1,500 of indebtedness outstanding to the Trust pursuant to a loan made by the Trust to the Company in October 1999 and for working capital purposes. The Loan is secured by a first priority security interest in all of the Company's assets as now owned or hereafter acquired by the Company. The Loan bears interest at the rate of 2% over the prime rate publicly announced by Citibank N. A. from time to time, which was 6.00% per annum at December 31, 2003, and is due June 18, 2004. As of December 31, 2003 the Loan was classified as short-term debt. The Loan may be pre-paid by the Company in whole or in part at any time without penalty, subject to the right of the Trust to convert the outstanding principal amount of the Loan into shares of common stock. Pursuant to the terms of the Loan, the Trust has the option, at any time prior to maturity, to convert all or any portion of the outstanding principal amount of the Loan into shares of common stock of the Company at a conversion price of $2.00 per share, subject to adjustment upon the occurrence of certain events. If, prior to maturity of the Loan, the Company consummates one or more financings providing $5 million or more in gross proceeds, the Company is required to apply 50% of the proceeds in excess of $5 million to the then outstanding principal amount of the Loan.

In connection with the Loan, the Company entered into a registration rights agreement with the Trust which obligates the Company to file a registration statement with the Securities and Exchange Commission covering the sale of the shares of the Company's common stock issuable upon conversion of the Loan if it receives a demand by the holder of the Loan to do so, and to use its reasonable best efforts to cause such registration statement to become effective. The Trust has made no demand of the Company to file such registration statement as of December 31, 2003.

Communication Intelligence Corporation Notes to Consolidated Financial Statements

(In thousands)

5. Short-term and Long-term Debt - related party (continued)

Short-term debt - related party

In 2002, $16 and in 2001, $150 in consulting fees, including office expenses, were paid to a party who, at that time, was a director and Chairman of the Board.

The weighted average interest rate was 6.8%, 6.8% and 8.8% for the years ended December 31, 2003, 2002, and 2001, respectively.

Interest expense for the years ended December 31, 2003, 2002, and 2001 was $205, $205, and $282, respectively. Interest expense associated with related party debt was $183, $200 and $274 for the years ended December 31, 2003, 2002 and 2001, respectively.

Long-term debt - related party

In June 2003 the Company's Joint Venture borrowed from one of its directors approximately $24 denominated in U. S. dollars to purchase a replacement van used in the Company's operations. The note bears interest at the rate of 5% per annum, and is due in June 2006. Principal payments on long term debt are $8, $8, and $5 for the years ended December 31, 2004, 2005, and 2006, respectively.

6. Stockholders' Equity

Common Stock Options

In 1994 the Company adopted the 1994 Stock Option Plan (the "1994 Plan"). Under1994 Plan directors, officers and employees are eligible for grants of incentive and non-qualified stock options. In May 1997, the stockholders approved an increase of 1,000 shares to the number of shares authorized for issuance under the 1994 Plan. Accordingly, a total of 6,000 shares of Common Stock are authorized for issuance under the 1994 Plan. The exercise prices of options under the 1994 Plan are determined by a committee of the Board of Directors, but, in the case of an incentive stock option, the exercise price may not be less than 100% of the fair market value of the underlying Common Stock on the date of grant. Non-qualified options may not have an exercise price of less than 85% of the fair market value of the underlying Common Stock on the date of grant. Options under the 1994 Plan are generally exercisable over a period not to exceed seven years and vest quarterly over three years. At December 31, 2003, there were 596 options available for grant under the 1994 Plan. As of December 31, 2003, 994 plan options were outstanding and exercisable with a weighted average exercise price of $0.85 per share.

The Company has issued non-plan options to its employees and directors. The non-plan options vest over four years or prorata quarterly over three years. For those non-plan options which vest over four years, 20% of the total non-plan options granted vest on the first anniversary of the date of grant and an additional 20%, 20%, and 40% of the total non-plan options granted vest on the second, third, and fourth anniversaries of the date of grant, respectively. Non-plan options are generally exercisable over a period not to exceed seven years. As of December 31, 2003, 3,115 non-plan options were outstanding and exercisable with a weighted average exercise price of $0.84 per share.

In June 1999, the Company adopted and the shareholders approved a stock option plan (the "1999 Plan"). Incentive and non-qualified options under the 1999 Plan may be granted to employees, officers, and consultants of the Company. There are 4,000 shares of Common Stock authorized for issuance under the 1999 Plan. The options have a seven year life and generally vest quarterly over three years. At December 31, 2003, there were 2,130 shares available for future grants As of December 31, 2003, 1,802 plan options were outstanding and 1,089 plan options were exercisable with a weighted average exercise price of $0.79 per share.

                                                 Year Ended December 31,
                                     -------------------------------------------
                                             2003                     2002
                                     ---------------------    ------------------
                                                  Weighted             Weighted
                                                   Average             Average
                                       Shares     Exercise             Exercise
                                                    Price     Shares    Price
                                     -------------------------------------------

Outstanding at beginning of period..     3,337      $1.26      3,442     $1.48
Granted.............................       858      $0.32      1,108     $0.60
Exercised...........................         -      $0.00       (169)    $0.75
Forfeited...........................    (1,399)     $1.83     (1,044)    $1.34


                                      -----------           ---------
Outstanding at period end...........     2,796      $0.71     3,337      $1.27
                                      ===========           =========


Options exercisable at period end....     2,083     $0.81     2,422      $1.36
                                       ===========           =========

Weighted average grant-date
fair value of  options granted
during the period....................     $0.27               $0.60
                                       ===========           =========

The following table summarizes information about stock options outstanding under the 1994 Plan and the 1999 Plan at December 31, 2003:

                                                      Weighted Average
                                    -------------------------------------------

                                                   Remaining
                                     Options    Contractual Life
Range of Exercise Prices           Outstanding      (Years)      Exercise Price
-------------------------------------------------------------------------------

$0.00 - $0.50..................            848        7.0             $0.31
$0.51 - $2.00..................          1,899        3.9             $0.83
$2.01 - $2.99..................              8        0.1             $2.75
$3.00 - $7.50..................             41        5.1             $3.37
                                  --------------
                                         2,796
                                  ==============

The following table summarizes information about stock options exercisable under the 1994 Plan and the 1999 Plan at December 31, 2003:

                                                                 Weighted
                                             Options              Average
Range of Exercise Prices                   Exercisable         Exercise Price
                                      ------------------------------------------

      $0.00 - $0.50.................               318           $0.31
      $0.51 - $2.00.................              1716           $0.84
      $2.01 - $2.99.................                 8           $2.75
      $3.00 - $7.50.................                41           $3.37
                                      -------------------
                                                 2,083
                                      ===================

Communication Intelligence Corporation Notes to Consolidated Financial Statements

(In thousands)

Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") as amended by Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosures-an Amendment of FASB Statement No. 123". The Company has elected to continue to use the intrinsic value based method of Accounting Principles Board Opinion No. 25, as allowed under SFAS 123, to account for its employee stock-based compensation plans. The Company complies with the disclosure provisions of SFAS 123.

Had compensation cost for the Company's option plans been determined based on the fair value of the options at the date of grant, as prescribed by SFAS 123, the Company's net loss available to common stockholders and basic and diluted net loss per share available to stockholders would have been as follows for the year ended December 31:

                                              2003          2002          2001
                                            ------------------------------------
Net loss as reported.......................  $ (2,298)   $ (3,561)    $ (3,215)
Add: Stock-based employee compensation
 expense included in  reported results
 of operations, net of related tax effects          -           -            -
Deduct: Total stock-based employee
 compensation expense  determined under
 fair value-based method for all awards, net
of related tax effects                           (380)      (795)       (1,528)
                                            -----------------------------------
   Pro forma net loss......................  $ (2,678)  $ (4,356)     $ (4,743)
                                            ====================================

Basic and diluted net loss per share
 available to stockholders:
  As reported..............................  $  (0.02)  $  (0.04)     $  (0.04)
  Pro forma................................  $  (0.03)  $  (0.05)     $  (0.05)

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants during the applicable periods: risk-free interest rate of 2.37% for 2003, 2.26% for 2002, and 4.1% for 2001, an expected life of 6.65 years for 2003, 8.6 years for 2002, and 6.0 years for 2001, expected volatility of 100% for all periods and dividend yield of 0% for all periods.

The Company expects to make additional option grants each year. The Company believes the above pro forma disclosures are not representative of the pro forma effects on reported results of operations to be expected in future periods.

As of December 31, 2003, 5,911 shares of Common Stock were reserved for issuance upon exercise of outstanding options.

Warrants

At December 31, 2003 there were no warrants outstanding.

7. Commitments

Operating Lease Commitments

The Company currently leases 9,634 square feet, its principal facilities, (the "Principal Offices) in Redwood Shores, California, pursuant to a sublease that expires in 2006. In addition, the Company subleased to third parties certain space adjacent to the Principal Offices through August 2001. The Joint Venture leases approximately 1,500 square feet in Nanjing, China. In addition to monthly rent, the U.S. facilities are subject to additional rental payments for utilities and other costs above the base amount. Facilities rent expense was approximately $450, $418, and $443, in 2003, 2002, and 2001, respectively. Sublease income was approximately $35, for the year ended December 31, 2001.

Future minimum lease payments under noncancelable operating leases are approximately, $419, $380, and $358 for the years ending December 31, 2004, 2005 and 2006, respectively. The Company's rent expense was

Communication Intelligence Corporation Notes to Consolidated Financial Statements

(In thousands)

Operating Lease Commitments (continued)

reduced by approximately $35 in 2001 in connection with the subleases described above. Future minimum payments required under capital leases, which expire in 2007, were insignificant at December 31, 2003.

8. Income Taxes

As of December 31, 2003, the Company had federal net operating loss carryforwards available to reduce taxable income through 2013 of approximately $69,463. The Company also had federal research and investment tax credit carryforwards of approximately $315 that expire at various dates through 2010.

        Deferred tax assets and liabilities at December 31, consist of the
following:

                                                     2003          2002
                                                ----------------------------
Deferred tax assets:
Net operating loss carryforwards............     $ 27,785       $ 26,857
Credit carryforwards................ .......          315            315
Deferred income.............................           67             40
Other, net..................................          933            945
                                                ----------------------------
Total deferred tax assets...................       29,100         28,157
                                                ----------------------------
Valuation allowance.........................      (29,100)       (28,157)
                                                ----------------------------
Net deferred tax assets.....................     $      -       $      -
                                                ============================

Income tax (benefit) differs from the expected statutory rate as follows:

                                           2003        2002            2001

Expected income tax benefit            $   (799)   $  (1,211)     $   (1,093)
State   income   tax  net  of  Federal     (144)        (214)           (193)
benefit
Loss write off of foreign investment          -       (4,357)              -
Change in valuation allowance               943        5,782          (1,286)
                                        ----------- ------------ -------------
  Income tax benefit                   $      -    $       -      $        -
                                        =========== ============ =============

A full valuation allowance has been established for the Company's net deferred tax assets since the realization of such assets through the generation of future taxable income is uncertain.

Under the Tax Reform Act of 1986, the amounts of, and the benefit from, net operating losses and tax credit carryforwards may be impaired or limited in certain circumstances. These circumstances include, but are not limited to, a cumulative stock ownership change of greater than 50%, as defined, over a three-year period. During 1997, the Company experienced stock ownership changes which could limit the utilization of its net operating loss and research and investment tax credit carryforwards in future periods.

9. Segment Information

Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131") establishes standards for related disclosures about products and services, geographic areas and major customers. The Company's information has been stratified into two segments - Handwriting Recognition Software and Systems Integration.

The accounting policies followed by the segments are the same as those described in the "Summary of Significant Accounting Policies." Segment data includes revenues, as well as allocated corporate-headquarters costs charged to each of the operating segments.

Communication Intelligence Corporation Notes to Consolidated Financial Statements

(In thousands)

9. Segment Information (continued)

The Company identifies reportable segments by classifying revenues into two categories Handwriting Recognition and System Integration. Handwriting recognition software is an aggregate of three revenue categories, OEM, Enterprise and Online sales. All handwriting recognition software is developed around the Company's core technology. System integration represents the sale and installation of third party computer equipment and systems that utilize the Company's products. All sales below represent sales to external customers.

The table below presents information about reporting segments for the years ended December 31:

                                  Handwriting        Systems
                                  Recognition      Integration       Total
                               ---------------   -------------- --------------
2003 Revenues                  $     2,322      $        712    $       3,034
     Loss from operations      $    (2,106)     $        (51)   $      (2,157)
     Total assets              $     6,294      $        921    $       7,215
     Depreciation and
     amortization              $       438      $         18    $         456

2002 Revenues                  $      2,214     $      1,015    $       3,272
     Loss from operations      $     (3,307)    $        (30)   $      (3,337)
     Total assets              $      6,181     $      1,005    $       7,186
     Depreciation and
     amortization              $        450     $         17    $         467

2001 Revenues                  $      4,546     $      1,401    $       5,947
     Loss from operations      $     (2,842)    $       (104)   $      (2,946)
     Total assets              $      8,662     $      1,410    $      10,072
     Depreciation and
     amortization              $        662     $         25    $         687

The following table represents revenues and long-lived asset information by geographic location for the period ended December 31:

                       Revenues Long Lived Assets
        ------------------------------- ------------------------------------
           2003        2002       2001       2003        2002         2001
        ---------    --------   --------   ---------  ---------  -----------

 U.S.    $ 2,003     $ 2,018    $ 4,223    $   5109   $  5,549     $  5,916

 China     1,031       1,254      1,724          71         31           44
        ---------    --------   --------   ---------  ---------- -----------
Total    $ 3,034     $ 3,272    $ 5,947    $  5,180   $  5,580     $  5,960
        =========    ========   ========   =========  ========== ===========

Interest expense is related solely to Handwriting recognition segment and was $205, $205, and $282, for the years ended December 31, 2003, 2002, and 2001, respectively.

The Company's export sales from U.S. operations were 14%, 12%, and 16% of total revenues in 2003, 2002, and 2001, respectively.