Washington, D.C.  20549

 

FORM 10-K

(Mark One)

 

 

Commission file number 0-7282

 

 

 

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

 

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

 

The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2003 was approximately $142,000,000.

 

The number of shares outstanding of each of the registrant’s classes of common stock as of March 10, 2004 were 30,551,552 shares.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

 

PART I

 

Item 1.  Business

 

General

 

Computer Horizons Corp., or CHC, or the Company, is a strategic solutions and human capital management company with more than thirty-six years of experience, specifically in information technology.  The Company provides its services to multi-national companies through its “bestshore” delivery centers located globally, and enabling its Fortune 2000 customer base to maximize technology investments.  With the acquisition of RGII Technologies, Inc., in July 2003, CHC has expanded its government practice to include the Federal government sector, in addition to various other vertical markets it serves, such as healthcare, insurance and financial services.  CHC’s wholly owned subsidiary, Chimes, uses its proprietary technology to enable its Global 2000 (which, Forbes magazine defines as the biggest and most important companies as measured by sales, profits, assets and market value), customer base to align and integrate business planning with human resource management across an enterprise’s business functions.

The Company markets solutions to existing and potential clients with the objective of becoming a preferred provider of comprehensive information technology services and solutions for such clients.  The Company believes that the range of services and solutions that it offers, combined with its proprietary Chimes technology, provides it with competitive advantages in the information technology marketplace.

The Company’s clients are primarily Global 2000 companies with significant information technology budgets and recurring staffing needs.  In 2003, the Company provided information technology services to 967 clients.  During 2003, the Company’s largest client accounted for 7% of the Company’s consolidated revenues.  The Company offers its clients a broad range of business and technical services as an outsourcer and systems integrator capable of providing complex total solutions.  This total solutions approach comprises proprietary software and tools, proven processes and methodologies, tested project management practices and resource management and procurement programs.

The Company offers global technology services and solutions, which are divided into three divisions; (1) Solutions, (2) IT Services and (3) Chimes.

 

 

(1) Solutions:  CHC Solutions Group (including RGII Technologies Inc., CHC Healthcare Solutions and CHC’s training/education practice) is an e-Business Solutions provider, enabling enterprises and Federal, State and Local government agencies to build business-critical and highly scalable solutions.  The Solutions Group, comprised of approximately 800 IT professionals, offers a comprehensive list of integrated solutions including e-business strategy and assessment; HIPAA compliance; on shore, near-shore and offshore outsourcing;  enterprise network management; web architecture design; hosting and integration; application development; customer relationship management (CRM); project management; systems integration; networking services and education/training.  In addition, in September 2003, the Company acquired the Xpress^TM  software suite which, along with related implementation services, enables manufacturers to become UCCnet compliant whereby product identification data is synchronized and standardized with retailers.  For projects in the Solutions’ division, CHC is responsible for the project management and supervision.  Generally, the gross margins in this division are higher than that of the IT Services division.  Revenues in the Solutions Group are recognized as services are performed under either time-and-material or a fixed fee basis.  However, adjustments are made if necessary to reflect progress against milestones or deliverables.

(1a) RGII Technologies, Inc. (RGII): In July 2003, the Company acquired RGII, a solutions provider of high-end technology and program management to Federal, State and Local government agencies.  RGII offers services and solutions in such areas as: enterprise management, network infrastructure, information assurance and security, web development and integration, call management, engineering technology and technical services.

(1b) Outsourcing:  Spurred by global competition and rapid technological change, large companies, in particular, are downsizing and outsourcing for reasons such as cost reduction, capital asset improvement, improved technology and better strategic focus.  In response to this trend, the Company has

 

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created a group of outsourcing centers onshore, near-shore in Montreal and offshore in Chennai, India with 24 hour / 7 day a week support, which are fully equipped with the latest technology and communications, as well as a complete staff that includes experienced project managers, technicians and operators.  These professionals facilitate essential data functions including:  applications development, systems maintenance, data network management, voice network administration and help desk operations.

(1c) CHC Healthcare Solutions, LLC:  CHC Healthcare Solutions was formed in 2002, as a consortium of Computer Horizons Corp. and a healthcare consulting firm, ZA Consulting, LLC. CHC Healthcare Solutions, reported under CHC Solutions, offers operational, compliance and technology services and solutions to the healthcare industry.

(1d) Education/Training:  The Company’s education division offers custom-designed and/or existing training programs to enhance the competencies of client staff in specific technologies, languages, methodologies and applications.  The prevailing focus of the Company is to assist clients through instructor-led, on-site training and consulting in the transitioning IT organization of Global 2000 corporations nationwide.   To support these changing technologies, the Company has developed extensive curriculum offerings in Web Technologies, Relational Databases, Programming Languages, Reporting Tools, Process Improvement, UNIX, Client/Server and Mainframe Technologies.

(1e) Software Products:  Princeton Softech, Inc. a wholly-owned subsidiary of the Company which was sold March 25, 2002, was a software products company that delivered leveraging technologies for enterprise-scale solutions.

 

(2) IT Services:  CHC’s IT Services Group provides highly skilled software professionals to augment the internal information management staffs of major corporations.  The Company offers its clients a just-in-time solution to supply their staffing needs from among the Company’s approximately 1,400 IT professionals.  Customers are serviced through the Company’s branch network of offices in the United States and Canada, and virtually through Chimes.  The customer is responsible for managing and supervising our software professionals. As a result, gross margins in this business area are significantly less than Solutions services.  Revenue for the IT Services Group is recognized as services are rendered on a time-and-material basis.  Hourly and daily rates are determined in advance and agreed to with the customer.  Time worked is documented in various forms using the applicable timekeeping process (i.e. the client’s or the Company’s timekeeping systems).

 

 

(3) Chimes: Chimes, Inc., a wholly-owned subsidiary of CHC, provides workforce procurement and management services to Global 2000 companies.   Through scalable, web-based software, Chimes administers the hiring cycle to identify, leverage and manage the enterprise-wide spend on human capital.  Chimes’ portfolio of services addresses contingent hiring (CVM), full-time hiring (CAM), program management (RPM) and consolidated time sheet and expense processing (CTE).

 

Personnel

As of December 3l, 2003, the Company had a staff of 2,665, including approximately 2,200 IT professionals.   The Company devotes significant resources to recruitment of qualified professionals and provides continuing in-house training and education, and a career path management development program within the Company.

 

Competition

The Company competes in the commercial information technology services market which is highly competitive and served by numerous firms, many of which serve only their respective local markets.  The market includes participants in a variety of market segments, including systems consulting and integration firms, professional services companies, application software firms, temporary employment agencies, the professional service groups of computer equipment companies, facilities management and management information systems or MIS outsourcing companies, certain accounting firms, and general management consulting firms.  The Company’s competitors include companies such as Analysts International Corp., CIBER, Inc., Computer Task Group Inc., iGATE Corp. and Covansys Corp.  Many participants in the information technology consulting and

 

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software solutions market have significantly greater financial, technical and marketing resources and generate greater revenues than the Company.  The Company believes that the principal competitive factors in the commercial information technology services industry include responsiveness to client needs, speed of application software development, quality of service, price, project management capability and technical expertise.  Pricing has its greatest importance as a competitive factor in the area of professional service staffing.  The Company believes that its ability to compete also depends in part on a number of competitive factors outside its control, including the ability of its competitors to hire, retain and motivate skilled technical and management personnel, the ownership by competitors of software used by potential clients, the price at which others offer comparable services and the extent of its competitors’ responsiveness to customer needs.

 

Available Information

The Company’s internet website address is www.computerhorizons.com.  The Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available free of charge through our website as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission.

 

Risk Factors

 

The Company’s revenues have declined and the operating loss has increased because demand for IT Services has weakened significantly, and may continue to weaken, in the industries and markets that CHC serves.

 

The Company’s revenues are affected by the level of business activity of its customers, and the related demand for IT Services to support these customer activities.  As a result of weakened demand for the Company’s IT Services, revenues and results of operations have been negatively impacted.  For the year ended December 31, 2003 and 2002, IT Services revenue decreased to $133.1 million from $201.3 million, respectively, a decrease of $68.2 million, or 33.9%.  For the years ended December 31, 2003 and 2002, IT Services operating loss increased to $4.1 million from $2.2 million, respectively, an increase of $1.9 million, or 86.4%.  CHC cannot predict when customer demand will significantly improve, and to what extent demand for the Company’s IT Services will improve.

 

The current trend of companies moving technology jobs and projects offshore has caused and could continue to cause revenues to decline.

 

In the past few years, more companies are using or are considering using low cost offshore outsourcing centers, particularly in India, to perform technology related work and projects.  This trend has contributed to the decline in domestic IT staff augmentation revenue as well as on-site solutions oriented projects.  The Company now has its own outsourcing centers in India and Canada to compete for this business, but this new business has not been sufficient to offset the revenue decline.  Additionally, the equivalent amount of work in low cost centers will generate substantially less revenue due to the lower billing rates that are charged in these offshore outsourcing centers.

 

The Company’s operating results have varied, and are likely to continue to vary significantly.  This may result in volatility in the market price of our common stock.

 

The Company’s revenues and operating results have varied in the past and are likely to vary significantly from year to year.  This may lead to volatility in the share price.  Some other factors that may cause the market price of the common stock to fluctuate substantially, include:

• the failure to be awarded a significant project on which the Company has bid;

 

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• the termination by a client of a material project or the decision by a client not to proceed to the stage of a project anticipated by the Company;

• announcement of new services by CHC or the competitors;

• announcement of acquisitions or other significant transactions by CHC or the competitors;

• changes in or failure to meet earnings estimates by securities analysts;

• sales of common stock by CHC or the existing stockholders or the perception that such sales may occur;

• adverse judgments or settlements obligating CHC to pay liabilities;

• changes in management; and

• general economic conditions and overall stock market volatility.

 

The failure to be successful in retaining existing and future highly-skilled technical personnel and attracting a sufficient number of IT professionals and project managers could adversely affect the Company’s business.

 

The Company’s business is labor intensive and depends to a large extent on its ability to attract, train, motivate and retain highly-skilled IT professionals and project managers.  The Company’s ability to win and retain new business is significantly affected by client relationships and the quality of service rendered.  The loss of key IT professionals and project managers may jeopardize existing client relationships with businesses that continue to use the Company’s services based upon past relationships with key IT professionals and project managers.

 

The Company derives a significant portion of its revenues from a limited number of large clients and the loss of any large client could have an adverse effect on its business.

 

The Company has derived, and it believes will continue to derive, a significant portion of its revenues from a limited number of large clients.  For the years ended December 31, 2003, 2002 and 2001, the Company’s ten largest clients accounted for approximately 38%, 38% and 30% of its revenues, respectively.  The loss of any large client could have an adverse effect on the Company’s business, results of operations and financial condition.  Prior to the acquisition of RGII by the Company, approximately 52% of RGII’s revenues were derived from restricted contracts (minority based contracts, etc.)  These contracts may be terminated pursuant to the Federal government’s rights under the Federal Acquisition Regulations (“FAR”).  In addition, as a result of RGII’s acquisition by the Company, RGII will not be eligible to compete for these types of contracts in the future and will have to replace this revenue stream with new contracts.  If these contracts are terminated or the Company is not able to enter new contracts on acceptable terms, the Company’s business could be adversely affected.

 

Changes in federal government programs and requirements, or budgetary changes affecting federal government spending in Company specific agencies, or changes in fiscal policies or available funding, may adversely affect the Company’s results of operations.

 

The Company acquired RGII Technologies, Inc. in July 2003.  RGII receives substantially all its revenue from the Federal government.  For the year ended December 31, 2003, the Company received approximately 7% of its total revenue from RGII.  Significant changes in RGII’s revenues may adversely affect the Company’s results of operations.

 

Projects performed by RGII are subject to Defense Contract Audit Agency audits and compliance with government cost accounting standards.  The results of such audits may result in adjustments to RGII’s reported financial results.

 

RGII has cost reimbursable type contracts with the U.S. Government.  Consequently, RGII is reimbursed based upon direct expenses attributable to the contract plus a percentage based upon indirect expenses.  The indirect rates are estimated.  Accordingly, if the actual rates as determined by the Defense Contract Audit Agency (“DCAA”) are below the estimated rates, a refund for the difference will be due to the U.S. Government.  A significant refund due to the U.S. Government may adversely affect the Company’s results

 

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of operations.  DCAA has completed their incurred cost audits for all fiscal years through December 31, 2001.

 

The Company faces competition from a number of existing competitors, as well as potential new competitors, which could result in loss of market share and adversely affect business.

 

The markets for CHC services are highly competitive.  The Company competes with large providers of IT staffing services including Cap Gemini and MPS Group, Inc.  In addition, it competes for staffing projects with the information systems groups of prospective clients.  In the Solutions business, the Company competes with consulting and system integration firms, including Analysts International Corporation, Accenture, Bearingpoint, CIBER, Inc., Computer Sciences Corporation, Computer Task Group, Electronic Data Systems Corp., IBM Corp. and Keane, Inc.  The Company also competes in the IT solutions market with vendors of application software.  There are relatively low barriers to entry in the markets the Company competes in and it has faced and expects to continue to face, additional competition from other established and emerging companies.  Increased competition may result in greater pricing pressure which could have an adverse effect on the Company’s business, results of operations and financial condition.  Many of the Company’s current and potential competitors have significantly greater financial, technical, marketing and other resources than CHC. As a result, they may be able to respond more quickly to new or emerging technologies and changes in clients’ requirements, or to devote greater resources to the development, promotion, sale and support of their services and products.  In addition, current and potential competitors may establish cooperative relationships among themselves or with third parties to increase the ability of their services or products to address the staffing and solution needs of prospective clients.  Accordingly, it is possible that new competitors, alliances among competitors or alliances between competitors and third parties may emerge and acquire significant market share.  If this were to occur, it could have an adverse effect on the Company’s business, results of operations and financial condition.

 

The introduction of competitive IT solutions embodying new technologies and the emergence of new industry standards may render the Company’s existing IT solutions or underlying technologies obsolete or unmarketable which could have an adverse effect on its business.

 

The IT solutions industry is characterized by rapid technological change, changing client requirements and new service and product introductions.  The introduction of competitive IT solutions embodying new technologies and the emergence of new industry standards may render the Company’s existing IT solutions or underlying technologies obsolete or unmarketable.  As a result, it is dependent in large part upon its ability to develop new IT solutions that address the increasingly sophisticated needs of its clients, keep pace with new competitive service and product offerings and emerging industry standards and achieve broad market acceptance.  The business will be adversely affected if CHC is not successful in developing and marketing new IT solutions that respond to technological change, changing client requirements or evolving industry standards.

 

Some of the Company’s services are offered on a fixed-price basis.  The failure to estimate accurately the resources and time required for a project or failure to complete our contractual obligations within the time frame committed could have an adverse effect on the Company’s business.

 

The Company offers some of its services on a fixed-price rather than on a time-and-materials or best efforts basis.  Under the terms of these contracts the Company bears the risk of cost overruns and inflation in connection with these projects.  In the event the Company fails to estimate accurately the resources and time required for a project or fails to complete its contractual obligations within the time frame committed, the Company’s business, operating results and financial condition could be adversely affected.

 

6

 

The Company’s strategy includes the pursuit of strategic acquisitions which present many risks and may have an adverse effect on its business in the event the financial and strategic goals that were contemplated at the time of the transaction are not realized.

 

As part of its strategy, the Company pursues strategic acquisitions.  On July 8, 2003, CHC purchased all of the capital stock of RGII Technologies, Inc., a federal IT services company.  Some of the risks faced in completing acquisitions similar to the RGII transaction are:

• difficulties integrating new operations, technology and personnel into operations;

• loss of significant clients acquired;

• loss of key management and technical personnel acquired;

• assumption of unanticipated legal or other financial liabilities;

• unanticipated operating, accounting or management difficulties in connection with the acquired entities; and

• diversion of management attention from other business concerns.

These difficulties could disrupt ongoing business and increase expenses.  Any acquisition, depending on its size, could result in the use of a significant portion of cash, or if the acquisition is made utilizing securities, could result in significant dilution to shareholders.  Furthermore, there can be no assurance that any acquired service capacity or technology will gain acceptance in the market.  Each of these results could adversely affect the Company’s business, results of operations, financial condition and the price of common stock.

 

The Company’s international operations subject it to additional risks that can adversely affect operating results.

 

CHC’s international operations, which comprised 10.5% of consolidated revenues for the year ended December 31, 2003, depend greatly upon business, immigration and technology transfer laws in those countries and upon the continued development of technology infrastructure.  As a result, the Company’s business is subject to the risks generally associated with non-U.S. operations including:

• unexpected changes in regulatory environments;

• the costs and difficulties relating to geographically diverse operations;

• differences in, and uncertainties arising from changes in, foreign business culture and practices;

• fluctuations in currency exchange rates;

• restrictions on the movement of cash;

• longer accounts receivable payment cycles and greater difficulties in collecting accounts receivable;

• potential foreign tax consequences, including the impact of repatriation of earnings, tariffs and other trade barriers; and

• political unrest and changing conditions in countries in which our services are provided or facilities are located.

If any of these factors were to render the conduct of business in a particular country undesirable or impracticable, there could be an adverse effect on the Company’s business, operating results and financial condition.

 

If CHC fails to protect its intellectual property rights, competitors may be able to use its technology and this could weaken its competitive position, reduce revenue and increase costs.

 

CHC relies primarily upon a combination of copyright and trademark laws, trade secrets, confidentiality procedures and contractual arrangements to protect proprietary rights.  The steps taken to protect proprietary rights may not prevent misappropriation of CHC’s proprietary rights, particularly in foreign countries where laws or law enforcement practices may not protect proprietary rights as fully as in the United States.  If third parties were to use or otherwise misappropriate CHC’s copyrighted materials, trademarks or other proprietary rights without consent or approval, CHC’s competitive position could be harmed, or it could become involved in litigation to enforce its rights.

 

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Third parties could assert that the Company’s services infringe their intellectual property rights, which if successful, could harm the Company’s business.

 

Third parties may assert trademark, copyright, patent and other types of infringement or unfair competition claims against the Company.  If CHC is forced to defend against any such claims, whether they are with or without merit or are determined in its favor, the Company may face costly litigation, loss of access to, and use of software and diversion of technical and management personnel.  As a result of such dispute, CHC may have to develop non-infringing technology or enter into royalty or licensing arrangements.  Such royalty or licensing agreements, if required, may be unavailable on terms acceptable to CHC, or at all.  If there is a successful claim of infringement against the Company and it is unable to develop non-infringing technology or license the infringed or similar technology on a timely basis, it could harm CHC’s business.

 

In the event of a failure in a client’s computer system, a claim for substantial damages may be made against the Company regardless of its responsibility for the failure, which if successful, could adversely affect the Company’s business.

 

Much of the Company’s business involves projects that are critical to the operations of its clients’ businesses and provide benefits that may be difficult to quantify.  Any failure in a client’s system could result in a claim for substantial damages against CHC, regardless of its responsibility for such failure.  Limitations of liability set forth in service contracts may not be enforceable in all instances and may not otherwise protect the Company from liability for damages.  CHC maintains general liability insurance, including coverage for errors and omissions, however, CHC may not be able to avoid significant claims and attendant publicity. Furthermore, there can be no assurance that the insurance coverage will be adequate or that coverage will remain available at acceptable costs.  Successful claims brought against the Company in excess of its insurance coverage could have an adverse effect on business, operating results and financial condition.

 

As a provider of staffing services, there are risks associated with placing employees (and independent contractors) at clients’ businesses, which could result in costly and time-consuming litigation.

 

CHC could be subject to liability if any of the following risks associated with placing its employees (and independent contractors) at clients’ businesses occurs:

• possible claims of discrimination and harassment;

• liabilities for errors and omissions by CHC’s employees (and independent contractors);

• misuse of client proprietary information or intellectual property;

• injury to client employees;

• misappropriation of client property;

• other criminal activity; and

• torts and other similar claims.

Any claims made against CHC could result in costly and time-consuming litigation.  In addition, under some circumstances, the Company may be held responsible for the actions of persons not under its direct control.

 

The Company has adopted anti-takeover defenses that could make it difficult for another company to acquire control of the Company or limit the price investors might be willing to pay for its stock.

 

Certain provisions of the Company’s Certificate of Incorporation and Bylaws could make a merger or tender offer involving CHC more difficult, even if such events would be beneficial to the interests of the stockholders. These provisions include adoption of a Preferred Shares Rights Agreement, commonly known as a “poison pill” and giving the Board the ability to issue preferred stock and determine the rights and designations of the preferred stock at any time without stockholder approval.  The rights of the holders of CHC’s common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future.  The issuance of preferred stock, while providing flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it

 

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more difficult for a third party to acquire, or of discouraging a third party from acquiring, a majority of CHC’s outstanding voting stock.  The above factors and certain provisions of the New York Business Corporation Law may have the effect of deterring hostile takeovers or otherwise delaying or preventing changes in the control or management of the Company, including transactions in which the stockholders might otherwise receive a premium over the fair market value of CHC common stock.

 

Item 2.   Properties

The Company’s Corporate and Financial Headquarters, as well as its Eastern Regional Office, comprising approximately 63,000 square feet, are located at 49 Old Bloomfield Avenue, Mountain Lakes, New Jersey.  The Mountain Lakes lease is for a term expiring December 31, 2005, at a current annual rental of approximately $1,400,000.  As of December 3l, 2003, the Company also maintained operating facilities, which are shared between the IT Services and Solutions Group business segments, in California, Connecticut, Florida, Georgia, Illinois, Indiana, Maryland, Michigan, Minnesota, New Jersey, New York, Ohio, Oklahoma, Tennessee, Texas, Virginia and Washington as well as international operations located in India and Canada, with an aggregate of approximately 281,000 square feet.  Chimes maintains facilities in California, Illinois, Michigan, Minnesota and New Jersey.  The leases for all of these facilities are at a current annual aggregate rental of approximately $3,665,000.  These leases expire at various times with no lease commitment longer than April 30, 2008.

 

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Item 3.  Legal Proceedings

 

On April 29, 2003, the Company filed an action in the United States District Court for the District of New Jersey against Aquent LLC, seeking (i) to enjoin Aquent from disseminating false and misleading proxy materials and press releases in support of its two nominees for director positions in connection with the Company’s May 14, 2003 Annual Meeting; (ii) to invalidate any proxies secured by Aquent through the use of unlawful proxy solicitation materials; and (iii) to require Aquent to disseminate corrective disclosure that not only amended the false and misleading proxy materials but also advised CHC shareholders how Aquent’s solicitations had violated the securities laws.

 

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

 

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

 

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

 

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

None.

 

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Executive Officers of the Company

 

The following table sets forth certain information with respect to the executive officers of the Company.  All the positions listed are or were held by such officers with the Company as of the filing date of this Annual Report.

 

NAME		AGE		TITLE		PERIOD POSITION HELD
William J. Murphy		59		President and CEO		2003 - Present
				Director		1999 - Present
				Executive Vice President
				and Chief Financial Officer		1997-2003
Michael J. Shea		44		Chief Financial Officer		2003 - Present
				Vice President		1996 - Present
				Controller		1995 - 2003
Kristin Evins		36		Controller		2003 - Present
				Assistant Controller		2001 - 2003
				Manager of Financial Reporting		2000 - 2001

 

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PART II

 

Item 5.   Market for Registrant’s Common Equity and Related Stockholder Matters

 

The Company’s common stock is quoted on the Nasdaq National Market, under the symbol CHRZ.  The range of high and low closing stock prices, as reported by the Nasdaq National Market, for each of the quarters for the years ended December 31, 2003 and 2002 is as follows:

 

		2003						2002
		High			Low			High			Low
Quarter
First		$	3.93		$	2.60		$	4.19		$	3.11
Second		4.72			2.84			4.87			3.65
Third		4.56			3.57			4.65			3.40
Fourth		4.21			3.43			4.00			2.95

 

 

The Company plans to reinvest its earnings in future growth opportunities and, therefore, does not anticipate paying cash dividends in the near future and has not paid any to date.  As of March 10, 2004, there were approximately 1,024 registered holders of common stock, per the Company’s transfer agent.

 

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Item 6.  Selected Financial Data

 

Consolidated Statement of Operations Data:

 

		December 31,
		2003			2002			2001			2000			1999
		(dollar amounts in thousands, except per share data)
Revenues		$	245,210		$	297,115		$	400,784		$	445,479		$	534,594
Costs and expenses:
Direct costs		169,802			216,181			281,576			312,815			365,310
Selling, general and administrative		80,634			91,343			128,832			170,143			131,087
Amortization of intangibles		1,084			—			2,695			7,434			6,202
Restructuring charges		3,278			2,515			1,048			1,166			6,355
Write-down of assets held for sale		—			—			5,473			40,362			—
Special charges		10,113			—			—			—			—
Income / (loss) from operations		(19,701		)	(12,924		)	(18,840		)	(86,441		)	25,640
Other income / (expense):
Gain/(loss) on sale of assets		(424		)	5,890			(3,197		)	—			—
Net (loss) / gain on investments		(432		)	(61		)	90			—			—
Interest income		529			928			2,293			620			1,353
Interest expense		(51		)	(174		)	(1,944		)	(1,825		)	(1,355		)
Income / (loss) before income taxes and cumulative effect of a change in accounting principle and minority interest		(20,079		)	(6,341		)	(21,598		)	(87,646		)	25,638
Income taxes / (benefit)		(5,220		)	1,869			(7,148		)	(29,819		)	11,013
Income / (loss) before cumulative effect of change in accounting principle and minority interest		(14,859		)	(8,210		)	(14,450		)	(57,827		)	14,625
Minority interest		(89		)	35			—			—			—
Cumulative effect of change in accounting principle		—			(29,861		)	—			—			—
Net income / (loss)		$	(14,948	)	$	(38,036	)	$	(14,450	)	$	(57,827	)	$	14,625
Earnings / (loss) per share:
Basic		$	(0.49	)	$	(1.22	)	$	(0.45	)	$	(1.83	)	$	0.47
Diluted		$	(0.49	)	$	(1.22	)	$	(0.45	)	$	(1.83	)	$	0.46
Weighted average number of shares outstanding:
Basic		30,455,000			31,243,000			31,911,000			31,656,000			30,940,000
Diluted		30,455,000			31,243,000			31,911,000			31,656,000			31,647,000

 

13

 

		December 31,
		2003			2002			2001			2000			1999
		(dollar amounts in thousands, except per share data)
Analysis (%)
Revenues		100.0		%	100.0		%	100.0		%	100.0		%	100.0		%
Gross margin		30.7			27.2			29.7			29.8			31.7
Selling, general and administrative		32.9			30.8			32.1			38.2			24.5
Amortization of intangibles		0.4			—			0.7			1.7			1.2
Restructuring charges		1.3			0.8			0.2			0.3			1.2
Write-down of assets held for sale		—			—			1.4			9.0			—
Special charges		4.1			—			—			—			—
Income / (loss) from operations		(8.0		)	(4.4		)	(4.7		)	(19.4		)	4.8
Gain / (loss) on sale of assets		(0.2		)	2.0			(0.8		)	—			—
Net (loss) / gain on investments		(0.2		)	—			—			—			—
Interest income / (expense) – net		0.2			0.3			0.1			(0.3		)	—
Income / (loss) before income taxes and cumulative effect of a change in accounting principle and minority interest		(8.2		)	(2.1		)	(5.4		)	(19.7		)	4.8
Income taxes / (benefit)		(2.1		)	0.6			(1.8		)	(6.7		)	2.1
Income / (loss) before cumulative effect of change in accounting principle		(6.1		)	(2.7		)	(3.6		)	(13.0		)	2.7
Cumulative effect of change in accounting principle		—			(10.1		)	—			—			—
Net income / (loss)		(6.1		)	(12.8		)	(3.6		)	(13.0		)	2.7
Revenue growth / (decline) YOY		(17.5		)	(25.9		)	(10.0		)	(16.7		)	3.8
Net income growth / (decline)YOY		60.7			(163.2		)	75.0			(495.4		)	(66.4		)
Return on equity, average		(10.8		)	(22.7		)	(7.3		)	(24.6		)	5.7
Effective tax rate		26.0			29.5			33.1			34.0			43.0
Consolidated Balance Sheet Data:
At year-end
Total assets		$	179,137		$	193,731		$	237,721		$	269,396		$	347,994
Working capital		66,420			105,579			115,747			134,472			129,857
Long-term debt		—			—			—			—			4,100
Shareholders’ equity		130,744			145,855			189,855			207,924			262,652
Other Data:
Stock price		$	3.92		$	3.27		$	3.21		$	2.44		$	16.19
P/E multiple		N/A			N/A			N/A			N/A			34
Employees		2,665			2,800			3,313			4,186			4,149
Clients (during year)		967			905			879			800			785
Offices (worldwide)		31			36			52			43			50

 

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Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operation

 

The following detailed discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the December 31, 2003 financial statements and related notes included in separate sections of this Form 10-K.

 

Overview

 

Computer Horizons Corp., (“CHC”, “the Company”), is a strategic solutions and human capital management company with more than thirty-six years of experience, specifically in information technology.  The Company’s clients are primarily Global 2000 companies, serviced by over 30 offices in the United States, Canada and India.

 

Due to continued decreases in the demand for temporary technology workers, the trend of companies to outsource technology jobs offshore and declines in the overall IT markets in which the Company operates, 2003 revenue decreased 17.5% from 2002.  The majority of the Company’s revenues are derived from consultant billable hours for professional services rendered.  As a result of declining customer demand, consultant headcount declined to approximately 2,200 at December 31, 2003 (including approximately 300 pertaining to RGII acquired in July 2003), from approximately 2,300 at December 31, 2002.

 

The loss from operations in 2003 totaled $19.7 million, including special charges of $10.1 million, restructuring charges of $3.3 million and amortization of intangibles of $1.1 million.  The loss from operations in 2002 totaled $12.9 million and included $2.5 million of restructuring charges.  The decrease in the loss from operations during 2003, excluding these special items, was primarily a result of gross margin improvement attributable to the change in the consolidated revenue mix to 46% Solutions revenue (including Chimes) for 2003, from 32% Solutions revenue (including Chimes) in 2002.  In addition, selling, general and administrative expenses were reduced due to office closures and staff headcount reductions.

 

Management continues to focus on maintaining a strong balance sheet, with $52.6 million of cash at December 31, 2003, along with $66.4 million in working capital and no debt outstanding.  Cash flow generated from operations exceeded $18 million for 2003, partially due to the receipt of a $20 million income tax refund and a significant reduction in accounts receivable.

 

Although 2003 showed a significant improvement in the Company’s operating results, the level of business activity in the IT market remains uncertain.  This uncertainty significantly reduced revenues (specifically revenues from IT Services) and results from operations in 2003.  As long as this uncertainty remains, the Company believes that demand for IT Services will continue to be diminished.  CHC cannot predict when the level of business activity in the IT market will improve, and if it does improve, CHC cannot predict whether and to what extent demand for the Company’s IT Services will increase.

 

Forward Looking Statements

 

Statements included in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this document that do not relate to present or historical conditions are “forward-looking statements” within the meaning of that term in Section 27A of the Securities Act of 1933, as amended, and in Section 21F of the Securities Exchange Act of 1934, as amended.  Additional oral or written forward-looking statements may be made by the Company from time to time, and such statements may be included in documents that are filed with the Securities and Exchange Commission (SEC).  Such forward-looking statements involve risks and uncertainties that could cause results or outcomes to differ materially from those expressed in such forward-looking statements.  Forward-looking statements may include, without limitation, statements relating to the Company’s plans, strategies, objectives, expectations and intentions and are intended to be made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.  Words such as “believes,” “forecasts,” “intends,” “possible,” “expects,” “estimates,” “anticipates,” or “plans” and similar

 

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expressions are intended to identify forward-looking statements.  Among the important factors on which such statements are based are assumptions concerning the anticipated growth of the information technology industry, the continued need of current and prospective customers for the Company’s services, the availability of qualified professional staff, and price and wage inflation.

 

Revenue Generating Activities

 

The majority of the Company’s revenues are derived from professional services rendered in the information technology sector. The Company also owned a stand-alone software products company, Princeton Softech Inc., (“Princeton”) which accounted for less than 1% of consolidated revenues in 2002.  On March 25, 2002, the net assets of Princeton were sold for a cash payment of approximately $16 million.

 

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

 

The IT Services business consists of providing technology consultants to large organizations on a temporary hire basis. The consultant work is supervised and managed by the customer. For the most recent year 2003, this segment represented approximately 54% of total revenues. The IT Services business tends to be a lower risk, lower gross margin business with very competitive pricing.

 

The Solutions Group, tends to be a higher margin, higher risk business, due to the fact that the Company is responsible for project deliverables and other conditions contained in statements of work and/or contracts with customers. Virtually all projects performed by the Solutions Group are IT related and consist of practices such as application development, outsourcing arrangements, government services, Health Insurance Portability and Accountability Act, (“HIPAA”), services, technology training and managed services.   For the year 2003, the Solutions Group (excluding Chimes) accounted for 38% of consolidated revenues.

 

The Company’s customer relationships are memorialized in a master agreement, which address the terms and conditions which define the client engagement.  Depending on the service to be performed for the client, either a task order (in the case of a Staffing engagement) or a Statement of Work (“SOW”) (in the case of a Solutions engagement) is generated. The SOW is signed by both the Company and the customer.  In general, no Solutions work is done unless there is a SOW because the SOW provides the technical details of the work to be done.  The SOW, although falling under the corresponding master agreement, is a stand-alone binding contractual document, typically outlining the project objectives, describing the personnel who will work on the project, describing phases of the project, the timeframes for work performance, and the rate of compensation, on a time-and-material basis.  In the event that the parameters of the project expand or otherwise change, a Project Change Request is implemented, to memorialize whatever change has occurred to the deliverables, personnel and/or time-and-material.  The master agreements, in conjunction with the SOW’s, are written to define, with as much detail as possible, the client relationship and all aspects of the work to be performed for the client.  With regard to revenues expected in future periods, each SOW 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 the agreement was renewable.  Generally, Solutions engagements are for a year or less.  Staffing engagements can and do last for more than a year, with variations in the number of consultants being provided at any given time.  Staffing engagements are generally cancelable by clients with a two to four week notice period.

 

Chimes, Inc. is a human capital management solution that, through the use of proprietary software and processes, manages the temporary workforce of large organizations. During 2003, Chimes accounted for approximately 8% of total revenues.

 

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Critical Accounting Policies

 

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

 

Revenue Recognition

 

Approximately 94% and 93% of consolidated revenue in 2003 and 2002, respectively, was derived from time-and-material contracts.

 

For the IT Services division revenues are recognized as services are performed under time-and material contracts.  Under a typical time-and-material billing arrangement, our customers are billed on a regularly scheduled basis, such as biweekly or monthly.  At the end of each accounting period, revenue is estimated and accrued for services performed since the last billing cycle.  These unbilled amounts are billed the following month.

 

The Solutions Group recognizes revenue either on a time-and-material basis or on a fixed fee basis, however, principally on a time-and-material basis. For fixed-fee contracts, revenue is recognized on the basis of the estimated percentage of completion based on costs incurred relative to total estimated costs.  Each fixed fee contract has different terms, milestones and deliverables.  The milestones and deliverables primarily relate to the work to be performed and the timing of the billing.  At the end of each reporting period an assessment of revenue recognized on the percentage of completion and milestones achieved criteria is made.  If it becomes apparent that estimated cost will be exceeded or required milestones or deliverables will not have been obtained, an adjustment will be made.  The cumulative effect of revisions in estimated revenues and costs are recognized in the period in which the facts that give rise to the impact of any revisions become known.

 

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

 

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

 

Princeton Softech, Inc., which was sold in 2002, recognized revenue in accordance with AICPA Statement of Position 97-2 (“SOP 97-2”), “Software Revenue Recognition,” and AICPA Statement of Position 98-9 (“SOP 98-9”).  Under SOP 97-2, the Company recognized software license revenue when a noncancelable license agreement had been executed, fees were fixed and determinable, the software had been delivered and collection was considered probable.

 

17

 

Evaluation of Bad Debt Reserve

 

The Company determines its bad debt reserve by considering a number of factors, including the length of time trade accounts receivable are past due, the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company and the condition of the general economy and the industry as a whole.  The Company writes off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts.

 

Goodwill

 

In June 2001, the Financial Accounting Standards Board approved the issuance of SFAS No. 141, “Business Combinations” and in July 2001, SFAS No. 142, “Goodwill and Other Intangible Assets.”  The new standards require that all business combinations initiated after June 30, 2001 must be accounted for under the purchase method.  In addition, all intangible assets acquired that are obtained through contractual or legal right, or are capable of being separately sold, transferred, licensed, rented or exchanged are recognized as an asset apart from goodwill.  Goodwill and intangibles with indefinite lives are no longer subject to amortization, but are subject to at least an annual assessment for impairment by applying a fair value based test.  The Company adopted SFAS 142 as of January 1, 2002 and in compliance with this new regulation has discontinued the amortization of goodwill.

 

During the quarter ended June 30, 2002, the Company completed the initial valuation of the carrying value of goodwill existing at January 1, 2002.  As a result, a non-cash charge of $29.9 million, or $(0.96) per share was retroactively recorded as the cumulative effect of an accounting change in the six months ended June 30, 2002 statement of operations.  For the years ended December 31, 2003 and 2002, the Company completed valuations of the carrying value of the remaining goodwill and it was determined that no impairment had occurred at either date.

 

The reporting units are equal to, or one level below, reportable segments.  The Company engaged independent valuation consultants to assist with the transitional goodwill and annual impairment tests.

 

As of December 31, 2003 and 2002, the fair value of each of the reporting units was calculated using the following approaches (i) market approach and (ii) income approach.  Under the market approach, value is estimated by comparing the performance fundamentals relating to similar public companies’ stock prices.  Multiples are then developed of the value of the publicly traded stock to various measures and are then applied to each reporting unit to estimate the value of its equity.  Under the income approach, value was determined using the present value of the projected future cash flows to be generated by the reporting unit.

 

The fair value conclusion of the reporting units reflects an appropriately weighted value of the market multiple approach and the income approach discussed above.  An asset approach was not used because the asset approach is most relevant for liquidation approaches, investment company valuations and asset rich company valuations (i.e. real estate entities) and was not deemed relevant for manufacturing and service company going-concern valuations.  When either the income approach or the market approach was used, each indicated value of the Solutions entity’s equity exceeded the carrying value of the Solutions entity by at least $12 million and $15 million as of December 31, 2003 and 2002, respectively.  Since each of the two approaches yielded values in excess of carrying value, any weighting of the two approaches or either approach used alone results in the same conclusion, that the goodwill was not impaired.

 

When the other entities, of the Company, were tested (IT Services and Education), in the second quarter 2002 initial valuation, both approaches yielded an indicated value which was below the carrying value of those entity’s equity, in such an amount that the entire amount of goodwill was written off.  As a result, a loss of $29.9 million was

 

18

 

recognized in June 2002 and recorded as a cumulative effect of change in accounting principle in the accompanying Consolidated Statements of Operations.  There was no income tax effect on the impairment charge as approximately $19 million of the charge related to goodwill in foreign tax jurisdictions where the Company believes it is more likely than not that future taxable income in these jurisdictions will not be sufficient to realize the related income tax benefits associated with the charge.  The remaining $11 million of the charge was related primarily to goodwill that was acquired prior to the ability to deduct goodwill for tax purposes.

 

Valuation of the Deferred Tax Asset

 

The Company records deferred tax assets for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and their respective tax bases, and to operating loss carryforwards.  Deferred tax assets are reduced by a valuation allowance if, based on available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.  In assessing the realizability of deferred tax assets, management considers the scheduled reversal periods of the deferred tax assets as well as projected future taxable income and tax planning strategies.

 

19

 

RESULTS OF OPERATIONS AND FINANCIAL CONDITION

 

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 Revenues

 

Revenues.  Consolidated revenue decreased to $245.2 million in the year ended December 31, 2003 from $297.1 million in the year ended December 31, 2002, a decrease of $51.9 million or 17.5%.

 

Solutions Group revenues, which included revenue from assets held for sale of $2.9 million for Princeton in 2002, increased to $92.1 million in the year ended December 31, 2003 from $79.3 million in the year ended December 31, 2002, an increase of $12.8 million or 16.1%.  The increase in Solutions Group revenues for the year ended December 31, 2003 is attributable to the acquisition of RGII in July 2003.  Solutions Group revenue was $73.9 million for the year ended December 31, 2003 excluding RGII.  The Solutions Group revenue excluding Princeton Softech, Inc. in 2002 was $76.4 million.  The $2.5 million decrease in Solutions Group revenue, excluding RGII, was primarily due to declining customer demand in several Solution Group practices, primarily web design/integration and education/training.

 

 IT Services revenues decreased to $133.1 million in the year ended December 31, 2003 from $201.3 million in the year ended December 31 2002, a decrease of $68.2 million or 33.9%.  The decrease in IT Services revenue of $68.2 million, is the result of continued decreases in the demand for temporary technology workers, the trend of companies to outsource technology jobs offshore, the impact of pricing decreases by customers and the lagging economy.  For the year ended December 31, 2003, IT Services consultant average headcount decreased by 23.9%, accounting for approximately $48 million of the revenue decrease.  The balance of the decrease in revenue (approximately $20 million) is attributable to a reduction in average bill rates.  The reduction in average bill rates was due to the competitive pricing pressures in the domestic staff augmentation market.  The Company does not anticipate growth during 2004 in IT Services headcount levels unless IT spending increases at the Company’s clients.

 

Chimes revenue increased to $20.0 million in the year ended December 31, 2003, from $16.5 million in the year ended December 31, 2002, an increase of $3.5 million or 21.2%.  This increase was primarily due to an increase in revenue from new customers of approximately $2.8 million and an increase of approximately $700,000 in revenue from existing customers in this segment.

 

Direct Costs.  Direct costs decreased to $169.8 million in the year ended December 31, 2003 from  $216.2 million in the year ended December 31, 2002. Consolidated gross margin, revenue less direct costs, increased to 30.8% for the year ended December 31, 2003 from 27.2% in the same period of 2002.  In the Company’s Solutions Group, gross profit increased to $30.0 million, or 32.6% as a result of the RGII acquisition.  Without RGII, gross profit for the year ended December 31, 2003 declined approximately $3.6 million from the year ended December 31, 2002.  These declines were a result of continued softness in the healthcare arena.  Gross margin in the Company’s IT Services segment stayed relatively flat at 20.1% for the year ended December 31, 2003.  Gross margin in the Company’s Chimes segment increased to 93.0% from 88.3% for the year ended December 31, 2003 and 2002, respectively, due to improved margins at existing customers.

 

Excluding the asset held for sale, Princeton Softech, Inc., in the year ended December 31, 2002, direct costs decreased to $169.8 million in the year ended December 31, 2003 from $215.7 million for the year ended December 31, 2002.  Gross margin for the year of 2002 excluding Princeton Softech, Inc. was 26.7%.

 

The Company’s consolidated gross margin improvement is primarily attributable to the change in the revenue mix among the Company’s business segments.  Chimes and the Solutions Group, including RGII, are higher gross margin businesses than the Company’s IT Services segment.  For the year ended December 31, 2003, Chimes and Solutions Group revenue totaled 45.7% of consolidated revenue, compared to 32.3% of consolidated revenue for the comparable period in 2002.

 

20

 

Selling, general and administrative expenses.  Selling, general and administrative expenses decreased to $80.6 million in the year ended December 31, 2003 from $91.3 million for the comparable period of 2002.  As a percentage of revenue, the Company’s SG&A expenses increased to 32.9% in the year ended December 31, 2003 from 30.7% in the year ended December 31, 2002.  The expenses in 2003 included a bad debt charge of $3.1 million related to the write-off of a sub-contract with ATEB, a privately held company, which the Company voluntarily terminated for financial reasons.  ATEB was the primary contractor to develop a new pharmacy system for Royal Ahold.  The Company is continuing recovery efforts for this receivable.  The expenses in 2002 included assets held for sale (Princeton Softech, Inc.) of $4.3 million.  Without these special items in 2003 and 2002, SG&A expenses would have decreased to $77.5 million in the year ended December 31, 2003 from $87.0 million in the comparable periods of 2002.  This decrease in SG&A expenses was primarily attributable to cost reductions in all segments, with approximately $544,000 from rent savings (office closures) and the balance primarily related to staff reduction and personnel costs.

 

Amortization of Intangibles.  During the year ended December 31, 2003, the Company recorded $1.1 million of amortization expense related to the 2003 acquisition of intangibles for RGII and Xpress Software.

 

Restructuring charges / (credits).   During the year ended December 31, 2003, the Company recorded restructuring charges of $3.3 million for terminated leases ($1.4 million), severance ($1.6 million) and general office closure expense ($330,000) relating primarily to the closing of facilities in Canada and the United Kingdom.  During the year ended December 31, 2002, the Company recorded a restructuring charge of $2.5 million pertaining to 2002 office closings, including a reversal of $192,000 of the previously recorded restructure reserves pertaining to lease buyouts and $140,000 pertaining to severance adjustments.  In both 2003 and 2002, the office closings were made to eliminate the infrastructure costs related to having offices in certain areas.  The Company did not eliminate marketing efforts or business in these areas, but rather turned these areas into virtual marketplaces whereby sales personnel work from their homes.  As a result of these office closings, in both IT Services and the Solutions business areas, rent expense and the related reduction of SG&A headcount (salary and fringe benefits) were eliminated from the current SG&A cost structure.

 

Special charges.  For the year ended December 31, 2003, the Company incurred special charges of $10.1 million consisting of a severance package for the Company’s former CEO and expenses related to the unilateral acquisition proposal and activities of Aquent LLC.  The separation package of the former CEO included a $3.5 million severance payment and $200,000 in continued medical coverage.  The remaining $6.4 million of the expense pertained to the unilateral acquisition proposal and activities of Aquent LLC.  This expense is primarily attributable to approximately $3.4 million of legal fees, $1.8 million in financial advisor fees and $1.2 million of proxy solicitation and other fees.  As management considers these special items to be infrequent and material in nature, the Company has reported the expenses on a separate line for full disclosure purposes, however, the amounts are reported within operating income.

 

Loss from Operations.   The Company’s loss from operations totaled $19.7 million in the year ended December 31, 2003, an increased loss of $6.8 million, from a loss of $12.9 million in the year ended December 31, 2002.  As discussed above this increase in the loss from operations in 2003 included special charges of $10.1 million, or 4.1% of revenue, restructuring charges of $3.3 million, or 1.3% of revenue, amortization of intangibles of $1.1 million, or 0.4% of revenue and a special bad debt charge of $3.1 million, or 1.3% of revenue due to the write-off of a terminated contract with a customer for financial reasons.  The loss from operations in 2002 included the loss from operations of the asset held for sale, Princeton Softech, Inc., of $1.9 million, or 0.6% of revenue and restructuring charges of $2.5 million or 0.8% of revenue.  The 2003 loss before income tax benefit, excluding the special items noted above and loss on sale of assets, net loss on investments and net interest income totaling expense of $378,000 totaled $2.2 million and was comprised of a loss of $4.1 million in IT Services, profit of $5.9 million in the Solutions Group and a loss of $4.0 million in Chimes.  This compares to the loss before income tax benefit of $10.4 million, excluding the special items noted above and gain on sale of assets, net loss on investments and net interest income totaling income of $6.6 million in the year ended December 31, 2002, consisting of a loss of $2.2 million in IT Services, income of $766,000 in the Solutions Group and a loss

 

21

 

of $8.9 million in Chimes.  Loss before income tax benefit, excluding all special items, was a loss of 0.9% for the year ended December 31, 2003 as compared to a loss of 3.5% in the comparable period of 2002.

 

Other Income/(Expense).   Other expense was $378,000 in the year ended December 31, 2003, compared to other income of $6.6 million in the comparable period of 2002.  This difference was primarily due to the gain on the sale of Princeton and Spargo in 2002 totaling approximately $5.9 million.

 

Provision for Income Taxes.  The effective tax rate for Federal, state and local income taxes was a tax benefit of 26% for the year ended December 31, 2003 compared with a tax expense of 29.5% for the year ended December 31, 2002.  The primary reason for the change in the effective tax rate was the establishment of a valuation allowance of state deferred tax assets in 2002.  A review of all available positive and negative evidence was conducted by the Company, including the Company’s current and past performance, market environment in which the company operates, and the length of carryback and carryforward periods.  In January 2003, the Company received a federal income tax refund of $20 million, resulting from the Economic Stimulus Act of 2002 (see Note 7).

 

Net Loss.  For the year ended December 31, 2003, the net loss was $14.9 million, or $0.49 loss per diluted share, compared to a net loss of $38.0 million, or $1.22 loss per diluted share for the year ended December 31, 2002.  The effect of restructuring charges, loss on sale of assets, loss on sale of investments, amortization expense, the write-off of the terminated project and special charges amounted to $0.45 loss per share, net of taxes in 2003.  The net loss in the year ended December 31, 2002 includes a charge for the cumulative effect of change in accounting principle of $29.9 million, or $0.96 per share and differences in the effective tax rate primarily relating to the recording of a valuation allowance in the Company’s state deferred tax assets of approximately $4.0 million, or $0.13 per share.  The effect of restructuring charges, operations of assets held for sale, gain on sale of assets, cumulative effect of change in accounting principle and the valuation allowance on deferred tax assets amounted to $1.06 loss per share, net of taxes, in 2002.

 

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001 Revenues

 

Revenues.  Consolidated revenues decreased to $297.1 million in the year ended December 31, 2002 from $400.8 million in the year ended December 31, 2001, a decrease of $103.7 million, or 25.9%.

 

Solutions Group revenues, which included revenue from assets held for sale of $2.9 million for Princeton in 2002, and $29.0 million for Princeton and $11.5 million for eB Networks, (“EBN”) in 2001, decreased to $79.3 million in the year ended December 31, 2002 from $116.9 million in the year ended December 31, 2001, a decrease of $37.6 million or 32.2 %.  The Solutions Group revenue, excluding the revenue of Princeton in 2002 and Princeton and EBN in 2001 remained flat at $76.4 million in the year ended December 31, 2002 and December 31, 2001, respectively.

 

IT Services revenues decreased to $201.3 million in the year ended December 31, 2002 from $274.4 million in the year ended December 31, 2001, a decrease of $73.1 million or 26.6%.  The decrease in IT Services revenue of $73.1 million is the result of continued decreases in the demand for temporary technology workers, the trend of companies to outsource technology jobs offshore, the impact of pricing decreases by customers and the lagging economy.  For the year ended December 31, 2002, IT Services consultant average headcount decreased by 24%, accounting for approximately $66 million of the revenue decrease.  The balance of the decrease in revenue (approximately $7 million) is attributable to a reduction in average bill rates.  The reduction in average bill rates was due to the competitive pricing pressures in the domestic staff augmentation market.

 

Chimes revenue increased to $16.5 million in the year ended December 31, 2002, from $9.5 million in the year ended December 31, 2001, an increase of $7 million, or 73.7%.  This increase was primarily due to an increase in revenue from existing customers of approximately $2.2 million and an increase of approximately $4.8 million in revenue from new customers in this segment.

 

22

 

Direct Costs.  Direct costs decreased to $216.2 million in the year ended December 31, 2002 from $281.6 million in the year ended December 31, 2001.  Gross margin decreased to 27.2% in the year ended December 31, 2002 from 29.7% in the year ended December 31, 2001.

 

Direct costs, excluding $494,000 of direct expense from Princeton in 2002 and $6.3 million of direct expense from Princeton and $7.3 million from EBN in 2001, decreased to $215.7 million in the year ended December 31, 2002 from $268.0 million in the year ended December 31, 2001.  Gross margins excluding these expenses in both years increased to 26.7% in the year ended December 31, 2002 from 25.6% in the year ended December 31, 2001.

 

This increase in gross margins was primarily attributable to the increase in higher margin business, primarily Chimes.

 

Selling, General and Administrative.  Selling, general and administrative expenses decreased to $91.3 million, or 30.7% of revenue, in the year ended December 31, 2002 from $128.8 million, or 32.1% of revenue, in the year ended December 31, 2001, a decrease of $37.5 million or 29.1%.  These expenses included assets held for sale expense of $4.3 million for Princeton in 2002 and $28.4 million for Princeton and $5.3 million for EBN in 2001.

 

The decrease in selling, general and administrative expenses was primarily attributable to cost reductions in all segments, with approximately $1.3 million from rent savings and the balance primarily related to staff reduction and personnel costs.  The decreases were offset by a $3.5 million increase in Chimes as the Company continues to invest in this subsidiary.  Chimes average headcount increased 21% from approximately 168 at December 31, 2001 to 204 at December 31, 2002 primarily from the hiring of additional program office personnel used in the implementation and delivery of Chimes services.

 

Restructuring Charges / (Credits).  During the year ended December 31, 2002, the Company recorded a restructuring charge of $2.5 million pertaining to 2002 office closings, including a reversal of $192,000 of the previously recorded restructure reserves pertaining to lease buyouts and $140,000 pertaining to severance adjustments.  These office closings were made to eliminate the infrastructure costs related to having offices in certain areas.  The Company did not eliminate marketing efforts or business in these areas, but rather turned these areas into virtual marketplaces whereby sales personnel work from their homes.  As a result of these office closings, in both IT Services and the Solutions business areas, rent expense and the related reduction of SG&A headcount (salary and fringe benefits) were eliminated from the current SG&A cost structure.

 

During the year ended December 31, 2001, the Company recorded a restructuring charge adjustment of $1.0 million primarily due to the termination, by the sublessee, of the sublease contracts for closed offices included in the 1999 restructure charge.  Since the sublessee defaulted on the rent payments, it was necessary to restore the Company’s liability for the remaining lease obligations.

 

Write-down of Assets Held for Sale.  In the second quarter of 2001, the Company recorded $5.5 million expense for the write-down of assets held for sale to further reduce the carrying amount of EBN to the estimated net realizable value.

 

Income / (Loss) from Operations.  The Company’s loss from operations excluding restructuring charges, write-down of assets held for sale and amortization expense in 2001, totaled $10.4 million for the year ended December 31, 2002, a decline of $0.8 million or 8.3%, from a loss of $9.6 million in the year ended December 31, 2001.  The composition of the operating loss of $10.4 million included a loss of $2.2 million in IT Services, profit of $766,000 in the Solutions Group and a loss of $8.9 million in Chimes.  This compares to the operating loss of $9.6 million in the year ended December 31, 2001, consisting of profit of $7.7 million in IT Services, loss

 

23

 

of $7.2 million in the Solutions Group and loss of $10.1 million in Chimes.  Operating margins, excluding restructuring charges, write-down of assets held for sale and amortization expense in 2001, were a loss of 3.5% in the year ended December 31, 2002 as compared to a loss of 2.4% in the year ended December 31, 2001.

 

The Company’s loss from operations, excluding the losses from the assets held for sale of $1.9 million loss in Princeton in 2002 and $5.7 million loss for Princeton and $1.1 million loss for EBN in 2001, restructuring charges, amortization expense and the write-down of assets held for sale, totaled $8.5 million in the year ended December 31, 2002, a decline of $5.6 million or 193.1%, from a loss of $2.9 million in the year ended December 31, 2001.  The composition of the operating loss of $8.5 million included a loss of $2.4 million in IT Services, profit of $2.8 million in the Solutions Group and a loss of $8.9 million in Chimes.  This compares to the operating loss of $2.9 million in the year ended December 31, 2001, consisting of profit of $5.7 million in IT Services, profit of $1.5 million in the Solutions Group and loss of $10.1 million in Chimes.  Operating margins, excluding restructuring charges, write-down of assets held for sale and amortization expense in 2001, were a loss of 2.9% in the year ended December 31, 2002 as compared to a loss of 0.8% in the year ended December 31, 2001.

 

Other Income/(Expense).  For the year ended December 31, 2002, other income increased to $6.6 million from other expense of $2.8 million in the year ended December 31, 2001.  This increase in other income was primarily attributable to a $3.2 million gain on the sale of Princeton and a $2.7 million gain on the sale of Spargo which resulted from a favorable purchase price adjustment after the final resolution of outstanding accounts receivables and the termination of leases.  In 2001, a $4.0 million loss was recorded on the sale of EBN offset in part by a $332,000 gain on the sale of ICM Education and the original $438,000 gain recorded for the sale of Spargo in 2001.

 

Provision for Income Taxes.  The effective tax rate for Federal, state, and local income taxes was 29.5% for the year ended December 31, 2002, and a tax benefit rate of 33.1% in the year ended December 31, 2001.  The primary reason for the change in the effective tax rate in 2002 was the establishment of a valuation allowance of state deferred tax assets.  A review of all available positive and negative evidence was conducted by the Company, including the Company’s current and past performance, the market environment in which the company operates, and the length of carry back and carry forward periods.  In January 2003, the Company received a federal income tax refund of $20 million, resulting from the Economic Stimulus Act of 2002 (see Note 7).

 

Net Loss.  The Company recorded a net loss of $38.0 million in the year ended December 31, 2002, a decline of $23.5 million or 162.1% from net loss of $14.5 million in the year ended December 31, 2001.  Net loss per share (diluted) totaled $1.22 in the year ended December 31, 2002 from net loss per share (diluted) of $0.45 in the year ended December 31, 2001.  The net loss in 2002 includes the cumulative effect of change in accounting principle of $29.9 million, or $0.96 per share and differences in the effective tax rate primarily relating to the recording of a valuation allowance in the Company’s state deferred tax assets of approximately $4.0 million, or $0.13 per share.  The effect of restructuring charges, operations of assets held for sale, gain on sale of assets, cumulative effect of change in accounting principle and the valuation allowance on deferred tax assets amounted to $1.06 loss per share, net of taxes, in 2002.  The effect of restructuring charges, loss on sale of assets, amortization expense and the operations of the assets held for sale amounted to $0.40 loss per share, net of taxes, in 2001.

 

Liquidity and Capital Resources

 

Computer Horizons has historically financed its operations primarily through cash generated from operations, borrowings against bank lines of credit and the public sale of its common stock.  At December 31, 2003, the Company had $66 million in working capital, of which $52.6 million was cash and cash equivalents.  The Company’s working capital ratio at December 31, 2003 was 2.5 to 1.  The Company has remained debt free throughout 2003.   In January 2003, the Company received a federal income tax refund of $20 million, resulting from the Economic Stimulus Act of 2002.  This refund pertains to deductions carried back to prior years and

 

24

 

since the tax structure of the transaction giving rise to the deduction is subject to determination by the tax authorities, the Company has recorded a reserve for the tax benefit until IRS audits for the applicable years are completed.

 

Net cash provided by operating activities for the years ended December 31, 2003, December 31, 2002 and December 31, 2001 totaled $18.7 million, $20.7 million, and $31.9 million respectively.  In 2003, this was primarily due to the federal income tax refund received and a reduction in accounts receivable partially offset by the Company’s net loss.  In 2002, this was primarily attributable to a reduction in accounts receivable.  In 2001, this was primarily attributable to income tax refunds, other non-cash charges and a reduction in accounts receivable.

 

Net cash used by investing activities was $23.5 million for the year ended December 31, 2003.  This was primarily attributable to the purchase of RGII.  Net cash provided by investing activities was $13.0 million and $6.1 million for the years ended December 31, 2002 and 2001, respectively.  In both years this was primarily attributable to cash received from the sale of assets.

 

For the years ended December 31, 2003, 2002 and 2001, respectively, net cash used in financing activities was $2.5 million, $14.6 million and $12.6 million, resulting in 2003 from the pay off of the notes payable of $2.6 million related to the acquisition of RGII and $1.2 million used in the repurchase of the Company’s common stock.  The $14.6 million used in 2002 resulted from a $10.0 million reduction of debt and a $6.1 million use in the repurchase of the Company’s common stock.  The $12.6 million used in 2001 resulted from a $10.7 million reduction of debt and a $3.4 million use for the repurchase of the Company’s common stock.

 

On July 31, 2001, amended February 14, 2003, the Company entered into a secured asset-based lending facility that replaced its two unsecured discretionary lines of credit.  This asset-based lending facility is a three-year, $40 million facility with availability based primarily on eligible customer receivables.  The interest rate for the first ninety days from closing was Prime plus 0.5%, thereafter the rate was LIBOR plus 2.75% based on the unpaid principal.  The borrowing base less outstanding loans must equal or exceed $17.5 million.  At the time of closing there was a $170,000 commitment fee paid to the agent.  As of December 31, 2003, the Company had no outstanding loan balance against the facility.  Borrowings under this facility are collateralized by certain assets of the Company.  Based on the Company’s eligible customer receivables and cash balances, $16.0 million and $24.7 million was available for borrowing as of December 31, 2003 and December 31, 2002, respectively.  The fee for the unused portion of the line of credit is 0.375% per annum charged to the Company monthly.  This charge was approximately $109,000 and $143,000 for the year ended December 31, 2003 and 2002.  This line of credit includes covenants relating to the maintenance of cash balances and providing for limitations on incurring obligations and spending limits on capital expenditures.  One covenant pertains to minimum cash collections over a three-month period.  The Company did not satisfy this covenant for the period December 2003 through February 2004.  A waiver was received from the lending institution.  This facility is scheduled to expire in July 2004 and the Company intends to enter into a new asset-based lending facility prior to expiration.

 

As a result of the Company’s acquisition of RGII, the seller of RGII may be entitled to contingent payments based on RGII’s performance against profitability objectives over the next three years.  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 financial performance objectives are met.  These financial performance objectives are based on earnings before interest and taxes (“EBIT”) targets totaling $19.8 million over a three-year period.  There are no minimum or maximum payment obligations under the terms of the contingent note. The contingent payment will be reduced on a dollar for dollar basis for financial performance below EBIT targets and increased by 29 cents ($0.29) for each dollar exceeding EBIT targets.  The payments, if the applicable EBIT targets are met, will be due as follows:  2003 payment of $1.7 million, 2004 payment of $3.3 million, 2005 payment of $3.3 million, and 2006 payment of $1.7 million.  These payments will be reduced or increased based on actual EBIT performance.

 

25

 

On February 24, 2004 a payment was made for the first six-month installment of approximately $631,000, pertaining to this contingent note.

 

The Company believes that its cash and cash equivalents, asset-based lending facility, internally generated funds and tax refunds (received in 2003) will be sufficient to meet its working capital needs through 2004.

 

The Company’s billed accounts receivable were $44.5 million and $49.4 million at December 31, 2003 and December 31, 2002, respectively.  Including both billed and unbilled receivables, days sales outstanding were 70 days at December 31, 2003 and 76 days at December 31, 2002, based on quarterly sales.

 

Contractual Obligations and Commercial Commitments

 

The Company does not utilize off balance sheet financing other than operating lease arrangements for office premises and related equipment. Leases are short term in nature and non-capital. The following table summarizes all commitments under contractual obligations as of December 31, 2003:

 

		Total Amount			1 year			2-3 years			4-5 years			Over 5 years
		in thousands
Operating Leases		$	14,093		$	6,409		$	6,533		$	1,151		$	—
RGII Contingent Note*		10,000			631			9,369			—			—
Deferred Compensation		2,103			—			—			—			2,103
Supplemental Retirement Plan		11,318			—			—			—			11,318
Other long term		765			765			—			—			—
Total Cash Obligations		$	38,279		$	7,805		$	15,902		$	1,151		$	13,421

 

*  Obligation if applicable EBIT targets are met.

 

Foreign Currency Exposure

 

The Company’s international operations expose it to translation risk when the local currency financial statements are translated to U.S. dollars.  As currency exchange rates fluctuate, translation of the financial statements of international businesses into U.S. dollars will affect the comparability of revenues and expenses between years.  None of the components of the Company’s consolidated statements of income was materially affected by exchange rate fluctuations in 2003, 2002 or 2001.  At December 31, 2003 the Company had $1,945,000 in cash maintained in overseas financial institutions.

 

26

 

Recent Accounting Pronouncements

 

In November 2002, the EITF reached a consensus on Issue No. 00-21, “ Accounting for Revenue Arrangements with Multiple Deliverables.”  This Issue provides guidance on when and how to separate elements of an arrangement that may involve the delivery or performance of multiple products, services and rights to use assets into separate units of accounting.  The guidance in the consensus is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003.  The transition provision allows either prospective application or a cumulative effect adjustment upon adoption.  The effect of the adoption of this statement was immaterial to the Company.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”  It establishes classification and measurement standards for three types of freestanding financial instruments that have characteristics of both liabilities and equity.  Instruments within the scope of SFAS 150 must be classified as liabilities within the Company’s financial statements.  The provisions of SFAS No. 150 are effective for (1) instruments entered into or modified after May 31, 2003 and (2) pre-existing instruments as of the first interim period after June 15, 2003.  SFAS 150 did not have a material effect on the Company’s financial statements.

 

In January 2003, the FASB issued Financial Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), which addresses consolidation by business enterprises of variable interest entities (“VIEs”).  The accounting provisions and disclosure requirements of FIN 46 are effective immediately for VIEs created after January 31, 2003, and are effective for the Company’s fiscal period ending March 31, 2004, for VIEs created prior to February 1, 2003.  In December 2003, the FASB published a revision to FIN 46 (“FIN 46R”) to clarify some of the provisions of the interpretation and to defer the effective date of implementation for certain entities.  Under the guidance of FIN 46R, public companies that have interests in VIE’s that are commonly referred to as special purpose entities are required to apply the provisions of FIN 46R for periods ending after December 15, 2003.  A public company that does not have any interests in special purpose entities but does have a variable interest in a VIE created before February 1, 2003, must apply the provisions of FIN 46R by the end of the first interim or annual reporting period ending after March 14, 2004.  Although the Company is still evaluating the impact of FIN 46R, it is not expected to have a material effect on the Company’s financial statements.

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

 

Market Risk Exposure

 

The Company has financial instruments that are subject to interest rate risk.  Historically, the Company has not experienced material gains or losses due to interest rate changes.  Based on the current holdings, the exposure to interest rate risk is not material.  Additionally, at December 31, 2003 the Company was debt free.

 

27

 

Item 8.  Financial Statements and Supplementary Data

 

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

 

Board of Directors and Shareholders

Computer Horizons Corp.

 

We have audited the accompanying consolidated balance sheets of Computer Horizons Corp. and Subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2003.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.

 

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

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Computer Horizons Corp. and Subsidiaries as of December 31, 2003 and 2002 and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.

 

 

/s/ Grant Thornton LLP
GRANT THORNTON LLP
Edison, New Jersey
February 17, 2004 (except for the second paragraph of Note 4, as to which the date is March 9, 2004).

 

28

 

Computer Horizons Corp. and Subsidiaries

 

CONSOLIDATED BALANCE SHEETS

 

		December 31,
		2003			2002
		(in thousands, except per share data )
ASSETS
Current assets:
Cash and cash equivalents (Note 1)		$	52,610		$	59,769
Accounts receivable (Note 2)		48,295			56,616
Deferred income taxes (Note 7)		4,514			4,557
Refundable income taxes (Note 7)		—			19,051
Other		4,759			7,219
Total current assets		110,178			147,212
Property and equipment:
Furniture, equipment and other		42,252			37,664
Less accumulated depreciation		32,929			26,647
		9,323			11,017
Other assets – net:
Goodwill (Note 1)		34,218			19,203
Intangibles (Note 1)		2,408			—
Deferred income taxes (Note 7)		13,624			8,020
Other		9,386			8,279
		59,636			35,502
Total Assets		$	179,137		$	193,731

 

The accompanying notes are an integral part of these statements.

 

29

 

		December 31,
		2003			2002
		(in thousands, except per share data )
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accrued payroll, payroll taxes and benefits		$	4,436		$	4,529
Accounts payable		8,287			10,830
Restructuring reserve (Note 13)		2,620			3,266
Income taxes payable		1,243			—
Tax benefit reserve (Note 7)		19,600			19,600
Other accrued expenses		7,572			3,408
Total current liabilities		43,758			41,633
Other liabilities		4,635			6,243
Commitments and Contingencies (Notes 4, 7, 11 and 20)
Shareholders’ equity:
Preferred stock, $.10 par; authorized and unissued, 200,000 shares, including 50,000 Series A
Common stock, $.10 par; authorized, 100,000,000 shares; issued 33,153,107 shares at December 31, 2003 and 2002, respectively		3,315			3,315
Additional paid-in capital		133,046			133,518
Accumulated other comprehensive loss		(4,589		)	(4,306		)
Retained earnings		13,307			28,255
		145,079			160,782
Less shares held in treasury, at cost; 2,537,692 shares and 2,660,667 shares at December 31, 2003 and 2002, respectively		(14,335		)	(14,927		)
Total shareholders’ equity		130,744			145,855
Total Liabilities and Shareholders’ Equity		$	179,137		$	193,731

 

30

 

Computer Horizons Corp. and Subsidiaries

CONSOLIDATED STATEMENTS OF OPERATIONS

 

		Year ended December 31,
		2003			2002			2001
		(in thousands, except per share data)
Revenues		$	245,210		$	297,115		$	400,784
Costs and expenses:
Direct costs		169,802			216,181			281,576
Selling, general and administrative		80,634			91,343			128,832
Amortization of intangibles		1,084			—			2,695
Restructuring charges (Note 13)		3,278			2,515			1,048
Special charges (Note 18)		10,113			—			—
Write-down of assets held for sale		—			—			5,473
		264,911			310,039			419,624
Loss from operations		(19,701		)	(12,924		)	(18,840		)
Other income /(expense):
Gain / (loss) on sale of assets (Note 17)		(424		)	5,890			(3,197		)
Net gain /(loss) on investments		(432		)	(61		)	90
Interest income		529			928			2,293
Interest expense		(51		)	(174		)	(1,944		)
		(378		)	6,583			(2,758		)
Loss before income taxes and cumulative effect of a change in accounting principle and minority interest		(20,079		)	(6,341		)	(21,598		)
Income taxes / (benefit) (Notes 1 and 7):
Current		341			(4,292		)	(10,292		)
Deferred		(5,561		)	6,161			3,144
		(5,220		)	1,869			(7,148		)
Loss before cumulative effect of change in accounting principle and minority interest		(14,859		)	(8,210		)	(14,450		)
Cumulative effect of change in accounting principle (Note 1)		—			(29,861		)	—
Minority interest		(89		)	35			—
Net Loss		$	(14,948	)	$	(38,036	)	$	(14,450	)
Loss per share – Basic and Diluted (Notes 1 and 8):
Before cumulative effect of change in accounting principle		$	(0.49	)	$	(0.26	)	$	(0.45	)
Cumulative effect of change in accounting principle		$	—		$	(0.96	)	$	—
Net Loss		$	(0.49	)	$	(1.22	)	$	(0.45	)
Weighted average number of shares outstanding:
Basic and Diluted		30,455,000			31,243,000			31,911,000

 

The accompanying notes are an integral part of these statements.

 

31

 

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

 

Years ended December 31, 2003, 2002 and 2001

 

							Additional Paid-in Capital			Accumulated other Comprehensive Income/(Loss)				Retained Earnings										Total
		Common Stock																Treasury Stock
		Shares		Amount														Shares		Amount
		(dollars in thousands)
Balance, December 31, 2000		33,152,206		$	3,315		$	139,418		$	(980		)	$	80,741			1,344,615		$	(14,570		)	$	207,924
Net loss for the year														(14,450			)							(14,450			)
Other comprehensive loss:
Foreign currency translation adjustments										(1,952			)											(1,952			)
Total comprehensive loss																								(16,402			)
Stock options exercised																		(15,000	)	30				30
Other issuances of common stock		901
Issuance of common stock for purchase of assets							(360		)									(77,144	)	633				273
Employee stock purchase program							(3,828		)									(643,280	)	5,273				1,445
Purchase of treasury shares																		1,111,000		(3,415			)	(3,415			)
Balance, December 31, 2001		33,153,107		3,315			135,230			(2,932			)	66,291				1,720,191		(12,049			)	189,855
Net loss for the year														(38,036			)							(38,036			)
Other comprehensive loss:
Current year unrealized loss on investments										(1,100			)											(1,100			)
Foreign currency translation adjustments										(274			)											(274			)
Total comprehensive loss																								(39,410			)
Stock options exercised																		(265,858	)	449				449
Employee stock purchase program							(1,712		)									(405,366	)	2,814				1,102
Purchase of treasury shares																		1,611,700		(6,141			)	(6,141			)
Balance, December 31, 2002		33,153,107		3,315			133,518			(4,306			)	28,255				2,660,667		(14,927			)	145,855
Net loss for the year														(14,948			)							(14,948			)
Other comprehensive loss:
Current year unrealized loss on investments										(489			)											(489			)
Foreign currency translation adjustments										206														206
Total comprehensive loss																								(15,231			)
Stock options exercised																		(361,410	)	959				959
Employee stock purchase program							(472		)									(153,765	)	863				391
Purchase of treasury shares																		392,200		(1,230			)	(1,230			)
Balance, December 31, 2003		33,153,107		$	3,315		$	133,046		$		(4,589	)	$		13,307		2,537,692		$		(14,335	)	$		130,744

 

The accompanying notes are an integral part of this statement.

 

32

 

Computer Horizons Corp. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		Year ended December 31,
		2003			2002			2001
		(in thousands)
Cash flows from operating activities
Net loss		$	(14,948	)	$	(38,036	)	$	(14,450	)
Adjustments to reconcile net loss to net cash provided by/(used in) operating activities:
Deferred taxes		(5,561		)	6,161			3,144
Depreciation		5,336			4,634			5,301
Amortization of intangibles		1,084			—			2,695
Provision for bad debts		4,644			4,996			3,397
Write-down of assets held for sale		—			—			5,473
Loss / (gain) on sale of assets		424			(5,890		)	3,197
Loss on investments		432			—			—
Write off of goodwill		—			29,861			—
Changes in assets and liabilities, net of acquisitions:
Accounts receivable		14,635			21,952			11,060
Other current assets		2,388			(1,981		)	(2,240		)
Assets held for sale		—			397			5,401
Other assets		(3,612		)	1,298			(474		)
Refundable income taxes/benefit reserve		19,051			8,541			13,333
Accrued payroll, payroll taxes and benefits		(93		)	(4,648		)	(2,023		)
Accounts payable		(4,026		)	(4,366		)	(2,749		)
Income taxes payable		1,033			—			—
Other accrued expenses		86			(1,432		)	(560		)
Other liabilities		(2,200		)	(837		)	1,426
Net cash provided by operating activities		18,673			20,650			31,931
Cash flows from investing activities
Purchases of furniture and equipment		(2,387		)	(3,178		)	(3,732		)
Proceeds on sale of investments		2,517			—			—
Acquisitions, net of cash received		(22,178		)	—			—
Proceeds received from the sale of assets		149			16,467			10,027
Acquisitions of intangibles		(566		)	—			—
Acquisitions of goodwill		(1,057		)	(339		)	(156		)
Net cash provided by/(used in) investing activities		(23,522		)	12,950			6,139
Cash flows from financing activities
Notes payable - banks, net		—			(10,000		)	(10,704		)
Payment of notes payable		(2,636		)	—			—
Stock options exercised		959			449			30
Purchase of treasury shares		(1,230		)	(6,141		)	(3,415		)
Stock issued on employee stock purchase plan		391			1,102			1,445
Net cash used in financing activities		(2,516		)	(14,590		)	(12,644		)
Effect of foreign currency gains/ (losses)		206			(274		)	(1,952		)
Net increase/ (decrease) in cash and cash equivalents		(7,159		)	18,736			23,474
Cash and cash equivalents at beginning of year		59,769			41,033			17,559
Cash and cash equivalents at end of year		$	52,610		$	59,769		$	41,033
Supplemental disclosures of cash flow information:
Cash paid/(received) during the year for:
Interest		$	(427	)	$	(461	)	$	(106	)
Income taxes		(20,339		)	(10,967		)	(24,097		)
Details of acquisition:
Tangible assets acquired (including cash of $347)		$	13,083		$	—		$	—
Liabilities assumed		(7,442		)	—			—
Goodwill		13,958			—			—
Intangibles		2,926			—			—
Cash paid		22,525			—			—
Less: cash received in acquisition		(347		)	—			—
Net cash paid*		$	22,178		$	—		$	—
Book value of assets held for sale, net of cash								$	22,116
Liabilities								11,735
Net assets held for sale before write-down, net of cash								$	10,381

 

*  Includes a $1.5 million note payment

 

 

Non Cash Activities:

 

During 2002, the Company recorded a refundable income tax and tax benefit reserve of $19.6 million.

 

 

The accompanying notes are an integral part of these statements.

 

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Computer Horizons Corp. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003, 2002 and 2001

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Description of Business

 

Computer Horizons Corp. is a strategic e-Business solutions and professional services company which does business principally in the United States.  The Company enables its Global 2000 (which Forbes magazine defines as the biggest and most important companies as measured by sales, profits, assets and market value) customer base to realize competitive advantages through three major divisions, IT Services, Solutions and Chimes, Inc.  The IT Services division provides highly skilled software professionals to augment the internal information management staffs of major corporations. The Solutions division, which includes RGII Technologies Inc., (“RGII”), provides enterprise application services, e-business solutions, customized Web development and Web enablement of strategic applications, Customer Relationship Management (CRM), network services, strategic outsourcing and managed resourcing as well as software and relational database products.  RGII provides innovative technology services and solutions to the federal, state and local government markets.  Chimes, Inc., a wholly-owned subsidiary of CHC, provides workforce procurement and management services to Global 2000 companies.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of Computer Horizons Corp. and its wholly-owned and majority-owned subsidiaries (the “Company”).  All subsidiaries of the Company have been consolidated into these financial statements.  ISG - Canada reports their financials on a one-month lag.  All material intercompany accounts and transactions have been eliminated.

 

Revenue Recognition

 

Approximately 94% and 93% of consolidated revenue in 2003 and 2002, respectively, was derived from time-and-material contracts.

 

For the IT Services division revenues are recognized as services are performed under time-and material contracts.  Under a typical time-and-material billing arrangement, our customers are billed on a regularly scheduled basis, such as biweekly or monthly.  At the end of each accounting period, unbilled revenue is estimated and accrued for services performed since the last billing cycle.  These unbilled amounts are billed the following month.

 

The Solutions Group recognizes revenue either on a time-and-material basis as described above or on a fixed fee basis, however, principally with time-and-material contracts. For fixed-fee contracts, revenue is recognized on the basis of the estimated percentage of completion based on costs incurred relative to total estimated costs.  Each fixed fee contract has different terms, milestones and deliverables.  The milestones and deliverables primarily relate to the work to be performed and the timing of the billing.  At the end of each reporting period an assessment of revenue recognized on the percentage of completion and milestones achieved criteria is made.  If it becomes apparent that estimated cost will be exceeded or required milestones or deliverables will not have been obtained, an adjustment will be made.  The cumulative effect of revisions in estimated revenues and costs are recognized in the period in which the facts that give rise to the impact of any revisions become known.

 

34

 

Unbilled accounts receivables represent amounts recognized as revenue based on services performed in advance of customer billings principally on a time-and-material basis.  At the end of each accounting period, revenue is accrued for services performed since the last billing cycle.  These unbilled amounts are billed the following month.  Costs and estimated earnings in excess of billing on fixed fee contracts arise when percentage of completion accounting is used.  Such amounts are billed at specific dates or at contract completion.

 

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

 

The Company’s Princeton subsidiary recognized revenue in accordance with AICPA Statement of Position 97-2 (“SOP 97-2”), “Software Revenue Recognition,” and AICPA Statement of Position 98-9 (“SOP 98-9”).  Under SOP 97-2, the Company recognized software license revenue when a noncancelable license agreement had been executed, fees were fixed and determinable, the software had been delivered, and collection was considered probable.  Princeton Softech was sold on March 25, 2002, (see Note 17).

 

Recruitment Costs

 

Recruitment costs are charged to operations as incurred.

 

Advertising Costs

 

The Company expenses all advertising costs as incurred and classifies these costs under selling, general and administrative expenses.  Advertising costs for the years ended December 31, 2003, 2002 and 2001 were $ 0.2 million, $0.3 million and $0.6 million, respectively.

 

Research and Development Costs

 

The Company charges all costs incurred to establish the technological feasibility of software products or product enhancements to research and development costs, which are included in selling, general and administrative expenses.  Research and Development costs for the years ended December 31, 2003, 2002 and 2001 were approximately $98,000, $0.9 million and $5.4 million, respectively.

 

35

 

Cash and Cash Equivalents

 

Cash and cash equivalents include highly liquid instruments with an original maturity of three months or less at the time of purchase and consist of the following at December 31:

 

		2003			2002
		in thousands
Cash		$	17,499		$	21,208
Commercial paper		32,954			36,963
Restricted cash		2,157			1,598
		$	52,610		$	59,769

 

Restricted cash represents funds received by Chimes and held in client-specific bank accounts, to be used to make payments to vendors of the applicable client.

 

Investments

 

The Company’s marketable securities are categorized as available-for-sale securities, as defined by the Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities.”  Unrealized gains and losses are reflected as a net amount under the caption of accumulated other comprehensive loss within the statement of stockholders’ equity.  Realized gains and losses are recorded within the statement of income under the caption other income or expenses. For the purposes of computing realized gains and losses, cost is identified on a specific identification basis.

 

Concentrations of Credit Risk

 

Financial instruments, which potentially subject the Company to concentrations of credit risk, regardless of the degree of such risk, consist principally of cash and cash equivalents and trade accounts receivable. The Company invests the majority of its excess cash in overnight commercial paper of high-credit, high quality short-term money market instruments, high-quality financial institutions or companies, with certain limitations as to the amount that can be invested in any one entity.

 

The Company maintains its cash balances principally in nine financial institutions located in the United States, Canada, India and the United Kingdom.  The balances in U.S. banks are insured by the Federal Deposit Insurance Corporation up to $100,000 for each entity at each institution. The balance in the Canadian bank is insured by the Canadian Deposit Insurance Corporation up to $60,000 Canadian (approximately $46,000 U.S.).  The balance in the Indian bank is insured by the Deposit Insurance and Credit Guarantee Corporation up to 100,000 Rupees (approximately $2,000 U.S.).  There is no depository insurance in the United Kingdom.  At December 31, 2003, uninsured amounts held by the Company at these financial institutions total approximately $51,862,000.  At December 31, 2003, the Company had approximately $1,945,000 in cash maintained in overseas financial institutions.

 

The Company’s customers are generally very large, Global 2000 companies in many industries and with wide geographic dispersion.  For the years ended December 31, 2003, 2002 and 2001, the Company’s ten largest clients accounted for approximately 38%, 38% and 30% of its revenues, respectively. The Company’s largest customers are the Federal Government and the City of New York. The Federal Government accounts for approximately 16.0% of consolidated billed accounts receivable at December 31, 2003 and the City of New York accounts for approximately 10.0 %, 19.6% and 15.0% of billed accounts receivable at December 31, 2003, 2002 and 2001, respectively.  Revenues from the Federal Government totaled approximately $18 million, or 7% of total consolidated revenues.  Revenues from the City of New York totaled approximately $12.5 million, or 5% of total consolidated revenues, $11.9 million, or 4% of total consolidated revenues and $9.1 million, or 2% of total consolidated revenues for the years ended December 31, 2003, 2002 and 2001, respectively.  Historically, there have been no collection issues with either customer; however, the payment cycle is significantly slower than the Company’s commercial customers.   The

 

36

 

Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends, and other information.

 

Fair Value of Financial Instruments

 

The carrying value of financial instruments (principally consisting of cash and cash equivalents, accounts receivable and payable) approximates fair value because of their short maturities.

 

Property and Equipment and Depreciation

 

Property and equipment are stated at cost.  Depreciation is computed using the straight-line method over the estimated useful lives of the assets which range from three to seven years.

 

Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of

 

Up to and including the year ended December 31, 2001, the Company evaluated its long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicated that the carrying amount of such assets or intangibles may not be recoverable.  Recoverability of assets to be held and used was measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset.  If such an asset was considered to be impaired, the impairment to be recognized was measured by the amount by which the carrying amount of the asset exceeded the fair value of the assets.  Assets to be disposed of were reported at the lower of the carrying amount or fair value less costs to sell.

 

Effective on January 1, 2002, the Company adopted Financial Accounting Standard No. 144 “Accounting for the Impairment or Disposal of Long Lived Assets,” (“SFAS 144”).  This supersedes SFAS 121, while retaining many of the requirements of such statement. The effect of this statement was immaterial to the Company.

 

Income Taxes

 

The Company and its domestic subsidiaries file a consolidated Federal income tax return.  The foreign subsidiaries file in each of their local jurisdictions.

 

The Company follows the liability method of accounting for income taxes.  Income taxes are provided for the tax effects of transactions reported in the financial statements and consist of taxes currently due plus deferred taxes.  Deferred income taxes are recognized for temporary differences between the financial statement carrying amounts and the tax bases of certain assets and liabilities.  Temporary differences result primarily from net operating loss carryovers, amortization of goodwill, allowance for doubtful accounts and certain accrued liabilities which are deductible, for tax purposes, only when paid.  In assessing the realizability of deferred tax assets, management considers the scheduled reversal periods of the deferred tax assets as well as projected future taxable income and tax planning strategies.  A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax asset will not be realized.

 

Tax benefits from early disposition of the stock by optionees under incentive stock options and from exercise of non-qualified options are credited to additional paid-in capital.

 

The Company provides United States income taxes on the earnings of foreign subsidiaries, unless they are considered permanently invested outside the United States.  As of December 31, 2003, there is no cumulative amount of foreign earnings on which United States income taxes have not been provided.

 

Loss Per Share

 

Basic loss per share is based on the weighted average number of common shares outstanding without consideration of common stock equivalents.  Diluted loss per share is based on the weighted average

 

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number of common and common equivalent shares outstanding, except when the effect is anti-dilutive.  The calculation takes into account when dilutive, the shares that may be issued upon exercise of stock options, reduced by the shares that may be repurchased with the funds received from the exercise, based on the average price during the year.  For all years presented all stock options (See Note 8) were excluded for diluted loss per share because they were antidilutive.

 

Use of Estimates in Financial Statements

 

In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

 

Foreign Currency Translation

 

For operations outside the United States that prepare financial statements in currencies other than the United States dollar (Canadian dollar, British pound, and Indian Rupee), results of operations and cash flows are translated at the average exchange rates during the period, and assets and liabilities are translated at end of period exchange rates.  Translation adjustments are included as a separate component of comprehensive income/(loss) within the statement of shareholders’ equity.

 

Accounts Receivable

 

Accounts receivable are generally due within 30 days and are stated at amounts due from customers net of an allowance for doubtful accounts.  Accounts outstanding longer than the contractual payment terms are considered past due.  The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company and the condition of the general economy and the industry as a whole.  The Company writes off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts.

 

Goodwill

 

In June 2001, the Financial Accounting Standards Board approved the issuance of SFAS No. 141, “Business Combinations” and in July 2001, SFAS 142, “Goodwill and Other Intangible Assets.”  The new standards require that all business combinations initiated after June 30, 2001 must be accounted for under the purchase method.  In addition, all intangible assets acquired that are obtained through contractual or legal right, or are capable of being separately sold, transferred, licensed, rented or exchanged are recognized as an asset apart from goodwill.  Goodwill and intangibles with indefinite lives are no longer subject to amortization, but are subject to at least an annual assessment for impairment by applying a fair value based test.  The Company adopted SFAS 142 as of January 1, 2002 and in compliance with this new regulation has discontinued the amortization of goodwill.

 

During the quarter ended June 30, 2002, the Company completed the initial valuation of the carrying value of goodwill existing at January 1, 2002.  As a result, a non-cash charge of $29.9 million, or $(0.96) per share was retroactively recorded as the cumulative effect of an accounting change in the six months ended June 30, 2002 statement of operations.  For the years ended December 31, 2003 and 2002 the Company completed valuations of the carrying value of the remaining goodwill and it was determined that no additional impairment had occurred.

 

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The changes in the carrying amount of goodwill for the years ended December 31, 2003 and 2002, are as follows (in 000’s):

 

Reporting Units		December 31, 2003			December 31, 2002
Balance as of January 1,		$	19,203		$	48,725
Additions to goodwill* (Solutions)		15,015			339
Impairment losses (IT Services and Education)		—			(29,861		)
Balance as of December 31,		$	34,218		$	19,203

 

* Reflects goodwill recorded as a result of the RGII ($14,588) and Global Business Technology Services, (“GBTS”) ($427) acquisitions.  See Note 15 of the notes to the consolidated financial statements.

 

The reporting units are equal to, or one level below, reportable segments.  The Company engaged independent valuation consultants to assist with the transitional goodwill impairment tests.

 

As of December 31, 2003 and 2002, the fair value of each of the reporting units was calculated using the following approaches (i) market approach and (ii) income approach.  Under the market approach, value is estimated by comparing the performance fundamentals relating to similar public companies’ stock prices.  Multiples are then developed of the value of the publicly traded stock to various measures and are then applied to each reporting unit to estimate the value of its equity.  Under the income approach, value was determined using the present value of the projected future cash flows to be generated by the reporting unit.

 

The fair value conclusion of the reporting units reflects an appropriately weighted value of the market multiple approach and the income approach discussed above.  An asset approach was not used because the asset approach is most relevant for liquidation approaches, investment company valuations and asset rich company valuations (i.e. real estate entities) and was not deemed relevant for manufacturing and service company going-concern valuations.  When either the income approach or the market approach was used, each indicted value of the Solutions entity’s equity exceeded the carrying value of the Solutions entity by at least $12 million and $15 million as of December 31, 2003 and 2002, respectively.  Since each of the two approaches yielded values in excess of carrying value, any weighting of the two approaches or either approach used alone results in the same conclusion, that the goodwill was not impaired.

 

When the other entities, of the Company, were tested (IT Services and Education), in the second quarter 2002 initial valuation, both approaches yielded an indicated value which was below the carrying value of those entity’s equity, in such an amount that the entire amount of goodwill was written off.  As a result, a loss of $29.9 million was recognized in June 2002 and recorded as a cumulative effect of change in accounting principle in the accompanying Consolidated Statements of Operations.  There was no income tax effect on the impairment charge as approximately $19 million of the charge related to goodwill in foreign tax jurisdictions where the Company believes it is more likely than not that future taxable income in these jurisdictions will not be sufficient to realize the related income tax benefits associated with the charge.  The remaining $11 million of the charge was related primarily to goodwill that was acquired prior to the ability to deduct goodwill for tax purposes.

 

39

 

The following pro forma table shows the effect of amortization expense and the cumulative effect of change in accounting principle on the Company’s net loss as follows:

 

		December 31, 2003			December 31, 2002			December 31, 2001
Reported net loss		$	(14,948	)	$	(38,036	)	$	(14,450	)
Cumulative effect of change in accounting  principle		—			29,861			—
Amortization of intangibles		—			—			2,695
Adjusted net loss		$	(14,948	)	$	(8,175	)	$	(11,755	)
Reported loss per share:
Basic & Diluted		$	(0.49	)	$	(1.22	)	$	(0.45	)
Adjustment for cumulative effect of change in accounting principle:
Basic & Diluted		—			0.96			—
Adjustment for amortization of intangibles:
Basic & Diluted		—			—			0.08
Adjusted loss per share:
Basic & Diluted		$	(0.49	)	$	(0.26	)	$	(0.37	)

 

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Intangible Assets

 

Intangible assets are the result of the acquisition, in July 2003, of certain assets and operations of RGII and the acquisition of the Xpress software from Commerce One. During the third quarter of 2003, the Company completed a purchase price allocation review and according to SFAS No. 142, assessed the useful lives of its acquired intangible assets.

 

The following table summarizes the acquired intangible assets, the remaining components and the accumulated amortization as of December 31, 2003 (in thousands):

 

		Gross Carrying Amount				Accumulated Amortization				Net Carrying Amount
Amortized intangible assets:
Non-compete agreements		$		250		$		18		$		232
RGII trademark		150				75				75
RGII software		726				74				652
Customer contracts		1,800				854				946
Xpress software		566				63				503
Total		$	3,492			$	1,084			$	2,408

 

Intangible assets are being amortized over periods ranging from six months to seven years, based on the estimated useful lives. The amortization expense on these intangible assets for the year ended December 31, 2003 was $1,084,000.  The estimated remaining amortization expense for each year ending December 31, is as follows (in thousands):

 

 

Recent Accounting Pronouncements

 

In November 2002, the EITF reached a consensus on Issue No. 00-21, “ Accounting for Revenue Arrangements with Multiple Deliverables.”  This Issue provides guidance on when and how to separate elements of an arrangement that may involve the delivery or performance of multiple products, services and rights to use assets into separate units of accounting.  The guidance in the consensus is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003.  The transition provision allows either prospective application or a cumulative effect adjustment upon adoption.  The effect of the adoption of this statement was immaterial to the Company.

 

41

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”  It establishes classification and measurement standards for three types of freestanding financial instruments that have characteristics of both liabilities and equity.  Instruments within the scope of SFAS 150 must be classified as liabilities within the Company’s financial statements.  The provisions of SFAS No. 150 are effective for (1) instruments entered into or modified after May 31, 2003 and (2) pre-existing instruments as of the first interim period after June 15, 2003.  SFAS 150 did not have a material effect on the Company’s financial statements.

 

In January 2003, the FASB issued Financial Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), which addresses consolidation by business enterprises of variable interest entities (“VIEs”).  The accounting provisions and disclosure requirements of FIN 46 are effective immediately for VIEs created after January 31, 2003, and are effective for reporting periods ending after December 15, 2003, for VIEs created prior to February 1, 2003.  In December 2003, the FASB published a revision to FIN 46 (“FIN 46R”) to clarify some of the provisions of the interpretation and to defer the effective date of implementation for certain entities.  Under the guidance of FIN 46R, public companies that have interests in VIE’s that are commonly referred to as special purpose entities are required to apply the provisions of FIN 46R for periods ending after December 15, 2003.  A public company that does not have any interests in special purpose entities but does have a variable interest in a VIE created before February 1, 2003, must apply the provisions of FIN 46R by the end of the first interim or annual reporting period ending after March 14, 2004.  Although the Company is still evaluating the impact of FIN 46R, it is not expected to have a material effect on the Company’s financial statements.

 

42

 

Accounting for Stock Based Compensation

 

In December 2002, the Financial Accounting Standards Board approved the issuance of SFAS No. 148, “Accounting for Stock-Based Compensation – Translation and Disclosure.”  This statement amends FASB Statement No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  In addition, this Statement amended the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the methods used on reported results.  The Company adopted the disclosure provisions as of December 31, 2002.

 

The exercise price per share on all options granted may not be less than the fair value at the date of the option grant.  The Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” as modified by FIN 44, “Accounting for Certain Transactions Involving Stock Compensation,” in accounting for stock-based employee compensation, whereby no compensation cost had been recognized for the plans.  The Company expects to continue following the guidance under APB 25 for stock based compensation to employees.  Had compensation cost for the plans been determined based on the fair value of the options at the grant dates and been consistent with the method of SFAS No. 123, the Company’s net loss and loss per share would have been reduced to the pro forma amounts indicated below:

 

				2003			2002			2001
Net loss		As reported		$	(14,948,000	)	$	(38,036,000	)	$	(14,450,000	)
		Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(2,401,000		)	(3,334,000		)	(3,847,000		)
		Pro forma		$	(17,349,000	)	$	(41,370,000	)	$	(18,297,000	)
Earnings per share
Basic		As reported		$	(0.49	)	$	(1.22	)	$	(0.45	)
		Pro forma		(0.57		)	(1.32		)	(0.57		)
Diluted		As reported		$	(0.49	)	$	(1.22	)	$	(0.45	)
		Pro forma		(0.57		)	(1.32		)	(0.57		)

 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted-average assumptions used for grants in 2003, 2002 and 2001, respectively:  expected volatility of 62%, 64% and 84%; risk-free interest rates of 4.27%, 3.62% and 5.14%; and expected lives of 7.8, 4.4 and 8.1 years.

 

Reclassifications

 

Certain reclassifications have been made to the 2002 and 2001 comparative financial statements to conform to the 2003 presentation.

 

43

 

NOTE 2 - ACCOUNTS RECEIVABLE

 

Accounts receivable consist of the following at December 31:

 

		2003			2002
		(in thousands)
Billed		$	44,489		$	49,453
Unbilled		9,238			14,859
		53,727			64,312
Less allowance for doubtful accounts		5,432			7,696
		$	48,295		$	56,616

 

 

NOTE 3 – PROPERTY AND EQUIPMENT

 

Property and equipment consist of the following:

 

		2003			2002
		(in thousands)
Furniture, Fixtures and Equipment		$	36,527		$	32,530
Software		3,242			2,651
Leasehold Improvements		2,483			2,483
		42,252			37,664
Less accumulated depreciation		32,929			26,647
		$	9,323		$	11,017

 

Property and equipment are stated at cost.  Depreciation is computed using the straight-line method over the estimated useful lives of the assets which range from three to seven years.  Depreciation expense was $5.3 million, $4.6 million and $5.3 million for the years ended December 31, 2003, 2003 and 2001, respectively.

 

 

NOTE 4 – ASSET-BASED LENDING FACILITY

 

On July 31, 2001, amended February 14, 2003, the Company entered into a secured asset-based lending facility that replaced its two unsecured discretionary lines of credit.  This new line of credit is a three-year, $40 million facility with availability based primarily on eligible customer receivables and requires a separate lockbox.  The interest rate for the first ninety days from closing was Prime plus 0.5%, thereafter the rate was LIBOR plus 2.75% based on the unpaid principal.  The borrowing base less outstanding loans must equal or exceed $17.5 million.  At the time of closing there was a $170,000 commitment fee paid to the agent.

 

As of December 31, 2003, the Company had no outstanding loan balance against this facility.  Borrowings under this facility are collateralized by certain assets of the Company.  Based on the Company’s eligible customer receivables and cash balances, $16.0 million, $24.7 million and $23.1 million was available for borrowing as of December 31, 2003, 2002 and 2001, respectively.  The fee for the unused portion of the line of credit is 0.375% per annum charged to the Company monthly.  This charge was approximately $109,000, $144,000 and $42,000 for the year ended December 31, 2003, 2002 and 2001, respectively.  This line

 

44

 

of credit includes covenants relating to the maintenance of cash balances and providing for limitations on incurring obligations and spending limits on capital expenditures.  One covenant pertains to minimum cash collections over a three-month period.  The Company did not satisfy this covenant for the period December 2003 through February 2004.  A waiver was received from the lending institution.  This facility is scheduled to expire in July 2004 and the Company intends to enter into a new asset-based lending facility prior to expiration.

 

NOTE 5 - PURCHASE OF TREASURY STOCK

 

In April of 2001, the Board of Directors approved the repurchase in the open market of up to 10% of its common shares outstanding, or approximately 3.2 million shares.  For the year ended December 31, 2003, the Company had repurchased, in the open market, 392,200 shares of its stock at an average price of $3.08 per share for an aggregate purchase amount of $1.2 million.  For the year ended December 31, 2002, the Company had repurchased, in the open market, 1,611,700 shares of its stock at an average price of $3.81 per share for an aggregate purchase amount of $6.1 million.  As of December 31, 2003 the remaining authorization for repurchase is approximately 93,000 shares.

 

NOTE 6 - SHAREHOLDERS’ EQUITY

 

Stock Options

 

In 1994, the Company adopted a stock option plan which provides for the granting of options, to officers and key employees, for the purchase of a maximum of 7,594,000 shares of common stock and stock appreciation rights (“SARs”). Options and SARs generally expire ten years from the date of grant and become exercisable in specified amounts during the life of the respective options.  No SARs have been granted as of December 31, 2003.  This plan, which replaces the Company’s 1985 Plan, will terminate on June 15, 2004.  There were 2,427,000, 2,036,000 and 1,930,000 shares available for option at December 31, 2003, 2002 and 2001, respectively.

 

In 1998, the Company amended the non-qualified Directors’ Stock Option Plan, providing that each new director of the Company who is not an employee of the Company (i) shall immediately receive options to purchase 10,000 shares of its common stock and (ii) shall receive annual grants to purchase 10,000 shares of its common stock.  The plan originally was to expire on March 4, 2001 and was extended by the Board of Directors and Shareholders to March 6, 2007.  There were 264,000, 334,000 and 384,000 shares available for grant at December 31, 2003, 2002 and 2001, respectively.

 

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A summary of the status of the Company’s stock option plans as of December 31, 2003, 2002 and 2001, and changes during the years ending on those dates is presented below:

 

		2003					2002					2001
		Shares (000’s)		Weighted average exercise price			Shares (000’s)		Weighted average exercise price			Shares (000’s)		Weighted average exercise price
Outstanding – January 1		4,527		$	7.93		4,841		$	10.11		4,216		$	13.05
Granted		1,527		3.76			1,340		3.68			1,535		2.17
Exercised		(361	)	2.66			(266	)	1.47			(15	)	2.02
Canceled/forfeited/expired		(1,848	)	13.27			(1,388	)	12.45			(895	)	10.47
Outstanding – December 31		3,845		4.08			4,527		7.93			4,841		10.11
Options exercisable – December 31		1,420		4.98			2,573		10.89			2,749		12.97
Weighted average fair value of options granted during the year				$	1.93				$	2.72				$	1.85

 

The following information applies to options outstanding at December 31, 2003:

 

Range of exercise prices		Outstanding as of December 31, 2003 (000’s)		Weighted average remaining contractual life		Weighted average exercise price			Exercisable as of December 31, 2003 (000’s)		Weighted average exercise price
$2.02 – $9.99		3,659		8.5		$	3.40		1,234		$	3.12
10.00 – 14.99		71		1.8		11.93			71		11.93
15.00 – 19.99		50		5.0		16.37			50		16.37
20.00 – 26.625		65		4.0		24.06			65		24.06
		3,845		8.2		$	4.08		1,420		$	4.98

 

Prior to 2002, certain officers had the right to borrow from the Company against the exercise price of options exercised.  As of December 31, 2003 and 2002, total outstanding borrowings, pertaining to one officer, amounted to $100,000 which was issued by the Company in 1999, prior to the adoption of FIN 44 and the Sarbanes-Oxley Act of 2002.

 

In 2001, the Company adopted a stock option plan for its Princeton subsidiary which provided for the granting, to Princeton key employees, of options for the purchase of a maximum of 3,000,000 shares of Princeton common stock.  These options expire ten years from the date of grant and become exercisable in two years.  As of the date of the sale of Princeton, the stock option plan was terminated.

 

The Company issued 150,001 warrants in 2003 to purchase shares of its common stock to one major shareholder.  The exercise price is the fair value at the date of grant.  As of December 31, 2003, 152,134 warrants were outstanding.  There were no warrants exercised in 2003, 2002 or 2001.

 

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