UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

_____________________________________

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2004

¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____ to _____

_____________________________________

Commission File Number 0-27138

[cat10q002.jpg]

CATALYST INTERNATIONAL, INC.

Delaware
(State of Incorporation)

39-1415889
(I.R.S. ID)

8989 North Deerwood Drive, Milwaukee, Wisconsin 53223

(414) 362-6800

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

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

As of August 12, 2004, 7,877,447 shares of the registrant’s common stock were outstanding.

CATALYST INTERNATIONAL, INC.

FORM 10-Q

For The Quarterly Period Ended June 30, 2004

INDEX

Page No.

PART I – FINANCIAL INFORMATION

Item 1.

Consolidated Financial Statements

Consolidated Balance Sheets – June 30, 2004 and December 31, 2003

Consolidated Statements of Operations – Three months ended

June 30, 2004 and 2003

Consolidated Statements of Operations – Six months ended

June 30, 2004 and 2003

Consolidated Statements of Cash Flows – Six months ended

June 30, 2004 and 2003

Notes to Consolidated Financial Statements

Item 2.

Management's Discussion and Analysis of Financial Condition and

Results of Operations

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

Item 4.

Controls and Procedures

PART II – OTHER INFORMATION

Item 1.

Legal Proceedings

Item 2.

Changes in Securities, Use of Proceeds and Issuer Purchases of

Equity Securities

Item 4.

Submission of Matters to a Vote of Security Holders

Item 6.

Exhibits and Reports on Form 8-K

Signatures

PART I – FINANCIAL INFORMATION

Item 1.

Consolidated Financial Statements

CATALYST INTERNATIONAL, INC.

Consolidated Balance Sheets

(in thousands, except share and per share data)

(unaudited)

	June 30, 2004	December 31, 2003
Assets

Current Assets:
Cash and cash equivalents	$ 1,840	$ 4,379
Accounts receivable	6,779	9,409
Prepaid expenses and other	806	611
Total Current Assets	9,425	14,399

Equipment and Leasehold Improvements:
Computer hardware and software	7,981	7,698
Office equipment	2,422	2,416
Leasehold improvements	973	972
	11,376	11,086
Less accumulated depreciation	(10,045)	(9,569)
Total Equipment and Leasehold Improvements	1,331	1,517

Capitalized software development costs, net of accumulated amortization of $728 in 2004 and $510 in 2003	583	801
Goodwill	1,225	1,225
Other assets	435	—
Intangible assets, net of accumulated
amortization of $664 in 2004 and $629 in 2003	35	70
Total Assets	$13,034	$18,012

See accompanying notes.

Note: The balance sheet at December 31, 2003 has been derived from the audited balance sheet at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

CATALYST INTERNATIONAL, INC.

Consolidated Balance Sheets

(in thousands, except share and per share data)

(unaudited)

	June 30, 2004	December 31, 2003
Liabilities and Shareholders’ Equity (Deficit)

Current Liabilities:
Accounts payable	$ 4,180	$ 4,033
Accrued liabilities	1,814	1,948
Accrued legal and professional fees	1,050	1,054
Line of credit	1,000	600
Notes payable	1,419	819
Deferred revenues	6,990	10,345
Current portion of capital lease obligations	6	13
Total Current Liabilities	16,459	18,812

Noncurrent Liabilities:
Capital lease obligations	43	43
Long-term debt	1,554	2,066
Deferred revenues	64	522
Deferred rent	29	53
Total Noncurrent Liabilities	1,690	2,684

Contingencies (Note 4)

Shareholders’ Equity (Deficit):
Preferred stock, $0.01 par value; 2,000,000 shares authorized; none issued or outstanding	--	--
Common stock, $0.10 par value; 25,000,000 shares authorized; shares issued: 9,294,362 in 2004 and 9,269,020 in 2003	931	927
Additional paid-in capital	44,408	44,402
Accumulated deficit	(44,660)	(43,019)
Treasury stock, at cost — 1,420,275 shares of common stock in 2004 and 2003	(5,794)	(5,794)
Total Shareholders’ Equity (Deficit)	(5,115)	(3,484)
Total Liabilities and Shareholders’ Equity (Deficit)	$13,034	$18,012

See accompanying notes.

CATALYST INTERNATIONAL, INC.

Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

Three Months Ended June 30,	2004	2003
Revenues:
Software	$ 698	$ 1,174
Services and post-contract customer support	6,140	4,760
Hardware	1,854	796
Total Revenues	8,692	6,730

Cost of Revenues:
Cost of software	356	256
Cost of services and post-contract customer support	3,593	2,660
Cost of hardware	1,368	711
Total Cost of Revenues	5,317	3,627

Gross Margin	3,375	3,103

Operating Expenses:
Product development	963	828
Sales and marketing	2,241	2,085
General and administrative	1,195	1,139
Separation costs	38	469
Total Operating Expenses	4,437	4,521

Loss From Operations	(1,062)	(1,418)

Other Income (Expense):
Interest expense	(166)	(29)
Investment income	3	7
Miscellaneous, net	5	(15)
Total Other Expense, Net	(158)	(37)

Net Loss	$ (1,220)	$ (1,455)

Basic and diluted loss per share	($0.15)	($0.19)

See accompanying notes.

CATALYST INTERNATIONAL, INC.

Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

Six Months Ended June 30,	2004	2003

Revenues:
Software	$ 1,450	$ 1,626
Services and post-contract customer support	12,335	9,496
Hardware	3,851	1,888
Total Revenues	17,636	13,010

Cost of Revenues:
Cost of software	567	674
Cost of services and post-contract customer support	6,737	5,463
Cost of hardware	2,875	1,484
Total Cost of Revenues	10,179	7,621

Gross Margin	7,457	5,389

Operating Expenses:
Product development	1,981	1,866
Sales and marketing	4,226	4,204
General and administrative	2,420	2,165
Separation costs	128	469
Total Operating Expenses	8,755	8,704

Loss From Operations	(1,298)	(3,315)

Other Income (Expense):
Interest expense	(296)	(37)
Investment income	6	15
Miscellaneous, net	(53)	12
Total Other Expense, Net	(343)	(10)

Net Loss	($ 1,641)	($ 3,325)

Basic and diluted loss per share	($0.21)	($ 0.43)

See accompanying notes

CATALYST INTERNATIONAL, INC.

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

Six Months Ended June 30,	2004	2003
Operating Activities:
Net loss	$ (1,641)	$ (3,325)
Adjustments to reconcile net loss to net cash provided by/(used in) operating activities:
Depreciation	459	575
Amortization	253	729
Amortization of debt discount	88	—
Compensation expense on stock options	2	2
Loss on disposal of equipment and leasehold improvements	—	1
Changes in operating assets and liabilities:
Accounts receivable	2,630	5,767
Prepaid expenses and other	(630)	(201)
Accounts payable	147	(865)
Accrued liabilities	(138)	215
Deferred revenues	(3,813)	(2,784)
Deferred rent	(24)	(20)
Total adjustments	(1,026)	3,419
Net cash provided by/(used in) operating activities	(2,667)	94

Investing Activities:
Capital expenditures	(273)	(203)
Net cash used in investing activities	(273)	(203)

Financing Activities:
Payments on capital lease obligations	(7)	(30)
Proceeds from exercise of options	8	4
Borrowings on line of credit, net	400	998
Net cash provided by financing activities	401	972
Net increase (decrease) in cash and cash equivalents	(2,539)	863

Cash and cash equivalents at beginning of period	4,379	3,005
Cash and cash equivalents at end of period	$ 1,840	$ 3,868
Supplemental Disclosure:
Cash paid for interest	209	37

See accompanying notes.

CATALYST INTERNATIONAL, INC.

Notes to Consolidated Financial Statements

June 30, 2004

(Unaudited)

1. Basis of Presentation

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for fiscal year end financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the financial statements and footnotes thereto included in the Catalyst International, Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 2003.

Net Loss Per Share of Common Stock

Catalyst International, Inc. (“Catalyst” or “we” or “our”) has presented net loss per share in accordance with Statement of Financial Accounting Standards (SFAS) No. 128, “Earnings Per Share.” The following table sets forth the computation of basic and diluted weighted average shares used in the per share calculations. The numerator for the calculation of basic and diluted loss per share is net loss in each period.

(in thousands)	For the Three Months Ended June 30,		For the Six Months Ended June 30,
	2004	2003	2004	2003
DENOMINATOR
Denominator for basic loss per share -
weighted average common shares	7,871	7,816	7,862	7,806

Effect of dilutive securities – stock
options and warrants	--	--	--	--
Denominator for diluted loss per share	7,871	7,816	7,862	7,806

3. Stock-Based Compensation

Catalyst has stock-based employee compensation plans. SFAS No. 123, “Accounting for Stock-Based Compensation,” encourages, but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. Catalyst has chosen to continue using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, in accounting for its stock option plans.

Had compensation cost been determined based upon the fair value at the grant date for awards under the plans based on the provisions of SFAS No. 123, the Company’s pro forma net loss and net loss per share would have been as follows (in thousands, except per share data):

	For the Three Months Ended June 30,		For the Six Months Ended June 30,
	2004	2003	2004	2003
Net income (loss):
As reported	($1,220)	($1,455)	($1,641)	($3,325)
Stock-based employee compensation expense
determined under fair value based method	(167)	(119)	(351)	(331)
Compensation expense on stock options
as reported	1	1	2	2

Pro forma	($1,386)	($1,573)	($1,990)	($3,654)
Net loss per share:
As reported, basic	($0.15)	($ 0.19)	($0.21)	($0.43)
Pro forma, basic	($0.18)	($ 0.20)	(0.25)	(0.47)
As reported, diluted	($0.15)	($ 0.19)	($0.21)	($0.43)
Pro forma, diluted	($0.18)	($ 0.20)	(0.25)	(0.47)

4. Contingencies

The Company has been involved in a dispute with a former customer. In January 2002, an arbitration panel issued an award in favor of the former customer for $800,000 plus 5% interest. The Company challenged the validity of the award on the basis that it was not issued by the arbitration panel in a timely manner consistent with the rules of arbitration.

On November 22, 2002, the District Court ruled in favor of Catalyst’s motion to vacate the arbitration award and denied the Claimant’s petition to confirm the award. The claimant appealed this decision to the 7^th Circuit Court of Appeals. On May 10, 2004, the 7^th Circuit Court of Appeals decided to vacate the judgment of the District Court and remanded for enforcement of the initial arbitration award. It is anticipated that this judgment will be settled and paid subsequent to the impending Comvest Investment Partners acquisition as more fully described in footnote 7.

Catalyst is involved in various other claims and legal matters of a routine nature which are being handled in the ordinary course of business. Although it is not possible to predict with certainty the outcome of these unresolved claims and legal matters or the range of possible loss or recovery, we believe that these unresolved claims and legal matters will not have a material effect on our financial position or results of operations.

5. Acquisition

Effective July 1, 2003, Catalyst acquired Catalyst Consulting Services, Inc., a leading independent provider of consulting, implementation and support services for the SAP Logistics Execution System (SAP LES). The purchase price was $2,018,640 of which $600,000 was paid upon the closing of the transaction. The balance is to be paid in installments as follows; $218,640 on or before March 31, 2004, $600,000 on March 31, 2004 and $600,000 on March 31, 2005. The two payments totaling $818,640 that were due March 31, 2004 have been amended to be paid on or before July 31, 2004 and further amended to be paid upon the closing of the ComVest Investment Partners acquisition. As part of the acquisition, Catalyst incurred approximately $253,000 of direct transaction costs. The acquisition was accounted for as a purchase and, accordingly, the results of operations are included in the consolidated financial statements from July 1, 2003, the effective date of the acquisition. The purchase price was allocated to the acquired assets and assumed liabilities on the basis of their estimated fair values as of the date of the acquisition, as summarized below:

	Current assets	$ 2,018,034
	Equipment and leasehold improvements	121,965
	Goodwill	1,224,975
	Total assets acquired	3,364,974
	Current liabilities	1,021,149
	Capital lease obligations	72,370
	Total liabilities assumed	1,093,519
	Purchase price, including transaction costs	$ 2,271,455

The goodwill of $1,224,975 recorded as a result of this acquisition is not amortized but is reviewed annually for potential impairment in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.”

6. Notes Payable

In September 2003, Catalyst issued $2,125,000 of notes payable with detachable warrants. The notes are secured by substantially all assets, pay 12% interest and mature in 2007. The notes may be subordinated to other senior financing up to an aggregate principal amount not to exceed $5,000,000. The notes have 50% warrant coverage and the warrants are exercisable into the Company’s common stock based on a 30% premium to the volume weighted average closing price of the common stock for 30 days prior to the note issuance and expire in September 2008.

Warrants for the purchase of 739,437 shares of common stock were issued in September 2003 at an exercise price of $1.42 per share. The value allocated to these warrants was measured at the date of grant because the number of shares was fixed and determinable. The value was determined based upon 130% of the volume weighted average closing price of Catalyst’s common stock for the 30 trading days prior to note issuance. The valuation of the warrants reduced the carrying value of the debt by $702,000 and was recorded as a debt discount. The debt discount is being amortized using the straight-line method over the four-year term of the debt.

7. ComVest Investment Partners Acquisition

On June 29, 2004, Catalyst announced that it had entered into an agreement and plan of merger dated as of June 28, 2004 pursuant to which ComVest Investment Partners agreed to acquire the Company by means of a merger in which the Company’s shareholders would receive $2.50 per share in cash. The consummation of the merger is subject to the approval of the Company’s shareholders and other customary closing conditions as described in the Company’s definitive proxy statement dated August 10, 2004. The special meeting of the stockholders to consider and vote on this transaction is currently scheduled to be held on September 2, 2004.

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

This document contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “anticipate,” “estimate,” “intend,” “expect,” “believe” and words and terms of similar substance used in connection with any discussion of future operating or financial performance identify such forward-looking statements. These forward-looking statements are based on management’s present expectations about future events. As with any projection or forecast, they are inherently susceptible to uncertainty and changes in circumstances. Our actual results may differ materially from the results discussed in such forward-looking statements. Factors that may cause such a difference include, but are not limited to, the factors identified in Exhibit 99.1 of Catalyst’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, which is incorporated herein by reference. The Company is under no obligation to (and expressly disclaims any such obligation to) update or alter its forward-looking statements whether as a result of such changes, new information, future events or otherwise.

CRITICAL ACCOUNTING POLICIES

Revenue Recognition

Catalyst derives revenue from the sale of software, services and post-contract customer support (PCS), and hardware. PCS includes telephone support, bug fixes, and rights to upgrades on a when-and-if-available basis. Services range from installation, training, and basic consulting to software modification and customization to meet specific customer needs. In software arrangements that include rights to multiple software products, specified upgrades, PCS and/or other services, Catalyst allocates the total arrangement fee to each deliverable based on the relative fair value of each of the deliverables determined based on vendor-specific objective evidence.

Software

For software with insignificant modifications, Catalyst recognizes that portion of the revenue allocable to software and specified upgrades upon delivery of the software product or upgrade to the end user, provided that it is considered collectible. For software with significant modifications, Catalyst recognizes the revenue allocable to the software on a percentage of completion method, with progress to completion measured based upon labor time expended.

Post-Contract Customer Support

Revenue allocable to PCS is recognized on a straight-line basis over the period the PCS is provided.

Services

Arrangements that include professional services are evaluated to determine whether those services are for modification of the software product or for the normal implementation of Catalyst software products. When professional services are considered part of the normal implementation process, revenue is recognized monthly as these services are invoiced. When professional services are for a modification of the software itself, an evaluation is made to determine if the modification requires more than 50 person-days of work. If the modification is estimated to exceed 50 days, revenue is recognized using contract accounting on a percentage completion method with progress to completion measured based upon labor time expended. When the modification is estimated to be fewer than 50 days, revenue is recognized as invoiced.

Hardware

Revenue on hardware is recognized when the hardware is shipped by the hardware vendor and title has transferred to the customer.

Contract Accounting

For arrangements that include significant customization or modification of the software, revenue is recognized using contract accounting. Revenue from these software arrangements is recognized on a percentage of completion basis, with progress to completion measured based upon labor time expended. Catalyst reserves for project cost overruns when such overruns are identified. We recognize project cost overruns where we will exceed our budgeted number of days on a project. The reserve is based on a standard cost per day.

Allowance for Doubtful Accounts

We evaluate the collectibility of our accounts receivable based on a combination of factors. We recognize reserves for bad debts based on the length of time the receivables are past due ranging from 5% to 100% for amounts more than 120 days past due for which a corresponding deferred revenue does not exist. Specific customer reserves are based upon our assessment of deviations in historical payment trends, the age of the account, and ongoing communications with our customers by both the finance and sales departments. For amounts less than 120 days past due, a small percentage is typically reserved based upon our historical experience. If circumstances change (i.e., higher than expected defaults or an unexpected material adverse change in a major customer’s ability to meet its financial obligations), our estimates of the recoverability of amounts due us could be reduced by a material amount.

Legal Accruals

As discussed in Note 4 of our consolidated financial statements, as of June 30, 2004, we have accrued our best estimate of the probable cost for the resolution of a claim with a former customer. This estimate has been developed in consultation with outside counsel. To the extent additional information arises or our strategies change, it is possible that our best estimate of the probable liability in this matter may change.

Impairment Charges

We review our long-lived assets for impairment whenever events or circumstances occur which indicate that we may be unable to recover the recorded value of the affected long-lived assets.

REVENUE

Catalyst's revenues are derived from software licenses, services and post-contract customer support, and hardware sales. Total revenues for the second quarter of 2004 were $8.7 million, which represented a 29.2% increase from second quarter of 2003 total revenues of $6.7 million. For the first six months of 2004, total revenues were $17.6 million, up 35.6% compared to 2003 total revenues of $13.0 million for the same period. In management’s view, the net increase in total revenues for the three- and six-month periods was due primarily to the acquisition of Catalyst Consulting Services, Inc. and new customer contracts.

International revenues were $1.7 million in the second quarter of 2004 compared to $1.1 million in the second quarter of 2003. International revenues represented 19.9% of total revenues for the second quarter of 2004 compared to 15.9% in the same period of 2003. International revenues were $3.2 million and $2.4 million for the six-month periods ended June 30, 2004 and 2003, respectively. The increase in international revenues was due primarily to an increase in professional services.

Software

Software consists of revenues from software license agreements for Catalyst's primary product, CatalystCommand™, related add-on products, and relational database management systems. Software license fees in the second quarter of 2004 were $698,000 representing a decrease of 40.5% compared to the second quarter of 2003 software license fees of $1.2 million. Software license fees were $1.5 million and $1.6 million for the six-month periods ended June 30, 2004 and 2003, respectively. The decrease in license revenue for the three- and six-month periods is primarily due to economic uncertainties which, due to Catalyst’s global tier 1 customer base and the large capital investment required for our software products, has negatively impacted our business.

Our quarterly revenues are subject to fluctuation because they depend on the sale of a relatively small number of orders for our products and related services. Many of these orders are realized at the end of the quarter. As a result, our quarterly operating results may fluctuate significantly if we are unable to complete several substantial sales in any given quarter. We continue to experience long sales cycles and deferrals of a number of anticipated orders, which we believe are affected by general economic uncertainty and our potential customers’ concerns over making significant capital expenditures in light of this uncertainty. Software revenues may fluctuate based upon the size of new or add-on license agreements, as well as progress toward completion for contracts that are accounted for using contract accounting.

Services and PCS

Services and post-contract customer support (PCS) revenues are derived from software modifications, professional services, and PCS agreements. Services and PCS revenues increased 29.0% to $6.1 million in the second quarter of 2004 from $4.8 million in the second quarter of 2003. For the six-month period ended June 30, 2004 services and PCS revenues were $12.3 million, an increase of 29.9%, compared to revenues of $9.5 for the first six months of 2003. The components of services and PCS revenues as a percentage of total revenues in the second quarter of 2004 were 12.3% for software modifications, 25.2% for professional services, and 33.1% for PCS agreements compared with 13.3%, 16.3%, and 41.1%, respectively, in the second quarter of 2003. Services and PCS revenues increased in the second quarter and first half of 2004 due to the acquisition of Catalyst Consulting Services, Inc. on July 1, 2003 and new customer contracts signed in the second quarter and first half of 2004, which resulted in more projects requiring software modifications and professional services. Software modifications are determined during the customer’s Conference Room Pilot (CRP) and consist of changes to the software to facilitate specific functionality desired by the customer.

Professional services revenues are derived from training, performance of the CRP, technical services, project management, and implementation services. Professional services revenues are generated based on the number of days of work actually performed.

Customers typically enter into an agreement for PCS at the time they license our software and, once installed, pay for the first year of PCS in advance. PCS revenues are recognized ratably over the term of the PCS agreement.

Hardware

Hardware revenues consist primarily of computer hardware, radio frequency equipment, and printers that Catalyst sells to its customers on behalf of hardware and other equipment manufacturers. Hardware purchases by customers may vary significantly from period to period and may depend on the customers’ own purchasing power. Hardware revenues increased by 132.9% to $1.9 million in the second quarter of 2004 from $796,000 in the same period of 2003. Hardware revenues represented 21.8% of total revenues in the first half of 2004 compared to 14.5% for the same period in 2003. The increase in hardware revenue was primarily due to the acquisition of Catalyst Consulting Services, Inc.

OPERATING EXPENSE

Cost of Software

Cost of software consists of the cost of related third-party software licenses sold by Catalyst and the amortization of capitalized software costs. In the second quarter of 2004, cost of software increased to

$356,000 compared to $256,000 in the same period of 2003 due primarily to an increase in third-party software licenses sales. Year-to-date cost of software decreased by 15.9% to $567,000 in 2004 from $674,000 in 2003, reflecting a decrease in software amortization. Software amortization during the six months ended June 30, 2004 was $218,000 versus $578,000 during the same period in 2003.

Cost of Services and PCS

Cost of services and PCS consists primarily of personnel and related costs for the performance of software modifications, professional services, and PCS. The cost of services and PCS increased to $3.6 million in the second quarter of 2004 from $2.7 million for the second quarter of 2003. As a percentage of services and PCS revenues, the cost of services and PCS increased to 58.5% of related revenues for the second quarter of 2004 from 55.9% for the second quarter of 2003. The cost of services and PCS increased due primarily to increased personnel costs resulting from our acquisition of Catalyst Consulting Services, Inc.

Year-to-date cost of services and PCS increased 23.3% to $6.7 million in 2004 from $5.5 million for the same period in 2003 and decreased as a percent of related revenues to 54.6% at June 30, 2004 from 57.5% at June 30, 2003. We believe that the cost of services and PCS as a percentage of related revenues will depend on the quantity and value of new customer contracts signed in 2004.

Cost of Hardware

Cost of hardware consists primarily of the cost of computer hardware, radio frequency equipment, and printers sold by Catalyst on behalf of the equipment manufacturers. We do not inventory hardware items, but make them available to customers who desire a turnkey solution. Cost of hardware in the second quarter of 2004 was $1.4 million compared to $711,000 in the second quarter of 2003. Cost of hardware was $2.9 million and $1.5 million for the six-month periods ended June 30, 2004 and 2003, respectively. The increase in cost for the quarter and six-month period ending June 30, 2004 was attributable to an increase in sales of hardware.

Product Development

Product development costs are expenses associated with research and development, including costs of engineering personnel and related development expenses such as software tools, training, and documentation. Product development costs as a percentage of total revenues for the second quarter of 2004 decreased to 11.1% from 12.3% in the second quarter of 2003. Product development costs were $963,000 and $828,000 in the second quarter of 2004 and 2003, respectively. Year to date product development costs increased by 6.2% to $2.0 million for the six months ended June 30, 2004. Product development costs increased due primarily to increased personnel costs.

Sales and Marketing

Sales and marketing expenses consist primarily of salaries; commissions; and marketing, promotional, and travel expenses paid to or on behalf of sales and marketing personnel. Sales and marketing expenses as a percentage of total revenues for the second quarter of 2004 decreased to 25.8% from 31.0% in the second quarter of 2003. Sales and marketing expenses increased to $2.2 million in the second quarter of 2004 from $2.1 million in the second quarter of 2003 and remained flat at $4.2 million for the six months ended June 30, 2004 and June 30, 2003. The increase in sales and marketing expenses for the current quarter was due primarily to trade shows attended during the quarter.

General and Administrative

General and administrative expenses consist primarily of the salaries of administrative, executive, finance, human resources, and quality assurance personnel. General and administrative expenses as a percentage of total revenues were 13.7% for the second quarter of 2004 and 16.9% for the second quarter of 2003. General and administrative expenses increased to $1.2 million in the second quarter of 2004 from $1.1 million in the second quarter of 2003. For the six-month period, general and administrative expenses were $2.4 million for 2004 compared to $2.2 million for 2003. The increase in cost was primarily attributable to the additional headcount from the acquisition of Catalyst Consulting Services, Inc.

OTHER OPERATING EXPENSES, INVESTMENT INCOME (LOSS), AND INCOME TAXES

Other Income and Expense

Other income and expense consists primarily of interest income and interest expense and does not have a material impact on operating results.

Income Tax Expense

No federal or state tax expense was recorded for the three-month periods ended June 30, 2004 and 2003 due to our federal and state net operating loss position. No deferred tax credit was recorded in the three- or six-month periods ended June 30, 2004 and 2003 as we continue to record a valuation allowance to reserve for the net deferred tax assets.

Liquidity and Capital Resources

Net cash used in operating activities was $2.7 million for the six months ended June 30, 2004, compared to net cash provided of $94,000 during the six months ended June 30, 2003. The increase was due primarily to an increase in our days sales outstanding on accounts receivable.

Cash used in investing activities was $274,000 during the six months ended June 30, 2004 compared to $203,000 during the three months ended June 30, 2003 and was primarily for capital expenditures.

Net cash provided by financing activities was $402,000 during the six months ended June 30, 2004, compared to $972,000 during the six months ended June 30, 2003. The decrease was due primarily to a reduction in net borrowings on our line of credit.

As of June 30, 2004, we had $1.8 million in cash and cash equivalents and negative working capital of $7.0 million. Cash and cash equivalents consist primarily of investments in money market funds.

During 2003, Catalyst issued $2,125,000 of notes payable with detachable warrants, of which $1,925,000 were issued to certain members of the Board of Directors. The notes are secured by substantially all assets, pay 12% interest and mature in 2007. Interest expense to members of the Board of Directors was approximately $58,000 and $116,000 during the second quarter and year to date, respectively. The notes may be subordinated to other senior financing up to an aggregate principal amount not to exceed $5,000,000. The notes have 50% warrant coverage and the warrants are exercisable into the Company’s common stock based on a 30% premium to the volume weighted average closing price of the common stock for 30 days prior to the note issuance and expire in September 2008.

Warrants for the purchase of 739,437 shares of common stock were issued in connection with the notes at an exercise price of $1.42 per share. The value allocated to these warrants was measured at the date of grant because the number of shares was fixed and determinable. The value was determined based upon 130% of the volume weighted average closing price of Catalyst’s common stock for the 30 trading days prior to note issuance. The valuation of the warrants reduced the carrying value of the debt by $702,465 and was recorded as a debt discount. The debt discount is being amortized using the straight-line method over the four-year term of the debt.

In February 2004, Catalyst entered into a new $3 million asset based credit facility with Silicon Valley Bank. The revolving credit facility bears interest at prime plus 2% subject to a minimum interest charge of 6.5%. This facility expires on February 17, 2005. Advances under this line are based upon a 75% advance rate of eligible accounts receivables as defined in the credit agreement. We are currently in default of the facility's minimum tangible net worth covenant. In addition, the merger with ComVest will require the bank's consent. We believe that the covenant default will be waived and the consent to the merger will be granted by the bank. The merger with ComVest is subject to our obtaining this waiver and consent. As of August 13, 2004, $1.0 million was outstanding under the facility.

The Company’s long-term debt at June 30, 2004 consists of the following:

Notes payable to former owner of Catalyst Consulting
	Services, Inc., bearing interest at
	applicable federal rate	$ 1,418,640

	Notes payable	2,125,000

	Less debt discount	(570,753)
		2,972,887

	Less current portion	1,418,640
		$ 1,554,247

Accounts receivable were $6.8 million as of June 30, 2004. This compares to $9.4 million at December 31, 2003. The decrease from December 31, 2003 was due to enhanced collection efforts, which resulted in an improvement in days sales outstanding. At June 30, 2004, we had a reserve for doubtful accounts of $295,000 and believe we have adequately provided for any risks with respect to our accounts receivable known or anticipated at this time.

Our future capital requirements will depend on numerous factors including the level and timing of revenue, the resources we devote to marketing and selling our products and services, and our future investments in product development. We currently anticipate that our cash and available borrowings under our Revolving Credit Facility will be sufficient to meet our anticipated needs for working capital and capital expenditures through at least December 31, 2004. However, any projections of future cash needs and cash flows are subject to uncertainty. Our long-term capital needs will depend on numerous factors, including the rate at which we are able to obtain new business from customers, the timing and amounts of expenditures on new and enhanced products and services, and the timing and size of acquisitions that we may pursue.

Effective July 1, 2003, we completed the asset purchase of Catalyst Consulting Services, Inc., a leading independent provider of consulting, implementation and support services for the SAP Logistics Execution System (SAP LES). The purchase price was $2,018,640 of which $600,000 was paid upon the closing of the transaction. The balance was to be paid in installments as follows; $218,640 on or before March 31, 2004, $600,000 on March 31, 2004 and $600,000 on March 31, 2005. The two payments totaling $818,640 that were due March 31, 2004 have been amended to be paid on or before July 31, 2004 and further amended to be paid upon the closing of the ComVest Investment Partners acquisition. Approximately $1,000,000 of net working capital was acquired in this asset purchase.

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

Catalyst does not believe it has material exposure to market risk with respect to any of its investments or debt instruments as we do not use market rate sensitive instruments for trading or other purposes. For purposes of the Consolidated Statements of Cash Flows, we consider all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash equivalents consist principally of investments in money market funds. The cost of these securities, which are considered "available for sale" for financial reporting purposes, approximates fair value at both June 30, 2004 and June 30, 2003. There were no realized gains or losses in the periods ended June 30, 2004 and 2003.

Item 4. Controls and Procedures

Catalyst maintains a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in the reports filed by us under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. As of June 30, 2004, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and President and our Executive Vice President and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based on that evaluation, our Chief Executive Officer and President and our Executive Vice President and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of June 30, 2004.

There has been no change in our internal control over financial reporting that has occurred during the quarter ended June 30, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1.

Legal Proceedings

See Note 4 to our consolidated financial statements as of June 30, 2004 for information regarding legal proceedings.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

During the quarter ended June 30, 2004, Catalyst did not sell any equity securities (including warrants or convertible securities) that were not registered under the Securities Act or repurchase any of its equity securities.

Item 4.

Submission of Matters to a Vote of Shareholders

(a)

Catalyst’s 2004 Annual Meeting of Shareholders was held on June 24, 2004.

(b)

Mr. Roy J. Carver was elected as a Class III director for a term of three years. Messrs. Douglas B. Coder, Terrence L. Mealy, William G. Nelson, and James B. Treleaven continue as directors.

(c)

The shareholders voted on the following matters:

(i)

Election of director. Management proposed the election of Mr. Carver.

	Nominee	Authority Granted	Authority Withheld	Authority Abstained
	Roy J. Carver	5,365,177	1,605,469	N/A

(ii)

Ratification of the appointment Ernst & Young LLP as independent auditors for 2004.

		Authority Granted	Authority Withheld	Authority Abstained
	Ratification of Ernst & Young LLP	5,363,811	1,590,816	16,019

No other matters were acted upon by the shareholders at the Annual Meeting.

Item 6.

Exhibits and Reports on Form 8-K

(a)

Exhibits

31.1

Rule 13a-14(a) Certification of President and Chief Executive Officer

31.2

Rule 13a-14(a) Certification of Executive Vice President and Chief Financial Officer

32.1

Section 1350 Certification of President and Chief Executive Officer

32.2

Section 1350 Certification of Executive Vice President and Chief Financial Officer

(b)

Reports on Form 8-K

During the fiscal quarter ended June 30, 2004, one report on Form 8-K was furnished (May 4, 2004), pursuant to item 12 and one report on Form 8-K was filed (June 30, 2004), pursuant to items 5 and 7.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

CATALYST INTERNATIONAL, INC.

Dated: August 16, 2004

By:/s/ James B. Treleaven

James B. Treleaven

President and Chief Executive Officer

Signing on behalf of the registrant and as

principal executive officer.

Dated: August 16, 2004

By:/s/ David H. Jacobson

David H. Jacobson

Executive Vice President and Chief Financial Officer

Signing on behalf of the registrant and as

principal financial officer.

CATALYST INTERNATIONAL INC 10-Q