**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**ý****        Quarterly Report Under Section 13 or 15(d)**

**of the Securities Exchange Act of1934**

** **

**forthe quarterly period ended March 31, 2006**

 

**or**

 

**o****        Transition Report pursuant to Section 13 or 15(d)**

**of the Securities Exchange Act of1934**

** **

**forthe transition period from         to         **

 

----

 

**Commission File Number 0-7282**

 

**COMPUTERHORIZONS CORP.**

(Exact name of registrant as specified in itscharter)

 

| **New York**                    | ** ** | **13-2638902**         |
|---------------------------------|------------|------------------------|
| (State or other jurisdiction of |       | (I.R.S. Employer       |
| incorporation or organization)  |       | Identification Number) |

 

**49 Old Bloomfield Avenue, Mountain Lakes, New Jersey07046-1495**

(Address of principal executiveoffices)              (Zipcode)

 

Registrant’s telephone number, including area code  **(973) 299-4000**

 

**Not Applicable**

(Former name, former address and former fiscal year, ifchanged since last report)

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding twelve months (or for such shorter period that the registrant wasrequired to file such reports) and (2) has been subject to such filingrequirements for the past 90 days.

 

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

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer or a non-accelerated filer. See definitions of “acceleratedfiler and large accelerated filer”.

 

| o    Large  Accelerated Filer |   | ý    Accelerated  Filer |   | o    Non-accelerated  Filer |
|----------------------------------------------|--------|---------------------------------------------|--------|--------------------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).

 

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

 

As of April 28, 2006 the issuer had   32,736,616 shares of common stockoutstanding.

 

 

----

 

**COMPUTER HORIZONS CORP. AND SUBSIDIARIES**

 

Index

 
| Part I  | Financial Information |
|---------|-----------------------|
|    |                  |   |
| Item  1 |                  | Financial  Statements: |
|    |                  |   |
|    |                  | Consolidated Balance Sheets March 31, 2006 (unaudited) and  December 31, 2005 |
|    |                  |   |
|    |                  | Consolidated Statements of Operations Three  Months Ended March 31, 2006 and March 31, 2005 (unaudited) |
|    |                  |   |
|    |                  | Consolidated Statements of Cash Flows Three  Months Ended March 31, 2006 and March 31, 2005 (unaudited) |
|    |                  |   |
|    |                  | Notes to Consolidated Financial Statements |
|    |                  |   |
| Item  2 |                  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|    |                  |   |
| Item 3  |                  | Quantitative and Qualitative Disclosures  about Market Risk |
|    |                  |   |
| Item 4  |                  | Controls and Procedures |
|    |                  |   |
| Part II | Other Information     |
|    |                  |   |
| Item 4  |                  |   |
|    |                  |   |
| Item 6  |                  | Exhibits |
|    |                  |   |
|    |                  | Signatures |
|         |                       |  |  |

 

4

----

PART I.  Financial Information

Item 1.

**COMPUTER HORIZONS CORP. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

(dollars in thousands)

 
| ** **                                                                                                                             | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                             | ** ** | **(unaudited)**    | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                             |       |               |       |                  |       |
| CURRENT ASSETS:                                                                                                                        |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                              |       | $                  | 22,802     |                  | $          | 46,365 |   |
| Accounts receivable, less allowance for  doubtful accounts of $4,565 and $4,654 at March 31, 2006 and December 31,  2005, respectively |       | 52,602             |       | 48,124                |       |
| Refundable and Deferred income taxes                                                                                                   |       | 7,465              |       | 6,430                 |       |
| Prepaid expenses and other                                                                                                             |       | 3,897              |       | 4,108                 |       |
| TOTAL CURRENT ASSETS                                                                                                                   |       | 86,766             |       | 105,027               |       |
|                                                                                                                                   |       |               |       |                  |       |
| PROPERTY AND EQUIPMENT                                                                                                                 |       | 46,410             |       | 46,116                |       |
| Less accumulated depreciation                                                                                                          |       | (41,730            | )          | (41,051               | )          |
| TOTAL PROPERTY AND EQUIPMENT, NET                                                                                                      |       | 4,680              |       | 5,065                 |       |
| OTHER ASSETS - NET:                                                                                                                    |       |               |       |                  |       |
| Goodwill                                                                                                                               |       | 27,625             |       | 27,625                |       |
| Intangibles                                                                                                                            |       | 1,705              |       | 1,938                 |       |
| Deferred income taxes                                                                                                                  |       | 1,705              |       | —                |       |
| Other                                                                                                                                  |       | 3,241              |       | 3,687                 |       |
| TOTAL OTHER ASSETS                                                                                                                     |       | 34,276             |       | 33,250                |       |
|                                                                                                                                   |       |               |       |                  |       |
| TOTAL ASSETS                                                                                                                           |       | $                  | 125,722    |                  | $          | 143,342 |   |
|                                                                                                                                   |       |               |       |                  |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                          |       |               |       |                  |       |
| CURRENT LIABILITIES:                                                                                                                   |       |               |       |                  |       |
| Accounts payable                                                                                                                       |       | $                  | 15,446     |                  | $          | 36,252 |   |
| Accrued payroll, payroll taxes and benefits                                                                                            |       | 10,703             |       | 10,548                |       |
| Income taxes payable                                                                                                                   |       | 1,147              |       | 1,150                 |       |
| Restructuring reserve                                                                                                                  |       | 1,028              |       | 1,668                 |       |
| Deferred income taxes                                                                                                                  |       | 1,705              |       | —                |       |
| Other accrued expenses                                                                                                                 |       | 3,834              |       | 4,005                 |       |
| TOTAL CURRENT LIABILITIES                                                                                                              |       | 33,863             |       | 53,623                |       |
|                                                                                                                                   |       |               |       |                  |       |
| OTHER LIABILITIES:                                                                                                                     |       |               |       |                  |       |
| Deferred compensation                                                                                                                  |       | 2,223              |       | 2,468                 |       |
| Change of control payable                                                                                                              |       | 2,449              |       | 2,938                 |       |
| Other                                                                                                                                  |       | 233                |       | 286                   |       |
| TOTAL LIABILITIES                                                                                                                      |       | $                  | 38,768     |                  | 59,315     |   |
|                                                                                                                                   |       |               |       |                  |       |
| 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 33,158,105 shares at March 31, 2006 and December  31, 2005              |       | 3,315              |       | 3,315                 |       |
| Additional paid in capital                                                                                                             |       | 147,162            |       | 148,083               |       |
| Accumulated other comprehensive loss                                                                                                   |       | (550               | )          | (643                  | )          |
| Retained deficit                                                                                                                       |       | (59,734            | )          | (60,492               | )          |
|                                                                                                                                   |       | 90,193             |       | 90,263                |       |
| Less shares held in treasury, at cost;  564,258 and 1,118,014 shares at March 31, 2006 and December 31, 2005,  respectively            |       | (3,239             | )          | (6,236                | )          |
| TOTAL SHAREHOLDERS’ EQUITY                                                                                                        |       | 86,954             |       | 84,027                |       |
|                                                                                                                                   |       |               |       |                  |       |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                        |       | $                  | 125,722    |                  | $          | 143,342 |   |

 

The accompanying notes are an integral part of these statements.

 

5

----

 

**COMPUTER HORIZONS CORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(Unaudited)

(dollars in thousands, except per share data)

 
| ** **                                             | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|
| ** **                                             | ** ** | **March 31, 2006**     | ** ** | **March 31, 2005** | ** ** |
| ** **                                             | ** ** | ** **             | ** ** | **%****of  revenue** | ** ** | ** ** | ** ** | **% of  revenue** | ** ** |
| REVENUES:                                              |       |                   |       |   |   |   |   |   |   |
| Commercial                                             |       | $                      | 45,839     |   | 72.1 | % | $ | 48,671 |   | 73.1 | % |
| Federal                                                |       | 10,326                 |       | 16.2 | % | 11,539 |   | 17.3 | % |
| Chimes                                                 |       | 7,441                  |       | 11.7 | % | 6,363 |   | 9.6 | % |
| Total                                                  |       | 63,606                 |       | 100.0 | % | 66,573 |   | 100.0 | % |
|                                                   |       |                   |       |   |   |   |   |   |   |
| COSTS AND  EXPENSES:                                   |       |                   |       |   |   |   |   |   |   |
| Direct costs                                           |       | 42,071                 |       | 66.1 | % | 45,588 |   | 68.5 | % |
| Selling,  general & administrative                 |       | 20,814                 |       | 32.7 | % | 20,977 |   | 31.5 | % |
| Amortization  of intangibles                           |       | 233                    |       | 0.4 | % | 350 |   | 0.5 | % |
| Special  charges / (credits)                           |       | (6                     | )          |   |   | (675 | ) |   |   |
|                                                   |       | 63,112                 |       | 99.2 | % | 66,240 |   | 99.5 | % |
|                                                   |       |                   |       |   |   |   |   |   |   |
| INCOME/(LOSS)  FROM OPERATIONS                         |       | 494                    |       | 0.8 | % | 333 |   | 0.5 | % |
|                                                   |       |                   |       |   |   |   |   |   |   |
| OTHER  INCOME/(EXPENSE):                               |       |                   |       |   |   |   |   |   |   |
| Interest  income                                       |       | 400                    |       | 0.6 | % | 180 |   | 0.3 | % |
| Interest  expense                                      |       | (65                    | )          | 0.0 | % | (5 | ) | — |   |
|                                                   |       | 335                    |       | 0.5 | % | 175 |   | 0.3 | % |
|                                                   |       |                   |       |   |   |   |   |   |   |
| INCOME/(LOSS)  BEFORE INCOME TAXES                     |       | 829                    |       | 1.3 | % | 508 |   | 0.8 | % |
|                                                   |       |                   |       |   |   |   |   |   |   |
| INCOME  (TAXES)/BENEFIT:                               |       |                   |       |   |   |   |   |   |   |
| Current                                                |       | (71                    | )          | -0.1 | % | (124 | ) | -0.2 | % |
| Deferred                                               |       | —                 |       | 0 | % | (54 | ) | -0.1 | % |
|                                                   |       | (71                    | )          | -0.1 | % | (178 | ) | -0.3 | % |
|                                                   |       |                   |       |   |   |   |   |   |   |
| NET  INCOME/(LOSS)                                     |       | $                      | 758        |   | 1.2 | % | $ | 330 |   | 0.5 | % |
|                                                   |       |                   |       |   |   |   |   |   |   |
| EARNINGS/(LOSS)  PER SHARE - BASIC                     |       | $                      | 0.02       |   |   |   | $ | 0.01 |   |   |   |
|                                                   |       |                   |       |   |   |   |   |   |   |
| WEIGHTED  AVERAGE NUMBER OF SHARES OUTSTANDING - BASIC |       | 32,067,905             |       |   |   | 31,193,000 |   |   |   |
|                                                   |       |                   |       |   |   |   |   |   |   |
| EARNINGS/LOSS  PER SHARE - DILUTED                     |       | $                      | 0.02       |   |   |   | $ | 0.01 |   |   |   |
|                                                   |       |                   |       |   |   |   |   |   |   |
| WEIGHTED  AVERAGE SHARES – DILUTED                |       | 32,355,667             |       |   |   | 31,524,000 |   |   |   |

 

The accompanying notes are an integral part of these statements.

 

6

----

 

**COMPUTER HORIZONS CORP. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(Unaudited)

(dollars in thousands)

 
| ** **                                                                                          | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                          | ** ** | **March 31, 2006**     | ** ** | **March 31, 2005** | ** ** |
|                                                                                                |       |                   |       |   |   |
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                                           |       |                   |       |   |   |
| Net income/(loss)                                                                                   |       | $                      | 758        |   | $ | 330 |   |
| Adjustments to reconcile net income/(loss)  to net cash provided by/(used in) operating activities: |       |                   |       |   |   |
| Deferred taxes                                                                                      |       | —                 |       | 54 |   |
| Depreciation                                                                                        |       | 699                    |       | 1,058 |   |
| Amortization of intangibles                                                                         |       | 233                    |       | 350 |   |
| Provision for bad debts                                                                             |       | 180                    |       | 201 |   |
| FAS 123R option expense                                                                             |       | 283                    |       | — |   |
| Changes in assets and liabilities, net of  acquisitions:                                            |       |                   |       |   |   |
| Accounts receivable                                                                                 |       | (4,658                 | )          | (58 | ) |
| Other receivables                                                                                   |       | —                 |       | 1,530 |   |
| Prepaid expenses and other current assets                                                           |       | 210                    |       |   |   |
| Other assets                                                                                        |       | 447                    |       | 124 |   |
| Refundable income taxes                                                                             |       | (948                   | )          | (836 | ) |
| Accrued payroll, payroll taxes and benefits                                                         |       | 156                    |       | 23 |   |
| Accounts payable                                                                                    |       | (20,805                | )          | 2,194 |   |
| Income taxes payable                                                                                |       | (3                     | )          | 91 |   |
| RGII contingency payment                                                                            |       | —                 |       | (1,851 | ) |
| Other accrued expenses and restructuring  reserve                                                   |       | (1,342                 | )          | (4,834 | ) |
| Deferred compensation                                                                               |       | (245                   | )          | (140 | ) |
| Supplemental executive retirement plan                                                              |       | —                 |       | 35 |   |
| Other liabilities                                                                                   |       | (144                   | )          | (113 | ) |
|                                                                                                |       |                   |       |   |   |
| **NET CASH PROVIDED BY/(USED IN) OPERATING  ACTIVITIES**                                            |       | (25,179                | )          | (1,842 | ) |
|                                                                                                |       |                   |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES**                                                            |       |                   |       |   |   |
| Purchases of furniture and equipment                                                                |       | (313                   | )          | (555 | ) |
| **NET CASH PROVIDED BY/(USED IN) INVESTING  ACTIVITIES**                                            |       | (313                   | )          | (555 | ) |
|                                                                                                |       |                   |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES**                                                            |       |                   |       |   |   |
| Stock options exercised                                                                             |       | 1,704                  |       | 325 |   |
| Stock issued on employee stock purchase  plan                                                       |       | 132                    |       | 28 |   |
| **NET CASH PROVIDED BY/(USED IN) FINANCING  ACTIVITIES**                                            |       | 1,836                  |       | 353 |   |
|                                                                                                |       |                   |       |   |   |
| Foreign currency gains/(losses)                                                                     |       | 93                     |       | (232 | ) |
|                                                                                                |       |                   |       |   |   |
| **NET INCREASE/(DECREASE) IN CASH AND CASH  EQUIVALENTS**                                           |       | (23,563                | )          | (2,276 | ) |
|                                                                                                |       |                   |       |   |   |
| **CASH AND CASH EQUIVALENTS AT BEGINNING OF  YEAR**                                                 |       | 46,365                 |       | 33,649 |   |
|                                                                                                |       |                   |       |   |   |
| **CASH AND CASH EQUIVALENTS AT END OF PERIOD**                                                      |       | $                      | 22,802     |   | $ | 31,373 |   |

 

The accompanying notes are an integral part of these statements.

 

7

----

 

**COMPUTER HORIZONS CORP.**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

For the Periods Ended March 31, 2006 andMarch 31, 2005

(unaudited)

 

**1.****         Basisof Presentation**

 

The consolidated balance sheet as of March 31, 2006, the consolidatedstatements of operations for the three months ended March 31, 2006 and March31, 2005, respectively, and the statement of cash flows for the three monthsended March 31, 2006 and 2005 have been prepared by the Company withoutaudit.  In the opinion of management, all adjustments (which includenormal recurring adjustments) necessary to present fairly the financialposition, results of operations and cash flows at March 31, 2006 (and for allperiods presented) have been made.

 

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 thatthese consolidated financial statements be read in conjunction with thefinancial statements and notes thereto included in the Annual Report on Form10-K for the year ended December 31, 2005 filed by the Company.  Theresults of operations for the periods ended March 31, 2006 and 2005 are notnecessarily indicative of the operating results for the respective full years.

 

**2.****         RecentAccounting Pronouncements**

 

In December 2004, theFASB issued Statement of Financial Accounting Standard No. 123 (revised2004), “Share-Based Payment” (FAS 123R). FAS 123R requires thatcompensation cost be recognized for all new awards and awards that aremodified, repurchased or cancelled after the adoption date. The SEC amended theeffective dates of FAS 123R for public companies in April 2005, whichallows registrants to implement FAS 123R at the beginning of their nextfiscal year, instead of the next interim period, that begins afterJune 15, 2005. The SEC also issued Staff Accounting Bulletin 107, “Share-BasedPayment” (SAB 107), in April 2005, which provides the views of the SECstaff regarding certain aspects of the application of FAS 123R.SAB 107 assists issuers in their initial implementation of FAS 123R.The provisions of this statement are effective for the Company’s first quarterended March 31, 2006.

 

FAS 123R allowsfor two alternative transition methods. The first method is the modifiedprospective application whereby compensation cost for the portion of awards forwhich the requisite service has not yet been rendered that are outstanding asof the adoption date will be recognized over the remaining service period. Thecompensation cost for that portion of awards will be based on the grant-datefair value of those awards as calculated for pro forma disclosures underStatement 123, “Accounting for Stock-Based Compensation”, as originallyissued. All new awards and awards that are modified, repurchased or cancelledafter the adoption date will be accounted for under the provisions of FAS123(R). The second method is the modified retrospective application, whichrequires that the Company restates prior period financial statements. Themodified retrospective application may be applied either to all prior periodsor only to prior interim periods in the year of adoption of this statement. TheCompany has elected to apply the modified prospective method.

 

On November 2005, the FASB issued FASB StaffPosition No. FAS 123R-3 — “Transition Election Related to Accounting for theTax Effects of Share-Based Payment Awards.” The Company has elected to adopt the alternative transition methodprovided in this FASB Staff Position for calculating the tax effects ofshare-based compensation pursuant to FAS 123R. The alternative transitionmethod includes a simplified method to establish the beginning balance of theadditional paid-in capital pool (APIC pool) related to the tax effects ofemployee share-based compensation, which is available to absorb taxdeficiencies recognized subsequent to the adoption of FAS 123R.

 

**3.****         Accountingfor Stock-Based Compensation**

 

*Accounting forStock-Based Compensation*

 

In December 2002,the FASB approved the issuance of Statement of Financial Accounting StandardNo. 148, “Accounting for Stock-Based Compensation — Translation andDisclosure” (FAS No. 148).  This statement amends FASB StatementNo. 123, “Accounting for Stock-Based Compensation,” to provide alternativemethods of transition for a voluntary change to the fair value based method ofaccounting for stock-based employee compensation.  In addition, thisStatement amended the disclosure requirements of the FAS 123 to requireprominent disclosures in both annual and interim financial statements about themethod of accounting for stock-based compensation and the effect of the methodsused on reported results. The Company adopted these disclosure provisions as ofDecember 31, 2002.

 

8

----

 

*Adoption of FAS 123R*

 

The Company issuescommon stock options to certain employees and certain of its board members. InJanuary 2006, the Company adopted Financial Accounting Standards Board  Statement No. 123 (revised 2004) (“FAS 123R”)- “Share-Based Payments”*.* FAS123R requires all entities to recognize compensation expense in an amount equalthe fair value of share-based payments, such as stock options granted toemployees. The Company has elected to apply FAS 123R on a modified prospectivemethod. Under this method, the Company is required to record compensationexpense for newly granted options and (as previous awards continue to vest) forthe unvested portion of previously granted awards that remain outstanding atthe date of adoption. Additionally, the financial statements for prior interimperiods and fiscal years do not reflect any adjusted amounts.

 

On March 31, 2006, theCompany has three share-based compensation plans and a Employee Stock PurchasePlan (“ESPP”) which are described below. The compensation cost that has beencharged against income for the three month ended March 31, 2006 was $283,000. This$283,000 reduced our earnings from continuing operations before and after taxesand net earnings. Basic and diluted net earnings per common share were reducedby $0.01 as a result of adopting this pronouncement. As the Company has a netoperating loss carryforward and has established a full valuation allowance onits deferred tax assets, there is no current tax benefit associated with theaccrued compensation expense for this quarter.

 

*Stock Options*

 

In 1994, the Companyadopted a stock option plan which provides for the granting of options, toofficers and key employees, for the purchase of a maximum of 7,594,000 sharesof common stock and stock appreciation rights (“SARs”). Options and SARsgenerally expire ten years from the date of grant and become exercisable inspecified amounts during the life of the respective options.**There are no shares available as of March31, 2006 for the 1994 stock option plan.

 

In May 2004, theCompany received shareholder approval and adopted the 2004 Omnibus IncentiveCompensation Plan (the “Omnibus Plan”). This plan replaced the 1994 StockOption and Appreciation Plan and provides for a maximum number of 3,500,000shares of common stock issuable under the plan. These awards may be stockoptions, stock appreciation rights, restricted stock or performance share awards,and expire after ten years. Awards from this plan are exercisable immediatelyfor members of the Board of Directors and ratably over a three year period foremployees. This Plan is scheduled to expire on May 19, 2014. As of March31, 2006, there were 2,711,500 shares available for awards under the OmnibusPlan.

 

The Company also has anon-qualified Directors’ stock option plan (the “Directors’ Plan”). In 1998,the Company amended the Directors’ Plan, providing that each new director ofthe Company who is not an employee of the Company (i) shall immediatelyreceive options to purchase 10,000 shares of the Company’s common stock and(ii) shall receive annual grants to purchase an additional 10,000 sharesof its common stock. Awards from this plan are exercisable immediately, andexpire in ten years. The Directors’ Plan originally was to expire onMarch 4, 2001 and was extended by the Board of Directors and Shareholdersthrough March 6, 2007. There were 24,000 shares of common stock availablefor grant at March 31, 2006 under the Directors’ Plan.

 

A summary of thestatus of all the Company’s stock option plans as of March 31, 2006 andthe changes during the three months ended on that date is presented below:

 
| **Options**                                                       | ** ** | **Shares  (000’s)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value  ($000)** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------|------------|----------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------|------------|
| Outstanding—December  31                                     |       | 2,675                    |       | $                                      | 3.69       |                                                 | —     |                                    | —     |   |
| Granted                                                           |       | 315                      |       | 4.39                                   |       | —                                               |       | —                                  |       |
| Exercised                                                         |       | 557                      |       | 3.45                                   |       | —                                               |       | —                                  |       |
| Canceled/forfeited/expired                                        |       | 0                        |       | —                                 |       | —                                               |       | —                                  |       |
| Outstanding—March 31                                    |       | 2,433                    |       | 3.84                                   |       | 5.9                                                  |       | $                                       | 3,000      |   |
| Options  exercisable—March 31                           |       | 2,018                    |       | 3.74                                   |       | 6.1                                                  |       | $                                       | 2,735      |   |
| Weighted  average fair value of options granted during the period |       |                     |       | $                                      | 2.47       |                                                 |       |                                    |       |   |

 

The fair value of eachoption grant is estimated on the date of the grant using the Black-Scholesoptions pricing model. The following weighted-average assumptions used forgrants in the three months ended March 31, 2006: expected volatility of 39%; arisk-free interest rate of 4.86%; and an expected life of 8.4 years. Theexpected term of the options is based on evaluations of historical

 

9

----

 

and expected future employee exercise behavior. Therisk-free rate is based on the US Treasury rates at the close of the quarterwith maturity dates approximately equal to the expected life at the grant date.The expected volatility is based on the historical volatility of the Company’sstock.

 

Cash received fromoption exercise under all share-based payment arrangements for the three monthsended March 31, 2006 was $1,836,000. The actual tax benefit realized for thetax deductions from option exercise of the share-based payment arrangementstotaled $ 153,800 for the same period. As the Company currently has a fullvaluation allowance with respect to its deferred tax assets, no tax benefitfrom the options are recognized at this time. If the Company determines that itis more likely than not that it will recognize a tax benefit from the exerciseof the options, then this amount would generally reflect the overall taxbenefit.

 

Prior to the adoptionof SFAS 123R, the Company presented all tax benefits of deductions resultingfrom the exercise of share-based awards as operating cash flows in theconsolidated statement of cash flows. SFAS 123R requires the cash flowsresulting from the tax benefits generated from tax deductions in excess of thecompensation costs recognized for the share-based awards (excess tax benefits)be classified as financing cash flows. SFAS 123R requires the cash flowsresulting from the tax benefits for the tax deductions in excess of thecompensation expense recorded for those options to be classified as financingcash flows. As the Company currently has a net operating loss carryforward anda full valuation allowance, no excess tax deductions are recognized at thistime.

 

As of March 31, 2006,there was $ 808,000 of total unrecognized compensation cost related tononvested share-based compensation arrangements granted under these plans; thatcost is expected to be recognized over a period of three years.

 

The Company offers anEmployee Stock Purchase Plan (“ESPP”) to its employees. The ESPP purchasesshares quarterly at a 15% discount from the lower of the opening and closingstock prices for the period. The shares are purchased at a fixed discount andtherefore give rise to a liability under FAS 123R. The liability for thequarter ended March 31, 2006 is $41,000. Shares are purchased the firstbusiness day after the end of each quarter. There were 2,003,280 shares ofcommon stock available for purchase after April 3, 2006 under the ESPP Plan.

 

Prior to the adoptionof FAS 123R, the Company applied Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees” (APB 25), as modifiedby FIN 44, “Accounting for Certain Transactions Involving Stock Compensation,”in accounting for stock-based employee compensation, whereby no compensationcost had been recognized for the plans. 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 FAS 123, the Company’s net income andearnings per share would have been decreased to the pro forma amounts indicatedbelow:

 

 
| **(in thousands, except per share  data)** | ** ** | **March 31, 2005**                                                                                                                        | ** ** |
|--------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                       |       |                                                                                                                                           |       |   |   |
| Net  income/(loss)                         |       | As reported                                                                                                                                    |       | $ | 330 |   |
|                                       |       | Deduct :  Total stock-based employee compensation expense determined under fair value  based method for all awards, net of related tax effects |       | (271 | ) |
|                                       |       |                                                                                                                                           |       |   |   |
|                                       |       | Pro forma                                                                                                                                      |       | $ | 59 |   |
|                                       |       |                                                                                                                                           |       |   |   |
| Earnings per  share                        |       |                                                                                                                                           |       |   |   |
| Basic/Diluted                              |       | As reported                                                                                                                                    |       | $ | 0.01 |   |
|                                       |       | Pro forma                                                                                                                                      |       | 0.00 |   |

 

The effect of adoptingSFAS No. 123R was a reduction of $283,000 to the Company’s income fromcontinuing operations for the three months ended March 31, 2006. There wasno additional cumulative effect of adoption using the modified-prospectivetransition method was similarly material.

 

**4.****         Cash**

 

Included in cash and cash equivalents at March 31, 2006 andDecember 31, 2005 is restricted cash of $378,000 and $219,000respectively.  Restricted cash represents funds received by Chimes andheld in client-specific bank accounts, to be used to make payments to vendorsof the applicable client. Cash and cash equivalents at March 31, 2006 andDecember 31, 2005 also include approximately $9.2 million and $29.4million, respectively, of cash to be disbursed to Chimes vendors in accordancewith the client payment terms.

 

10

----

 

**5.****         EarningsPer Share**

 

Basic Earnings PerShare (“EPS”) is based on the weighted average number of common sharesoutstanding without consideration of common stock equivalents.  Dilutedearnings per share is based on the weighted average number of common and commonequivalent shares outstanding.  The calculation takes into account theshares that may be issued upon exercise of stock options, reduced by the sharesthat may be repurchased with the funds received from the exercise, based on theaverage price during the year.

 

In accordance withSFAS No. 128, the table below presents both basic and diluted earnings pershare:

 
| ** **                                                                                                         | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                         | ** ** | **March 31, 2006**     | ** ** | **March 31, 2005** | ** ** |
|                                                                                                               |       |                   |       |   |   |
| Numerator:                                                                                                         |       |                   |       |   |   |
| Net income/(loss) - in thousands                                                                                   |       | $                      | 758        |   | $ | 330 |   |
| Denominator:                                                                                                       |       |                   |       |   |   |
| Denominator for basic earnings per share -  weighted average shares outstanding                                    |       | 32,067,905             |       | 31,193,000 |   |
| Effect of  stock options                                                                                           |       | 287,762                |       | 331,000 |   |
| Diluted  earnings/(loss) per share:                                                                                |       |                   |       |   |   |
| Denominator for diluted earnings per share  - adjusted weighted average shares outstanding and assumed conversions |       | 32,355,667             |       | 31,524,000 |   |
| Basic  earnings/(loss) per share                                                                                   |       | $                      | 0.02       |   | $ | 0.01 |   |
| Diluted  earnings/(loss) per share                                                                                 |       | $                      | 0.02       |   | $ | 0.01 |   |

 

The computation ofdiluted earnings per share excludes all options with exercise prices greaterthan the average market price in 2006 and 2005.  During the three monthsended March 31, 2006, 70,000 options were excluded with exercise pricesbetween $4.70 and $16.38.  During the three months ended March 31,2005, 1,005,769 options were excluded with exercise prices between $3.89 and$23.00.

 

11

----

 

**6.****         SegmentInformation**

 

During the fourth quarter of 2004, the Company completed arestructuring initiative whereby the Company’s business model was realigned,effective January 1, 2005, around its three distinct segments of clients:Commercial, Federal Government and Vendor Management services (Chimes). This realigned business model is designed to deliver improved operationalperformance for the Company and reduce annual operating costs.

 

Income/(loss) beforeincome tax benefit consists of income/(loss) before income taxes, excludinginterest income, interest expense, gain/(loss) on the sale ofassets/investments, change of control charges, restructuring charges, specialcharges/(credits), the write-off of assets, amortization of intangiblesand goodwill impairment. These exclusions total income of $108,000 and $500,000for the quarters ended March 31, 2006 and 2005 respectively. Long-term assets include goodwill, intangibles and property, plant andequipment. Corporate services, consisting of general and administrativeservices are provided to the segments from a centralized location. Such costsare allocated to the applicable segments receiving Corporate services based onrevenue.

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|
| **(dollars in thousands)**                               | ** ** | **March 31,  2006**    | ** ** | **March 31,  2005** | ** ** |
| Revenues :                                               |       |                   |       |   |   |
| Commercial                                               |       | $                      | 45,839     |   | $ | 48,671 |   |
| Federal                                                  |       | 10,326                 |       | 11,539 |   |
| Chimes                                                   |       | 7,441                  |       | 6,363 |   |
| Total  Revenues                                          |       | $                      | 63,606     |   | $ | 66,573 |   |
|                                                     |       |                   |       |   |   |
| Gross Profit  :                                          |       |                   |       |   |   |
| Commercial                                               |       | $                      | 9,633      |   | $ | 9,518 |   |
| Federal                                                  |       | 4,638                  |       | 5,415 |   |
| Chimes                                                   |       | 7,263                  |       | 6,052 |   |
| Total Gross  Profit                                      |       | $                      | 21,534     |   | $ | 20,985 |   |
| %                                                        |       | 33.9                   | %          | 31.5 | % |
|                                                     |       |                   |       |   |   |
| Operating  Income :                                      |       |                   |       |   |   |
| Commercial                                               |       | $                      | 3,736      |   | $ | 2,606 |   |
| Federal                                                  |       | 1,050                  |       | 1,323 |   |
| Chimes                                                   |       | 1,260                  |       | 1,189 |   |
| Total  Operating Income                                  |       | $                      | 6,046      |   | $ | 5,118 |   |
| %                                                        |       | 9.5                    | %          | 7.7 | % |
|                                                     |       |                   |       |   |   |
| Corporate  Allocation :                                  |       |                   |       |   |   |
| Commercial                                               |       | $                      | 4,137      |   | $ | 4,073 |   |
| Federal                                                  |       | 433                    |       | 443 |   |
| Chimes                                                   |       | 755                    |       | 594 |   |
| Total  Corporate Allocation                              |       | $                      | 5,325      |   | $ | 5,110 |   |
| %                                                        |       | 8.4                    | %          | 7.7 | % |
|                                                     |       |                   |       |   |   |
| Total Income  / (Loss) before Income Taxes / (Benefit) : |       |                   |       |   |   |
| Commercial                                               |       | $                      | (401       | ) | $ | (1,467 | ) |
| Federal                                                  |       | 617                    |       | 880 |   |
| Chimes                                                   |       | 505                    |       | 595 |   |
| Total Income  / (Loss) before Income Taxes / (Benefit)   |       | $                      | 721        |   | $ | 8 |   |
| %                                                        |       | 1.1                    | %          | 0.0 | % |

 

12

----

 

*Reconciliation of Segment Income / (Loss)before Income Taxes / (Benefit) to Consolidated Income / (Loss) Before IncomeTaxes / (Benefit):*

 
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | ** **          | ** ** |
|--------------------------------------------------------------|------------|------------------------|------------|---------------------|------------|
| **(dollars in thousands)**                                   | ** ** | **March 31,  2006**    | ** ** | **March 31,  2005** | ** ** |
| Total segment  income/(loss) before income taxes/(benefit) : |       | $                      | 721        |                | $          | 8 |   |
|                                                         |       |                   |       |                |       |
| Adjustments  :                                               |       |                   |       |                |       |
| Special  (charges) / credits                                 |       | 6                      |       | 675                 |       |
| Amortization  of intangibles                                 |       | (233                   | )          | (350                | )          |
| Net interest  income                                         |       | 335                    |       | 175                 |       |
| Total  adjustments                                           |       | 108                    |       | 500                 |       |
|                                                         |       |                   |       |                |       |
| Consolidated  income/(loss) before income taxes/(benefit)    |       | $                      | 829        |                | $          | 508 |   |

 

**7.****         Shareholders’Equity**

 
| ** **                                        | ** ** | **Three Months Ended March 31, 2006** | ** ** |
|---------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                        | ** ** | **Amount**                            | ** ** | **Shares** | ** ** |
| ** **                                        | ** ** | **(dollars in thousands)**            | ** ** | ** ** | ** ** |
| Balance at  beginning of period                   |       | $                                     | 84,027     |   | 32,040,091 |   |
| Net income                                        |       | 758                                   |       |   |   |
| Proceeds  upon exercise of stock options and ESPP |       | 1,834                                 |       | 553,756 |   |
| Stock option  expense                             |       | 242                                   |       |   |   |
| Other  comprehensive income                       |       | 93                                    |       |   |   |
|                                              |       | $                                     | 86,954     |   | 32,593,847 |   |

 

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

 

Statement of Financial Accounting Standards No. 130, “ReportingComprehensive Income” (FAS 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 months ended March 31, 2006 and March 31,2005 are as follows:

 
| ** **                                  | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------|------------|------------------------|------------|
| **(dollars in thousands)**                  | ** ** | **March 31,  2006**    | ** ** | **March 31,  2005** | ** ** |
| Comprehensive  income/(loss) :              |       |                   |       |   |   |
|                                        |       |                   |       |   |   |
| Net  income/(loss)                          |       | $                      | 758        |   | $ | 330 |   |
| Foreign  currency adjustment                |       | 93                     |       | (232 | ) |
| Unrealized  gain/(loss) on SERP investments |       | —                 |       | (169 | ) |
| Comprehensive  income/(loss)                |       | $                      | 851        |   | $ | (71 | ) |

 

13

----

 

The accumulated balances related to each component of othercomprehensive income (loss) for the three months ended March 31, 2006 and March31, 2005 were as follows:

 
| **(dollars in thousands)**               | ** ** | **Foreign Currency  Translation** | ** ** | **Unrealized Gain/(Loss)  on Investments** | ** ** | **Accumulated Other  Comprehensive Loss** | ** ** |
|------------------------------------------|------------|-----------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------|------------|
| Balance at  December 31, 2005       |       | $                                 | (643       | )                                               | $          | —                                    |       | $ | (643 | ) |
| Accumulated  comprehensive income/(loss) |       | 93                                |       | —                                          |       | 93                                        |       |
| Balance at  March 31, 2006               |       | $                                 | (550       | )                                               | —     |                                      | $          | (550 | ) |
|                                     |       |                              |       |                                            |       |                                      |       |
| Balance at  December 31, 2004       |       | $                                 | (936       | )                                               | $          | (1,264                                    | )          | $ | (2,200 | ) |
| Accumulated  comprehensive income/(loss) |       | (232                              | )          | (169                                            | )          | (401                                      | )          |
| Balance at  March 31, 2005               |       | $                                 | (1,168     | )                                               | (1,433     | )                                         | $          | (2,601 | ) |

 

**9.****     Purchaseof 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.  The Company did not repurchaseshares of its common stock during the three months ended March 31, 2006 andMarch 31, 2005, respectively. As of March 31, 2006, the remaining authorizationfor repurchase is approximately 93,000 shares.

 

**10.****  Asset-BasedLending Facility**

 

The Company has a $40 million line of credit facility with availabilitybased primarily on eligible client receivables. Since November 4, 2005,the interest rate has been calculated using the lesser of: Prime or LIBOR plus2.5% based on unpaid principal. The minimum borrowing base threshold has beeneliminated as of November 4, 2005. As of December 31, 2005, theCompany had no outstanding loan balance against the facility. Based on theCompany’s eligible client receivables and cash balances, $8.5 million was availablefor borrowing as of March 31, 2006. The fee for the unused portion of the lineof credit is 0.375% per annum based on $20 million, charged to the Companymonthly. This charge, including other associated fees, was approximately$29,000 and $27,000 for the three months ended March 31, 2006 and 2005,respectively. This line of credit includes covenants relating to themaintenance of cash balances and providing for limitations on incurringobligations of operating leases exceeding $9 million annually and spendinglimits on capital expenditures exceeding $8 million annually. As of March 31,2006, the Company was in compliance with the covenants. This credit facilitywill remain in effect until July 2006 and the Company is currently indiscussions to extend the facility.

 

**11.****  IncomeTaxes**

 

The Company has recorded its March 31, 2006 first quarter tax provisionusing the actual effective tax rate. The Company has determined that thismethod will yield a more reliable tax provision calculation due to the inclusionof the valuation allowance created during the prior year (see note below). Thisis a change from the prior year method as the Company was able to determine anannual effective tax rate during the year ended December 31, 2005. Accordingly,the Company is not in a position to disclose its projected December 31, 2006annual effective tax rate but will update the actual 2006 quarterly effectivetax rate in the subsequent reporting periods.

 

For the first quarter ended March 31, 2006, the Company calculated itsactual effective tax rate to be 8.6%. For the quarter ended March 31, 2005, theCompany calculated its annual effective tax to be 35%.

 

*Deferred Tax Asset and Valuation Allowance*

 

The Company records deferred tax assets for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and their respective tax bases, and operating losscarryforwards. Deferred tax assets are reduced by a valuation allowance if,based on available evidence, it is more likely than not that some portion orall of the deferred tax assets will not be realized. In assessing therealizability of deferred tax assets, management considers the scheduledreversal periods of the deferred tax assets, whether sustained profitabilityhas been achieved and tax planning strategies.

 

The Company has significant deferred tax assets resulting from netoperating loss carryforwards, capital loss carryforwards, and deductibletemporary differences that may reduce taxable income in future periods. TheCompany has provided full valuation allowances on the future tax benefitsrelated to capital losses, foreign net operating losses, and all state netoperating losses. The Company believes that the valuation allowance isappropriate because these deferred tax assets have relatively shortcarryforward periods or relate to taxing jurisdictions which do not allow thefiling of consolidated tax returns. The Company expects to continue to

 

14

----

 

maintain a valuation allowance on these deferred tax assets until anappropriate level of profitability has been achieved in the applicable taxingjurisdictions, or strategies are developed that would enable the Company toconclude that it is more likely than not that a portion of these deferred taxassets will be realized.

 

In prior years, management relied primarily on future projected incomein assessing the realizability of deferred tax assets resulting from federalnet operating loss carryforwards and other deductible temporary differences. Asof December 31, 2005 and March 31, 2006, it was determined that because ofcontinued losses through the fourth quarter of the prior year, it was no longerappropriate to rely on future projected income until sustained profitabilityhas been achieved. Accordingly, the Company recorded a full valuation allowanceon its remaining net deferred tax assets for the year end and quarter end,respectively.

 

**12.****  LegalMatters**

 

The Company is involved in various and routine litigation matters,which arise through the normal course of business. Management believes that theresolution of these matters will not have a material adverse effect on theCompany’s financial position or results of operations.

 

**13.****  Terminationof Proposed Merger**

 

As previously reported, in April, 2005, the Company, JV Merger Corp., aMinnesota corporation and a wholly-owned subsidiary of the Company (the “Sub”),and Analysts, entered into an Agreement and Plan of Merger (the “MergerAgreement”), pursuant to which, among other things, subject to satisfaction orwaiver of applicable conditions, Sub would have been merged with and intoAnalysts (the “Merger”) and each issued and outstanding share of common stock,par value $.10 per share, of Analysts (other than shares held of record by theCompany, Sub, Analysts and any of their subsidiaries) would have been convertedinto the right to receive 1.15 fully paid and non-assessable shares of theCompany’s common stock, par value $.10 per share (the “Merger Consideration”).Completion of the Merger was subject to several conditions, including approvalby the shareholders of each company and, on September 2, 2005, the Companyheld a Special Meeting of its Shareholders for the purpose of voting on theproposals related to the proposed merger. The Company’s shareholders voted notto approve the proposals related to the proposed merger and, as such, theproposed merger was not consummated. Due to the failure of the condition ofshareholder approval, the Merger Agreement was terminated subsequent to theSpecial Meeting of Shareholders.

 

**14.****  Changeof Control and other Special Charges and Contingency Payments**

 

In the fourth quarter of 2005, the Company recorded a charge ofapproximately $13.2 million related to the change of control resulting from theremoval of the Company’s then existing Board of Directors. The $13.2 millioncharge is comprised of the following:

 

•  $9.7million charge for change of control payments resulting from provisions definedin the Company’s supplemental executive retirement plan (SERP);

 

•  $3.5million charge pertaining to employment agreements which contain change ofcontrol provisions requiring payments of specified amounts;

 

For fiscal year 2005, the Company recorded special charges/(credits) of$5.7 million primarily pertaining to expenses associated with two proxycontests (including approximately $0.5 million paid to reimburseparticipants in the proxy contest for costs incurred therein) andmerger-related charges pertaining to the proposed merger with AnalystsInternational Corp., which was not approved by the Company’s shareholders atthe September 2, 2005 special meeting.

 

*Vesting of Stock Options*

 

Under the Company’s various equity incentive plans, as a result of theOctober 2005 change of control as defined in each plan, approximately 704,000of outstanding unvested stock options vested and became immediatelyexercisable.

 

Pursuant to the terms of the Company’s acquisition of RGII, the sellerof RGII may be entitled to contingent payments based on RGII’s performanceagainst profitability objectives over three years ending June 30, 2006.The contingent payments are evidenced by a contingent note with a face value of$10 million that is payable over three years only if certain financialperformance objectives are met. These financial performance objectives arebased on earnings before interest and taxes (“EBIT”) targets totaling $19.8million over a three-year period. The $10 million contingent note iscollateralized by the assets of RGII. There are no minimum or maximum paymentobligations under the terms of the contingent note. The contingent payment willbe reduced on a dollar for dollar basis for financial performance below EBITtargets and increased by 29 cents ($0.29) for each dollar exceeding EBITtargets. In February 2004, a payment was made for the first six-monthinstallment of approximately $631,000, pertaining to this contingent note. InFebruary 2005, a payment of approximately $1.8 million was maderepresenting the second installment of the contingent note. EBIT targetswere not achieved for the third installment of the note for the period endingDecember 31, 2005 and no contingent payment is due. If EBIT targets arenot met at the expiration of the contingent earnout period (June 30, 2006),significant amounts previously paid are to be repayable to the Company.

 

**15. Restructuring Charges**

 

During 2005, inconnection with the reorganization of the Commercial Services Division, theCompany recorded restructuring charges of approximately $2.2 million, comprisedof $1.2 million in severance costs and $1.0 million pertaining to theclosing/consolidation of office space in the United States. The leaseobligation is calculated based on current rent commitments, less a estimatedsublease amount.

 

15

----

 
| ** **           | ** ** | **Remaining at  December 31, 2005**  | ** ** | **Paid** | ** ** | **Remaining at  March 31, 2006** | ** ** |
|----------------------|------------|--------------------------------------|------------|----------|------------|-------------------------------------------------|------------|
| ** **           | ** ** | **(dollars in thousands)** | ** ** |
| Severance:           |       |                                 |       |     |       |                                            |       |
| Canada               |       | $                                    | 401        |     | $          | (299                                            | )          | $ | 102 |   |
| United States        |       | 9                                    |       | (9       | )     | 0                                               |       |
| Total  Severance     |       | $                                    | 410        |     | $          | (308                                            | )          | $ | 102 |   |
| Lease  Obligations : |       |                                 |       |     |       |                                            |       |
| United States        |       | $                                    | 530        |     | $          | (250                                            | )          | $ | 280 |   |
| Total                |       | $                                    | 940        |     | $          | (558                                            | )          | $ | 382 |   |

 

During 2004, in connection with the Company’s business modelrealignment, the Company recorded a restructuring charge of approximately $2.9million comprised of approximately $2.8 million in severance costs and $0.1million in lease obligation costs. The lease obligation of $110,000 iscalculated based on current rent commitments less a calculated sublease amountbased on current market conditions.

 
| ** **               | ** ** | **Remaining at  December 31, 2005** | ** ** | **Paid**   | ** ** | **Remaining at  March 31, 2006** | ** ** |
|--------------------------|------------|----------------------------------------------------|------------|------------|------------|-------------------------------------------------|------------|
| ** **               | ** ** | **(dollars in thousands)**               | ** ** | ** ** | ** ** | ** **                                      | ** ** |
| Severance:               |       |                                               |       |       |       |                                            |       |
| United States            |       | $                                                  | 107        |       | $          | (27                                             | )          | $ | 80 |   |
| Canada                   |       | 383                                                |       | 0          |       | 383                                             |       |
| Total  Severance         |       | $                                                  | 490        |       | $          | (27                                             | )          | $ | 463 |   |
| Lease Obligations:       |       |                                               |       |       |       |                                            |       |
| United States            |       | $                                                  | 12         |       | $          | (12                                             | )          | $ | 0 |   |
| United Kingdom           |       | 85                                                 |       | (6         | )          | 79                                              |       |
| Canada                   |       | 141                                                |       | (37        | )          | 104                                             |       |
| Total Lease  Obligations |       | $                                                  | 238        |       | $          | (55                                             | )          | $ | 183 |   |
|                     |       |                                               |       |       |       |                                            |       |
| Total                    |       | $                                                  | 728        |       | $          | (82                                             | )          | $ | 646 |   |

 

During 2003, the Company recorded restructuring charges ofapproximately $3.3 million relating to the closing of several offices in theUnited States, Canada and the United Kingdom, including the related severancecosts. The severance costs approximated $1.5 million and future leaseobligation costs (less a calculated sublease amount), including office closureexpenses, approximated $1.8 million, which were fully paid by December 31,2005.

 

16

----

 

**Item2.**

 

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF**

**FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

For the Periods Ended March 31, 2006 andMarch 31, 2005

 

The following detailed discussion and analysis of the Company’sfinancial condition and results of operations should be read in conjunctionwith the financial statements and related notes included in the Company’s Form10-K for the year ended December 31, 2005, and the financial statements andnotes included elsewhere in this Form 10-Q.

 

**FORWARD-LOOKING STATEMENTS**

This report contains forward-looking statements within the meaning ofthe safe harbor provisions of the Private Securities Litigation Reform Act of1995. In some cases, forward-looking statements can be identified by words suchas “believe,” “expect,” “anticipate,” “plan,” “potential,” “continue” orsimilar expressions. Forward-looking statements also include the assumptionsunderlying or relating to any of the foregoing statements. Such forward-lookingstatements are based upon current expectations and beliefs and are subject to anumber of factors and uncertainties that could cause actual results to differmaterially from those described in the forward-looking statements including,but not limited to, risks associated with unforeseen technical difficulties,the ability to meet customer requirements, market acceptance of serviceofferings, changes in technology and standards, the ability to complete costreduction initiatives, dependencies on certain technologies, delays, marketacceptance and competition, as well as other risks described from time to timein the Company’s filings with the Securities and Exchange Commission, pressreleases and other communications. All forward-looking statements included inthis report are based on information available to the Company on the datehereof. The Company undertakes no obligation (and expressly disclaims any suchobligation) to update forward-looking statements made in this report to reflectevents or circumstances after the date of this report or to update reasons whyactual results would differ from those anticipated in such forward-lookingstatements.

 

**Overview**

 

Computer Horizons Corp. (“CHC”, or the “Company”), founded in 1969,provides professional information technology (IT) services to national and multi-nationalcompanies throughout North America and to the United States government. CHC wasfounded in 1969 and incorporated in 1972 under the laws of the State of NewYork. The Company provides a broad range of IT staffing and project-basedsolution services using a global delivery model that allows the Company toperform work at client sites or at CHC development centers in the U.S.,Montreal, Canada and Chennai, India. Effective January 1, 2005, the Companybegan reporting by its realigned operating segments : Commercial, FederalGovernment and Vendor Management Services (Chimes.).

 

The Company had revenues for the quarter ended March 31, 2006 of $63.6million, a 4.5 percent decrease from the comparable period in 2005.  Netincome before taxes for the first quarter of 2006 totaled $829,000 comparedwith a net income of $508,000 in the comparable period of 2005.  The netgain for the three months ended March 31, 2006, reflects the positive impact ofthe business restructure completed in the fourth quarter of 2005, as well asadditional cost containment in SG&A .

 

Management continues to focus on maintaining a strong balance sheet,with approximately $23 million in cash and cash equivalents (including $9.2million of Chimes vendor cash) at March 31, 2006, along with $53 million inworking capital and no debt outstanding at the end of the quarter.

 

**Recent Developments**

 

*Board Review of Strategic Alternatives*

 

In September of 2005, the Company’s Board of Directors retained theservices of Jefferies Broadview to assist the Company in exploring strategicalternatives to maximize shareholder value. These alternatives include, but arenot limited to, the possible sale of all or parts of the Company. Expressionsof interest have been received from various parties and are currently beingreviewed by the Company.

 

*Termination of Proposed Merger*

 

As previously reported, in April, 2005, the Company, JV Merger Corp., aMinnesota corporation and a wholly-owned subsidiary of the Company (the “Sub”),and Analysts International Corporation, a Minnesota corporation (“Analysts”),entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuantto which, among other things, subject to satisfaction or waiver of applicableconditions, Sub would have been merged with and into Analysts (the “Merger”)and each issued and outstanding share of common stock, par value $.10 pershare, of Analysts (other than shares held of record by the Company, Sub,Analysts and any of their subsidiaries) would have been converted into the rightto receive 1.15 fully paid and non-assessable shares of the Company’s commonstock, par value $.10 per share (the “Merger Consideration”). Completion of theMerger was subject to several conditions, including

 

17

----

 

approval by the shareholders of each company and, on September 2,2005, the Company held a Special Meeting of its Shareholders for the purpose ofvoting on the proposals related to the proposed merger. The Company’sshareholders voted not to approve the proposals related to the proposed mergerand, as such, the proposed merger was not consummated. Due to the failure ofthe condition of shareholder approval, the Merger Agreement was terminatedsubsequent to the Special Meeting of Shareholders.

 

*Special Meeting of Shareholders*

 

On July 22, 2005, a group comprised of Crescendo Partners II, L.P.,Series R, Crescendo Investments II, LLC, Eric Rosenfeld, F. Annette ScottFlorida Trust, Richard L. Scott Florida Trust, Scott Family Florida PartnershipTrust, Richard L. Scott , Stephen T. Braun and The Computer Horizons Full ValueCommittee (collectively, the “Full Value Committee”), filed a Statement onSchedule 13D (the “Schedule 13D”) with the SEC disclosing their opposition tothe Company’s previously announced proposed merger with Analysts and theirintention to solicit the Company’s shareholders to vote against the Company’sproposals in furtherance of the proposed merger. The Schedule 13D furtherdisclosed the Full Value Committee’s intention to call a special meeting of theCompany’s shareholders in order to remove up to all of the Company’s existingdirectors and to replace them with the Full Value Committee’s own slate ofdirector nominees. As previously reported, at the Company’s Special Meeting ofShareholders held on September 2, 2005, the Company’s shareholders votednot to approve the proposals related to the proposed merger and, as such, theproposed merger was not consummated.

 

On July 27, 2005, the Company received from the Full Value Committee arequest that a special meeting of the shareholders of the Company be called forthe following purposes: (i) to remove all of the existing directors serving onthe Company’s board of directors without cause, (ii) to fix the number ofmembers comprising the board at five, and (iii) to elect five director nomineesselected by the Full Value Committee.

 

This second Special Meeting of Shareholders took place on October 11,2005. At the Special Meeting, the Company’s shareholders voted (i) to removeall of the existing directors serving on the Company’s board of directorswithout cause, (ii) to fix the number of members comprising the board at five,and (iii) to elect the five director nominees selected by the Full ValueCommittee, specifically: Messrs. Eric Rosenfeld, Karl L. Meyer, Robert F.Walters, Frank J. Tanki, and Willem van Rijn.

 

Since the Special Meeting, Mr. Eric Rosenfeld has been namednon-executive Chairman of the Company and the Company’s Board of Directorsnamed Dennis J. Conroy, President and Chief Executive Officer, and Brian A.Delle Donne, Executive Vice President and Chief Operating Officer.  Mr.Conroy replaces William J. Murphy as President and Chief Executive Officer.

 

*Change of Control and other Special Charges*

 

In the fourth quarter of 2005, the Company recorded a charge ofapproximately $13.2 million related to the change of control resulting from theremoval of the Company’s then existing Board of Directors. The $13.2 millioncharge is comprised of the following:

 

•       $9.7million charge for change of control payments resulting from provisions definedin the Company’s supplemental executive retirement plan (SERP);

 

•       $3.5million charge pertaining to employment agreements which contain change ofcontrol provisions requiring payments of specified amounts;

 

For fiscal year 2005, the Company recorded special charges/(credits) of$5.7 million primarily pertaining to expenses associated with two proxycontests (including approximately $0.5 million paid to reimburseparticipants in the proxy contest for costs incurred therein) andmerger-related charges pertaining to the proposed merger with AnalystsInternational Corp., which was not approved by the Company’s shareholders atthe September 2, 2005 special meeting.

 

For the year ended December 31, 2004, the Company recorded aspecial credit of $939,000 consisting of an insurance refund. In addition, asof December 31, 2004, the Company determined that goodwill pertaining toCommercial Solutions business unit was impaired and recorded a non-cashimpairment charge of $20.3 million.  The Company also recorded a write-offof assets in 2004 approximating $0.9 million relating to the write-off of asecurity deposit in connection with an escrow agreement of a previously soldsubsidiary and the write-off of fixed assets related to previously closedoffices.

 

*Vesting of Stock Options*

 

Under the Company’s various equity incentive plans, as a result of theOctober 2005 change of control as defined in each plan, approximately 704,000of outstanding unvested stock options vested and became immediatelyexercisable.

 

**Revenue Generating Activities**

 

The majority of the Company’s revenues are derived from professionalservices rendered in the information technology sector. EffectiveJanuary 1, 2005, the Company realigned its business operations into threesegments : Commercial, Federal Government and Vendor Management Services(Chimes).

 

18

----

 

The Commercial business consists of providing technology consultants tolarge organizations on a temporary hire basis and is classified in two generalcategories, staff augmentation and solutions work.  For the quarter endedMarch 31, 2006, this segment represented approximately 72.1% of total revenues,including $31million of staff augmentation revenue and $15 million ofcommercial solutions revenue.

 

For staff augmentation assignments, the consultant work is supervisedand managed by the customer. Staff augmentation tends to be a lower risk, lowergross margin business with very competitive pricing.  The Company’ssolutions work tends to be higher margin, higher risk business, due to the factthat the Company is responsible for project deliverables and other conditionscontained in statements of work and/or contracts with clients.  Virtuallyall projects performed by the commercial solutions group are IT related andconsist of practices such as application development, outsourcing arrangements,government services, technology training and managed services.

 

The Company’s customer relationships are memorialized in masteragreements that address the terms and conditions that define the clientengagement.  Depending on the service to be performed for the client,either a task order (in the case of a Staffing engagement) or a Statement ofWork (“SOW”) (in the case of a Solutions engagement) is generated. The SOW issigned by both the Company and the customer.  In general, no Solutionswork is done unless there is a SOW because the SOW provides the technicaldetails of the work to be done.  The SOW, although falling under thecorresponding master agreement, is a stand-alone binding contractual document,typically outlining the project objectives, describing the personnel who willwork on the project, describing phases of the project, the timeframes for workperformance, and the rate of compensation.  In the event that theparameters of the project expand or otherwise change, a Project Change Requestis implemented to memorialize whatever change has occurred to the deliverables,personnel and/or time and materials.  The master agreements, inconjunction with the SOWs, are written to define, with as much detail aspossible, the client relationship and all aspects of the work to be performedfor the client.  With regard to revenues expected in future periods, eachSOW has a defined term or sets forth the anticipated length of a project. Where a client engagement is on-going, like certain “Help Desk” type services,the master agreements would still have a term length, but would recite that theagreement was renewable.  Generally, commercial solutions engagements arefor a year or less.  Staff augmentation engagements can and do last formore than a year, with variations in the number of consultants being providedat any given time.  Staffing engagements are generally cancelable byclients with a two to four week notice period.

 

The Federal Government segment consists primarily of solutions typeassignments, whereby the Company is responsible for project deliverables andother conditions contained in SOWs and/or contracts with the FederalGovernment.  Federal Government engagements generally have a duration ofseveral years, contingent upon the Federal Government exercising annual optionsto continue work.  For the quarter ended March 31, 2006, the FederalGovernment segment accounted for approximately 16% of consolidated revenues.

 

Chimes, Inc. is a human capital management solution that, throughthe use of proprietary software and processes, manages the temporary workforceof large organizations. For the quarter ended March 31, 2006, Chimes accountedfor approximately 12% of total revenues.

 

**Critical Accounting Policies**

 

The most critical accounting policies used in the preparation of theCompany’s financial statements are related to revenue recognition, theevaluation of the bad debt reserve, the valuation of goodwill, and thevaluation of deferred tax assets.

 

**Revenue Recognition**

 

The Company recognizes revenues either on a time-and-materials basis oron a fixed fee basis.  Under a typical time-and-materials billingarrangement, our customers are billed on a regularly scheduled basis, such asbiweekly or monthly.  At the end of each accounting period, revenue isestimated and accrued for services performed since the last billingcycle.  These unbilled amounts are billed the following month.

 

For fixed fee contracts, revenue is recognized on the basis of theestimated percentage of completion.  Each fixed fee contract has differentterms, milestones and deliverables.  The milestones and deliverables primarilyrelate to the work to be performed and the timing of the billing.  At theend of each reporting period an assessment of revenue recognized on thepercentage of completion and milestones achieved criteria is made.  If itbecomes apparent that estimated cost will be exceeded or required milestones ordeliverables will not have been obtained, an adjustment to revenue and/or costswill be made.  The cumulative effect of revisions in estimated revenuesand costs are recognized in the period in which the facts that give rise to theimpact of any revisions become known.

 

Unbilled accounts receivable represent amounts recognized as revenuebased on services performed in advance of customer billings principally on atime-and-materials basis.  At the end of each accounting period, revenueis accrued for services performed since the last billing cycle.  Forsolutions contracts, unbilled revenues occur when the contractual criteria forbilling are met after

 

19

----

 

the final quarterly billing cycle. These unbilled amounts are billedthe following month.

 

The Company’s Chimes subsidiary recognizes revenue on a transaction feebasis.  The Chimes service offering aggregates the suppliers of temporaryworkers to the customer and renders one invoice to the customer.  Uponpayment from the customer, Chimes deducts a transaction fee and remits thebalance of the client payment to the applicable vendor.  Chimes recognizesonly their fee for the service, not the aggregate billing to thecustomer.  The gross amount of the customer invoicing is not consideredrevenue or a receivable to Chimes because there is no earnings process for thegross amount and by contract terms, Chimes is not obligated to pay the vendoruntil 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 writes off accounts receivable when theybecome uncollectible, and payments subsequently received on such receivablesare credited to the allowance for doubtful accounts.

 

**Goodwill**

 

In June 2001, the FASB approved the issuance of Statement ofFinancial Accounting Standards No. 141 “Business Combinations” (“FAS 141”),and in July 2001, Financial Accounting Standards No. 142 “Goodwilland Other Intangible Assets” (“FAS 142”). The new standards require that allbusiness combinations initiated after June 30, 2001 must be accounted forunder the purchase method. In addition, all intangible assets acquired that areobtained through contractual or legal right, or are capable of being separatelysold, transferred, licensed, rented or exchanged are recognized as an assetapart from goodwill. Goodwill and intangibles with indefinite lives are nolonger subject to amortization, but are subject to at least an annualassessment for impairment by applying a fair value based test.

 

For the years ended December 31, 2003 and 2002 the Companycompleted valuations of the carrying value of goodwill and it determined thatno impairment had occurred. For the year ended December 31, 2004, theCompany reassessed the carrying value of goodwill associated with itsCommercial Solutions Group using an evaluation prepared by an independentappraisal firm. Because of a reduction in projected future cash flows in theCommercial Solutions business unit, primarily resulting from significantrevenue declines in 2004, the Company determined that goodwill was impaired andrecorded a non-cash charge of $20.3 million, related to the write-off of theCommercial Solutions goodwill. There was no income tax effect on the impairmentcharge as the related goodwill was primarily attributable to acquisitions whichyielded no tax basis for the Company. The remaining goodwill of $27.6 million,as of December 31, 2004, is associated with the Company’s FederalGovernment segment.

 

For the year ended December 31, 2005, using an evaluation preparedby an independent appraisal firm, the Company completed an assessment of thefair value and carrying value of its Federal Government segment. As of December 31,2005, the indicated fair value of the Federal Government reporting unitexceeded the carrying value. As a result, the Company concluded that thegoodwill of approximately $27.6 million is not impaired.

 

20

----

 

The changes in the carrying amount of goodwill for the years endedDecember 31, 2005 and 2004, are as follows (in thousands):

 
| **Reporting Units**                  | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Balance as  of January 1,            |       | $                           | 27,625     |                        | $          | 34,218 |   |
| Additions to  goodwill*                   |       | —                      |       | 13,713                      |       |
| Impairment  losses (Commercial Solutions) |       | —                      |       | (20,306                     | )          |
| Balance as  of December 31,          |       | $                           | 27,625     |                        | $          | 27,625 |   |

 

----

*                    Additionsto goodwill in 2004 recorded principally as a result of the acquisition of AIM($11.2 million) by RGII, and the contingent note paid on the EBIT target ofRGII ($1.8 million).

 

As of December 31, 2005 and 2004, the fair value of each of thereporting units was calculated using the following approaches (i) marketapproach and (ii) income approach. The reporting units are equal to, orone level below, reportable segments. Under the market approach, value isestimated by comparing the performance fundamentals relating to similar publiccompanies’ stock prices. Multiples are then developed of the value of thepublicly traded stock to various measures and are then applied to eachreporting unit to estimate the value of its equity. Under the income approach,value was determined using the present value of the projected future cash flowsto be generated by the reporting unit.

 

The fair value conclusion of the reporting units reflects anappropriately weighted value of the market multiple approach and the incomeapproach discussed above. An asset approach was not used because the assetapproach is most relevant for liquidation approaches, investment companyvaluations and asset rich company valuations (i.e. real estate entities) andwas not deemed relevant for manufacturing and service company going-concernvaluations.

 

**Valuation of Deferred Tax Assets**

 

The Company records deferred tax assets for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and their respective tax bases, and operating losscarryforwards. Deferred tax assets are reduced by a valuation allowance if,based on available evidence, it is more likely than not that some portion orall of the deferred tax assets will not be realized. In assessing therealizability of deferred tax assets, management considers the scheduledreversal periods of the deferred tax assets, whether sustained profitabilityhas been achieved and tax planning strategies.

 

The Company has significant deferred tax assets resulting from netoperating loss carryforwards, capital loss carryforwards, and deductibletemporary differences that may reduce taxable income in future periods. TheCompany has provided full valuation allowances on the future tax benefitsrelated to capital losses, foreign net operating losses, and all state netoperating losses. The Company believes that the valuation allowance isappropriate because these deferred tax assets have relatively shortcarryforward periods or relate to taxing jurisdictions which do not allow thefiling of consolidated tax returns. The Company expects to continue to maintaina valuation allowance on these deferred tax assets until an appropriate levelof profitability has been achieved in the applicable taxing jurisdictions, orstrategies are developed that would enable the Company to conclude that it ismore likely than not that a portion of these deferred tax assets will berealized.

 

In prior years, management relied primarily on future projected incomein assessing the realizability of deferred tax assets resulting from federalnet operating loss carryforwards and other deductible temporary differences. Asof December 31, 2005, it was determined that because of continued lossesthrough the fourth quarter of the prior year, it was no longer appropriate torely on future projected income until sustained profitability has been achieved.Accordingly, the Company recorded a full valuation allowance on its remainingnet deferred tax assets for the year end and quarter end, respectively.

 

**Results of Operations**

 

*Revenues*. Consolidated revenues decreased to $63.6 million in the first quarter of 2006from $66.6 million in the first quarter of 2005, a decrease of $3 millionor 4.5%.  Commercial Group revenues decreased to $45.8 million in thefirst quarter of 2006 from $48.7 million in the first quarter of 2005, adecrease of $2.9 million or 6%. The year-over-year decrease in the CommercialGroup revenues for the first quarter of 2006 is primarily attributable to adecrease in average consultant headcount of approximately 14%, along with anincrease  in average bill rates incomparison to the first quarter of 2005.

 

Federal Government Group revenues (comprised of RGII and AIM) decreasedto $10.3 million in the first quarter of 2006 from $11.5 million in the firstquarter of 2005, a net decrease of approximately $1.2 million or 11%.  Theyear-over-year decrease is attributable to the transition of restrictedcontracts, customer/agency budget cuts and delays in funding.

 

Chimes revenues increased to $7.4 million in the first quarter of 2006from $6.4 million in the first quarter of 2005, an increase

 

21

----

 

of $1.0 million, or 16%.  Gross profits increased from $6.1million at March 31, 2005 to $7.3 million at March 31, 2006, an increase of20%.

 

*Direct Costs and Gross Margins*. Direct costs were $42.1 million and $45.6 million in the first quarter of 2006and 2005, respectively.  Gross margin, revenues less direct costs,increased to $21.5 million, or 33.9% in the first quarter of 2006from 31.5% in the same period of 2005.  In the Company’s Commercial Group,gross profit totaled $9.6 million, or 21.0% for the three months ending March31, 2006 compared to $9.5 million, or 19.6% in the comparable prior yearperiod. This increase is primarily attributable to an emphasis on improvedgross profit margins.

 

The Federal Government Group gross margins for the three months endedMarch 31, 2006 were $4.6 million, or 44.9%, compared to $5.4 million, or 46.9%for the comparable period of 2005.  Chimes gross margins totaled$7.3million, or 97.6 % for the three months ended March 31, 2006, compared to$6.1 million, or 95.1% in the same period of 2005.

 

*Costs and Expenses*. Selling, general and administrative expenses were $20.8 million in the firstquarter of 2006, compared to $21.0 million in the comparable period of2005.  As a percentage of revenue, the Company’s SG&A expenseswere 33% in the first quarter of 2006, as compared to 32% in thecomparable period of 2005. The first quarter 2006 increase as a percentage ofrevenue is primarily attributable to the adoption of FAS 123R, including acharge of $242,000 for the 2004 Omnibus Incentive Compensation Plan and $41,000for the Employee Stock Purchase Plan.

 

*Income / (Loss) from Operation*. The Company’s income from operations totaled $494,000 in the first quarter of 2006.This compares to an income from operations of $333,000 in the first quarter of2005, which includes amortization expense totaling $350,000 and a specialcredit of $675,000 related to a bad debt recovery. The composition of theoperating income for the quarter ended March 31, 2006, excluding specialcharges, restructuring charges and amortization expense included a loss of$401,000 in the Commercial Group, income of $617,000 in the Federal GovernmentGroup and income of $505,000 in Chimes.  For the comparable quarter of2005, the Commercial Group had a loss of $1.5 million, the Federal Group had anincome of approximately $880,000 and Chimes had an income of $595,000.

 

*Other Income/(Expense)*. Other income (primarily net interest income) totaled $335,000 in the firstquarter of 2006, compared to $175,000 in the first quarter of 2005.

 

*Provision for Income Taxes*. The Company has recorded its March 31, 2006 first quarter tax provision usingthe actual effective tax rate. The Company has determined that this method willyield a more reliable tax provision calculation due to the inclusion of thevaluation allowance created during the prior year (see note below). This is achange from the prior year method as the Company was able to determine anannual effective tax rate during the year ended December 31, 2005. Accordingly,the Company is not in a position to disclose its projected December 31, 2006annual effective tax rate but will update the actual 2006 quarterly effectivetax rate in the subsequent reporting periods.

 

For the first quarter ended March 31, 2006, the Company calculated itsactual effective tax rate to be 8.6%. For the quarter ended March 31, 2005, theCompany calculated its annual effective tax to be 35%.

 

*Net Income / (Loss)*. The net income for the first quarter of 2006 was $758,000, or $0.02 income perbasic and diluted share, compared to a net income of $330,000, or $0.01 perbasic and diluted share for the first quarter of 2005.

 

22

----

 

**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 March 31, 2006, the Company had approximately$53 million in working capital, of which $22.8 million was cash and cashequivalents. Cash and cash equivalents at March 31, 2006 and December 31,2005 includes approximately $9.2 million and $29.4 million of cash,respectively, to be disbursed to Chimes vendors in accordance with the clientpayment terms. Vendor cash varies quarter to quarter based on the relationshipof the final billing cycle to the end of the quarter, and does not represent achange in the level of operations. At March 31, 2006, the Company had a currentratio position of 2.6 to 1.

 

Net cash used in operating activities in the first three months of 2006was $25.2 million consisting primarily of net income of $758,000 offset by anincrease in net Accounts Receivable of $4.6 million and a decrease in AccountsPayable of $20.8 million.

 

Net accounts receivable increased $4.6 million to $52.6 million atMarch 31, 2006, from $48.1 million at December 31, 2005.  Accountsreceivable days sales outstanding (“DSO”) were 74 days at March 31, 2006, and66 days at December 31, 2005. This increase can be primarily attributableto historical customer payment patterns in the first quarter. DSOs are expectedto return to the year-end 2005 level over the remainder of 2006.  Allclient receivable collectibility and billing issues identified by managementhave been adequately reserved. For the period ended March 31, 2006, there wereno significant changes in credit terms, credit policies or collection efforts.

 

The decrease in Accounts Payable of $20.8 million was primarily due tothe decrease in vendor cash.

 

Net cash used in investing activities in the first three months of 2006was $313,000, consisting primarily of capital expenditures.

 

Net cash provided by financing activities in the first three months of2006 was $1.8 million, 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 client receivables. Since November 4, 2005,the interest rate has been calculated using the lesser of: Prime or LIBOR plus2.5% based on unpaid principal. The minimum borrowing base threshold has beeneliminated as of November 4, 2005. As of December 31, 2005, the Companyhad no outstanding loan balance against the facility. Based on the Company’seligible client receivables and cash balances, $8.5 million was available forborrowing as of March 31, 2006. The fee for the unused portion of the line ofcredit is 0.375% per annum based on $20 million, charged to the Companymonthly. This charge, including other associated fees, was approximately$29,000 and $27,000 for the three months ended March 31, 2006 and 2005,respectively. This line of credit includes covenants relating to themaintenance of cash balances and providing for limitations on incurringobligations of operating leases exceeding $9 million annually and spendinglimits on capital expenditures exceeding $8 million annually. As of March 31,2006, the Company was in compliance with the covenants. This credit facilitywill remain in effect until July 2006 and the Company is currently indiscussions to extend the facility.

 

Pursuant to the terms of the Company’s acquisition of RGII, the sellerof RGII may be entitled to contingent payments based on RGII’s performanceagainst profitability objectives over three years ending June 30, 2006.The contingent payments are evidenced by a contingent note with a face value of$10 million that is payable over three years only if certain financialperformance objectives are met. These financial performance objectives arebased on earnings before interest and taxes (“EBIT”) targets totaling $19.8million over a three-year period. The $10 million contingent note iscollateralized by the assets of RGII. There are no minimum or maximum paymentobligations under the terms of the contingent note. The contingent payment willbe reduced on a dollar for dollar basis for financial performance below EBITtargets and increased by 29 cents ($0.29) for each dollar exceeding EBITtargets. In February 2004, a payment was made for the first six-monthinstallment of approximately $631,000, pertaining to this contingent note. InFebruary 2005, a payment of approximately $1.8 million was made representingthe second installment of the contingent note. EBIT targets were notachieved for the third installment of the note for the period endingDecember 31, 2005 and no contingent payment is due. If EBIT targets arenot met at the expiration of the contingent earnout period (June 30,2006), significant amounts previously paid are to be repayable to the Company.

 

On October 18, 2005, as a consequence of the removal of the Company’sthen existing Board of Directors without cause and the election of the newBoard of Directors, a change of control was deemed to have occurred under theCompany’s SERP. Accordingly, change of control payments totaling $11.9 millionwere paid on October 25, 2005, including $10.4 million to the SERP participantsand $1.5 million to a key executive, pursuant to the terms of the relatedemployment agreement. As of October 25, 2005, the recorded accrual for the SERPpayments approximated $2.2 million, resulting in a charge of approximately $9.7million, which was recorded in the fourth quarter of 2005. In addition, as ofOctober 25, 2005, the Company had unrealized losses on the applicable SERPinvestments totaling $1.2 million. This loss was recognized in the fourthquarter of 2005 as a result of the sale of all SERP

 

23

----

 

investments, which generated sales proceeds of approximately $4.7million.

 

On October 18, 2005, the Company’s Board of Directors appointed a newPresident and CEO for the Company. The former CEO was paid severance in theamount of $895,000, along with his deferred compensation funds, whichapproximated $381,000.

 

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.

 

**Contractual Obligations and CommercialCommitments**

 

The Company does not utilize off balance sheet financing other thanoperating lease arrangements for office premises and related equipment. The following table summarizes all commitments under contractual obligations asof March 31, 2006:

 
| ** **                 | ** ** | **Obligation Due** | ** ** |
|----------------------------|------------|--------------------|------------|
| **(dollars in thousands)** | ** ** | **Total Amount**   | ** ** | **1 Year** | ** ** | **2-3 Years** | ** ** | **4-5 Years** | ** ** | **Over 5 Years** | ** ** |
| Operating  Leases          |       | $                  | 7,815      |   | $ | 4,322 |   | $ | 2,844 |   | $ | 521 |   | $ | 128 |   |
| RGII  Contingent Notes*    |       | 7,596              |       | 7,596 |   |   |   |   |   |   |   |
| Deferred  Compensation     |       | 2,223              |       | 557 |   | 21 |   | 10 |   | 1,635 |   |
| Retention  Bonus           |       | 214                |       | 214 |   |   |   |   |   |   |   |
| Change of  Control         |       | 3,227              |       | 778 |   |   |   |   |   | 2,449 |   |
| Other                      |       | 555                |       | 491 |   | 64 |   |   |   |   |   |
| Total Cash  Obligations    |       | $                  | 21,630     |   | $ | 13,958 |   | $ | 2,929 |   | $ | 531 |   | $ | 4,212 |   |

 

----

* Obligation if applicable EBIT targets are met.

 

**Recent Accounting Pronouncements**

 

In December 2004, theFASB issued Statement of Financial Accounting Standard No. 123 (revised2004), “Share-Based Payment” (FAS 123R). FAS 123R requires thatcompensation cost be recognized for all new awards and awards that aremodified, repurchased or cancelled after the adoption date. The SEC amended theeffective dates of FAS 123R for public companies in April 2005, whichallows registrants to implement FAS 123R at the beginning of their nextfiscal year, instead of the next interim period, that begins afterJune 15, 2005. The SEC also issued Staff Accounting Bulletin 107, “Share-BasedPayment” (SAB 107), in April 2005, which provides the views of the SECstaff regarding certain aspects of the application of FAS 123R.SAB 107 assists issuers in their initial implementation of FAS 123R.The provisions of this statement are effective for the Company’s first quarterending March 31, 2006.

 

FAS 123R allowsfor two alternative transition methods. The first method is the modifiedprospective application whereby compensation cost for the portion of awards forwhich the requisite service has not yet been rendered that are outstanding asof the adoption date will be recognized over the remaining service period. Thecompensation cost for that portion of awards will be based on the grant-datefair value of those awards as calculated for pro forma disclosures underStatement 123, “Accounting for Stock-Based Compensation”, as originallyissued. All new awards and awards that are modified, repurchased or cancelledafter the adoption date will be accounted for under the provisions of FAS123(R). The second method is the modified retrospective application, which requiresthat the Company restates prior period financial statements. The modifiedretrospective application may be applied either to all prior periods or only toprior interim periods in the year of adoption of this statement. The Companyhas elected to apply the modified prospective method.

 

On November 2005, theFASB issued FASB Staff Position No. FAS 123R-3 – “Transition Election Relatedto Accounting for the Tax Effects of Share-Based Payment Awards.”  The Company has elected to adopt thealternative transition method provided in this FASB Staff Position forcalculating the tax effects of share-based compensation pursuant to FAS 123R. Thealternative transition method includes a simplified method to establish thebeginning balance of the additional paid-in capital pool (APIC pool) related tothe tax effects of employee share-based compensation, which is available toabsorb tax deficiencies recognized subsequent to the adoption of FAS 123R.

 

Item 3.    Quantitativeand Qualitative Disclosures about Market Risk

 

The Company does not ordinarily hold market risk sensitive instrumentsfor trading purposes. However, the Company does recognize market risk frominterest rate and foreign currency exchange exposure. The Company has financialinstruments that are subject to interest rate risk. However, at March 31, 2006,the Company was debt-free. Historically, the Company has not experiencedmaterial gains or losses due to interest rate changes. However, a reduction ininterest rates would reduce the interest income received by the Company on thecash it holds for payment to Chimes vendors. The Company’s internationaloperations expose it to translation risk when the local currency financialstatements are translated to US dollars. As currency exchange rates fluctuate,translation of the

 

24

----

 

financial statements of international businesses into US dollars willaffect the comparability of revenues and expenses between years. In addition,the Company bills customers with respect to certain Canadian operations in USdollars but pays Canadian workers in Canadian dollars.

 

Item 4.    Controlsand Procedures

 

###### **DisclosureControls and Procedures**

###### ** **

The Company’s CEO and CFO have evaluated the effectiveness of theCompany’s disclosure controls and procedures (as such term is defined inRules 13a-15(e) under the Securities Exchange Act of 1934, asamended) as of the end of the period covered by this report.  Based uponsuch evaluation, the Company’s Chief Executive Officer and Chief Financial Officerhave concluded that, as of the end of the period, the Company’s disclosurecontrols and procedures are effective in recording, processing, summarizing andreporting, on a timely basis, information required to be disclosed by theCompany in the reports that it files or submits under the Securities ExchangeAct of 1934, as amended.

 

###### **InternalControls over Financial Reporting**

###### ** **

There have not been any changes in the Company’s internal controls overfinancial reporting (as such term is defined in Rules 13a-15(f) and15d-15e under the Securities Exchange Act of 1934, as amended) during theperiod to which this report relates that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting. A control system, no matter how well conceived andoperated, can provide only reasonable, not absolute, assurance that theobjectives of the control system are met. Because of the inherent limitationsin all control systems, no evaluation of controls can provide absoluteassurance that all control issues and instances of fraud, if any, within acompany have been detected.

 

25

----

 

PART II -Other Information

 

Item 6.    Exhibits

 
| Exhibits |
|----------|
|     |
| 31.1     | – | CEO Certification required by Rule 13a-15(e)/15d-15(e) under the  Securities Exchange Act of 1934. |
|     |   |   |
| 31.2     | – | CFO Certification required by Rule 13a-15(e)/15d-15(e) under the  Securities Exchange Act of 1934. |
|     |   |   |
| 32.1     | – | CEO Certification pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|     |   |   |
| 32.2     | – | CFO Certification pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

26

----

 

Signatures

 

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

 

 
|   | COMPUTER HORIZONS CORP.          |
|--------|----------------------------------|
|   | (Registrant)                     |
|   |                             |
|   |                             |
| DATE:  | MAY 10, 2006                     |   | /s/  Dennis Conroy |
|   | Dennis Conroy, President and CEO |
|   | (Principal Executive Officer)    |
|   |                             |
|   |                             |
| DATE:  | MAY 10, 2006                     |   | /s/ Barbara Moss |
|   | Barbara Moss,                    |
|   | Chief Financial Officer          |
|   | (Principal Financial Officer)    |
|   |                             |
|   |                             |
| DATE:  | MAY 10, 2006                     |   | /s/ Marci Braunstein |
|   | Marci Braunstein,                |
|   | Corporate Controller             |
|   | (Principal Accounting Officer)   |
|        |                                  |  |  |  |  |

 

 

27

----