**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**

 

**Forthe quarterly period ended September 27, 2003**

 

**or**

 

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

 

**Commissionfile number 0-4090**

 

**ANALYSTSINTERNATIONAL CORPORATION**

 

**Minnesota****                                                                                       41-0905408**

 

**3601West 76th StreetMinneapolis, MN  55435(952) 835-5900**

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months and (2) has been subject to such filing requirements for the past 90days.

 

Yes    ý   No    o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).

 

Yes    ý   No    o

 

As of November 4, 2003,24,211,807 shares of the Registrant’s Common Stock were outstanding.

 

 

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ANALYSTSINTERNATIONAL CORPORATION

 

INDEX

 
| Part I.       |   | FINANCIAL INFORMATION                                                                       |
|---------------|--------|---------------------------------------------------------------------------------------------|
|          |   |                                                                                        |
| Item 1.       |   | Condensed Consolidated Balance Sheets                                                       |
|          |   | September  27, 2003 (Unaudited) and December 28, 2002                                       |
|          |   |                                                                                        |
|          |   | Condensed  Consolidated Statements of Operations                                            |
|          |   | Three  and nine months ended September 27, 2003 and September 30, 2002 (Unaudited)          |
|          |   |                                                                                        |
|          |   | Condensed  Consolidated Statements of Cash Flows                                            |
|          |   | Nine  months ended September 27, 2003 and September 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                                                                     |
|          |   |                                                                                        |
| 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

 

Item1.

 

**Analysts International Corporation**

**Condensed Consolidated Balance Sheets**

 
| **(In thousands)**                                         |   | **September  27,  2003** |    | **December  28,  2002** |   |
|------------------------------------------------------------|--------|--------------------------|---------|-------------------------|--------|
|                                                       |   | **(Unaudited)**          |    |                    |   |
|                                                       |   |                     |    |                    |   |
| **ASSETS**                                                 |   |                     |    |                    |   |
| Current assets:                                            |   |                     |    |                    |   |
| Cash and cash equivalents                                  |   | $                        | 8,114   |                    | $      | 54 |   |
| Accounts receivable, less allowance for doubtful  accounts |   | 54,517                   |    | 59,776                  |   |
| Prepaid expenses and other current assets                  |   | 4,352                    |    | 8,848                   |   |
| Total current assets                                       |   | 66,983                   |    | 68,678                  |   |
|                                                       |   |                     |    |                    |   |
| Property and equipment, net                                |   | 6,559                    |    | 7,071                   |   |
| Intangible assets other than goodwill                      |   | 11,442                   |    | 12,022                  |   |
| Goodwill                                                   |   | 16,460                   |    | 16,460                  |   |
| Other assets                                               |   | 2,203                    |    | 2,513                   |   |
|                                                       |   | $                        | 103,647 |                    | $      | 106,744 |   |
|                                                       |   |                     |    |                    |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**             |   |                     |    |                    |   |
|                                                       |   |                     |    |                    |   |
| Current liabilities:                                       |   |                     |    |                    |   |
| Accounts payable                                           |   | $                        | 13,080  |                    | $      | 18,966 |   |
| Line of credit                                             |   | —                   |    | 324                     |   |
| Salaries and vacations                                     |   | 11,148                   |    | 6,036                   |   |
| Deferred revenue                                           |   | 3,355                    |    | 4,340                   |   |
| Self-insured health care reserves and other amounts        |   | 2,748                    |    | 2,659                   |   |
| Restructuring accruals, current portion                    |   | 403                      |    | 648                     |   |
| Total current liabilities                                  |   | 30,734                   |    | 32,973                  |   |
|                                                       |   |                     |    |                    |   |
| Restructuring accruals, non-current portion                |   | 306                      |    | 550                     |   |
| Deferred compensation accrual                              |   | 3,484                    |    | 3,055                   |   |
| Shareholders’ equity                                  |   | 69,123                   |    | 70,166                  |   |
|                                                       |   | $                        | 103,647 |                    | $      | 106,744 |   |

 

Note:  The balance sheet at December 28, 2002 hasbeen taken from the audited financial statements at that date, and condensed.

 

See notes tocondensed consolidated financial statements.

 

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**AnalystsInternational Corporation**

**CondensedConsolidated Statements of Operations**

*(Unaudited)*

 
|                                                                              |   | **Three Months Ended**   |   | **Nine Months Ended**    |       |
|-----------------------------------------------------------------------------------|--------|--------------------------|--------|--------------------------|------------|
| **(In thousands except per share amounts)**                                       |   | **September  27,  2003** |   | **September  30,  2002** | ** ** | **September  27,  2003** | ** ** | **September 30,  2002** | ** ** |
| Professional services revenue:                                                    |   |                     |   |                     |       |   |   |   |   |
| Provided directly                                                                 |   | $                        | 69,432 |                     | $          | 85,245 |   | $ | 210,510 |   | $ | 252,788 |   |
| Provided through subsuppliers                                                     |   | 10,604                   |   | 22,169                   |       | 38,177 |   | 80,054 |   |
| Total revenue                                                                     |   | 80,036                   |   | 107,414                  |       | 248,687 |   | 332,842 |   |
|                                                                              |   |                     |   |                     |       |   |   |   |   |
| Expenses:                                                                         |   |                     |   |                     |       |   |   |   |   |
| Salaries, contracted services and direct charges                                  |   | 65,406                   |   | 88,715                   |       | 203,601 |   | 276,401 |   |
| Selling, administrative and other operating costs                                 |   | 15,035                   |   | 19,380                   |       | 45,662 |   | 57,988 |   |
| Amortization of intangible assets                                                 |   | 193                      |   | 193                      |       | 580 |   | 591 |   |
| Loss on sale of corporate headquarters building                                   |   | —                   |   | —                   |       | — |   | 1,860 |   |
|                                                                              |   |                     |   |                     |       |   |   |   |   |
| Operating loss                                                                    |   | (598                     | )      | (874                     | )          | (1,156 | ) | (3,998 | ) |
| Non-operating income                                                              |   | 39                       |   | 53                       |       | 64 |   | 119 |   |
| Interest expense                                                                  |   | —                   |   | (86                      | )          | (8 | ) | (997 | ) |
| Loss on debt extinguishment                                                       |   | —                   |   | —                   |       | — |   | (744 | ) |
|                                                                              |   |                     |   |                     |       |   |   |   |   |
| Loss before income taxes and cumulative effect of  change in accounting principle |   | (559                     | )      | (907                     | )          | (1,100 | ) | (5,620 | ) |
| Income tax benefit                                                                |   | —                   |   | (224                     | )          | (57 | ) | (1,059 | ) |
| Net loss before cumulative effect of change in  accounting principle              |   | (559                     | )      | (683                     | )          | (1,043 | ) | (4,561 | ) |
| Cumulative effect of change in accounting for  goodwill                           |   | —                   |   | —                   |       | — |   | (16,389 | ) |
| Net loss                                                                          |   | $                        | (559   | )                        | $          | (683 | ) | $ | (1,043 | ) | $ | (20,950 | ) |
|                                                                              |   |                     |   |                     |       |   |   |   |   |
| Per common share:                                                                 |   |                     |   |                     |       |   |   |   |   |
| Basic and diluted loss:                                                           |   |                     |   |                     |       |   |   |   |   |
| Loss before cumulative effect of change in  accounting principle                  |   | $                        | (.02   | )                        | $          | (.03 | ) | $ | (.04 | ) | $ | (.19 | ) |
| Cumulative effect of change in accounting for  goodwill                           |   | —                   |   | —                   |       | — |   | (.68 | ) |
| Net loss:                                                                         |   | $                        | (.02   | )                        | $          | (.03 | ) | $ | (.04 | ) | $ | (.87 | ) |
|                                                                              |   |                     |   |                     |       |   |   |   |   |
| Average common shares outstanding                                                 |   | 24,199                   |   | 24,198                   |       | 24,199 |   | 24,197 |   |
| Average common and common equivalent shares  outstanding                          |   | 24,199                   |   | 24,198                   |       | 24,199 |   | 24,197 |   |

 

See notes tocondensed consolidated financial statements.

 

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**AnalystsInternational Corporation**

**CondensedConsolidated Statements of Cash Flows**

*(Unaudited)*

* *
|                                                |   | **Nine Months Ended**    |       |
|-----------------------------------------------------|--------|--------------------------|------------|
| **(In thousands)**                                  |   | **September  27,  2003** | ** ** | **September  30,  2002** | ** ** |
|                                                |   |                     |       |   |   |
| Net cash provided by operating activities           |   | $                        | 9,948      |   | $ | 3,948 |   |
|                                                |   |                     |       |   |   |
| Cash flows from investing activities:               |   |                     |       |   |   |
| Property and equipment additions                    |   | (1,586                   | )          | (1,469 | ) |
| Proceeds from property and equipment sales          |   | 22                       |       | 16,445 |   |
| Net cash (used in) provided by investing activities |   | (1,564                   | )          | 14,976 |   |
|                                                |   |                     |       |   |   |
| Cash flows from financing activities:               |   |                     |       |   |   |
| Net change in Working Capital Line of Credit        |   | (324                     | )          | 5,608 |   |
| Proceeds from borrowings                            |   | —                   |       | 29,525 |   |
| Repayment of borrowings                             |   | —                   |       | (70,525 | ) |
| Proceeds from exercise of stock options             |   | —                   |       | 8 |   |
| Net cash used in financing activities               |   | (324                     | )          | (35,384 | ) |
|                                                |   |                     |       |   |   |
| Net increase (decrease) in cash and equivalents     |   | 8,060                    |       | (16,460 | ) |
|                                                |   |                     |       |   |   |
| Cash and cash equivalents at beginning of period    |   | 54                       |       | 18,204 |   |
|                                                |   |                     |       |   |   |
| Cash and cash equivalents at end of period          |   | $                        | 8,114      |   | $ | 1,744 |   |

 

See notes tocondensed consolidated financial statements.

 

5

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**Analysts International Corporation**

**Notesto Condensed Consolidated Financial Statements**

(Unaudited)

 

1.                                   Summaryof Significant Accounting Policies

 

CondensedConsolidated Financial Statements - The condensed consolidated balance sheet asof September 27, 2003, the condensed consolidated statements of operations forthe three- and nine-month periods ended September 27, 2003 and September 30, 2002,and the condensed consolidated statements of cash flows for the nine-monthperiods ended September 27, 2003 and September 30, 2002 have been prepared bythe Company, without audit.  In theopinion of management, all adjustments necessary to present fairly thefinancial position at September 27, 2003 and the results of operations and thecash flows for the periods ended September 27, 2003 and September 30, 2002 havebeen made.

 

Effective December28, 2002, the Company changed its fiscal year to end on the Saturday closest toDecember 31.  Subsequent to this change,the Company’s fiscal quarters will end on the Saturday closest to the end ofthe calendar quarter.  This change inyear and quarter end did not have a material impact on the Company’s operations.

 

Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with accounting principles generally accepted in theUnited States of America have been condensed or omitted.  The Company suggests reading these condensedconsolidated financial statements in conjunction with the financial statementsand notes thereto included in the Company’s December 28, 2002 annual report toshareholders.

 

Comprehensive loss(i.e. net loss plus available-for-sale securities valuation adjustments) forthe three and nine months ended September 27, 2003 was $559,000 and $1,043,000,respectively, and for the three and nine months ended September 30, 2002 was$685,000 and $20,959,000, respectively.

 

Effective January 1, 2002, the Company fully adopted the provisions ofStatement of Financial Accounting Standards (SFAS) No. 141, “BusinessCombinations” and SFAS No. 142, “Goodwill and Other Intangible Assets.”  SFAS No. 141 requires business combinationsinitiated after June 30, 2001 to be accounted for using the purchase method ofaccounting, and broadens the criteria for recording intangible assets otherthan goodwill.

 

SFAS No. 142 no longer allows the amortization of purchased goodwilland certain indefinite-lived intangible assets. Instead, companies must testsuch assets for impairment at least annually. The Company evaluated its intangible assets as of January 1, 2002 andagain at January 1, 2003 and determined that the customer list had adeterminable life while the tradename did not. Effective January 1, 2002 the Company ceased amortization of thetradename asset.

 

SFAS No. 142 prescribes a two-phase process for impairment testing ofgoodwill.  The first phase screens forthe existence of impairment, while the second phase (if necessary) measures theimpairment.  The Company completed itsfirst phase impairment analysis for 2003 during the first quarter and found noindication of impairment of its recorded goodwill, although the valuationdetermined the fair value of the Infrastructure and Solutions reporting unitsto approximate their carrying value.

 

Upon the initial adoption of SFAS No. 142 during the first quarter of2002, there was an indication of impairment of our goodwill found in the firstphase testing.  Accordingly, wecompleted the second phase testing in June 2002.  Based on the impairment tests, we recognized a transitionalimpairment of $16,389,000 in the first quarter of 2002 to reduce the carryingvalue of goodwill for our Infrastructure reporting unit to its implied fairvalue.  We did not record a tax benefitfor this adjustment, as our current operating performance requires theestablishment of a reserve against the deferred tax asset created by thisimpairment.  The transition impairmentwas required because economic conditions at the time of testing

 

6

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(including declining operating margins and lower demand for ourservices) reduced the estimated future expected performance for this operatingunit.  Under SFAS 142, the impairmentadjustment recognized at adoption of the new rules was reflected as acumulative effect of accounting change in our first quarter 2002 statement ofoperations.  Impairment adjustmentsrecognized after adoption, if any, generally are required to be recognized asoperating expenses.

 

Forthe nine months ended September 27, 2003, no goodwill or other intangibles wereacquired, impaired or disposed.  Otherintangibles consisted of the following:

 
|               |   | **September  27, 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     |                          | $          | (2,415 | ) | $ | 9,855 |   | $ | 12,270 |   | $ | (1,835 | ) | $ | 10,435 |   |
| Tradename          |   | 1,720                       |       | (133                          | )          | 1,587 |   | 1,720 |   | (133 | ) | 1,587 |   |
|               |   | $                           | 13,990     |                          | $          | (2,548 | ) | $ | 11,442 |   | $ | 13,990 |   | $ | (1,968 | ) | $ | 12,022 |   |

 

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

 

We adopted SFAS145, “Recission of Financial Accounting Standards Board (FASB) Statements No.4, 44 and 64, Amendments of FASB Statement No. 13 and Technical Corrections” asof December 28, 2002.  Upon the adoptionof SFAS 145, we reclassified the loss resulting from the exinguishment of debtas a separate component in income from continuing operations.

 

Effective December29, 2002, the Company adopted the disclosure provisions of SFAS No. 148,“Accounting for Stock-Based Compensation – Transition and Disclosure”, whichamends SFAS No. 123, “Accounting for Stock-Based Compensation”.  We have continued to apply AccountingPrinciples Board (APB) Opinion No. 25 and related interpretations in accountingfor our four stock-based compensation plans. SFAS 148 provides alternative methods of transition for a voluntarychange to the fair value based method of accounting for stock-based employeecompensation.  In addition, SFAS 148amends the disclosure requirements of SFAS 123 to require more prominent andmore frequent disclosures in financial statements of the effects of stock-basedcompensation.

 

Had compensationcost for our stock-based compensation plans been determined based on the fairvalue at the grant dates as calculated in accordance with SFAS No. 148, our proforma net loss and loss per share for the three and nine months ended September27, 2003 and September 30, 2002 would have been the amounts indicated below:

 
|                          |   | **Three  Months Ended**  |   | **Nine  Months Ended**   |       |
|-------------------------------|--------|--------------------------|--------|--------------------------|------------|
|                          |   | **September  27,  2003** |   | **September  30,  2002** | ** ** | **September  27,  2003** | ** ** | **September  30,  2002** | ** ** |
| Net loss *(in thousands):*    |   |                     |   |                     |       |   |   |   |   |
| As reported                   |   | $                        | (559   | )                        | $          | (683 | ) | $ | (1,043 | ) | $ | (20,950 | ) |
| Pro forma                     |   | (741                     | )      | (998                     | )          | (1,589 | ) | (21,873 | ) |
| Net loss per share (basic):   |   |                     |   |                     |       |   |   |   |   |
| As reported                   |   | $                        | (.02   | )                        | $          | (.03 | ) | $ | (.04 | ) | $ | (.87 | ) |
| Pro forma                     |   | (.03                     | )      | (.04                     | )          | (.07 | ) | (.90 | ) |
| Net loss per share (diluted): |   |                     |   |                     |       |   |   |   |   |
| As reported                   |   | $                        | (.02   | )                        | $          | (.03 | ) | $ | (.04 | ) | $ | (.87 | ) |
| Pro forma                     |   | (.03                     | )      | (.04                     | )          | (.07 | ) | (.90 | ) |

 

7

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2.                                 Long-termDebt

 

Effective April11, 2002, the Company consummated an asset-based revolving credit facility withup to $55,000,000 of availability.  TheCompany reduced the level of availability to $45,000,000 following the sale of itscorporate 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 theline of credit bear interest at the Wall Street Journal’s “Prime Rate” plus..75% (4.75% on September 27, 2003) while the fixed-term advances bear interestat the LIBOR rate plus 3.0%.  The creditagreement requires the payment of a commitment fee of .50% of the unusedportion 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 andrequires the Company to maintain a minimum accounts payable turnover ratio.  The Company believes it will be able to continueto meet the requirements of the new agreement for the foreseeable future and asof September 27, 2003 did not have any borrowings under this agreement.

 

3.                                 Shareholders’Equity

 
|                           |   | **Nine  Months Ended  September 27, 2003** |   |
|--------------------------------|--------|--------------------------------------------|--------|
|                           |   | **(In  thousands)**                        |   |
|                           |   |                                       |   |
| Balance at beginning of period |   | $                                          | 70,166 |   |
| Comprehensive loss             |   | (1,043                                     | )      |
| Balance at end of period       |   | $                                          | 69,123 |   |

 

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 commonstockholders by the weighted-average number of common shares outstanding forthe period.  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 1,983,000 and 2,181,000shares of common stock were outstanding at the end of the periods ended September27, 2003 and September 30, 2002, respectively, but were excluded from thecomputation of common stock equivalents because they were anti-dilutive.

 

5.                                 Restructuring

 

In December 2000,the Company recorded a restructuring charge of $7,000,000.  Of this charge, $2,600,000 related to workforcereductions (primarily non-billable staff), and $4,400,000 related to leasetermination and abandonment costs (net of sub-lease income), including anamount for assets to be disposed of in conjunction with this consolidation.  The restructuring accrual for workforcereductions has been fully used as of December 28, 2002.  A summary of activity with respect to therestructuring charge for the nine-month period ended September 27, 2003 is asfollows:

 
| **(In thousands)**            |   | **Office  Closure/  Consolidation** | ** ** |
|-------------------------------|--------|-------------------------------------|------------|
|                          |   |                                |       |
| Balance at December 28, 2002  |   | $                                   | 1,198      |   |
|                          |   |                                |       |
| Cash expenditures             |   | 489                                 |       |
|                          |   |                                |       |
| Balance at September 27, 2003 |   | $                                   | 709        |   |

 

The remainingbalance in this accrual is to cover the ongoing lease payments for propertiesabandoned as a part of the restructuring. The last of these lease obligations is expected to terminate inSeptember 2006.

 

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Item2.

 

**Management’s Discussion and Analysisof Financial Condition and Results of Operations**

Nine Months EndedSeptember 27, 2003 and September 30, 2002

 

The following discussionof the results of our operations and our financial condition should be read inconjunction with our consolidated financial statements and the related notes toconsolidated financial statements in this 10-Q, our other filings with theSecurities and Exchange Commission and our other investor communications.

 

Critical AccountingPolicies

 

The discussion andanalysis of our financial condition and results of operations are based on ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States of America.  The preparation of these financialstatements requires us to make estimates and judgments that affect the reportedamount of assets and liabilities, revenues and expenses, and related disclosureof contingent assets and liabilities at the date of our financialstatements.  Actual results may differfrom these estimates under different assumptions or conditions.

 

Critical accountingpolicies are defined as those that involve significant judgments anduncertainties and potentially result in materially different outcomes underdifferent assumptions and conditions. Application of these policies is particularly important to the portrayalof our financial condition and results of operations.  We believe the accounting policies described below meet thesecharacteristics.

 

*Revenue Recognition*

 

We recognize revenue forour staffing business and the majority of our business solutions andinfrastructure business as services are performed or products aredelivered.  Certain of our outsourcingand help desk engagements provide for a specific level of service each monthfor which we bill a standard monthly fee. We recognize revenue for these engagements in monthly installments overthe period of the contract.  In somesuch contracts we invoice in advance for two or more months of service.  When we do this, the revenue is deferred andrecognized over the term of the invoicing agreement.

 

In certain clientsituations, where the nature of the engagement requires, we utilize theservices of other companies in our industry. If these services are provided under an arrangement whereby we agree toretain only a fixed portion of the amount billed to the client to cover ourmanagement and administrative costs, we classify the amount billed to theclient as subsupplier revenue.  Allrevenue derived from services provided by our employees or other independent contractorsworking directly for us is recorded as direct revenue.

 

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

 

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

 

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*Bad Debt*

 

Each accounting period wedetermine an amount to be set aside to cover potentially uncollectibleaccounts.  Our determination is basedupon an evaluation of accounts receivable for risk associated with a client’sability to make contractually required payments.  These determinations require considerable judgment in assessingthe ultimate potential for collection of these receivables and includereviewing the financial stability of the client, the clients’ willingness topay, and current market conditions.  Ifour evaluation of a client’s ability to pay is incorrect, we may incur futurecharges.

 

*Goodwill and Intangible Impairment*

 

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

 

In June 2001, the FASBissued SFAS No. 142 “Goodwill and Other Intangible Assets.”  In accordance with the provisions of SFASNo. 142, effective January 1, 2002 we ceased amortization of certain intangibleassets including goodwill.  Intangibleassets with definite useful lives will continue to be amortized over theiruseful lives and reviewed for impairment in accordance with SFAS No. 144“Accounting for the Impairment or Disposal of Long-Lived Assets.”  Also in conjunction with the adoption of theprovisions of SFAS No. 142, we recorded a goodwill impairment charge during thefirst quarter of 2002 of $16.389 million. This impairment was recorded as a cumulative effect of a change inaccounting principle as of January 1, 2002, and therefore did not impactoperating income.  The Company completedits impairment analysis for 2003 during the first quarter and found noindication of impairment of its recorded goodwill although the valuationdetermined the fair value of the Infrastructure and Solutions reporting unitsto approximate their carrying value. Additional write-downs of intangible assets may be required if futurevaluations do not support current carrying value.

 

*Deferred Taxes*

 

We account for incometaxes in accordance with SFAS No. 109, “Accounting for Income Taxes,” whichrequires that deferred tax assets and liabilities be recognized for the effectof temporary differences between reported income and income considered taxableby the taxing authorities.  SFAS No. 109also requires the resulting deferred tax assets to be reduced by a valuationallowance if some portion or all of the deferred tax asset is not expected tobe realized.  Based upon prior taxableincome and estimates of future taxable income, we expect our deferred taxassets, net of the established valuation allowance, will be fully realized inthe future.  If actual future taxableincome is less than we anticipate from our estimates, we may be required torecord a valuation allowance against our deferred tax assets resulting inadditional income tax expense which will be recorded in our consolidatedstatement of operations.

 

*Benefit Accruals*

 

Each accounting period weestimate 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 evaluationof past rates of claim payouts and trends in the amount of payouts.  This determination requires significantjudgment and assumes past patterns are indicative of future payment patterns.  A significant shift in usage and paymentpatterns within our medical plans could necessitate significant adjustments tothese accruals in future accounting periods.

 

*Restructuring*

 

We recorded arestructuring charge and reserves associated with restructuring plans approvedby management in December 2000.  Theremaining reserve consists of an estimate pertaining to real estate leaseobligations.  Factors such as theability to obtain subleases, the creditworthiness of sublessees, and theability to negotiate early termination agreements with lessors could materiallyaffect this real estate reserve.  Whilewe believe our current

 

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estimates regarding leaseobligations are adequate, our inability to sublet the remaining space or obtainpayments from sublessees could necessitate significant adjustments to theseestimates in the future.

 

**RESULTS OF OPERATIONS, THREE- AND NINE-MONTH PERIODS ENDEDSEPTEMBER 27, 2003 VS. SEPTEMBER 30, 2002**

 

The followingtables illustrate the relationship between revenue and expense categories alongwith a count of employees and technical consultants for the three- andnine-month periods ended September 27, 2003 and September 30, 2002.  The tables provide guidance in our explanationof our operations and results.

 
|                                               |   | **Three  Months Ended September 27, 2003** |   | **Three  Months Ended September 30, 2002** |   | **Increase  (Decrease)** |   |
|----------------------------------------------------|--------|--------------------------------------------|--------|--------------------------------------------|--------|--------------------------|--------|
| **(dollars in thousands)**                         |   | **Amount**                                 |   | **% of  Revenue**                          |   | **Amount**               |   | **% of  Revenue** |   | **Amount** | ** ** | **%  Inc (Dec)** | ** ** | **As %  of Revenue** | ** ** |
| Professional services revenue:                     |   |                                       |   |                                       |   |                     |   |   |   |   |   |   |   |   |   |
| Provided directly                                  |   | $                                          | 69,432 |                                       | 86.8   | %                        | $      | 85,245 |   | 79.4 | % | $ | (15,813 | ) | (18.6 | )% | 7.4 | % |
| Provided through subsuppliers                      |   | 10,604                                     |   | 13.2                                       |   | 22,169                   |   | 20.6 |   | (11,565 | ) | (52.2 | ) | (7.4 | ) |
| Total revenue                                      |   | 80,036                                     |   | 100.0                                      |   | 107,414                  |   | 100.0 |   | (27,378 | ) | (25.5 | ) | .0 |   |
| Salaries, contracted services and direct  charges  |   | 65,406                                     |   | 81.7                                       |   | 88,715                   |   | 82.5 |   | (23,309 | ) | (26.3 | ) | (.8 | ) |
| Selling, administrative and other operating  costs |   | 15,035                                     |   | 18.8                                       |   | 19,380                   |   | 18.0 |   | (4,345 | ) | (22.4 | ) | .8 |   |
| Amortization of intangible assets                  |   | 193                                        |   | .2                                         |   | 193                      |   | .2 |   | — |   | .0 |   | .0 |   |
| Non-operating income                               |   | (39                                        | )      | (.0                                        | )      | (53                      | )      | (.0 | ) | 14 |   | (26.4 | ) | .0 |   |
| Interest Expense                                   |   | —                                     |   | .0                                         |   | 86                       |   | .1 |   | (86 | ) | (100.0 | ) | (.1 | ) |
|                                               |   |                                       |   |                                       |   |                     |   |   |   |   |   |   |   |   |   |
| Loss before income taxes                           |   | (559                                       | )      | (.7                                        | )      | (907                     | )      | (.8 | ) | 348 |   | 38.4 |   | .1 |   |
| Income tax benefit                                 |   | —                                     |   | .0                                         |   | (224                     | )      | (.2 | ) | 224 |   | 100.0 |   | .2 |   |
|                                               |   |                                       |   |                                       |   |                     |   |   |   |   |   |   |   |   |   |
| Net loss                                           |   | $                                          | (559   | )                                          | (.7    | )%                       | $      | (683 | ) | (.6 | )% | $ | 124 |   | 18.2 | % | (.1 | )% |

 
|                                                    |   | **Nine  Months Ended  September 27, 2003** |       | **Nine  Months Ended  September 30, 2002** | ** ** | **Increase  (Decrease)** | ** ** |
|---------------------------------------------------------|--------|--------------------------------------------|------------|--------------------------------------------|------------|--------------------------|------------|
| **(dollars in thousands)**                              |   | **Amount**                                 | ** ** | **% of  Revenue**                          | ** ** | **Amount**               | ** ** | **%****of  Revenue** | ** ** | **Amount** | ** ** | **%  Inc (Dec)** |   | **As****%****of Revenue** | ** ** |
| Professional services revenue:                          |   |                                       |       |                                       |       |                     |       |   |   |   |   |   |   |   |   |
| Provided directly                                       |   | $                                          | 210,510    |                                       | 84.6       | %                        | $          | 252,788 |   | 75.9 | % | $ | (42,278 | ) | (16.7 | )% | 8.7 | % |
| Provided through subsuppliers                           |   | 38,177                                     |       | 15.4                                       |       | 80,054                   |       | 24.1 |   | (41,877 | ) | (52.3 | ) | (8.7 | ) |
| Total revenue                                           |   | 248,687                                    |       | 100.0                                      |       | 332,842                  |       | 100.0 |   | (84,155 | ) | (25.3 | ) | .0 |   |
| Salaries, contracted services and direct  charges       |   | 203,601                                    |       | 81.9                                       |       | 276,401                  |       | 83.0 |   | (72,800 | ) | (26.3 | ) | (1.1 | ) |
| Selling, administrative and other operating  costs      |   | 45,662                                     |       | 18.3                                       |       | 57,988                   |       | 17.4 |   | (12,326 | ) | (21.3 | ) | .9 |   |
| Amortization of intangible assets                       |   | 580                                        |       | .2                                         |       | 591                      |       | .2 |   | (11 | ) | (1.9 | ) | .0 |   |
| Loss on sale of corporate headquarters  building        |   | —                                     |       | —                                     |       | 1,860                    |       | .6 |   | (1,860 | ) | (100.0 | ) | (.6 | ) |
| Non-operating income                                    |   | (64                                        | )          | (.0                                        | )          | (119                     | )          | (.0 | ) | 55 |   | (46.2 | ) | .0 |   |
| Interest Expense                                        |   | 8                                          |       | .0                                         |       | 997                      |       | .3 |   | (989 | ) | (99.2 | ) | (.3 | ) |
| Loss on debt extinguishment                             |   | —                                     |       | —                                     |       | 744                      |       | .2 |   | (744 | ) | (100.0 | ) | (.2 | ) |
| Cumulative effect of change in accounting  for goodwill |   | —                                     |       | —                                     |       | 16,389                   |       | 4.9 |   | (16,389 | ) | (100.0 | ) | (4.9 | ) |
|                                                    |   |                                       |       |                                       |       |                     |       |   |   |   |   |   |   |   |   |
| Loss before income taxes                                |   | (1,100                                     | )          | (.4                                        | )          | (22,009                  | )          | (6.6 | ) | 20,909 |   | 95.0 |   | 6.2 |   |
| Income tax benefit                                      |   | (57                                        | )          | (.0                                        | )          | (1,059                   | )          | (.3 | ) | 1,002 |   | 94.6 |   | .3 |   |
|                                                    |   |                                       |       |                                       |       |                     |       |   |   |   |   |   |   |   |   |
| Net loss                                                |   | $                                          | (1,043     | )                                          | (.4        | )%                       | $          | (20,950 | ) | (6.3 | )% | $ | 19,907 |   | 95.0 | % | 5.9 | % |
|                                                    |   |                                       |       |                                       |       |                     |       |   |   |   |   |   |   |   |   |
| Personnel:                                              |   |                                       |       |                                       |       |                     |       |   |   |   |   |   |   |   |   |
| Management and Administrative                           |   | 460                                        |       |                                       |       | 525                      |       |   |   | (65 | ) | (12.4 | )% |   |   |
| Technical Consultants                                   |   | 2,590                                      |       |                                       |       | 2,785                    | *          |   |   | (195 | ) | (7.0 | )% |   |   |

 

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*Technical Consultant total restated for nine months ended September30, 2002 due to a change in the way the Comapny counts consultants who arebetween projects or have left the company but not yet been terminated in theaccounting systems.

 

Revenue provided directly for the three- and nine-month periods endedSeptember 27, 2003 decreased 18.6% and 16.7%, respectively, from the comparablequarter a year ago.  We derived asubstantially greater percentage of our total revenue from direct billingsduring these periods in 2003 as compared to the same periods last year.  This increase in the percentage of directrevenue was due principally to the decrease in revenue from certain ManagedServices clients, most of which had been provided through subsuppliers.  Our subsupplier revenue is mainlypass-through revenue with associated fees providing minimal profit.

 

11

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The decrease inrevenue resulted primarily from the decrease in the number of consultants wehad billable during these periods, which is reflective of an overall reductionin spending for the IT services we provide and significant pricing pressuresimposed by our clients.  Our technicalconsultant staff has decreased by 195 consultants from September 30, 2002.  We continue to experience decreasing averagebill rates due to pricing pressures imposed by our clients.  These pressures have resulted in a 10%reduction in average bill rates within our staffing business thus far thisyear.  As demand for the services ourindustry provides has declined, many clients have taken the opportunity todemand pricing concessions, and we have had to concede lower prices to retainour relationships with these clients.

 

Salaries,contracted services and direct charges primarily represent our payroll andbenefit costs associated with billable consultants.  Comparing the 2003 periods to the 2002 periods, these expensesdecreased slightly as a percentage of revenue. We have been successful at managing our direct labor rates downward inresponse to decreasing bill rates.  Wehave been able to do this by passing billing rate decreases through to ourconsultants in the form of labor rate decreases where possible and increasingproductivity levels of our billable technical staff.  The shifting of our revenue mix to include more direct revenue,with better margins, and less low margin subsupplier revenue also played a rolein decreasing 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,administrative and other operating (SG&A) costs include commissions paid tosales representatives and recruiters, location costs, and other administrativecosts.  This category of costsrepresented 18.8% of total revenue for the three-month period and 18.3% for thenine-month period ended September 27, 2003, up from 18.0% and 17.4% for thethree-and nine-month periods in 2002, respectively.  While the significant decline in our total revenue, especiallysubsupplier revenue, has caused these costs to increase as a percentage oftotal revenue, the actual amounts of these costs have decreased considerablyduring these periods.  These decreasesare the result of our ongoing efforts to manage costs downward as demand forour services and our average billing rates decline.  We have managed these costs downward primarily by reducingdiscretionary spending for non-billable travel, imposing wage controls onadministrative and management personnel, eliminating office space wherepossible, and by reducing the number of non-technical personnel we employ.  We are committed to continuing to manage thiscategory of expense to the right level for our company; however, there can beno assurance this category of cost will not increase as a percentage of incomeif our revenue continues to decline.

 

Amortization ofintangible assets remained the same in the three-month period and decreasedslightly in the nine-month period ended September 27, 2003 compared to the sameperiods last year.

 

In the secondquarter of 2002 we sold our corporate headquarters building, incurring a lossof $1.9 million.  Net proceeds of $16.4million were used to reduce the balance on our line of credit.  The Company remains a major tenant in thebuilding following the sale.

 

Non-operatingincome, consisting primarily of interest income, declined slightly during thethree months ended September 27, 2003 compared to the same quarter a yearago.  While invested cash balances werehigher during the 2003 period, rates of return were lower than in the prioryear.  Non-operating income declinedduring the nine months ended September 27, 2003 compared to the same period ayear ago.  The higher level of interestincome in the 2002 period resulted from significant cash investments during theearly part of the nine months ended September 30, 2002.  The cash invested during this time was thenused to reduce outstanding debt.

 

Interest expenseduring the three- and nine-month periods ended September 27, 2003 decreasedsignificantly from the same periods last year. The reduction in interest expense is the result of lower levels ofborrowing and reduced interest rates subsequent to the April 11, 2002 debtrestructuring.  During the third quarterof 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.  If the trend of declining accountsreceivable balances

 

12

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is reversed as a resultof increasing headcount and revenue, we may need to utilize borrowings underour line of credit in future periods.

 

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 tomake-whole payments associated with our 1998 Note Purchase Agreement and thewrite-off of costs associated with previous financings.

 

We adopted thefull provisions of SFAS No. 142 in the first quarter of 2002 and recorded an impairmentcharge of approximately $16.4 million. SFAS No. 142 no longer allows the amortization of purchased goodwill andcertain indefinite-lived intangible assets instead companies must test suchassets for impairment at least annually. Based on the impairment tests, during the nine months ended September30, 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 noincome tax benefit during the three months ended September 27, 2003 asnon-deductible items (primarily travel meals and entertainment) negated the taxbenefit of our operating loss.  Duringthe nine months ended September 27, 2003 we recorded an income tax benefit of$57,000.  This is reflective of anoverall tax benefit rate of 5.2% compared to a statutory tax benefit rate of35%.  This reduced rate resultsprimarily from non-deductible meals and entertainment expenses.

 

As a result of thefactors discussed above, we reported a net loss in the three- and nine-monthperiods ended September 27, 2003 of $559,000 and $1,043,000, respectively,compared with a net loss of $683,000 and $21.0 million, respectively, for the comparableperiods of 2002.

 

The decrease intechnical consultants is reflective of the overall slowness in the economywhich has resulted 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 CapitalResources

 

The following tableprovides information relative to the liquidity of our business.

 
| **(dollars in thousands)**      |   | **September  27,  2003** | ** ** | **December  28,  2002** | ** ** | **Increase  (Decrease)** |   | **Percentage  Increase  (Decrease)** |   |
|---------------------------------|--------|--------------------------|------------|-------------------------|------------|--------------------------|--------|--------------------------------------|--------|
|                            |   |                     |       |                    |       |                     |   |                                 |   |
| Cash and Cash Equivalents       |   | $                        | 8,114      |                    | $          | 54                       |   | $                                    | 8,060  |   | 14,925.9 | % |
| Accounts Receivable             |   | 54,517                   |       | 59,776                  |       | (5,259                   | )      | (8.8                                 | )      |
| Other Current Assets            |   | 4,352                    |       | 8,848                   |       | (4,496                   | )      | (50.8                                | )      |
| Total Current Assets            |   | $                        | 66,983     |                    | $          | 68,678                   |   | $                                    | (1,695 | ) | (2.5 | ) |
|                            |   |                     |       |                    |       |                     |   |                                 |   |
| Accounts Payable                |   | $                        | 13,080     |                    | $          | 18,966                   |   | $                                    | (5,886 | ) | (31.0 | ) |
| Current Debt                    |   | —                   |       | 324                     |       | (324                     | )      | (100.0                               | )      |
| Other Current Liabilities       |   | 17,654                   |       | 13,683                  |       | 3,971                    |   | 29.0                                 |   |
| Total Current Liabilities       |   | $                        | 30,734     |                    | $          | 32,973                   |   | $                                    | (2,239 | ) | (6.8 | ) |
|                            |   |                     |       |                    |       |                     |   |                                 |   |
| Working Capital                 |   | $                        | 36,249     |                    | $          | 35,705                   |   | $                                    | 544    |   | 1.5 |   |
| Current Ratio                   |   | 2.18                     |       | 2.08                    |       | .10                      |   | 4.8                                  |   |
|                            |   |                     |       |                    |       |                     |   |                                 |   |
| Total Shareholders’ Equity |   | $                        | 69,123     |                    | $          | 70,166                   |   | $                                    | (1,043 | ) | (1.5 | )% |

 

13

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Working capital atSeptember 27, 2003 was up slightly from December 28, 2002.  During the third quarter of 2003, we havebeen able to keep our line of credit at zero and maintain cash and cashequivalents in the $5.0 million range. Accounts receivable decreased from December 28, 2002 to September 27,2003.  We continue to devote additionalresources to pursue the timely collection of our receivables.  The reduction in our accounts receivablebalance was offset by the decline in accounts payable, which is reflective ofthe lower usage of subsuppliers.  Theratio of current assets to current liabilities increased at September 27, 2003,compared to December 28, 2002.

 

Historically, wehave been able to support internal growth in our business with internallygenerated funds. Our primary need for working capital is to support accountsreceivable resulting from our business and to fund the time lag between payrolldisbursement and receipt of fees billed to clients.  Most recently, as revenues and payroll have declined, our needfor working capital to support accounts receivable has also declined, resultingin a reduction in our need to borrow. When our revenue and payroll begin to grow again, we would expect ourneed for working capital to once again increase.

 

During 2002,reduction of debt and associated borrowing costs was one of our toppriorities.  In pursuit of thispriority, effective April 11, 2002, we consummated an asset-based revolvingcredit agreement with up to $55.0 million of availability.  This borrowing facility reduced our cost ofborrowing from 9% to prime plus .75%, or 4.75% currently.  To reduce our cost of financing evenfurther, we reduced the level of availability under this credit agreement to$45.0 million following the sale of our corporate headquarters building on May15, 2002.  We have been successful atreducing our borrowings on our line of credit to zero earlier this year andthey have remained at zero throughout the quarter ended September 27, 2003.  At September 27, 2003 our borrowingcapability was at $22.0 million under our credit facility.  Borrowings under the credit agreement aresecured by all of our assets.

 

The revolvingcredit agreement requires us to take advances or pay down the outstandingbalance on the line of credit daily. However, we can request fixed-term advances of one, two, or three monthsfor a portion of the outstanding balance on the line of credit.  The daily advances on the line of creditbear interest at the Wall Street Journal’s “Prime Rate” plus .75% 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 us to maintain a minimum accountspayable turnover ratio.  We believe wewill be able to continue to meet the requirements of the agreement.  The credit agreement matures on April 10,2005.

 

During thethree-month period ended September 27, 2003, we made capital expenditurestotaling $850,000 compared to $472,000 in the three-month period endedSeptember 30, 2002.  These capital expenditureswere made primarily to increase the capacity of our internet hostingfacilities, and were funded with internally generated funds.  We continue to tightly control capitalexpenditures to preserve working capital.

 

Commitments andContingencies

 

Office facilitiesare leased under non-cancelable operating leases.  Minimum future obligations on these operating leases at September27, 2003, are as follows (in thousands):

 
|             |   | **1 Year** |   | **2-3 Years** |   | **4-5 Years** |   | **Over 5  Years** |   | **Total** |   |
|------------------|--------|------------|--------|---------------|--------|---------------|--------|-------------------|--------|-----------|--------|
|             |   |       |   |          |   |          |   |              |   |      |   |
| Operating Leases |   | $          | 5,955  |          | $      | 10,946        |   | $                 | 5,513  |      | $      | 221 |   | $ | 22,635 |   |
|                  |        |            |        |               |        |               |        |                   |        |           |        |  |  |  |  |  |

 

14

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Market Conditions,Business Outlook and Risks to Our Business

 

*Forward Looking Statements*

 

The statements containedin “Management’s Discussion and Analysis of Financial Condition and Results ofOperations,” including without limitation, our statements relating to prospectsfor our business, recovery of the IT services industry, our working capitalneeds and sufficiency of our working capital, the continued need of current andprospective customers for our services and our ability to win that business,the effects of competition and our ability to respond to competitiveconditions, the availability and utilization of qualified professional staff, ourability to increase billing rates as labor and benefit costs increase, ourability to maintain gross margin levels and control operating cost increases,and our ability to achieve and maintain profitability are forward lookingstatements made under the safe harbor provision of the Private SecuritiesLitigation Reform Act.  Words such as“believes,” “intends,” “possible,” “expects,” “estimates,” “anticipates,” or“plans” and similar expressions are intended to identify forward lookingstatements.  Such statements are basedon management’s current expectations as of the date of this document butinvolve risks, uncertainties and other factors which could cause actual resultsto differ materially from those contemplated by such forward lookingstatements.  Investors are cautioned toconsider these forward looking statements in light of important factors whichmay result in variations from results contemplated by such forward lookingstatements including, but not limited to, the risk factors discussed below.

 

Several marketconditions are affecting our industry. Increased price competition in the area of technical staff augmentationhas created pressure 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 offshore 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 and have entered into arelationship with an e-procurement software vendor.  We have established a relationship with an offshore vendor.  We have also implemented new software andinternet capabilities in our recruiting function.  Although management believes these changes will have a positiveeffect on our results, there is no guarantee that these changes alone will besuccessful.

 

Management continues to concentrate on staffaugmentation in Fortune 500 and small and medium-sized businesses, businesssolutions for small and medium-sized businesses, and business opportunitieswith its technology and product partners. In addition, we plan to develop a low-cost staffing delievery model,expand our offshore service capabilities and develop relationships with saleschannel partners with which we will share sales leads.  While we believe these areasof our business present opportunities to grow our business, growth in these areaswill depend on improvement in the economy and spending in the overall ITservices market, our ability to compete with other vendors and our success inobtaining new clients.

 

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 saw aslight increase in demand for our services during the third quarter, and we areoptimistic this trend will continue through the balance of 2003 and into 2004,there can be no assurance as to when, or if, we will begin to see significantincreases in revenue.  Our ability torespond to the conditions outlined above will bear directly on our performance.

 

Ourability to quickly identify, attract and retain qualified technical personnel,especially when recovery begins, will affect our results of operations andability to grow in the future. Competition for qualified personnel is intense, and if we are unable tohire the talent required by our client in a cost-effective manner, it willaffect our

 

15

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ability to grow our business.

 

In addition to our abilityto control 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 2003,and we continue to adjust our benefit plans to control these costs.  While we believe we can effectively managethese costs, actual results may vary due to factors we cannot control such asrising medical costs, the amount of medical services used by our employees andsimilar factors.

 

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, reducing administrativeand management personnel and continuing to review our company structure formore efficient methods of operating our business and delivering ourservices.  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 andconditions standard to computer consulting services contracts also present arisk to our business.  In general, ourclients can cancel or reduce their contracts on short notice.  Loss of a significant client relationship ora significant portion thereof, a significant number of relationships or a majorcontract could have a material adverse effect on our business.

 

While we believe ourworking capital will be sufficient for the foreseeable needs of our business,significant rapid growth in our business could create a need for additionalworking capital.  An inability to obtainadditional working capital, should it be required, could have an adverse effecton our ability to grow the business.  Weexpect 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.

 

Item3.

 

**Quantitative and Qualitative Disclosures About Market Risk**

 

We are exposed to certainmarket risks on our line of credit agreement because of the variable interestrate charged.  Market risk is thepotential loss arising from the adverse changes in market rates and prices,such as interest rates.  Market risk isestimated as the potential increase in fair value resulting from a hypotheticalone percent increase in interest rates which assuming an average outstandingdebt balance of $5.0 million would result in an annual interest expenseincrease of approximately $50,000.

 

16

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Item 4.

 

**Controls and Procedures**

 

(a)          Evaluationof Disclosure Controls and Procedures.

 

The Company’s ChiefExecutive Officer, Michael J. LaVelle, and Interim Chief Financial Officer,David J. Steichen, have reviewed the Company’s disclosure controls andprocedures as of September 27, 2003. While there can be no assurance these controls will be effective in allcircumstances, based upon their review, these officers believe that theCompany’s disclosure controls and procedures are effective in ensuring thatmaterial information related to the Company is made known to them by otherswithin the Company.

 

(b)         Changesin Internal Controls

 

There were no significantchanges in the Company’s internal controls or in other factors that couldsignificantly affect these controls during the quarter covered by this reportor from the end of the reporting period to the date of this report on Form10-Q.

 

PART II.  OTHERINFORMATION

 

Item6.

 

**Exhibitsand Reports on Form 8-K**

 

(a)          Exhibits

 

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

31.2 Certification of Interim CFO Pursuant to Section 302 of the Sarbanes-OxleyAct of 2002

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

32.2 Certification of Interim CFO Pursuant to Section 906 of theSarbanes-Oxley Act of 2002

 

(b)         Reports on Form 8-K

 

A.     Form 8-K filed July 29,2003 providing information pursuant to Item 12, “Disclosure of Results ofOperations and Financial Condition,” for 2003 Second Quarter.

 

B.     Form 8-K filed July 31,2003 providing transcript of publicly available telephone conference held July29, 2003 concerning 2003 Second Quarter earnings.

 

C.     Form 8-K filed August 28,2003 announcing Chief Financial Officer, John T. Paprocki, will return to histurnaround consulting practice.

 

17

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SIGNATURES

 

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned there untoduly authorized.

 
|                    | ANALYSTS INTERNATIONAL  CORPORATION |   |
|-------------------------|-------------------------------------|--------|
|                    | (Registrant)                        |   |
|                    |                                |   |   |
| Date: November 11, 2003 |                                | By:    |   | /s/ David J. Steichen |   |
|                    |                                |   |   | David J. Steichen |
|                    |                                |   |   | Interim Chief Financial Officer |
|                    |                                |   |   | (Chief Accounting Officer) |
|                         |                                     |        |  |  |  |

 

18

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**ANALYSTS INTERNATIONAL CORPORATION**

**EXHIBIT INDEX**

**FORM 10-Q**

**QUARTER ENDED SEPTEMBER 27, 2003**

 
| **Exhibit No.** |   | **Description**                                                                         |
|-----------------|--------|-----------------------------------------------------------------------------------------|
|            |   |                                                                                    |
| 31.1            |   | Certification of CEO  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002         |
| 31.2            |   | Certification of  Interim 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  Interim CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

19

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