Excellence.Integrity. Innovation.

 

**AnnualReport 2001**

 

 

 

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**About the Company**

** **

Headquartered in Minneapolis, we are a diversified IT servicescompany. In business for more than 35 years, we have sales and customer supportoffices throughout the United States and Canada.

Our lines of business include the Sequoia Services Group, whichprovides business solutions and network infrastructure services; our ManagedServices Group, which provides a comprehensive range of outsourced businessfunctions; and our IT Supplemental Resources, which provides high demandresources for supporting a client’s IT staffing needs.

In 2001 ComputerWorld listed us as one of the best 100 places for ITprofessionals to work and Microsoft Corporation named us its worldwide winnerof the top IT Infrastructure Solution.

For more information, visitour Web site at http://www.analysts.com.

 

 

 

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**Financial Highlights**

 

 
|                                                      |   | **Year  Ended December 31,** |    |
|-----------------------------------------------------------|--------|------------------------------|---------|
| ***(Dollars in thousands,except for per share amounts)*** |   | **2001**                     |    | **2000** |   |
|                                                      |   |                         |    | (unaudited) |   |
| Professional services  revenues:                          |   |                         |    |   |   |
| Provided directly                                         |   | $                            | 411,387 |   | $ | 430,213 |   |
| Provided through  subsuppliers                            |   | 140,340                      |    | 128,944 |   |
| Total revenues                                            |   | 551,727                      |    | 559,157 |   |
|                                                      |   |                         |    |   |   |
| Loss before income taxes  and minority interest           |   | (2,764                       | )       | (4,394 | ) |
| Net loss                                                  |   | (2,980                       | )       | (2,624 | ) |
|                                                      |   |                         |    |   |   |
| Per share of common stock:                                |   |                         |    |   |   |
| Net loss (diluted)                                        |   | (.12                         | )       | (.12 | ) |
| Shareholders equity                                       |   | 3.76                         |    | 3.93 |   |
| Dividends declared                                        |   | .10                          |    | .40 |   |
| Average common and common  equivalent shares outstanding  |   | 24,196                       |    | 22,612 |   |
| Number of personnel                                       |   | 3,800                        |    | 4,750 |   |
| Current ratio                                             |   | 1.18                         |    | 1.78 |   |
| Working capital                                           |   | $                            | 16,622  |   | $ | 47,848 |   |

 

 

**Recent Announcements**

On February 26, 2002 it wasannounced that Frederick W. Lang, Founder, Chief Executive Officer and Chairmanof the Board of Directors of Analysts International, would retire as the April30, 2002. That same day, the Company announced that Michael J. LaVelle,President and Chief Operating Officer, would succeed Lang as Chief ExecutiveOfficer and that John D. Bamberger, Senior Vice President, Sales andOperations, had been elected Executive Vice President and Chief OperatingOfficer, effective May 1, 2002. Lang will continue as Chairman of the Board.

Fred Lang founded the Company in March of 1966, operating initiallyfrom a carriage house behind his home in Minnetonka Beach, Minnesota. From thebeginning, Fred Lang has focused Analysts International on the fundamentalvalues of excellence, integrity and innovation. These values have fueled thegrowth and will be maintained. These values are also the theme of this, our2001 Annual Report to Shareholders.

 

 

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**To Our Shareholders**

 

 

**A**nalystsInternational faced a challenging and difficult business environment in 2001, as didall of the major players in our industry. It was a year that saw a significantreduction in the IT budgets of many of our clients and a year that saw thenational tragedy of September 11th. These and other factors contributed to asuncertain a market as we have ever experienced. Yet, despite the challenges andthe difficulties, we were able to meet a number of our objectives for the year.

 

We managed the business tooperational profitability in an environment when many in the industry did not.Revenue for the year totaled $552 million, down slightly from the $559 millionreported for the twelve months ended December 31, 2000. Cash earnings for theyear were $0.10 per diluted share, compared with $0.38 per diluted share for2000. Cash earnings per share excludes the amortization of goodwill and otherintangible assets, along with restructuring and other unusual charges. For theyear ended December 31, 2001, the net loss was $3.0 million, or $(0.12) perdiluted share, compared with a loss of $2.6 million, or $(0.12) per dilutedshare, in the prior year. The year’s results include a fourth on investment isa write-off of an equity investment in a private, Minneapolis-based softwarecompany specializing in the storage and transmission of high volume data.

Although we believe the technology remains viable and the company hasactive customers, the loss of a significant contract makes future prospectsuncertain; we have no other such investments. For a more in-depth discussion ofthe to the “Management’s Discussion and Analysis” section of this annualreport.

With a strong focus on the future of IT, we became a stronger, leanerand more versatile company over the past year. We have built on the strengthsof our 35 years of experience, our solid customer relationships and oursuperior technical resources, especially our knowledgeable staff of ITprofessionals and engineers. In the report that follows we are pleased to beable to provide you a summary of the scope of our service offerings and fourrecent case studies that highlight our expertise and our commitment to customersatisfaction.

During the year, we shifted our business mix to provide a morediversified yet balanced set of services in high-growth markets, developed acentralized, customer-focused sales organization and created a lean operatingmodel to weather the economic downturn.

Although there was anacross-the-board drop in demand for IT services, we maintained our client base,providing services to almost half of the *Fortune*100, and won several new accounts over the past year. We forged newcustomer relationships in the areas of Solutions and Infrastructure services,hosting services, Web development, telecommunications and network engineering.

 

 

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| **[Photo]**                                         |   | **[Photo]**                             |
|-----------------------------------------------------|--------|-----------------------------------------|
| **Frederick W.Lang**                                |   | **Michael J.LaVelle**                   |
| *Chairman of the Board and Chief Executive Officer* |   | *President and Chief Operating Officer* |

 

 

We believe the future of Analysts International is bright. According toindustry analyst firm I.D.C., U.S. spending for Internet-related services isforecast to grow from $11.2 billion in 2000 to $30.9 billion in 2005, andspending in the area of network security services is expected to grow from $5.1billion in 2000 to $14.2 billion in 2005. The Gartner Group, another keyanalyst firm, forecasts that the overall IT services market will reach $603billion in 2002, growing at a rate of 8.9 percent. In listening to ourcustomers, we learned that we are well positioned to provide the kinds of ITservices that businesses need going forward, helping them leverage theircurrent IT investments as well as implementing additional technologies thatwill take them, and us, forward toward a profitable future.

Looking ahead in 2002, most analysts expect to see the market stabilizein the first half of the year and improve in the second half. While revenuesfor 2002 will be less than 2001, as the economy recovers, we expect to see animprovement in operating profitability for the year and a return to netprofitability in the second half of the year.

In closing, we would like to note that Analysts International was againrecognized in a number of significant ways in 2001. *IT Services Business Report*ranked us 13th among the toprevenue producing IT services firms in the United States, *ComputerWorld*listed us among the 100 bestinformation technology companies to work for, and Microsoft Corporation namedus as the recipient of its Worldwide Infrastructure Solution of the Year Award.This recognition is due in large part to the dedication of our employees andmanagement to the fundamental values of excellence, integrity and innovation.On their behalf and on behalf of our directors, we would like to thank you, ourcustomers and shareholders, for your ongoing interest and support.

*Sincerely,*

 

 
|                                                |   |                                    |
|-----------------------------------------------------|--------|-----------------------------------------|
| /s/ Frederick W. Lang                               |   | /s/ Michael J. LaVelle                  |
| Frederick W. Lang                                   |   | Michael J. LaVelle                      |
| *Chairman of the Board and Chief Executive Officer* |   | *President and Chief Operating Officer* |

 

 

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**Company Overview**

 

 

In business for more than 35 years, Analysts International is a diversifiedinformation technology services firm that has established a loyal following ofmore than 1,000 corporate and government clients ranging from Fortune 50 globalcompanies to mid-tier industry leaders in a variety of industries. We are aleader in the network infrastructure marketplace, a strong player ine-solutions, and a pioneer in full-service technology staffing. Our roots inthe IT community are deep and far reaching, and our expertise is sought afterby the best companies.

 

As an organization, we are being challenged every day to deliver on thepromise of Information Technology. IT will continue to play a critical role inpromoting efficiency, communication and organization in companies now and wellinto the future. Through the services and expertise we offer, AnalystsInternational provides the skills and the innovation that organizations need tomeet their business challenges.

 

We create dynamic and solid solutions for our clients by determiningand using the most efficient technologies, development tools and softwareavailable. We do it with expertise that comes with a deep competence in thetechnology and tools, and a wide strategic perspective that comes with a provenrecord of performance. Over the years, we have received numerous industryawards and recognition for our accomplishments.

 

Our nationwide network of 35offices and customer service sites allows us to combine resources and servicesfor any size project or supplemental requirement. This means that clients havea single point of contact across our full range of services. Our serviceofferings include the Sequioa Services Group, focused primarily on BusinessSolutions Services such as Enterprise Solutions and Network InfrastructureServices; Managed Services, which provides a comprehensive range of outsourcedbusiness and IT functions; and IT Supplemental Resources, which provideshigh-demand technical and consulting resources for ongoing support of aclient’s IT essential legacy systems on which many companies continue to rely.

 

**IT Supplemental Resources**

Analysts fosters anenvironment where talented and experienced programmers, analysts and engineers,who have earned the respect of clients and industry-leading organizations, canexcel at developing and maintaining custom programs for our  clients’ essential business systems. We havebuilt a nationwide network of 3,200 quality-driven business and technologyconsultants, skilled in the high-demand technologies that

 

 

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**International Truck and EngineCorporation**

 

The trend for many Fortune 1000 companies is to migrate IT staffing andcontract professional needs to managed services programs.International Truckand Engine Corporation,Chicago,IL,quickly understood how a single point ofcontact could enhance the flexibility,efficiency and effectiveness of their ITstaffing and contract professional resource relationships.So, whenInternational Truck decided to move to a managed services relationship,they firstconsulted with and then chose Analysts International,with whom they had enjoyeda 15-year relationship as a valued and trusted provider of staffing resources.

 

“The ‘one-stop-shop’ capability for the procurement of IT resourcesacross our broad range of skill needs is of great benefit to InternationalTruck and Engine Corporation.  Withtheir proven experience and expertise,Analysts International hasdelivered,allowing us to drive significant efficiencies into our processes,”stated Jim Guziak, Director of International’s I.T.Project Office.

 

 

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enable businesses to leverage their IT investments. Our range frominformation architects and systems analysts to Java programmers and Webdevelopers.

**Infrastructure Services**

*Enterprise Networking*

When businesses look to acquire and make investments in technology,they want the most efficient equipment, skilled personnel to install andmaintain it, and the best possible pricing—all done as fast as possible. AtAnalysts, we provide strategic, leading-edge Enterprise Networking solutionsthat range from developing and installing network infrastructures and productprocurement to hosting and field engineering. We are consistently up to speedon the latest technology, and we maintain close relationships with majorvendors and distributors.

*Security Services*

Our Security Services specialists provide companies with securityconsulting services intended to keep an organization running smoothly in themidst of quick-moving viruses and hackers. We examine an organization’ssecurity needs and offer a wide range of services to help address those needs.

*Field Engineering*

Field Engineering is acompany’s “right arm,” there to assist with reliable operation and availabilityof 

its computing and networkinfrastructure.  Our experienced, highlytrained engineers have the know-how

to support virtually any mixof hardware and software technologies. We provide comprehensive, on-site 

support, maintenance andrepair for multivendor, distributed computing platforms for high-traffic ASPsor 

global corporate networks.Our service plans range from total outsourcing of maintenance functions at 

widespread sites to blendedcoverage based on device type within an existing network, to complete 

maintenance coverage formultivendor networks with thousands of clients.

 

*Product Procurement*

Our Product Procurementspecialists offer strong product knowledge and close vendor and distributorrelationships to help clients maximize hardware investments. Our relationshipswith companies like Dell, Compaq, HP, Microsoft, Novell, Citrix and CiscoSystems provide leverage for acquiring the most suitable technology to supporta business' requirements, at competitive prices and within short cycle times.As a single point of control over the process, our Product Procurement

 

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**Microsoft Corporation**

Analysts International partner relationships offer clients importantbenefits they could not find with less experienced or less knowledgeable firms.In 2001, Analysts International was presented with the Worldwide InfrastructureSolution of the Year Award from Microsoft Corporation.Selected from nearly 800entries, the award-winning project resulted from Microsoft’s review of howeffectively Analysts International responded to the specific needs of theclient and then met those needs.

 

The project involved migrating a large international client from aninefficient and impractical e-mail system to a Microsoft platform. Client needsdemanded that the implementation be completed in less than eight weeks.Analysts International’s Sequoia Services Group team completed the solution andmet the deadline.

 

“The award is a testament to the value that Analysts Internationalbrings to customers in the infrastructure solutions space,” stated Ian Rogoff,Vice President of Microsoft Corporation’s Worldwide Partner Group.

 

 

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specialists provide the value-added controland flexibility needed for rapidly deploying IT hardware, software,infrastructure and custom solutions.

 

*Voice and Data Cabling*

Cabling is essential to the reliability andlong-term viability of IT networks and avoiding costly down time. Our Voice andData Cabling practice designs, installs and supports voice, data and videocabling solutions. Our capabilities include cable certification, category 6/5e,fiber optics, cable removal and directional boring.

 

*Call Center*

Our Call Center service is staffed withtrained hardware and software engineers experienced in supporting desktop andnetwork systems. They are available around the clock to solve technicalproblems quickly and effectively.

 

*Hosting*

We provide the infrastructure, includingsystems, services and skilled people, to deliver the 24-hour, 7-days-a-weekavailability required by Application Service Providers (ASPs) for high-speeddata transfer, quick download times and smooth operation.

 

**Business Solutions Services**

*Enterprise Solutions*

We provide a full range of enterprise solutionsand consulting services in IT architecture, and Web design and development thatenables clients to increase efficiency and maximize their return on investment.We have proven capabilities in eBusiness, Internet development, businessintelligence and custom applications using a disciplined process that includesdefinition, analysis, design, programming, testing, implementation and projectmanagement.

 

*Application Integration*

We are a leading integrator ofenterprise-level software solutions that cover all areas of business fromfinancial reporting, human resources, marketing, manufacturing and supply chainmanagement. Working in close partnership with leading software companies, weprovide the talent and resources for fine tuning application packages throughcustomization, modifications and client-specific interfaces. Takingcustomization one step further, our consultants are able to link thesepreviously isolated applications in complementary ways that provideorganizations with a true, seamless enterprise solution.

 

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**Children’s Cancer Research Fund WebSite**

For over 20 years,Children’s Cancer Research Fund has been fighting one of the most importantbattles there is ... saving children from cancer. In 2000,the organization soughtto expand the horizons of its Internet presence. The experienced EnterpriseSolutions practice of Analysts International undertook the project.

 

The grouprecommended that the charity see the Internet as broadly and as strategicallyas possible, as a means to disseminate information, recruit volunteers andgenerate funds. Today the charity has a state-of-the-art Web site that meetsits near, intermediate and long-term strategic objectives.

 

“We are mostimpressed with the expertise and commitment of Analysts International,” saidKay Christianson, executive director for the Children’s Cancer Research Fund.”They helped us develop an effective Web strategy, implemented in a timelymanner, that helped us raise more than $100,000 in online donations during ourmost recent fundraising event.Working with Analysts has put us ahead of thegame in utilizing the Internet as an outreach tool.”

 

*The Children’s Cancer Research FundWeb site is located at www.childrenscancer.org.*

 

 

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*Mobile & Wireless Solutions*

Our Mobile & Wirelesspractice helps clients streamline processes, increase productivity and delivermission-critical information. In conjunction with leading technology andenterprise partners, Analysts is driving the mobility revolution.

 

The practice merges ourin-depth knowledge of numerous vertical markets and our 35 years of ITconsulting experience with cutting-edge mobile and wireless technology. Whilemaintaining a technology, platform, and vendor neutral approach, clientsatisfaction is the practice’s top priority.

 

*Criminal Justice Information Systems*

The need to know is at theheart of effective law enforcement, legal and criminal justice disciplines.These government agencies need access to accurate, time-sensitive informationto be able to do their jobs effectively and promote public safety.

 

Analysts’ Criminal JusticeSystems (CJIS) group has the expertise and resources to implement IT andeGovernment initiatives that take these organizations to the next level.Combining our experience in leveraging existing systems with new technologiesand security measures, we can help large and complex organizations designsystem architectures that facilitate information sharing and improve the flowof communication.

 

 

**ManagedServices**

 

Whether interfacing with theIT department, human resources or procurement, the Managed Services Group atAnalysts International is a highly flexible service that can be tailored to fitan organization’s needs. Businesses face many challenges regarding theacquisition and management of contract professionals. We offer a centralized,national recruiting network and integrated approach for managing the keyprocesses associated with selecting and retaining valuable contractprofessionals. Through our Managed Services Group, we provide a means forcompanies to quickly establish a single point of contact for staffaugmentation, performance tracking, cost control and improved reporting.

 

 

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**State of Nebraska**

Three years agowhen the State of Nebraska decided to move to information architectures tosupport local and state law enforcement efforts, it turned to AnalystsInternational for the solution. What the State received was a Web-based, highlysecure computer network that linked a multitude of criminal justice agenciesacross the state.

 

The State choseAnalysts International to develop the system because its experience in dataconsolidation and data reporting provided a solid foundation for transitioninglegacy systems and implementing an effective solution for the client.

 

“This projectrequired the integration of the latest Internet and software developmenttechnologies with our disparate systems and data. Analysts Internationaldelivered a great solution for our varied criminal justice constituencies andthe citizens of the State of Nebraska,” commented Michael Overton, NebraskaCrime Commission.

 

 

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**Management’sDiscussion and Analysis**

 

 

**Resultsof Operations and Financial Condition**

 

As a means ofbetter explaining our operations and results, the following table illustratesthe relationship between revenue and expense categories for the twelve monthsended December 31, 2001 and 2000, the six months ended December 31, 2000, andthe years ended June 30, 2000, and 1999.

 

 
|                                                     |   | **Percent  of Total Revenues**     |   |
|----------------------------------------------------------|--------|------------------------------------|--------|
|                                                     |   | **Year  Ended**

**December  31,** |   | **Six  Months Ended**

**December  31,** |   | **Year  Ended**

**June  30,** |   |
|                                                     |   |                               |   |   |
|                                                     |   | **2001**                           |   | **2000** |   | **2000** |   | **2000** |   | **1999** |   |
|                                                     |   |                               |   | **(unaudited)** |   |   |   |   |   |   |   |
| Professional services revenues:                          |   |                               |   |   |   |   |   |   |   |   |   |
| Provided directly                                        |   | 74.6                               | %      | 76.9 | % | 78.6 | % | 75.2 | % | 77.5 | % |
| Provided through subsuppliers                            |   | 25.4                               |   | 23.1 |   | 21.4 |   | 24.8 |   | 22.5 |   |
| Total revenues                                           |   | 100.0                              |   | 100.0 |   | 100.0 |   | 100.0 |   | 100.0 |   |
| Salaries, contracted services and direct charges         |   | 83.0                               |   | 81.6 |   | 81.6 |   | 81.0 |   | 78.5 |   |
| Selling, administrative and other operating costs        |   | 15.9                               |   | 17.2 |   | 18.5 |   | 16.0 |   | 15.6 |   |
| Amortization of goodwill and other intangible assets     |   | .6                                 |   | .4 |   | .5 |   | .2 |   | .1 |   |
| Restructuring charges                                    |   | —                             |   | 1.2 |   | 2.4 |   | — |   | — |   |
| Non-operating income and interest expense, net           |   | .5                                 |   | .4 |   | .5 |   | — |   | (.2 | ) |
| Loss on Investment                                       |   | .5                                 |   | — |   | — |   | — |   | — |   |
|                                                     |   |                               |   |   |   |   |   |   |   |   |   |
| (Loss) income before income taxes and minority  interest |   | (.5                                | )      | (.8 | ) | (3.5 | ) | 2.8 |   | 6.0 |   |
| Income taxes (benefit) and minority interest             |   | .0                                 |   | (.3 | ) | (1.3 | ) | 1.0 |   | 2.3 |   |
|                                                     |   |                               |   |   |   |   |   |   |   |   |   |
| Net (loss) income                                        |   | (.5                                | %)     | (.5 | %) | (2.2 | ) | 1.8 | % | 3.7 | % |

 

We changed ourfiscal year end to December 31 from June 30, effective December 31, 2000. Referencesto fiscal 2000 and 1999 relate to the years ended June 30, 2000 and 1999.

 

**Results of Operations, Year EndedDecember 31, 2001 vs. Year Ended December 31, 2000**

 

Total revenues for the year ended December 31, 2001 were $551.7million, a decrease of $7.5 million, or 1.3%, from the year ended December 31,2000. Revenues provided directly for the twelve months ended December 31, 2001were $411.4 million, a decrease of $18.8 million, or 4.4%, from the same periodof 2000. Had the Sequoia acquisition taken place on January 1, 2000, revenueprovided directly for the year ended December 31, 2000 would have been $17.6million higher, resulting in an 8.1% decrease in 2001. Nearly all of thisdecrease in revenue is the result of a 15.0% decrease in billable hours, whichis the result of increased competition in the area of supplemental staffing, anindustry-wide slowdown and the general state of the economy. The decrease inbillable hours was partially offset by an increase in hourly rates charged inour supplemental staffing business. While we have been able to increase ratessomewhat over the prior year, there can be no assurance we will be able tocontinue this as competitive conditions in the industry make it difficult tocontinually increase the hourly rates we charge for services. Revenues providedthrough subsupplier billings, primarily with Qwest and IBM, increased $11.4million, or 8.8%, in the twelve months ended December 31, 2001 as compared tothe twelve months ended December 31, 2000. This increase in subsupplierrevenues resulted from increases in billable hours of service rendered to theseclients, and the addition of new clients under our Managed Services offering.Our subsupplier revenue is mainly pass-through revenue with associated feesproviding minimal profit.

 

Personnel totaled 3,800 at December 31, 2001, compared to 4,750 atDecember 31, 2000. Of the December 31, 2001 total, 3,200 were technicalconsultants. Much of the overall decrease from 2000 to 2001 consisted ofbillable technical consultants; however, our administrative and managementpersonnel decreased by 200 as a result of our reorganization and restructuringefforts. Salaries, contracted services and direct charges, which representprimarily our direct labor costs, were 83.0% of revenue in the twelve monthsended December 31, 2001 compared to 81.6% of revenues in the same period of2000. The increase in this expense category as a percentage of revenue ismainly a consequence of normal increases in direct labor rates and reducedhourly rates on some client contracts. Excluding both revenue and labor costsassociated with subsupplier contracts, this category of expense was 77.1% ofrevenue in the twelve month period of 2001, and 76.1% in the comparable periodof 2000. Salaries, contracted services and direct charges for the period ended

 

 

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December 31, 2001 included approximately $1.8 million of increasedbenefit costs. Salaries, contracted services and direct charges for the periodended December 31, 2000 included approximately $3.0 million of unusual costs.These unusual costs consisted of compensation for terminations deemed not to bea part of the restructuring plan and costs of the change in our fiscal year.Without these unusual costs, salaries, contractual services and other directcharges would have been 75.4% of revenue in 2000 and 76.7% in 2001. Our effortsto control these costs involve controlling labor costs, passing on labor costincreases through increased billing rates where possible, and maintainingproductivity levels of billable technical consultants. Even though we havetaken steps to control this category of expense, there can be no assurance wewill be able to return to historical gross margin levels due to intense competitionin the industry, which makes it difficult to sustain such gross margin levels.

 

Selling, administrative and other operating (SG&A) costs includecommissions paid to sales representatives and recruiters, location andadministrative costs. As a percentage of revenue, SG&A was 15.9% in thetwelve months ended December 31, 2001 and 17.2% in the same period of 2000.Excluding the subsupplier revenue associated with our subsupplier contracts,this percentage would have been 21.4% for 2001, and 22.4% for 2000. The overalldecrease in this category of costs resulted directly from our efforts to reducecosts through reorganization and through reduced labor costs for non-technicalpersonnel, primarily by reducing personnel through our restructuring efforts. Thedecrease in SG&A is offset by the fact that SG&A costs during the yearended December 31, 2000 included $4.9 million of unusual bad debt costs andconsulting and travel costs associated with our restructuring initiatives.

 

Amortization of goodwill and intangible assets increased to $3.2million in the twelve months ended December 31, 2001 compared to $2.1 millionfor the same period in 2000. This increase is a result of the purchase ofSequoia and the amortization of the associated intangible assets for a fullyear in 2001 versus eight months in 2000.

 

We recorded a restructuring expense of $7.0 million in 2000, but had nosuch expense during the current period. During 2001, we paid $2.2 million ofseverance costs and $1.5 million associated with office closures andconsolidations resulting from the restructuring.  At December 31, 2001, the remaining accrual for office closuresand consolidations was $2.6 million.

 

Non-operating income, consisting primarily of interest income, declinedto $247,000 during the twelve months ended December 31, 2001 down from $391,000during the same period of 2000. Interest expense increased to $2.9 million from$2.4 million during the December 31, 2001 period. These changes are the resultof lower cash reserves and higher debt levels during the current period,primarily as a result of the use of cash to purchase Sequoia on April 25, 2000.

 

We recorded a $3.0 million loss during 2001 related to a 1999 equityinvestment in a privately held Minneapolis-based software company specializingin the storage and transmission of high volume data. Although we believe thetechnology deployed by this company remains viable and the company has activecustomers, future prospects of the company are uncertain. We have no other suchinvestments.

 

We recorded an income tax expense of $216,000 during the twelve monthsended December 31, 2001 in spite of the $2.8 million pre-tax loss, primarilydue to the effect of items deducted to arrive at book income that are notdeductible for tax purposes. This figure includes the loss of the investment of$3.0 million which represents a capital loss for tax purposes. We do not expectto generate capital gains to enable us to utilize this capital loss during thecarry-forward period. The effective tax benefit rate in the comparable periodof 2000 was 38%.

 

As a result of the factors discussed above, we reported a net loss inthe current twelve month period of $3.0 million compared with net loss of $2.6million for the same period of 2000.

 

Inflation has not had a major impact on our operations because revenuesare derived primarily from services billed at hourly rates, which are generallysubject to renegotiation on a periodic basis.

 

**Results of Operations, Six MonthsEnded December 31, 2000 vs. Six Months Ended December 31, 1999**

 

Revenue provided directly for the six months ended December 31, 2000were $227 million, an increase of 4.6% from levels for the same period of 1999.Excluding approximately $32.0 million of revenue generated by the acquisitionof Sequoia during the period ended December 31, 2000, revenue provided directlydeclined by 10.1% period to period. Nearly all of this decrease is the resultof a 10.2% decrease in billable hours due to an industry-wide slowdown. Thedecrease in billable hours was partially offset by an increase in hourly ratescharged in the Company’s supplemental staffing business. Revenue provided through subsupplierbillings, primarily with Qwest and IBM, decreased 13.5% in the six months endedDecember 31, 2000 as compared to the six months ended December 31, 1999. Thisdecrease in subsupplier revenue resulted from an overall decrease in billablehours of service rendered to these clients.

 

Personnel totaled 4,750 at December 31, 2000, including 580 employeesassociated with the Sequoia acquisition, compared to 4,700 at December 31,1999. Excluding the Sequoia employees, the number of personnel had fallen 530,or 11.3%, to 4,170 at December 31, 2000. Much of

 

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the decrease from 1999 to 2000 consisted of billable technicalconsultants; however, our administrative and management personnel decreased by100 as part of our reorganization and restructuring efforts.

 

Salaries, contracted services and direct charges, which representprimarily our direct labor costs, were 81.6% of revenues in the six monthsended December 31, 2000 compared to 80.3% of revenues in the same period of1999. The increase in this expense category as a percentage of revenue wasmainly a consequence of: (i) normal increases in direct labor rates; (ii)unusually high idle time for technical personnel during the month of December2000 caused by inclement weather conditions in certain key markets; and (iii)approximately $3.0 million of compensation-related payments for terminationsdeemed not to be a part of the restructuring plan and costs of the change inour fiscal year. Excluding both revenue and labor costs associated withsubsupplier contracts, this category of expense was 76.6% of revenues in thesix month period of 2000 and 73.9% in the comparable period of 1999.

 

Selling, administrative and other operating costs include commissionspaid to sales representatives and recruiters, employee fringe benefits andlocation costs. These costs, as a percentage of revenue, were 18.5% in the sixmonths ended December 31, 2000, and 16.2% in the same period of 1999. Excludingthe sub-supplier revenues associated with the contracts referred to above, thispercentage would have been 23.5% for 2000, and 21.5% for 1999. The increase inthis expense category as a percentage of revenue is primarily a result of aprovision for bad debts, which exceeded historical levels by approximately $3.1million, and consulting and travel costs associated with the restructuring,which totaled approximately $1.8 million. The increase in bad debt is largelydue to the write-off of several large balances due from dot-com companies.

 

Amortization of goodwill and intangible assets increased to $1.4million in the six months ended December 31, 2000 compared to $331,000 for thesame period in 1999. This increase is a result of the purchase of Sequoia onApril 25, 2000, and the amortization of the associated intangible assets.

 

In December 2000, we recorded a restructuring charge of $7.0 million.Of this charge, $2.6 million related to workforce reductions of approximately120 employees (primarily non-billable staff). In addition, we consolidated oursix regions to four and our 45 branch and field locations to 15 district salesoffices. While we maintain a presence in most of the 30 locations which werenot converted to district sales offices, the need for office space in theselocations has declined. As a result, we established a reserve of $4.4 millionto cover lease termination and abandonment costs (net of sublease income),including an amount for assets to be disposed of in this consolidation.

 

Non-operating income, consisting primarily of interest income, declinedto $68,000 during the six months ended December 31, 2000 from $1.1 millionduring the same period of 1999. Interest expense increased to $1.5 million from$702,000 during the same periods. These changes are the result of lower cashreserves and higher debt levels during the six-month period ending December 31,2000, primarily as a result of the use of cash to purchase Sequoia on April 25,2000.

 

An income tax benefit of $3.9 million during the six months endedDecember 31, 2000 is reflective of a 39% effective tax benefit rate which isthe same effective tax rate as in the comparable period of 1999. These netoperating losses were carried back to obtain refunds.

 

As a result of the factors discussed above, the Company incurred a netloss in the six month period ended December 31, 2000 of $6.3 million comparedwith net income of $6.1 million for the same period of 1999.

 

**Results of Operations, Year EndedJune 30, 2000 vs. Year Ended June 30, 1999**

 

Revenue provided directly for the year ended June 30, 2000 were $420million, a decrease of 12.6% from 1999 levels. Nearly all of these decreaseswere the result of a 17.2% decrease in core billable hours, which was a resultof an industry-wide slowdown. The decrease in billable hours was partiallyoffset by $9.4 million of revenue associated with the acquisition of SequoiaNET.com on April 25, 2000 and a 3.2% increase in hourly rates charged in ourcore business. Revenue provided through subsupplier billings, primarily withQwest and IBM, decreased .6 % in fiscal 2000 from 1999. These decreases insubsupplier revenue resulted from an overall decrease in billable hours ofservice rendered to these clients.

 

Personnel totaled 4,800 at June 30, 2000, including 575 employeesassociated with the Sequoia acquisition, compared to 4,900 at June 30, 1999.Excluding the Sequoia employees, personnel levels had fallen 675 or 13.8% to4,225 at June 30, 2000. Substantially all of the decrease from 1999 to 2000consisted of billable technical consultants.

 

Salaries, contracted services and direct charges, which representprimarily the 81.0% of revenue in fiscal 2000 compared to 78.5% of revenue infiscal 1999. The increase in this expense category as a percentage of revenuewas mainly a consequence of: (i) normal increases in direct labor rates; and(ii) unusually high idle time as the Company elected to retain higher than neededconsultant levels during the second half of the year, in anticipation of anearlier recovery from the industry-wide slowdown. Excluding both revenue andlabor costs associated with subsupplier contracts, this category of expense was74.7% of revenue in fiscal 2000, and 72.3% in fiscal 1999.

 

Selling, administrative and other operating costs include commissionspaid to sales representatives and recruiters, employee fringe benefits andlocation costs. These costs, as a

 

14

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percentage of revenue, were 16.0% in fiscal 2000, and 15.6% in 1999.Excluding the revenue associated with the subsupplier contracts referencedabove, this percentage would have been 21.3% for fiscal 2000, and 20.2% forfiscal 1999. The increase in these expense categories as a percentage ofrevenue was a consequence of revenue declining more rapidly during fiscal 2000than these expense categories.

 

Income taxes decreased from $14.5 million in fiscal 1999 to $5.7million in fiscal 2000. The effective rate of income taxes decreased from 39%of pre-tax income in 1999 to 36.4% in 2000 primarily due to the reversal oftaxes provided for in previous years.

 

Net income in fiscal 2000 decreased 56.9% from fiscal 1999. As apercentage of total revenue, net income was 1.8% in fiscal 2000 as compared to3.7% in fiscal 1999. The Company’s net income as a percentage of revenue forservices provided directly was 2.3% and 4.7% for fiscal years 2000 and 1999,respectively.

 

**Liquidityand Capital Resources**

 

Working capital at December 31, 2001 was $16.6 million, down 65.3% from$47.8 million at December 31, 2000, which was down 14.3% from $55.8 million atJune 30, 2000. The current year decrease in working capital is primarily theresult of the reclassification of all of our debt from a long-term liability toa current liability. During the fourth quarter of 2001, we began pursuingoptions for refinancing of our debt since on a number of occasions during 2001we failed to meet operating covenant requirements and sought and receivedamendments to the agreements. We did not complete this refinancing by the endof the year. As a result, we did not meet operating and other requirements ofour credit line and Note Purchase Agreement. Therefore, effective December 28,2001, reflective of our continuing desire to restructure our debt, we amendedour bank line of credit and our Note Purchase Agreement to move the maturitieson these instruments to June 30, 2002, and to eliminate all but two operatingcovenants. Subsequent to December 31, 2001, we have obtained a commitment torefinance this debt and we expect to close this transaction during the firsthalf of 2002. See further discussion below regarding this $55.0 millioncommitment. Current assets include cash and cash equivalents of $18.2 millionat December 31, 2001 compared to $2.2 million at December 31, 2000 and $2.0million at June 30, 2000 and accounts receivable of $83.3 million at December31, 2001, compared to $98.5 million at December 31, 2000 and $98.4 million atJune 30, 2000. Absent the effect of debt classifications, the ratios of currentassets to current liabilities and total assets to total liabilities haveincreased since December 31, 2000.

 

Our primary need for working capital is to support accounts receivableresulting from our business and to fund the time lag between payrolldisbursement and receipt of fees billed to clients. Over the past three years,we have been able to support changes in our business, except for theacquisition of Sequoia and the purchase of the headquarters building, withinternally generated funds. More recently, as revenues and payroll havedeclined, our need for working capital to support accounts receivable has alsodeclined, resulting in larger cash reserves. When our revenues and payrollbegin to grow again, we would expect our need for working capital to once againincrease. 

 

In January of 2000, we obtained a $25.0 million bank line of credit.This line of credit was increased to $30.0 million in December 2000. On April25, 2000, the Company drew down $13.0 million on the line of credit andutilized $30.5 million of its cash balances to complete the acquisition ofSequoiaNET.com, Inc. Following the December 2001 amendment, which reduced theline of credit back down to $25.0 million, there was $4.0 million available tobe drawn on the line of credit at December 31, 2001. The line of credit bearsinterest at 9%.

 

On December 30, 1998, we entered into a Note Purchase Agreement wherebywe sold $20.0 million of 7% Senior Notes. These notes bear interest at 9%,require a $1.5 million principal payment on March 29, 2002 and mature on June30, 2002.

 

Following the December 28, 2001 amendments, the credit line and NotePurchase Agreement contain provisions requiring us to maintain minimum monthlyearnings before interest, income taxes, depreciation and amortization (EBITDA),and trailing three-month “Net Cash Flow,” defined as EBITDA less cash paid fortaxes, capital expenditures, restructuring charges, interest expense, and principalpaid on Senior Notes. The credit line and Note Purchase Agreement restrictpayment of dividends on common stock. We believe the provisions imposed bythese amendments are achievable based on our expected operating results duringthe first half of 2002.

 

Subsequent to our December 2001 amendments, we have obtained acommitment from a major financial institution to extend us a $55.0 million lineof credit secured by the assets of the Company. The commitment carries athree-year term with interest to be charged at either the London InterBankOffered Rate (LIBOR) plus 3.0% or the Prime Rate plus 0.75%.

 

Upon refinancing of our existing debt, we expect to record a pre-taxloss on the early extinguishment of debt of approximately $1.0 million. This isprimarily related to make-whole payments associated with the 1998 Note PurchaseAgreement and the write-off of costs associated with the previous financingswhich were being amortized over the original terms of those agreements.

 

In addition to this $55.0 million line of credit, to increaseavailability of working capital for future growth, we are currently evaluatingoptions with respect to our corporate headquarters building. Possible optionsinclude a sale and partial lease-back of the facility or obtaining a long-term

 

 

15

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mortgage on the facility. The sale of the building, should we decide tosell it in the current real estate market, would likely result in a loss of$1.5 to $2.5 million.

 

During the twelve months ended December 31, 2001, we made capitalexpenditures totaling $4.9 million compared to $2.1 million in the six monthperiod ended December 31, 2000, and $3.4 million in fiscal year 2000. Thesecapital expenditures were funded through a combination of unsecured debt andcash reserves. Fiscal 2002 capital spending is expected to approximate $3.0million.

 

In October 2001, the Board of Directors voted to suspend the quarterlydividend to retain capital. The amount of future quarterly dividends, if any,will be based on results of operations, available cash, obligations in ourfinancing agreements and anticipated cash requirements of the business.

 

In June 2001, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standard (SFAS) Nos. 141, “BusinessCombinations” and 142, “Goodwill and Other Intangible Assets.” SFAS No. 141 waseffective for all business combinations initiated after June 30, 2001, and hashad no impact on our financial statements. SFAS No. 142 addresses howintangible assets should be accounted for, and is effective for our fiscal yearbeginning January 1, 2002. We expect to adopt SFAS No. 142 during the firstquarter of fiscal year 2002. Amortization recorded during the years endedDecember 31, 2001 and 2000 was $3.2 million and $2.1 million, respectively.Upon adoption of SFAS No. 142, this amortization is expected to declinesignificantly. As of December 31, 2001 and 2000, we had net goodwill and otherintangible assets of approximately $45.7 million and $49.3 million,respectively. Based on a review of the standard and preliminary impairmentassessment, management believes we will record a goodwill impairment chargeupon adoption, and the amount of such charge is likely to be significant inrelation to our unamortized goodwill balance. Such impairment charge will berecorded as a cumulative effect of a change in accounting principle andtherefore will not impact operating income.

 

During the period ended December 31, 2000, we adopted Staff AccountingBulletin No. 101 “Revenue Recognition in Financial Statements.” The impact ofthe adoption of this bulletin was not material.

 

On July 1, 2000, we adopted Statement of Financial Accounting Standard(SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities,”as amended by SFAS No. 138, “Accounting for Certain Derivative Instruments andCertain Hedging Activities.” Management has reviewed the requirements of SFASNo. 133 and has determined that they have no free-standing or embeddedderivatives. All agreements that contain provisions meeting the definition of aderivative also meet the requirements of, and have been designated as, normalpurchases or sales. Our policy is not to use free-standing derivatives and notto enter into contracts with terms that cannot be designated as normalpurchases or sales.

 

On April 25, 2000, we purchased an 80.1% interest in SequoiaNET.com,Inc. for $43.5 million. Effective December 29, 2000, we acquired the remaining19.9% of SequoiaNET.com in exchange for common shares valued at $6.1 millionand notes payable totaling $3.3 million. SequoiaNET.com, which provided networkinstallation and support services and other eBusiness services, has beeneffectively merged and now makes up a significant portion of our Infrastructureand Business Solutions practices of our Sequoia Services Group. SequoiaNET.comreported $57.7 million in revenues with pre-tax profits of $3.8 million for theyear ended  December 31, 1999.

 

During the third quarter of the fiscal year ending June 30, 2000, weinvested $3.0 million in an alliance partner, a software company specializingin the storage and transmission of high volume data. Due to the uncertainfuture prospects of this company, this investment was written off in 2001. Seediscussion under Results of Operations and Financial Condition.

 

We believe funds generated from our business, current cash balances andcredit available under the new credit facility will be adequate to meet demandsplaced upon our resources by our operations and capital investments.

 

**Market Conditions,Business Outlookand Risks to Our Business**

 

*Forward Looking Statements*

 

The statements contained in the letter from the CEO and the Presidentand in “Managements Discussion and Analysis of Financial Condition and Results ofOperations” that are not strictly historical fact, including withoutlimitation, our statements relating to 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 of qualified professional staff, our ability toincrease billing rates as labor costs increase, our ability to maintain grossmargin levels and control operating cost increases, our belief that we willhave the ability to secure favorable terms for the refinancing of our debt andour 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 areintended to identify forward looking statements. Such statements are based onmanagement’s current expectations as of the date of this document but involve risks,uncertainties and other factors which could cause actual results to differmaterially from those contemplated by such forward looking statements.Investors are cautioned to consider these forward looking statements in lightof important factors which may result in variations from results

 

 

16

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contemplated by such forward looking statements including, but notlimited to, the risk factors discussed below.

 

For the past two years, several competitive conditions have affectedour industry. The number of large competitors, the industry-wide slowdown andthe general state of the economy have created pricing pressures in thetechnical staff augmentation sector of the computer consulting industry. Staffaugmentation continues to represent almost half of total revenue (revenue fromservices provided directly to client (direct revenue) plus revenue fromservices provided to our clients by subsuppliers (subsupplier revenue)) andwell over half of our direct revenue. While we expect the industry slowdown tobegin to reverse in 2002, there can be no assurance as to when, or if, revenuewill return to previous levels. Our ability to respond to these conditions willbear directly on our performance.

 

Increased competition in the area of technical staff augmentation hascreated pressure on billable hourly rates, and clients have begun to requestincreasingly lower cost models for staff augmentation services. As a result,while we were able to increase billing rates slightly over the prior year,there can be no assurance we will be able to continue to do so or to return tohistorical gross margin levels. Management expects that clients will continuefor the foreseeable future to request lower cost offerings for staffaugmentation services through e-procurement systems, extremely competitivebidding processes, the granting of various types of discounts and the use ofoff-shore resources. We are considering various low-cost alternatives,including relationships with e-procurement software vendors and off-shoreservice providers, in response to these developments in the industry, and wehave implemented new software and internet capabilities in our recruitingfunction. Our ability to respond to customer requests for lower pricing or toprovide other low cost solutions in this area of our business will have adirect 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.

 

Increased competition could affect our ability to obtain and retainclient contracts. Our two top clients are IBM and Qwest. In 2001, these clientseach represented 15% of our revenues. During the six-month transition period,these clients represented 14% and 13% of our revenue, respectively. Duringfiscal years ending June 30, 2000 and 1999, IBM represented 17% and 16% ofrevenue, respectively; and Qwest represented 22% and 23% of revenue,respectively. While we have reduced our dependence on each of these clients,loss of either of these client relationships or a significant portion thereofcould have a material adverse effect on the Company.

 

Our ability to control labor costs, employee benefit costs and othercosts also will affect our future performance. In an effort to contain ourbenefits costs, we implemented substantial changes to our benefits plans forfiscal year 2002. While we believe the changes we implemented will beeffective, the actual results from these changes may vary due to factors wecannot control such as rising medical costs, the amount of medical servicesused by our employees and similar factors. We have streamlined our operationsby consolidating offices, reducing administrative and management personnel andcontinue to review our company structure for more efficient methods ofoperating our business and delivering our 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.

 

As a result of the pricing and other competitive pressures affectingthe technical staff augmentation area of our business, management has soughtand plans to continue to seek new customers for our other service offerings,especially with small and medium size companies. Management plans to continueadding new customers or obtaining contracts with existing customers in theareas of software and web site development and maintenance (businesssolutions), network infrastructure services, computer security and criminaljustice. While we believe these areas of our business present opportunities togrow our business, growth in these areas will depend on improvement in spendingin the overall IT services market, our ability to compete with other vendorsand how successful we are at obtaining new clients.

 

We believe the provisions imposed by the December 2001 amendments toour credit line and Note Purchase Agreement are achievable based on ourexpected operating results during the first half of 2002. We expect to completeour refinancing before the June 30, 2002 maturity date of our existing debt.However, if we were unable to complete this financing, it could have a materialadverse impact on our ability to operate on a daily basis or to support growthin our business. If this were to occur, we may choose to enter into a sale andlease-back transaction or arrange for a long-term mortgage on our corporateheadquarters building.

 

Our existing credit facilities bear interest at a fixed rate,minimizing our exposure to market risk. The new financing transaction, which isexpected to close during the first half of 2002, will carry a variable interestrate, which will expose us to certain market risk. Market risk is the potentialloss arising from the adverse changes in market rates and prices, such as interestrates. Market risk is estimated as the potential increase in fair valueresulting from a hypothetical one percent increase in interest rates which,assuming an average outstanding debt balance of $30.0 million, would result inan annual interest expense increase of approximately $300,000.

 

 

17

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**Consolidated Balance Sheets**

 

 
|                                                                                                                                         |   | **December  31,**                                        |    |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------|---------|
|                                                                                                                                         |   | **2001**                                                 |    | **2000** |   |
|                                                                                                                                         |   | **(Dollars  in thousands,except for per share amounts)** |    |
| **Assets**                                                                                                                                   |   |                                                     |    |   |   |
|                                                                                                                                         |   |                                                     |    |   |   |
| Current assets:                                                                                                                              |   |                                                     |    |   |   |
| Cash and cash equivalents                                                                                                                    |   | $                                                        | 18,204  |   | $ | 2,192 |   |
| Accounts receivable, less allowance for doubtful  accounts of $1,170 and $2,110, respectively                                                |   | 83,322                                                   |    | 98,495 |   |
| Prepaid expenses and other current assets                                                                                                    |   | 6,904                                                    |    | 6,035 |   |
| Income tax refund receivable                                                                                                                 |   | 2,405                                                    |    | 2,157 |   |
| Total current assets                                                                                                                         |   | 110,835                                                  |    | 108,879 |   |
| Property and equipment                                                                                                                       |   | 28,406                                                   |    | 28,752 |   |
| Intangible assets, net of accumulated amortization  of $6,606 and $3,364, respectively                                                       |   | 45,656                                                   |    | 49,335 |   |
| Other assets                                                                                                                                 |   | 7,987                                                    |    | 14,763 |   |
|                                                                                                                                         |   | $                                                        | 192,884 |   | $ | 201,729 |   |
|                                                                                                                                         |   |                                                     |    |   |   |
| **Liabilities and Shareholders’  Equity**                                                                                               |   |                                                     |    |   |   |
|                                                                                                                                         |   |                                                     |    |   |   |
| Current liabilities:                                                                                                                         |   |                                                     |    |   |   |
| Accounts payable                                                                                                                             |   | $                                                        | 37,778  |   | $ | 30,927 |   |
| Dividend payable                                                                                                                             |   | —                                                   |    | 1,452 |   |
| Salaries and vacations                                                                                                                       |   | 6,399                                                    |    | 8,515 |   |
| Self-insured health care reserves and other accounts                                                                                         |   | 7,882                                                    |    | 5,766 |   |
| Payable to former Sequoia NET.com shareholders                                                                                               |   | —                                                   |    | 3,323 |   |
| Long-term debt, current portion                                                                                                              |   | 41,000                                                   |    | 5,250 |   |
| Restructuring accruals, current portion                                                                                                      |   | 1,154                                                    |    | 5,798 |   |
| Total current liabilities                                                                                                                    |   | 94,213                                                   |    | 61,031 |   |
|                                                                                                                                         |   |                                                     |    |   |   |
| Long-term debt                                                                                                                               |   | —                                                   |    | 35,750 |   |
| Restructuring accruals, non-current portion                                                                                                  |   | 1,500                                                    |    | 750 |   |
| Deferred compensation accrual, non-current portion                                                                                           |   | 6,088                                                    |    | 9,115 |   |
| Commitments (Note I)                                                                                                                         |   |                                                     |    |   |   |
|                                                                                                                                         |   |                                                     |    |   |   |
| Shareholders’ equity:                                                                                                                   |   |                                                     |    |   |   |
| Common stock, par value $.10 a share; authorized  120,000,000 shares; issued and outstanding 24,196,622 and 24,195,077 shares,  respectively |   | 2,420                                                    |    | 2,419 |   |
| Additional capital                                                                                                                           |   | 20,121                                                   |    | 20,116 |   |
| Accumulated other comprehensive loss                                                                                                         |   | (106                                                     | )       | (48 | ) |
| Retained earnings                                                                                                                            |   | 68,648                                                   |    | 72,596 |   |
| Total shareholders’ equity                                                                                                              |   | 91,083                                                   |    | 95,083 |   |
|                                                                                                                                         |   | $                                                        | 192,884 |   | $ | 201,729 |   |
|                                                                                                                                         |   |                                                     |    |   |   |
| *The accompanying notes are an  integral part of the financial statements.*                                                                  |   |                                                     |    |   |   |

 

 

18

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**Consolidated Statements of Operations**

 

 
|                                                                             |   | **Year  Ended**

**December  31,**                       |    | **Six  Months Ended**

**December  31,** |   | **Year  Ended**

**June  30,** |   |
|----------------------------------------------------------------------------------|--------|----------------------------------------------------------|---------|------------------------------------------|--------|--------------------------------|--------|
|                                                                             |   |                                                     |    |                                     |
|                                                                             |   | **2001**                                                 |    | **2000**                                 |   | **2000**                       |   | **2000** |   | **1999** |   |
|                                                                             |   |                                                     |    | **(unaudited)**                          |   |                           |   |   |   |   |   |
|                                                                             |   | **(Dollars  in thousands,except for per share amounts)** |    |
| Professional services revenues:                                                  |   |                                                     |    |                                     |   |                           |   |   |   |   |   |
| Provided directly                                                                |   | $                                                        | 411,387 |                                     | $      | 430,213                        |   | $ | 226,706 |   | $ | 420,140 |   | $ | 480,790 |   |
| Provided through subsuppliers                                                    |   | 140,340                                                  |    | 128,944                                  |   | 61,634                         |   | 138,591 |   | 139,366 |   |
| Total revenues                                                                   |   | 551,727                                                  |    | 559,157                                  |   | 288,340                        |   | 558,731 |   | 620,156 |   |
|                                                                             |   |                                                     |    |                                     |   |                           |   |   |   |   |   |
| Expenses:                                                                        |   |                                                     |    |                                     |   |                           |   |   |   |   |   |
| Salaries, contracted services and direct charges                                 |   | 457,706                                                  |    | 456,250                                  |   | 235,238                        |   | 452,334 |   | 486,816 |   |
| Selling, administrative and other operating costs                                |   | 87,909                                                   |    | 96,252                                   |   | 53,239                         |   | 89,683 |   | 96,887 |   |
| Amortization of goodwill and other intangible assets                             |   | 3,212                                                    |    | 2,064                                    |   | 1,370                          |   | 1,025 |   | 415 |   |
| Restructuring charges                                                            |   | —                                                   |    | 7,000                                    |   | 7,000                          |   | — |   | — |   |
|                                                                             |   |                                                     |    |                                     |   |                           |   |   |   |   |   |
| Operating income (loss)                                                          |   | 2,900                                                    |    | (2,409                                   | )      | (8,507                         | )      | 15,689 |   | 36,038 |   |
| Non-operating income                                                             |   | 247                                                      |    | 391                                      |   | 68                             |   | 1,452 |   | 1,408 |   |
| Loss on investment                                                               |   | 3,012                                                    |    | —                                   |   | —                         |   | — |   | — |   |
| Interest expense                                                                 |   | 2,899                                                    |    | 2,376                                    |   | 1,494                          |   | 1,584 |   | 178 |   |
| (Loss) income before income taxes and minority  interest                         |   | (2,764                                                   | )       | (4,394                                   | )      | (9,933                         | )      | 15,557 |   | 37,268 |   |
| Income tax expense (benefit)                                                     |   | 216                                                      |    | (2,149                                   | )      | (3,897                         | )      | 5,656 |   | 14,535 |   |
| Minority interest                                                                |   | —                                                   |    | 379                                      |   | 266                            |   | 113 |   | — |   |
| Net (loss) income                                                                |   | $                                                        | (2,980  | )                                        | $      | (2,624                         | )      | $ | (6,302 | ) | $ | 9,788 |   | $ | 22,733 |   |
|                                                                             |   |                                                     |    |                                     |   |                           |   |   |   |   |   |
| Per common share:                                                                |   |                                                     |    |                                     |   |                           |   |   |   |   |   |
| Net (loss) income (basic)                                                        |   | $                                                        | (.12    | )                                        | $      | (.12                           | )      | $ | (.28 | ) | $ | .43 |   | $ | 1.01 |   |
| Net (loss) income (diluted)                                                      |   | $                                                        | (.12    | )                                        | $      | (.12                           | )      | $ | (.28 | ) | $ | .43 |   | $ | 1.00 |   |
|                                                                             |   |                                                     |    |                                     |   |                           |   |   |   |   |   |
| Average common shares outstanding                                                |   | 24,196,000                                               |    | 22,612,000                               |   | 22,624,000                     |   | 22,583,000 |   | 22,524,000 |   |
|                                                                             |   |                                                     |    |                                     |   |                           |   |   |   |   |   |
| Average common and common equivalent shares  outstanding                         |   | 24,196,000                                               |    | 22,612,000                               |   | 22,624,000                     |   | 22,624,000 |   | 22,732,000 |   |
|                                                                             |   |                                                     |    |                                     |   |                           |   |   |   |   |   |
| *The  accompanying notes are an integral part of the financial statements*  |   |                                                     |    |                                     |   |                           |   |
|                                                                                  |        |                                                          |         |                                          |        |                                |        |  |  |  |  |  |  |  |  |  |  |

 

 

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**Consolidated Statements of Cash Flows**

 

 
|                                                                                      |   | **Year  Ended**

**December  31,**                       |   | **Six  Months Ended**

**December  31,** |   | **Year  Ended**

**June  30,** |   |
|-------------------------------------------------------------------------------------------|--------|----------------------------------------------------------|--------|------------------------------------------|--------|--------------------------------|--------|
|                                                                                      |   |                                                     |   |                                     |
|                                                                                      |   | **2001**                                                 |   | **2000**                                 |   | **2000**                       |   | **2000** |   | **1999** |   |
|                                                                                      |   |                                                     |   | **(unaudited)**                          |   |                           |   |   |   |   |   |
|                                                                                      |   | **(Dollars  in thousands,except for per share amounts)** |   |
| Cash flows from operating activities:                                                     |   |                                                     |   |                                     |   |                           |   |   |   |   |   |
| Net (loss) income                                                                         |   | $                                                        | (2,980 | )                                        | $      | (2,624                         | )      | $ | (6,302 | ) | $ | 9,788 |   | $ | 22,733 |   |
| Adjustments to reconcile net (loss) income to net  cash provided by operating activities: |   |                                                     |   |                                     |   |                           |   |   |   |   |   |
| Depreciation                                                                              |   | 5,124                                                    |   | 5,227                                    |   | 2,753                          |   | 4,892 |   | 3,844 |   |
| Amortization of goodwill and other intangible assets                                      |   | 3,212                                                    |   | 2,064                                    |   | 1,370                          |   | 1,025 |   | 415 |   |
| Loss (gain) on disposal of assets                                                         |   | 96                                                       |   | 121                                      |   | (8                             | )      | (499 | ) | 19 |   |
| Loss on investments                                                                       |   | 3,012                                                    |   | —                                   |   | —                         |   | — |   | — |   |
| Decrease (increase) in deferred income tax benefit                                        |   | 2,405                                                    |   | (2,312                                   | )      | (2,883                         | )      | 510 |   | (436 | ) |
| Tax effect of stock transactions                                                          |   | —                                                   |   | 45                                       |   | —                         |   | 45 |   | 543 |   |
| Change in:                                                                                |   |                                                     |   |                                     |   |                           |   |   |   |   |   |
| Accounts receivable                                                                       |   | 15,173                                                   |   | (363                                     | )      | 357                            |   | 13,508 |   | (7,229 | ) |
| Prepaid expenses                                                                          |   | (2,251                                                   | )      | (1,054                                   | )      | (647                           | )      | (111 | ) | (590 | ) |
| Other assets                                                                              |   | 2,775                                                    |   | 420                                      |   | 118                            |   | 149 |   | (582 | ) |
| Accounts payable                                                                          |   | 3,528                                                    |   | (1,327                                   | )      | (419                           | )      | (1,079 | ) | 9,555 |   |
| Salaries and vacations                                                                    |   | (2,116                                                   | )      | 285                                      |   | (2,497                         | )      | (12,581 | ) | 7,558 |   |
| Other accrued expenses                                                                    |   | 5,484                                                    |   | 845                                      |   | 1,134                          |   | (276 | ) | 1,150 |   |
| Income taxes                                                                              |   | (248                                                     | )      | (4,675                                   | )      | (1,278                         | )      | (4,581 | ) | (551 | ) |
| Restructuring accrual                                                                     |   | (3,894                                                   | )      | 6,604                                    |   | 6,604                          |   | — |   | — |   |
| Long-term liabilities                                                                     |   | (3,027                                                   | )      | 1,267                                    |   | 1,289                          |   | 292 |   | 363 |   |
| Net cash provided by (used in) operating activities                                       |   | 26,293                                                   |   | 4,523                                    |   | (409                           | )      | 11,082 |   | 36,792 |   |
| Cash flows from investing activities:                                                     |   |                                                     |   |                                     |   |                           |   |   |   |   |   |
| Property and equipment additions                                                          |   | (4,910                                                   | )      | (3,381                                   | )      | (2,090                         | )      | (3,413 | ) | (23,182 | ) |
| Investment purchases                                                                      |   | —                                                   |   | (190                                     | )      | —                         |   | (190 | ) | — |   |
| Payments for acquisitions, net of cash acquired                                           |   | (2,993                                                   | )      | (42,687                                  | )      | —                         |   | (42,687 | ) | (3,847 | ) |
| Investment in alliance partners                                                           |   | —                                                   |   | (3,012                                   | )      | —                         |   | (3,012 | ) | — |   |
| Proceeds from property and equipment sales                                                |   | 36                                                       |   | 116                                      |   | 95                             |   | 1,575 |   | 35 |   |
| Net cash used in investing activities                                                     |   | (7,867                                                   | )      | (49,154                                  | )      | (1,995                         | )      | (47,727 | ) | (26,994 | ) |
| Cash flows from financing activities:                                                     |   |                                                     |   |                                     |   |                           |   |   |   |   |   |
| Cash dividends                                                                            |   | (2,420                                                   | )      | (9,048                                   | )      | (4,521                         | )      | (9,037 | ) | (8,560 | ) |
| Proceeds from borrowings                                                                  |   | 52,895                                                   |   | 138,013                                  |   | 87,919                         |   | 50,094 |   | 20,000 |   |
| Repayment of borrowings                                                                   |   | (52,895                                                  | )      | (117,350                                 | )      | (80,832                        | )      | (36,518 | ) | — |   |
| Proceeds from exercise of stock options                                                   |   | 6                                                        |   | 127                                      |   | —                         |   | 266 |   | 764 |   |
| Net cash (used in) provided by financing activities                                       |   | (2,414                                                   | )      | 11,742                                   |   | 2,566                          |   | 4,805 |   | 12,204 |   |
| Net increase (decrease) in cash and equivalents                                           |   | 16,012                                                   |   | (32,889                                  | )      | 162                            |   | (31,840 | ) | 22,002 |   |
| Cash and equivalents at beginning of year                                                 |   | 2,192                                                    |   | 35,081                                   |   | 2,030                          |   | 33,870 |   | 11,868 |   |
| Cash and equivalents at end of year                                                       |   | $                                                        | 18,204 |                                     | $      | 2,192                          |   | $ | 2,192 |   | $ | 2,030 |   | $ | 33,870 |   |
| Supplemental cash flow information:                                                       |   |                                                     |   |                                     |   |                           |   |   |   |   |   |
| Cash paid (refunded) during the year for:                                                 |   |                                                     |   |                                     |   |                           |   |   |   |   |   |
| Income taxes                                                                              |   | $                                                        | (1,846 | )                                        | $      | 2,945                          |   | $ | 264 |   | $ | 7,109 |   | $ | 15,421 |   |
| Interest                                                                                  |   | 3,811                                                    |   | 2,298                                    |   | 794                            |   | 2,206 |   | — |   |
| Non-cash investing and financing activities:                                              |   |                                                     |   |                                     |   |                           |   |   |   |   |   |
| Common stock issued to acquire 19.9% of  SequoiaNET.com                                   |   | —                                                   |   | 6,069                                    |   | 6,069                          |   | — |   | — |   |
| Payable issued to acquire 19.9% of SequoiaNET.com                                         |   | —                                                   |   | 3,323                                    |   | 3,323                          |   | — |   | — |   |
|                                                                                      |   |                                                     |   |                                     |   |
| *The  accompanying notes are an integral part of the financial statements*           |   |                                                     |   |                                     |   |

 

 

20

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**Consolidated Statements of Shareholders’ Equity**

 

 
|                                                                              |   | **Common**

**Stock**                                    |   | **Additional**

**Capital** |   | **Accumulated**

**Other**

**Comprehensive**

**Loss** |   | **Retained**

**Earnings** |   | **Total**

**Shareholders**

**Equity** |   |
|-----------------------------------------------------------------------------------|--------|----------------------------------------------------------|--------|-----------------------------|--------|---------------------------------------------------------|--------|----------------------------|--------|-----------------------------------------|--------|
|                                                                              |   |                                                     |   |                        |   |                                                    |
|                                                                              |   |                                                     |   |                        |   |                                                    |
|                                                                              |   |                                                     |   |                        |   |                                                    |
|                                                                              |   | **(Dollars  in thousands,except for per share amounts)** |   |
| Balances at June 30, 1998                                                         |   | $                                                        | 2,244  |                        | $      | 12,604                                                  |   |                       |   | $                                       | 68,146 |   | $ | 82,994 |   |
|                                                                              |   |                                                     |   |                        |   |                                                    |   |                       |   |                                    |   |
| Common stock issued — 112,698 shares upon exercise  of stock options         |   | 11                                                       |   | 753                         |   |                                                    |   |                       |   | 764                                     |   |
| Income tax benefit from stock option plans                                        |   |                                                     |   | 102                         |   |                                                    |   |                       |   | 102                                     |   |
| Other                                                                             |   |                                                     |   | 441                         |   |                                                    |   |                       |   | 441                                     |   |
| Cash dividends ($.40 per share)                                                   |   |                                                     |   |                        |   |                                                    |   | (9,020                     | )      | (9,020                                  | )      |
| Net income                                                                        |   |                                                     |   |                        |   |                                                    |   | 22,733                     |   | 22,733                                  |   |
| Balances at June 30, 1999                                                         |   | 2,255                                                    |   | 13,900                      |   |                                                    |   | 81,859                     |   | 98,014                                  |   |
|                                                                              |   |                                                     |   |                        |   |                                                    |   |                       |   |                                    |   |
| Common stock issued — 54,385 shares upon exercise of  stock options          |   | 6                                                        |   | 260                         |   |                                                    |   |                       |   | 266                                     |   |
| Income tax benefit from stock option plans                                        |   |                                                     |   | 45                          |   |                                                    |   |                       |   | 45                                      |   |
| Cash dividends ($.40 per share)                                                   |   |                                                     |   |                        |   |                                                    |   | (9,037                     | )      | (9,037                                  | )      |
| Unrealized loss on available for sale securities                                  |   |                                                     |   |                        |   | $                                                       | (23    | )                          |   |                                    | (23    | ) |
| Net income                                                                        |   |                                                     |   |                        |   |                                                    |   | 9,788                      |   | 9,788                                   |   |
| Comprehensive income                                                              |   |                                                     |   |                        |   |                                                    |   |                       |   | 9,765                                   |   |
| Balances at June 30, 2000                                                         |   | 2,261                                                    |   | 14,205                      |   | (23                                                     | )      | 82,610                     |   | 99,053                                  |   |
|                                                                              |   |                                                     |   |                        |   |                                                    |   |                       |   |                                    |   |
| Shares issued for purchase of SequoiaNET.com                                      |   | 158                                                      |   | 5,911                       |   |                                                    |   |                       |   | 6,069                                   |   |
| Cash dividends ($.16 per share)                                                   |   |                                                     |   |                        |   |                                                    |   | (3,712                     | )      | (3,712                                  | )      |
| Unrealized loss on available for sale securities                                  |   |                                                     |   |                        |   | (25                                                     | )      |                       |   | (25                                     | )      |
| Net loss                                                                          |   |                                                     |   |                        |   |                                                    |   | (6,302                     | )      | (6,302                                  | )      |
| Comprehensive loss                                                                |   |                                                     |   |                        |   |                                                    |   |                       |   | (6,327                                  | )      |
| Balances at December 31, 2000                                                     |   | 2,419                                                    |   | 20,116                      |   | (48                                                     | )      | 72,596                     |   | 95,083                                  |   |
|                                                                              |   |                                                     |   |                        |   |                                                    |   |                       |   |                                    |   |
| Common stock issued — 1,545 shares upon exercise of  stock options           |   | 1                                                        |   | 5                           |   |                                                    |   |                       |   | 6                                       |   |
| Cash dividends ($.04 per share)                                                   |   |                                                     |   |                        |   |                                                    |   | (968                       | )      | (968                                    | )      |
| Unrealized loss on available for sale securities                                  |   |                                                     |   |                        |   | (58                                                     | )      |                       |   | (58                                     | )      |
| Net loss                                                                          |   |                                                     |   |                        |   |                                                    |   | (2,980                     | )      | (2,980                                  | )      |
| Comprehensive loss                                                                |   |                                                     |   |                        |   |                                                    |   |                       |   | (3,038                                  | )      |
| Balances at December 31, 2001                                                     |   | $                                                        | 2,420  |                        | $      | 20,121                                                  |   | $                          | (106   | )                                       | $      | 68,648 |   | $ | 91,093 |   |
|                                                                              |   |                                                     |   |                        |   |                                                    |   |                       |   |                                    |   |
| *The  accompanying notes are an integral part of the financial statements.*  |   |                                                     |   |                        |   |

 

 

21

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**Notes to Consolidated Financial Statements**

 

**A. Summary of Significant AccountingPolicies**

 

*Description of business.*Analysts International Corporation is adiversified IT services company. Services are provided through the SequoiaServices Group, which provides business solutions and network infrastructureservices; the Managed Services Group, which provides a comprehensive range ofoutsourced business functions; and IT Supplemental Resources (also referred toas Technical Staff Augmentation), which provides high demand resources forsupporting clients’ IT staffing needs.

 

*Basis of presentation.*The consolidated financial statementsinclude the accounts of the Company and its subsidiaries. All intercompanyaccounts and transactions have been eliminated.

 

As described in Note J, on April 25, 2000, the Company completed theacquisition of 80.1% of SequoiaNET.com. The acquisition was accounted for as apurchase. The accompanying financial statements include 100% of SequoiaNET.com’s operatingresults for the period from April 25, 2000 to December 31, 2000, offset by the minorityshareholders’ interest in Sequoia's net earnings. Effective December 29, 2000, the Companyacquired the remaining 19.9% of Sequoia.

 

*Change in fiscal year.*Analysts International changed its fiscalyear end to December 31 from June 30, effective December 31, 2000. Referencesto fiscal 2000 and 1999 relate to the years ended June 30, 2000 and 1999.

 

Unaudited consolidated statements of operations and cash flows for thetwelve months ended December 31, 2000 have been included in the accompanyingconsolidated financial statements for comparative purposes.

 

*Depreciation.*Property and equipment is beingdepreciated using the straight-line method over the estimated useful lives (15to 50 years for building and improvements and 2 to 7 years for office furnitureand equipment) of the assets for financial statement purposes and acceleratedmethods for income tax purposes.

 

*Financial instruments.*In accordance with the requirements ofStatement of Financial Accounting Standards (SFAS) No. 107, “Disclosures aboutFair Value of Financial Instruments,” management estimates the carrying valueof long-term debt exceeds fair value by approximately $400,000 at December 31,2000. The carrying value approximated the fair value at December 31, 2001 as aresult of the amendments to move the maturity of the long term debt to June 30,2002. The estimated fair value amount for December 31, 2000 was determinedthrough the use of discounted cash flow analysis using interest rates currentlyavailable to the Company for issuance of debt with similar terms and remainingmaturities. All other financial instruments approximate fair value because ofthe short-term nature of these instruments.

 

*Revenue recognition.*The Company provides custom softwaredesign and implementation services primarily under time and material contracts.The Company records professional services revenue at contractually agreed uponrates as the services are provided. The Company grants credit withoutcollateral to customers, a significant portion of whom are engaged in theelectronics and telecommunications industries. One customer and its variousdivisions and operating units accounted for approximately 15%, 13%, 22% and 23%of revenue in fiscal 2001, the six month period ending December 31, 2000 andfiscal 2000 and 1999, respectively. Another customer accounted for 15%, 14%,17% and 16% of revenue in fiscal 2001, the six month period ending December 31,2000 and fiscal 2000 and 1999, respectively.

 

*Comprehensive income/loss.*Other comprehensive income/loss consistsof unrealized losses on available-for-sale securities.

 

*Net income per share.*Basic and diluted earnings per share(EPS) are presented in accordance with Statement of Financial AccountingStandards No. 128, “Earnings per Share.” Basic EPS excludes dilution and iscomputed by dividing income available to common stockholders by theweighted-average number of common shares outstanding for the period. The differencebetween weighted-average common shares and average common and common equivalentshares used in computing diluted EPS is the result of outstanding stockoptions. Options to purchase 1,819,000, 1,792,000, 908,000 and 358,000 sharesof common stock were outstanding during fiscal 2001, the six months endedDecember 31, 2000 and the fiscal years ended June 30, 2000 and 1999,respectively, but were excluded from the computation of common stockequivalents because they were anti-dilutive.

 

*Cash equivalents.*Temporary cash investments in moneymarket accounts are considered to be cash equivalents.

 

*Shares reserved.*At December 31, 2001, there wereapproximately 29,244,000 shares reserved for issuance under the stock optionplans and the rights plan.

 

*Estimates.*The preparation of consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsaffecting the reported amounts of assets and liabilities, the disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from these estimates.

 

*Intangible assets.*Intangible assets consist of tradenames,in-place work force, customer lists and goodwill, the excess of the purchaseprice over the appraised fair value of assets acquired in acquisitions.Intangibles are amortized on a

 

 

22

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straight-line basis over periods of 2 to 18 years. At December 31,2001, management assessed whether there has been a permanent impairment in thevalue of intangible assets and the amount of such impairment by comparinganticipated undiscounted future operating income from the applicable businessunit with the carrying value of the related intangible assets. The factorsconsidered by management in performing this assessment include currentoperating results, trends and prospects, as well as the effects of demand,competition and other economic factors. No impairment was indicated at December31, 2001.

 

In June 2001, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standard (SFAS)        Nos. 141, “Business Combinations” and 142, “Goodwill andOther Intangible Assets.” SFAS No. 141 was effective for all businesscombinations initiated after June 30, 2001, and has had no impact on theCompany’s financialstatements. SFAS No. 142 addresses how intangible assets should be accountedfor, and is effective for the Company’s fiscal year beginning January 1, 2002.Company expects to adopt SFAS No. 142 during the first quarter of fiscal year2002. Amortization recorded during the years ended December 31, 2001 and 2000was $3,212,000 and $2,064,000, respectively. Upon adoption of SFAS No. 142,this amortization is expected to decline significantly. As of December 31, 2001and 2000, the Company had net goodwill and other intangible assets ofapproximately $45,656,000 and $49,335,000, respectively. Based on a review ofthe standard and preliminary impairment assessment, management believes theCompany will record a goodwill impairment charge upon adoption, and the amountof such charge is likely to be significant in relation to the Company’sunamortized goodwill balance. Such impairment charge will be recorded as acumulative effect of a change in accounting principle and therefore will notimpact operating income.

 

*Accounting Pronouncements.*On July 1, 2000, the Company adoptedStatement of Financial Accounting Standard (SFAS) No. 133, “Accounting forDerivative Instruments and Hedging Activities”, as amended by SFAS No. 138,“Accounting for Certain Derivative Instruments and Certain Hedging Activities”.Management has reviewed the requirements of SFAS No. 133 and has determinedthat the Company has no free-standing or embedded derivatives. All agreementsthat contain provisions meeting the definition of a derivative also meet therequirements of, and have been designated as, normal purchases or sales. Thederivatives and not to enter into contracts with terms that cannot bedesignated as normal purchases or sales.

 

During the period ended December 31, 2000, the Company adopted StaffAccounting Bulletin No. 101 “Revenue Recognition in Financial Statements”. Theimpact of the adoption of this bulletin was not material.

 

**B.Property and Equipment**

 
|                             |   | **December  31,** |   |
|----------------------------------|--------|-------------------|--------|
| ***(In thousands)***             |   | **2001**          |   | **2000** |   |
| Land                             |   | $                 | 1,917  |   | $ | 1,917 |   |
| Building and improvements        |   | 20,522            |   | 18,659 |   |
| Office furniture & equipment |   | 30,716            |   | 29,989 |   |
|                             |   | 53,155            |   | 50,565 |   |
| Accumulated depreciation         |   | 24,749            |   | 21,813 |   |
|                             |   | $                 | 28,406 |   | $ | 28,752 |   |

 

**C. Intangible Assets**

 

Intangible assetsconsist of the following:

 
|                     |   | **December  31,** |   |
|--------------------------|--------|-------------------|--------|
| ***(In thousands)***     |   | **2001**          |   | **2000** |   |
| Goodwill                 |   | $                 | 36,932 |   | $ | 37,369 |   |
| Tradename                |   | 1,720             |   | 1,720 |   |
| Workforce                |   | 1,340             |   | 1,340 |   |
| Customer list            |   | 12,270            |   | 12,270 |   |
|                     |   | 52,262            |   | 52,699 |   |
| Accumulated amortization |   | 6,606             |   | 3,364 |   |
|                     |   | $                 | 45,656 |   | $ | 49,335 |   |

 

**D. Deferred Compensation**

 

The Company has a Deferred Compensation Plan for key managementemployees as determined by the Board. Included in liabilities at December 31,2001 and December 31, 2000 is $8,580,000 and $9,115,000, respectively,representing the Company’s liability under the plan. This liability is beingpartially funded by the purchase of life insurance and annuity contracts.Included in assets at December 31, 2001 and December 31, 2000 is $5,679,000 and$5,962,000, respectively, representing the carrying value, which approximatesmarket value, of the annuities and insurance cash value. Deferred compensationexpense for the year ended December 31, 2001, the six months ended December 31,2000 and for fiscal years 2000 and 1999 was approximately $299,000, $1,218,000,$292,000 and $363,000, respectively.

 

**E. Long-term Debt**

 

In January 2000, the Company obtained a $25,000,000 bank line ofcredit. This line of credit was increased to $30,000,000 in December 2000.Effective December 28, 2001, this agreement was amended to reduce the line ofcredit to $25,000,000, amend the maturity date to June 30, 2002, and increasethe interest rate to a fixed 9%. A commitment fee of .30% is charged on theunused portion of the line. 

 

In December 1998, the Company entered into a Note Purchase Agreementwhereby it sold $20,000,000 of 7% Senior Notes due December 30, 2006. Duringfiscal year 2001, this agreement was amended to increase the interest rate to9%, reduce the make-whole penalty for early

 

 

23

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extinguishment, defer the $5.3 million principal payment due atDecember 31, 2001, require a $1.5 million principal payment on March 29, 2002and move the maturity of the remaining note balance to June 30, 2002.

 

During fiscal year 2001, the credit line and Note Purchase Agreementboth contained provisions requiring the maintenance of certain operating andother ratios. On a number of occasions during 2001, the Company failed to meetthese requirements and sought and received amendments to the agreements. Inanticipation of restructuring all of its debt, effective December 28, 2001, theCompany amended both agreements to move all present and future maturities, withthe exception of a $1.5 million principal payment of the Notes on March 29,2002, to June 30, 2002 to give the Company time to effectively restructure itsdebt. The December 2001 amendments eliminate all previous operating covenantsand replace them with required minimum earnings before income taxes, interest,depreciation and amortization (EBITDA), and net cash flow, which is defined asEBITDA less cash paid for taxes, capital expenditures, restructuring accruals,interest expenses, and principal paid on the Notes.

 

Subsequent to December 31, 2001, the Company has obtained a commitmentfrom a major financial institution to extend the Company a $55.0 million lineof credit secured by the assets of the Company. The commitment is for athree-year term, carries interest at either the LIBOR rate plus 3.00% or thePrime rate plus .75%. The Company expects to close this refinancing before theJune 30, 2002 maturity date of its existing debt. Upon refinancing of itsexisting debt, the Company expects to record a pre-tax loss on earlyextinguishment of debt of approximately $1,000,000.

 

**F. Stock Option Plans**

 

The Company has five stock-based compensation plans, which aredescribed below. The Company has adopted the disclosure provisions of SFAS No.123, “Accounting for Stock-Based Compensation”, and has continued to apply APBOpinion No. 25 and related interpretations in accounting for its plans.Accordingly, no compensation cost has been recognized for its stock optionplans. Had compensation cost for the Company’s stock-based compensation plans been determined basedon the fair value at the grant dates as calculated in accordance with SFAS No.123, the Company’s pro forma net (loss) income and (loss) earnings per share for theyear ended December 31, 2001, the six months ended December 31, 2000 and theyears ended June 30, 2000 and 1999 would have been the amounts indicated below:

 
|                                   |   | **Year  Ended**

**December  31,** |   | **Six  Months Ended**

**December  31,** |   | **Year  Ended**

**June  30,** |   |
|----------------------------------------|--------|------------------------------------|--------|------------------------------------------|--------|--------------------------------|--------|
|                                   |   |                               |   |                                     |
|                                   |   | **2001**                           |   | **2000**                                 |   | **2000**                       |   | **1999** |   |
|                                   |   |                               |   |                                     |   |                           |   |   |   |
| Net (loss) income *(in  thousands)*:   |   |                               |   |                                     |   |                           |   |   |   |
| As reported                            |   | $                                  | (2,980 | )                                        | $      | (6,302                         | )      | $ | 9,788 |   | $ | 22,733 |   |
| Pro forma                              |   | (3,949                             | )      | (7,375                                   | )      | 8,411                          |   | 22,038 |   |
| Net (loss) income per share (basic):   |   |                               |   |                                     |   |                           |   |   |   |
| As reported                            |   | $                                  | (.12   | )                                        | $      | (.28                           | )      | $ | .43 |   | $ | 1.01 |   |
| Pro forma                              |   | (.16                               | )      | (.33                                     | )      | .37                            |   | .98 |   |
| Net (loss) income per share (diluted): |   |                               |   |                                     |   |                           |   |   |   |
| As reported                            |   | $                                  | (.12   | )                                        | $      | (.28                           | )      | $ | .43 |   | $ | 1.00 |   |
| Pro forma                              |   | (.16                               | )      | (.33                                     | )      | .37                            |   | .97 |   |

 

The fair marketvalue of each stock option is estimated on the date of grant using theBlack-Scholes option-pricing model with the following weighted-averageassumptions:

 
|                    |   | **Year  Ended**

**December  31,** |   | **Six  Months Ended**

**December  31,** |   | **Year  Ended**

**June  30,** |   |
|-------------------------|--------|------------------------------------|--------|------------------------------------------|--------|--------------------------------|--------|
|                    |   |                               |   |                                     |
|                    |   | **2001**                           |   | **2000**                                 |   | **2000**                       |   | **1999** |   |
|                    |   |                               |   |                                     |   |                           |   |   |   |
| Expected life           |   | 5 years                            |   | 5 years                                  |   | 5 years                        |   | 5 years |   |
| Expected volatility     |   | 74%                                |   | 59%                                      |   | 59%                            |   | 53% |   |
| Expected dividend yield |   | 0.0%                               |   | 3.0%                                     |   | 2.0%                           |   | 1.0% |   |
| Risk-free interest rate |   | 6.0%                               |   | 8.0%                                     |   | 8.0%                           |   | 7.0% |   |

 

 

24

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The weighted average fair value of options granted during the yearended December 31, 2001, the six-month period ended December 31, 2000 and theyears ended June 30, 2000 and 1999 was $2.23, $1.91, $4.42 and $6.15,respectively.

 

The Company has options outstanding under five option plans, four ofwhich remain active. Under the 1994 Stock Option Plan, the Company may grantoptions to its employees for up to 1,200,000 shares of common stock. Under the1996 Stock Option Plan for Non-Employee Directors, the Company may grantoptions to its non-employee directors for up to 240,000 shares of common stock.Under the 1996 Non-Employee Directors Plan, options to purchase 6,000 sharesare automatically granted on January 3 of each year to each eligiblenon-employee director. Under the 1999 Stock Option Plan, the Company may grantoptions to its employees for up to 1,000,000 shares of common stock. Under the2000 Stock Option Plan, the Company may grant non-qualified options to itsemployees for up to 225,000 shares of common stock. Under all plans, theexercise price of each option equals the market price of the Company’s stock on thedate of grant and an option’s maximum term is generally 10 years. Options are generally exercisable at 25%annually beginning one year after date of grant.

 

A summary of the status of the plans as of December 31, 2001, December31, 2000, June 30, 2000 and June 30, 1999 and changes during the periods endingon those dates is presented below:

 
|                           |   | **Shares** |   | **Weighted-**

**Average**

**Exercise  Price** |   |
|--------------------------------|--------|------------|--------|-------------------------------------------------|--------|
|                           |   |       |   |
|                           |   |       |   |
| Outstanding at June 30, 1998   |   | 889,760    |   | $                                               | 14.58  |   |
| Granted                        |   | 228,223    |   | $                                               | 16.45  |   |
| Exercised                      |   | (101,189   | )      | 8.62                                            |   |
| Expired                        |   | (11,135    | )      | 16.10                                           |   |
| Outstanding at June 30, 1999   |   | 1,005,659  |   | $                                               | 15.58  |   |
| Granted                        |   | 721,532    |   | $                                               | 10.71  |   |
| Exercised                      |   | (87,932    | )      | 7.48                                            |   |
| Expired                        |   | (80,110    | )      | 11.69                                           |   |
| Outstanding at June 30, 2000   |   | 1,559,149  |   | $                                               | 14.09  |   |
| Granted                        |   | 304,330    |   | 3.53                                            |   |
| Exercised                      |   | —     |   | —                                          |   |
| Expired                        |   | (71,382    | )      | 13.15                                           |   |
| Outstanding at December31,2000 |   | 1,792,097  |   | 12.34                                           |   |
| Granted                        |   | 520,250    |   | 4.37                                            |   |
| Exercised                      |   | (1,719     | )      | 3.19                                            |   |
| Expired                        |   | (491,574   | )      | 12.55                                           |   |
| Outstanding at December31,2001 |   | 1,819,054  |   | 10.01                                           |   |

 

Shares available for future grant at December 31, 2001 and 2000 were704,692 and 733,368, respectively.

 

The following table summarizes information about stock optionsoutstanding at December 31, 2001:

 
|                                |               | **Options  Outstanding**                      |       | **Options  Exercisable**                                   |       |
|-------------------------------------|--------------------|-----------------------------------------------|------------|------------------------------------------------------------|------------|
|                                |               | **Number**

**Outstanding**

**at  12/31/01** |       | **Weighted-Average**

**Remaining**

**Contractual  Life** |       | **Weighted-Average**

**Exercise  Price** |   | **Number**

**Exercisable**

**at  12/31/01** |   | **Weighted-Average**

**Exercise  Price** |   |
| **Range  of**

**Exercise  Prices** |               | ** **                                    | ** ** | ** **                                                 | ** ** |   |
|                                | ** **         | ** **                                    | ** ** | ** **                                                 |       |
| $                                   | 3.19 — $3.94  |                                          | 259,891    |                                                       | 8.98       |   | $ | 3.33 |   | 159,616 |   | $ | 3.21 |   |
| $                                   | 4.40 —$8.44   |                                          | 517,150    |                                                       | 9.42       |   | $ | 4.53 |   | 9,500 |   | $ | 6.12 |   |
| $                                   | 9.44 —$11.06  |                                          | 553,050    |                                                       | 8.18       |   | $ | 10.18 |   | 162,777 |   | $ | 10.30 |   |
| $                                   | 11.38 —$34.94 |                                          | 488,963    |                                                       | 6.57       |   | $ | 19.17 |   | 324,736 |   | $ | 20.59 |   |
| $                                   | 3.19 — $34.94 |                                          | 1,819,054  |                                                       | 8.21       |   | $ | 10.01 |   | 656,629 |   | $ | 13.61 |   |
|                                     |                    |                                               |            |                                                            |            |  |  |  |  |  |  |  |  |  |  |  |

 

**G. Shareholders’ Rights Plan**

 

On June 15, 1989, the Board of Directors adopted a common stock theBoard of Directors declared a dividend of one common share purchase right foreach outstanding share of common stock and stock options granted and availablefor grant. The Board of Directors amended the plan on April 29, 1996 and April16, 1998. The rights, which expire on April 16, 2008, are exercisable onlyunder certain conditions, and when exercisable the holder will be entitled topurchase from the Company one share of common stock at a price of $160.00,subject to certain adjustments. The rights will become exercisable after aperson or group acquires beneficial ownership of 15% or more (or as low as 10%as the Board of Directors may determine) of the common stock or after a personor group announces an offer, the consummation of which would result in suchperson or group owning 15% or more of the common stock. If the Company isacquired at any time after the rights become exercisable, the rights will beadjusted so as to entitle a holder to purchase a number of shares of commonstock of the acquiring company at one-half of their market value. If any personor group acquires beneficial ownership of 15% or more of the Company’s shares, therights will be adjustedso as to entitle a holder (other than such person or group whose rights becomevoid) to purchase a number of

 

 

25

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shares of common stock of Analysts International Corporation atone-half of their market value or the Board of Directors may exchange therights, in whole or in part, at an exchange ratio of one common share per right(subject to adjustment).

 

At any time prior to an acquisition by a person or group of beneficialownership of 15% or more of the shares, the Board of Directors may redeem therights at $.01 per right.

 

**H. Income Taxes**

 

The provision for income tax expense (benefit) was as follows:

 
|                                      |   | **Year  Ended**

**December  31,** |   | **Six  Months Ended**

**December  31,** |   | **Year  Ended**

**June  30,** |   |
|-------------------------------------------|--------|------------------------------------|--------|------------------------------------------|--------|--------------------------------|--------|
|                                      |   |                               |   |                                     |
| *(In thousands)*                          |   | **2001**                           |   | **2000**                                 |   | **2000**                       |   | **1999** |   |
|                                      |   |                               |   |                                     |   |                           |   |   |   |
| Currently (receivable) payable:           |   |                               |   |                                     |   |                           |   |   |   |
| Federal                                   |   | $                                  | (2,075 | )                                        | $      | (808                           | )      | $ | 4,363 |   | $ | 12,648 |   |
| State                                     |   | (393                               | )      | (206                                     | )      | 783                            |   | 2,323 |   |
|                                      |   | $                                  | (2,468 | )                                        | (1,014 | )                              | 5,146  |   | 14,971 |   |
| Deferred:                                 |   |                               |   |                                     |   |                           |   |   |   |
| Federal                                   |   | 3,403                              |   | (2,426                                   | )      | 394                            |   | (348 | ) |
| State                                     |   | 424                                |   | (457                                     | )      | 116                            |   | (88 | ) |
|                                      |   | 3,827                              |   | (2,883                                   | )      | 510                            |   | (436 | ) |
| Valuation allowance on deferred tax asset |   | (1,143                             | )      | 0                                        |   | 0                              |   | 0 |   |
|                                      |   | 2,684                              |   | (2,883                                   | )      | 510                            |   | (436 | ) |
| Total:                                    |   | $                                  | 216    |                                     | $      | (3,897                         | )      | $ | 5,656 |   | $ | 14,535 |   |

 

Net deferred taxassets are comprised of the following:

 
|                                   |   | **December  31,** |   |
|----------------------------------------|--------|-------------------|--------|
| *(In  thousands)*                      |   | **2001**          |   | **2000** |   |
| Deferred compensation                  |   | $                 | 3,346  |   | $ | 3,555 |   |
| Accrued vacation and compensatory time |   | 888               |   | 1,272 |   |
| Accrued reorganization costs           |   | 1,042             |   | 2,427 |   |
| Self-insured health care reserves      |   | 702               |   | 858 |   |
| Investment market valuation allowance  |   | 64                |   | — |   |
| Allowance for doubtful accounts        |   | 456               |   | 820 |   |
| Depreciation                           |   | (86               | )      | (55 | ) |
| Capital Loss Carryforward              |   | 1,143             |   | — |   |
| Other                                  |   | 155               |   | 152 |   |
| Deferred tax assets                    |   | 7,710             |   | 9,029 |   |
| Other                                  |   | (469              | )      | (457 | ) |
| Valuation allowance                    |   | (1,143            | )      | — |   |
| Deferred tax liabilities               |   | (1,612            | )      | (457 | ) |
| Net deferred tax assets                |   | $                 | 6,098  |   | $ | 8,572 |   |
| Whereof:                               |   |              |   |   |   |
| Current                                |   | $                 | 2,392  |   | $ | 3,599 |   |
| Noncurrent                             |   | 3,706             |   | 4,973 |   |
|                                   |   | $                 | 6,098  |   | $ | 8,572 |   |

 

 

26

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The provision for income taxes differs from the amount of income taxdetermined by applying the federal statutory income tax rates to pretax (loss)income as a result of the following differences:

 
|                                           |   | **Year  Ended**

**December  31,** |   | **Six  Months Ended**

**December  31,** |   | **Year  Ended**

**June  30,** |   |
|------------------------------------------------|--------|------------------------------------|--------|------------------------------------------|--------|--------------------------------|--------|
|                                           |   |                               |   |                                     |
| *(In thousands)*                               |   | **2001**                           |   | **2000**                                 |   | **2000**                       |   | **1999** |   |
| Income tax (benefit) at statutory federal rate |   | $                                  | (965   | )                                        | $      | (3,477                         | )      | $ | 5,445 |   | $ | 13,044 |   |
| State and local taxes, net of federal benefit  |   | (107                               | )      | (431                                     | )      | 585                            |   | 1,453 |   |
| Valuation allowance for deferred tax asset     |   | 1,143                              |   |                                     |   |                           |   |   |   |
| Other                                          |   | 145                                |   | 11                                       |   | (374                           | )      | 38 |   |
| Total tax provision                            |   | $                                  | 216    |                                     | $      | (3,897                         | )      | $ | 5,656 |   | $ | 14,535 |   |

 

**I. Commitments**

 

At December 31, 2001 aggregate net minimum rental commitments undernoncancelable operating leases having an initial or remaining term of more thanone year are payable as follows:

 
| *(In  thousands)*         |   |   |   |   |
|---------------------------|--------|--------|--------|--------|
| Year ending  December 31, |   | 2002   |   | $      | 6,117 |
|                      |   | 2003   |   | 5,475  |
|                      |   | 2004   |   | 3,958  |
|                      |   | 2005   |   | 3,533  |
|                      |   | 2006   |   | 2,293  |
|                      |   | Later  |   | 2,485  |
| Total minimum  obligation |   |   |   | $      | 23,861 |

 

Rent expense, primarily for office facilities, for the year endedDecember 31, 2001, the six months ended December 31, 2000 and the years endedJune 30, 2000 and 1999 was $5,570,000, $2,928,000, $5,761,000 and $5,879,000,respectively.

 

The Company has compensation arrangements with its corporate officersand certain other employees which provide for certain payments in the event ofa change of control of the Company.

 

The Company also sponsors a 401(k) plan. Substantially all employeesare eligible to participate and may contribute up to 15% of their pretaxearnings, subject to IRS maximum contribution amounts. The Company makesmatching contributions to the plan up to a specified percentage. The Company’scompleted five years of service and for the year ended December 31, 2001, thesix months ended December 31, 2000 and the years ended June 30, 2000 and 1999amounted to approximately $1,208,000, $492,000, $1,389,000 and $1,439,000,respectively.

 

**J. Business Acquisitions**

 

On April 25, 2000, the Company purchased an 80.1% interest inSequoiaNET.com for $43.5 million. To complete the transaction the Companyutilized $30.5 million of its cash balances and drew down $13.0 million on itsline of credit. Effective December 29, 2000, the Company purchased theremaining 19.9% of SequoiaNET.com in exchange for common stock valued at$6,069,000 and $3,323,000 of notes payable. SequoiaNET.com provides networkinstallation and support services and other eBusiness services. SequoiaNET.comreported $57.7 million in revenues with pretax profits of $3.8 million for theyear ended December 31, 1999. The purchase of SequoiaNET.com has been accountedfor under the purchase method of accounting. Accordingly, the assets acquired,including customer and employee-based intangibles, are recorded at their fairvalues at the date of acquisition and amortized on a straight-line basis overperiods ranging from 3 to 18 years.

 

The following represents the pro forma operating results for theCompany assuming the acquisition of 100% of Sequoia NET.com had occurred onJuly 1, 1998:

 
|                                           |   | **Six  Months Ended December 31,** |    | **Year  Ended June 30,**  |   |
|------------------------------------------------|--------|------------------------------------|---------|---------------------------|--------|
|                                           |   | **2000**                           |    | **2000**                  |   | **1999** |   |
| *(In thousands except for per share  amounts)* |   | **As**

**Reported**               |    | ** **

**Pro Forma** |   | **As**

**Reported** |   | **Pro Forma** |   | **As**

**Reported** |   | **Pro Forma** |   |
|                                           |   |                               |    |                      |   |   |
| Total revenues                                 |   | $                                  | 226,706 |                      | $      | 226,706 |   | $ | 558,731 |   | $ | 608,029 |   | $ | 620,156 |   | $ | 672,217 |   |
| Net (loss) income                              |   | (6,302                             | )       | (6,273                    | )      | 9,788 |   | 9,975 |   | 22,733 |   | 20,154 |   |
| (Loss) income per share (diluted)              |   | (.28                               | )       | (.26                      | )      | .43 |   | .41 |   | 1.00 |   | .83 |   |
|                                                |        |                                    |         |                           |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

27

----

 

On November 6, 1998, the Company acquired specific assets and assumedcertain liabilities of Enterprise Solutions, Inc., a Minneapolis,Minnesota-based provider of software services. On February 26, 1999, theCompany acquired all of the assets of Real World Training Systems LLC, aPhoenix, Arizona-based provider of software services. The amount paid inconnection with these purchases was approximately $4.2 million which was paidwith internal funds. These acquisitions were accounted for under the purchasemethod of accounting. Accordingly, the assets acquired, primarily accountsreceivable and property and equipment, were recorded at their estimated fairvalues as of the date of acquisition. The excess of the purchase price over theestimated fair value of the assets acquired was recorded as goodwill and isbeing amortized on a straight-line basis over periods of 3 to 12 years.

 

**K.Restructuring Charge**

 

In December 2000, the Company recorded a restructuring charge of $7.0million. Of this charge, $2.6 million related to workforce reductions ofapproximately 120 employees (primarily non-billable staff). In addition, theCompany has consolidated its six regions to four and its 45 branch and fieldlocations to 15 district sales offices. While the Company maintains a presencein most of the 30 locations which were not converted to district sales offices,the need for office space in these locations has declined. As a result, theCompany has established a reserve of $4.4 million to cover lease terminationand abandonment costs (net of sublease income) including an amount for assetsto be disposed of in conjunction with this consolidation. 

 

A summary of the restructuring charge is as follows:

 
|                         |   | **Workforce** |   | **Office  Closure/** |   |      |   |
|------------------------------|--------|---------------|--------|----------------------|--------|-----------|--------|
| ***(In thousands)***         |   | **Reduction** |   | **Consolidation**    |   | **Total** |   |
| Restructuring charge         |   | $             | 2,600  |                 | $      | 4,400     |   | $ | 7,000 |   |
| Cash expenditures            |   | 396           |   | —               |   | 396       |   |
| Non-cash charges             |   | —        |   | 56                   |   | 56        |   |
| Balance at December 31, 2000 |   | $             | 2,204  |                 | $      | 4,344     |   | $ | 6,548 |   |
|                         |   |          |   |                 |   |      |   |
| Cash expenditures            |   | 2,180         |   | 1,517                |   | 3,697     |   |
| Non-cash charges             |   | —        |   | 197                  |   | 197       |   |
| Balance at December 31, 2001 |   | $             | 24     |                 | $      | 2,630     |   | $ | 2,654 |   |

 

During the second quarter of fiscal 2001, in response to a weakeningreal estate market, and to better manage its resources, the Company chose notto pay substantial lump sum fees to terminate many of its leases. Instead, theCompany has abandoned and is attempting to sublease these spaces. As a resultof this change, the Company has reclassified $1.4 million of the OfficeClosure/Consolidation reserve to a long-term liability.

 

 

28

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**Independent Auditors’ Report**

 

 

Shareholders and Board of Directors

Analysts International Corporation

Minneapolis, Minnesota

 

We have audited the accompanying consolidated balance sheets ofAnalysts International Corporation and its subsidiaries (the Company) as ofDecember 31, 2001 and 2000 and the related consolidated statements ofoperations, equity and cash flows for the year ended December 31, 2001, thesix-month period ended December 31, 2000 and each of the two years in theperiod ended June 30, 2000. These consolidated financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that we planand perform the audit to obtain reasonable assurance about whether theconsolidated financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the consolidated financial statements. An audit also includes assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall consolidated financial statement presentation.We believe our audits provide a reasonable basis for our opinion. 

 

In our opinion, such consolidated financial statements present fairly,in all material respects, the consolidated financial position of the Company asof December 31, 2001 and 2000, and the results of their operations and theircash flows for the year ended December 31, 2001, the six-month period endedDecember 31, 2000 and each of the two years in the period ended June 30, 2000,in conformity with accounting principles generally accepted in the UnitedStates of America.

 

 

/s/ Deloitte & Tousche LLP

 

Minneapolis,Minnesota

February 27, 2002(March 18, 2002 as to the last paragraph of Note E)

 

 

29

----

 

**Report of Management**

 

The consolidatedfinancial statements of Analysts International Corporation published in thisreport were prepared by company management, which is responsible for theirintegrity and objectivity. The statements have been prepared in accordance withaccounting principles generally accepted in the United States of Americaapplying certain estimates and judgments as required. The financial informationelsewhere in this report is consistent with the statements.

 

AnalystsInternational maintains internal controls adequate to provide reasonableassurance its transactions are appropriately recorded and reported, its assetsare protected and its established policies are followed. The structure isenforced by written policies and procedures, internal audit activities and aqualified financial staff.

 

Our independentauditors, Deloitte & Touche LLP, provide an objective independent review byaudit of Analysts International’s consolidated financial statements and withauditing standards generally accepted in the United States of America.

 

The AuditCommittee of the Board of Directors, comprised solely of outside directors,meets with the independent auditors and representatives from management toappraise the adequacy and effectiveness of the audit functions, internalcontrols and quality of our financial accounting and reporting.

 

 
| /s/ Frederick W.  Lang                |   | /s/ Marti R.  Charpentier              |
|---------------------------------------|--------|----------------------------------------|
| Frederick W.  Lang                    |   | Marti R.  Charpentier                  |
| Chairman and  Chief Executive Officer |   | Vice President,  Finance and Treasurer |

 

 

**Stock Data**

 
|                                           |   | **Market  Range** |   | **Dividend** |   |
|------------------------------------------------|--------|-------------------|--------|--------------|--------|
| **Fiscal  Year Ended December 31, 2001**       |   | **High**          |   | **Low**      |   | **Close** |   | **Declared** |   |
| Fourth Quarter                                 |   | $                 | 4.35   |         | $      | 2.43 |   | $ | 4.13 |   | $ | .00 |   |
| Third Quarter                                  |   | 5.50              |   | 2.67         |   | 5.08 |   | .00 |   |
| Second Quarter                                 |   | 7.00              |   | 3.81         |   | 5.46 |   | .01 |   |
| First Quarter                                  |   | 7.88              |   | 3.63         |   | 7.13 |   | .03 |   |
|                                           |   |              |   |         |   |   |   |   |   |
| **Transition Period Ended December 31,  2000** |   |              |   |         |   |   |   |   |   |
| Second Quarter                                 |   | $                 | 6.94   |         | $      | 3.19 |   | $ | 3.81 |   | $ | .06 |   |
| First Quarter                                  |   | 9.88              |   | 6.88         |   | 7.22 |   | .10 |   |
|                                           |   |              |   |         |   |   |   |   |   |
| **Fiscal Year Ended June 30, 2000**            |   |              |   |         |   |   |   |   |   |
| Fourth Quarter                                 |   | $                 | 12.94  |         | $      | 7.75 |   | $ | 11.13 |   | $ | .10 |   |
| Third Quarter                                  |   | 15.50             |   | 9.38         |   | 12.88 |   | .10 |   |
| Second Quarter                                 |   | 12.94             |   | 8.63         |   | 12.50 |   | .10 |   |
| First Quarter                                  |   | 15.94             |   | 9.88         |   | 14.13 |   | .10 |   |

 

The Company’s common shares are traded on The NasdaqStock Market® under the symbol ANLY. As of March 8, 2002, there wereapproximately 1,300 shareholders of record and approximately 7,500 shareholdersfor whom securities firms act as nominees. The above table sets forth for theperiods indicated the market prices for the as reported by Nasdaq and dividendsdeclared for each quarterly period.

 

The Board of Directors had adopted a policy ofdeclaring regular quarterly dividends subject to favorable earnings, cash flowand the Company’s debt agreement obligations. During the quarter endedSeptember 30, 2001, the Board elected to suspend the quarterly dividend toretain capital. There can be no assurance the Company will be able to reinstatea dividend paying policy.

 

*Sales of Unregistered Securities*

On December 29,2000, the Company acquired the 19.9% of SequoiaNET.com it previously did notown in a business combination accounted for as a purchase. The Company issued1,588,000 shares of its common stock, having an aggregate value of $6.1million, to the former shareholders of SequoiaNET.com. In addition, the Companyexchanged 386,216 options to purchase common stock of SequoiaNET.com for193,108 non-qualified options to purchase common stock of the Company. Theseshares were not registered under the Securities Act of 1933. The unregisteredshares were issued in reliance upon Section 4(2) of the Securities Act of 1933,as amended, as a sale by the Company not involving a public offering. Nounderwriters were involved with such issuance of common stock.

 

 

30

----

 

**Five Year Financial Summary**

 

 
|                                                     |   |                                                     |    | **Six  Months Ended**

**December  31** |             |       |   |       |    |
|----------------------------------------------------------|--------|----------------------------------------------------------|---------|-----------------------------------------|------------------|------------|--------|------------|---------|
|                                                     |   | **Fiscal  Year**                                         |    |                                    | **Fiscal  Year** |       |
|                                                     |   | **2001**                                                 |    | **2000**                                |             | **2000**   |   | **1999**   |    | **1998** |   | **1997*** |   |
|                                                     |   | **(Dollars in thousands except for per  share amounts)** |    |
| Professional services revenues:                          |   |                                                     |    |                                    |             |       |   |       |    |   |   |   |   |
| Provided directly                                        |   | $                                                        | 411,387 |                                    | $                | 226,706    |   | $          | 420,140 |   | $ | 480,790 |   | $ | 454,339 |   | $ | 344,790 |   |
| Provided through subsuppliers                            |   | 140,340                                                  |    | 61,634                                  |             | 138,591    |   | 139,366    |    | 133,072 |   | 94,756 |   |
| Total revenues                                           |   | 551,727                                                  |    | 288,340                                 |             | 558,731    |   | 620,156    |    | 587,411 |   | 439,546 |   |
| Salaries, contracted services and direct charges         |   | 457,706                                                  |    | 235,238                                 |             | 452,334    |   | 486,816    |    | 457,318 |   | 340,483 |   |
| Amortization of goodwill and other intangible assets     |   | 3,212                                                    |    | 1,370                                   |             | 1,025      |   | 415        |    | 277 |   | 277 |   |
| Restructuring charges                                    |   | —                                                   |    | 7,000                                   |             | —     |   | —     |    | — |   | — |   |
| Non-operating income                                     |   | 247                                                      |    | 68                                      |             | 1,452      |   | 1,408      |    | 1,299 |   | 1,045 |   |
| Loss on investment                                       |   | 3,012                                                    |    | —                                  |             | —     |   | —     |    | — |   | — |   |
| Interest expense                                         |   | 2,899                                                    |    | 1,494                                   |             | 1,584      |   | 178        |    | — |   | — |   |
| (Loss) income before income taxes and minority  interest |   | (2,764                                                   | )       | (9,933                                  | )                | 15,557     |   | 37,268     |    | 37,687 |   | 27,210 |   |
| Income taxes (benefit) and minority interest             |   | 216                                                      |    | (3,631                                  | )                | 5,769      |   | 14,535     |    | 15,077 |   | 10,829 |   |
| Net (loss) income                                        |   | (2,980                                                   | )       | (6,302                                  | )                | 9,788      |   | 22,733     |    | 22,610 |   | 16,381 |   |
|                                                     |   |                                                     |    |                                    |             |       |   |       |    |   |   |   |   |
| Total assets                                             |   | 192,884                                                  |    | 201,729                                 |             | 192,144    |   | 186,216    |    | 132,661 |   | 105,370 |   |
| Long-term liabilities                                    |   | 7,588                                                    |    | 45,615                                  |             | 41,739     |   | 27,534     |    | 7,171 |   | 6,444 |   |
| Shareholders’ equity                                |   | 91,083                                                   |    | 95,083                                  |             | 99,053     |   | 98,014     |    | 82,994 |   | 66,104 |   |
| Per share data:                                          |   |                                                     |    |                                    |             |       |   |       |    |   |   |   |   |
| Net (loss) income (basic)                                |   | (.12                                                     | )       | (.28                                    | )                | .43        |   | 1.01       |    | 1.01 |   | .74 |   |
| Net (loss) income (diluted)                              |   | (.12                                                     | )       | (.28                                    | )                | .43        |   | 1.00       |    | .99 |   | .73 |   |
| Cash dividends                                           |   | .10                                                      |    | .20                                     |             | .40        |   | .40        |    | .31 |   | .24 |   |
| Shareholders’ equity                                |   | 3.76                                                     |    | 3.93                                    |             | 4.38       |   | 4.35       |    | 3.70 |   | 2.97 |   |
| Average common shares outstanding                        |   | 24,196,000                                               |    | 22,624,000                              |             | 22,583,000 |   | 22,524,000 |    | 22,376,000 |   | 22,095,000 |   |
| Average common and common equivalent shares  outstanding |   | 24,196,000                                               |    | 22,624,000                              |             | 22,624,000 |   | 22,732,000 |    | 22,829,000 |   | 22,544,000 |   |
| Number of personnel                                      |   | 3,800                                                    |    | 4,750                                   |             | 4,800      |   | 4,900      |    | 5,300 |   | 4,650 |   |
|                                                          |        |                                                          |         |                                         |                  |            |        |            |         |  |  |  |  |  |  |  |  |  |  |

----

*Per share data and average shares outstanding wererestated for the effect of the 3-for-2 common stock split in the form of a 50%stock dividend paid December 3, 1997.

We changed ourfiscal year end to December 31 from June 30, effective December 31, 2000.Accordingly, we have presented financial information for the six months endedDecember 31, 2000 (the transition period).

 

 

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**QuarterlyRevenues and Income**

** **

The followingtable sets forth certain statements of operations data for each of the quartersindicated below, and in the opinion of management, contains all adjustments,consisting only of normal recurring adjustments, necessary for a fairpresentation thereof.

 
|                                  |   | **Quarter  Ended**                                       |    | **Quarter  Ended** |   | **Quarter  Ended** |   | **Quarter  Ended** |    |      |   |
|---------------------------------------|--------|----------------------------------------------------------|---------|--------------------|--------|--------------------|--------|--------------------|---------|-----------|--------|
|                                  |   | **March  31**                                            |    | **June  30**       |   | **September  30**  |   | **December  31**   |    | **Total** |   |
|                                  |   | **(Dollars in thousands except for per  share amounts)** |    |
| **Fiscal 2001**                       |   |                                                     |    |               |   |               |   |               |    |      |   |
| Total revenues                        |   | $                                                        | 144,440 |               | $      | 145,793            |   | $                  | 136,996 |      | $      | 124,498 |   | $ | 551,727 |   |
| Income (loss) before income taxes     |   | 1,243                                                    |    | 606                |   | 52                 |   | (4,665             | )       | (2,764    | )      |
| Income taxes (benefit)                |   | 472                                                      |    | 233                |   | 20                 |   | (509               | )       | 216       |   |
| Net income (loss)                     |   | 771                                                      |    | 373                |   | 32                 |   | (4,156             | )       | (2,980    | )      |
| Net income (loss) per share (basic)   |   | .03                                                      |    | .02                |   | .00                |   | (.17               | )       | (.12      | )      |
| Net income (loss) per share (diluted) |   | .03                                                      |    | .02                |   | .00                |   | (.17               | )       | (.12      | )      |
|                                       |        |                                                          |         |                    |        |                    |        |                    |         |           |        |  |  |  |  |  |

 
|                                                     |   | **Quarter  Ended** |    | **Quarter Ended** |   | **Quarter Ended** |   | **Quarter Ended** |    |      |   |
|----------------------------------------------------------|--------|--------------------|---------|-------------------|--------|-------------------|--------|-------------------|---------|-----------|--------|
|                                                     |   | **September  30**  |    | **December 31**   |   | **March 31**      |   | **June 30**       |    | **Total** |   |
| **Six Months Ended December 31, 2000**                   |   |               |    |              |   |              |   |              |    |      |   |
| Total revenues                                           |   | $                  | 148,571 |              | $      | 139,769           |   | N/A               |    | N/A       |   | $ | 288,340 |   |
| Income (loss) before income taxes and minority  interest |   | 3,064              |    | (12,997           | )      | N/A               |   | N/A               |    | (9,933    | )      |
| Income taxes (benefit) and minority interest             |   | 1,359              |    | (4,990            | )      | N/A               |   | N/A               |    | (3,631    | )      |
| Net income (loss)                                        |   | 1,705              |    | (8,007            | )      | N/A               |   | N/A               |    | (6,302    | )      |
| Net income (loss) per share (basic)                      |   | .08                |    | (.35              | )      | N/A               |   | N/A               |    | (.28      | )      |
| Net income (loss) per share (diluted)                    |   | .08                |    | (.35              | )      | N/A               |   | N/A               |    | (.28      | )      |
|                                                     |   |               |    |              |   |              |   |              |    |      |   |
| **Fiscal 2000**                                          |   |               |    |              |   |              |   |              |    |      |   |
| Total revenues                                           |   | $                  | 149,045 |              | $      | 138,869           |   | $                 | 132,455 |      | $      | 138,362 |   | $ | 558,731 |   |
| Income before income taxes and minority interest         |   | 6,190              |    | 3,828             |   | 2,803             |   | 2,736             |    | 15,557    |   |
| Income taxes and minority interest                       |   | 2,414              |    | 1,494             |   | 1,073             |   | 788               |    | 5,769     |   |
| Net income                                               |   | 3,776              |    | 2,334             |   | 1,730             |   | 1,948             |    | 9,788     |   |
| Net income per share (basic)                             |   | .17                |    | .10               |   | .08               |   | .09               |    | .43       |   |
| Net income per share (diluted)                           |   | .17                |    | .10               |   | .08               |   | .09               |    | .43       |   |
|                                                     |   |               |    |              |   |              |   |              |    |      |   |
| **Fiscal 1999**                                          |   |               |    |              |   |              |   |              |    |      |   |
| Total revenues                                           |   | $                  | 158,464 |              | $      | 152,986           |   | $                 | 154,128 |      | $      | 154,578 |   | $ | 620,156 |   |
| Income before income taxes                               |   | 10,193             |    | 8,136             |   | 9,357             |   | 9,582             |    | 37,268    |   |
| Income taxes                                             |   | 4,067              |    | 3,175             |   | 3,652             |   | 3,641             |    | 14,535    |   |
| Net income                                               |   | 6,126              |    | 4,961             |   | 5,705             |   | 5,941             |    | 22,733    |   |
| Net income per share (basic)                             |   | .27                |    | .22               |   | .26               |   | .26               |    | 1.01      |   |
| Net income per share (diluted)                           |   | .27                |    | .22               |   | .25               |   | .26               |    | 1.00      |   |

 

 

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**Corporate Information**

 

 
| **Board  of Directors**        | **Officers**                        | **10-K  Available**                       |
|--------------------------------|-------------------------------------|-------------------------------------------|
|                           |                                |                                      |
| **Frederick  W. Lang**         | **Frederick  W. Lang**              | A copy of the                             |
| Chairman and                   | Chairman and                        | Report on Form  10-K, filed with the      |
| Chief Executive Officer        | Chief Executive Officer             | Securities and  Exchange Commission, is   |
|                           |                                | available to  security holders without    |
|                           |                                | charge upon  request to the Treasurer at: |
| **Michael  J. LaVelle**        | **Michael  J. LaVelle**             | Analysts  International Corporation,      |
| President and                  | President and                       | 3601 West 76th  Street, Minneapolis,      |
| Chief Operating Officer        | Chief Operating Officer             | Minnesota  55435-3000.                    |
|                           |                                |                                      |
| **John  D. Bamberger**         | **Sarah  P. Spiess**                | **Stock  Transfer Agent**                 |
| Senior Vice  President, Sales  | Executive Vice  President           |                                      |
| and Operations                 |                                | EquiServe Trust  Company, N.A.            |
|                           |                                | P.O. Box 43011                            |
|                           | **Paulette  M. Quist**              | Providence,  Rhode Island 02940-3011      |
| **Willis  K. Drake**           | Senior Vice  President,             | Shareholder  Inquiries:                   |
| Retired Chairman  of the Board | National Business Practices         | 800-426-5523                              |
| Data Card Corporation          |                                | http://www.equiserve.com                  |
|                           | **John  D. Bamberger**              |                                      |
| **Margaret  A. Loftus**        | Senior Vice  President,             | **Independant  Auditors**                 |
| Principal                      | Sales and  Operations               |                                      |
| Loftus  Brown-Wescott, Inc.    |                                | Deloitte &  Touche LLP                |
|                           |                                | Minneapolis,  Minnesota                   |
|                           | **Colleen  M. Davenport**           |                                      |
| **Edward  M. Mahoney**         | Secretary and  General Counsel      |                                      |
| Retired Chairman  and          |                                | **Quarterly  Reports**                    |
| Chief Executive Officer        |                                |                                      |
| Fortis  Investors, Inc. and    | **Charles  E. Jones**               | Analysts  International Corporation       |
| Fortis Advisers, Inc.          | Assistant  Secretary and            | mails quarterly  earnings releases to     |
|                           | Associate General Counsel           | registered  shareholders.                 |
|                           |                                |                                      |
| **Robb  L. Prince**            |                                |                                      |
| Retired Vice  President        | **Marti  R. Charpentier**           | **World  Wide Web Address**               |
| and Treasurer                  | Vice President,                     |                                      |
| Jostens, Inc.                  | Finance and Treasurer               | www.analysts.com                          |
|                           |                                |                                      |
|                           | **David  J. Steichen**              |                                      |
|                           | Controller and  Assistant Treasurer |                                      |

 

 

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**Analysts International Corporation**

3601West 76th Street

Minneapolis,Minnesota  55435-3000

 

Telephone:  952 835-5900

www.analysts.com

 

 

 

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