**EXHIBIT
13**





[COVER]





Analysts
International








Annual
Report





2004

















Emerging
Technologies





Strong
Alliances





Fundamental
Values







[INSIDE
COVER]








Forward
Looking Statements





Statements
contained in the letter from the CEO and the President and in “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” that
are not strictly historical fact, are forward-looking statements. Words such as
“believes,” “intends,” “possible,” “expects,” “estimates,” “anticipates,” or
“plans” and similar expressions are intended to identify forward-looking
statements. Any forward-looking statements in this release are made pursuant to
the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. Such statements are based on the Company’s current expectations relating
to future revenues, earnings, results of operations and future sales or growth.
The Company’s actual results may vary materially from those projected due to
certain risks and uncertainties such as the general state of the economy, volume
of business activity, continued need for our services by current and prospective
clients, our ability to integrate acquisitions effectively, client cancellations
or re-bidding of work, the Company’s ability to control and improve profit
margins, including our ability to control operating and labor costs and hourly
rates for our services, the availability and utilization of qualified technical
personnel and other similar factors.













Financial
Highlights








***(Dollars
      in thousands except per share amounts)***
    
    **Year
      Ended**
      **January
      1, 2005**
    
    **Year
      Ended**
      **January
      3, 2004**Revenue:Professional
      services provided directly
    
    $
    269,610
    
    $
    266,175Professional
      services provided through subsuppliers
    
    
    55,806
    
    
    50,543Product
      sales
    
    
    16,196
    
    
    15,181Total
      revenue
    
    
    341,612
    
    
    331,899Income
      (loss) before income taxes
    
    
    3,852
    
    
    (1,524
    )Net
      income (loss)
    
    
    3,852
    
    
    (1,524
    )Per
      share of common stock:Net
      income (loss)*(diluted)*
    
    
    .16
    
    
    (.06
    )Shareholders’
      equity
    
    
    3.00
    
    
    2.84Dividends
      declared
    
    
    .00
    
    
    .00Average
      common and common equivalentshares
      outstanding*(in
      thousands)*
    
    
    24,398
    
    
    24,201Number
      of personnel
    
    
    3,015
    
    
    3,000Working
      capital
    
    $
    40,820
    
    $
    35,665Current
      ratio
    
    
    2.41
    
    
    2.22




1








Congratulations to you, our employees, customers and
management, for helping us complete a successful year of operations, evidenced
by our return to revenue growth and profitability.



Our revenues grew to $341.6 million from $331.9 million reported one
year ago. We were profitable for all four quarters of 2004. Our net profit for
the year was $3.9 million, or $0.16 per share, compared to a net loss of ($1.5)
million, or ($0.06) per share in fiscal 2003.



We are especially pleased to report our successful year during a time
of change and opportunity throughout our industry. Over the past six months we
have identified three opportunities within our industry: 1) the desire of high
volume staffing customers to adopt the next generation staffing model, 2) the
desire of mid-market clients to build and sustain strong infrastructure services
with world class technology leaders, and 3) the need for companies in our
industry to consolidate to create larger but more flexible and efficient IT
service and solution providers. We believe we are well positioned to take
advantage of and benefit from these opportunities. Let’s address each of
these.



Next Generation Staffing



Based on work we began in 2002, we are developing a transformational
workforce deployment and human capital management system which assists our
clients with maximizing their return on investment and improving service levels
to consultants and customers. As a part of this ongoing work, in October of 2003
we created New Equities. New Equities combines an Internet-centric technology
with our vast experience in the staffing business. Our customers’ response to
our vision and hard work and, specifically, to New Equities has been very
positive and encouraging.



Mid-market Opportunity



Many mid-sized companies are looking to build or rebuild strong
technology infrastructure. They wish to partner with a single services and
solutions provider with strong, long-standing alliances with world-class
technology leaders. These providers have a focused set of services and solutions
built around high-demand, emerging technologies. In 2004 we significantly
refocused our offerings around our relationships with technology leaders and
sought ways to enhance our expertise in emerging technologies such as IP
Communications. Our January 2005 acquisition of WireSpeed Networks LLC, an IP
Communications and wireless networking company, reflects our commitment to this
opportunity and to meeting the needs of mid-market customers.



Consolidation



Over the next 12 to 18 months, we expect that a number of companies
in our industry will seek strategic alliances to enhance growth and
profitability. As a result, we expect significant consolidation throughout our
industry. We believe that we are well-positioned to benefit



2




[PHOTO]





from this opportunity, having one of the industry’s strongest balance
sheets, a strong customer base and a broad geographic presence. We continue to
evaluate our position in the marketplace and to investigate possible strategic
alternatives that may enhance our operations and shareholder value. In addition,
we believe that the way in which we have met and managed the challenges of the
past five to six years demonstrates our resilience, our stability and our
commitment to meet and exceed the expectations of our customers, consultants and
shareholders.



This annual report marks the first since Jeff Baker joined our
executive management team in June of 2004 as President. During this challenging
and exciting time Jeff will lead us on a number of fronts. As an accomplished
executive, Jeff has the experience to identify, pursue and secure large scale
engagements, to identify, pursue and secure strategic acquisitions involving
emerging technologies and to continue to develop and deepen strategic alliances
with technology’s best-known leaders. Jeff will be responsible for positioning
the Company in a way that best rewards shareholders in what we have already
defined as a consolidating industry.  We are also pleased to note that
joining Jeff on our executive management team in 2004 was David J. Steichen, who
was named the Company’s Chief Financial Officer and Treasurer in June.



In closing, our Board of Directors and executive management team are
excited and optimistic about our future. We thank you, our customers, employees
and management, for your continuing interest and support.



Sincerely,





/s/
      Michael J. LaVelle
    
    /s/
      Jeffrey P. BakerMichael
      J. LaVelle
    
    Jeffrey
      P. BakerChief
      Executive Officer
    
    President






3




Company Overview





[PHOTO]

“Our employees remain our best source of referrals.  They are
because they appreciate our loyalty, our integrity and our commitment to
excellence.”



Sandra Jackson – Technical Recruiter

San Francisco, California







Emerging Technologies



Strong Alliances



Fundamental Values





Analysts International is a global technology services company.
Committed to helping businesses become more adaptive, competitive and
profitable, we help our clients achieve sustained growth through the intelligent
application of technology solutions, including emerging and cutting edge
technologies. We partner with technology leaders to bring our customers the
products and services they need to achieve their business goals. Strong
alliances enhance our capabilities, expand our portfolio of services and open
new channels of opportunity for our customers. Our customers benefit from the
increased value partnering brings to our service offerings. And our partners
extend their capabilities as well as their market presence. Our lines of
business include technology integration services for applications and hardware;
advisory services for optimizing IT investments; outsourcing services with
local, national and international capabilities; and staffing services to support
human capital management needs.



Our people include the industry’s best and we firmly believe that
they are our single greatest resource, committed to excellence, technology and
innovation. We are pleased to profile the following five employees. They are but
a small cross section of the 3000 or so employees who represent us every day in
this very challenging, competitive marketplace.



4










“We have a team based approach that allows
clients to get the best that we have to offer and also allows each of us to work
with the best we have to offer.”



Amit Bhati –
Consultant

Minneapolis,
Minnesota





Sandra Jackson is an anomaly in the highly
charged and competitive technology recruiting and staffing industry. She has
been with Analysts International for 10 years and a recruiter the entire time,
based in San Francisco, California. “I love putting people to work in
challenging and exciting environments and I love doing it for Analysts
International. One of the most gratifying aspects of my job is finding the right
resource for a client's team that is developing an exciting product - whether it
is a sysplex storage system that keeps our credit card transactions up and
running, or creating disaster security systems, or creating software for
life-saving technologies. Some years ago we were named one of the best places to
work in Information Technology. What was true then is true today.” Sandra gets
the tools and resources she needs in today’s market. “The market has never been
more competitive. Companies need to constantly come up with ways to remain
relevant to consultants and to clients and Analysts International has managed to
do that for me, and for our clients and consultants.” Sandra believes that she
has one of the industry’s very best resources to do her job- current employees.
“Our employees remain our best source of referrals. They are because they
appreciate our loyalty, our integrity and our commitment to excellence.”



Amit Bhati is a Minneapolis-based consultant who has been
employed by Analysts International for the past ten years. He thoroughly enjoys
his work in the Enterprise Solutions Group, where he does project-based
consulting, specializing in front-end, web-based sell-side solutions and
business process automation. Amit believes that his relatively long tenure at
Analysts International is a significant differentiator in an industry that is
not known for stability or its loyalty. “Analysts International has always had a
formula that actively encourages people to work from their home base. In
addition, by stressing our consultants’ proven experience and expertise with a
specific number of products and





5








[PHOTO]

“It’s great working with the latest
technology and I have the privilege of working with a great team of people.”



Maia D’Amato – Server
Infrastructure Manager

Auburn
Hills, Michigan







technologies from world class providers, we can build and sustain
solutions with a maturity and confidence which is never trendy, but always
strategically focused and client-driven.” He believes that some of the things
that make Analysts International a great place to work also make it a great
solutions provider, “We have a team based approach that allows clients to get
the best that we have to offer and also allows each of us to work with the best
we have to offer.”



Maia D’Amato has spent seven and one-half years with Analysts
International and Sequoia Services Group in Auburn Hills, Michigan. Maia
currently is Server Infrastructure Manager for User Support Services, where she
manages the server/desktop and USS helpdesk teams. Maia has also worked with
e-mail systems for the past five years, with a special emphasis in Microsoft
Exchange®. Day-to-day, Maia’s work includes design and implementation of
corporate systems, assisting in support with current systems, and working with
her teams to make positive changes for our users. With her expertise in email
she also works with the Hosting Practice developing and supporting hosted email
solutions sold to external customers. “It’s great working with the latest
technology and I have the privilege of working with a great team of people.
We’re all committed to making our users happy and helping them get the most out
of their technology and our service offerings.”



Jason McClure is a Kansas City-based consultant currently
working on a major project for a Des Moines--based financial services company.
Prior to joining Analysts International in October of 2004, Jason had the
experience of knowing members of a team of consultants from Analysts
International. “I was very impressed by the confidence and competence of the
team members and also impressed with the level of resources and expertise that
Analysts made available to support them.” Jason had an opportunity to join



6




[PHOTO]                                                                                                                                                                                                                  
[PHOTO]

“I was also impressed with the level of resources and expertise that
Analysts made available to support its consultants.”



< Jason McClure – Consultant, Kansas City,
Missouri



“Cisco wants partners who are as good at delivering the total
solution as they are with the technology itself.”



>
Gregg Jankowski – Leader IP Communications

Solutions
Practice, Auburn Hills, Michigan





Analysts International when a recruiter called him about the project
that he manages today. “This is the best professional experience of my life. As
project manager for Analysts International I get to meet and to work with people
at all levels of our client. It’s especially fulfilling to touch every aspect of
the client’s business and assist them in meeting their strategic business goals
and objectives.”



Gregg Jankowski joined Analysts International from Cisco
Systems Inc., where he had been a regional engineering manager. “After earning
my MBA from the University of Michigan in 2003, I was looking for an opportunity
that would allow me to do more with the client and the client’s business.
Analysts International offered me that opportunity.” Today, as the leader of
Analysts International’s IP Communications Solutions Practice in Auburn Hills,
Michigan, Gregg is involved in all aspects of sales and service. “It’s
particularly rewarding to use the business skills that I have learned and
acquired to help sell and secure business.” Those skills include demonstrating
how clients will benefit and reap a significant return on investment from the
emerging technology that is IP Communications. “We can show our clients how IP
Communications can save them money and enhance business processes and overall
efficiency.” Given his background, Gregg also understands the value of Analysts
International’s strategic alliance with Cisco Systems. “Cisco wants partners who
are as good at delivering the total solution as they are with the technology
itself. That’s why we are good partners.”







Analysts International has established strong alliances with the
world’s technology leaders to bring customers the products, services and
emerging technologies that they require to achieve their business goals.






7




When our clients want to increase productivity, streamline complex
tasks and build customer relationships, we assist them by implementing Microsoft
technology. Our relationship with Microsoft allows us access to the most current
training and technology to support clients’ business needs. Additionally, our
access to 24x7 support from Microsoft helps us to deliver premium service for
clients’ mission critical applications.



When our clients need us to deliver and implement world-class IP
communications technology, we often rely on our relationship with Cisco Systems.
We specialize in IP Telephony, VPN Security and Wireless LAN, and we have the
training, skills and knowledge to help clients integrate Cisco networking
solutions into their enterprises. Our highly skilled network technicians are
evaluated annually to verify that they meet Cisco’s rigorous standards for
network expertise and support capabilities.



When our clients look to Lawson Software to assist in the management
of their enterprises- we are prepared. We have been a Lawson business partner
since 1995 and are one of only two partners certified to implement Lawson
upgrade services. Our technical and application consulting services, including
custom modifications, data conversions and third party integrations, help
clients unlock the potential of their Lawson enterprise software.



Our other industry alliances enable us to provide our clients with
products and services to administer and protect their critical data with
industry-leading solutions for information storage and management. These
alliances also allow us to help clients free internal resources to focus on core
competencies while streamlining their organizations through the use of offshore
expertise and resources.



“Emerging
Technologies, Fundamental Values and Strong Alliances” ,




8


****


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





Overview





Total
revenue for the year ended January 1, 2005 (fiscal year 2004) was $342 million,
up from $332 million in the year ended January 3, 2004 (fiscal year 2003). The
increase included a 1.3% growth in revenue from services we supply directly to
customers, a 10.4% growth in revenue from services we provide to our clients
through subsuppliers, and a 6.7% increase in product sales. The increase in
subsupplier revenue is attributable to an increase in activity with one
significant client, and the increase in product sales is attributable primarily
to the growth in our VoIP (Voice over Internet Protocol or “IP Telephony”)
business where we are a reseller of Cisco products. In 2004 direct services
represented 78.9% of our revenues, compared to 80.2% in 2003. Our gross margin
improved from 18.3% in 2003 to 19.2% in 2004 while our gross margin on direct
services revenue increased from 21.9% in 2003 to 23.0% in 2004. Margin
improvement was a result of our success in controlling our direct labor and
benefit costs while slightly increasing our bill rates.





Net
income for the year was $3.9 million, compared with last year’s net loss of $1.5
million. On a diluted per share basis, net income for the year ended January 1,
2005 was $.16 per share, compared with a net loss of ($.06) per share last year.
At year-end, our financial position remained strong. With $7.9 million in cash,
no debt on the balance sheet and an unused revolving credit facility, we believe
we are well positioned to support future growth.





In
keeping with our focus on productivity and cost effectiveness in the staffing
business, we are concentrated on the key elements to our future success: (i) the
number and quality of requirements our sales organization brings to the Company
from new and existing clients; (ii) the number of qualified candidates our
recruiting organization submits against those requirements; and most importantly
(iii) the rate at which quality submittals turn into placements.





As a
result of this focus, the productivity of both our sales and recruiting staff
improved during 2004. During that period, average weekly requirements coming
from new and existing clients increased 31.7% over the prior year. Additionally,
during the same period average weekly candidate submittals against requirements
increased 27.7%. The improvements in these key indicators have not yet resulted
in a significant growth in technical headcount, however. While we are pleased
that weekly placements increased by six per week, an increase of 13.6%, average
weekly terminations of existing technical employees also increased, resulting in
a net increase in technical headcount of only ten during 2004. Unfortunately, as
the apparent modest recovery under way in the Information Technology (IT) market
continues, a decrease in the average length of assignments offset our
improvements in productivity during 2004.





We
believe that by continuing to focus on improving our placement rate, significant
headcount growth in 2005 is possible. Achievement of such growth is dependent
upon the continuation of increased sales and recruiting productivity, a
reduction in termination of technical personnel and continuation of the modest
recovery underway in the IT sector.





As
important as the above indicators are to growth of revenue, the bill rates we
are able to charge to clients and the margins we are able to obtain on those
bill rates are the key indicators of our profitability. Although we continue to
experience intense competition on average bill rates, we have seen bill rates
stabilize and increase slightly throughout 2004. Average hourly bill rates have
increased 1.1% from 2003 to 2004, and our average hourly margins on direct
billings have increased 1.2%. We believe that as the IT services market
continues its recovery, we will see bill rates and margins continue to show
marginal improvement in 2005; however, we do not expect to see a significant
improvement in these indicators until the demand for IT services and the supply
of IT resources return to balance.





In
addition, to enhance profitability in an environment of intense margin
pressures, we are focused on the following key objectives: i) implementing a
next generation staffing model, which will transform workforce deployment and
human capital management; ii) implementing a number of improvements around key
business processes that we believe will better align our business with the
market needs and allow us to build a more adaptive delivery model to drive
growth; iii) building a focused set of services and solutions around
high-demand, emerging technologies; and iv) being an active participant in the
significant consolidation taking place throughout the industry .





Critical
Accounting Estimates





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


9


*Estimates
of Future Operating Results*





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





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





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





*Allowance
for Doubtful Accounts*





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





*Accrual
of Unreported Medical Claims*





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





Critical
Accounting Policies





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





*Revenue
Recognition*





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





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





10


*Subsupplier
Revenue*





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





*Goodwill
and Other Intangible Impairment*





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





In
accordance with the provisions of SFAS 142, “Goodwill and Other Intangible
Assets,” effective January 1, 2002 we ceased amortization of certain intangible
assets including goodwill. Intangible assets with definite useful lives are
amortized over their useful lives and reviewed for impairment in accordance with
SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”
In conjunction with the adoption of the provisions of SFAS 142, we recorded a
goodwill impairment charge of $16.4 million during 2002. This impairment was
recorded as a cumulative effect of a change in accounting principle as of
January 1, 2002, and therefore did not impact operating income. The Company
completed its impairment analysis for 2004 during the first quarter and found no
indication of impairment of its recorded goodwill although the valuation
determined the fair value of the Infrastructure and Solutions reporting units to
approximate their carrying value. Additional write-downs of intangible assets
may be required if future valuations do not support current carrying
value.





During
the third quarter of 2004, the Company changed its designated date of the annual
evaluation of goodwill from the first day of the fiscal year to the last day of
its monthly accounting period for August. This change allows the Company to
perform testing at a point in the reporting cycle other than during the year-end
closing and reporting process so that additional resources are available. The
Company performed the test at September 4, 2004, and determined that no
impairment charge for goodwill was required, although the valuation determined
the fair value of the Staffing, Infrastructure and Solutions reporting units to
approximate their carrying value.





*Deferred
Taxes*





We
account for income taxes in accordance with SFAS No. 109, “Accounting for Income
Taxes,” which requires that deferred tax assets and liabilities be recognized
for the effect of temporary differences between reported income and income
considered taxable by the taxing authorities. SFAS 109 also requires the
resulting deferred tax assets to be reduced by a valuation allowance if some
portion or all of the deferred tax assets are not expected to be realized. Based
upon prior taxable income and estimates of future taxable income, we expect our
deferred tax assets, net of the established valuation allowance, will be fully
realized in the future. We recorded no income taxes during 2004 as income tax
expense, which would have been recorded, was negated by a reversal of previously
established reserves against deferred tax assets. If actual future taxable
income is less than we anticipate from our estimates, we may be required to
record an additional valuation allowance against our deferred tax assets
resulting in additional income tax expense, which will be recorded in our
consolidated statement of operations. If, however, we continue our recovery in
terms of profitability to a point where future realization of deferred tax
assets which are currently reserved, becomes "more likely than not,” we may be
required to reverse the existing valuation allowances resulting in an
income tax benefit.





*Restructuring*





We
recorded a restructuring charge and reserves associated with restructuring plans
approved by management in December 2000. The remaining reserve of $318,000 at
January 1, 2005, consists of estimates pertaining to real estate lease
obligations. Factors such as our ability to enter into subleases, the
creditworthiness of sublessees, and the ability to negotiate early termination
agreements with lessors could materially affect this real estate reserve. While
we believe our current estimates regarding lease obligations are adequate, our
inability to sublet the remaining space or obtain payments from sublessees could
necessitate significant adjustments to these estimates in the
future.


11


**RESULTS
OF OPERATIONS, YEAR ENDED JANUARY 1, 2005 VS. YEAR ENDED JANUARY 3, 2004**





The
following table illustrates the relationship between revenue and expense
categories and provides a count of employees and technical consultants for the
fiscal years ended January 1, 2005 (fiscal year 2004) versus January 3, 2004
(fiscal year 2003). The tables provide guidance in our explanation of our
operations and results.





****
    **Year
      Ended**
      **January
      1, 2005**
    ****
    **Year
      Ended**
      **January
      3, 2004**
    ****
    ****
      **Increase
      (Decrease)**
    ********
      ***(Dollars
      in thousands)***
    ****
    ****
      **Amount**
    ****
    **%
      of**
      **Revenue**
    ****
    ****
      **Amount**
    ****
    **%
      of**
      **Revenue**
    ****
    ****
      **Amount**
    ****
    **%**
      **Inc
      (Dec)**
    ****
    **As
      %**
      **of
      Revenue**Revenue:Professional
      services provided directly
    
    $
    269,610
    
    
    78.9
    %
    $
    266,175
    
    
    80.2
    %
    $
    3,435
    
    
    1.3
    %
    
    (1.3
    %)Professional
      services provided through subsuppliers
    
    
    55,806
    
    
    16.3
    
    
    50,543
    
    
    15.2
    
    
    5,263
    
    
    10.4
    
    
    1.1Product
      sales
    
    
    16,196
    
    
    4.8
    
    
    15,181
    
    
    4.6
    
    
    1,015
    
    
    6.7
    
    
    .2Total
      revenue
    
    
    341,612
    
    
    100.0
    
    
    331,899
    
    
    100.0
    
    
    9,713
    
    
    2.9
    
    
    .0Salaries,
      contracted services and direct charges
    
    
    261,005
    
    
    76.4
    
    
    256,643
    
    
    77.3
    
    
    4,362
    
    
    1.7
    
    
    (.9
    )Cost
      of product sales
    
    
    14,964
    
    
    4.4
    
    
    14,562
    
    
    4.4
    
    
    402
    
    
    2.8
    
    
    .0Selling,
      administrative and other operating costs
    
    
    61,015
    
    
    17.9
    
    
    61,511
    
    
    18.6
    
    
    (496
    )
    
    (.8
    )
    
    (.7
    )Amortization
      of intangible assets
    
    
    774
    
    
    .2
    
    
    773
    
    
    .2
    
    
    1
    
    
    .0
    
    
    .0Non-operating
      income
    
    
    (39
    )
    
    (.0
    )
    
    (79
    )
    
    (.0
    )
    
    40
    
    
    (50.6
    )
    
    .0Interest
      expense
    
    
    41
    
    
    .0
    
    
    13
    
    
    .0
    
    
    28
    
    
    215.4
    
    
    .0Income
      (loss) before income taxes
    
    
    3,852
    
    
    1.1
    
    
    (1,524
    )
    
    (.5
    )
    
    5,376
    
    
    352.8
    
    
    1.6Income
      taxes (benefit)
    
    
    --
    
    
    --
    
    
    --
    
    
    --
    
    
    --
    
    
    .0
    
    
    .0Net
      income (loss)
    
    $
    3,852
    
    
    1.1
    %
    $
    (1,524
    )
    
    (.5
    )%
    $
    5,376
    
    
    352.8
    %
    
    1.6
    %Personnel:Management
      and Administrative
    
    
    430
    
    
    
    
    
    425
    
    
    
    
    
    5
    
    
    1.2
    %Technical
      Consultants
    
    
    2,585
    
    
    
    
    
    2,575
    
    
    
    
    
    10
    
    
    .4
    %




*Revenue*





Services
revenue provided directly during the year ended January 1, 2005 increased 1.3%
from the comparable period a year ago while revenue from product sales increased
6.7% during the same period. We derived a lower percentage of our total revenue
from direct billings (services and product) during 2004 as compared to 2003. The
decrease in direct revenue as a percentage of total revenue during 2004 was due
to the increase in revenue from one particular client, for whom services were
provided mostly by subsuppliers. Our subsupplier revenue is mainly pass-through
revenue with associated fees for management and administration providing minimal
profit.





The
increase in revenue from 2003 to 2004 resulted primarily from the increase in
the average number of consultants we had billable during 2004, which appears to
be reflective of a modest recovery in the IT market. Our technical consultant
staff has increased by 10 from January 3, 2004 to year end. In addition to the
increase in technical consultants, hourly rates increased slightly during 2004
as compared to 2003. As demand for IT services improved with the apparent modest
recovery, hourly rates began to stabilize and trend slightly upward. Product
sales have increased from fiscal year 2003, due largely to the success of our
VoIP services line where we resell a significant amount of Cisco IP telephony
products. With our acquisition of Wirespeed Networks LLC in January 2005, we
expect product revenue to increase in 2005, both in terms of real dollars and as
a percent of revenue.





Effective
January 1, 2005, we are no longer a prime vendor to Bank of America. We will
continue to provide services to Bank of America as a subsupplier to one of their
prime vendors. During 2004 and 2003 we reported $22.8 million and $9.5 million,
respectively, in subsupplier revenue with Bank of America. This revenue will not
continue into 2005. Also, we are working, where possible, to change the nature
of our subsupplier relationships to allow us to recognize subsupplier revenue at
other clients on a net basis. This would allow us to recognize the service fees
collected for this service on a net basis rather than grossing up the revenue
and cost as we do today. As a result of these two factors, we expect a
significant decline in subsupplier revenue in 2005. If we are able to accomplish
this, our gross margin will likely improve if all other factors in our business
remain the same.


12


*Salaries,
Contracted Services and Direct Charges*





Salaries,
contracted services and direct charges primarily represent our payroll and
benefit costs associated with billable consultants. Comparing the 2004 period to
the 2003 period, these expenses decreased slightly as a percentage of revenue.
We have been successful at managing our direct labor rates as our bill rates
have increased slightly. We have been able to do this in part by receiving
better margins with placements of new and existing billable technical staff,
increasing productivity levels of our billable technical staff and partially
passing on increases in benefit costs to all of our employees. The shifting of
our revenue mix in 2004 to include more subsupplier revenue, with lower margins,
played a role in offsetting the decrease of this category of expense as a
percentage of revenue. We continuously attempt to control the factors which
affect this category of expense. Due to the pricing pressures previously
discussed, there can be no assurance we will be able to maintain or improve this
level.





*Cost
of Product Sales*





Cost of
product sales represent our cost where we act as a reseller of hardware and
software products. These costs, as a percentage of product sales, decreased
significantly from 95.9% in 2003 to 92.4% in 2004. This decrease is due mainly
to our work in emerging technologies where we can charge a greater margin such
as our VoIP services line.





*Selling,
Administrative and Other Operating Costs*





Selling,
administrative and other operating (SG&A) costs include management and
administrative salaries, commissions paid to sales representatives and
recruiters, location costs, and other administrative costs. This category of
costs represented 17.9% of total revenue for the year ended January 1, 2005,
down from 18.6% for the year ended January 3, 2004. Despite the increase in
revenue during 2004, we have managed these costs downward primarily by reducing
discretionary spending for non-billable travel, imposing wage controls on
administrative and management personnel, eliminating office space where
possible, and by managing the number of non-technical personnel we employ. We
are committed to continuing to manage this category of expense to the right
level for the Company; however, there can be no assurance this category of cost
will not increase as a percentage of revenue, especially if our revenue were to
decline.





*Non-Operating
Income*





Non-operating
income, consisting primarily of interest income, declined slightly during the
year ended January 1, 2005 compared to the year ended January 3, 2004. The lower
level of interest income in 2004 was due to a decrease in invested cash
balances.





*Interest
Expense*





Interest
expense during the year ended January 1, 2005 increased slightly compared to the
year ended January 3, 2004. As our revenue and payroll continue to grow, and we
use modest amounts of available cash to fund acquisitions, our need to borrow to
support our growth is also expected to increase modestly.





*Income
Taxes*





We
recorded no income taxes during the years ended January 1, 2005 and January 3,
2004. Income tax expense, which would have been recorded, was negated by
reversals of previously established reserves against deferred tax assets. As we
continue to generate profit, we anticipate reversing portions of the reserves we
have established on our deferred tax assets to negate any tax expense that may
otherwise have been recorded.





*Personnel*





We
believe the fact that our technical consultants headcount increased slightly
from 2003 to 2004 is an indication of what appears to be the beginning of a
modest recovery in the IT sector. Administrative and management personnel
increased slightly from 2003 to 2004.


13




**RESULTS
OF OPERATIONS, YEAR ENDED JANUARY 3, 2004 VS. YEAR ENDED DECEMBER 28, 2002**
 
 The
following table illustrates the relationship between revenue and expense
categories and provides a count of employees and technical consultants for the
fiscal years ended January 3, 2004 (fiscal year 2003) versus December 28, 2002
(fiscal year 2002). The tables provide guidance in our explanation of our
operations and results.
 
 ****
    **Year
      Ended**
      **January
      3, 2004**
    ****
    **Year
      Ended**
      **December
      28, 2002**
    ****
    ****
      **Increase
      (Decrease)**
    ********
      ***(Dollars
      in thousands)***
    ****
    ****
      **Amount**
    ****
    **%
      of**
      **Revenue**
    ****
    ****
      **Amount**
    ****
    **%
      of**
      **Revenue**
    ****
    ****
      **Amount**
    ****
    **%**
      **Inc
      (Dec)**
    ****
    **As
      %**
      **of
      Revenue**Revenue:Professional
      services provided directly
    
    $
    266,175
    
    
    80.2
    %
    $
    312,085
    
    
    73.2
    %
    $
    (45,910
    )
    
    (14.7
    %)
    
    7.0
    %Professional
      services provided through subsuppliers
    
    
    50,543
    
    
    15.2
    
    
    98,578
    
    
    23.1
    
    
    (48,035
    )
    
    (48.7
    )
    
    (7.9
    )Product
      sales
    
    
    15,181
    
    
    4.6
    
    
    15,497
    
    
    3.7
    
    
    (316
    )
    
    (2.0
    )
    
    .9Total
      revenue
    
    
    331,899
    
    
    100.0
    
    
    426,160
    
    
    100.0
    
    
    (94,261
    )
    
    (22.1
    )
    
    .0Salaries,
      contracted services and direct charges
    
    
    256,643
    
    
    77.3
    
    
    339,016
    
    
    79.6
    
    
    (82,373
    )
    
    (24.3
    )
    
    (2.3
    )Cost
      of product sales
    
    
    14,562
    
    
    4.4
    
    
    14,699
    
    
    3.4
    
    
    (137
    )
    
    (.9
    )
    
    1.1Selling,
      administrative and other operating costs
    
    
    61,511
    
    
    18.6
    
    
    73,694
    
    
    17.3
    
    
    (12,183
    )
    
    (16.5
    )
    
    1.3Amortization
      of intangible assets
    
    
    773
    
    
    .2
    
    
    785
    
    
    .2
    
    
    (12
    )
    
    (1.5
    )
    
    .0Loss
      on sale of corporate headquarters building
    
    
    --
    
    
    --
    
    
    1,860
    
    
    .4
    
    
    (1,860
    )
    
    (100.0
    )
    
    (.4
    )Non-operating
      income
    
    
    (79
    )
    
    (.0
    )
    
    (122
    )
    
    .0
    
    
    43
    
    
    (35.2
    )
    
    .0Loss
      on investment
    
    
    --
    
    
    --
    
    
    190
    
    
    .0
    
    
    (190
    )
    
    (100.0
    )
    
    .0Interest
      expense
    
    
    13
    
    
    .0
    
    
    1,042
    
    
    .2
    
    
    (1,029
    )
    
    (98.8
    )
    
    (.2
    )Loss
      on debt extinguishment
    
    
    --
    
    
    --
    
    
    744
    
    
    .2
    
    
    (744
    )
    
    (100.0
    )
    
    (.2
    )Cumulative
      effect of change in accounting for goodwill
    
    
    --
    
    
    --
    
    
    16,389
    
    
    3.9
    
    
    (16,389
    )
    
    (100.0
    )
    
    (3.9
    )Loss
      before income taxes
    
    
    (1,524
    )
    
    (.5
    )
    
    (22,137
    )
    
    (5.2
    )
    
    20,613
    
    
    93.1
    
    
    4.7Income
      taxes (benefit)
    
    
    --
    
    
    --
    
    
    (1,106
    )
    
    (.3
    )
    
    1,106
    
    
    100.0
    
    
    .3Net
      loss
    
    $
    (1,524
    )
    
    (.5
    )%
    $
    (21,031
    )
    
    (4.9
    )%
    $
    19,507
    
    
    92.8
    %
    
    4.4
    %Personnel:Management
      and Administrative
    
    
    425
    
    
    
    
    
    450
    
    
    
    
    
    (25
    )
    
    (5.6
    )%Technical
      Consultants
    
    
    2,575
    
    
    
    
    
    2,625
    
    
    
    
    
    (50
    )
    
    (1.9
    )%


*Revenue*





Revenue
provided directly for the year ended January 3, 2004 decreased 14.7% from the
comparable period of the prior year. We derived a substantially greater
percentage of our total revenue from direct billings during 2003 compared to
2002. This increase in the percentage of direct revenue was due principally to
the decrease in Chevron Texaco and Qwest Communications Managed Services
contract revenue, most of which had been provided through subsuppliers. Our
subsupplier revenue is mainly pass-through revenue with associated fees for
management and administration providing minimal profit.





The
decrease in revenue from 2002 to 2003 resulted primarily from the decrease in
the average number of consultants we had billable during 2003, as well as
significant pricing pressures imposed by our clients. Product sales, consisting
of the reselling of hardware and software products, were essentially unchanged
from 2002 to 2003.





*Salaries,
Contracted Services and Direct Charges*





Salaries,
contracted services and direct charges primarily represent our payroll and
benefit costs associated with billable consultants. Comparing the 2003 period to
the 2002 period, these expenses decreased slightly as a percentage of revenue.
In 2003, we were successful at reducing our direct labor rates in response to
decreasing bill rates. We were able to do this in part by passing billing rate
decreases through to our consultants in the form of labor rate decreases where
possible, increasing productivity levels of our billable technical staff and
partially passing on increases in benefit costs to employees. The shift of our
revenue mix to include more direct revenue with better margins and less low
margin subsupplier revenue also played a role in decreasing this category of
expense as a percentage of revenue.





*Cost
of Product Sales*





Cost of
product sales represent our cost where we act as a reseller of hardware and
software products. These costs, as a percentage of product sales, increased
slightly from 94.9% in 2002 to 95.9% in 2003.


14


*Selling,
Administrative and Other Operating Costs*





Selling,
administrative and other operating (SG&A) costs include management and
administrative salaries, commissions paid to sales representatives and
recruiters, location costs, and other administrative costs. This category of
costs represented 18.6% of total revenue for the year ended January 3, 2004, up
from 17.3% for the year ended December 28, 2002. The significant decline in our
total revenue, especially subsupplier revenue, caused SG&A costs to increase
as a percentage of total revenue. The actual amounts of these costs decreased by
nearly $12 million from 2002 to 2003, however. This decrease was the result of
our ongoing efforts to reduce costs as demand for our services and our average
billing rates declined. We decreased these costs primarily by reducing
discretionary spending for non-billable travel, imposing wage controls on
administrative and management personnel, eliminating or subleasing office space
where possible and reducing the number of non-technical personnel we
employ.





*Loss
on Sale of Corporate Headquarters Building*





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





*Non-Operating
Income*





Non-operating
income, consisting primarily of interest income, declined slightly during the
year ended January 3, 2004 compared to the year ended December 28, 2002. The
higher level of interest income in the 2002 period resulted from significant
cash investments during the early part of the year. The cash invested during
this time was then used to reduce outstanding debt.





*Loss
on Investment*





During
2002 we wrote off a $190,000 equity investment we made during 2000. The market
value of this security had declined significantly, and we deemed the decline in
value to be other than temporary. We disposed of this security prior to December
28, 2002.





*Interest
Expense*





Interest
expense during the year ended January 3, 2004 decreased significantly compared
to the year ended December 28, 2002. The reduction in interest expense is the
result of lower levels of borrowing and reduced interest rates subsequent to our
April 11, 2002 debt restructuring. In April 2003, we reduced our borrowing on
our line of credit to zero, and the balance remained at or near zero throughout
the remainder of fiscal 2003. Debt levels declined to zero primarily as a result
of using cash invested during the first quarter of 2002, proceeds from the sale
of our corporate headquarters building in May 2002 and proceeds from the
Company’s federal income tax refund received in April 2003. We also experienced
a decreased need to borrow to support accounts receivable as our revenue
declined.





*Loss
on Debt Extinguishment*





We
completed the restructuring of our credit facility with GE Capital Corporation
in the second quarter of 2002. Upon the refinancing of our debt, we recorded a
loss on extinguishment of debt of $744,000 primarily related to make-whole
payments associated with our 1998 Note Purchase Agreement and the write-off of
costs associated with previous financing arrangements.





*Cumulative
Effect of Change in Accounting for Goodwill*





We
adopted the full provisions of SFAS 142 in the first quarter of 2002 and
recorded an impairment charge of approximately $16.4 million. SFAS 142 no longer
allows the amortization of purchased goodwill and certain indefinite lived
intangible assets. Instead, companies must test such assets for impairment at
least annually. Based on the impairment tests during the year ended December 28,
2002, we reduced the carrying value of goodwill for our Infrastructure reporting
unit to its implied fair value. The impairment was required because the
estimated future performance for this reporting unit was reduced. Following the
initial adoption of SFAS 142, at least annually, we are required to test our
remaining goodwill for impairment. We performed these tests as of December 29,
2002 and found no indication of impairment although the carrying value of the
Infrastructure and the Solutions reporting units approximated their fair values.
Any significant deterioration in the outlook for these reporting units could
result in future impairment of the associated goodwill. See footnote “J” to the
consolidated financial statements for further discussion of our adoption of SFAS
142.


15


*Income
Taxes*





We
recorded no income tax benefit during the year ended January 3, 2004 as
non-deductible items (primarily travel meals and entertainment) negated the tax
benefit of our operating loss. This compares to a tax benefit of $1.1 million
recorded for the year ended December 28, 2002, or an effective tax rate of
5.0%.





*Personnel*





We
believe the fact that our technical consultants headcount decreased only
slightly indicated the beginning of a stabilization of the IT market sector.
Administrative and management personnel decreased as a result of our continuing
efforts to contain our operating costs.





**Liquidity
and Capital Resources**





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





***(Dollars
      in thousands)***
    
    **1/1/05**
    
    **1/3/04**
    
    **Increase**
      **(Decrease)**
    
    **Percentage**
      **Increase**
      **(Decrease)**Cash
      and Cash Equivalents
    
    $
    7,889
    
    $
    4,499
    
    $
    3,390
    
    
    75.4
    %Accounts
      Receivable
    
    
    57,764
    
    
    55,623
    
    
    2,141
    
    
    3.8Other
      Current Assets
    
    
    4,029
    
    
    4,737
    
    
    (708
    )
    
    (14.9
    )Total
      Current Assets
    
    
    69,682
    
    
    64,859
    
    
    4,823
    
    
    7.4Accounts
      Payable
    
    
    16,366
    
    
    15,825
    
    
    541
    
    
    3.4Other
      Current Liabilities
    
    
    12,496
    
    
    13,369
    
    
    (873
    )
    
    (6.5
    )Total
      Current Liabilities
    
    
    28,862
    
    
    29,194
    
    
    (332
    )
    
    (1.1
    )Working
      Capital
    
    $
    40,820
    
    $
    35,665
    
    $
    5,155
    
    
    14.5Current
      Ratio
    
    
    2.41
    
    
    2.22
    
    
    .19
    
    
    8.6Total
      Shareholders’ Equity
    
    $
    72,618
    
    $
    68,663
    
    $
    3,955
    
    
    5.8





*Cash
Requirements*





The
day-to-day operation of our business requires a significant amount of cash to
flow through our Company. During fiscal year 2004, we made total payments of
approximately $204.6 million to pay our employees wages, benefits, and
associated taxes. We also made payments of approximately $88.3 million to pay
vendors who provided billable technical resources to our clients through us.
Finally, we made payments of approximately $43.2 million to fund general
operating expenses such as employee expense reimbursement, office space rental
and utilities.





The cash
to fund these significant payments comes almost exclusively from our collection
of amounts due us for services rendered to our clients (approximately $339.5
million in fiscal year 2004). Generally, payments made to fund the day-to-day
operation of our business are due and payable regardless of the rate of cash
collections from our clients. While we do not anticipate such an occurrence, a
significant decline in the rate of collections from our clients, or an inability
of the Company to timely invoice and therefore collect from our clients, could
rapidly increase our need to borrow to fund the operations of our
business.





*Sources
and Uses of Cash/Credit Facility*





Cash and
cash equivalents at January 1, 2005 increased by almost $3.4 million from
January 3, 2004. During 2004 we have been able to keep our line of credit at or
near zero and excess cash in short-term investments.





Historically,
we have been able to support internal growth in our business with internally
generated funds. Our primary need for working capital is to support accounts
receivable resulting from our business and to fund the time lag between payroll
disbursement, a bi-weekly occurrence, and receipt of fees billed to clients,
which generally occurs 30 or more days after invoicing. During fiscal year 2004
as revenues and payroll have grown, our need for working capital to support
accounts receivable has also grown. If our revenue and payroll continue to grow,
we would expect our need for working capital to continue to
increase.





We made
capital expenditures totaling $2.5 million during the twelve-month period ended
January 1, 2005 compared to $2.3 million in the twelve-month period ended
January 3, 2004. We funded these capital expenditures with internally generated
funds. We continue to tightly control capital expenditures to preserve working
capital.


16


On
January 6, 2005 we acquired the assets of Wirespeed Networks LLC for cash
consideration of $2.0 million. This cash outlay, and other such acquisitions we
may complete during 2005 will likely result in increased usage of our line of
credit during 2005.





We
believe funds generated from our business and credit available under our credit
facility will be adequate to meet demands placed upon our resources by our
operation, capital investments and any small acquisitions we expect to complete
in 2005. If we were to acquire larger companies, we may be required to seek
additional financing.





Effective
April 11, 2002, we entered into an asset-based revolving credit agreement with
up to $55.0 million of availability. We reduced the level of availability under
this credit agreement to $45.0 million following the sale of our corporate
headquarters building on May 15, 2002. The Company must take advances or pay
down the outstanding balance daily. We can, however, choose to request
fixed-term advances of one, two, or three months for a portion of the
outstanding balance on the line of credit. The agreement restricts, among other
things, the payment of dividends, establishes limits on capital expenditures and
requires us to maintain a minimum accounts payable turnover ratio.





Effective
August 5, 2004, the Company amended its revolving credit agreement to extend the
expiration date from April 10, 2005 to October 31, 2006 and modified certain
terms of the agreement. The amendment reduced the commitment fee from .50% to
..25% of the unused portion of the line, reduced the annual administration fee
from $50,000 to $25,000, and reduced the interest rates on daily advances from
the Wall Street Journal’s “Prime Rate” plus .75% to only its Prime Rate (5.25%
on January 1, 2005) and fixed-term advances from the LIBOR rate plus 3.0% to the
LIBOR rate plus 2.0%. This line of credit is available to us to fund working
capital needs and other investments such as acquisitions as these needs
arise.





In April
2003 we successfully reduced our borrowings on our line of credit to zero, and
they have remained at or near zero throughout the remainder of fiscal 2003 and
all of 2004. At January 1, 2005 our borrowing capability was at $29.0 million
under our credit facility. Borrowings under this credit agreement are secured by
all of the Company’s assets. We believe we will be able to continue to meet the
requirements of this agreement for the foreseeable future.





Commitments
and Contingencies





The
Company leases office facilities under non-cancelable operating leases. Deferred
compensation is payable to participants in accordance with the terms of
individual contracts. Minimum future obligations on operating leases and
deferred compensation agreements at January 1, 2005, are as
follows:





***(In
      thousands)***
    
    **1
      Year**
    
    **2-3
      Years**
    
    **4-5
      Years**
    
    **Over
      5 Years**
    
    **Total**Operating
      Leases
    
    $
    5,035
    
    $
    7,381
    
    $
    1,594
    
    $
    --
    
    $
    14,010Deferred
      Compensation
    
    
    863
    
    
    535
    
    
    683
    
    
    2,049
    
    
    4,130Total
    
    $
    5,898
    
    $
    7,916
    
    $
    2,277
    
    $
    2,049
    
    $
    18,140








New
Accounting Pronouncements





In
December 2004, the Financial Accounting Standards Board issued a revision to
SFAS 123, ** “Share-Based
Payment.” The revision requires all entities to recognize compensation expense
in an amount equal to the fair value of share-based payments granted to
employees. The statement eliminates the alternative method of accounting for
employee share-based payments previously available under APB Opinion No. 25. The
Statement is effective for the Company beginning in the second quarter of fiscal
2005. The Company has not completed the process of evaluating the impact that
will result from adopting SFAS 123(R).


17


**Market
Conditions, Business Outlook and Risks to Our Business**





During
fiscal 2004, several market conditions continued to affect our industry. Intense
price competition in the area of IT staffing continued, pressure on billing
rates, and many clients continued to request increasingly lower cost models for
staff augmentation services. Although we have seen a slight reversal of these
trends during 2004, increasing billing rates continue to be a challenge.
Management expects that clients will continue, for the foreseeable future, to
request lower cost offerings for IT staffing services through e-procurement
systems, extremely competitive bidding processes, the granting of various types
of discounts and the use of offshore resources. Our ability to respond to
customer requests for lower pricing or to provide other low-cost solutions in
this area of our business will have a direct effect on our performance.
Management expects competitive conditions in the area of IT staffing services to
continue for the foreseeable future, although it expects that demand for these
services will increase modestly as the apparent economic recovery
continues.





IT
staffing continues to represent more than half of total revenue (revenue from
services provided directly to clients (direct revenue) plus revenue from
services provided to our clients by subsuppliers (subsupplier revenue)) and over
half of our direct revenue. While we saw a slight increase in demand for our
services in 2004, there can be no assurance as to when, or if, we will
experience sustained revenue growth. Our ability to respond to the conditions
outlined above will bear directly on our performance.





Our
ability to quickly identify, attract and retain qualified technical personnel,
especially during an economic recovery, will affect our results of operations
and ability to grow in the future. Competition for qualified personnel is
intense. If we are unable to hire the talent required by our clients in a
timely, cost-effective manner, it will affect our ability to grow our business.
In addition to our ability to control labor costs, our ability to control
employee benefit costs and other employee-related costs will affect our future
performance. In an effort to contain our benefits costs, we implemented changes
to our benefits plans for fiscal year 2004 and have implemented additional
changes for 2005. While we believe the changes we implemented will be effective,
the effectiveness of these changes may vary due to factors we cannot control
such as rising medical costs, the amount of medical services used by our
employees and similar factors.





We
continue to concentrate on IT staffing services in Fortune 500 and small and
medium-sized businesses, business solutions for small and medium-sized
businesses, and business opportunities with technology and product partners. To
serve this client base, we are focusing on the following objectives: i)
implementing a next generation staffing model, which will transform workforce
deployment and human capital management; ii) implementing a number of
improvements around key business processes that we believe will better align our
business with the market needs and allow us to build a more adaptive delivery
model to drive growth; iii) building a focused set of services and solutions
around high-demand, emerging technologies; and iv) being an active participant
in the significant consolidation taking place throughout our industry. We
believe these objectives present opportunities to grow our business and provide
the scale, which we believe is necessary to be successful in the staffing
business in the long term. We believe scale is important because more and more
clients are requiring it and it provides the operating leverage necessary to
create competitive margins. Success in meeting the objectives outlined above
will depend on, among other things, our ability to compete with other vendors,
our ability to obtain qualified technical personnel, our success in obtaining
new clients and our ability to implement those objectives.





As the IT
services market continues to consolidate, we continue to look for opportunities
to acquire well-managed companies with strong client and/or vendor
relationships, and with geographic or vertical market presence complementary to
our business. In pursuit of this strategy, on January 6, 2005 we acquired the
assets of Wirespeed Networks, LLC. Pursuit of an acquisition strategy presents
significant risks to the Company. If we are unable to transition and maintain
employee, client and vendor relationships of the acquired companies, or are
unable to integrate the back office operations of these companies to provide
seamless and cost effective service to our combined clients, the anticipated
benefits of these transactions may be less than expected. Additionally, use of
our financial resources to acquire these companies means these resources are not
available for our ordinary operations. While we expect to enter into
transactions that are accretive to earnings and enhance our cash flow, failure
to successfully integrate acquired companies and achieve such results could have
a material adverse effect on our business.





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





Compliance
with the Sarbanes-Oxley Act under Section 404 of the Act has created substantial
cost to us and strained our internal resources. We incurred significant costs
throughout 2004, and we expect to continue to incur these costs in future years
for maintaining compliance. An inability to control these costs, a failure to
comply with Sarbanes-Oxley, or a failure to adequately remediate control
deficiencies, if any, as they are identified could have a material adverse
effect on our business.


18


Terms and
conditions standard to computer consulting services contracts also present a
risk to our business. In general, our clients can cancel or reduce their
contracts on short notice. Loss of a significant client relationship or a
significant portion thereof, a significant number of relationships or a major
contract could have a material adverse effect on our business. During the fourth
quarter, we were notified that we would no longer be a prime vendor to Bank of
America. While we will continue to provide direct revenue to Bank of America
working through another prime vendor, effective January 1, 2005, we are no
longer providing services to Bank of America using our subsupplier network.
These subsupplier revenues were $22.8 million during 2004.





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





**Quantitative
and Qualitative Disclosures About Market Risk**





Our
financing agreement with GE Capital Corporation carries a variable interest
rate, which exposes us to certain market risks. Market risk is the potential
loss arising from the adverse changes in market rates and prices, such as
interest rates. Market risk is estimated as the potential increase in fair value
resulting from a hypothetical one percent increase in interest rates. For
example, while our outstanding balance on our line of credit has averaged less
than $1.0 million during 2004, if our average outstanding debt balance were $5.0
million, a one percent increase in interest rates would result in an annual
interest expense increase of approximately $50,000.


19




**Consolidated
Balance Sheets**








***(Dollars
      in thousands except per share amounts)***
    
    **January
      1,**
      **2005**
    
    **January
      3,**
      **2004****ASSETS**Current
      assets:Cash
      and cash equivalents
    
    $
    7,889
    
    $
    4,499Accounts
      receivable, less allowance for doubtfulaccounts
      of $1,809 and $1,508, respectively
    
    
    57,764
    
    
    55,623Prepaid
      expenses and other current assets
    
    
    4,029
    
    
    4,737Total
      current assets
    
    
    69,682
    
    
    64,859Property
      and equipment, net
    
    
    5,658
    
    
    6,297Intangible
      assets other than goodwill, net of accumulatedamortization
      of $3,515 and $2,741, respectively
    
    
    10,475
    
    
    11,249Goodwill
    
    
    16,460
    
    
    16,460Other
      assets
    
    
    3,402
    
    
    3,030$
    105,677
    
    $
    101,895**LIABILITIES
      AND SHAREHOLDERS' EQUITY**Current
      liabilities:Accounts
      payable
    
    $
    16,366
    
    $
    15,825Salaries
      and vacations
    
    
    8,828
    
    
    7,774Deferred
      revenue
    
    
    1,658
    
    
    2,766Health
      care reserves
    
    
    1,479
    
    
    1,821Other
      current liabilities
    
    
    531
    
    
    1,008Total
      current liabilities
    
    
    28,862
    
    
    29,194Non-current
      liabilities, primarily deferred compensation
    
    
    4,197
    
    
    4,038Commitments
      (Note H)Shareholders'
      equity:Common
      stock, par value $.10 a share; authorized120,000,000
      shares;
      issued
      and outstanding 24,212,457and
      24,211,807 shares, respectively
    
    
    2,421
    
    
    2,421Additional
      capital
    
    
    21,095
    
    
    20,149Deferred
      compensation
    
    
    (843
    )
    
    --Retained
      earnings
    
    
    49,945
    
    
    46,093Total
      shareholders' equity
    
    
    72,618
    
    
    68,663$
    105,677
    
    $
    101,895








See notes
to consolidated financial statements.


20


**Consolidated
Statements of Operations**








**Fiscal
      Year*****(In
      thousands except per share amounts)***
    
    **2004**
    
    **2003**
    
    **2002**Revenue:Professional
      services provided directly
    
    $
    269,610
    
    $
    266,175
    
    $
    312,085Professional
      services provided through subsuppliers
    
    
    55,806
    
    
    50,543
    
    
    98,578Product
      sales
    
    
    16,196
    
    
    15,181
    
    
    15,497Total
      revenue
    
    
    341,612
    
    
    331,899
    
    
    426,160Operating
      expenses:Salaries,
      contracted services and direct charges
    
    
    261,005
    
    
    256,643
    
    
    339,016Cost
      of product sales
    
    
    14,964
    
    
    14,562
    
    
    14,699Selling,
      administrative and other operating costs
    
    
    61,015
    
    
    61,511
    
    
    73,694Amortization
      of intangible assets
    
    
    774
    
    
    773
    
    
    785Loss
      on sale of corporate headquarters building
    
    
    --
    
    
    --
    
    
    1,860Operating
      income (loss)
    
    
    3,854
    
    
    (1,590
    )
    
    (3,894
    )Non-operating
      income
    
    
    39
    
    
    79
    
    
    122Loss
      on investments
    
    
    --
    
    
    --
    
    
    190Interest
      expense
    
    
    41
    
    
    13
    
    
    1,042Loss
      on debt extinguishment
    
    
    --
    
    
    --
    
    
    744Income
      (loss) before income taxes and cumulative effect of change inaccounting
      principle
    
    
    3,852
    
    
    (1,524
    )
    
    (5,748
    )Income
      tax benefit
    
    
    --
    
    
    --
    
    
    (1,106
    )Income
      (loss) before cumulative effect of change in accounting
      principle
    
    
    3,852
    
    
    (1,524
    )
    
    (4,642
    )Cumulative
      effect of change in accounting for goodwill
    
    
    --
    
    
    --
    
    
    16,389Net
      income (loss)
    
    $
    3,852
    
    $
    (1,524
    )
    $
    (21,031
    )Per
      common share (basic):Income
      (loss) before cumulative effect of change in accounting
      principle
    
    $
    .16
    
    $
    (.06
    )
    $
    (.19
    )Cumulative
      effect of change in accounting for goodwill
    
    
    --
    
    
    --
    
    
    (.68
    )Net
      income (loss):
    
    $
    .16
    
    $
    (.06
    )
    $
    (.87
    )Per
      common share (diluted):Income
      (loss) before cumulative effect of change in accounting
      principle
    
    $
    .16
    
    $
    (.06
    )
    $
    (.19
    )Cumulative
      effect of change in accounting for goodwill
    
    
    --
    
    
    --
    
    
    (.68
    )Net
      income (loss):
    
    $
    .16
    
    $
    (.06
    )
    $
    (.87
    )Average
      common shares outstanding
    
    
    24,212
    
    
    24,201
    
    
    24,198Average
      common and common equivalent shares outstanding
    
    
    24,398
    
    
    24,201
    
    
    24,198











See notes
to consolidated financial statements.


21


**Consolidated
Statements of Cash Flows**





**Fiscal
      Year*****(In
      thousands)***
    
    **2004**
    
    **2003**
    
    **2002**Cash
      flows from operating activities:Net
      income (loss)
    
    $
    3,852
    
    $
    (1,524
    )
    $
    (21,031
    )Cumulative
      effect of change in accounting for goodwill
    
    
    --
    
    
    --
    
    
    16,389Adjustments
      to reconcile net income (loss) to net cash providedby
      operating activities:Depreciation
    
    
    2,918
    
    
    2,883
    
    
    4,704Amortization
      of intangible assets
    
    
    774
    
    
    773
    
    
    785Loss
      on sale of building
    
    
    --
    
    
    --
    
    
    1,860Loss
      on disposal of other assets
    
    
    211
    
    
    202
    
    
    296Loss
      on investments
    
    
    --
    
    
    --
    
    
    190Change
      in deferred income tax assets
    
    
    --
    
    
    (330
    )
    
    3,712Amortization
      of deferred compensation
    
    
    101
    
    
    --
    
    
    --Change
      in:Accounts
      receivable
    
    
    (2,141
    )
    
    4,153
    
    
    23,546Prepaid
      expenses
    
    
    451
    
    
    (706
    )
    
    (815
    )Other
      assets
    
    
    (115
    )
    
    (214
    )
    
    (268
    )Accounts
      payable
    
    
    541
    
    
    (3,141
    )
    
    (18,812
    )Salaries
      and vacations
    
    
    1,054
    
    
    1,738
    
    
    (363
    )Other
      accrued expenses
    
    
    (781
    )
    
    (119
    )
    
    139Deferred
      revenue
    
    
    (1,108
    )
    
    (1,574
    )
    
    1,470Income
      tax refund receivable
    
    
    --
    
    
    4,844
    
    
    (2,103
    )Restructuring
      accrual
    
    
    (293
    )
    
    (587
    )
    
    (1,456
    )Deferred
      compensation
    
    
    414
    
    
    661
    
    
    (5,525
    )Net
      cash provided by operating activities
    
    
    5,878
    
    
    7,059
    
    
    2,718Cash
      flows from investing activities:Property
      and equipment additions
    
    
    (2,508
    )
    
    (2,334
    )
    
    (1,664
    )Proceeds
      from liquidation of annuities and other contracts
    
    
    --
    
    
    --
    
    
    5,016Proceeds
      from property and equipment sales
    
    
    18
    
    
    23
    
    
    16,448Net
      cash (used in) provided by investing activities
    
    
    (2,490
    )
    
    (2,311
    )
    
    19,800Cash
      flows from financing activities:Net
      change in line of credit
    
    
    --
    
    
    (324
    )
    
    324Proceeds
      from borrowings
    
    
    --
    
    
    --
    
    
    29,525Repayment
      of borrowings
    
    
    --
    
    
    --
    
    
    (70,525
    )Proceeds
      from exercise of stock options
    
    
    2
    
    
    21
    
    
    8Net
      cash provided by (used in) financing activities
    
    
    2
    
    
    (303
    )
    
    (40,668
    )Net
      increase (decrease) in cash and equivalents
    
    
    3,390
    
    
    4,445
    
    
    (18,150
    )Cash
      and equivalents at beginning of year
    
    
    4,499
    
    
    54
    
    
    18,204Cash
      and equivalents at end of year
    
    $
    7,889
    
    $
    4,499
    
    $
    54Supplemental
      cash flow information:Cash
      paid (refunded) during the year for:Income
      taxes
    
    $
    35
    
    $
    (4,515
    )
    $
    (2,715
    )Interest
    
    
    41
    
    
    13
    
    
    1,073





See notes
to consolidated financial statements.


22


**Consolidated
Statements of Shareholders' Equity**








***(Dollars
      in thousands)***
    
    **Common**
      **Stock**
    
    **Additional**
      **Capital**
    
    **Deferred**
      **Compensation**
    
    **Accumulated**
      **Other**
      **Comprehensive****Loss**
    
    **Retained**
      **Earnings**
    
    **Total**
      **Shareholders’**
      **Equity**Balances
      at December 31, 2001
    
    $
    2,420
    
    $
    20,121
    
    
    
    
    $
    (106
    )
    $
    68,648
    
    $
    91,083Common
      stock issued - 2,685 shares upon exercise of
      stock
      options
    
    
    
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    8Realized
      loss on available for sale securities
    
    
    
    
    
    
    
    
    
    
    
    106
    
    
    
    
    
    106Net
      loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (21,031
    )
    
    (21,031
    )Comprehensive
      loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (20,925
    )Balances
      at December 28, 2002
    
    
    2,420
    
    
    20,129
    
    
    
    
    $
    0
    
    
    47,617
    
    
    70,166Common
      stock issued - 12,500 shares upon exercise of
      stock
      options
    
    
    1
    
    
    20
    
    
    
    
    
    
    
    
    
    
    
    21Net
      loss (Comprehensive loss)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,524
    )
    
    (1,524
    )Balances
      at January 3, 2004
    
    
    2,421
    
    
    20,149
    
    
    
    
    
    
    
    
    46,093
    
    
    68,663Common
      stock issued - 650 shares upon exercise of
      stock
      options
    
    
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    2Issuance
      of restricted stock - 300,000 shares
    
    
    
    
    
    944
    
    $
    (944
    )
    
    
    
    
    
    
    
    --Amortization
      of deferred compensation
    
    
    
    
    
    
    
    
    101
    
    
    
    
    
    
    
    
    101Net
      income(Comprehensive
      income)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,852
    
    
    3,852Balances
      at January 1, 2005
    
    $
    2,421
    
    $
    21,095
    
    $
    (843
    )
    
    
    
    $
    49,945
    
    $
    72,618











See notes
to consolidated financial statements.








23





NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


****


**A.
Summary of Significant Accounting Policies**





*Description
of business -* Analysts
International Corporation (the Company) is a diversified IT services company.
Services are provided through the Business Solutions Group, which provides
business solutions and network infrastructure services; the Managed Services
Group, which provides a comprehensive range of outsourced business functions;
and IT supplemental resources (also referred to as technical staff
augmentation), which provides resources for supporting clients’ IT staffing
needs.





*Basis
of presentation -* The
consolidated financial statements include the accounts of Analysts International
and our subsidiaries. All intercompany accounts and transactions have been
eliminated.





*Change
in fiscal year -* Effective
December 28, 2002, we changed our fiscal year to end on the Saturday closest to
December 31. This change in year-end did not have a material impact on our
operations. References to fiscal 2004 and fiscal 2003 refer to the fiscal
periods from January 4, 2004 to January 1, 2005 and from December 29, 2002 to
January 3, 2004, respectively.





*Depreciation
-* Property
and equipment is being depreciated using the straight-line method over the
estimated useful lives (1 to 10 years for leasehold improvements and 2 to 7
years for office furniture and equipment) of the assets for financial statement
purposes and accelerated methods for income tax purposes.





*Financial
instruments -* In
accordance with the requirements of Statement of Financial Accounting Standards
(SFAS) No. 107, “Disclosures about Fair Value of Financial Instruments,”
management estimates the carrying value of all financial instruments approximate
fair value because of the short-term nature of these instruments.





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





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





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





*Net
income (loss) per share -* Basic and
diluted earnings per share (EPS) are presented in accordance with SFAS No. 128,
"Earnings per Share.” Basic EPS excludes dilution and is computed by dividing
income available to common stockholders by the weighted-average number of common
shares outstanding for the period. The difference between weighted-average
common shares and average common and common equivalent shares used in computing
diluted EPS is the result of outstanding stock options and restricted stock
awards. Options to purchase 2,391,000, 2,126,000 and 2,067,000 shares of common
stock were outstanding at the end of fiscal periods 2004, 2003 and 2002,
respectively, but were excluded from the computation of common stock equivalents
because they were anti-dilutive.





*Cash
equivalents -* Temporary
cash investments in money market accounts are considered to be cash
equivalents.





*Allowance
for doubtful accounts* - In
each accounting period we determine an amount to set aside to cover potentially
uncollectible accounts based on our evaluation of accounts receivable for risk
associated with a client’s ability to make contractually required payments. Our
revenue and accounts receivable are concentrated with large, established
companies. IBM and Bank of America represented 12% and 11% of our total revenue
for 2004, respectively. IBM represented 12% of our total accounts receivable
balance at January 1, 2005.


24





Notes to Consolidated Financial Statements
(Continued)




*Shares
reserve -* At
January 1, 2005, there were approximately 30,806,000 shares reserved for
issuance under the stock option plans and the shareholders' rights
plan.





*Estimates* - The
preparation of consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions affecting the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from these estimates.





*Other
intangible assets* - Other
intangible assets consist of tradenames and customer lists. The customer list is
amortized on a straight-line basis over 15 years. At January 1, 2005, management
assessed whether indications of impairment in the value of intangible assets
were present. The factors considered by management in performing this assessment
included current operating results, trends and prospects, as well as the
anticipated effects of demand, competition and other economic factors. No
indicators of impairment were identified at January 1, 2005.





*Goodwill
assets* -
Effective January 1, 2002, we adopted the provisions of SFAS No. 142, “Goodwill
and Other Intangible Assets.” SFAS No. 142 prohibits companies from amortizing
purchased goodwill. Instead, we examine our goodwill at least annually to
determine if impairment has occurred. See Note J for discussion of the impact of
this adoption. Effective September 4, 2004, we changed the date at which we will
perform our annual examination for impairment from the first day of the fiscal
year to the last day of our monthly accounting period for August. The change was
made in response to significant constraints on our resources during our first
fiscal quarter.





*Derivatives* - The
Company’s policy is not to use freestanding derivatives and not to enter into
contracts with terms that cannot be designated as normal purchases or
sales.





*Stock
Option Plans* -
Analysts International has five stock-based compensation plans, which are
described below. We have adopted the disclosure provisions of SFAS No. 123,
“Accounting for Stock-Based Compensation,” and have continued to apply
Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued
to Employees,” and related interpretations in accounting for these plans.
Accordingly, no compensation cost has been recognized for these stock option
plans. Had compensation cost for our stock-based compensation plans been
determined based on the fair value at the grant dates as calculated in
accordance with SFAS No. 123, our pro forma net income (loss) and net income
(loss) per share for the years ended January 1, 2005, January 3, 2004 and
December 28, 2002 would have been the amounts indicated below:





**Year
      Ended*****(In
      thousands except per share amounts)***
    
    **January
      1,**
      **2005**
    
    **January
      3,**
      **2004**
    
    **December
      28,**
      **2002**Net
      income (loss) as reported*:*
    
    $
    3,852
    
    $
    (1,524
    )
    $
    (21,031
    )Deduct:
      Total stock-based employee compensation expense determined under
      the
      fair value based method, net of related tax effects
    
    
    (567
    )
    
    (542
    )
    
    (1,171
    )Pro
      forma net income (loss)
    
    $
    3,285
    
    $
    (2,066
    )
    $
    (22,202
    )Net
      income (loss) per share:Basic
      - as reported
    
    $
    .16
    
    $
    (.06
    )
    $
    (.87
    )Basic
      - pro forma
    
    
    .14
    
    
    (.09
    )
    
    (.92
    )Diluted
      - as reported
    
    $
    .16
    
    $
    (.06
    )
    $
    (.87
    )Diluted
      - pro forma
    
    
    .13
    
    
    (.09
    )
    
    (.92
    )




25


****


**Notes
to Consolidated Financial Statements (Continued)**





The fair
market value of each stock option is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions:





**Year
      Ended****January
      1,**
      **2005**
    
    **January
      3,**
      **2004**
    
    **December
      28,**
      **2002**Expected
      life
    
    
    8
      year
    
    
    5
      year
    
    
    5
      yearExpected
      volatility
    
    
    72
    %
    
    79
    %
    
    72
    %Expected
      dividend yield
    
    
    0.0
    %
    
    0.0
    %
    
    0.0
    %Risk-free
      interest rate
    
    
    2.7
    %
    
    2.6
    %
    
    5.0
    %





The
weighted average fair value of options granted during the years ended January 1,
2005, January 3, 2004 and December 28, 2002 was $1.98, $1.75 and $1.82,
respectively.





Analysts
International has options outstanding under three option plans under which new
options may be granted. Under the 1999 Stock Option Plan, the Company may grant
options to its employees for up to 1,000,000 shares of common stock. Under the
2000 Stock Option Plan, the Company may grant non-qualified options to its
employees for up to 225,000 shares of common stock. Under the 2004 Equity
Incentive Plan, the Company may grant incentive options, non-qualified options
or stock awards for up to 1,000,000 shares of common stock. In addition the
Company has outstanding options under the 1994 Incentive Stock Option Plan and
the 1996 Stock Option Plan for Non-Employee Directors. Under all plans, the
exercise price of each option equals the market price of the Company's stock on
the date of grant and an option's maximum term is generally 10 years. Options
and awards are generally exercisable 25% annually beginning one year after date
of grant. ****





A summary
of the status of the Company's stock option plans as of January 1, 2005, January
3, 2004 and December 28, 2002 and changes during the periods ending on those
dates is presented below:





**Shares**
    
    **Weighted-Average**
      **Exercise
      Price**Outstanding
      at December 31, 2001
    
    
    1,819,054
    
    $
    10.01Granted
    
    
    536,500
    
    
    3.27Exercised
    
    
    (2,828
    )
    
    3.19Expired
    
    
    (285,314
    )
    
    10.65Outstanding
      at December 28, 2002
    
    
    2,067,412
    
    
    8.18Granted
    
    
    287,000
    
    
    2.85Exercised
    
    
    (12,500
    )
    
    1.68Expired
    
    
    (216,230
    )
    
    4.88Outstanding
      at January 3, 2004
    
    
    2,125,682
    
    
    7.83Granted
    
    
    445,000
    
    
    3.10Exercised
    
    
    (650
    )
    
    3.19Expired
    
    
    (178,748
    )
    
    8.69Outstanding
      at January 1, 2005
    
    
    2,391,284
    
    $
    6.88








Shares
available for future grant at January 1, 2005 and January 3, 2004 were 905,445
and 382,736, respectively.





The
following table summarizes information about stock options outstanding at
January 1, 2005:





**Options
      Outstanding**
    
    **Options
      Exercisable****Range
      of****Exercise
      Prices**
    
    **Number**
      **Outstanding**
      **at
      1/1/05**
    
    **Weighted-Average**
      **Remaining**
      **Contractual
      Life**
    
    **Weighted-Average**
      **Exercise
      Price**
    
    **Number**
      **Exercisable**
      **at
      1/1/05**
    
    **Weighted-Average**
      **Exercise
      Price**$2.00
      - $3.00
    
    
    894,500
    
    
    8.72
    
    $
    2.94
    
    
    202,250
    
    $
    2.95$3.19
      - $4.40
    
    
    631,608
    
    
    6.79
    
    $
    3.93
    
    
    437,590
    
    $
    3.92$5.01
      - $10.38
    
    
    463,250
    
    
    5.69
    
    $
    9.04
    
    
    428,250
    
    $
    9.37$10.81
      - $34.94
    
    
    401,926
    
    
    3.78
    
    $
    17.80
    
    
    401,926
    
    $
    17.80$2.00
      - $34.94
    
    
    2,391,284
    
    
    6.79
    
    $
    6.88
    
    
    1,470,016
    
    $
    9.17





Shares
exercisable at January 1, 2005, January 3, 2004 and December 28, 2002 were
1,470,016, 1,255,346 and 911,533, respectively.


26


**Notes
to Consolidated Financial Statements (Continued)**


*Accounting
Pronouncements* - In
December 2004, the Financial Accounting Standards Board issued a revision to
SFAS 123, ** “Share-Based
Payment.” The revision requires all entities to recognize compensation expense
in an amount equal to the fair value of share-based payments granted to
employees. The statement eliminates the alternative method of accounting for
employee share-based payments previously available under APB Opinion No. 25. The
Statement is effective for the Company beginning in the third quarter of fiscal
2005. The Company has not completed the process of evaluating the impact that
will result from adopting SFAS 123(R).
 
 *Reclassifications* -
Certain balances in prior fiscal years have been reclassified to conform to the
presentation adopted in the current fiscal year. These reclassifications had no
impact on our results of operations or shareholders’ equity as previously
reported.
 
 **B.
Property and Equipment**
 
 ***(In
      thousands)***
    
    **January
      1,**
      **2005**
    
    **January
      3,**
      **2004**Leasehold
      improvements
    
    $
    3,133
    
    $
    3,105Office
      furniture & equipment
    
    
    30,785
    
    
    30,66833,918
    
    
    33,773Accumulated
      depreciation
    
    
    28,260
    
    
    27,476$
    5,658
    
    $
    6,297
 
 On May
15, 2002, we completed the sale of our corporate headquarters building. The net
proceeds of the sale were $16,380,000. The Company recorded a $1,860,000 loss on
the sale. The Company remains a major tenant in the building following the sale.
The balance in leasehold improvements includes improvements in leased office
spaces throughout the Company.
 
 **C.
Other Intangible Assets**
 
 For the
year ended January 1, 2005, we did not acquire or dispose of any intangible
assets. Other intangibles consisted of the following:




**January
      1, 2005**
    
    **January
      3, 2004*****(In
      thousands)***
    
    **Gross****Carrying****Amount**
    
    **Accumulated**
      **Amortization**
    
    **Other
      Intangibles,****Net**
    
    **Gross
      Carrying****Amount**
    
    **Accumulated****Amortization**
    
    **Other**
      **Intangibles,****Net**Customer
      list
    
    $
    12,270
    
    $
    (3,382
    )
    $
    8,888
    
    $
    12,270
    
    $
    (2,608
    )
    $
    9,662Tradename
    
    
    1,720
    
    
    (133
    )
    
    1,587
    
    
    1,720
    
    
    (133
    )
    
    1,587$
    13,990
    
    $
    (3,515
    )
    $
    10,475
    
    $
    13,990
    
    $
    (2,741
    )
    $
    11,249





The
customer list is scheduled to be fully amortized by 2015 with corresponding
amortization estimated to be approximately $800,000 per year. The tradename is
considered to have an indefinite life and is not amortized.





**D.
Deferred Compensation**





Analysts
International has a Deferred Compensation Plan for key management employees as
determined by the Compensation Committee. Included in liabilities at January 1,
2005 and January 3, 2004 is $4,130,000 and $3,716,000, respectively,
representing the Company's liability under the Plan. This liability is being
partially funded by the purchase of life insurance and annuity contracts.
Included in other assets at January 1, 2005 and January 3, 2004 is $1,310,000
and $1,195,000, respectively, representing the carrying value, which
approximates **** market
value, of the annuities and insurance cash value. Deferred compensation expense
for the years ended January 1, 2005, January 3, 2004 and December 28, 2002 was
approximately $920,000, $1,003,000 and $162,000,
respectively.


27


**Notes
to Consolidated Financial Statements (Continued)**





**E.
Long-term Debt**





Effective
April 11, 2002, we consummated an asset-based revolving credit facility with up
to $55,000,000 of availability. We
reduced the level of availability to $45,000,000 following the sale of our
corporate headquarters building on May 15, 2002. Borrowings under this credit
agreement are secured by all of the Company’s assets. The Company must take
advances or pay down the outstanding balance daily. We can, however, choose to
request fixed-term advances of one, two, or three months for a portion of the
outstanding balance on the line of credit. During 2002, we used an initial
advance under the line of credit of $29,800,000 to pay the outstanding balance
of the senior notes ($19,100,000, including make-whole obligations), the
outstanding balance on an existing line of credit ($10,300,000), and certain
transaction expenses. Repayment of the senior notes resulted in a loss on the
early extinguishment of debt of $744,000 in 2002.





Effective
August 5, 2004, the Company amended its revolving credit agreement to extend the
expiration date from April 10, 2005 to October 31, 2006 and modified certain
terms of the agreement. The
amendment reduced the commitment fee from .50% to .25% of the unused portion of
the line, reduced the annual administration fee from $50,000 to $25,000, and
reduced the interest rates on daily advances from the Wall Street Journal’s
“Prime Rate” plus .75% to only its Prime Rate (5.25% on January 1, 2005) and
fixed-term advances from the LIBOR rate plus 3.0% to the LIBOR rate plus 2.0%. The
agreement restricts, among other things, the payment of dividends, establishes
limits on capital expenditures and requires us to maintain a minimum accounts
payable turnover ratio. We believe we will be able to continue to meet the
requirements of this agreement for the foreseeable future.





**F.
Shareholders' Rights Plan**





On June
15, 1989, the Board of Directors adopted a common stock shareholders' rights
plan. Under this plan, the Board of Directors declared a dividend of one common
share purchase right for each outstanding share of common stock and stock
options granted and available for grant. The Board of Directors amended the plan
on April 29, 1996 and April 16, 1998. The rights, which expire on April 16,
2006, are exercisable only under certain conditions, and when exercisable the
holder will be entitled to purchase from the Company one share of common stock
at a price of $160.00, subject to certain adjustments. The rights will become
exercisable after a person or group acquires beneficial ownership of 15% or more
(or as low as 10% as the Board of Directors may determine) of the Company's
common stock or after a person or group announces an offer, the consummation of
which would result in such person or group owning 15% or more of the common
stock.





If the
Company is acquired at any time after the rights become exercisable, the rights
will be adjusted so as to entitle a holder to purchase a number of shares of
common stock of the acquiring company at one-half of their market value. If any
person or group acquires beneficial ownership of 15% or more of the Company's
shares, the rights will be adjusted so as to entitle a holder (other than such
person or group whose rights become void) to purchase a number of shares of
common stock of Analysts International Corporation at one-half of their market
value or the Board of Directors may exchange the rights, 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 beneficial ownership of 15%
or more of the Company's shares, the Board of Directors may redeem the rights at
$.01 per right.


**G.**  **Income
Taxes**


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




**Fiscal
      Year*****(In
      thousands)***
    
    **2004**
    
    **2003**
    
    **2002**Currently
      payable (receivable):Federal
    
    $
    --
    
    $
    277
    
    $
    (4,818
    )State
    
    
    --
    
    
    53
    
    
    --0
    
    
    330
    
    
    (4,818
    )Deferred:Federal
    
    
    (1,581
    )
    
    (296
    )
    
    (2,220
    )State
    
    
    (233
    )
    
    (34
    )
    
    (1,185
    )(1,814
    )
    
    (330
    )
    
    (3,405
    )Valuation
      allowance for deferred tax asset
    
    
    1,814
    
    
    --
    
    
    7,1170
    
    
    (330
    )
    
    3,712Total:
    
    $
    0
    
    $
    0
    
    $
    (1,106
    )


28


**Notes
to Consolidated Financial Statements (Continued)**





Net
deferred tax assets (liabilities) are comprised of the following:





***(In
      thousands)***
    
    **January
      1,**
      **2005**
    
    **January
      3,**
      **2004**Deferred
      compensation
    
    $
    1,611
    
    $
    1,449Accrued
      vacation and compensatory time
    
    
    400
    
    
    487Accrued
      reorganization costs
    
    
    124
    
    
    238Self-insured
      health care reserves
    
    
    (102
    )
    
    36Allowance
      for doubtful accounts
    
    
    773
    
    
    588Depreciation
    
    
    287
    
    
    169Capital
      loss carryforward
    
    
    1,148
    
    
    1,148Goodwill
      and other intangibles
    
    
    3,050
    
    
    4,063State
      net operating loss carryforwards
    
    
    764
    
    
    1,120Federal
      net operating loss carryforward
    
    
    806
    
    
    1,509Other
    
    
    213
    
    
    81Valuation
      allowance
    
    
    (6,478
    )
    
    (8,292
    )Net
      deferred tax assets
    
    $
    2,596
    
    $
    2,596Whereof:Current
    
    $
    366
    
    $
    968Noncurrent
    
    
    2,230
    
    
    1,628$
    2,596
    
    $
    2,596


The
federal net operating loss (NOL) carryforward was generated in 2003 and expires
in 2023. The state NOL carryforwards expire as follows: $10,000 in 2005,
$215,000 in 2006 through 2009, $257,000 in 2010 through 2019 and $282,000 in
2020 and beyond.






****


**Fiscal
      Year*****(In
      thousands)***
    
    **2004**
    
    **2003**
    
    **2002**Income
      tax (benefit) at statutory federal rate
    
    $
    1,349
    
    $
    (533
    )
    $
    (7,748
    )State
      and local taxes, net of federal benefit
    
    
    100
    
    
    (59
    )
    
    (863
    )Valuation
      allowance for deferred tax asset
    
    
    (1,814
    )
    
    --
    
    
    7,117Meals
      and Entertainment
    
    
    215
    
    
    232
    
    
    241Other
    
    
    150
    
    
    360
    
    
    147Total
      tax provision
    
    $
    0
    
    $
    0
    
    $
    (1,106
    )


**H.
Commitments**


At
January 1, 2005 aggregate net minimum rental commitments under noncancelable
operating leases having an initial or remaining term of more than one year are
payable as follows:





***(In
      thousands)***Year
      ending December 31,
    
    
    2005
    
    $
    7,1452006
    
    
    5,7112007
    
    
    3,3382008
    
    
    1,594Later
    
    
    --17,788Less:
      sublease contracts
    
    
    
    
    
    (3,778
    )Total
      minimum obligation
    
    
    
    
    $
    14,010




Rent
expense, primarily for office facilities, for the years ended January 1, 2005,
January 3, 2004 and December 28, 2002 were $5,250,000, $6,216,000 and
$6,327,000, respectively.





29


****


**Notes
to Consolidated Financial Statements (Continued)**





Analysts
International has compensation arrangements with its corporate officers and
certain other employees, which provide for certain payments in the event of a
change of control of the Company.





We also
sponsor a 401(k) plan. Substantially all employees are eligible to participate
and may contribute up to 50% of their pretax earnings, subject to IRS maximum
contribution amounts. After one year of employment, we make matching
contributions in the form of Company stock of 18% of a participant’s first 15%
of pre-tax contributions. Match contributions vest at the rate of 20% per year
and are fully vested after five years of service. We made match contributions
for the years ended January 1, 2005, January 3, 2004 and December 28, 2002 in
the amount of approximately $580,000, $663,000 and $852,000,
respectively.





**I.
Restructuring Charge**





In
December 2000, we recorded a restructuring charge of $7.0 million including $4.4
million to cover lease terminations and abandonment costs (net of sublease
income). A summary of the restructuring charge and subsequent activity in the
restructuring accrual account, which is included in other current and other
non-current liabilities, is as follows:


***(In
      thousands)***
    
    **Workforce**
      **Reduction**
    
    **Office
      Closure/**
      **Consolidation**
    
    **Total**Balance
      at December 31, 2001
    
    $
    24
    
    $
    2,630
    
    $
    2,654Cash
      expenditures
    
    
    24
    
    
    1,511
    
    
    1,535Non-cash
      charges
    
    
    --
    
    
    96
    
    
    96Additional
      accrual
    
    
    --
    
    
    175
    
    
    175Balance
      at December 28, 2002
    
    $
    --
    
    $
    1,198
    
    $
    1,198Cash
      expenditures
    
    
    
    
    
    587
    
    
    587Non-cash
      charges
    
    
    
    
    
    --
    
    
    --Balance
      at January 3, 2004
    
    
    
    
    $
    611
    
    $
    611Cash
      expenditures
    
    
    
    
    
    293
    
    
    293Non-cash
      charges
    
    
    
    
    
    --
    
    
    --Balance
      at January 1, 2005
    
    
    
    
    $
    318
    
    $
    318


During
fiscal 2002, we were less successful than anticipated in subleasing certain of
the vacated spaces. As a result it became necessary to add $175,000 to the
reserve. While we believe the reserve is currently adequate, negative sublease
activity in the future, including any defaults of existing subleases could
create the need for future adjustments to this reserve.





**J.
Adoption of SFAS No. 141 and SFAS No. 142**





In
preparation for the adoption of SFAS No. 141 and SFAS No. 142 we evaluated our
goodwill and intangible assets acquired prior to June 30, 2001, the effective
date of SFAS No. 141, using the criteria of SFAS No. 141. This evaluation
resulted in $1,080,000 of other intangibles (comprised entirely of assembled
workforce intangibles) being subsumed into goodwill at January 1,
2002. ****





SFAS No.
142 prohibits companies from continuing to amortize purchased goodwill and
certain indefinite-lived intangible assets. Instead companies must test such
assets for impairment at least annually. We evaluated our intangible assets as
of January 1, 2002 and determined that the customer list had a determinable life
while the tradename did not. Effective January 1, 2002 we ceased amortization of
the tradename asset.





SFAS No.
142 prescribes a two-phase process for impairment testing of goodwill. The first
phase screens for impairment, while the second phase measures the impairment. We
completed our first phase impairment analysis during the first quarter of 2004
and found no indication of impairment of our recorded goodwill; accordingly, the
second phase testing was not required.





Based on
the impairment tests for fiscal 2002, we recognized a transitional impairment
loss of $16,389,000 in the first quarter of 2002 to reduce the carrying value of
goodwill at our infrastructure reporting unit to its implied fair value. We did
not record a tax benefit for this adjustment, as our current operating
performance required the establishment of a reserve against the deferred tax
asset created by this impairment.


30


**Notes
to Consolidated Financial Statements (Continued)**





The
impairment was required because economic conditions at the time of testing
(including declining operating margins and lower demand for our services)
reduced the estimated future expected performance for this operating unit. Under
SFAS 142, the impairment adjustment recognized at adoption of the new rules was
reflected as a cumulative effect of accounting change in our first quarter 2002
statement of operations. Impairment adjustments recognized after adoption, if
any, generally are required to be recognized as operating expenses.





The
Company’s year-end closing and reporting process has been truncated in order to
meet current, as well as future, accelerated periodic filing requirements,
resulting in significant constraints on its resources during its first fiscal
quarter. Accordingly, effective September 4, 2004, the Company changed the
designated date of the annual evaluation of goodwill from the first day of the
fiscal year to the last day of its monthly accounting period for August. This
change allows the Company to perform testing at a point in the reporting cycle
that does not fall during the year-end closing and reporting process so that
additional resources are available. The Company performed the test at September
4, 2004, and determined that no impairment charge for goodwill was required,
although the valuation determined the fair value of the Staffing, Infrastructure
and Solutions reporting units to approximate their carrying value. The change is
not intended to delay, accelerate, or avoid an impairment charge. The Company
believes that the change described above is to an alternative accounting method
that is preferable under the circumstances.





**K.** **Restricted
Stock**





Effective
June 18, 2004, the Company hired a new President who was granted a restricted
stock award of 200,000 shares. At the time of the award, the aggregate market
value of the restricted stock was $558,000 and was recorded as deferred
compensation, a separate component of shareholders’ equity. The restricted stock
award vests at the rate of 25% per year and is fully vested after four
years.


****


Effective
October 21, 2004, the Company’s CEO was granted a restricted stock award of
100,000 shares. At the time of the award, the aggregate market value of the
restricted stock was $386,000 and was recorded as deferred compensation, a
separate component of shareholders’ equity. The restricted stock award vests at
the rate of 33% per year and is fully vested after three years.





**L.** **Subsequent
Events**





On
January 6, 2005, the Company acquired the assets of Wirespeed Networks LLC for
$2.0 million in cash and 103,093 shares of common stock, valued at $400,000. The
common stock and $250,000 were placed in escrow to be paid to the Principals of
Wirespeed over the next three years. In addition, the purchase agreement
contains a maximum payout of an additional $2.8 million in earn-out
consideration over the next four years, contingent upon the achievement of
aggressive financial targets.


31


**REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**














Shareholders
and Board of Directors


Analysts
International Corporation


Minneapolis,
Minnesota











We have
audited the accompanying consolidated balance sheets of Analysts International
Corporation and subsidiaries (the “Company”) as of January 1, 2005 and
January 3, 2004, and the related consolidated statements of operations,
shareholders’ equity, and cash flows for the years ended January 1, 2005,
January 3, 2004 and December 28, 2002. These financial statements are
the responsibility of the Company’s management. Our responsibility is to express
an opinion on these financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.





In our
opinion, such consolidated financial statements present fairly, in all material
respects, the financial position of Analysts International Corporation and
subsidiaries as of January 1, 2005 and January 3, 2004, and the
results of their operations and their cash flows for the years ended
January 1, 2005, January 3, 2004 and December 28, 2002, in
conformity with accounting principles generally accepted in the United States of
America.





We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of the Company’s internal
control over financial reporting as of January 1, 2005, based on the
criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated March 17, 2005 expressed an unqualified opinion on management’s assessment
of the effectiveness of the Company’s internal control over financial reporting
and an unqualified opinion on the effectiveness of the Company’s internal
control over financial reporting.





As
discussed in Note J to the consolidated financial statements, the Company
changed its method of accounting for goodwill and certain intangibles in
2002.











/s/
      Deloitte & Touche LLPMinneapolis,
      MinnesotaMarch
      17, 2005




32


**REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**














Shareholders
and Board of Directors


Analysts
International Corporation


Minneapolis,
Minnesota














We have
audited management’s assessment, included in the accompanying Management’s
Report on Internal Control Over Financial Reporting, that Analysts International
Corporation and subsidiaries (the “Company”) maintained effective internal
control over financial reporting as of January 1, 2005, based on criteria
established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. The Company’s management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management’s
assessment and an opinion on the effectiveness of the Company’s internal control
over financial reporting based on our audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management’s assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinions.





A
company’s internal control over financial reporting is a process designed by, or
under the supervision of, the company’s principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company’s board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of management
and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a material effect on the
financial statements.





Because
of the inherent limitations of internal control over financial reporting,
including the possibility of collusion or improper management override of
controls, material misstatements due to error or fraud may not be prevented or
detected on a timely basis. Also, projections of any evaluation of the
effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.





In our
opinion, management’s assessment that the Company maintained effective internal
control over financial reporting as of January 1, 2005, is fairly stated,
in all material respects, based on the criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission. Also in our opinion, the Company maintained, in all
material respects, effective internal control over financial reporting as of
January 1, 2005, based on the criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission.





We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated financial statements and
financial statement schedule as of and for the year ended January 1, 2005
of the Company and our reports dated, March 17, 2005 expressed an unqualified
opinion on those financial statements and financial statement
schedule.







/s/
      Deloitte & Touche LLPMinneapolis,
      MinnesotaMarch
      17, 2005


33





**Report
of Management**








The
consolidated financial statements of Analysts International Corporation
published in this report were prepared by company management, which is
responsible for their integrity and objectivity. The statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America applying certain estimates and judgments as required.
The financial information elsewhere in this report is consistent with the
statements.





Analysts
International maintains internal controls adequate to provide reasonable
assurance its transactions are appropriately recorded and reported, its assets
are protected and its established policies are followed. The structure is
enforced by written policies and procedures, internal audit activities and a
qualified financial staff.





Our
independent auditors, Deloitte & Touche LLP, provide an objective
independent review by audit of Analysts International’s consolidated financial
statements and issuance of a report thereon.





The Audit
Committee of the Board of Directors, comprised solely of outside directors,
meets with the independent auditors and representatives from management to
appraise the adequacy and effectiveness of the audit functions, internal
controls and quality of our financial accounting and reporting.











Dated:
      March 17, 2005
    By:
    /s/
      Michael J. LaVelleMichael
      J. LaVelleChief
      Executive OfficerDated:
      March 17, 2005
    By:
    /s/
      David J. SteichenDavid
      J. SteichenChief
      Financial Officer








**Management’s
Report on Internal Control Over Financial Reporting**











Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f). Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, we conducted
an evaluation of the effectiveness of our internal control over financial
reporting based on the framework in *Internal
Control - Integrated Framework* issued
by the Committee of Sponsoring Organizations of the Treadway Commission. Based
on our evaluation under the framework in *Internal
Control - Integrated Framework* , our
management concluded that our internal control over financial reporting was
effective as of January 1, 2005. Our management’s assessment of the
effectiveness of our internal control over financial reporting as of January 1,
2005 has been audited by Deloitte & Touche LLP, an independent registered
public accounting firm, as stated in their report which is included
herein.











Dated:
      March 17, 2005
    By:
    /s/
      Michael J. LaVelleMichael
      J. LaVelleChief
      Executive OfficerDated:
      March 17, 2005
    By:
    /s/
      David J. SteichenDavid
      J. SteichenChief
      Financial Officer


34


**Stock
Data**








**Market
      Range**
    ******Fiscal
      Year Ended January 1, 2005**
    ****
    **High**
    ****
    **Low**
    ****
    **Close**Fourth
      Quarter
    
    $
    4.26
    
    $
    3.20
    
    $
    4.00Third
      Quarter
    
    
    4.63
    
    
    2.81
    
    
    3.78Second
      Quarter
    
    
    3.50
    
    
    2.68
    
    
    3.14First
      Quarter
    
    
    3.59
    
    
    2.71
    
    
    3.05**Fiscal
      Year Ended January 3, 2004**Fourth
      Quarter
    
    $
    3.70
    
    $
    2.10
    
    $
    3.18Third
      Quarter
    
    
    3.15
    
    
    2.11
    
    
    2.56Second
      Quarter
    
    
    2.54
    
    
    1.25
    
    
    2.45First
      Quarter
    
    
    2.15
    
    
    1.15
    
    
    1.51








The
Company’s common shares are traded on The Nasdaq Stock Market® under the symbol
ANLY. As of March 7, 2005, there were approximately 1,121 shareholders of
record. The above table sets forth for the periods indicated the market prices
for the Company's Common Stock as reported by Nasdaq.





The
Company’s current debt arrangement prohibits the payment of dividends. There can
be no assurance the Company will be able to reinstate a dividend paying policy
in the future.








*Sales
of Unregistered Securities*





On
January 6, 2005, the Company acquired Wirespeed Networks LLC. The Company issued
103,093 of its common stock, having an aggregate value of $400,000, to an escrow
account. The shares will be distributed on a pro rata basis from the escrow
account to the Principals of Wirespeed Networks LLC at the end of the next three
fiscal years. These shares were not registered under the Securities Act of 1933.
The unregistered shares 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. No underwriters were involved with such issuance of common
stock. ****


35





**Five
Year Financial Summary**







***(In
      thousands except per share amounts***
    
    ****
      **Fiscal
      Year**
    ****
    **Six
      Months**
      **Ended**
      **December
      31,**
    ****
    ****
      ****
      **Fiscal
      Year**
    *******and
      number of personnel)***
    ****
    **2004**
    ****
    **2003**
    ****
    **2002**
    ****
    **2001**
    ****
    **2000**
    ****
    **2000**Revenue:Professional
      services provided directly
    
    $
    269,610
    
    $
    266,175
    
    $
    312,085
    
    $
    390,320
    
    $
    221,760
    
    $
    420,140Professional
      services provided through subsuppliers
    
    
    55,806
    
    
    50,543
    
    
    98,578
    
    
    140,340
    
    
    61,634
    
    
    138,591Product
      sales
    
    
    16,196
    
    
    15,181
    
    
    15,497
    
    
    21,067
    
    
    4,946
    
    
    --Total
      revenue
    
    
    341,612
    
    
    331,899
    
    
    426,160
    
    
    551,727
    
    
    288,340
    
    
    558,731Salaries,
      contracted services and direct charges
    
    
    261,005
    
    
    256,643
    
    
    339,016
    
    
    438,420
    
    
    230,731
    
    
    452,334Cost
      of product sales
    
    
    14,964
    
    
    14,562
    
    
    14,699
    
    
    19,286
    
    
    4,507
    
    
    --Amortization
      of goodwill and other intangible assets
    
    
    774
    
    
    773
    
    
    785
    
    
    3,212
    
    
    1,370
    
    
    1,025Loss
      on sale of corporate headquarters(See
      Note B)
    
    
    --
    
    
    --
    
    
    1,860
    
    
    --
    
    
    --
    
    
    --Restructuring
      charge (See Note I)
    
    
    --
    
    
    --
    
    
    --
    
    
    --
    
    
    7,000
    
    
    --Non-operating
      income
    
    
    39
    
    
    79
    
    
    122
    
    
    247
    
    
    68
    
    
    1,452Loss
      on investment*
    
    
    --
    
    
    --
    
    
    190
    
    
    3,012
    
    
    --
    
    
    --Interest
      expense
    
    
    41
    
    
    13
    
    
    1,042
    
    
    2,899
    
    
    1,494
    
    
    1,584Loss
      on debt extinguishment (See Note E)
    
    
    --
    
    
    --
    
    
    744
    
    
    --
    
    
    --
    
    
    --Income
      taxes (benefit) and minority interest
    
    
    --
    
    
    --
    
    
    (1,106
    )
    
    216
    
    
    (3,631
    )
    
    5,769Net
      income (loss) before cumulative effect of change in
      accounting
      for goodwill
    
    
    3,852
    
    
    (1,524
    )
    
    (4,642
    )
    
    (2,980
    )
    
    (6,302
    )
    
    9,788Cumulative
      effect of change in accounting for goodwil
      (See
      Note J)
    
    
    --
    
    
    --
    
    
    16,389
    
    
    --
    
    
    --
    
    
    --Total
      assets
    
    
    105,677
    
    
    101,895
    
    
    106,744
    
    
    192,884
    
    
    201,729
    
    
    192,144Long-term
      liabilities
    
    
    4,197
    
    
    4,038
    
    
    3,605
    
    
    7,588
    
    
    45,615
    
    
    41,739Shareholders’
      equity
    
    
    72,618
    
    
    68,663
    
    
    70,166
    
    
    91,083
    
    
    95,083
    
    
    99,053Per
      share data:Net
      income (loss) before cumulative effect of change in
      accounting
      for goodwill (basic)
    
    
    .16
    
    
    (.06
    )
    
    (.19
    )
    
    (.12
    )
    
    (.28
    )
    
    .43Net
      income (loss) before cumulative effect of change in
      accounting
      for goodwill (diluted)
    
    
    .16
    
    
    (.06
    )
    
    (.19
    )
    
    (.12
    )
    
    (.28
    )
    
    .43Cash
      dividends
    
    
    .00
    
    
    .00
    
    
    .00
    
    
    .10
    
    
    .20
    
    
    .40Shareholders’
      equity
    
    
    3.00
    
    
    2.84
    
    
    2.90
    
    
    3.76
    
    
    3.93
    
    
    4.38Average
      common shares outstanding
    
    
    24,212
    
    
    24,201
    
    
    24,198
    
    
    24,196
    
    
    22,624
    
    
    22,583Average
      common and common equivalent shares
      outstanding
    
    
    24,398
    
    
    24,201
    
    
    24,198
    
    
    24,196
    
    
    22,624
    
    
    22,624Number
      of Personnel
    
    
    3,015
    
    
    3,000
    
    
    3,075
    
    
    3,800
    
    
    4,750
    
    
    4,800





*We
recorded a $3.0 million loss during 2001 relating to a 1999 equity investment in
a privately held Minneapolis-based software company specializing in the storage
and transmission of high volume data.




We
changed our fiscal year end to December 31, 2000. Accordingly, we have presented
financial information for the six months ended December 31, 2000 (the transition
period). Effective December 28, 2002, we changed our fiscal year to end on the
Saturday closest to December 31. Accordingly, references herein to our fiscal
year 2004 refers to the period from January 4, 2004 to January 1, 2005, our
fiscal year 2003 refers to the period from December 29, 2002 to January 3, 2004,
and our fiscal year 2002 refers to the period from January 1, 2002 to December
28, 2002.


36





**Quarterly
Revenues and Income**


****


The
following table sets forth certain statements of operations data for each of the
quarters indicated below, and in the opinion of management, contains all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation thereof.




**Quarter
      Ended*****(In
      thousands except per share amounts)***
    
    **April
      3**
    
    **July
      3**
    
    **October
      2**
    
    **January
      1**
    
    **Total****Fiscal
      2004**Total
      revenue
    
    $
    85,394
    
    $
    86,865
    
    $
    86,380
    
    $
    82,973
    
    $
    341,612Gross
      margin
    
    
    15,730
    
    
    16,071
    
    
    16,385
    
    
    17,457
    
    
    65,643Income
      before income taxes
    
    
    454
    
    
    706
    
    
    1,284
    
    
    1,408
    
    
    3,852Income
      taxes (benefit)
    
    
    --
    
    
    --
    
    
    --
    
    
    --
    
    
    --Net
      income
    
    
    454
    
    
    706
    
    
    1,284
    
    
    1,408
    
    
    3,852Net
      income per share (basic)
    
    
    .02
    
    
    .03
    
    
    .05
    
    
    .06
    
    
    .16Net
      income per share (diluted)
    
    
    .02
    
    
    .03
    
    
    .05
    
    
    .06
    
    
    .16
  **Quarter
      Ended****March
      29**
    
    **June
      28**
    
    **September
      27**
    
    **January
      3**
    
    **Total****Fiscal
      2003**Total
      revenue
    
    $
    86,041
    
    $
    82,610
    
    $
    80,036
    
    $
    83,212
    
    $
    331,899Gross
      margin
    
    
    15,385
    
    
    15,071
    
    
    14,630
    
    
    15,608
    
    
    60,694Loss
      before income taxes
    
    
    (373
    )
    
    (168
    )
    
    (559
    )
    
    (424
    )
    
    (1,524
    )Income
      taxes (benefit)
    
    
    (57
    )
    
    --
    
    
    --
    
    
    57
    
    
    --Net
      loss
    
    
    (316
    )
    
    (168
    )
    
    (559
    )
    
    (481
    )
    
    (1,524
    )Net
      loss per share (basic and diluted)
    
    
    (.01
    )
    
    (.01
    )
    
    (.02
    )
    
    (.02
    )
    
    (.06
    )




37


[INSIDE
BACK COVER]




**Corporate
Information**
 
 
 **Board
      of Directors**
    **Officers**
    **10-K
      and Other Reports Available*****Inside
      Directors***
      
      Michael
      J. LaVelle
      Chairman
      of the Board and
      Chief
      Executive Officer
      
      Frederick
      W. Lang
      Chairman
      Emeritus of the Board
      
      John
      D. Bamberger
      Executive
      Vice President and
      Chief
      Operating Officer
      
      ***Outside
      Directors***
      
      Krzysztof
      K. Burhardt
      Partner,
      Clotho & Associates
      
      Willis
      K. Drake
      Retired
      Chairman of the Board,Data
      Card Corporation
      
      Michael
      B. Esstman
      General
      Partner,Esstman
      Investments, Ltd. and
      Retired
      Senior Vice President,GTE
      Corporation
      
      Margaret
      A. Loftus
      Principal,
      Loftus Brown-Wescott, Inc.
      
      Edward
      M. Mahoney
      Retired
      Chairman andChief
      Executive Officer,
      Fortis
      Investors, Inc. and Fortis Advisers, Inc.
      
      Robb
      L. Prince
      Retired
      Vice President and Treasurer,Jostens,
      Inc.
    Michael
      J. LaVelle
      Chief
      Executive Officer
      
      Jeffrey
      P. Baker
      President
      
      John
      D. Bamberger
      Executive
      Vice President and
      Chief
      Operating Officer
      
      David
      J. Steichen
      Chief
      Financial Officer and Treasurer
      
      Colleen
      M. Davenport
      Secretary
      and General Counsel
      
      Paulette
      M. Quist
      Senior
      Vice President,
      Business
      Development and Strategy
      
      David
      H. Jenkins
      Chief
      Information Officer
    A
      copy of the Company's 2004 Annual Report on Form 10-K and other reports,
      filed with the Securities and Exchange Commission, is available to
      security holders without charge upon request to the Treasurer
      at:
      
      Analysts
      International Corporation
      3601
      West 76th Street
      Minneapolis,
      Minnesota 55435-3000
      
      **Stock
      Transfer Agent**
      
      EquiServe
      Trust Company, N.A.
      P.O.
      Box 43023
      Providence,
      Rhode Island 02940-3023
      
      Shareholder
      Inquiries:
      800-254-5196
      http://www.equiserve.com
      
      **Independent
      Auditors**
      
      Deloitte
      & Touche LLP
      Minneapolis,
      Minnesota
      
      **World
      Wide Web Address**
      
      http://www.analysts.com





[BACK
COVER]




















Analysts
International Corporation


3601 West
76 th Street


Minneapolis,
Minnesota 66435-3000





Phone:
952-835-5900


www.analysts.com