**FORM 10-Q**

 

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**ý****Quarterly Report Pursuant toSection 13 or 15(d) ofthe Securities Exchange Act of 1934**

**For thequarterly period ended June 28, 2003**

 

**or**

 

**o****Transition Report Pursuant toSection 13 or 15(d) ofthe Securities Exchange Act of 1934**

 

**Commissionfile number 0-4090**

 

| **ANALYSTS  INTERNATIONAL CORPORATION**                                 |
|-------------------------------------------------------------------------|
|                                                                    |   |   |
| **Minnesota**                                                           |   | **41-0905408** |
|                                                                    |   |   |
| **3601  West 76th Street  Minneapolis, MN  55435  (952) 835-5900** |

 

Indicate by check mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months and (2) has been subject tosuch filing requirements for the past 90 days.

 

Yes    ý    No    o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

Yes    ý    No    o

 

As of August 4, 2003, 24,199,307 shares of theRegistrant’s Common Stock were outstanding.

 

 

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ANALYSTS INTERNATIONALCORPORATION

 

INDEX

 
| Part  I.  FINANCIAL INFORMATION |
|--------------------------------------|
|                                 |
| Item  1.                             | Condensed Consolidated Balance Sheets  June 28, 2003 (Unaudited) and December 28, 2002 |
|                                 |   |
|                                 | Condensed  Consolidated Statements of Operations  Three and six months ended June 28, 2003 and June 30, 2002 (Unaudited) |
|                                 |   |
|                                 | Condensed Consolidated  Statements of Cash Flows  Six months ended June 28, 2003 and June 30, 2002 (Unaudited) |
|                                 |   |
|                                 | Notes to Condensed  Consolidated Financial Statements (Unaudited) |
|                                 |   |
| Item  2.                             | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
|                                 |   |
| Item  3.                             | Quantitative and Qualitative Disclosures About  Market Risk |
|                                 |   |
| Item  4.                             | Controls and Procedures |
|                                 |   |
|                                 | Submission of  Matters to a Vote of Security Holders |
|                                 |   |
| Part  II.                            | OTHER INFORMATION |
|                                 |   |
| Item  6.                             | Exhibits and Reports on Form 8-K |
|                                 |
| Signatures                           |
|                                 |
| Exhibit Index                        |

 

2

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PART I.  FINANCIAL INFORMATION

 

Item 1.

 

**AnalystsInternational Corporation**

**CondensedConsolidated Balance Sheets**

 
| **(In thousands)**                                         |   | **June 28,  2003** |    | **December  28,  2002** |   |
|------------------------------------------------------------|--------|--------------------|---------|-------------------------|--------|
|                                                       |   | **(Unaudited)**    |    |                    |   |
|                                                       |   |               |    |                    |   |
| **ASSETS**                                                 |   |               |    |                    |   |
| Current assets:                                            |   |               |    |                    |   |
| Cash and cash  equivalents                                 |   | $                  | 4,946   |                    | $      | 54 |   |
| Accounts  receivable, less allowance for doubtful accounts |   | 56,852             |    | 59,776                  |   |
| Prepaid expenses  and other current assets                 |   | 4,479              |    | 8,848                   |   |
| Total current  assets                                      |   | 66,277             |    | 68,678                  |   |
|                                                       |   |               |    |                    |   |
| Property and  equipment, net                               |   | 6,432              |    | 7,071                   |   |
| Intangible  assets other than goodwill                     |   | 11,635             |    | 12,022                  |   |
| Goodwill                                                   |   | 16,460             |    | 16,460                  |   |
| Other assets                                               |   | 2,201              |    | 2,513                   |   |
|                                                       |   | $                  | 103,005 |                    | $      | 106,744 |   |
|                                                       |   |               |    |                    |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**             |   |               |    |                    |   |
|                                                       |   |               |    |                    |   |
| Current  liabilities:                                      |   |               |    |                    |   |
| Accounts payable                                           |   | $                  | 15,333  |                    | $      | 18,966 |   |
| Line of credit                                             |   | —             |    | 324                     |   |
| Salaries and  vacations                                    |   | 7,005              |    | 6,036                   |   |
| Deferred revenue                                           |   | 4,457              |    | 4,340                   |   |
| Self-insured  health care reserves and other amounts       |   | 2,215              |    | 2,659                   |   |
| Restructuring  accruals, current portion                   |   | 443                |    | 648                     |   |
| Total current  liabilities                                 |   | 29,453             |    | 32,973                  |   |
|                                                       |   |               |    |                    |   |
| Restructuring  accruals, non-current portion               |   | 387                |    | 550                     |   |
| Deferred  compensation accrual                             |   | 3,483              |    | 3,055                   |   |
| Shareholders’  equity                                 |   | 69,682             |    | 70,166                  |   |
|                                                       |   | $                  | 103,005 |                    | $      | 106,744 |   |

 

Note:  Thebalance sheet at December 28, 2002 has been taken from the audited financialstatements at that date, and condensed.

 

See notes to condensedconsolidated financial statements.

 

3

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**AnalystsInternational Corporation**

**Condensed Consolidated Statementsof Operations**

*(Unaudited)*

 
|                                                                              |   | **Three  Months Ended** |   | **Six Months  Ended** |   |
|-----------------------------------------------------------------------------------|--------|-------------------------|--------|-----------------------|--------|
| **(In  thousands except per share amounts)**                                      |   | **June 28,  2003**      |   | **June 30,  2002**    |   | **June 28,  2003** |   | **June 30,  2002** |   |
| Professional  services revenue:                                                   |   |                    |   |                  |   |   |   |   |   |
| Provided  directly                                                                |   | $                       | 71,443 |                  | $      | 84,062 |   | $ | 141,078 |   | $ | 167,543 |   |
| Provided through  subsuppliers                                                    |   | 11,167                  |   | 26,682                |   | 27,573 |   | 57,885 |   |
| Total revenue                                                                     |   | 82,610                  |   | 110,744               |   | 168,651 |   | 225,428 |   |
|                                                                              |   |                    |   |                  |   |   |   |   |   |
| Expenses:                                                                         |   |                    |   |                  |   |   |   |   |   |
| Salaries,  contracted services and direct charges                                 |   | 67,539                  |   | 92,252                |   | 138,195 |   | 187,686 |   |
| Selling,  administrative and other operating costs                                |   | 15,062                  |   | 19,258                |   | 30,627 |   | 38,608 |   |
| Amortization of  intangible assets                                                |   | 194                     |   | 199                   |   | 387 |   | 398 |   |
| Loss on sale of  corporate headquarters building                                  |   | —                  |   | 1,860                 |   | — |   | 1,860 |   |
|                                                                              |   |                    |   |                  |   |   |   |   |   |
| Operating loss                                                                    |   | (185                    | )      | (2,825                | )      | (558 | ) | (3,124 | ) |
| Non-operating  income                                                             |   | 17                      |   | 22                    |   | 25 |   | 66 |   |
| Interest expense                                                                  |   | —                  |   | (253                  | )      | (8 | ) | (911 | ) |
| Loss on debt  extinguishment                                                      |   | —                  |   | (744                  | )      | — |   | (744 | ) |
|                                                                              |   |                    |   |                  |   |   |   |   |   |
| Loss before  income taxes and cumulative effect of change in accounting principle |   | (168                    | )      | (3,800                | )      | (541 | ) | (4,713 | ) |
| Income tax  benefit                                                               |   | —                  |   | (623                  | )      | (57 | ) | (835 | ) |
| Net loss before  cumulative effect of change in accounting principle              |   | (168                    | )      | (3,177                | )      | (484 | ) | (3,878 | ) |
| Cumulative  effect of change in accounting for goodwill                           |   | —                  |   | —                |   | — |   | (16,389 | ) |
| Net loss                                                                          |   | $                       | (168   | )                     | $      | (3,177 | ) | $ | (484 | ) | $ | (20,267 | ) |
|                                                                              |   |                    |   |                  |   |   |   |   |   |
| Per common  share:                                                                |   |                    |   |                  |   |   |   |   |   |
| Basic and  diluted loss:                                                          |   |                    |   |                  |   |   |   |   |   |
| Loss before  cumulative effect of change in accounting principles                 |   | $                       | (.01   | )                     | $      | (.13 | ) | $ | (.02 | ) | $ | (.16 | ) |
| Cumulative  effect of change in accounting for goodwill                           |   | —                  |   | —                |   | — |   | (.68 | ) |
| Net loss:                                                                         |   | $                       | (.01   | )                     | $      | (.13 | ) | $ | (.02 | ) | $ | (.84 | ) |
|                                                                              |   |                    |   |                  |   |   |   |   |   |
| Average common  shares outstanding                                                |   | 24,199                  |   | 24,197                |   | 24,199 |   | 24,197 |   |
| Average common  and common equivalent shares outstanding                          |   | 24,199                  |   | 24,197                |   | 24,199 |   | 24,197 |   |

 

See notes to condensedconsolidated financial statements.

 

4

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**AnalystsInternational Corporation**

**Condensed Consolidated Statements of CashFlows**

*(Unaudited)*

* *
|                                                 |   | **Six Months  Ended** |   |
|------------------------------------------------------|--------|-----------------------|--------|
| **(In thousands)**                                   |   | **June 28,  2003**    |   | **June 30,  2002** |   |
|                                                 |   |                  |   |   |   |
| Net cash  provided by (used in) operating activities |   | $                     | 5,935  |   | $ | (1,879 | ) |
|                                                 |   |                  |   |   |   |
| Cash flows from  investing activities:               |   |                  |   |   |   |
| Property and  equipment additions                    |   | (736                  | )      | (997 | ) |
| Proceeds from  property and equipment sales          |   | 17                    |   | 16,445 |   |
| Net cash (used  in) provided by investing activities |   | (719                  | )      | 15,448 |   |
|                                                 |   |                  |   |   |   |
| Cash flows from  financing activities:               |   |                  |   |   |   |
| Net change in  Working Capital Line of Credit        |   | (324                  | )      | 9,488 |   |
| Proceeds from  borrowings                            |   | —                |   | 29,525 |   |
| Repayment of  borrowings                             |   | —                |   | (70,525 | ) |
| Proceeds from  exercise of stock options             |   | —                |   | 7 |   |
| Net cash used in  financing activities               |   | (324                  | )      | (31,505 | ) |
|                                                 |   |                  |   |   |   |
| Net increase  (decrease) in cash and equivalents     |   | 4,892                 |   | (17,936 | ) |
|                                                 |   |                  |   |   |   |
| Cash and cash  equivalents at beginning of period    |   | 54                    |   | 18,204 |   |
|                                                 |   |                  |   |   |   |
| Cash and cash  equivalents at end of period          |   | $                     | 4,946  |   | $ | 268 |   |

 

See notes to condensedconsolidated financial statements.

 

5

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**AnalystsInternational Corporation**

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

(Unaudited)

 

1.                                       Summaryof Significant Accounting Policies

 

Condensed ConsolidatedFinancial Statements - The condensed consolidated balance sheet as of June 28,2003, the condensed consolidated statements of operations for the three- andsix-month periods ended June 28, 2003 and June 30, 2002, and the condensedconsolidated statements of cash flows for the six-month periods ended June 28,2003 and June 30, 2002 have been prepared by the Company, without audit.  In the opinion of management, alladjustments necessary to present fairly the financial position at June 28, 2003and the results of operations and the cash flows for the periods ended June 28,2003 and June 30, 2002 have been made.

 

Effective December 28,2002, we changed our fiscal year to end on the Saturday closest to December31.  Subsequent to this change, ourfiscal quarters will end on the Saturday closest to the end of the calendarquarter.  This change in year andquarter end did not have a material impact on our operations.

 

Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted. It is suggested these condensed consolidated financial statements beread in conjunction with the financial statements and notes thereto included inthe Company’s December 28, 2002 annual report to shareholders.

 

Comprehensive loss (i.e.net loss plus available-for-sale securities valuation adjustments) for thethree and six months ended June 28, 2003 was $168,000 and $484,000,respectively, and for the three and six months ended June 30, 2002 was$3,184,000 and $20,274,000, respectively.

 

Effective January1, 2002, the Company fully adopted the provisions of Statement of FinancialAccounting Standards (SFAS) No. 141, “Business Combinations” and SFAS No. 142,“Goodwill and Other Intangible Assets.” SFAS No. 141 requires business combinations initiated after June 30,2001 to be accounted for using the purchase method of accounting, and broadensthe criteria for recording intangible assets other than goodwill.

 

SFAS No. 142no longer allows the amortization of purchased goodwill and certainindefinite-lived intangible assets. Instead companies must test such assets forimpairment at least annually.  TheCompany evaluated its intangible assets as of January 1, 2002 and again atJanuary 1, 2003 and determined that the customer list had a determinable lifewhile the tradename did not.  EffectiveJanuary 1, 2002 the Company ceased amortization of the tradename asset.

 

SFAS No. 142prescribes a two-phase process for impairment testing of goodwill.  The first phase screens for impairment,while the second phase (if necessary) measures the impairment.  The Company completed its first phaseimpairment analysis for 2003 during the first quarter and found no indicationof impairment of its recorded goodwill, although the valuation determined thefair value of the Infrastructure and Solutions reporting units to approximatetheir carrying value.

 

Upon theinitial adoption of SFAS No. 142 during the first quarter of 2002, there was anindication of impairment of our goodwill found in the first phase testing.  Accordingly, we completed the second phasetesting in June 2002.  Based on theimpairment tests, we recognized a transitional impairment of $16,389,000 in thefirst quarter of 2002 to reduce the carrying value of goodwill for ourInfrastructure reporting unit to its implied fair value.  We did not record a tax benefit for thisadjustment, as our current operating performance requires the establishment ofa reserve against the deferred tax asset created by this impairment.  The transition impairment was requiredbecause economic conditions at the time of testing (including decliningoperating margins and lower demand for our services) reduced the estimatedfuture

 

6

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expectedperformance for this operating unit. Under SFAS 142, the impairment adjustment recognized at adoption of thenew rules was reflected as a cumulative effect of accounting change in ourfirst quarter 2002 statement of operations. Impairment adjustments recognized after adoption, if any, generally arerequired to be recognized as operating expenses.

 

Forthe six months ended June 28, 2003, no goodwill or other intangibles wereacquired, impaired or disposed.  Otherintangibles consisted of the following:

 
|               |   | **June 28,  2003**          |   | **December  28, 2002**        |   |
|--------------------|--------|-----------------------------|--------|-------------------------------|--------|
| **(In thousands)** |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   | **Other  Intangibles,  Net** |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   | **Other  Intangibles,  Net** |   |
|               |   |                        |   |                          |   |   |   |   |   |   |   |   |   |
| Customer list      |   | $                           | 12,270 |                          | $      | (2,222 | ) | $ | 10,048 |   | $ | 12,270 |   | $ | (1,835 | ) | $ | 10,435 |   |
| Tradename          |   | 1,720                       |   | (133                          | )      | 1,587 |   | 1,720 |   | (133 | ) | 1,587 |   |
|               |   | $                           | 13,990 |                          | $      | (2,355 | ) | $ | 11,635 |   | $ | 13,990 |   | $ | (1,968 | ) | $ | 12,022 |   |

 

The customer list isscheduled to be fully amortized by 2015 with corresponding amortizationestimated to be approximately $800,000 per year.

 

We adopted FASB 145,“Recission of FASB Statements No. 4, 44 and 64, Amendments of FASB StatementNo. 13 and Technical Corrections” as of December 28, 2002.  Upon the adoption of FASB 145, wereclassified the loss resulting from the exinguishment of debt as a separatecomponent in income from continuing operations.

 

Effective December 29,2002, the Company adopted the disclosure provisions of SFAS No. 148,“Accounting for Stock-Based Compensation – Transition and Disclosure” (“FAS148”), which amends Statement of Financial Standards No. 123, “Accounting forStock-Based Compensation” (“FAS 123”). We have continued to apply APB Opinion No. 25 and relatedinterpretations in accounting for our five stock-based compensation plans.  FAS 148 provides alternative methods oftransition for a voluntary change to the fair value based method of accountingfor stock-based employee compensation. In addition, FAS 148 amends the disclosure requirements of FAS 123 torequire more prominent and more frequent disclosures in financial statements ofthe effects of stock-based compensation.

 

Had compensation cost forour stock-based compensation plans been determined based on the fair value atthe grant dates as calculated in accordance with SFAS No. 148, our pro forma netloss and loss per share for the three and six months ended June 28, 2003 andJune 30, 2002 would have been the amounts indicated below:

 
|                           |   | **Three  Months Ended** |   | **Six Months  Ended** |   |
|--------------------------------|--------|-------------------------|--------|-----------------------|--------|
|                           |   | **June 28,  2003**      |   | **June 30,  2002**    |   | **June 28,  2003** |   | **June 30,  2002** |   |
| Net loss *(in  thousands):*    |   |                    |   |                  |   |   |   |   |   |
| As reported                    |   | $                       | (168   | )                     | $      | (3,177 | ) | $ | (484 | ) | $ | (20,267 | ) |
| Pro forma                      |   | (439                    | )      | (3,420                | )      | (1,009 | ) | (20,876 | ) |
| Net loss per  share (basic):   |   |                    |   |                  |   |   |   |   |   |
| As reported                    |   | $                       | (.01   | )                     | $      | (.13 | ) | $ | (.02 | ) | $ | (.84 | ) |
| Pro forma                      |   | (.02                    | )      | (.14                  | )      | (.04 | ) | (.86 | ) |
| Net loss per  share (diluted): |   |                    |   |                  |   |   |   |   |   |
| As reported                    |   | $                       | (.01   | )                     | $      | (.13 | ) | $ | (.02 | ) | $ | (.84 | ) |
| Pro forma                      |   | (.02                    | )      | (.14                  | )      | (.04 | ) | (.86 | ) |

 

7

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2.                                       Long-termDebt

 

Effective April 11, 2002,the Company consummated an asset-based revolving credit facility with up to$55,000,000 of availability.  TheCompany reduced the level of availability to $45,000,000 following the sale ofits corporate headquarters building on May 15, 2002.  Borrowings under this credit agreement are secured by all of theCompany’s assets.  Under the revolvingcredit agreement, which matures on April 10, 2005, the Company must takeadvances or pay down the outstanding balance daily.  The Company can, however, choose to request fixed-term advancesof one, two, or three months for a portion of the outstanding balance on theline of credit. Daily advances on the line of credit bear interest at the WallStreet Journal’s “Prime Rate” plus .75% (4.75% on June 28, 2003) while thefixed-term advances bear interest at the LIBOR rate plus 3.0%.  The credit agreement requires the payment ofa commitment fee of .50% of the unused portion of the line plus an annualadministration fee of $50,000.  Theagreement restricts, among other things, the payment of dividends, establisheslimits on capital expenditures and requires the Company to maintain a minimumaccounts payable turnover ratio.  TheCompany believes it will be able to continue to meet the requirements of thenew agreement for the foreseeable future and as of June 28, 2003 did nothave any borrowings against this agreement.

 

3.                                       Shareholders’Equity

 

|                           |   | **Six Months Ended  June 28, 2003** |   |
|--------------------------------|--------|-------------------------------------|--------|
|                           |   | **(In thousands)**                  |   |
|                           |   |                                |   |
| Balance at beginning of period |   | $                                   | 70,166 |   |
| Comprehensive loss             |   | (484                                | )      |
| Balance at end of period       |   | $                                   | 69,682 |   |

 

4.                                       NetIncome Per Common Share

 

Basic and dilutedearnings (loss) per share (EPS) are presented in accordance with SFAS No. 128,“Earnings per Share.”  Basic EPSexcludes dilution and is computed by dividing income available to common stockholdersby the weighted-average number of common shares outstanding for theperiod.  The difference betweenweighted-average common shares and average common and common equivalent sharesused in computing diluted EPS is the result of outstanding stock options.  Options to purchase 2,018,000 and 1,832,000shares of common stock were outstanding at the end of the periods ended June28, 2003 and June 30, 2002, respectively, but were excluded from thecomputation of common stock equivalents because they were anti-dilutive.

 

5.                                       Restructuring

 

In December2000, the Company recorded a restructuring charge of $7,000,000.  Of this charge, $2,600,000 related toworkforce reductions (primarily non-billable staff), and $4,400,000 related tolease termination and abandonment costs (net of sub-lease income), including anamount for assets to be disposed of in conjunction with thisconsolidation.  The restructuringaccrual for workforce reductions has been fully used as of December 28, 2002.

 

A summary ofactivity with respect to the restructuring charge for the six-month periodended June 28, 2003 is as follows:

 

| **(In thousands)**           |   | **Office Closure/  Consolidation** |   |
|------------------------------|--------|------------------------------------|--------|
|                         |   |                               |   |
| Balance at December 28, 2002 |   | $                                  | 1,198  |   |
|                         |   |                               |   |
| Cash expenditures            |   | 368                                |   |
|                         |   |                               |   |
| Balance at June 28, 2003     |   | $                                  | 830    |   |

 

8

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Item2.

 

**Management’sDiscussion and Analysisof Financial Condition and Results of Operations**

Six Months Ended June 28, 2003 and June 30, 2002

 

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

 

Critical Accounting Policies

 

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

 

Critical accounting policies are defined as those thatinvolve significant judgments and uncertainties and potentially result inmaterially different outcomes under different assumptions and conditions.  Application of these policies isparticularly important to the portrayal of our financial condition and resultsof operations.  We believe the accountingpolicies described below meet these characteristics.

 

*Revenue Recognition*

 

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

 

In certain client situations, where the nature of theengagement requires it, we utilize the services of other companies in ourindustry.  If these services areprovided under an arrangement where-by we agree to retain only a fixed portionof the amount billed to the client, to cover our management and administrativecosts, the amount billed to the client is classified as subsupplierrevenue.  All revenue derived fromservices provided by our employees or other independent contractors workingdirectly for us is recorded as direct revenue.

 

We generally do not enter into fixed price engagementsexcept as summarized above.

 

In all of our services, risk associated with clientsatisfaction exists.  Althoughmanagement feels these risks are adequately addressed by our adherence toproven project management methodologies and other procedures, the potentialexists for future revenue charges relating to unresolved issues.

 

*Bad Debt*

 

Each accounting period we determine an amount to beset aside to cover potentially uncollectible accounts.  Our determination is based upon anevaluation of accounts receivable for risk associated with a client’s abilityto make contractually required payments. These determinations require considerable judgment in assessing theultimate potential for collection of these receivables and include reviewingthe financial stability of the client, the clients’ willingness to pay, andcurrent market conditions.  If ourevaluation of a client’s ability to pay is incorrect, we may incur futurecharges.

 

9

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*Goodwill and Intangible Impairment*

 

We evaluate goodwill and other intangible assets on aperiodic basis.  This evaluation relieson assumptions regarding estimated future cash flows and other factors todetermine the fair value of the respective assets.  If these estimates or related assumptions change, we may berequired to recognize impairment charges.

 

In June 2001, the Financial Accounting Standards Board(FASB) issued Statement of Financial Accounting Standards (“SFAS”) No. 142“Goodwill and Other Intangible Assets.” In accordance with the provisions of SFAS No. 142, effective January 1,2002 we ceased amortization of certain intangible assets includinggoodwill.  Intangible assets withdefinite useful lives will continue to be amortized over their useful lives andreviewed for impairment in accordance with SFAS No. 144 “Accounting for theImpairment or Disposal of Long-Lived Assets.” Also in conjunction with the adoption of the provisions of SFAS No. 142,we recorded a goodwill impairment charge during the first quarter of 2002 of$16.389 million.  This impairment wasrecorded as a cumulative effect of a change in accounting principle as ofJanuary 1, 2002, and therefore did not impact operating income.  The Company completed its impairmentanalysis for 2003 during the first quarter and found no indication ofimpairment of its recorded goodwill although the valuation determined the fairvalue of the Infrastructure and Solutions reporting units to approximate theircarrying value.

 

*Deferred Taxes*

 

We account for income taxes in accordance with SFASNo. 109, “Accounting for Income Taxes,” which requires that deferred tax assetsand liabilities be recognized for the effect of temporary differences betweenreported income and income considered taxable by the taxing authorities.  SFAS No. 109 also requires the resultingdeferred tax assets to be reduced by a valuation allowance if some portion orall of the deferred tax asset is not expected to be realized.  Based upon prior taxable income andestimates of future taxable income, we expect our deferred tax assets, net ofthe established valuation allowance, will be fully realized in the future.  If actual future taxable income is less thanwe anticipate from our estimates, we may be required to record a valuationallowance against our deferred tax assets resulting in additional income taxexpense which will be recorded in our consolidated statement of operations.

 

*Benefit Accruals*

 

Each accounting period we estimate an amount to accruefor medical costs incurred but not yet reported (IBNR) under our self-fundedemployee medical insurance plans.  Webase our determination on an evaluation of past rates of claim payouts andtrends in the amount of payouts.  Thisdetermination requires significant judgment and assumes past patterns are representativeof future payment patterns.  Asignificant shift in usage and payment patterns within our medical plans couldnecessitate significant adjustments to these accruals in future accountingperiods.

 

*Restructuring*

 

We recorded a restructuring charge and reservesassociated with restructuring plans approved by management in December2000.  The remaining reserve consists ofan estimate pertaining to real estate lease obligations.  Factors such as the ability to obtainsubleases, the creditworthiness of sublessees, and the ability to negotiateearly termination agreements with lessors could materially affect this realestate reserve.  While we believe ourcurrent estimates regarding lease obligations are adequate, our inability tosublet the remaining space, or obtain payments from sublessees couldnecessitate significant adjustments to these estimates in the future.

 

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**RESULTSOF OPERATIONS, THREE- AND SIX-MONTH PERIODS ENDED JUNE 28, 2003 VS. JUNE30, 2002**

 

The following tablesillustrate the relationship between revenue and expense categories along with acount of employees and technical consultants for the three- and six-monthperiods ended June 28, 2003 and June 30, 2002. The tables provide guidance in our explanation of our operations andresults.

 
|                                               |   | **Three  Months Ended  June 28, 2003** |   | **Three  Months Ended  June 30, 2002** |   | **Increase  (Decrease)** |   |
|----------------------------------------------------|--------|----------------------------------------|--------|----------------------------------------|--------|--------------------------|--------|
| **(dollars  in thousands)**                        |   | **Amount**                             |   | **% of  Revenue**                      |   | **Amount**               |   | **%****of  Revenue** |   | **Amount** |   | **%  Inc (Dec)** |   | **As%  of Revenue** |   |
| Professional services revenue:                     |   |                                   |   |                                   |   |                     |   |   |   |   |   |   |   |   |   |
| Provided directly                                  |   | $                                      | 71,443 |                                   | 86.5   | %                        | $      | 84,062 |   | 75.9 | % | $ | (12,619 | ) | (15.0 | )% | 10.6 | % |
|                                               |   |                                   |   |                                   |   |                     |   |   |   |   |   |   |   |   |   |
| Provided through subsuppliers                      |   | 11,167                                 |   | 13.5                                   |   | 26,682                   |   | 24.1 |   | (15,515 | ) | (58.1 | ) | (10.6 | ) |
| Total revenue                                      |   | 82,610                                 |   | 100.0                                  |   | 110,744                  |   | 100.0 |   | (28,134 | ) | (25.4 | ) | .0 |   |
| Salaries, contracted services and direct  charges  |   | 67,539                                 |   | 81.8                                   |   | 92,252                   |   | 83.3 |   | (24,713 | ) | (26.8 | ) | (1.5 | ) |
| Selling, administrative and other operating  costs |   | 15,062                                 |   | 18.2                                   |   | 19,258                   |   | 17.4 |   | (4,196 | ) | (21.8 | ) | .8 |   |
| Amortization of intangible assets                  |   | 194                                    |   | .2                                     |   | 199                      |   | .2 |   | (5 | ) | (2.5 | ) | .0 |   |
| Loss on sale of corporate headquarters  building   |   | —                                 |   | —                                 |   | 1,860                    |   | 1.7 |   | (1,860 | ) | (100.0 | ) | (1.7 | ) |
| Non-operating income                               |   | (17                                    | )      | (.0                                    | )      | (22                      | )      | (.0 | ) | 5 |   | (22.7 | ) | .0 |   |
| Interest Expense                                   |   | —                                 |   | .0                                     |   | 253                      |   | .2 |   | (253 | ) | (100.0 | ) | (.2 | ) |
| Loss on debt extinguishment                        |   | —                                 |   | —                                 |   | 744                      |   | .6 |   | (744 | ) | (100.0 | ) | (.6 | ) |
|                                               |   |                                   |   |                                   |   |                     |   |   |   |   |   |   |   |   |   |
| Loss before income taxes                           |   | (168                                   | )      | (.2                                    | )      | (3,800                   | )      | (3.4 | ) | 3,632 |   | 95.6 |   | 3.2 |   |
| Income tax benefit                                 |   | —                                 |   | (.0                                    | )      | (623                     | )      | (.5 | ) | 623 |   | 100.0 |   | .5 |   |
|                                               |   |                                   |   |                                   |   |                     |   |   |   |   |   |   |   |   |   |
| Net loss                                           |   | $                                      | (168   | )                                      | (.2    | )%                       | $      | (3,177 | ) | (2.9 | )% | $ | 3,009 |   | 94.7 | % | 2.7 | % |
|                                                    |        |                                        |        |                                        |        |                          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                                                    |   | **Six Months  Ended  June 28, 2003** |    | **Six Months  Ended  June 30, 2002** |   | **Increase  (Decrease)** |   |
|---------------------------------------------------------|--------|--------------------------------------|---------|--------------------------------------|--------|--------------------------|--------|
| **(dollars  in thousands)**                             |   | **Amount**                           |    | **% of  Revenue**                    |   | **Amount**               |   | **%****of  Revenue** |   | **Amount** |   | **%  Inc (Dec)** |   | **As%  of Revenue** |   |
| Professional services revenue:                          |   |                                 |    |                                 |   |                     |   |   |   |   |   |   |   |   |   |
| Provided directly                                       |   | $                                    | 141,078 |                                 | 83.7   | %                        | $      | 167,543 |   | 74.3 | % | $ | (26,465 | ) | (15.8 | )% | 9.4 | % |
|                                                    |   |                                 |    |                                 |   |                     |   |   |   |   |   |   |   |   |   |
| Provided through subsuppliers                           |   | 27,573                               |    | 16.3                                 |   | 57,885                   |   | 25.7 |   | (30,312 | ) | (52.4 | ) | (9.4 | ) |
| Total revenue                                           |   | 168,651                              |    | 100.0                                |   | 225,428                  |   | 100.0 |   | (56,777 | ) | (25.2 | ) | .0 |   |
| Salaries, contracted services and direct  charges       |   | 138,195                              |    | 81.9                                 |   | 187,686                  |   | 83.3 |   | (49,491 | ) | (26.4 | ) | (1.4 | ) |
| Selling, administrative and other operating  costs      |   | 30,627                               |    | 18.2                                 |   | 38,608                   |   | 17.1 |   | (7,981 | ) | (20.7 | ) | 1.1 |   |
| Amortization of intangible assets                       |   | 387                                  |    | .2                                   |   | 398                      |   | .2 |   | (11 | ) | (2.8 | ) | .0 |   |
| Loss on sale of corporate headquarters  building        |   | —                               |    | —                               |   | 1,860                    |   | .8 |   | (1,860 | ) | (100.0 | ) | (.8 | ) |
| Non-operating income                                    |   | (25                                  | )       | (.0                                  | )      | (66                      | )      | (.0 | ) | 41 |   | (62.1 | ) | .0 |   |
| Interest Expense                                        |   | 8                                    |    | .0                                   |   | 911                      |   | .4 |   | (903 | ) | (99.1 | ) | (.4 | ) |
| Loss on debt extinguishment                             |   | —                               |    | —                               |   | 744                      |   | .3 |   | (744 | ) | (100.0 | ) | (.3 | ) |
| Cumulative effect of change in accounting  for goodwill |   | —                               |    | —                               |   | 16,389                   |   | 7.3 |   | (16,389 | ) | (100.0 | ) | (7.3 | ) |
|                                                    |   |                                 |    |                                 |   |                     |   |   |   |   |   |   |   |   |   |
| Loss before income taxes                                |   | (541                                 | )       | (.3                                  | )      | (21,102                  | )      | (9.4 | ) | 20,561 |   | 97.4 |   | 9.1 |   |
| Income tax benefit                                      |   | (57                                  | )       | (.0                                  | )      | (835                     | )      | (.4 | ) | 778 |   | 93.2 |   | .4 |   |
|                                                    |   |                                 |    |                                 |   |                     |   |   |   |   |   |   |   |   |   |
| Net loss                                                |   | $                                    | (484    | )                                    | (.3    | )%                       | $      | (20,267 | ) | (9.0 | )% | $ | 19,783 |   | 97.6 | % | 8.7 | % |
|                                                    |   |                                 |    |                                 |   |                     |   |   |   |   |   |   |   |   |   |
| Personnel:                                              |   |                                 |    |                                 |   |                     |   |   |   |   |   |   |   |   |   |
| Management and Administrative                           |   | 440                                  |    |                                 |   | 545                      |   |   |   | (105 | ) | (19.3 | )% |   |   |
| Technical Consultants                                   |   | 2,575                                |    |                                 |   | 2,995                    |   |   |   | (420 | ) | (14.0 | )% |   |   |

 

Revenue provided directlyfor the three- and six-month periods ended June 28, 2003 decreased 15.0% and15.8%, respectively, from the comparable quarter a year ago.  However, we derived a substantially greaterpercentage of our revenue from direct billings during these periods in 2003 ascompared to the same periods last year. This increase in the percentage of direct revenue was due principally tothe decrease in revenue from certain Managed Services clients, most of which hadbeen provided through subsuppliers.  Oursubsupplier revenue is mainly pass-through revenue with associated feesproviding minimal profit.

 

The decrease in revenueresulted primarily from the decrease in the number of consultants we hadbillable during these periods, which is reflective of an overall reduction inspending for the IT services we provide. Our consultant staff has decreased by 420 consultants from June 30,2002.  In addition, we continue toexperience decreasing average bill rates due to pricing pressures imposed byour clients.  These pressures haveresulted in a 9% reduction in average bill rates within our staffing businessthus far this year.  As demand for theservices our

 

11

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industry provides has declined,many clients have taken the opportunity to demand pricing concessions and wehave had to concede lower prices to retain our relationship with these clients.

 

Salaries, contractedservices and direct charges primarily represent our payroll and benefit costsassociated with billable consultants. Comparing the 2003 periods to the 2002 periods, these expenses decreasedslightly as a percentage of revenue.  Wehave been successful at managing our direct labor rates downward in response todecreasing bill rates.  We have beenable to do this by passing billing rate decreases through to our consultants inthe form of labor rate decreases where possible and increasing productivitylevels of our billable technical staff. The shifting of our revenue mix to include more direct revenue, withbetter margins, and less low margin subsupplier revenue also played a role indecreasing this category of expense as a percentage of revenue.  Although we continuously attempt to controlthe factors which affect this category of expense, there can be no assurance wewill be able to maintain or improve this level.

 

Selling, administrativeand other operating (SG&A) costs include commissions paid to salesrepresentatives and recruiters, location costs, and other administrativecosts.  This category of costsrepresented 18.2% of total revenue for each of the three- and six-month periodsended June 28, 2003, up from 17.4% and 17.1% for the three-and six-monthperiods in 2002, respectively.  Whilethe significant decline in our total revenue, especially subsupplier revenue,has caused these costs to increase as a percentage of total revenue, the actualamounts of these costs have decreased considerably during these periods.  These decreases are the result of our ongoingefforts to manage costs downward as demand for our services and our averagebilling rates decline.  We have managedthese costs downward primarily by reducing discretionary spending fornon-billable travel, imposing wage controls on administrative and managementpersonnel, eliminating office space where possible, and by reducing the numberof non-technical personnel we employ. We are committed to continuing to manage this category of expense to theright level for our company; however, there can be no assurance this categoryof cost will not increase as a percentage of income if our headcount andbilling rates continue to decline.

 

Amortization ofintangible assets decreased slightly in the three- and six-month periods endedJune 28, 2003 compared to the same periods last year.

 

In the second quarter of2002 we sold our corporate headquarters building, incurring a loss of $1.9million.  Net proceeds of $16.4 millionwere used to reduce the balance on our line of credit.  The Company remains a major tenant in thebuilding following the sale.

 

Non-operating income,consisting primarily of interest income, declined slightly during the threemonths ended June 28, 2003 compared to the same quarter a year ago.  While invested cash balances were higherduring the 2003 period, rates of return were lower than in the prior year.  Non-operating income, consisting primarilyof interest income, declined during the six months ended June 28, 2003compared to the same period a year ago. The higher level of interest income in the 2002 period resulted fromsignificant cash investments during the first half of the six monthsended June 30, 2002.  The cashinvested during this time was then immediately used to reduce outstanding debt.

 

Interest expense duringthe three- and six-month periods ended June 28, 2003 decreased significantlyfrom the same periods last year.  Thereduction in interest expense is the result of lower levels of borrowings andreduced interest rates subsequent to the April 11, 2002 debtrestructuring.  During the secondquarter of 2003 we maintained a zero balance on our line of credit.  Debt levels have declined to zero primarilyas a result of using cash invested during the first quarter of 2002 andproceeds from the sale of our corporate headquarters building in May 2002 toreduce debt.  We are also experiencing adecreased need to borrow to support accounts receivable.  As our revenue, and accordingly, ourreceivable balance declined throughout 2002 and the first half of 2003, thecash collected from accounts receivable was used to reduce debt.

 

We completed therestructuring of our credit facility with GE Capital in the second quarter of2002.  Upon the refinancing of our debt,we recorded a loss on extinguishment of debt of $744,000 primarily related to make-wholepayments associated with our 1998 Note Purchase Agreement and the write-off ofcosts associated with previous financings.

 

12

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We adopted the fullprovisions of SFAS No. 142 in the first quarter of 2002 and recorded animpairment charge of approximately $16.4 million.  SFAS No. 142 no longer allows the amortization of purchasedgoodwill and certain indefinite-lived intangible assets instead companies musttest such assets for impairment at least annually.  Based on the impairment tests, during the six months ended June30, 2002, we reduced the carrying value of goodwill for our Infrastructurereporting unit to its implied fair value. The impairment was required because economic conditions at the time oftesting reduced the estimated future expected performance for this reportingunit.  Following the initial adoption ofSFAS No. 142, at least annually, we are required to test our remaining goodwillfor impairment.  We performed thesetests as of January 1, 2003 and found no indication of impairment although thecarrying value of the Infrastructure and the Solutions reporting unitsapproximated their fair values.  Anysignificant deterioration in the outlook for these reporting units could resultin future impairment of the associated goodwill.

 

We recorded no income taxbenefit during the three months ended June 28, 2003 as non-deductible items(primarily travel meals and entertainment) negated the tax benefit of ouroperating loss.  During the six months endedJune 28, 2003 we recorded an income tax benefit of $57,000.  This is reflective of an overall tax benefitrate of 10.5% compared to a statutory tax benefit rate of 35%.  This reduced rate results primarily fromnon-deductible meals and entertainment expenses.

 

As a result of the factorsdiscussed above, we reported a net loss in the three- and six-month periodsended June 28, 2003 of $168,000 and $484,000, respectively, compared witha net loss of $3.2 million and $20.3 million, respectively, for the comparableperiods of 2002.

 

The decrease in technicalconsultants is reflective of the overall slowness in the economy which hasresulted in an overall reduction in spending for the IT services weprovide.  Administrative and managementpersonnel decreased as a result of our continuing efforts to contain ouroperating costs.

 

Liquidity and Capital Resources

 

The following table provides information relative tothe liquidity of our business.

 
| **(dollars  in thousands)**      |   | **June 28,  2003** |   | **December  28,  2002** |   | **Increase  (Decrease)** |   | **Percentage  Increase  (Decrease)** |   |
|----------------------------------|--------|--------------------|--------|-------------------------|--------|--------------------------|--------|--------------------------------------|--------|
|                             |   |               |   |                    |   |                     |   |                                 |   |
| Cash and Cash  Equivalents       |   | $                  | 4,946  |                    | $      | 54                       |   | $                                    | 4,892  |   | 9,059.3 | % |
| Accounts  Receivable             |   | 56,852             |   | 59,776                  |   | (2,924                   | )      | (4.9                                 | )      |
| Other Current  Assets            |   | 4,479              |   | 8,848                   |   | (4,369                   | )      | (49.4                                | )      |
| Total Current  Assets            |   | $                  | 66,277 |                    | $      | 68,678                   |   | $                                    | (2,401 | ) | (3.5 | ) |
|                             |   |               |   |                    |   |                     |   |                                 |   |
| Accounts Payable                 |   | $                  | 15,333 |                    | $      | 18,966                   |   | $                                    | (3,633 | ) | (19.2 | ) |
| Current Debt                     |   | —             |   | 324                     |   | (324                     | )      | (100.0                               | )      |
| Other Current  Liabilities       |   | 14,120             |   | 13,683                  |   | 437                      |   | 3.2                                  |   |
| Total Current  Liabilities       |   | $                  | 29,453 |                    | $      | 32,973                   |   | $                                    | (3,520 | ) | (10.7 | ) |
|                             |   |               |   |                    |   |                     |   |                                 |   |
| Working Capital                  |   | $                  | 36,824 |                    | $      | 35,705                   |   | $                                    | 1,119  |   | 3.1 |   |
| Current Ratio                    |   | 2.25               |   | 2.08                    |   | .17                      |   | 8.2                                  |   |
|                             |   |               |   |                    |   |                     |   |                                 |   |
| Total  Shareholders’ Equity |   | $                  | 69,682 |                    | $      | 70,166                   |   | $                                    | (484   | ) | (0.7 | )% |

 

Working capital at June 28, 2003 was up slightly fromDecember 28, 2002.  During the secondquarter of 2003, we have been able to keep our line of credit at zero andmaintain cash and cash equivalents in the $5.0 million range.  Accounts receivable decreased from December28, 2002 to June 28, 2003.  We continueto devote additional resources to pursue the timely collection of ourreceivables.  The reduction in ouraccounts receivable balance was

 

13

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offset by the decline in accounts payable, which isreflective of the lower usage of subsuppliers. The ratio of current assets to current liabilities increased at June 28,2003, as compared to at December 28, 2002.

 

Historically, we have been able to support internalgrowth in our business with internally generated funds. Our primary need forworking capital is to support accounts receivable resulting from our businessand to fund the time lag between payroll disbursement and receipt of feesbilled to clients.  Most recently, asrevenues and payroll have declined, our need for working capital to supportaccounts receivable has also declined, resulting in a reduction in our need toborrow.  When our revenue and payrollbegin to grow again, we would expect our need for working capital to once againincrease.

 

During 2002, reduction of debt and associatedborrowing costs was one of our top priorities. In pursuit of this priority, effective April 11, 2002, weconsummated an asset-based revolving credit agreement with up to $55.0 millionof availability.  This borrowingfacility reduced our cost of borrowing from 9% to prime plus .75%, or 4.75%currently.  To reduce our cost offinancing even further, we reduced the level of availability under this creditagreement to $45.0 million following the sale of our corporateheadquarters building on May 15, 2002. We have been successful at reducing our borrowings on our line of creditto zero earlier this year and they have remained at zero throughout the quarterended June 28, 2003.  At June 28, 2003our borrowing capability was up to $22.2 million under our credit facility ifbusiness and working capital needs warrant it. Borrowings under the credit agreement are secured by all of our assets.

 

The revolving credit agreement requires us to takeadvances or pay down the outstanding balance on the line of credit daily.  However, we can request fixed-term advancesof one, two, or three months for a portion of the outstanding balance on theline of credit.  The daily advances onthe line of credit bear interest at the Wall Street Journal’s “Prime Rate” plus..75% while the fixed-term advances bear interest at the LIBOR rate plus3.0%.  The credit agreement requires thepayment of a commitment fee of .50% of the unused portion of the line plus anannual 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 aminimum accounts payable turnover ratio. We believe we will be able to continue to meet the requirements of theagreement.  The credit agreement matureson April 10, 2005.

 

During the three-month period ended June 28, 2003, wemade capital expenditures totaling $498,000 compared to $403,000 in thethree-month period ended June 30, 2002. These capital expenditures were funded with internally generatedfunds.  We continue to tightly controlcapital expenditures to preserve working capital.

 

Commitments and Contingencies

 

Office facilities areleased under non-cancelable operating leases. Minimum future obligations on these operating leases at June 28,2003, are as follows (in thousands):

 

|             |   | **1 Year** |   | **2-3 Years** |   | **4-5 Years** |   | **Over 5  Years** |   | **Total** |   |
|------------------|--------|------------|--------|---------------|--------|---------------|--------|-------------------|--------|-----------|--------|
|             |   |       |   |          |   |          |   |              |   |      |   |
| Operating Leases |   | $          | 6,002  |          | $      | 10,985        |   | $                 | 5,866  |      | $      | 472 |   | $ | 23,325 |   |
|                  |        |            |        |               |        |               |        |                   |        |           |        |  |  |  |  |  |

 

14

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Market Conditions, Business Outlook and Risks to OurBusiness

 

*ForwardLooking Statements*

 

The statements contained in “Management’s Discussionand Analysis of Financial Condition and Results of Operations,” includingwithout limitation, our statements relating to prospects for our business,recovery of the IT services industry, our working capital needs and sufficiencyof our working capital, the continued need of current and prospective customersfor our services and our ability to win that business, the effects ofcompetition and our ability to respond to competitive conditions, theavailability and utilization of qualified professional staff, our ability toincrease billing rates as labor and benefit costs increase, our ability tomaintain gross margin levels and control operating cost increases, and ourability to achieve and maintain profitability are forward looking statementsmade under the safe harbor provision of the Private Securities LitigationReform Act.  Words such as “believes,”“intends,” “possible,” “expects,” “estimates,” “anticipates,” or “plans” andsimilar expressions are intended to identify forward looking statements.  Such statements are based on management’scurrent expectations as of the date of this document but involve risks, uncertaintiesand other factors which could cause actual results to differ materially fromthose contemplated by such forward looking statements.  Investors are cautioned to consider theseforward looking statements in light of important factors which may result invariations from results contemplated by such forward looking statementsincluding, but not limited to, the risk factors discussed below.

 

Several market conditionsare affecting our industry.  Increasedprice competition in the area of technical staff augmentation has createdpressure on billable hourly rates, and clients have been requestingincreasingly lower cost models for staff augmentation services.  As a result, we have encountered lowerbilling rates for quite some time. Management expects that clients will continue, for the foreseeablefuture, to request lower cost offerings for staff augmentation services throughe-procurement systems, extremely competitive bidding processes, the granting ofvarious types of discounts and the use of off-shore resources.  Our ability to respond to customer requestsfor lower pricing or to provide other low cost solutions in this area of ourbusiness will have a direct effect on our performance.  Management expects competitive conditions inthe area of technical staff augmentation to continue for the foreseeablefuture, although it expects that demand for these services will increase as thegeneral economy begins to recover.

 

We are consideringvarious low-cost staffing model alternatives, including relationships withe-procurement software vendors, at least in partial response to thesedevelopments in the industry.  We haveestablished a relationship with an offshore vendor.  We have also implemented new software and internet capabilitiesin our recruiting function.  Althoughmanagement believes these changes will have a positive effect on our results,there is no guarantee that the changes alone will be successful.

 

Staff augmentationcontinues to represent more than half of total revenues (revenue from servicesprovided directly to client (direct revenue) plus revenue from servicesprovided to our clients by subsuppliers (subsupplier revenue)) and over half ofour direct revenue.  While we expect theindustry slowdown to begin to reverse in the latter part of 2003, there can beno assurance as to when, or if, revenue will return to previous levels.  Our ability to respond to the conditionsoutlined above will bear directly on our performance.

 

As a result of the pricing and othercompetitive pressures affecting the technical staff augmentation area of ourbusiness, management has sought and plans to continue to seek new customers forour other service offerings.  In 2003,management plans to concentrate on staff augmentation/managed services inFortune 500 companies, business solutions for small and medium-sizedbusinesses, and business opportunities with its technology and productpartners.  In addition, we plan todevelop a low cost staffing delievery model, expand our offshore servicecapabilities and develop relationships with sales channel partners with whichwe will share sales leads.  Whilewe believe these areas of our business present opportunities to grow ourbusiness, growth in these areas will depend on improvement in the economy andspending in the overall IT services market, our ability to compete with othervendors and our success in obtaining new clients.

 

Our ability to quickly identify, attract andretain qualified technical personnel, especially when recovery begins, willaffect our results of operations and ability to grow in the future.  Competition for qualified personnel is 

 

 

15

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intense, and if we are unable to hire thetalent required by our client in a cost-effective manner, it will affect ourability to grow our business. In addition to our ability tocontrol labor costs, our ability to control employee benefit costs and otheremployee-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 2002and have implemented additional changes in 2003.  While we believe the changes we implemented will be effective,actual results may vary due to factors we cannot control such as rising medicalcosts, the amount of medical services used by our employees and similarfactors.

 

Controlling operatingcosts while attempting not to impact our ability to respond to our clients alsois a factor in our future success.  Wehave streamlined our operations by consolidating offices, reducingadministrative and management personnel and continuing to review our companystructure for more efficient methods of operating our business and deliveringour services.  We may not be able tocontinue to reduce costs without affecting our ability to deliver service toour clients and therefore may choose to forego particular cost reductions if webelieve it would be prudent to do so for the future business of the Company.

 

Terms and conditions standard to computer consultingservices contracts also present a risk to our business.  In general, our clients can cancel or reducetheir contracts on short notice.  Lossof a significant client relationship or a significant portion thereof, asignificant number of relationships or a major contract could have a materialadverse effect on our business.

 

While we believe our working capital will besufficient for the foreseeable needs of our business, significant rapid growthin our business could create a need for additional working capital.  An inability to obtain additional workingcapital, should it be required, could have an adverse material effect on ourbusiness.  We expect to be able tocomply with the requirements of our credit agreement; however, failure to do socould have a material adverse effect on our business.

 

Item 3.

 

**Quantitativeand Qualitative Disclosures About Market Risk**

 

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

 

Item4.

 

**4(i)  Controls and Procedures**

 

(a)  Evaluation of Disclosure Controls andProcedures.

 

The Company’s Chief Executive Officer, Michael J.LaVelle, and Chief Financial Officer, John T. Paprocki, have reviewed theCompany’s disclosure controls and procedures as of June 28, 2003.  While there can be no assurance thesecontrols will be effective in all circumstances, based upon their review, theseofficers believe that the Company’s disclosure controls and procedures areeffective in ensuring that material information related to the Company is madeknown to them by others within the Company.

 

(b)  Changes in Internal Controls

 

There were no significant changes in the Company’sinternal controls or in other factors that could significantly affect thesecontrols during the quarter covered by this report or from the end of thereporting period to the date of this report on Form 10-Q.

 

16

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**4(ii)  Submission of Mattersto a Vote of Security Holders**

 

(a)  Electionof directors.

 

The following nominees, all of whom were listed in theCompany’s proxy statement prepared in accordance with Regulation 14(a), wereelected:

 
| **Nominee**    |   | **Votes For** |   | **Authority  Withheld** |   |
|----------------|--------|---------------|--------|-------------------------|--------|
|           |   |          |   |                    |   |
| J.D. Bamberger |   | 20,738,496    |   | 1,121,155               |   |
| K.K. Burhardt  |   | 20,961,975    |   | 897,675                 |   |
| W.K. Drake     |   | 20,875,478    |   | 991,417                 |   |
| M.B. Esstman   |   | 20,984,193    |   | 875,969                 |   |
| F.W. Lang      |   | 20,936,686    |   | 930,209                 |   |
| M.J. Lavelle   |   | 20,035,954    |   | 1,823,697               |   |
| M.A. Loftus    |   | 20,980,845    |   | 878,806                 |   |
| E.M. Mahoney   |   | 20,948,405    |   | 911,246                 |   |
| R.L. Prince    |   | 20,922,346    |   | 937,305                 |   |

 

(b) Ratification of auditors.

 

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

 
| In favor |   | 21,238,399 |   |
|----------|--------|------------|--------|
| Against  |   | 418,031    |   |
| Abstain  |   | 203,208    |   |

 

PART II.  OTHER INFORMATION

 

Item 6.

 

**Exhibits and Reports on Form 8-K**

 

(a)  Exhibits

 

31.1Certification of CEO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2Certification of CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1Certification of CEO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2Certification of CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(b)  Reports on Form 8-K

 

A.      Form 8-K filed May 29, 2003announcing the non-intentional disclosure of certain information not previouslydisclosed to the public in the oral remarks of its executives at the annualshareholders meeting held on May 28, 2003.

 

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SIGNATURES

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned there unto duly authorized.

 
|                  | ANALYSTS INTERNATIONAL CORPORATION |                                                            |
|-----------------------|------------------------------------|-----------------------------------------------------------------|
|                  | (Registrant)                       |                                                            |
|                  |
| Date: August 11, 2003 | By:                                | /s/ John T. Paprocki                                            |   |
|                  |                               | John T. Paprocki                                                |
|                  |                               | Chief Financial Officer  and  Executive Vice President          |
|                  |                               |                                                            |
|                  |                               |                                                            |
| Date: August 11, 2003 | By:                                | /s/ David J. Steichen                                           |   |
|                  |                               | David J. Steichen                                               |
|                  |                               | Controller and  Assistant Treasurer  (Chief Accounting Officer) |
|                       |                                    |                                                                 |  |  |  |

 

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**ANALYSTSINTERNATIONAL CORPORATION**

**EXHIBIT INDEX**

**FORM10-QQUARTER ENDED JUNE 28, 2003**

 
| **Exhibit  No.** |   | **Description**                                                                 |
|------------------|--------|---------------------------------------------------------------------------------|
|             |   |                                                                            |
| 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 |
| 32.1             |   | Certification of CEO Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
| 32.2             |   | Certification of CFO Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

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