**UNITED STATES**


**SECURITIES AND EXCHANGE COMMISSION**


Washington, D.C. 20549





**FORM 10-Q**





**x Quarterly Report Pursuant to Section 13 or 15(d) of**


**the Securities Exchange Act of 1934**


For the quarterly period ended July 3, 2004





or





**o 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 0-4090








**ANALYSTS INTERNATIONAL CORPORATION**(Exact name of registrant as specified in its charter)**Minnesota**
**41-0905408**(State of Incorporation)
(IRS Employer Identification No.)**3601 West 76****th****Street****Minneapolis, MN**
**55435**(Address of Principal Executive Offices)
(Zip Code)Registrants telephone number, including area code:**(952) 835-5900**








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





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











As of August 5, 2004, 24,211,957 shares of the registrant's common stock were outstanding.























**ANALYSTS INTERNATIONAL CORPORATION**





**INDEX**







**Part I.**
**FINANCIAL INFORMATION**Item 1.
Condensed Consolidated Balance SheetsJuly 3, 2004 (Unaudited) and January 3, 2004Condensed Consolidated Statements of OperationsThree and six months ended July 3, 2004 and June 28, 2003 (Unaudited)Condensed Consolidated Statements of Cash FlowsSix months ended July 3, 2004 and June 28, 2003 (Unaudited)Notes to Condensed Consolidated Financial Statements (Unaudited)Item 2.
Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3.
Quantitative and Qualitative Disclosures About Market RiskItem 4.
Controls and Procedures**Part II.**
**OTHER INFORMATION**Item 4.
Submission of Matters to a Vote of Security HoldersItem 6.
Exhibits and Reports on Form 8-KSignaturesExhibit Index





2








****PART I. FINANCIAL INFORMATION****





****Item 1.****





****Analysts International Corporation**
**Condensed Consolidated Balance Sheets****





**July 3,**
****
**January 3,**
*******(In thousands)***
****
**2004**
****
**2004**
********
****
***(Unaudited)*****ASSETS**Current assets:Cash and cash equivalents

$
4,061

$
4,499Accounts receivable, less allowance for doubtful accounts


60,488


55,623Prepaid expenses and other current assets


4,572


4,737Total current assets


69,121


64,859Property and equipment, net


6,304


6,297Intangible assets other than goodwill, net


10,862


11,249Goodwill


16,460


16,460Other assets


3,550


3,030$
106,297

$
101,895**LIABILITIES AND SHAREHOLDERS' EQUITY**Current liabilities:Accounts payable

$
16,844

$
15,825Salaries and vacations


9,995


7,774Deferred revenue


1,797


2,766Self-insured health care reserves and other amounts


3,454


2,829Total current liabilities


32,090


29,194Non-current liabilities, primarily deferred compensation


4,377


4,038Shareholders' equity


69,830


68,663$
106,297

$
101,895





Note: The balance sheet at January 3, 2004 has been taken from the audited financial statements at that date, and condensed.








See notes to condensed consolidated financial statements.





3








**Analysts International Corporation**


****Condensed Consolidated Statements of Operations****


*(Unaudited)*





**Three Months Ended**
****
**Six Months Ended**
********
****
**July 3,**
****
**June 28,**
****
**July 3,**
****
**June 28,**
*******(In thousands except per share amounts)***
****
**2004**
****
**2003**
****
**2004**
****
**2003**Professional services revenue:Provided directly

$
72,084

$
71,443

$
143,153

$
141,078Provided through subsuppliers


14,781


11,167


29,106


27,573Total revenue


86,865


82,610


172,259


168,651Expenses:Salaries, contracted services and direct charges


70,794


67,539


140,458


138,195Selling, administrative and other operating costs


15,159


15,062


30,240


30,627Amortization of intangible assets


194


194


387


387Operating income (loss)


718


(185
)

1,174


(558
)Non-operating income


2


17


8


25Interest expense


(14
)

--


(22
)

(8
)Income (loss) before income taxes


706


(168
)

1,160


(541
)Income tax expense (benefit)


--


--


--


(57
)Net income (loss)

$
706

$
(168
)
$
1,160

$
(484
)Per common share:Basic income (loss)

$
.03

$
(.01
)
$
.05

$
(.02
)Diluted income (loss)

$
.03

$
(.01
)
$
.05

$
(.02
)Average common shares outstanding


24,212


24,199


24,212


24,199Average common and common equivalent shares outstanding


24,223


24,199


24,228


24,199











See notes to condensed consolidated financial statements.








4








**Analysts International Corporation**


****Condensed Consolidated Statements of Cash Flows**** **


*(Unaudited)*








**Six Months Ended****July 3,**

**June 28,*****(In thousands)***

**2004**

**2003**Net cash provided by operating activities

$
1,038

$
5,935Cash flows from investing activities:Property and equipment additions


(1,488
)

(736
)Proceeds from property and equipment sales


11


17Net cash used in investing activities


(1,477
)

(719
)Cash flows from financing activities:Net change in working capital line of credit


--


(324
)Proceeds from exercise of stock options


1


--Net cash provided by (used in) financing activities


1


(324
)Net (decrease) increase in cash and cash equivalents


(438
)

4,892Cash and cash equivalents at beginning of period


4,499


54Cash and cash equivalents at end of period

$
4,061

$
4,946


See notes to condensed consolidated financial statements.





5








**Analysts International Corporation**


****Notes to Condensed Consolidated Financial Statements****


(Unaudited)





1.  Summary of Significant Accounting Policies





Condensed Consolidated Financial Statements - The condensed consolidated balance sheet as of July 3, 2004, the condensed consolidated statements of operations for the three- and six-month periods ended July 3, 2004 and June 28, 2003, and the condensed consolidated statements of cash flows for the six-month periods ended July 3, 2004 and June 28, 2003 have been prepared by the Company, without audit. In the opinion of management, all adjustments necessary to present fairly the financial position atJuly 3, 2004 and the results of operations and the cash flows for the periods ended July 3, 2004 and June 28, 2003 have been made.





The Company operates on a fiscal year ending on the Saturday closest to December 31. Accordingly, the Companys fiscal quarters end on the Saturday closest to the end of the calendar quarter.





Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. The Company suggests reading these condensed consolidated financial statements in conjunction with the financial statements and notes thereto included in the Company's January 3, 2004 annual report to shareholders.





Comprehensive income (loss) for the three and six months ended July 3, 2004 and June 28, 2003 was equivalent to reported net income (loss).




In accordance with Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets," the Company evaluates its goodwill and indefinite-lived intangible assets for impairment as of the first day of the fiscal year and whenever events or changes in circumstances indicate that the assets might be impaired. In the current year, the Company evaluated these assets on January 3, 2004 and found no indication of impairment of its recorded goodwill, although the valuation determined the fair value of the Infrastructure and Solutions reporting units to approximate their carrying value.


For the six months ended July 3, 2004, no goodwill or other intangibles were acquired, impaired or disposed. Other intangibles consisted of the following:





**July 3, 2004**
****
**January 3, 2004**
********
****
***(In thousands)***
****
**Gross**
**CarryingAmount**
****
****
**Accumulated**
**Amortization**
****
**Other Intangibles,Net**
****
**Gross CarryingAmount**
****
****
**AccumulatedAmortization**
****
**Other Intangibles,Net**Customer list

$
12,270

$
(2,995
)
$
9,275

$
12,270

$
(2,608
)
$
9,662Tradename


1,720


(133
)

1,587


1,720


(133
)

1,587$
13,990

$
(3,128
)
$
10,862

$
13,990

$
(2,741
)
$
11,249





The customer list is scheduled to be fully amortized by 2015 with corresponding amortization estimated to be approximately $800,000 per year.  The tradename is considered to have an indefinite life and therefore is no longer amortized.








6








The Company applies the disclosure provisions of SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," and continues to account for its five stock-based compensation plans under Accounting Principles Board (APB) Opinion No. 25 and related interpretations.


Had compensation cost for our stock-based compensation plans been determined based on the fair value at the grant dates in accordance with SFAS 148, our pro forma net income (loss) and net income (loss) per share for the three and six months ended July 3, 2004 and June 28, 2003 would have been the amounts indicated below:





**Three Months Ended**
****
**Six Months Ended**
********
****
**July 3,**
****
**June 28,**
****
**July 3,**
****
**June 28,**
********
****
**2004**
****
**2003**
****
**2004**
****
**2003**Net income (loss)*(in thousands):*As reported

$
706

$
(168
)
$
1,160

$
(484
)Pro forma


530


(439
)

763


(1,009
)Net income (loss) per share (basic):As reported

$
.03

$
(.01
)
$
.05

$
(.02
)Pro forma


.02


(.02
)

.03


(.04
)Net income (loss) per share (diluted):As reported

$
.03

$
(.01
)
$
.05

$
(.02
)Pro forma


.02


(.02
)

.03


(.04
)








2.  Line of Credit





The Company has an asset-based revolving credit facility with up to $45,000,000 of availability. Borrowings under this credit agreement are secured by all of the Companys assets. Under the revolving credit agreement, which matures on April 10, 2005, the Company must take advances or pay down the outstanding balance daily. The Company can, however, choose to request fixed-term advances of one, two, or three months for a portion of the outstanding balance on the line of credit. Daily advances on the line of credit bear interest at the Wall Street Journals "Prime Rate" plus .75% (5.00% on July 3, 2004) while the fixed-term advances bear interest at the LIBOR rate plus 3.0%. The credit agreement requires the payment of a commitment fee of .50% of the unused portion of the line plus an annual administration fee of $50,000. The agreement restricts, among other things, the payment of dividends, establishes limits on capital expenditures and requires the Company to maintain a minimum accounts payable turnover ratio. The Company believes it will be able to continue to meet these requirements for the foreseeable future and as of July 3, 2004 did not have any borrowings under this agreement.





Subsequent to July 3, 2004, the Company amended its credit agreement to extend the expiration date to October 31, 2006 and modify certain terms of the agreement. The amendment reduces the commitment fee from .50% to .25% of the unused portion of the line, reduces the annual administration fee from $50,000 to $25,000, and reduces the interest rates on daily advances to the Wall Street Journals "Prime Rate" and fixed-term advances to the LIBOR rate plus 2.0%.





7











3.  Shareholders' Equity





****
**Six Months Ended**
*******(In thousands)***
****
**July 3, 2004**Balance at beginning of period

$
68,663Proceeds upon exercise of stock options


1Amortization of Deferred Compensation


6Comprehensive income


1,160Balance at end of period

$
69,830





4.  Earnings Per Share





Basic and diluted earnings (loss) per share (EPS) are presented in accordance with SFAS No. 128, "Earnings per Share." Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. The difference between weighted-average common shares and average common and common equivalent shares used in computing diluted EPS is the result of outstanding stock options and other contracts to issue common stock. Options to purchase 2,394,000 and 2,018,000 shares of common stock were outstanding at the end of the periods ended July 3, 2004 and June 28, 2003, respectively. Options to purchase 2,129,000 and 1,543,000 shares were considered anti-dilutive and excluded from the computation of common equivalent shares for the three and six months ended July 3, 2004, respectively, because the exercise price was greater than the average share price. All outstanding options were considered anti-dilutive and excluded from the computation of common equivalent shares for the three and six months ended June 28, 2003 because the Company reported a net loss. The computation of basic and diluted earnings (loss) per share for the three and six months ended July 3, 2004 and June 28, 2003 is as follows:




**Three Months Ended**
****
**Six Months Ended*****(In thousands, except per share amounts)***

**July 3,**
**2004**
****
**June 28,**
**2003**
****
**July 3,**
**2004**
****
**June 28,2003**Net income (loss)

$
706

$
(168
)
$
1,160

$
(484
)Weighted-average number of common shares outstanding


24,212


24,199


24,212


24,199Dilutive effect of employee stock options and restricted stock award


11


--


16


--Weighted-average number of common and common equivalent shares outstanding


24,223


24,199


24,228


24,199Earnings (loss) per share:Basic

$
.03

$
(.01
)
$
.05

$
(.02
)Diluted

$
.03

$
(.01
)
$
.05

$
(.02
)


8











5.  Restructuring





In December 2000, the Company recorded a restructuring charge of $7,000,000. Of this charge, $2,600,000 related to workforce reductions (primarily non-billable staff), and $4,400,000 related to lease termination and abandonment costs (net of sub-lease income), including an amount for assets to be disposed of in conjunction with this consolidation. The restructuring accrual for workforce reductions was fully used prior to January 3, 2004. A summary of activity with respect to the restructuring charge for the six-month period ended July 3, 2004 is as follows:





****
**Office Closure/**
*******(In thousands)***
****
**Consolidation**Balance at January 3, 2004

$
611Cash expenditures


141Balance at July 3, 2004

$
470





The remaining balance in this accrual is to cover the ongoing lease payments for properties abandoned as a part of the restructuring. The last of these lease obligations is expected to terminate in September 2006.








6.  Restricted Stock





Effective June 18, 2004, Jeffrey P. Baker joined the Company as its President and was granted a restricted stock award of 200,000 shares. At the time of the award, the aggregate market value of the restricted stock was $558,000 and was recorded as deferred compensation, a separate component of shareholders equity. The restricted stock award vests at the rate of 25% per year for the next four years.





9








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


Six Months Ended July 3, 2004 and June 28, 2003





*Forward Looking Statements*





The statements contained in "Managements Discussion and Analysis of Financial Condition and Results of Operations," that are not historical fact, including without limitation, statements relating to the need of current and prospective clients for our services and our ability to retain and/or win that business, the effects of competition and our ability to respond to competitive and market conditions, our success in retaining and placing qualified professional staff, our ability to balance changes in billing and labor rates and to control other employee-related and operating costs (our ability to maintain gross margin levels), our ability to comply with the terms of our credit agreement, our ability to meet our working capital requirements and our ability to achieve and maintain profitability are forward looking statements made under the safe harbor provision of the Private Securities Litigation Reform Act. Words such as "believes," "intends," "possible," "expects," "estimates," "anticipates," or "plans" and similar expressions are intended to identify forward-looking statements. Such statements are based on managements current expectations as of the date of this document but involve risks, uncertainties and other factors which could cause actual results to differ materially from those contemplated by such forward looking statements. Investors are cautioned to consider these forward looking statements in light of important factors including, but not limited to, the risk factors discussed below, which may result in variations from results contemplated by such forward looking statements.





The following discussion of the results of our operations and our financial condition should be read in conjunction with our condensed consolidated financial statements and the related notes to condensed consolidated financial statements in this 10-Q, our other filings with the Securities and Exchange Commission and our other investor communications.





Overview





Total revenue for the three and six months ended July 3, 2004 was $86.9 million and $172.3 million, respectively, up from $82.6 million and $168.7 million during the comparable periods ended June 28, 2003. The increase included a 0.9% and 1.5% increase in revenue from services we supply directly to clients for the three and six months ended July 3, 2004, respectively. For the three- and six-month periods ended July 3, 2004, 83.0% and 83.1% of our revenues, respectively, were derived from services provided directly, compared to 86.5% and 83.7% in the comparable periods a year ago. The change in revenue mix was due mainly to an increase in revenue from a certain client, most of which had previously been provided through subsuppliers.





Our net income for the three and six months ended July 3, 2004 was $706,000 and $1.2 million, respectively, compared with a net loss of ($168,000) and ($484,000) for the comparable periods ended June 28, 2003. On a diluted per share basis, the net income for the three and six months ended July 3, 2004 was $.03 and $.05 per share, respectively, compared with a net loss of ($.01) and ($.02) per share, respectively, for the comparable periods ended June 28, 2003.





During the second quarter we continued our focus on managing the key elements to our future success: (i) increasing the number of requirements our sales organization brings to the Company from new and existing clients; (ii) increasing the number of qualified candidates our recruiting organization submits against those requirements; and most importantly, (iii) increasing the rate at which quality submittals turn into placements.





During the second quarter of 2004, the productivity of both our sales and recruiting staff remained strong. During this period, average weekly requirements coming from new and existing clients increased 21.8% over the comparable period last year. Additionally, during the second quarter of 2004, average weekly candidate submittals against requirements increased 33.3% over the comparable period last year. As a result of the improvements in these key indicators, average weekly placements increased by sixteen during the second quarter of 2004 over the comparable period last year. This improvement is an indication of the industry and general economic recovery we have been experiencing.





10








As important as the above key elements are to growth of revenue, the bill rates we are able to charge to clients and the margins we are able to obtain on those bill rates are the key indicators of our profitability. Although we continue to experience intense competition on average bill rates, we did experience a slight increase in these rates during the second quarter. This increase, while encouraging, was more than offset by increases in medical and other fringe benefit costs, resulting in a slight decrease in our overall gross margin. As evidence of the continuing pressure on bill rates, one of our most significant clients implemented a 5% bill rate reduction during the second quarter of 2004. This rate reduction, and other rate competitive situations we have encountered and expect to arise during the remainder of 2004, will make further improvements in our average bill rates very difficult to achieve. As a result, we are anticipating average bill rates to remain flat for the remainder of 2004. To enhance the profitability in an environment of intense margin pressures, we are focused on three key objectives: i) developing the lowest-cost staffing delivery model in the industry and becoming the service provider, and employer of choice to the IT consulting community; ii) fully integrating offshore capabilities into each line of business; and iii) developing channel sales partners to drive new business opportunities.





Critical Accounting Estimates





The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.


**


*Estimates of Future Operating Results*





The realization of certain assets recorded in our balance sheet is dependent upon our ability to maintain profitability. In evaluating the recorded value of our intangible assets ($10.9 million), goodwill ($16.5 million), and deferred tax assets ($2.6 million, net of the valuation allowance) for indication of impairment, we are required to make critical accounting estimates regarding the future operating results of the Company. These estimates are based on managements current expectations but involve risks, uncertainties and other factors that could cause actual results to differ materially from these estimates.





To evaluate our intangible assets and goodwill for impairment, we rely heavily on the discounted cash flow model to assess the value of the associated reporting units. The discounted cash flow valuation technique requires us to project operating results and the related cash flows over a ten-year period. These projections involve risks, uncertainties and other factors and are by their nature extremely subjective. If actual results were substantially below projected results, an impairment of the recorded value of our goodwill and intangible assets could result.





To assess the recorded value of our deferred tax assets for possible impairment, we must predict the likelihood of future taxable income generation. Realization of the net deferred tax assets of $2.6 million requires the generation of at least $6.8 million of future taxable income. If the Company does not generate sufficient future taxable income, an impairment of the recorded assets could result.





*Allowance for Doubtful Accounts*





In each accounting period we determine an amount to be set aside to cover potentially uncollectible accounts. We base our determination on an evaluation of accounts receivable for risk associated with a clients ability to make contractually required payments. These determinations require considerable judgment in assessing the ultimate potential for collection of these receivables and include reviewing the financial stability of the client, the clients willingness to pay and current market conditions. If our evaluation of a clients ability to pay is incorrect, we may incur future charges.





11








*Accrual of Unreported Medical Claims*





In each accounting period we estimate an amount to accrue for medical costs incurred but not yet reported (IBNR) under our self-funded employee medical insurance plans. We base our determination on an evaluation of past rates of claim payouts and trends in the amount of payouts. This determination requires significant judgment and assumes past patterns are representative of future payment patterns and that we have identified any trends in our claim experience. A significant shift in usage and payment patterns within our medical plans could necessitate significant adjustments to these accruals in future accounting periods.





Critical Accounting Policies





Critical accounting policies are defined as those that involve significant judgments and uncertainties or affect significant line items within our financial statements and potentially result in materially different outcomes under different assumptions and conditions. Application of these policies is particularly important to the portrayal of our financial condition and results of operations. We believe the accounting policies described below meet these characteristics.





*Revenue Recognition*





We recognize revenue for our staffing business and the majority of our business solutions and infrastructure business as services are performed or products are delivered. Certain of our outsourcing and help desk engagements provide for a specific level of service each month for which we bill a standard monthly fee. Revenue for these engagements is recognized in monthly installments over the period of the contract. In some such contracts we invoice in advance for two or more months of service. When we do this, the revenue is deferred and recognized over the term of the invoicing agreement.





We generally do not enter into fixed price engagements. If we enter into such an engagement, revenue is recognized over the life of the contract based on time and materials input to date and estimated time and materials to complete the project. This method of revenue recognition relies on accurate estimates of the cost, scope and duration of the engagement. If the Company does not accurately estimate the resources required or the scope of the work to be performed, then future revenues may be negatively affected or losses on contracts may need to be recognized. All future anticipated losses are recognized in the period they are identified.





In all of our services, risk associated with client satisfaction exists. Although management feels these risks are adequately addressed by our adherence to proven project management methodologies and other procedures and policies, the potential exists for future revenue charges relating to unresolved issues with a small number of clients.





*Subsupplier Revenue*





In certain client situations, where the nature of the engagement requires it, we utilize the services of other companies in our industry. If these services are provided under an arrangement whereby we agree to retain only a fixed portion of the amount billed to the client to cover our management and administrative costs, we classify the amount billed to the client as subsupplier revenue. These revenues, however, are recorded on a gross versus net basis because we retain credit risk and are the primary obligor to our client. All revenue derived from services provided by our employees or other independent contractors who work directly for us are recorded as direct revenue.


**


*Goodwill and Intangible Impairment*





We evaluate goodwill and other intangible assets on a periodic basis. This evaluation relies on assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or related assumptions change, we may be required to recognize impairment charges.





12








In accordance with the provisions of SFAS 142, "Goodwill and Other Intangible Assets," effective January 1, 2002 we ceased amortization of certain intangible assets including goodwill. Intangible assets with definite useful lives will continue to be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The Company completed its impairment analysis for 2004 during the first quarter and found no indication of impairment of its recorded goodwill although the valuation determined the fair value of the Infrastructure and Solutions reporting units to approximate their carrying value. Additional write-downs of intangible assets may be required if future valuations do not support current carrying value.





*Deferred Taxes*





We account for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes," which requires that deferred tax assets and liabilities be recognized for the effect of temporary differences between reported income and income considered taxable by the taxing authorities. SFAS 109 also requires the resulting deferred tax assets to be reduced by a valuation allowance if some portion or all of the deferred tax assets are not expected to be realized. Based upon prior taxable income and estimates of future taxable income, we expect our deferred tax assets, net of the established valuation allowance, will be fully realized in the future. If actual future taxable income is less than we anticipate from our estimates, we may be required to record a valuation allowance against our deferred tax assets resulting in additional income tax expense which will be recorded in our consolidated statement of operations.





*Restructuring Charge*





We recorded a restructuring charge and reserves associated with restructuring plans approved by management in December 2000. The remaining reserve consists of an estimate pertaining to real estate lease obligations. Factors such as the Companys ability to enter into subleases, the creditworthiness of sublessees, and the ability to negotiate early termination agreements with lessors could materially affect this real estate reserve. While we believe our current estimates regarding lease obligations are adequate, our inability to sublet the remaining space or obtain payments from sublessees could necessitate significant adjustments to these estimates in the future.





**RESULTS OF OPERATIONS, THREE- AND SIX-MONTH PERIODS ENDED JULY 3, 2004 VS. JUNE 28, 2003**





The following tables illustrate the relationship between revenue and expense categories along with a count of employees and technical consultants for the three- and six-month periods ended July 3, 2004 and June 28, 2003. The tables provide guidance in our explanation of our operations and results.





****
**Three Months Ended**
****
**Three Months Ended**
****
****
****
****
****
****
********
****
**July 3, 2004**
****
**June 28, 2003**
****
**Increase (Decrease)**
********
****
****
****
**% of**
****
****
****
**% of**
****
**%**
****
****
****
**As % of**
*******(In thousands)***
****
**Amount**
****
**Revenue**
****
**Amount**
****
**Revenue**
****
**Amount**
****
**Inc (Dec)**
****
**Revenue**Professional services revenue:Provided directly

$
72,084


83.0
%
$
71,443


86.5
%
$
641


.9
%

(3.5
)%Provided through subsuppliers


14,781


17.0


11,167


13.5


3,614


32.4


3.5Total revenue


86,865


100.0


82,610


100.0


4,255


5.2


.0Salaries, contracted services and direct charges


70,794


81.5


67,539


81.8


3,255


4.8


(.3
)Selling, administrative and other operating costs


15,159


17.5


15,062


18.2


97


.6


(.7
)Amortization of intangible assets


194


.2


194


.2


--


.0


.0Non-operating income


(2
)

(.0
)

(17
)

(.0
)

15


(88.2
)

.0Interest expense


14


.0


--


.0


14


--


.0Income (loss) before income taxes


706


.8


(168
)

(.2
)

874


520.2


1.0Income tax expense (benefit )


--


.0


--


(.0
)

--


.0


.0Net income (loss)

$
706


.8
%
$
(168
)

(.2
)%
$
874


520.2
%

1.0
%








13











****
**Six Months Ended**
****
**Six Months Ended**
****
****
****
****
****
****
********
****
**July 3, 2004**
****
**June 28, 2003**
****
**Increase (Decrease)**
********
****
****
****
**% of**
****
****
****
**% of**
****
**%**
****
****
****
**As % of**
*******(In thousands)***
****
**Amount**
****
**Revenue**
****
**Amount**
****
**Revenue**
****
**Amount**
****
**Inc (Dec)**
****
**Revenue**Professional services revenue:Provided directly

$
143,153


83.1
%
$
141,078


83.7
%
$
2,075


1.5
%

(.6
)%Provided through subsuppliers


29,106


16.9


27,573


16.3


1,533


5.6


.6Total revenue


172,259


100.0


168,651


100.0


3,608


2.1


.0Salaries, contracted services and direct charges


140,458


81.5


138,195


81.9


2,263


1.6


(.4
)Selling, administrative and other operating costs


30,240


17.6


30,627


18.2


(387
)

(1.3
)

(.6
)Amortization of intangible assets


387


.2


387


.2


--


.0


.0Non-operating income


(8
)

(.0
)

(25
)

(.0
)

17


(68.0
)

.0Interest expense


22


.0


8


.0


14


175.0


.0Income (loss) before income taxes


1,160


.7


(541
)

(.3
)

1,701


314.4


1.0Income tax expense (benefit )


--


.0


(57
)

(.0
)

57


100.0


.0Net income (loss)

$
1,160


.7
%
$
(484
)

(.3
)%
$
1,644


339.7
%

1.0
%Personnel:Management and administrative


410





440





(30
)

(6.8
)%Technical consultants


2,600





2,575





25


1.0
%


*Revenue*





Services provided directly during the three- and six-month periods ended July 3, 2004 resulted in a 0.9% and 1.5% increase, respectively, in direct revenue over the comparable periods a year ago. We derived a lower percentage of our total revenue from direct billings during the periods in 2004 as compared to the comparable periods last year, however. The decrease in direct revenue as a percentage of total revenue during the periods in 2004 was due to the increase in revenue from one particular client, provided mostly through subsuppliers. The increase in subsupplier revenue from this client was partially offset by significant decreases in subsupplier revenue with certain other clients. Our subsupplier revenue is mainly pass-through revenue with associated fees providing minimal profit.





The increase in direct revenue resulted primarily from the increase in the number of consultants we had billable during these periods, which appears to be reflective of a modest recovery in the Information Technology (IT) market sector. Our technical consultant staff has increased by 25 consultants from June 28, 2003. In addition to the increase in technical consultants, hourly rates increased by 3% during the period ending July 3, 2004 as compared to last year. As demand for the services our industry provides has improved with the modest recovery, hourly rates have begun to stabilize.





*Salaries, Contracted Services and Direct Charges*





Salaries, contracted services and direct charges primarily represent our payroll and benefit costs associated with billable consultants. Comparing the 2004 periods to the 2003 periods, these expenses decreased slightly as a percentage of revenue. We have been successful at managing our direct labor rates as our bill rates have increased slightly. The shifting of our revenue mix in 2004 to include more subsupplier revenue, with lower margins, played a role in offsetting the decrease of this category of expense as a percentage of revenue. Excluding the revenue and cost associated with subsupplier activity, this category of expense as a percentage of revenue was 78.6% for both the three- and six-month periods ended July 3, 2004, compared to 79.4% and 79.1% for the comparable periods a year ago. Although we continuously attempt to control the factors which affect this category of expense, there can be no assurance we will be able to maintain or improve this level.











14








*Selling, Administrative and Other Operating Costs*





Selling, administrative and other operating (SG&A) costs include management and administrative salaries, commissions paid to sales representatives and recruiters, location costs, and other administrative costs. This category of costs represented 17.5% and 17.6% of total revenue for the three- and six-month periods ended July 3, 2004, respectively, down from 18.2% for both of the comparable periods in 2003. We have managed these costs downward primarily by reducing discretionary spending for non-billable travel, imposing wage controls on administrative and management personnel, eliminating office space where possible, and by reducing the number of non-technical personnel we employ. We are committed to continuing to manage this category of expense to the right level for our company; however, there can be no assurance this category of cost will not increase as a percentage of revenue, especially if our revenue declines.





*Non-Operating Income*





Non-operating income, consisting primarily of interest income, declined during the three and six months ended July 3, 2004 compared to the equivalent periods a year ago due to a decrease in invested cash balances.





*Interest Expense*





Interest expense during the three- and six-month periods ended July 3, 2004 increased over the equivalent periods last year. As our revenue and consequently our payroll have grown in the first half of 2004, our need to borrow from our line of credit to support that growth has also increased.








*Income Taxes*





We recorded no income taxes during the three- and six-month periods ended July 3, 2004. Income tax expense, which would have been recorded, was negated by a reversal of previously established reserves against deferred tax assets. As we continue to generate profit, we anticipate reversing portions of the reserves we have established on our deferred tax assets to negate any tax expense in which may otherwise have been recorded.





*Personnel*





The increase in technical consultants is an indication of what appears to be the beginning of a modest recovery in the IT market sector. Administrative and management personnel decreased as a result of our continuing efforts to contain our operating costs.








15








Liquidity and Capital Resources





The following table provides information relative to the liquidity of our business.


****
****
****
****
****
****
****
****
****
****
****
**Percentage**
********
****
****
****July 3,****
****
****
**January 3,**
****
****
**Increase**
****
****
**Increase**
*******(In thousands)***
****
****
**2004**
****
****
**2004**
****
****
**(Decrease)**
****
****
**(Decrease)**Cash and Cash Equivalents

$
4,061

$
4,499

$
(438
)

(9.7
)%Accounts Receivable


60,488


55,623


4,865


8.7Other Current Assets


4,572


4,737


(165
)

(3.5
)Total Current Assets

$
69,121

$
64,859

$
4,262


6.6Accounts Payable

$
16,844

$
15,825

$
1,019


6.4Salaries and Vacations


9,995


7,774


2,221


28.6Other Current Liabilities


5,251


5,595


(344
)

(6.1
)Total Current Liabilities

$
32,090

$
29,194

$
2,896


9.9Working Capital

$
37,031

$
35,665

$
1,366


3.8Current Ratio


2.15


2.22


(.07
)

(3.2
)Total Shareholders Equity

$
69,830

$
68,663

$
1,167


1.7
%




**


*Cash Requirements*





The day-to-day operation of our business requires a significant amount of cash to flow through our Company. During the three- and six-month periods ended July 3, 2004, we made total payments of approximately $49.0 million and $102.9 million, respectively, to pay our employees wages, benefits and associated taxes. We also made payments of approximately $21.2 million and $42.8 million, respectively, to pay vendors who provided billable technical resources to our clients through us. Finally, we made payments of approximately $11.8 million and $22.1 million, respectively, to fund general operating expenses such as employee expense reimbursement, office space rental and utilities.





The cash to fund these significant payments comes almost exclusively from our collection of amounts due us for services rendered to our clients (approximately $85.4 million and $167.4 million, respectively, in the three- and six-month periods ended July 3, 2004). Generally, payments made to fund the day-to-day operation of our business are due and payable regardless of the rate of cash collections from our clients. While we do not anticipate such an occurrence, a significant decline in the rate of collections from our clients, or an inability of the Company to timely invoice and therefore collect from our clients, could rapidly increase our need to borrow to fund the operations of our business.





*Sources and Uses of Cash/Credit Facility*





Cash and cash equivalents at July 3, 2004 decreased slightly from January 3, 2004. As our revenue and consequently our receivable balance have grown during that time, our cash reserves have been utilized to fund that growth. Our primary need for working capital is to support accounts receivable resulting from our business and to fund the time lag between payroll disbursement and receipt of fees billed to clients. Historically, we have been able to support internal growth in our business with internally generated funds. If our revenue and payroll continue to grow, we would expect our need to borrow to increase.





Working capital at July 3, 2004 was up from January 3, 2004. During the first half of 2004, we have been able to keep our line of credit at or near zero and maintain our average cash and cash equivalents position in the $2.0 million range. The ratio of current assets to current liabilities decreased at July 3, 2004, compared to January 3, 2004.





16








Our asset-based revolving credit agreement, consummated in April 2002, provides us with up to $45.0 million of availability. We have been successful at maintaining the balance on this line of credit at or near zero throughout the quarter ended July 3, 2004. At July 3, 2004 our borrowing availability, which fluctuates based on our level of eligible accounts receivable, was at $30.8 million under our credit facility. The level of availability has increased compared to January 3, 2004 as our receivable collateral base has increased. Borrowings under the credit agreement are secured by all of our assets.





The revolving credit agreement requires us to take advances or pay down the outstanding balance on the line of credit daily. However, we can request fixed-term advances of one, two, or three months for a portion of the outstanding balance on the line of credit. The daily advances on the line of credit bear interest at the Wall Street Journals "Prime Rate" plus .75%, or 5.00% currently, while the fixed-term advances bear interest at the LIBOR rate plus 3.0%. The credit agreement requires the payment of a commitment fee of .50% of the unused portion of the line plus an annual administration fee of $50,000. The agreement restricts, among other things, the payment of dividends, establishes limits on capital expenditures and requires us to maintain a minimum accounts payable turnover ratio. We believe we will be able to continue to meet the requirements of the agreement. The credit agreement matures on April 10, 2005.





Subsequent to July 3, 2004, we amended our credit agreement to extend the expiration date to October 31, 2006 and modify certain terms of the agreement. The amendment reduces the commitment fee from .50% to .25% of the unused portion of the line, reduces the annual administration fee from $50,000 to $25,000, and reduces the interest rates on daily advances to the Wall Street Journals "Prime Rate" and fixed-term advances to the LIBOR rate plus 2.0%.  The Company expects these new terms to reduce borrowing costs by approximately $330,000 on an annual basis.





During the three- and six-month periods ended July 3, 2004, we made capital expenditures totaling $860,000 and $1,488,000, respectively, compared to $498,000 and $736,000, respectively, in the three- and six-month periods ended June 28, 2003. We funded these capital expenditures with internally generated funds. We continue to tightly control capital expenditures to preserve working capital.





Commitments and Contingencies





The Company leases office facilities under non-cancelable operating leases. Deferred compensation is payable to participants in accordance with the terms of individual contracts. Minimum future obligations on operating leases and deferred compensation at July 3, 2004, are as follows (in thousands):





****
****
**1 Year**
****
****
**2-3 Years**
****
****
**4-5 Years**
****
**Over 5Years**
****
****
**Total**Operating Leases

$
5,823

$
10,119

$
2,551

$
--

$
18,493Deferred Compensation


270


389


502


2,976


4,137Total

$
6,093

$
10,508

$
3,053

$
2,976

$
22,630








Market Conditions, Business Outlook and Risks to Our Business





Several market conditions are affecting our industry. Intense price competition in the area of technical staff augmentation has created pressure on billable hourly rates, and clients have been requesting increasingly lower cost models for staff augmentation services. As a result, although we have seen some reversal of these trends in 2004, we have encountered lowering billing rates for quite some time. Low cost offerings for staff augmentation services through e-procurement systems, extremely competitive bidding processes, the granting of various types of discounts and the use of offshore resources will continue, thus making improvement in our average billing rates very difficult. Our ability to respond to customer requests for lower pricing or to provide other low cost solutions in this area of our business will have a direct effect on our performance. Management expects competitive conditions in the area of


17


technical staff augmentation to continue for the foreseeable future, although it expects that demand for these services will increase as the economic recovery continues.





Management continues to concentrate on staff augmentation in Fortune 500 and small and medium-sized businesses, business solutions for small and medium-sized businesses, and business opportunities with its technology and product partners. In addition, we are developing a low-cost staffing model, expanding our offshore service capabilities and developing relationships with sales channel partners with which we will share sales leads.





While we believe these areas of our business present opportunities to grow our business, growth in these areas will depend on improvement in the economy and spending in the overall IT services market, our ability to compete with other vendors and our success in obtaining new clients.





Staff augmentation continues to represent more than half of total revenues (revenue from services provided directly to client (direct revenue) plus revenue from services provided to our clients by subsuppliers (subsupplier revenue)) and over half of our direct revenue. While we saw a slight increase in demand for our services during the first half of 2004, there can be no assurance as to when, or if, we will begin to see significant increases in revenue. Our ability to respond to the conditions outlined above will bear directly on our performance.





Our ability to quickly identify, attract and retain qualified technical personnel, especially during an economic recovery, will affect our results of operations and ability to grow in the future. Competition for qualified personnel is intense. If we are unable to hire the talent required by our client in a timely, cost-effective manner, it will affect our ability to grow our business. In addition to our ability to control labor costs, our ability to control employee benefit costs and other employee-related costs will affect our future performance. In an effort to contain our benefits costs, we implemented substantial changes to our benefits plans in fiscal year 2003 and have implemented additional changes in 2004. While we believe the changes we implemented will be effective, the effectiveness of these changes may vary due to factors we cannot control such as rising medical costs, the amount of medical services used by our employees and similar factors.





Controlling operating costs while attempting not to impact our ability to respond to our clients also is a factor in our future success. We have streamlined our operations by consolidating offices, reducing administrative and management personnel and continuing to review our company structure for more efficient methods of operating our business and delivering our services. We may not be able to continue to reduce costs without affecting our ability to deliver service to our clients and therefore may choose to forego particular cost reductions if we believe it would be prudent to do so for the future business of the Company.





Terms and conditions standard to computer consulting services contracts also present a risk to our business. In general, our clients can cancel or reduce their contracts on short notice. Loss of a significant client relationship or a significant portion thereof, a significant number of relationships or a major contract could have a material adverse effect on our business.





We believe our working capital will be sufficient for the foreseeable needs of our business. Significant rapid growth in our business or a significant stretching of payment terms with major clients, could create a need for additional working capital. An inability to obtain additional working capital, should it be required, could have a material adverse effect on our business. We expect to be able to comply with the requirements of our credit agreement; however, failure to do so could have a material adverse effect on our business.





****Item 3. Quantitative and Qualitative Disclosures About Market Risk****





We are exposed to certain market risks on our line of credit agreement because of the variable interest rate charged. Market risk is the potential loss arising from the adverse changes in market rates and prices, such as interest rates. Market risk is estimated as the potential increase in fair value resulting from a hypothetical one percent increase in interest rates which assuming an average outstanding debt balance of $5.0 million would result in an annual interest expense increase of approximately $50,000.








18








****Item 4. Controls and Procedures****





(a)  Evaluation of Disclosure Controls and Procedures





As of the end of the period covered by this report, the Company conducted an evaluation under the supervision and with the participation of the Companys management, including the Companys Chief Executive Officer, Michael J. LaVelle, and Chief Financial Officer, David J. Steichen, regarding the effectiveness of the design and operation of the Companys disclosure controls and procedures pursuant to Rules 13a-15(b) of the Securities Exchange Act of 1934 (the "Exchange Act"). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures are effective to ensure that information that is required to be disclosed by the Company in reports that it files under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the rules of the Securities Exchange Commission.





(b)  Changes in Internal Controls





There were no changes in the Companys internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.








****PART II. OTHER INFORMATION****





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





At the annual meeting of shareholders held May 26, 2004, the following actions were taken:





(a)  Election of Directors





The following nominees, all of whom were listed in the Companys proxy statement prepared in accordance with Regulation 14(a), were elected:








**Nominee**
****
**Votes For**
****
**Authority Withheld**John D. Bamberger

20,735,285

1,380,304Krzysztof K. Burhardt

20,945,156

1,170,433Willis K. Drake

20,682,126

1,433,463Michael B. Esstman

20,895,629

1,219,960Frederick W. Lang

20,602,703

1,512,886Michael J. LaVelle

20,735,741

1,379,848Margaret A. Loftus

20,705,169

1,410,420Edward M. Mahoney

20,562,397

1,553,192Robb L. Prince

20,867,479

1,248,110








(b)  Ratification of Auditors





The shareholders voted their shares to ratify the appointment of Deloitte & Touche LLP by the following vote:





In favor
21,411,126Against
497,321Abstain
207,142








19











(c)  Approval of the 2004 Equity Incentive Plan





The shareholders voted their shares to approve the 2004 Equity Incentive Plan by the following vote:





In favor
11,929,500Against
2,037,617Abstain
1,449,979No-vote
6,698,493








****Item 6. Exhibits and Reports on Form 8-K****





(a)  Exhibits





Exhibit 10-p
2004 Equity Incentive Plan.Exhibit 10-q
Employment contract with Jeffrey P. Baker, recently appointed President of the Company.Exhibit 31.1
Certification of CEO Pursuant to Section 302 of the Sarbanes Oxley Act of 2002.Exhibit 31.2
Certification of CFO Pursuant to Section 302 of the Sarbanes Oxley Act of 2002.Exhibit 32
Certification of CEO and CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes Oxley Act of 2002.





(b)  Reports on Form 8-K





A.
Form 8-K filed April 14, 2004 containing a press release announcing the Companys updated earnings guidance and the date of its conference call for its first quarter ended April 3, 2004.





B.
Form 8-K filed April 27, 2004 containing the earnings release of the Companys financial results for its first quarter ended April 3, 2004.





C.
Form 8-K filed June 21, 2004 containing a press release announcing changes to the Board of Directors and appointments of President and Chief Financial Officer.





D.
Form 8-K filed June 23, 2004 containing a press release announcing the Company granted 200,000 restricted shares to Jeffrey P. Baker, recently appointed President of the Company, as incentive for his employment agreement effective June 18, 2004.














20








****SIGNATURES****











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 there unto duly authorized.














ANALYSTS INTERNATIONAL CORPORATION(Registrant)Date: August 11, 2004
By:
/s/ Michael J. LaVelleMichael J. LaVelleChief Executive OfficerDate: August 11, 2004
By:
/s/ David J. SteichenDavid J. SteichenChief Financial Officer(Principal Financial and Accounting Officer)








21








****EXHIBIT INDEX****














**Exhibit No.**

**Description**10-p

2004 Equity Incentive Plan.10-q

Employment contract with Jeffrey P. Baker, recently appointed President of the Company.31.1

Certification of CEO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2

Certification of CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32

Certification of CEO and CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.








22