**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

 

**Washington, D.C. 20549**

 

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**FORM 10-Q/A**

 
| **ý** | ** ** | **Quarterly  Report Under Section 13 or 15(d)  of the Securities Exchange Act of 1934**                                                                                             | ** ** | ** ** |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** ** | ** ** | ** **                                                                                                                                                                               | ** ** | ** ** |
| ** ** | ** ** | **for the quarterly period ended  June 30, 2004**                                                                                                                                   | ** ** | ** ** |
| ** ** | ** ** | ** **                                                                                                                                                                               | ** ** | ** ** |
| ** ** | ** ** | **or**                                                                                                                                                                                   | ** ** | ** ** |
| ** ** | ** ** | ** **                                                                                                                                                                               | ** ** | ** ** |
| **o**      |       | **Transition  Report pursuant to Section 13 or 15(d)  of the Securities Exchange Act of 1934**                                                                                      |       |       |
|       |       | ** **                                                                                                                                                                               |       |       |
|       |       | **for the transition period from                 to           ** |       |       |

 

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**Commission File Number 0-7282**

 

**COMPUTER HORIZONS CORP.**

(Exact name of registrant as specified in itscharter)

 

| **New York**                                                                         |   | **13-2638902**                           |
|--------------------------------------------------------------------------------------|--------|------------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                      |   | (I.R.S. Employer  Identification Number) |
|                                                                                 |   |                                     |
| **49 Old Bloomfield Avenue, Mountain Lakes,  New Jersey 07046-1495**                 |
| (Address of principal executive offices)                                             |   | (Zip code)                               |
|                                                                                 |   |                                     |
| Registrant’s telephone number, including  area code **(973) 299-4000**          |
|                                                                                 |   |                                     |
| **Not Applicable**                                                                   |
| (Former name, former address and former  fiscal year, if  changed since last report) |

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding twelve months (or forsuch 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.

 
|   | ý |   | o  |   |
|--------|--------|--------|----|--------|
|   | Yes    |   | No |   |

 

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

 
|   | ý |   | o  |   |
|--------|--------|--------|----|--------|
|   | Yes    |   | No |   |

 

As of August 3, 2004 the issuer had 30,757,323 shares of commonstock outstanding.

 

 

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Explanatory Note

 

This Form 10-Q/A is being filed solely to correct typographical errorsto the unaudited pro forma results as reported in Note 9 to the Company’sunaudited consolidated financial statements for the three months ended June 30,2003 and the six months ended June 30, 2004. Pro forma Net Income (Loss) for the three months ended June 30, 2003 wasreported as ($9,568) and should have been reported as ($9,586).  Pro forma Net Income/(loss) per share (basic& diluted) for the six months ended June 30, 2004 was reported as ($0.02)and should have been reported as $0.02. No other information contained in this Form 10-Q has been amended.

 

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**COMPUTER HORIZONS CORP. AND SUBSIDIARIES**

 

Index

 
| Part I  | Financial Information                                                                                                   |   |
|---------|-------------------------------------------------------------------------------------------------------------------------|--------|
|    |                                                                                                                    |   |
| Item 1  | Consolidated Balance Sheets June 30, 2004 (unaudited) and  December 31, 2003                                  |   |
|    |                                                                                                                    |   |
|    | Consolidated Statements of Operations Three  and Six Months Ended June 30, 2004 and June 30, 2003 (unaudited) |   |
|    |                                                                                                                    |   |
|    | Consolidated Statements of Cash Flows Six  Months Ended June 30, 2004 and June 30, 2003 (unaudited)           |   |
|    |                                                                                                                    |   |
|    | Notes to Consolidated Financial Statements                                                                              |   |
|    |                                                                                                                    |   |
| Item 2  | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                             |   |
|    |                                                                                                                    |   |
| Item 4  | Controls and Procedures                                                                                                 |   |
|    |                                                                                                                    |   |
| Part II | Other Information                                                                                                       |   |
|    |                                                                                                                    |   |
| Item 4  | Submission of Matters to a Vote of Security  Holders                                                                    |   |
|    |                                                                                                                    |   |
| Item 6  | Exhibits and Reports on Form 8-K                                                                                        |   |
|    |                                                                                                                    |   |
|    | Signatures                                                                                                              |   |
|         |                                                                                                                         |        |  |

 

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COMPUTER HORIZONS CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands)

 
| ** **                                                                                                                                         | ** ** | **June 30,  2004** | ** **   | **December 31,  2003** | ** **             |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|--------------|-----------------------------|------------------------|
|                                                                                                                                               |       | **(unaudited)**         |         |                        |                   |
| ASSETS                                                                                                                                             |       |                    |         |                        |                   |
| CURRENT ASSETS:                                                                                                                                    |       |                    |         |                        |                   |
| Cash and cash equivalents                                                                                                                          |       | $                       | 36,700       |                        | $                      | 52,610 |   |
| Accounts receivable, net of allowance for  doubtful  accounts of $5,871 and $5,432 at June 30, 2004 and  December 31, 2003, respectively |       | 54,392                  |    | 48,295                      |  

 

  |
| Deferred income taxes                                                                                                                              |       | 4,141                   |         | 4,514                       |                   |
| Other                                                                                                                                              |       | 4,187                   |         | 4,759                       |                   |
| TOTAL CURRENT ASSETS                                                                                                                               |       | 99,420                  |         | 110,178                     |                   |
|                                                                                                                                               |       |                    |         |                        |                   |
| PROPERTY AND EQUIPMENT                                                                                                                             |       | 42,149                  |         | 42,252                      |                   |
| Less accumulated depreciation                                                                                                                      |       | (34,447                 | )            | (32,929                     | )                      |
|                                                                                                                                               |       | 7,702                   |         | 9,323                       |                   |
|                                                                                                                                               |       |                    |         |                        |                   |
| OTHER ASSETS - NET:                                                                                                                                |       |                    |         |                        |                   |
| Goodwill                                                                                                                                           |       | 45,461                  |         | 34,218                      |                   |
| Intangibles                                                                                                                                        |       | 4,220                   |         | 2,408                       |                   |
| Deferred income taxes                                                                                                                              |       | 12,546                  |         | 13,624                      |                   |
| Other                                                                                                                                              |       | 9,768                   |         | 9,386                       |                   |
| TOTAL OTHER ASSETS                                                                                                                                 |       | 71,995                  |         | 59,636                      |                   |
|                                                                                                                                               |       |                    |         |                        |                   |
| TOTAL ASSETS                                                                                                                                       |       | $                       | 179,117      |                        | $                      | 179,137 |   |
|                                                                                                                                               |       |                    |         |                        |                   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                          |       |                    |         |                        |                   |
| CURRENT LIABILITIES:                                                                                                                               |       |                    |         |                        |                   |
| Accounts payable                                                                                                                                   |       | $                       | 10,024       |                        | $                      | 8,287 |   |
| Accrued payroll, payroll taxes and benefits                                                                                                        |       | 3,878                   |         | 4,436                       |                   |
| Income taxes payable                                                                                                                               |       | 346                     |         | 1,243                       |                   |
| Tax benefit reserve                                                                                                                                |       | —                  |         | 19,600                      |                   |
| Restructuring reserve                                                                                                                              |       | 1,675                   |         | 2,620                       |                   |
| Other accrued expenses                                                                                                                             |       | 6,853                   |         | 7,572                       |                   |
| TOTAL CURRENT LIABILITIES                                                                                                                          |       | 22,776                  |         | 43,758                      |                   |
|                                                                                                                                               |       |                    |         |                        |                   |
| OTHER LIABILITIES                                                                                                                                  |       | 5,147                   |         | 4,635                       |                   |
|                                                                                                                                               |       |                    |         |                        |                   |
| SHAREHOLDERS’ EQUITY:                                                                                                                         |       |                    |         |                        |                   |
| Preferred stock, $.10 par; authorized and  unissued 200,000 shares, including 50,000 Series A                                                      |       |                    |         |                        |                   |
| Common stock, $.10 par, authorized 100,000,000  shares; issued 33,153,107 shares at June 30, 2004 and December 31,  2003 respectively    |       | 3,315                   |         | 3,315                       |                   |
| Additional paid-in capital                                                                                                                         |       | 152,703                 |         | 133,046                     |                   |
| Accumulated comprehensive loss                                                                                                                     |       | (5,462                  | )            | (4,589                      | )                      |
| Retained earnings                                                                                                                                  |       | 14,120                  |         | 13,307                      |                   |
|                                                                                                                                               |       | 164,676                 |         | 145,079                     |                   |
| Less shares held in treasury, at cost;  2,322,767 shares and 2,537,692 shares at June 30, 2004 and  December 31, 2003, respectively      |       | (13,482                 | )            | (14,335                     | )                      |
| TOTAL SHAREHOLDERS’ EQUITY                                                                                                                    |       | 151,194                 |         | 130,744                     |                   |
|                                                                                                                                               |       |                    |         |                        |                   |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                    |       | $                       | 179,117      |                        | $                      | 179,137 |   |

 

3

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COMPUTER HORIZONS CORP. AND SUBSIDIARIES

CONSOLIDATEDSTATEMENTS OF OPERATIONS

(Unaudited)

(dollars in thousands, except per sharedata)

 
|                                               |       | **THREE MONTHS ENDED** |       | **SIX MONTHS ENDED**   |       |
|----------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                         | ** ** | **June 30, 2004** | ** ** | **June 30, 2003** | ** ** | **June 30, 2004** | ** ** | **June 30, 2003** | ** ** |
| ** **                                         | ** ** | ** **             | ** ** | **% of  revenue**      | ** ** | ** ** | ** ** | **% of  revenue** | ** ** | ** ** | ** ** | **% of  revenue** | ** ** | ** ** | ** ** | **% of  revenue** | ** ** |
| REVENUES:                                          |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| IT Services                                        |       | $                      | 32,073     |                   | 48.8       | % | $ | 35,320 |   | 60.0 | % | $ | 61,877 |   | 49.3 | % | $ | 71,503 |   | 60.0 | % |
| Solutions Group                                    |       | 27,788                 |       | 42.2                   | %          | 18,691 |   | 31.8 | % | 52,337 |   | 41.7 | % | 38,292 |   | 32.2 | % |
| Chimes                                             |       | 5,929                  |       | 9.0                    | %          | 4,822 |   | 8.2 | % | 11,282 |   | 9.0 | % | 9,291 |   | 7.8 | % |
|                                               |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                               |       | 65,790                 |       | 100.0                  | %          | 58,833 |   | 100.0 | % | 125,496 |   | 100.0 | % | 119,086 |   | 100.0 | % |
|                                               |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| COSTS AND EXPENSES:                                |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Direct costs                                       |       | 43,213                 |       | 65.7                   | %          | 41,511 |   | 70.6 | % | 83,153 |   | 66.3 | % | 84,284 |   | 70.8 | % |
| Selling, general and administrative                |       | 21,554                 |       | 32.8                   | %          | 20,716 |   | 35.2 | % | 41,142 |   | 32.8 | % | 39,642 |   | 33.3 | % |
| Amortization of intangibles                        |       | 520                    |       | 0.8                    | %          | — |   | 0.0 | % | 728 |   | 0.6 | % | — |   | 0.0 | % |
| Restructuring charges                              |       | —                 |       | 0.0                    | %          | 1,949 |   | 3.3 | % | — |   | 0.0 | % | 2,198 |   | 1.8 | % |
| Special charges (credits)                          |       | (939                   | )          | -1.4                   | %          | 7,978 |   | 13.6 | % | (939 | ) | -0.7 | % | 7,978 |   | 6.7 | % |
|                                               |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                               |       | 64,348                 |       | 97.8                   | %          | 72,154 |   | 122.7 | % | 124,084 |   | 98.9 | % | 134,102 |   | 112.5 | % |
|                                               |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| INCOME/(LOSS) FROM OPERATIONS                      |       | 1,442                  |       | 2.2                    | %          | (13,321 | ) | -22.7 | % | 1,412 |   | 1.1 | % | (15,016 | ) | -12.5 | % |
|                                               |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| OTHER INCOME / (EXPENSE):                          |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gain/(loss) on sale of assets                      |       | —                 |       | 0.0                    | %          | — |   | 0.0 | % | — |   | 0.0 | % | (273 | ) | -0.2 | % |
| Interest income                                    |       | 47                     |       | 0.1                    | %          | 102 |   | 0.2 | % | 140 |   | 0.1 | % | 276 |   | 0.2 | % |
| Interest expense                                   |       | (18                    | )          | 0.0                    | %          | (12 | ) | 0.0 | % | (28 | ) | 0.0 | % | (18 | ) | 0.0 | % |
|                                               |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                               |       | 29                     |       | 0.0                    | %          | 90 |   | 0.2 | % | 112 |   | 0.1 | % | (15 | ) | 0.0 | % |
|                                               |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| INCOME/(LOSS) BEFORE INCOME TAXES                  |       | 1,471                  |       | 2.2                    | %          | (13,231 | ) | -22.5 | % | 1,524 |   | 1.2 | % | (15,031 | ) | -12.5 | % |
|                                               |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| INCOME TAXES / (BENEFIT):                          |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Current                                            |       | 287                    |       | 0.4                    | %          | — |   | 0.0 | % | 311 |   | 0.3 | % | — |   | 0.0 | % |
| Deferred                                           |       | 412                    |       | 0.6                    | %          | (3,719 | ) | -6.3 | % | 436 |   | 0.3 | % | (4,259 | ) | -3.6 | % |
|                                               |       | 699                    |       | 1.1                    | %          | (3,719 | ) | -6.3 | % | 747 |   | 0.6 | % | (4,259 | ) | -3.6 | % |
|                                               |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| INCOME / (LOSS) BEFORE MINORITY INTEREST           |       | 772                    |       | 1.1                    | %          | (9,512 | ) | -16.2 | % | 777 |   | 0.6 | % | (10,772 | ) | -9.0 | % |
| Minority Interest                                  |       | 45                     |       | 0.0                    | %          | (18 | ) | 0.0 | % | 36 |   | 0.0 | % | (37 | ) | 0.0 | % |
|                                               |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| NET INCOME / (LOSS)                                |       | $                      | 817        |                   | 1.1        | % | $ | (9,530 | ) | -16.2 | % | $ | 813 |   | 0.6 | % | $ | (10,809 | ) | -9.0 | % |
|                                               |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| EARNINGS / (LOSS) PER SHARE (BASIC & DILUTED): |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                               |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
|   Basic                                  |       | $                      | 0.03       |                   |       |   | $ | (0.31 | ) |   |   | $ | 0.03 |   |   |   | $ | (0.36 | ) |   |   |
|                                               |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
|   Diluted                                |       | $                      | 0.03       |                   |       |   | $ | (0.31 | ) |   |   | $ | 0.03 |   |   |   | $ | (0.36 | ) |   |   |
|                                               |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| WEIGHTED AVERAGE NUMBER OF                         |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| SHARES OUTSTANDING:                                |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                              |       | 30,810,000             |       |                   |       | 30,292,000 |   |   |   | 30,743,000 |   |   |   | 30,331,000 |   |   |   |
|                                               |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Diluted                                            |       | 31,215,000             |       |                   |       | 30,292,000 |   |   |   | 31,324,000 |   |   |   | 30,331,000 |   |   |   |

 

4

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COMPUTER HORIZONS CORP. AND SUBSIDIARIES

CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(Unaudited)

(dollars in thousands)

 
| ** **                                                                                          | ** ** | **Six Months Ended**    | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                          | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES                                                                |       |                    |       |   |   |
| Net income / (loss)                                                                                 |       | $                       | 813        |   | $ | (10,809 | ) |
| Adjustments to reconcile net income/(loss)  to net cash provided by/(used in) operating activities: |       |                    |       |   |   |
| Deferred taxes                                                                                      |       | 436                     |       | (4,259 | ) |
| Depreciation                                                                                        |       | 2,591                   |       | 2,575 |   |
| Provision for bad debts                                                                             |       | 745                     |       | 3,863 |   |
| Loss/(Gain) on sale of assets                                                                       |       | —                  |       | 273 |   |
| Amortization of intangibles                                                                         |       | 728                     |       | — |   |
| Change in assets and liabilities, net of  acquisitions:                                             |       |                    |       |   |   |
| Accounts receivable                                                                                 |       | (3,542                  | )          | 4,677 |   |
| Other current assets                                                                                |       | 590                     |       | 1,631 |   |
| Other assets                                                                                        |       | (382                    | )          | (3,130 | ) |
| Refundable income taxes                                                                             |       | —                  |       | 19,051 |   |
| Accrued payroll, payroll taxes and benefits                                                         |       | (1,305                  | )          | 219 |   |
| Accounts payable                                                                                    |       | 1,337                   |       | (3,108 | ) |
| Income taxes payable                                                                                |       | (897                    | )          | 706 |   |
| Other accrued expenses                                                                              |       | (1,975                  | )          | 1,135 |   |
| Other liabilities                                                                                   |       | 766                     |       | (250 | ) |
|                                                                                                |       |                    |       |   |   |
| NET CASH PROVIDED BY/(USED IN) OPERATING  ACTIVITIES                                                |       | (95                     | )          | 12,574 |   |
|                                                                                                |       |                    |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                                                | ** ** | ** **              | ** ** | ** ** | ** ** |
| Purchases of furniture and equipment                                                                |       | (844                    | )          | (979 | ) |
| Acquisitions, net of cash acquired                                                                  |       | (14,704                 | )          | — |   |
| Proceeds received from the sale of assets                                                           |       | —                  |       | 149 |   |
| Acquisition of assets                                                                               |       | —                  |       | (387 | ) |
| NET CASH (USED IN) INVESTING ACTIVITIES                                                             |       | (15,548                 | )          | (1,217 | ) |
|                                                                                                |       |                    |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES                                                                |       |                    |       |   |   |
| Stock options exercised                                                                             |       | 376                     |       | 847 |   |
| Purchase of treasury shares                                                                         |       | —                  |       | (1,230 | ) |
| Stock issued on employee stock purchase  plan                                                       |       | 280                     |       | 193 |   |
| NET CASH PROVIDED BY / (USED IN) FINANCING  ACTIVITIES                                              |       | 656                     |       | (190 | ) |
|                                                                                                |       |                    |       |   |   |
| Foreign currency gains/(losses)                                                                     |       | (923                    | )          | 121 |   |
|                                                                                                |       |                    |       |   |   |
| NET INCREASE/(DECREASE) IN CASH AND CASH  EQUIVALENTS                                               |       | (15,910                 | )          | 11,288 |   |
|                                                                                                |       |                    |       |   |   |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF  YEAR                                                     |       | 52,610                  |       | 59,769 |   |
|                                                                                                |       |                    |       |   |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                                                          |       | $                       | 36,700     |   | $ | 71,057 |   |
|                                                                                                |       |                    |       |   |   |
|                                                                                                |       |                    |       |   |   |
| Supplemental Disclosures of Cash Flow  Information:                                                 |       |                    |       |   |   |
| Details of acquistion:                                                                              |       |                    |       |   |   |
| Assets acquired (including cash of $1,168)                                                          |       | $                       | 4,613      |   |   |   |
| Liabilities assumed                                                                                 |       | (2,523                  | )          |   |   |
| Goodwill                                                                                            |       | 11,242                  |       |   |   |
| Intangibles                                                                                         |       | 2,540                   |       |   |   |
| Cash paid                                                                                           |       | 15,872                  |       |   |   |
| Less:   cash received in acquisition                                                           |       | 1,168                   |       |   |   |
| Net cash paid                                                                                       |       | $                       | 14,704     |   |   |   |

 

Non Cash Activities:

 

Duringthe first quarter of 2004, the Company recorded a reduction in tax benefitreserves and an increase in additional paid-in capital of $19.9 million.

 

5

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**COMPUTER HORIZONS CORP.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

For the Periods June 30, 2004 andJune 30, 2003

(unaudited)

 

**1.****              Basis ofPresentation**

 

The consolidated balance sheet as of June 30, 2004, theconsolidated statements of operations for the three and six months ended June 30,2004 and June 30, 2003, respectively, and the statement of cash flows forthe six months ended June 30, 2004 and 2003 have been prepared by theCompany without audit.  In the opinion ofmanagement, all adjustments (which include normal recurring adjustments)necessary to present fairly the financial position, results of operations andcash flows at June 30, 2004 (and for all periods presented) have beenmade.

 

Certain information and note disclosures, normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America, which are not required forinterim purpose, have been condensed or omitted.  It is suggested that these consolidated financialstatements be read in conjunction with the financial statements and notesthereto included in the Annual Report on Form 10-K for the year endedDecember 31, 2003 filed by the Company. The results of operations for the periods ended June 30, 2004 and2003 are not necessarily indicative of the operating results for the respectivefull years.

 

**2.****              Recent AccountingPronouncements**

 

InJanuary 2003, the FASB issued Financial Interpretation No. 46,“Consolidation of Variable Interest Entities” (“FIN 46”), which addressesconsolidation by business enterprises of variable interest entities(VIEs).  The accounting provisions anddisclosure requirements of FIN 46 are effective immediately for VIEs createdafter January 31, 2003, and are effective for the Company’s fiscal periodending March 31, 2004, for VIEs created prior to February 1,2003.  In December 2003, the FASBpublished a revision to FIN 46 (“FIN 46R”) to clarify some of the provisions ofthe interpretation and to defer the effective date of implementation forcertain entities.  Under the guidance ofFIN 46R, public companies that have interests in VIE’s that are commonlyreferred to as special purpose entities are required to apply the provisions ofFIN 46R for periods ending after December 15, 2003.  A public company that does not have anyinterests in special purpose entities but does have a variable interest in aVIE created before February 1, 2003, must apply the provisions of FIN 46Rby the end of the first interim or annual reporting period ending afterMarch 14, 2004.  During the quarterended March 31, 2004, the Company adopted the provisions of FIN 46R.Adoption of FIN 46R did not have a material effect on the Company’s financialstatements.

 

6

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**3.****              Accounting for StockBased Compensation**

 

TheCompany applies Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees,” as modified by FIN 44, “Accounting for CertainTransactions Involving Stock Compensation,” in accounting for stock-basedemployee compensation, whereby no compensation cost had been recognized for theplans.  The exercise price per share onall options granted may not be less than the fair value at the date of theoption grant.  The Company expects tocontinue following the guidance under APB 25 for stock based compensation toemployees.  Had compensation cost for theplans been determined based on the fair value of the options at the grant datesand been consistent with the method of SFAS No. 123, the Company’s net income /(loss) and income / (loss) per share would have been decreased to the pro formaamounts indicated below:

 
| ** **                   | ** **                                                                                                                                          | ** ** | **Three Months Ended**  | ** ** | **Six Months Ended**    | ** ** |
|------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| **(in  000’s)**         | ** **                                                                                                                                          | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
| Net income / (loss)          | As reported                                                                                                                                         |       | $                       | 817        |                    | $          | (9,530 | ) | $ | 813 |   | $ | (10,809 | ) |
|                         | Deduct:   Total stock-based employee compensation expense determined under fair  value based method for all awards, net of related tax effects |       | (555                    | )          | (403                    | )          | (1,257 | ) | (1,387 | ) |
|                         |                                                                                                                                                |       |                    |       |                    |       |   |   |   |   |
|                         | Pro forma                                                                                                                                           |       | $                       | 262        |                    | $          | (9,933 | ) | $ | (444 | ) | $ | (12,196 | ) |
| Earnings  / (loss) per share |                                                                                                                                                |       |                    |       |                    |       |   |   |   |   |
| Basic                        | As reported                                                                                                                                         |       | $                       | 0.03       |                    | $          | (0.31 | ) | $ | 0.03 |   | $ | (0.36 | ) |
|                         | Pro forma                                                                                                                                           |       | 0.01                    |       | (0.33                   | )          | (0.01 | ) | (0.40 | ) |
|                         |                                                                                                                                                |       |                    |       |                    |       |   |   |   |   |
| Diluted                      | As reported                                                                                                                                         |       | $                       | 0.03       |                    | $          | (0.31 | ) | $ | 0.03 |   | $ | (0.36 | ) |
|                         | Pro forma                                                                                                                                           |       | 0.01                    |       | (0.33                   | )          | (0.01 | ) | (0.40 | ) |

 

7

----

 

**4.****              Restricted Cash**

 

Included in cash and cash equivalents at June 30, 2004 andDecember 31, 2003 is restricted cash of approximately $ 315,000 and $2.2million, respectively.  Restricted cashrepresents funds received by Chimes and held in client-specific bank accounts,to be used to make payments to vendors of the applicable client.

 

**5.****              Earnings Per Share**

 

BasicEarnings Per Share (“EPS”) is based on the weighted average number of commonshares outstanding without consideration of common stock equivalents.  Diluted earnings per share is based on theweighted average number of common and common equivalent shares outstanding,except the three-month period ended June 30, 2003 and the six-month periodended June 30, 2003, where the effect would have been antidilutive.  The calculation takes into account the sharesthat may be issued upon exercise of stock options, reduced by the shares thatmay be repurchased with the funds received from the exercise, based on theaverage price during the year.

 

Inaccordance with SFAS No. 128, the table below presents both basic and dilutedearnings per share:

 
| ** **                                                                                                                | ** ** | **Three Months Ended**  | ** ** | **Six Months Ended**    | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                                                                                | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
| Numerator:                                                                                                                |       |                    |       |                    |       |   |   |   |   |
| Net Income/(Loss) –in thousands                                                                                      |       | $                       | 817        |                    | $          | (9,530 | ) | $ | 813 |   | $ | (10,809 | ) |
| Denominator:                                                                                                              |       |                    |       |                    |       |   |   |   |   |
| Denominator for basic earnings per share —   weighted average shares outstanding                                     |       | 30,810,000              |       | 30,292,000              |       | 30,743,000 |   | 30,331,000 |   |
| Effect of stock options                                                                                                   |       | 405,000                 |       | —                  |       | 581,000 |   | — |   |
| Diluted earnings/(loss) per share:                                                                                        |       |                    |       |                    |       |   |   |   |   |
| Denominator for diluted earnings per share  —   adjusted weighted average shares outstanding and assumed conversions |       | 31,215,000              |       | 30,292,000              |       | 31,324,000 |   | 30,331,000 |   |
| Basic earnings/(loss) per share                                                                                           |       | $                       | 0.03       |                    | $          | (0.31 | ) | $ | 0.03 |   | $ | (0.36 | ) |
| Diluted earnings/(loss) per share                                                                                         |       | $                       | 0.03       |                    | $          | (0.31 | ) | $ | 0.03 |   | $ | (0.36 | ) |

 

The computation of dilutedearnings per share excludes options with exercise prices greater than theaverage market price.  As of June 30,2004 there were 1,021,084 and 268,472 excluded options, respectively, for thesecond quarter and the first six months ended June 30, 2004, with exerciseprices between $3.89 and $26.63 and $4.40 and $26.63 respectively, per share.

 

There were 257,739 and 264,913excluded options, respectively for the second quarter and first six monthsended June 30, 2003, outstanding at June 30, 2003 with exercise prices between$4.40 and $26.63 and $4.00 and $26.63 respectively, per share.

 

8

----

 

**6.****              Segment Information**

 

The Company has identified three business segments: IT Services, theSolutions Group and Chimes, Inc.  The ITServices division provides highly skilled software professionals to augment theinternal information management staffs of major corporations.  IT Services is primarily staffaugmentation.  The Solutions divisionprovides enterprise application services, e-business solutions, customized Webdevelopment and Web enablement of strategic applications, Customer RelationshipManagement (CRM), network services, strategic outsourcing and managedresourcing to major corporations, along with federal, state and localgovernments.  Chimes, Inc., awholly-owned subsidiary of CHC, provides workforce procurement and managementservices to Global 2000 companies which, according to Forbes magazine,represents the biggest and most important companies, as measured by sales,profits, assets andmarket value. Income/(loss) before income taxes/(benefits) consists of income/(loss)before income taxes, excluding interest income, interest expense, gain/(loss)on the sale of assets, restructuring charges, amortization of intangibles,special charges (credits) and the write-off of a terminated project.  These exclusions total income of $0.4 millionand expense of $ 12.9 million for the second quarter of 2004 and 2003**,**respectively and income of $0.3 millionand expense of $13.3 million for the first six months of June 30, 2004 and2003, respectively (see reconciliation of segments income/(loss) before incometaxes/ (benefit) to consolidated income/(loss) before incometaxes/(benefit)).  Corporate services,consisting of general and administrative services are provided to the segmentsfrom a centralized location.  Such costsare allocated to the applicable segments receiving Corporate services based onrevenue.

 

9

----

 
| ** **                                               | ** ** | **(In thousands)**      | ** ** | ** **              | ** ** | ** **              | ** ** |
|----------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                               | ** ** | **THREE MONTHS ENDED**  | ** ** | **SIX MONTHS ENDED**    | ** ** |
| ** **                                               | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
| **Revenues:**                                            |       |                    |       |                    |       |                    |       |   |   |
| **IT  Services**                                         |       | **$**                   | **32,073** | ** **              | $          | 35,320                  |       | **$** | **61,877** | ** ** | $ | 71,503 |   |
| **Solutions  Group**                                     |       | **27,788**              | ** ** | 18,691                  |       | **52,337**              | ** ** | 38,292 |   |
| **Chimes**                                               |       | **5,929**               | ** ** | 4,822                   |       | **11,282**              | ** ** | 9,291 |   |
| **Total  Revenues**                                      |       | **65,790**              | ** ** | 58,833                  |       | **125,496**             | ** ** | 119,086 |   |
| ** **                                               |       | ** **              | ** ** |                    |       | ** **              | ** ** |   |   |
| **Gross  Profit:**                                       |       | ** **              | ** ** |                    |       | ** **              | ** ** |   |   |
| **IT  Services**                                         |       | **6,525**               | ** ** | 7,079                   |       | **12,582**              | ** ** | 14,249 |   |
| **Solutions  Group**                                     |       | **10,491**              | ** ** | 5,793                   |       | **19,139**              | ** ** | 11,999 |   |
| **Chimes**                                               |       | **5,561**               | ** ** | 4,450                   |       | **10,622**              | ** ** | 8,554 |   |
| **Total  Gross Profit**                                  |       | **22,577**              | ** ** | 17,322                  |       | **42,343**              | ** ** | 34,802 |   |
| **%**                                                    |       | **34.3**                | **%**      | 29.4                    | %          | **33.7**                | **%**      | 29.2 | % |
| ** **                                               |       | ** **              | ** ** |                    |       | ** **              | ** ** |   |   |
| **Operating  Income:**                                   |       | ** **              | ** ** |                    |       | ** **              | ** ** |   |   |
| **IT  Services**                                         |       | **1,963**               | ** ** | 2,289                   |       | **4,004**               | ** ** | 4,175 |   |
| **Solutions  Group**                                     |       | **3,825**               | ** ** | 3,010                   |       | **6,726**               | ** ** | 6,365 |   |
| **Chimes**                                               |       | **728**                 | ** ** | (697                    | )          | **822**                 | ** ** | (2,264 | ) |
| **Total  Operating Income/ (Loss):**                     |       | **6,516**               | ** ** | 4,602                   |       | **11,552**              | ** ** | 8,276 |   |
| **%**                                                    |       | **9.9**                 | **%**      | 7.8                     | %          | **9.2**                 | **%**      | 6.9 | % |
| ** **                                               |       | ** **              | ** ** |                    |       | ** **              | ** ** |   |   |
| **Corporate  Allocation:**                               |       | ** **              | ** ** |                    |       | ** **              | ** ** |   |   |
| **IT  Services**                                         |       | **3,392**               | ** ** | 2,961                   |       | **6,280**               | ** ** | 6,036 |   |
| **Solutions  Group**                                     |       | **1,475**               | ** ** | 1,567                   |       | **2,926**               | ** ** | 3,233 |   |
| **Chimes**                                               |       | **626**                 | ** ** | 404                     |       | **1,145**               | ** ** | 783 |   |
| **Total  Corporate Allocation**                          |       | **5,493**               | ** ** | 4,932                   |       | **10,351**              | ** ** | 10,052 |   |
| **%**                                                    |       | **8.3**                 | **%**      | 8.4                     | %          | **8.2**                 | **%**      | 8.4 | % |
| ** **                                               |       | ** **              | ** ** |                    |       | ** **              | ** ** |   |   |
| **Total  Income/ (loss) before Income Taxes (benefit):** |       | ** **              | ** ** |                    |       | ** **              | ** ** |   |   |
| **IT  Services**                                         |       | **(1,429**              | **)**      | (672                    | )          | **(2,276**              | **)**      | (1,861 | ) |
| **Solutions  Group**                                     |       | **2,350**               | ** ** | 1,443                   |       | **3,800**               | ** ** | 3,133 |   |
| **Chimes**                                               |       | **102**                 | ** ** | (1,101                  | )          | **(323**                | **)**      | (3,048 | ) |
| **Total  Income/ (loss) before Income Taxes (benefit)**  |       | **$**                   | **1,023**  | ** **              | $          | (330                    | )          | **$** | **1,201** | ** ** | $ | (1,776 | ) |
| **%**                                                    |       | **1.6**                 | **%**      | (0.6                    | )%         | **1.0**                 | **%**      | (1.5 | )% |

 

10

----

 

*Reconciliation ofSegment Income / (Loss) before Income Taxes / (Benefit) to Consolidated Income/ (Loss) Before Income Taxes/(Benefit):*

 
| ** **                                                  | ** ** | **Three Months Ended**  | ** ** | **Six Months Ended**    | ** ** |
|-------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| **(000’s)**                                            | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
| Total Segments Income/(Loss) before Income  Taxes/(Benefit) |       | $                       | 1,023      |                    | $          | (330 | ) | $ | 1,201 |   | $ | (1,776 | ) |
| Adjustments:                                                |       |                    |       |                    |       |   |   |   |   |
| Interest Income, net                                        |       | 29                      |       | 90                      |       | 112 |   | 258 |   |
| Loss on sale of assets                                      |       | —                  |       | —                  |       | — |   | (273 | ) |
| Restructuring charges                                       |       | ——            |       | (1,949                  | )          | — |   | (2,198 | ) |
| Special (charges)/credits                                   |       | 939                     |       | (7,978                  | )          | 939 |   | (7,978 | ) |
| Write-off of terminated project                             |       | —                  |       | (3,064                  | )          | — |   | (3,064 | ) |
| Amortization of Intangibles                                 |       | (520                    | )          | —                  |       | (728 | ) | — |   |
| Total Adjustments:                                          |       | $                       | 448        |                    | $          | (12,901 | ) | $ | 323 |   | $ | (13,255 | ) |
| Consolidated Income/(Loss) Before Income  Taxes             |       | $                       | 1,471      |                    | $          | (13,231 | ) | $ | 1,524 |   | $ | (15,031 | ) |

 

**7.****              RestructuringCharges**

 

 During thefourth quarter of 2003, the Company recorded a restructuring charge ofapproximately $329,000 relating to the closing of one office in the U.S. andthe related severance.  The Companydecided to continue business in this area through virtual offices and thereforerecorded the charge after the building was closed.  The lease obligation of $90,000 wascalculated based on current rent commitments less a calculated sublease amountbased on current market conditions.

 

| ** **         | ** ** | **Remaining at  December 31, 2003** | ** ** | **Paid** | ** ** | **Remaining at  June 30,  2004** | ** ** |
|--------------------|------------|-----------------------------------------------|------------|----------|------------|---------------------------------------|------------|
| Lease Obligations: |       |                                          |       |     |       |                                  |       |
| United States      |       | $                                             | 90         |     | $          | (36                                   | )          | $ | 54 |   |
|                    |            |                                               |            |          |            |                                       |            |  |  |  |

 

11

----

 

During the third quarter of 2003, the Companyrecorded a restructuring charge of approximately $787,000 relating to theclosing of Chimes (UK) Ltd. and severance charges related to U.S.operations.  The Company decided tocontinue business in this geographic area through a third party and thereforerecorded the charge after the building was closed.  The provision includes an accrual relating tothe future costs associated with continuing rent on this property in the UnitedKingdom.  The closing of this officeresulted in a severance charge of $305,000.

 

| ** **             | ** ** | **Remaining at  December 31,  2003** | ** ** | **Paid** | ** ** | **Exchange Rate  Fluctuation** | ** ** | **Remaining at  June 30,  2004** | ** ** |
|------------------------|------------|-------------------------------------------|------------|----------|------------|--------------------------------|------------|---------------------------------------|------------|
|                   |       |                                      |       |     |       |                           |       |                                  |       |
| Severance              |       | $                                         | 47         |     | $          | —                         |       | $                                     | 1          |   | $ | 48 |   |
|                   |       |                                      |       |     |       |                           |       |                                  |       |
|                   |       |                                      |       |     |       |                           |       |                                  |       |
| Lease Obligations      |       | $                                         | 150        |     | $          | (17                            | )          | $                                     | 2          |   | $ | 135 |   |
|                   |       |                                      |       |     |       |                           |       |                                  |       |
|                   |       |                                      |       |     |       |                           |       |                                  |       |
| General Office Closure |       | $                                         | 49         |     | $          | (7                             | )          | $                                     | 1          |   | $ | 43 |   |
|                   |       |                                      |       |     |       |                           |       |                                  |       |
| Total                  |       | $                                         | 246        |     | $          | (24                            | )          | $                                     | 4          |   | $ | 226 |   |

 

During the second quarter of 2003, the Companyevaluated the geographic area in Canada and decided to close facilities and govirtual in the smaller Canadian markets. After the buildings were entirely closed, the Company recorded arestructuring charge of approximately $1.7 million relating to theconsolidating and closing of these facilities in the Canadian subsidiary.  The $1.3 million expense for leaseobligations was calculated based on current rent commitments less a calculatedsublease amount based on current market conditions.  The entire provision of $1.3 million includedan accrual relating to the future costs associated with continuing rent on sixproperties, five of which are in Canada, with rents continuing through 2004,2006 and 2007.

 
| ** **         | ** ** | **Remaining at  December 31,  2003** | ** ** | **Paid** | ** ** | **Exchange Rate  Fluctuation** | ** ** | **Remaining at  June 30,  2004** | ** ** |
|--------------------|------------|-------------------------------------------|------------|----------|------------|--------------------------------|------------|---------------------------------------|------------|
| Lease Obligations: |       |                                      |       |     |       |                           |       |                                  |       |
| Canada             |       | $                                         | 739        |     | $          | (245                           | )          | $                                     | (25        | ) | $ | 469 |   |
|                    |            |                                           |            |          |            |                                |            |                                       |            |  |  |  |  |

 

12

----

 

 

During the fourth quarter of 2002, the Companyrecorded a restructuring charge of $2.8 million pertaining to 2002 officeclosings.  During the second quarter of2003, half of the rent for one office closing was reversed after the rent wasnegotiated at a lower rate for half the building.  During the fourth quarter of 2003, theCompany made an additional adjustment to the reserve for four of the propertiesdue to sublease.

 
| ** **         | ** ** | **Remaining at  December 31,  2003** | ** ** | **Paid** | ** ** | **Remaining at  June 30,  2004** | ** ** |
|--------------------|------------|-------------------------------------------|------------|----------|------------|---------------------------------------|------------|
| Lease Obligations: |       |                                      |       |     |       |                                  |       |
| United States      |       | $                                         | 1,159      |     | $          | (463                                  | )          | $ | 696 |   |
|                    |            |                                           |            |          |            |                                       |            |  |  |  |

 
| ** **         | ** ** | **Remaining at  December 31,  2002** | ** ** | **Paid** | ** ** | **Reversed** | ** ** | **Remaining at   June 30,  2003** | ** ** |
|--------------------|------------|-------------------------------------------|------------|----------|------------|--------------|------------|----------------------------------------|------------|
| Lease Obligations: |       |                                      |       |     |       |         |       |                                   |       |
| United States      |       | $                                         | 2,483      |     | $          | (695         | )          | $                                      | (25        | ) | $ | 1,763 |   |
|                    |            |                                           |            |          |            |              |            |                                        |            |  |  |  |  |

 

At the end of 2003, the Company had $78,000 of fivelease obligations remaining from the restructure expense recorded in 2001.  Of the five lease obligations, two remain andthe balance as of June 30, 2004 was $14,000.

 
| ** **         | ** ** | **Remaining at  Dec. 31,  2003** | ** ** | **Paid** | ** ** | **Remaining at  June 30,  2004** | ** ** |
|--------------------|------------|----------------------------------|------------|----------|------------|---------------------------------------|------------|
|               |       |                             |       |     |       |                                  |       |
| Lease Obligations: |       |                             |       |     |       |                                  |       |
| United States      |       | $                                | 78         |     | $          | (64                                   | )          | $ | 14 |   |
|                    |            |                                  |            |          |            |                                       |            |  |  |  |

 

13

----

 

 
| ** **         | ** ** | **Remaining at  Dec. 31,  2002** | ** ** | **Paid** | ** ** | **Remaining at  June 30,  2003** | ** ** |
|--------------------|------------|----------------------------------|------------|----------|------------|----------------------------------|------------|
|               |       |                             |       |     |       |                             |       |
| Lease Obligations: |       |                             |       |     |       |                             |       |
| United States      |       | $                                | 294        |     | $          | (114                             | )          | $ | 180 |   |
|                    |            |                                  |            |          |            |                                  |            |  |  |  |

 

Atthe end of 2003, the Company had $308,000 of one lease obligation remaining onthe restructure expense recorded in 2000, with the lease terminating in2005.  The balance remaining atJune 30, 2004 was $217,000.

 
| ** **         | ** ** | **Remaining at  Dec. 31,  2003** | ** ** | **Paid** | ** ** | **Remaining at  June 30,  2004** | ** ** |
|--------------------|------------|----------------------------------|------------|----------|------------|----------------------------------|------------|
| Lease Obligations: |       |                             |       |     |       |                             |       |
| United States      |       | $                                | 308        |     | $          | (91                              | )          | $ | 217 |   |
|                    |            |                                  |            |          |            |                                  |            |  |  |  |

 
| ** **         | ** ** | **Remaining at  Dec. 31,  2002** | ** ** | **Paid** | ** ** | **Remaining at   June 30,  2003** | ** ** |
|--------------------|------------|----------------------------------|------------|----------|------------|----------------------------------------|------------|
| Lease Obligations: |       |                             |       |     |       |                                   |       |
| United States      |       | $                                | 488        |     | $          | (89                                    | )          | $ | 399 |   |
|                    |            |                                  |            |          |            |                                        |            |  |  |  |

 

14

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**8.****              ComprehensiveIncome/(Loss)**

 

Statement of Financial Accounting Standards No. 130, ReportingComprehensive Income (“SFAS No.130”), requires that items defined as othercomprehensive income/ (loss), such as foreign currency translation adjustmentsand unrealized gains and losses, be separately classified in the financialstatements and that the accumulated balance of other comprehensive income/(loss) be reported separately from retained earnings and additional paid-incapital in the equity section of the balance sheet. The components ofcomprehensive loss for the three and six months ended June 30, 2004 andJune 30, 2003 are as follows:

 
| ** **                                                             | ** ** | **Three Months Ended**  | ** ** | **Six Months Ended**    | ** ** |
|------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                             | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
|                                                                   |       |                    |       |                    |       |   |   |   |   |
| Comprehensive Income/(Loss):                                           |       |                    |       |                    |       |   |   |   |   |
|                                                                   |       |                    |       |                    |       |   |   |   |   |
| Net Income/(Loss)                                                      |       | $                       | 817        |                    | $          | (9,530 | ) | $ | 813 |   | $ | (10,809 | ) |
| Other comprehensive income/ (loss) –  foreign currency adjustment |       | (271                    | )          | 135                     |       | (923 | ) | 120 |   |
| Unrealized gain /(loss) on SERP investments                            |       | (24                     | )          | 943                     |       | 50 |   | 733 |   |
| Comprehensive Income/(Loss)                                            |       | $                       | 522        |                    | $          | (8,452 | ) | $ | (60 | ) | $ | (9,956 | ) |

 

**9.****             ****Acquisitions**

 

On April 1, 2004 the Company’s subsidiary RGII Technologies, Inc.acquired all of the common stock of privately held Automated InformationManagement, Inc. (“AIM”). The cash transaction is valued at approximately $13.8million plus an adjustment to purchase price for excess working capital ofapproximately $2.0 million.

 

The Company purchased AIM to further its commitment to driving thegrowth potential that exists in the Federal government market and to expandRGII’s footprint, providing an entrance into certain government agencies, aswell as strong relationships with large, prime contractors.

 

15

----

 

The Company completed a preliminary allocation of the purchase price toassets and liabilities acquired, utilizing outside valuation consultants toassist in the process.  The allocation ofthe purchase price to assets acquired and liabilities assumed (which is subjectto adjustment) was as follows (in thousands):

 
| ** **               | ** ** | **Allocation of  Purchase Price** | ** ** |
|--------------------------|------------|-----------------------------------|------------|
|                     |       |                              |       |
| Cash                     |       | $                                 | 1,168      |   |
|                     |       |                              |       |
| Accounts Receivable      |       | 3,300                             |       |
|                     |       |                              |       |
| Other Current Assets     |       | 18                                |       |
|                     |       |                              |       |
| Goodwill                 |       | 11,242                            |       |
|                     |       |                              |       |
| Intangibles              |       | 2,540                             |       |
|                     |       |                              |       |
| Property and Equipment   |       | 127                               |       |
|                     |       |                              |       |
| Total Assets             |       | 18,395                            |       |
|                     |       |                              |       |
| Accounts Payable         |       | 400                               |       |
|                     |       |                              |       |
| Accrued Payroll          |       | 747                               |       |
|                     |       |                              |       |
| Other Accrued Expenses   |       | 361                               |       |
|                     |       |                              |       |
| Deferred Tax Liabilities |       | 1,015                             |       |
|                     |       |                              |       |
| Total Liabilities        |       | 2,523                             |       |
|                     |       |                              |       |
| Net Assets               |       | $                                 | 15,872     |   |

 

Purchased intangibles totaling $2.5 million included unfunded backlog,funded backlog and non-compete agreements; approximately $11.2 million wasrecorded as goodwill.

 

The acquisition was structured as a purchase of common stock; andaccordingly, goodwill will not be subject to amortization for tax purposes.

 

16

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Pro Forma Results

 

Effective April 1, 2004 the results of AIM’s operations have beenincluded in the consolidated financial statements of the Company.  The following unaudited pro forma financialinformation presents the combined results of operations of the Company and AIMas if the acquisition had occurred as of the beginning of the periodspresented.  The revenues and results ofoperations included in the following pro forma unaudited consolidated condensedstatement of operations is not considered necessarily indicative of the resultsof operations for the periods specified had the transaction actually beencompleted at the beginning of the period.

 
| ** **                                         | ** ** | **Actual**                            | ** ** | **Pro Forma**                    | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|----------------------------------|------------|
| ** **                                         | ** ** | **Three Months  Ended  June 30** | ** ** | **Three Months  Ended  June 30** | ** ** | **Six Months  Ended  June 30** | ** ** | **Six Months  Ended  June 30** | ** ** |
| ** **                                         | ** ** | **2004**                              | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                                          |       |                                  |       |                             |       |   |   |   |   |
| IT Services                                        |       | $                                     | 32,073     |                             | $          | 35,320 |   | $ | 61,877 |   | $ | 71,503 |   |
| Solutions Group                                    |       | 27,788                                |       | 23,158                           |       | 56,775 |   | 47,018 |   |
| Chimes                                             |       | 5,929                                 |       | 4,822                            |       | 11,282 |   | 9,291 |   |
| Total                                              |       | 65,790                                |       | 63,300                           |       | 129,934 |   | 127,812 |   |
| Income/(loss) before minority interest             |       | 772                                   |       | (9,568                           | )          | 713 |   | (10,632 | ) |
| Minority interest                                  |       | 45                                    |       | (18                              | )     | 36 |   | (37 | ) |
| Net Income/(Loss)                                  |       | $                                     | 817        |                             | $          | (9,586 | ) | $ | 749 |   | $ | (10,669 | ) |
| Net Income/(loss) per share (basic &  diluted) |       | $                                     | 0.03       |                             | $          | (0.32 | ) | $ | 0.02 |   | $ | (0.35 | ) |
| Weighted average number of shares  outstanding     |       |                                  |       |                             |       |   |   |   |   |
| Basic                                              |       | 30,810,000                            |       | 30,292,000                       |       | 30,743,000 |   | 30,331,000 |   |
| Diluted                                            |       | 31,215,000                            |       | 30,292,000                       |       | 31,324,000 |   | 30,331,000 |   |

 

The unaudited pro forma financial information abovereflects the following adjustments to the historical consolidated financialstatements for the three months ended June 30, 2003: $313,000 amortizationexpense on purchased intangible assets, $43,500 reduction of interest incomefor cash consideration paid and $26,000 adjustment to record income taxes forAIM as if it was a C-Corporation and to record income tax effect of pro formaadjustments.

 

The unaudited pro forma financial information abovereflects the following adjustments to the historical consolidated financialstatements for the six months ended June 30, 2004: $313,000 amortizationexpense on purchased intangible assets, elimination of Acquisition relatedbonuses of $2.3 million, $43,500 reduction of interest income for cashconsideration paid and $62,000

 

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adjustment to record income tax benefit for AIM asif it was a C-Corporation and to record income tax effect of pro formaadjustments.

 

The unaudited pro forma financial information above reflects thefollowing adjustments to the consolidated financial statements for the sixmonths ended June 30, 2003: $625,000 amortization expense on purchasedintangible assets, $87,000 reduction of interest income for cash considerationpaid and $55,000 adjustment to record income taxes for AIM as if it was aC-Corporation and to record income tax effect of pro forma adjustments.

 

On September 12, 2003, the Company acquired,from Commerce One, the Xpress solution, a suite of software and servicesdesigned to rapidly facilitate product data synchronization between tradingpartners.  The purchase price of thesoftware was $566,000, recorded as intangible assets, and is being amortizedover a three-year period.

 

 

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On July 8, 2003, the Company acquired all ofthe stock of privately-held RGII Technologies, Inc. (“RGII”).  The Company purchased RGII because acquiringa platform company in the Federal government IT Services marketplace has been along-term priority for the Company.  Thepurchase price of approximately $22.1 million included an up-front cashpayment, acquisition expenses, working capital adjustment and the payoff of anote payable of $1.5 million.  Inaddition, the seller may be entitled to contingent payments based on RGII’sperformance against profitability objectives over the next three years.  The contingent payments are evidenced by acontingent note with a face value of $10 million that is payable over three years,only if performance objectives are met. These financial performance objectives are based on earnings beforeinterest and taxes (“EBIT”) targets totaling $19.8 million over a three yearperiod.  There are no minimum or maximumpayment obligations under the terms of the contingent note. The contingentpayment will be reduced on a dollar-for-dollar basis for financial performancebelow EBIT targets, and increased by 29 cents ($0.29) for each dollar exceedingEBIT targets.  The Company made a paymentof $631,000 during the first quarter of 2004. The Company also entered into employment agreements with the formershareholder and employees of RGII and has agreed to issue an aggregate of600,000 options to purchase shares of Computer Horizons stock over a three yearperiod.

 

The Company completed the allocation of the purchaseprice to assets and liabilities acquired utilizing outside valuationconsultants to assist in this process.

 

As a result of the integration of AIM into RGII, the Company and theseller of RGII are assessing the impact of RGII EBIT targets related tocontingent payments.  Although notfinalized for the entire earn-out period, the agreement could result inpayments of a maximum of $667,000 for fiscal year 2004, and a maximum of $2.0million (which includes the $667,000) over the three year period.

 

OnJanuary 31, 2003, the Company acquired the IT Solutions operations ofGlobal Business Technology Solutions (GBTS), from Alea (Bermuda) Limited, amember of the Alea Group of companies and Westfield Services, Inc., asubsidiary of Westfield Financial Corporation for $400,000.  The outsourcing facility and its ITprofessionals are located in Chennai (Madras), India.  This transaction was accounted for as a purchaseand the entire purchase price was allocated to goodwill.

 

**10.  Goodwill**

 

The changes in the carrying amount of goodwill for the six months endedJune 30, 2004, are as follows: 

 
| **Reporting  Units**            | ** ** | **Solutions** | ** ** | **IT Services** | ** ** | **Education** | ** ** | **Chimes** | ** ** | **Consolidated** | ** ** |
|---------------------------------|------------|---------------|------------|-----------------|------------|---------------|------------|------------|------------|------------------|------------|
|                            |       |          |       |            |       |          |       |       |       |             |       |
| Balance as of December 31, 2003 |       | $             | 34,218     |            | $          | —        |       | $          | —     |             | $          | — |   | $ | 34,218 |   |
| Additions to Goodwill*          |       | 11,242        |       | —          |       | —        |       | —     |       | 11,242           |       |
| Balance as of June 30, 2004     |       | $             | 45,460     |            | $          | —        |       | $          | —     |             | $          | — |   | $ | 45,460 |   |

 

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* reflects goodwill resultingfrom AIM acquisition.  See Note 9.

 

The reporting units are equalto, or one level below, reportable segments. The company engaged outside valuation consultants to assist with thecompletion of a preliminary allocation of the purchase price to assets andliabilities acquired.

 

**11.****       Sale of Subsidiaries**

 

On February 14, 2003, theCompany sold the business and net assets of Computer Horizons e-Solutions(Europe) Limited, (“Solutions UK”) to Systems Associates Limited for 92,822British Sterling Pounds (approximately US$ 145,500).  The loss from the transaction was $272,000.

 

**12.****       Purchase of Treasury Stock**

 

In April of 2001, the Board of Directors approved the repurchasein the open market of up to 10% of its common shares outstanding, orapproximately 3.2 million shares.  As ofJune 30, 2004 the remaining authorization for repurchase is approximately93,000 shares.

 

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**13.****       Asset-Based LendingFacility**

 

The Company has a $40 million line of credit facility with availabilitybased primarily on eligible customer receivables.  The interest rate is LIBOR plus 2.75% basedon unpaid principal.  The borrowing baseless outstanding loans must equal or exceed $5.0 million.  As of June 30, 2004, the Company had nooutstanding loan balance against the facility. Based on the Company’s eligible customer receivables and cash balances,$16.3 million was available for borrowing as of June 30, 2004.  The fee for the unused portion of the line ofcredit is 0.375% per annum charged to the Company monthly.  This charge was approximately $52,000 and$62,000 for the six month periods ended June 30, 2004 and 2003,respectively.  This line of creditincludes covenants relating to the maintenance of cash balances and providingfor limitations on incurring obligations and spending limits on capitalexpenditures.  The Company did notsatisfy this covenant for the quarter ended March 31, 2004.  A waiver was received from the lendinginstitution for the quarter ended March 31, 2004 along with an amendment to theloan agreement lowering the three-month average minimum collections covenant to$10 million.  At June 30, 2004, theCompany is in compliance with the covenant. The facility was scheduled to expire in July 2004; however, onJuly 14, 2004, the Company signed a one-year extension of the facility,which will remain in effect until July 2005.

 

**14.****       Tax Benefit Reserve**

 

On March 9, 2002, the Job Creation and Worker Assistance Act of2002 (the “Act”) was enacted into law. This Act contained many economic and tax incentives, including theextension of the carryback period for losses arising in years ending during2001 and 2002 to five years from the previous two year carryback rule.  As a result, the Company’s tax refund claimof approximately $10 million at December 31, 2001 was increased toapproximately $30 million.  The additionalrefund amount of $20 million was received in January 2003.

 

During1998, the Company completed a business combination, which for financialstatement purposes, was accounted for as a pooling-of-interests.  For income tax purposes, the transaction wastreated as a taxable purchase that gave rise to future tax deductions.  Upon the sale of the acquired business in2001, these deductions were recognized for tax purposes.  The tax benefit of $19.6 million relating tothe part of these deductions that was carried back to prior years was includedin refundable income taxes in 2002. Since the tax structure of the transaction was subject to review by thetax authorities, the Company recorded a reserve for the tax benefits resultingfrom the carryback and did not record deferred tax assets for the tax benefitsbeing carried forward. The Company intended that upon conclusion of review ofthe relevant tax returns by the authorities, it would record a deferred taxasset for the part of the tax benefits being carried forward and a tax benefitfor the portion that was carried back, net of an appropriate valuationallowance. The tax benefit would be reflected as an increase in additionalpaid-in capital.  Any adjustments to thevaluation allowance would be charged or credited to income.

 

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InDecember 2003, the Internal Revenue Service examined the Company’s federalincome tax returns for the years ended December 31, 2001 and 2000, alongwith its federal refund claims for the calendar years 1996 through 1999.  The additional refund amount received inJanuary 2003 was shown as a liability until the audit was completed.  During the first quarter of 2004, theInternal Revenue Service and the Joint Committee on Taxation completed theirexamination of the Company’s federal income tax returns and federal refundclaims, and accepted them without change. Accordingly, the tax benefit was recorded as a decrease in tax benefitreserves of $19.6 million, a decrease in other tax reserves of $0.3 million,and an increase in additional paid-in capital of $19.9 million. There was nocharge or credit to income.

 

**15.****      ****Rescission Offer**

 

From April 2001 through January 2003, thesale of shares of the Company’s common stock pursuant to the Employee StockPurchase Plan were not exempt from registration or qualification under federalsecurities laws.  As a result, theCompany may have failed to comply with the registration or qualificationrequirements of federal and applicable state securities laws because theCompany did not register or qualify these stock issuances under either federalor applicable state securities laws.

 

As a result, the Company made a rescission offer,effective July 27, 2004, to all those persons who purchased shares of commonstock pursuant to the Employee Stock Purchase Plan during the affectedperiods.  The rescission offer was madepursuant to a registration statement filed under the Securities Act andpursuant to applicable state securities laws. In this rescission offer, the Company is offering to repurchase theshares, subject to our rescission offer, for the price paid per share plusinterest from the date of purchase until the rescission offer expires, at thecurrent statutory rate per year mandated by the state in which the shares werepurchased.  The rescission offer willexpire on August 27, 2004.  Assumingall of the shares subject to the rescission offer (approximately 659,000) aretendered in the rescission offer, the aggregate purchase price, excluding interestis estimated to be approximately $1.8 million. This contingency payment is considered remote by the Company, as thecurrent price of the stock is above the price at which the shares would berepurchased.

 

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**16.****      ****Special Items**

 

Incomefrom operations for the second quarter of 2004 includes a one-time credit of$939,000, primarily relating to an insurance refund.  During the second quarter of 2003, theCompany incurred special charges of $8.0 million consisting of $3.7 million forthe separation package of the former CEO and $4.3 million pertaining toexpenses related to the unilateral acquisition proposal and activities ofAquent.  The separation package of theformer CEO included a $3.5 million severance payment and $200,000 in continuedmedical coverage.  The $4.3 millionexpense related to the unilateral acquisition proposal and activities of AquentLLC was primarily attributable to approximately $2.3 million of legal fees,$1.0 million in financial advisor fees and $1.0 million of proxy solicitationsand other fees.  As management considersthese special items to be infrequent and material in nature, the Company hasreported the charges/credits on a separate line for full disclosure purposes;however, the amounts are reported within operating income.

 

TheCompany also incurred a restructuring expense of $1.9 million during the secondquarter of 2003 relating primarily to the closing of facilities in Canada.  In addition, the Company voluntarily terminateda sub-contract with ATEB, a privately held company, for financial reasons andrecorded a write-off of approximately $3.1 million (reported in second quarterof 2003 in SG&A expense) due to the uncertainty of the realization of thereceivable.  ATEB was the primarycontractor to develop a new pharmacy system for Royal Ahold.  The Company is continuing recovery efforts ofthis receivable.

 

**17.****      ****Aquent/Legal Matters**

 

On April 29, 2003, the Company filed an action in the UnitedStates District Court for the District of New Jersey against Aquent LLC,seeking (i) to enjoin Aquent from disseminating false and misleading proxymaterials and press releases in support of its two nominees for directorpositions in connection with the Company’s May 14, 2003 Annual Meeting; (ii) toinvalidate any proxies secured by Aquent through the use of unlawful proxysolicitation materials; and (iii) to require Aquent to disseminate correctivedisclosure that not only amended the false and misleading proxy materials butalso advised CHC shareholders how Aquent’s solicitations had violated thesecurities laws.

 

On May 27, 2003, the Company brought an action in the Supreme Court ofthe State of New York, New York County, seeking an order invalidating votes fordirectors Karl Meyer and Robert Trevisani cast at the Annual Meeting bystockholders of record who sold their shares between the record date and thedate of the Annual Meeting.

 

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Each of the legal proceedings described above weresettled and dismissed as a result of a settlement agreement between the Companyand Aquent LLC entered into on December 12, 2003.  As part of the settlement, the Company agreedto modify its June 30, 2003 by-law agreement regarding special meetingprocedures by, among other things, reducing from 75 to 50 the minimum number ofdays between the time a 10 percent or more shareholder requests a specialmeeting of shareholders and the date of that meeting.  In addition, Aquent entered into a standstillagreement pursuant to which, for a period of one year, it agreed not to requesta special meeting of Computer Horizons’ shareholders for any purpose, ornominate anyone to serve as a member of CHC’s Board of Directors, or engage inany proxy solicitation of Computer Horizons’ shareholders.

 

The Company is involved in various and routinelitigation matters, which arise through the normal course of business.  Management believes that the resolution ofthese matters will not have a material adverse effect on the Company’sfinancial position or results of operations.

 

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**MANAGEMENT’S DISCUSSION AND ANALYSIS OF**

**FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

For the Periods Ended June 30, 2004 andJune 30, 2003

 

The following detailed discussion andanalysis of the Company’s financial condition and results of operations shouldbe read in conjunction with the December 31, 2003 financial statements andrelated notes included in the Companies Form 10-K and the financial statementsand notes included elsewhere in this Form 10-Q.

 

**Overview**

 

Computer Horizons Corp., (“CHC” or the“Company”), is a strategic solutions and human capital management company withmore than thirty-six years of experience, specifically in information technology.  The Company’s clients are primarily Global2000 companies, serviced by over 20 offices in the United States, Canada, andIndia.

 

The Company had revenues for the quarterending June 30, 2004 of $65.8 million, a twelve percent increase from thecomparable period in 2003.  For the sixmonths ended June 30, 2004, revenues totaled $125.5 million, compared to$119.1 million in the comparable period of 2003.  The revenue increases for the quarter and sixmonths ended June 30, 2004 were attributable to growth in our Solutionsbusiness due to the July 2003 acquisition of RGII and the April 2004acquisition, by RGII, of Automated Information Management, Inc. (AIM).  Also contributing to the revenue increase wasgrowth achieved by the Company’s Chimes subsidiary.  Revenue growth during the first six months of2004 was partially offset by revenue declines in our commercial (non-federal)Solutions business and declines in our IT Services (staff augmentation) due toa decrease in demand for temporary technology workers and the trend ofcompanies to outsource technology jobs offshore.

 

Net income for the second quarter of 2004totaled $817,000, or $0.03 per share, compared with a net loss of approximately$9.5 million, or $(0.31) per share, in the comparable period of 2003.  Net income for the six months endingJune 30, 2004 totaled $813,000, or $0.03 per share, compared with a netloss of $10.8 million, or $(0.36) per share, in the comparable six monthsending June 30, 2003.  Net incomefor the six months ending June 30, 2004 includes a one-time credit ofapproximately $0.02 per share, primarily relating to an insurance refund, and a$(0.01) per share charge pertaining to the amortization of intangibles.  The first half of 2003 net loss includesspecial charges of $(0.32) per share relating to severance charges, thewrite-off of a terminated project, costs associated with the unilateralproposal and activities of Aquent and restructuring charges at the Company’sCanadian facilities.

 

Management continues to focus on maintaininga strong balance sheet, with approximately $36.7 million in cash and cashequivalents at June 30, 2004, along with $76.6 million in working capitaland no debt outstanding.

 

On April 1, 2004, the Company’ssubsidiary RGII acquired Automated Information Management, Inc. (AIM), afederal government IT Services company, for approximately $15.8 million incash.  The acquisition of AIM is directlylinked to the Company’s strategy of expanding its presence in the federalgovernment IT market and pursuing bolt-on expansions to its RGII subsidiary.

 

Although the Company reported net income of$813,000 in the first half of 2004, the level of business activity in the ITmarket remains uncertain, primarily in the Company’s IT Services and commercialsolutions business.  This uncertaintysignificantly reduced revenues in the Company’s IT Services business in thefirst half of 2004, compared to the prior year. The IT Services business accounted for approximately 49% of theCompany’s total revenue in the first half of 2004.  Although IT Services

 

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second quarter revenue increased sequentiallyfrom the first quarter of 2004, the Company cannot predict if these increasesare sustainable and when the overall level of business activity in the ITmarket will improve.

 

**FORWARD-LOOKINGSTATEMENTS**

 

Statements included in this Management’sDiscussion and Analysis of Financial Condition and Results of Operations andelsewhere in this document that do not relate to present or historicalconditions are “forward-looking statements” within the meaning of that term inSection 27A of the Securities Act of 1933, as amended, and inSection 21F of the Securities Exchange Act of 1934, as amended.  Additional oral or written forward-lookingstatements may be made by the Company from time to time, and such statementsmay be included in documents that are filed with the Securities and ExchangeCommission (SEC).  Such forward-lookingstatements involve risks and uncertainties that could cause results or outcomesto differ materially from those expressed in such forward-lookingstatements.  Forward-looking statementsmay include, without limitation, statements relating to the Company’s plans,strategies, objectives, expectations and intentions and are intended to be madepursuant to the safe harbor provisions of the Private Securities LitigationReform Act of 1995.  Words such as“believes,” “forecasts,” “intends,” “possible,” “expects,” “estimates,”“anticipates,” or “plans”, and similar expressions, are intended to identifyforward-looking statements.  Among theimportant factors on which such statements are based are assumptions concerningthe anticipated growth of the information technology industry, the continuedneed of current and prospective customers for the Company’s services, theavailability of qualified professional staff, and price and wage inflation.

 

## **Revenue GeneratingActivities**

## ** **

The majority of the Company’s revenues arederived from professional services rendered in the information technologysector.

 

The Company operates its business in threebasic segments: IT Services, the Solutions Group and Chimes, Inc.  The distinctions between the IT Services andSolutions Group segments primarily relate to the management and supervision ofservices performed and related gross margins. Chimes, Inc., a wholly-owned subsidiary of CHC, provides workforceprocurement and management services to Global 2000 companies.

 

The IT Services business consists ofproviding technology consultants to large organizations on a temporary hirebasis. The consultant work is supervised and managed by the customer. For thequarter and first half ended June 30, 2004, this segment representedapproximately 49% of total revenues. The IT Services business tends to be alower risk, lower gross margin business with very competitive pricing.

 

The Solutions Group, tends to be a highermargin, higher risk business, due to the fact that the Company is responsiblefor project deliverables and other conditions contained in statements of workand/or contracts with customers. Virtually all projects performed by theSolutions Group are IT related and consist of practices such as applicationdevelopment, outsourcing arrangements, government services, Health InsurancePortability and Accountability Act, or HIPAA, services, technology training andmanaged services.  For the quarter andfirst half ended June 30, 2004, the Solutions Group (excluding Chimes)accounted for 42% of consolidated revenues.

 

The Company’s customer relationships are memorialized in a masteragreement, which address the terms and conditions, which define the clientengagement.  Depending on the service tobe performed for the client, either a task order (in the case of a Staffingengagement) or a Statement of Work (“SOW”) (in the case of a Solutionsengagement) is generated. The SOW is signed by both the Company and thecustomer.  In general, no Solutions workis done unless there is a SOW because the SOW provides the technical details ofthe work to be done.  The SOW, althoughfalling under the corresponding master agreement, is a stand-

 

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alone binding contractual document, typically outlining the projectobjectives, describing the personnel who will work on the project, describingphases of the project, the timeframes for work performance, and the rate ofcompensation, on a time and materials basis.  In the event that the parameters of theproject expand or otherwise change, a Project Change Request is implemented, tomemorialize whatever change has occurred to the deliverables, personnel and ortime/materials.

 

The master agreements, in conjunction with theSOW’s, are written to define, with as much detail as possible, the clientrelationship and all aspects of the work to be performed for the client.  With regard to revenues expected in futureperiods, each SOW has a defined term or sets forth the anticipated length of aproject.  Where a client engagement is ongoing, like certain “Help Desk” type services, the master agreements wouldstill have a term length, but would recite that the agreement wasrenewable.  Generally, Solutionsengagements are for a year or less. Staffing engagements can and do last for more than a year, withvariations in the number of consultants being provided at any given time.  Staffing engagements are generally cancelableby clients with a two to four week notice period.

 

Chimes, Inc. is a human capital management solutioncompany that, through the use of proprietary software and processes, managesthe temporary workforce of large organizations. During the quarter and firsthalf ended June 30, 2004, Chimes accounted for approximately 9.0% of totalrevenues.

 

## **Critical Accounting Policies**

 

The most critical accounting policies used in thepreparation of the Company’s financial statements are related to revenuerecognition, the evaluation of the bad debt reserve, the valuation of goodwilland the valuation of the deferred tax asset.

 

##### Revenue Recognition

 

Approximately 95% and 93% of consolidated revenue inthe quarter and first half ended June 30, 2004 and June 30, 2003,respectively, was derived from time-and-material contracts.

 

For the IT Services division, revenues arerecognized as services are performed under time-and material contracts.  Under a typical time and materials billingarrangement, our customers are billed on a regularly scheduled basis, such asbiweekly or monthly.  At the end of eachaccounting period, revenue is estimated and accrued for services performedsince the last billing cycle.  Theseunbilled amounts are billed the following month.

 

The Solutions Group recognizes revenue either on atime and material basis or on a fixed fee basis, however, principally on a timeand material basis. For fixed-fee contracts, revenue is recognized on the basisof the estimated percentage of completion based on costs incurred relative tototal estimated costs.  Each fixed feecontract has different terms, milestones and deliverables.  The milestones and deliverables primarily relateto the work to be performed and the timing of the billing.  At the end of each reporting period anassessment of revenue recognized on the percentage of completion and milestonesachieved criteria is made.  If it becomesapparent that estimated cost will be exceeded or required milestones ordeliverables will not have been obtained, an adjustment will be made.  The cumulative effect of revisions inestimated revenues and costs are recognized in the period in which the factsthat give rise to the impact of any revisions become known.

 

Unbilled accounts receivable, in the IT Services and Solutions Group,represent amounts recognized as revenue based on services performed in advanceof customer billings principally on a time-and- material basis.  At the end of each accounting period, revenueis accrued for services performed since the last billing cycle.  These unbilled amounts are billed thefollowing month.  Costs and estimated earningsin excess of billings on fixed fee contracts arise when percentage of completionaccounting is used.  Such amounts arebilled at specific dates or at contract completion.

 

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The Company’s Chimes subsidiary recognizes revenueon a transaction fee basis.  The Chimesservice offering aggregates the suppliers of temporary workers to the customerand renders one invoice to the customer. Upon payment from the customer, Chimes deducts a transaction fee andremits the balance of the client payment to the applicable vendor.  Chimes recognizes only their fee for theservice, not the aggregate billing to the customer.  The gross amount of the customer invoicing isnot considered revenue or receivable to Chimes because there is no earningsprocess for the gross amount and by contract terms, Chimes is not obligated topay the vendor until paid by the customer.

 

Evaluation of Bad Debt Reserve

 

The Company determines its allowance by considering a number offactors, including the length of time trade accounts receivable are past due,the Company’s previous loss history, the customer’s current ability to pay itsobligation to the Company and the condition of the general economy and theindustry as a whole.  The Company writesoff accounts receivable when they become uncollectible, and paymentssubsequently received on such receivables are credited to the allowance fordoubtful accounts.

 

Goodwill 

 

For the years ended December 31, 2003and 2002 the Company completed valuations of the carrying value of theremaining goodwill and it was determined that no impairment had occurred ateither date.

 

As of December 31, 2003 and 2002, thefair value of each of the reporting units was calculated using the followingapproaches (i) market approach and (ii) income approach.  Under the market approach, value is estimatedby comparing the performance fundamentals relating to similar public companies’stock prices.  Multiples are thendeveloped of the value of the publicly traded stock to various measures and arethen applied to each reporting unit to estimate the value of its equity.  Under the income approach, value wasdetermined using the present value of the projected future cash flows to begenerated by the reporting unit.

 

The fair value conclusion of the reportingunits reflects an appropriately weighted value of the market multiple approachand the income approach discussed above. An asset approach was not used because the asset approach is mostrelevant for liquidation approaches, investment company valuations and assetrich company valuations (i.e. real estate entities) and was not deemed relevantfor manufacturing and service company going-concern valuations.  When either the income approach or the marketapproach was used, each indicated value of the Solutions entity’s equityexceeded the carrying value of the Solutions entity by at least $12 million and$15 million as of December 31, 2003 and 2002, respectively.  Since each of the two approaches yieldedvalues in excess of carrying value, any weighting of the two approaches oreither approach used alone results in the same conclusion, that the goodwillwas not impaired.

 

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Valuationof the Deferred Tax Asset

 

The Company records deferred tax assets forthe future tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and their respective tax bases,and to operating loss carryforwards. Deferred tax assets are reduced by a valuation allowance if, based on availableevidence, it is more likely than not that some portion or all of the deferredtax assets will not be realized.  Inassessing the realizability of deferred tax assets, management considers thescheduled reversal periods of the deferred tax assets as well as projectedfuture taxable income and tax planning strategies

 

**RESULTS OF OPERATIONS**

 

*Revenues*. Revenues increased to $65.8 million in the second quarter of 2004 from$58.8 million in the second quarter of 2003, an increase of $7.0 million or12%.  Revenues increased to $125.5million in the first six months of 2004 from $119.1 million in the first sixmonths of 2003, an increase of $6.4 million or 5.4%.

 

Solutions Group revenues increased to $27.8 million in the secondquarter of 2004 from $18.7 million in the second quarter of 2003, an increaseof $9.1 million or 49%.** **The increase in Solutions Grouprevenues is attributable to the Company’s federal government practice,including the July 2003 acquisition of RGII and the April 2004acquisition, by RGII, of AIM, with revenues in the second quarter of 2004totaling approximately $13.9 million. This revenue increase for the quarter was partially offset by severalcommercial (non-federal) domestic solutions projects ending and revenuedeclines attributable to projects with the City of New York, totalingapproximately $4.8 million, in comparison to the second quarter of 2003.  Solutions Group revenues increased to $52.3million in the first six months of 2004 from $38.3 million in the first sixmonths of 2003, an increase of****$14.0****million or 36.7%**. **The increase in Solutions Grouprevenues is attributable to the Company’s federal government practiceexpansion, including the acquisition of RGII and AIM, with total first half2004 revenues of $23.4 million, partially offset by revenue declines incommercial domestic solutions projects and the City of New York, totalingapproximately $9.5 million, in comparison to the first six months of 2003.

 

IT Services revenues decreased to $32.1 million in the second quarterof 2004 from $35.3 million in the second quarter of 2003, a decrease of $3.2million or 9%.  For the second quarter of2004, headcount decreased by 9%, in comparison with the second quarter of2003.  IT Services revenues decreased to$61.9 million in the first half of 2004 from $71.5 million in the first half of2003, a decrease of $9.6 million or 13.5%. For the first six months of 2004, average headcount decreased by 12% incomparison to the first six months of 2003, accounting for approximately $8.5million of the revenue decrease.  The balanceof the decrease in revenue (approximately $1.1 million) is attributable to areduction in average bill rates.  Thedecrease in IT Services revenue for the quarter and the first six months, isthe result of continued decreases in the demand for temporary technologyworkers, the trend of companies to outsource technology jobs offshore and theimpact of pricing decreases by customers.

 

Chimes revenues increased to $5.9 million in the second quarter of 2004from $4.8 million in the second quarter of 2003, an increase of $1.1 million,or 23.0%.  Chimes revenues, for the firstsix months of 2004, increased to $11.3 million from $9.3 million in the firstsix months of 2003, an increase of $2.0 million or 21.4%. This increase inChimes revenue for the first half of 2004 is due to the expansion of managedspend at existing customers (accounting for $1.3 million of the revenueincrease) and the addition of new customers (accounting for $0.7 million of therevenue increase) in this segment.

 

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*Direct Costs and Gross margins*.  Direct costs were $43.2 million and $83.2million in the second quarter and first half of 2004, respectively, and $41.5million and $84.3 million in the second quarter and first half of 2003,respectively.  Gross margin, revenuesless direct costs, increased to 34.3% in the second quarter of 2004 from 29.4%in the same period of 2003.  Gross marginincreased to 33.7% in the first six months of 2004 from 29.2% in the sameperiod of 2003. In the Company’s Solutions Group, gross profit totaled $19.1million, or 36.6% for the six months ending June 30, 2004 compared to$12.0 million, or 31.3%. This increase is primarily attributable to the RGIIand AIM acquisitions.  IT Services grossmargins for the six months ended June 30, 2004 were $12.6 million, or20.3%, compared to $14.2 million, or 20.0% for the comparable period of2003.  Chimes gross margins approximated94.1% for the six months ended June 30, 2004, compared to 92.1% in 2003,due to improved leveraging of direct costs.

 

The Company’s gross margin improvement is primarily attributable to thechange in the revenue mix among the Company’s business segments.  Chimes and the Solutions Group are highergross margin businesses than the Company’s IT Services segment.  For the first six months of 2004, Chimes andSolutions Group revenue totaled approximately 50% of consolidated revenue,compared to approximately 40% of consolidated revenue for the comparable periodin 2003.

 

*Costs and Expenses. *Selling, general and administrative expensesincreased to $21.6 million and $41.1 million in the second quarter andfirst half of 2004, respectively, from $20.7 million and $39.6 million in thecomparable periods of 2003.  For thequarter ending June 30, 2003, SG&A expenses include a write-off of aterminated project with ATEB, for financial reasons, of approximately $3.1million.  Excluding this write-off in2003, as a percentage of revenue, the Company’s SG&A expenses were 32.8%and 32.8% in the second quarter and first half of 2004, respectively; anincrease from 30.0% and 30.7% in the comparable periods of 2003.  The increase in the second quarter and firsthalf of 2004 SG&A expenses is primarily attributable to the acquisitions ofRGII and AIM in July 2003 and April 2004, respectively.

 

*Income / (Loss) from Operations*.  The Company’s income from operations totaled$1.4 million in the second quarter of 2004, including amortization expensetotaling $520,000 and special credits (insurance refund) of $939,000.  This compares to a loss from operations of$13.3 million in the second quarter of 2003, which includes restructuringcharges of $1.9 million, special charges of $8.0 million pertaining to costsassociated with the unilateral proposal and activities of Aquent and thewrite-off of a terminated project with ATEB, for financial reasons, ofapproximately $3.1 million.

 

The composition of the operating profit for the quarter endingJune 30, 2004, excluding all special charges/(credits), interestincome/(expense) and amortization expense, of $1.0 million included a loss of$1.4 million in IT Services, income of $2.3 million in the Solutions Group andincome of $0.1 million in Chimes.

 

The Company’s income from operations totaled $1.4 million in the firstsix months of 2004, including amortization expense of $728,000 and specialcredits of $939,000.  This compares to aloss from operations of $15.0 million in the first half of 2003, which includesrestructuring charges of $2.2 million, special charges of $8.0 millionpertaining to costs associated with the unilateral proposal and activities ofAquent and the write-off of a terminated project with ATEB, for financialreasons, of approximately $3.1 million. The composition of the 2004 operating income excluding all specialcharges/(credits), interest income/(expense) and amortization expense, of $1.2million included a loss of $2.3 million in IT Services, income of $3.8 millionin the Solutions Group and a loss of $0.3 million in Chimes.

 

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*Other Income/(Expense)*.  Other income was $29,000 in the secondquarter of 2004, compared to other income of $90,000 in the comparable periodof 2003.  This decrease of other incomeduring the second quarter of 2004 was due to decreased interest incomeprimarily resulting from lower balances on cash investments.  Other income was $112,000 in the first sixmonths of 2004, compared to other expense of $15,000 in the comparable periodof 2003, which included a loss on sale of assets of $273,000.

 

*Provision for Income Taxes*.  The effective tax rates for Federal, stateand local income taxes were 48% for the second quarter of 2004 and 49% for thefirst six months of 2004, compared with a tax benefit of 28% for the comparableperiods of 2003.

 

*Net Income / (Loss)*.  Net income for the second quarter of 2004 was$817,000, or $0.03 per diluted share, compared to net loss of $9.5 million, or$(0.31) loss per diluted share for the second quarter of 2003, an increase of$10.3 million.  The effect of specialcredits and amortization expense amounted to $0.01 income per share in thesecond quarter of 2004.  The secondquarter of 2003 net loss includes special charges of $(0.31) per share relatingto severance charges, the write-off of a terminated project with ATEB forfinancial reasons, costs associated with the unilateral proposal and activitiesof Aquent and restructuring costs at our Canadian facilities.  For the first half of 2004, the net incomewas $813,000, or $0.03 per diluted share, compared to a net loss of $10.8million, or $0.36 loss per diluted share for the first half of 2003.

 

**Liquidity and Capital Resources**

 

Computer Horizons has historically financed its operations through cashgenerated from operations, borrowings against bank lines of credit and thepublic sale of its common stock. At June 30, 2004, the Company hadapproximately $77 million in working capital, of which $36.7 million was cashand cash equivalents. At June 30, 2004, the Company had a current ratioposition of 4.4 to 1.

 

Net cash used in operating activities in the first six months of 2004was $95,000, primarily attributable to net income, the effect of non-cashcharges totaling approximately $4.5 million, offset by an increase in accountsreceivable of $3.5 million and a decrease in accrued expenses and accruedpayroll.

 

Total accounts receivable increased $6.1 million to $54.4 million atJune 30, 2004 (including $3.3 million of accounts receivable acquired fromAIM), from $48.3 million at December 31, 2003.  Accounts receivable days sales outstanding(“DSO”) were 74 days at June 30, 2004 compared to 77 days atMarch 31, 2004 and 70 days at December 31, 2003.  The increase in DSO’s from December 31,2003, is primarily attributable to the seasonal slowdown of payments from clients,which historically occurs in the first quarter of each year.  A three-day improvement in DSO’s was noted inthe second quarter and DSO’s are expected to decrease for the remainder of2004.  All client receivablecollectibility and billing issues identified by management have been adequatelyreserved.  For the period endingJune 30, 2004, there were no significant changes in credit terms, creditpolicies or collection efforts.

 

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Net cash used in investing activities in the first six months of 2004was $15.5 million, consisting primarily of capital expenditures totaling $0.8million and the acquisition of AIM for cash, totaling approximately $14.7million, net of cash acquired.

 

Net cash provided by financing activities in the first six months of2004 was $656,000, primarily consisting of shares issued pursuant to theemployee stock option plan and employee stock purchase plan.

 

The Company has a $40 million line of credit facility with availabilitybased primarily on eligible customer receivables.  The interest rate is LIBOR plus 2.75% basedon unpaid principal.  The borrowing baseless outstanding loans must equal or exceed $5.0 million.  As of June 30, 2004, the Company had nooutstanding loan balance against the facility. Based on the Company’s eligible customer receivables and cash balances,$16.3 million was available for borrowing as of June 30, 2004.  The fee for the unused portion of the line ofcredit is 0.375% per annum charged to the Company monthly.  This charge was approximately $52,000 and$62,000 for the six month periods ended June 30, 2004 and 2003,respectively.  This line of creditincludes covenants relating to the maintenance of cash balances and providingfor limitations on recurring obligations and spending limits on capitalexpenditures.  The Company did notsatisfy this covenant for the quarter ended March 31, 2004.  A waiver was received from the lendinginstitution for the quarter ended March 31, 2004 along with an amendment to theloan agreement lowering the three-month average minimum collections covenant to$10 million.  At June 30, 2004 theCompany is in compliance with the covenant. The facility was scheduled to expire in July 2004; however, onJuly 14, 2004, the Company signed a one-year extension of the facility,which will remain in effect until July 2005.

 

During the first quarter of 2004, the Company recorded a non-cashreduction in tax benefit reserves and an increase in additional paid-in capitalof $19.9 million.

 

Asa result of the Company’s acquisition of RGII, the seller of RGII may beentitled to contingent payments based on RGII’s performance againstprofitability objectives over the next three years.  The contingentpayments are evidenced by a contingent note with a face value of $10 millionthat is payable over three years, only if certain financial performanceobjectives are met.  These financial performance objectives are based onearnings before interest and taxes (“EBIT”) targets totaling $19.8 million overa three-year period.  There are no minimum or maximum payment obligationsunder the terms of the contingent note. The contingent payment will be reducedon a dollar for dollar basis for financial performance below EBIT targets andincreased by 29 cents ($0.29) for each dollar exceeding EBIT targets.  The Company made a payment of $631,000 duringthe first quarter of 2004.  Future payments, if the applicable EBITtargets are met, will be due as follows:  2004 payment of $3.3 million,2005 payment of $3.3 million, and 2006 payment of $1.7 million.  Thesepayments will be reduced or increased based on actual EBIT performance over thethree-year period.

 

On April 1, 2004, the Company’s subsidiary, RGII TechnologiesInc., closed on its acquisition of Automated Information Management Inc. (AIM),a federal government IT Services company with 2003 revenues of approximately$18.5 million.  The all-cash transactiontotaled approximately $15.8 million, including a working capitaladjustment.  As a result of the integrationof AIM into RGII, the Company and the seller of RGII are assessing the impactof RGII EBIT targets related to contingent payments.  Although not finalized for the entireearn-out period, the agreement could result in payments of a maximum of$667,000 for fiscal year 2004, and a maximum of $2.0 million (which includesthe $667,000) over the period ending June 30, 2006.

 

The Company believes that its cash and cash equivalents, availableborrowings and internally generated funds will be sufficient to meet itsworking capital needs through the next year.

 

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**Contractual Obligations and CommercialCommitments**

 

TheCompany does not utilize off balance sheet financing other than operating leasearrangements for office premises and related equipment.  The following table summarizes allcommitments under contractual obligations as of June 30, 2004:

 
| ** **                   | ** ** | **Obligation Due** | ** ** |
|------------------------------|------------|--------------------|------------|
| ** **                   | ** ** | **Total Amount**   | ** ** | **1 Year** | ** ** | **2-3 Years** | ** ** | **4-5 Years** | ** ** | **Over 5 Years** | ** ** |
| ** **                   | ** ** | **(in thousands)** | ** ** |
| Operating leases             |       | $                  | 12,659     |   | $ | 3,205 |   | $ | 7,632 |   | $ | 1,822 | ** ** | **$** | **—** | ** ** |
| RGII Contingent Note         |       | 9,369              |       | 3,300 |   | 6,069 |   |   |   |   |   |
| Deferred Compensation        |       | 2,288              |       |   |   |   |   |   |   | 2,288 |   |
| Supplemental Retirement Plan |       | 12,318             |       |   |   |   |   |   |   | 12,318 |   |
| Other                        |       | 2,937              |       | 1,604 |   | 1,333 |   | — | ** ** | ** ** | ** ** |
| Total Cash Obligations       |       | $                  | 39,571     |   | $ | 8,109 |   | $ | 15,034 |   | $ | 1,822 |   | $ | 14,606 |   |

 

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## **Recent AccountingPronouncements**

## ** **

InJanuary 2003, the FASB issued Financial Interpretation No. 46,“Consolidation of Variable Interest Entities” (“FIN 46”), which addressesconsolidation by business enterprises of variable interest entities(VIEs).  The accounting provisions anddisclosure requirements of FIN 46 are effective immediately for VIEs createdafter January 31, 2003, and are effective for the Company’s fiscal periodending March 31, 2004, for VIEs created prior to February 1,2003.  In December 2003, the FASBpublished a revision to FIN 46 (“FIN 46R”) to clarify some of the provisions ofthe interpretation and to defer the effective date of implementation forcertain entities.  Under the guidance ofFIN 46R, public companies that have interests in VIE’s that are commonlyreferred to as special purpose entities are required to apply the provisions ofFIN 46R for periods ending after December 15, 2003.  A public company that does not have anyinterests in special purpose entities but does have a variable interest in aVIE created before February 1, 2003, must apply the provisions of FIN 46Rby the end of the first interim or annual reporting period ending afterMarch 14, 2004.  Adoption of FIN 46Rdid not have a material effect on the Company’s financial statements.

 

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Item4.             Control and Procedures

 

Disclosure Controls and Procedures

 

The Company’s CEO and CFO have evaluated theeffectiveness of the Company’s disclosure controls and procedures (as such termis defined in Rules 13a-15(e) under the Securities Exchange Act of 1934, asamended) as of the end of the period covered by this report.  Based upon such evaluation, the Company’sChief Executive Officer and Chief Financial Officer have concluded that, as ofthe end of the period, the Company’s disclosure controls and procedures areeffective in recording, processing, summarizing and reporting, on a timelybasis, information required to be disclosed by the Company in the reports thatit files or submits under the Securities Exchange Act of 1934, as amended.

 

Internal Controls over Financial Reporting

 

There have not been any changes in the Company’sinternal controls over financial reporting (as such term is defined in Rules13a-15(f) under the Securities Exchange Act of 1934, as amended) during thefiscal quarter to which this report relates that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

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PART II - Other Information

 

Item 4.Submission of Matters to a Vote of Security Holders

 

On May 19, 2004, the Company held its Annual Meeting of Stockholders.

 

(1)     Thefollowing directors were elected to serve on the Company’s Board of Directors:

 
| ** **             | ** ** | **For**    | ** ** | **Against** | ** ** |
|------------------------|------------|------------|------------|-------------|------------|
| William M. Duncan      |       | 23,733,555 |       | 3,003,528   |       |
| Eric P. Edelstein      |       | 23,626,058 |       | 3,111,025   |       |
| William J. Marino      |       | 23,632,620 |       | 3,104,463   |       |
| Earl L. Mason          |       | 23,623,875 |       | 3,113,208   |       |
| L. White Matthews, III |       | 23,608,844 |       | 3,128,239   |       |
| William J. Murphy      |       | 23,800,923 |       | 2,936,160   |       |
| Edward J. Obuchowski   |       | 23,608,814 |       | 3,128,269   |       |

 

(2)     Theappointment of Grant Thornton LLP as independent auditors of the Company forfiscal year 2004 was ratified.

 
| For:     |   | 25,790,388 |   |
|----------|--------|------------|--------|
| Against: |   | 893,891    |   |
| Abstain: |   | 52,804     |   |

 

(3)     TheCompany’s 2004 Omnibus Incentive Compensation Plan was approved.

 
| For:     |   | 10,287,495 |   |
|----------|--------|------------|--------|
| Against: |   | 6,913,056  |   |
| Abstain: |   | 207,714    |   |

 

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Item6.                                     Exhibits and Reports on Form 8-K

 

a)              Exhibits

 

31.1– CEO Certification required by Rule 13a-14(a)/15d-14(a) under the SecuritiesExchange Act of 1934.

 

31.2– CFO Certification required by Rule 13a-14(a)/15d-14(a) under the SecuritiesExchange Act of 1934.

 

32.1 – CEO Certification pursuant to 18 U.S.C.Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

32.2 – CFO Certification pursuant to 18 U.S.C.Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

b)             *Report on Form 8-K*

 

Areport on Form 8-K was filed on April 2, 2004, reporting that ComputerHorizons subsidiary, RGII Technologies, Inc., has acquired all of the commonstock of Automated Information Management, Inc.

 

Tworeports on Form 8-K were filed on April 28, 2004, reporting the issuanceof a press release reporting the financial results of Computer Horizons for itsfirst quarter, along with a regulation FD disclosure resulting from the Companyconference call held to discuss first quarter 2004 financial results.

 

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Signatures

 

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

 

 
|   |                 |   | COMPUTER HORIZONS CORP.              |   |
|--------|----------------------|--------|--------------------------------------|--------|
|   |                 |   | (Registrant)                         |   |
|   |                 |   |                                 |
|   |                 |   |                                 |
| DATE:  | August 30, 2004 |   | /s/  William J. Murphy          |   |
|   |                 |   | William J. Murphy, President and CEO |
|   |                 |   | (Principal Executive Officer)        |
|   |                 |   |                                 |
|   |                 |   |                                 |
| DATE:  | August 30, 2004 |   | /s/ Michael J. Shea                  |   |
|   |                 |   | Michael J. Shea,                     |
|   |                 |   | Vice President and CFO               |
|   |                 |   | (Principal Financial Officer)        |
|   |                 |   |                                 |
|   |                 |   |                                 |
| DATE:  | August 30, 2004 |   | /s/ Nicholas Orichio                 |   |
|   |                 |   | Nicholas Orichio                     |
|   |                 |   | Interim Controller                   |
|   |                 |   | (Principal Accounting Officer)       |
|        |                      |        |                                      |        |  |  |  |

 

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