** **

**UNITEDSTATES**

**SECURITIES AND EXCHANGE COMMISSION**

## **Washington, D.C. 20549**

 

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**FORM 10-Q**

 

**(Mark One)**

 

**ý****                                ****QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.**

 

**For the quarterly period ended April 3,2005**

 

**or**

 

**o****                                ****TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.**

 

**For theTransition Period From              to              **

 

**Commission file number 0-26786**

 

**APAC Customer Services, Inc.**

(Exact name of registrant as specified in itscharter)

 
| **Illinois**                                                    | ** ** | **36-2777140**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction  of incorporation or organization) | ** ** | (I.R.S. Employer  Identification No.) |
|                                                            |       |                                  |
| **Six Parkway North, Deerfield, Illinois  60015**          |
| (Address of Principal Executive  Offices, Zip Code)             |

 

Registrant’s telephone number,including area code:  **(847)374-4980**

 

Indicate by check mark whether registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter periods that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes ý         No o

 

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

 

Yes ý         No o

 

There were 49,454,654 common shares, $0.01 par valueper share, outstanding as of May 12, 2005.

 

 

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## **Index**

 
| **Part I. Financial Information**                                                                   |                                                                                                                       |
|-----------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------|
|                                                                                                |                                                                                                                       |   |
| Item 1. Consolidated Condensed Financial  Statements (Unaudited):                                   |                                                                                                                       |
|                                                                                                |                                                                                                                       |   |
|                                                                                                | Consolidated Condensed Balance Sheets as of  April 3, 2005, and January 2, 2005                                  |   |
|                                                                                                |                                                                                                                       |   |
|                                                                                                | Consolidated Condensed Statements of  Operations for the Thirteen Weeks Ended April 3, 2005, and March 28,  2004 |   |
|                                                                                                |                                                                                                                       |   |
|                                                                                                | Consolidated Condensed Statements of Cash  Flows for the Thirteen Weeks Ended April 3, 2005, and March 28,  2004 |   |
|                                                                                                |                                                                                                                       |
|                                                                                                | Notes to Consolidated Condensed Financial  Statements..                                                                    |   |
|                                                                                                |                                                                                                                       |
| Item 2. Management’s Discussion and  Analysis of Financial Condition and Results of Operations |                                                                                                                       |
|                                                                                                |                                                                                                                       |
| Item 3. Quantitative and Qualitative  Disclosures About Market Risk                                 |                                                                                                                       |
|                                                                                                |                                                                                                                       |
| Item 4. Controls and Procedures.                                                                    |                                                                                                                       |
|                                                                                                |                                                                                                                       |
| **Part II. Other Information**                                                                      |                                                                                                                       |
|                                                                                                |                                                                                                                       |
| Item 1. Legal Proceedings                                                                           |                                                                                                                       |
|                                                                                                |                                                                                                                       |
| Item 6. Exhibits.                                                                                   |                                                                                                                       |

 

2

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## **Part I. FinancialInformation**

 

# **Item1.**Consolidated Condensed Financial Statements

 

## **APAC Customer Services, Inc. and Subsidiaries**

**Consolidated Condensed Balance Sheets**

**(Unaudited)**

**(In thousands, except share data)**

 
| ** **                                                                                                                                | ** ** | **April 3,  2005** | ** ** | **January 2,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|---------------------------|------------|
| ** **                                                                                                                                | ** ** | ** **              | ** ** | ** **                | ** ** |
| **Assets**                                                                                                                                | ** ** | ** **              | ** ** | ** **                | ** ** |
| **Current  assets:**                                                                                                                      |       |                    |       |                      |       |
| Cash and cash equivalents                                                                                                                 |       | $                       | 110        |                      | $          | 271 |   |
| Accounts receivable, net                                                                                                                  |       | 43,920                  |       | 41,002                    |       |
| Other current assets                                                                                                                      |       | 10,561                  |       | 11,253                    |       |
| Total current assets                                                                                                                      |       | 54,591                  |       | 52,526                    |       |
|                                                                                                                                      |       |                    |       |                      |       |
| **Property  and equipment, net**                                                                                                          |       | 24,513                  |       | 24,214                    |       |
|                                                                                                                                      |       |                    |       |                      |       |
| **Goodwill**                                                                                                                              |       | 23,876                  |       | 23,876                    |       |
|                                                                                                                                      |       |                    |       |                      |       |
| **Other  intangible assets, net**                                                                                                         |       | 12,101                  |       | 12,688                    |       |
|                                                                                                                                      |       |                    |       |                      |       |
| **Deferred  taxes**                                                                                                                       |       | 8,345                   |       | 5,748                     |       |
| ** **                                                                                                                                |       |                    |       |                      |       |
| **Other  assets**                                                                                                                         |       | 462                     |       | 481                       |       |
| Total assets                                                                                                                              |       | $                       | 123,888    |                      | $          | 119,533 |   |
|                                                                                                                                      |       |                    |       |                      |       |
| **Liabilities and Shareholders’ Equity**                                                                                             |       |                    |       |                      |       |
| **Current  liabilities:**                                                                                                                 |       |                    |       |                      |       |
| Current maturities of long-term debt                                                                                                      |       | $                       | 5,511      |                      | $          | 313 |   |
| Accounts payable                                                                                                                          |       | 3,656                   |       | 3,544                     |       |
| Income taxes payable                                                                                                                      |       | 17,608                  |       | 16,629                    |       |
| Accrued payroll and related items                                                                                                         |       | 15,732                  |       | 15,048                    |       |
| Accrued liabilities                                                                                                                       |       | 8,217                   |       | 8,481                     |       |
| Total current liabilities                                                                                                                 |       | 50,724                  |       | 44,015                    |       |
|                                                                                                                                      |       |                    |       |                      |       |
| **Long-term  debt, less current maturities**                                                                                              |       | —                  |       | —                    |       |
|                                                                                                                                      |       |                    |       |                      |       |
| **Other  liabilities**                                                                                                                    |       | 1,342                   |       | 1,355                     |       |
|                                                                                                                                      |       |                    |       |                      |       |
| **Commitments  and contingencies**                                                                                                        |       | —                  |       | —                    |       |
|                                                                                                                                      |       |                    |       |                      |       |
| **Shareholders’  equity**                                                                                                            |       |                    |       |                      |       |
| Common shares, $0.01 par value; 200,000,000  shares authorized; 49,695,699 shares issued at April 3, 2005, and January 2,  2005 |       | 497                     |       | 497                       |       |
| Additional paid-in capital                                                                                                                |       | 99,598                  |       | 99,598                    |       |
| Accumulated deficit                                                                                                                       |       | (27,294                 | )          | (24,912                   | )          |
| Accumulated other comprehensive loss                                                                                                      |       | (132                    | )          | (173                      | )          |
| Treasury shares: 241,045 shares, at cost at  April 3, 2005 and January 2, 2005                                                  |       | (847                    | )          | (847                      | )          |
| Total shareholders’ equity                                                                                                           |       | 71,822                  |       | 74,163                    |       |
| Total liabilities and shareholders’ equity                                                                                           |       | $                       | 123,888    |                      | $          | 119,533 |   |

 

Seenotes to consolidated condensed financial statements

 

3

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**APACCustomer Services, Inc. and Subsidiaries**

**Consolidated Condensed Statements ofOperations**

**(Unaudited)**

**(In thousands, except  share data)**

 
| ** **                                               | ** ** | **Thirteen Weeks Ended**  | ** ** |
|----------------------------------------------------------|------------|---------------------------|------------|
| ** **                                               | ** ** | **April 3,****2005** | ** ** | **March 28,****2004** | ** ** |
| ** **                                               | ** ** | ** **                | ** ** | ** ** | ** ** |
| **Net revenue**                                          |       | $                         | 65,674     |   | $ | 71,404 |   |
| Cost of  services                                        |       | 58,974                    |       | 60,130 |   |
| **Gross Profit**                                         |       | 6,700                     |       | 11,274 |   |
|                                                     |       |                      |       |   |   |
| **Operating expenses:**                                  |       |                      |       |   |   |
| Selling,  general and administrative  expenses      |       | 9,861                     |       | 10,819 |   |
| Restructuring  and other charges                         |       | 277                       |       | 851 |   |
| Asset  impairment charges                                |       | —                    |       | 2,110 |   |
| Total  operating expenses                                |       | 10,138                    |       | 13,780 |   |
| **Operating loss**                                       |       | (3,438                    | )          | (2,506 | ) |
|                                                     |       |                      |       |   |   |
| Interest  expense, net                                   |       | 182                       |       | 160 |   |
|                                                     |       |                      |       |   |   |
| **Loss before income taxes**                             |       | (3,620                    | )          | (2,666 | ) |
| Income tax benefit                                       |       | (1,238                    | )          | (1,013 | ) |
|                                                     |       |                      |       |   |   |
| **Net loss**                                             |       | $                         | (2,382     | ) | $ | (1,653 | ) |
| ** **                                               | ** ** | ** **                | ** ** | ** ** | ** ** |
| **Net loss per share:**                                  | ** ** | ** **                | ** ** | ** ** | ** ** |
| Basic                                                    |       | $                         | (0.05      | ) | $ | (0.03 | ) |
| Diluted                                                  |       | $                         | (0.05      | ) | $ | (0.03 | ) |
|                                                     |       |                      |       |   |   |
| **Weighted average number of  shares outstanding:** |       |                      |       |   |   |
| Basic                                                    |       | 49,455                    |       | 49,447 |   |
| Diluted                                                  |       | 49,455                    |       | 49,447 |   |

 

See notes to consolidated condensed financialstatements.

 

4

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**APAC Customer Services, Inc. and Subsidiaries**

**Consolidated Condensed Statements of CashFlows**

**(Unaudited)**

**(In thousands)**

 
| ** **                                             | ** ** | **Thirteen Weeks Ended** | ** ** |
|--------------------------------------------------------|------------|--------------------------|------------|
| ** **                                             | ** ** | **April 3,  2005**  | ** ** | **March 28,  2004** | ** ** |
|                                                   |       |                     |       |   |   |
| **Operating  activities:**                             |       |                     |       |   |   |
|                                                   |       |                     |       |   |   |
| Net loss                                               |       | $                        | (2,382     | ) | $ | (1,653 | ) |
| Depreciation and amortization                          |       | 2,871                    |       | 2,720 |   |
| Non-cash restructuring charges                         |       | 15                       |       | 47 |   |
| Asset impairment charges                               |       | —                   |       | 2,110 |   |
| Deferred income taxes                                  |       | (1,835                   | )          | (78 | ) |
| Change in operating assets and liabilities             |       | (1,444                   | )          | (5,156 | ) |
| Net cash used by operating activities                  |       | (2,775                   | )          | (2,010 | ) |
|                                                   |       |                     |       |   |   |
| **Investing  activities:**                             |       |                     |       |   |   |
|                                                   |       |                     |       |   |   |
| Purchases of property and equipment, net of  disposals |       | (2,584                   | )          | (2,545 | ) |
| Net cash used by investing activities                  |       | (2,584                   | )          | (2,545 | ) |
|                                                   |       |                     |       |   |   |
| **Financing  activities:**                             |       |                     |       |   |   |
|                                                   |       |                     |       |   |   |
| Borrowings under revolving credit facility             |       | 5,300                    |       | — |   |
| Payments on long-term debt                             |       | (102                     | )          | (94 | ) |
| Stock and warrant transactions                         |       | —                   |       | 11 |   |
| Net cash provided (used) by financing  activities      |       | 5,198                    |       | (83 | ) |
|                                                   |       |                     |       |   |   |
| **Net change  in cash and cash equivalents**           |       | (161                     | )          | (4,638 | ) |
|                                                   |       |                     |       |   |   |
| **Cash and  cash equivalents:**                        |       |                     |       |   |   |
| ** **                                             |       |                     |       |   |   |
| **Beginning  balance**                                 |       | 271                      |       | 11,428 |   |
| ** **                                             |       |                     |       |   |   |
| **Ending  balance**                                    |       | $                        | 110        |   | $ | 6,790 |   |

 

See notes to consolidated condensed financialstatements

 

5

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**APAC Customer Services, Inc. and Subsidiaries**

**Notes to Consolidated Condensed FinancialStatements**

**(Unaudited)**

**(Dollars in thousands, except as otherwiseindicated)**

 

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

 

The accompanyingunaudited consolidated condensed financial statements of APAC CustomerServices, Inc. and its subsidiaries (collectively, the “Company”) havebeen prepared in accordance with generally accepted accounting principles forinterim financial information and the instructions to Form 10-Q and Article 10of Regulation S-X.  Accordingly, they donot include all of the information and footnotes required by generally acceptedaccounting principles for complete financial statements.  In the opinion of management, all adjustments(consisting of normal recurring accruals) considered necessary for a fairpresentation have been included. Operating results for the thirteen week period ended April 3, 2005, are not necessarily indicative ofthe results that may be expected for the fiscal year ending January 1,2006.  The balance sheet at January 2,2005, has been derived from the audited financial statements at that date butdoes not include all of the information and footnotes required by generallyaccepted accounting principles for complete financial statements.  For additional information, refer to thefinancial statements and footnotes thereto included in the Company’s AnnualReport on Form 10-K for the year ended January 2, 2005.  Copies of the Company’s filings are availableon a web site maintained by the SEC at http://www.sec.gov.

 

**2.****              AccruedLiabilities**

 

The components ofother accrued liabilities included in the consolidated condensed balance sheetsare as follows:

 
| ** **                         | ** ** | **April 3,  2005** | ** ** | **January 2,  2005** | ** ** |
|------------------------------------|------------|-------------------------|------------|---------------------------|------------|
|                               |       |                    |       |                      |       |
| Accrued worker’s compensation |       | $                       | 3,254      |                      | $          | 3,122 |   |
| Accrued professional fees          |       | 889                     |       | 1,007                     |       |
| Restructuring charges              |       | 695                     |       | 391                       |       |
| Accrued relocation                 |       | 494                     |       | 400                       |       |
| Accrued property tax               |       | 492                     |       | 752                       |       |
| Telecommunications expenses        |       | 487                     |       | 523                       |       |
| Other                              |       | 1,906                   |       | 2,286                     |       |
| Total                              |       | $                       | 8,217      |                      | $          | 8,481 |   |

 

**3.****              IntangibleAssets**

 

* *Theidentifiable intangible assets of the Company represent acquired customerrelationships with a gross carrying value of $28,493 and accumulatedamortization of $16,392 and $15,805 as of April 3, 2005, and January 2,2005, respectively.  Under the provisionsof Statement of Financial Accounting Standards No. 142, “Goodwill and OtherIntangible Assets” (“SFAS No. 142”), identifiable intangible assets with finitelives are amortized.  The customerrelationship intangible assets are amortized on a straight-line basis over theexpected period of benefit of 12 years. Total amortization expense relatedto intangible assets as of April 3, 2005, and March 28, 2004, was$587. Annual amortization expense is expected to be $2.3 million forfiscal 2005 through 2009 and $1.0 million in fiscal 2010.

 

Under SFAS No. 142, the Company is required to test all existinggoodwill and intangible assets for impairment at least annually.  The Company’s policy is to test goodwill forimpairment as of the end of the fiscal year.

 

6

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**(Dollars in thousands, except per share dataor as otherwise indicated)**

**(Unaudited)**

 

**4.****             ****Accounting for Stock-Based Compensation**

 

For stock-based employee compensation plans, the Company has elected touse the intrinsic value method prescribed by Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”).  In accordance with APB No. 25, nocompensation expense is recognized for stock options issued to employees whenthe option price equals or exceeds the fair market value of the Company’scommon shares at the date of grant. Stock-based compensation expense for non-employees is recognized inaccordance with Statement of Financial Accounting Standards No. 123, “Accountingfor Stock Based Compensation” (“SFAS No. 123”).

 

The following table illustrates the effect on net income and earningsper share if the Company had adopted the fair value recognition provisions ofSFAS No. 123.

 
| ** **                                                             | ** ** | **Thirteen Weeks Ended** | ** ** |
|------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                             | ** ** | **April 3,  2005**  | ** ** | **March 28,  2004** | ** ** |
|                                                                   |       |                     |       |   |   |
| Net loss as reported                                                   |       | $                        | (2,382     | ) | $ | (1,653 | ) |
| Less-compensation expense on stock options,  net of income tax benefit |       | (286                     | )          | (420 | ) |
| Net loss pro forma                                                     |       | $                        | (2,668     | ) | $ | (2,073 | ) |
| Loss per share – basic                                            |       |                     |       |   |   |
| As reported                                                            |       | $                        | (0.05      | ) | $ | (0.03 | ) |
| Pro forma                                                              |       | $                        | (0.05      | ) | $ | (0.04 | ) |
| Loss per share – diluted                                          |       |                     |       |   |   |
| As reported                                                            |       | $                        | (0.05      | ) | $ | (0.03 | ) |
| Pro forma                                                              |       | $                        | (0.05      | ) | $ | (0.04 | ) |

 

In order tocalculate the pro forma information set forth above, the fair value of eachoption is estimated on the date of grant based on the Black-Scholesoption-pricing model.  Assumptionsinclude no dividend yield, risk-free interest rates ranging from 4% to 7%,expected volatility ranging between 45% and 90%, and an expected life rangingfrom 7 years to 10 years.

 

**5.****              New****Accounting Pronouncements**

 

In the fourth quarter of 2004, the FinancialAccounting Standards Board (“FASB”) issued Statement No. 123 (revised 2004), orSFAS No. 123(R), “Share-Based Payment”, which replaces SFAS No. 123 “Accountingfor Stock-Based Compensation”, and supersedes Accounting Principles BoardOpinion No. 25 (“APB”), “Accounting for Stock Issued to Employees.” SFAS No.123(R) establishes accounting standards for equity instruments that an entityexchanges for goods or services. It also addresses transactions where an entityincurs liabilities in exchange for goods or services that are based on the fairvalue of the entity’s equity instruments or that may be settled by the issuanceof those equity instruments. This Statement focuses primarily on accounting forshare-based payment transactions as it relates to employee services. SFAS No.123(R) requires a public entity to measure the value of an award of equityinstruments based on the grant-date fair value of the award. That cost is to berecognized over the period during which an employee is required to provideservice in exchange for the award (usually the vesting period). If an employeeterminates before the vesting period expires, any compensation cost recognizedto date for that individual’s equity instrument is reversed at the date

 

7

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of termination. The grant-date fair value of shareoptions and similar instruments is to be estimated using option-pricing modelsadjusted for the unique characteristics of those instruments.

 

SFAS No. 123(R) eliminates the option to use ABP Opinion 25’s intrinsic value method ofaccounting that was provided in Statement No. 123 as originally issued. UnderABP Opinion 25, issuing stock options to employees generally resulted inrecognition of no compensation cost. Statement No 123 also required pro formadisclosure showing the effect on net income and earnings per share as if theCompany had applied the fair value recognition provision of Statement No. 123.After a phase-in period for Statement No. 123(R), this type of disclosure willno longer be allowed.

 

Although alternative phase-in methods are allowedunder Statement No. 123(R), the Company has not yet determined the phase-inmethod it will use.  The Company believesthat whatever phase-in method is selected, the adoption of SFAS No. 123(R) islikely to have a material effect on the Company’s results of operations andfinancial position. On April 14, 2005, the Securities and ExchangeCommission (SEC) announced the adoption of a rule that defers the requiredeffective date of SFAS 123(R).  The SECrule provides that Statement 123(R) is now effective for registrants as of thebeginning of the first fiscal year beginning after June 15, 2005, insteadof at the beginning of the first fiscal quarter after June 15, 2005 (asprescribed originally by the FASB Statement).

 

**6.****             ****Comprehensive Income (Loss) and Accumulated OtherComprehensive Income (Loss)**

 

Comprehensive loss is as follows:

 
| ** **                               | ** ** | **Thirteen Weeks Ended** | ** ** |
|------------------------------------------|------------|--------------------------|------------|
| ** **                               | ** ** | **April 3,  2005**  | ** ** | **March 28,  2004** | ** ** |
|                                     |       |                     |       |   |   |
| Net loss                                 |       | $                        | (2,382     | ) | $ | (1,653 | ) |
| Foreign currency translation gain (loss) |       | 41                       |       | (47 | ) |
| Total comprehensive loss                 |       | $                        | (2,341     | ) | $ | (1,700 | ) |

 

Foreign currencytranslation gains and losses  relate tothe impact of a change in exchange rates on net assets located outside of theUnited States.

 

**7.****              LegalProceedings**

 

The Company is a party to an arbitrationproceeding with Apogee Enterprises, Inc. and Harmon Glass Solutions, which is describedin the Company’s Annual Report on Form 10-K for the fiscal year ended January 2,2005.

 

The Company is subject to occasionallawsuits, governmental investigations and claims arising out of the normalconduct of its business.  Management doesnot believe the outcome of any such pending claims will have a material adverseimpact on the Company’s consolidated financial position, annual results ofoperations or liquidity.  Although theCompany does not believe that any of these proceedings will result in amaterial adverse effect, no assurance to that effect can be given.

 

8

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**8.****              LongTerm Debt**

 

On December 20,2002, the Company entered into an Amended and Restated Credit Agreement (“CreditAgreement”) replacing the previous Amended and Restated Credit Facility.  Under the terms of the Credit Agreement, theCompany has a revolving credit facility, which expires on December 20,2005.  The facility initially provided$65.0 million of total credit availability which was gradually reduced to $57.5million as of September 26, 2004.

 

On October 26,2004, the Credit Agreement was amended, reducing the size of the revolver to$50 million. Under terms of the amendment, availability will vary monthly basedon the level of eligible receivables at the end of the preceding month.

 

The Credit Agreement issecured principally by a grant of a security interest in all personal propertyand fixtures of the Company.  Under theterms of the Credit Agreement, the Company is also required to maintain certainfinancial covenants which limit the Company’s ability to incur additionalindebtedness, repurchase outstanding common shares, create liens, acquire, sellor dispose of certain assets, engage in certain mergers and acquisitions andmake certain restricted payments.

 

Borrowings under theCredit Agreement incur a floating interest rate usually based on the LIBORindex rate, although the Company has the option of using an alternate base ratedefined in the agreement.  In addition, theCompany pays a commitment fee on the unused portion of the revolving facilityas well as quarterly fees on the outstanding letters of credit.

 

The Company has received a waiver of certain financial covenants setforth in that agreement.  However, thiswaiver is conditional on the Company’s completing its refinancing. On April 18,2005 the Company received a commitment from LaSalle Bank National Associationto replace its current revolving credit agreement.  This new three-year $40 million revolvingcredit facility will be based on accounts receivable to determine borrowingcapacity.  If this facility had been inplace on April 3, 2005 the Company would have had approximately $26million of borrowing capacity. The Company is currently in the process of negotiatingthe final terms of a definitive loan and security agreement that is expected tobe completed by the end of May, 2005. Although the Company believes the agreement will be signed, no assuranceto that effect can be given.

 

9

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**9.****              Restructuringand Other Charges/Asset Impairment Charges**

 

The Company recorded $0.2 million of restructuring charges in the firstquarter of fiscal 2005 related to the closure of one Customer InteractionCenter. These charges included severance costs of $0.1 million and $0.1 millionfor the write down of property and lease termination and other costs. Cashcharges totaling $0.1 million relating to the restructuring have been paidthrough April 3, 2005. The remaining $0.1 million of cash charges,primarily related to lease costs, are payable over the next year.  The Company also recorded $0.4 million ofother severance charges during the first quarter of fiscal 2005, which werepartially offset by a $0.3 million sales and use tax refund.

 

The Company recorded $0.9 million of restructuring charges in the firstquarter of fiscal 2004 related to the closure of one Customer InteractionCenter and the elimination of certain administrative and support positions.These charges included severance costs of $0.8 million resulting from theelimination of 22 administrative and support positions, and $0.1 million forthe write down of property and lease termination and other costs. The Companyalso recorded $2.1 million of asset impairment charges relating to thewrite-off of unutilized software assets.

 

Following is a summary of the fiscal 2005 year-to-date activity in thereserves established in connection with the Company’s restructuringinitiatives:

 
| ** **                           | ** ** | ** **                | ** ** | **2005**                 | ** ** | ** **              | ** ** |
|--------------------------------------|------------|---------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                           | ** ** | **January 2,  2005** | ** ** | **Charges  (Reversals)** | ** ** | **Asset****Write-down** | ** ** | **Cash****Payments** | ** ** | **April 3,  2005** | ** ** |
|                                 |       |                      |       |                     |       |                    |       |   |   |   |   |
| 2002 Restructuring Initiatives       |       |                      |       |                     |       |                    |       |   |   |   |   |
| Lease obligations and other          |       | $                         | 12         |                     | $          | —                  |       | $ | — |   | $ | (2 | ) | $ | 10 |   |
|                                 |       |                      |       |                     |       |                    |       |   |   |   |   |
| 2003 Restructuring Initiatives       |       |                      |       |                     |       |                    |       |   |   |   |   |
| Employee severance costs             |       | 302                       |       | —                   |       | —                  |       | (40 | ) | 262 |   |
| Lease obligations and other          |       | 4                         |       | —                   |       | —                  |       | — |   | 4 |   |
|                                 |       |                      |       |                     |       |                    |       |   |   |   |   |
| 2004 Restructuring Initiatives       |       |                      |       |                     |       |                    |       |   |   |   |   |
| Employee severance costs             |       | 260                       |       | —                   |       | —                  |       | (76 | ) | 184 |   |
| Lease obligations and other          |       | 65                        |       | —                   |       | —                  |       | (47 | ) | 18 |   |
|                                 |       |                      |       |                     |       |                    |       |   |   |   |   |
| 2005 Restructuring Initiatives       |       |                      |       |                     |       |                    |       |   |   |   |   |
| Employee severance costs             |       | —                    |       | 67                       |       | —                  |       | (39 | ) | 28 |   |
| Write down of property and equipment |       | **—**                | ** ** | 15                       |       | —                  | ** ** | **—** |   | 15 |   |
| Lease obligations and other          |       | —                    |       | 95                       |       | —                  |       | (20 | ) | 75 |   |
| Total                                |       | $                         | 643        |                     | $          | 177                     |       | $ | — |   | $ | (224 | ) | $ | 596 |   |

 

10

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**10.****       IncomeTaxes**

 

The Companyaccounts for income taxes using the asset and liability approach.  Under the asset and liability method,deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases.  Valuation allowances are recordedwhen management believes it is more likely than not that some portion or all ofthe deferred tax assets will not be realized in the future.  The Company records a reserve for taxcontingencies until management believes it is probable that the deductionsgiving rise to these contingencies will not be successfully challenged.  The Company’s effective income tax rate is34.2% and 38.0% for the three months ended April 3, 2005, and March 28,2004, respectively.

 

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# **Item2. Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

The Company is a leading provider of customer interaction solutions formarket leaders in the communications, financial services, health care,logistics, publishing, insurance and travel and hospitality industries. To helpits clients better manage their customer relationships, APAC Customer Servicesdevelops and delivers customer care and customer acquisition programs. TheCompany operates and manages approximately 6,800 workstations in 23 CustomerInteraction Centers. The Customer Interaction Centers are managed centrallythrough the application of telecommunications and computer technology topromote the consistent delivery of quality service.  The Company consists of a single operatingsegment that offers customer interaction solutions to its clients.

 

The following discussion of the Company’s results of operations andliquidity and capital resources should be read in conjunction with theConsolidated Condensed Financial Statements of the Company and related notesthereto appearing elsewhere in this report.

 

**Results of Operations**

 

The following table sets forth the Consolidated Condensed Statements ofOperations data as a percent of net revenue for the thirteen week periods ended April 3, 2005, and March 28,2004, respectively.

 
| ** **                                    | ** ** | **Thirteen Weeks Ended** | ** ** |
|-----------------------------------------------|------------|--------------------------|------------|
| ** **                                    | ** ** | **April 3,  2005**  | ** ** | **March 28,  2004** | ** ** |
|                                          |       |                     |       |   |   |
| **Net  revenues**                             |       | 100.0                    | %          | 100.0 | % |
| Cost of services                              |       | 89.8                     |       | 84.2 |   |
| **Gross  Profit**                             |       | 10.2                     |       | 15.8 |   |
|                                          |       |                     |       |   |   |
| **Operating  expenses:**                      |       |                     |       |   |   |
| Selling, general and administrative  expenses |       | 15.0                     |       | 15.2 |   |
| Restructuring and other charges               |       | .4                       |       | 1.2 |   |
| Asset impairment charges                      | ** ** | **—**               |       | 2.9 |   |
| Total operating expenses                      |       | 15.4                     |       | 19.3 |   |
| **Operating  income (loss)**                  |       | (5.2                     | )          | (3.5 | ) |
|                                          |       |                     |       |   |   |
| Interest expense, net                         |       | .3                       |       | .2 |   |
|                                          |       |                     |       |   |   |
| **Loss  before income taxes**                 |       | (5.5                     | )          | (3.7 | ) |
| Income tax benefit                            |       | (1.9                     | )          | (1.4 | ) |
|                                          |       |                     |       |   |   |
| **Net loss**                                  |       | (3.6                     | )%         | (2.3 | )% |

 

**Comparison of Results of Operations for the thirteen weeks ended April 3,2005, and March 28, 2004**

 

Net revenue decreased 8.0% to $65.7 million in the first quarter offiscal 2005 from $71.4 million in the same period of fiscal 2004, adecrease of $5.7 million. The revenue decline from the first quarter of fiscal2004 is primarily attributable to lower revenue rates in response to competitivepressure and reduced customer acquisition volumes related to customer cutbacksin marketing programs.

 

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Cost of services decreased $1.1 million in the first quarter of fiscal2005, or 1.9%, to $59.0 million from $60.1 million in the same period offiscal 2004. This decrease is primarily due to a reduction in cost of servicesresulting from lower direct costs associated with the decline in revenuepartially offset by increased training and information technology costs.

 

Gross profit margins decreased to 10.2% in the first three months offiscal 2005 versus 15.8% in the comparable period of fiscal 2004.  This decrease is principally due to theeffect of lower revenue rates as previously discussed, lower capacityutilization, higher labor costs, and operational improvement initiatives.

 

Selling, general and administrative expenses decreased to$9.9 million in the first quarter of fiscal 2005 from $10.8 million in thesame period of fiscal 2004, a decrease of $0.9 million or 8.9%. Expensesdeclined from the prior year primarily due to lower employee incentiveexpenses. As a percent of net revenue, selling, general and administrativeexpenses were 15.0% in the first quarter of fiscal 2005 versus 15.2% in thesame period of fiscal 2004.

 

The Company recorded $0.2 million of restructuring charges in the firstquarter of fiscal 2005 related to the closure of one Customer InteractionCenter. These charges included severance costs of $0.1 million and $0.1 millionfor the write down of property and lease termination and other costs. Cashcharges totaling $0.1 million relating to the restructuring have been paidthrough April 3, 2005. The remaining $0.1 million of cash charges,primarily related to lease costs, are payable over the next  year. The Company also recorded $0.4 million of other severance charges duringthe first quarter of fiscal 2005, which were partially offset by a $0.3 millionsales and use tax refund.

 

The Company recorded $0.9 million of restructuring charges in the firstquarter of fiscal 2004 related to the closure of one Customer InteractionCenter and the elimination of certain administrative and support positions.These charges included severance costs of $0.8 million resulting from the eliminationof 22 administrative and support positions, and $0.1 million for the write downof property and lease termination and other costs. The Company also recorded$2.1 million of asset impairment charges relating to the write-off ofunutilized software assets.

 

The Company generated a net loss of $2.4 million in the firstquarter of fiscal 2005 compared to a $1.7 million loss for the same period offiscal 2004. The decrease is primarily due to the lower revenue and grossprofit margins, partially offset by a reduction in selling, general andadministrative expenses and restructuring and asset impairment charges, aspreviously discussed.

 

The Company’s effective income tax rate is 34.2% for the three monthsended April 3, 2005, versus 38.0% in the prior year period.

 

**Critical Accounting Policies and Estimates**

 

The preparation of the Company’s financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the amounts reported in the consolidatedfinancial statements and accompanying notes. The Company believes its estimatesand assumptions are reasonable; however, actual results and the timing of therecognition of such amounts could differ from those estimates. The Company hasidentified the following critical accounting policies and estimates utilized bymanagement in the preparation of the Company’s financial statements: revenuerecognition, accounting for long-lived assets, allowance for doubtful accounts,accounting for employee benefits and income taxes. Any deviation from thesepolicies or estimates could have a material impact on the financial statementsof the Company.

 

## **Revenue recognition**

 

The Company recognizes customer services revenue as services areperformed for our clients. Client contracts generally require that clients bebilled for the Company’s services on the basis of time spent by Companyrepresentatives providing services. The Company’s services are alsoincreasingly priced on a pay-for-performance basis, pursuant to which theCompany typically receives fees that are a combination of base-rate plus feeper sale. The Company is

 

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generally subject to varying client performance standards, such asaverage handle time, occupancy rate, abandonment rate and sales per hour.  The Company’s performance against suchstandards may provide bonus opportunities, or conversely, may subject theCompany to penalties, which are recognized as earned or incurred.

 

## **Accounting for long-livedassets**

 

The Company’slong-lived assets consist primarily of property and equipment, capitalizedsoftware and intangible assets. In addition to the original cost of theseassets, their recorded value is impacted by a number of estimates made by theCompany, including estimated useful lives and salvage values. In addition, anydecision by the Company to reduce capacity by closing Customer InteractionCenters or to abandon software may result in a write-off of the net book valueof the affected assets. In accordance with SFAS No. 144, “Accounting forthe Impairment or Disposal of Long-Lived Assets,” the Company recordsimpairment charges on long-lived assets used in operations when events andcircumstances indicate that the assets may be impaired and the undiscountedcash flows estimated to be generated by those assets are less than the carryingamount of those assets. In this circumstance, the impairment charge isdetermined based upon the amount the net book value of the assets exceeds theirfair market value. In making these determinations, the Company utilizes certainassumptions, including, but not limited to, the estimated fair marketvalue of the assets, which are based on additional assumptions such as assetutilization, length of time the asset will be used in the Company’s operationsand estimated salvage values.

 

Under the provisions of SFAS No. 142, “Goodwill and Other IntangibleAssets,” the Company evaluates the remaining useful life of the customerrelationships balance at least annually to determine whether events orcircumstances warrant a revision to the remaining period of amortization.  Based on the Company’s evaluation, no changeswere made to the amortization period.

 

The amortization expense related to customer relationships as of April 3,2005, and March 28, 2004, was $587. Annual amortization expense is expected to be $2.3 million forfiscal years 2005 through 2009 and $1.0 million in fiscal 2010.

 

Under SFAS No. 142, the Company is required to test all existinggoodwill for impairment at least annually. The Company’s policy is to test goodwill for impairment as of the end ofthe fiscal year.  The Company tested thegoodwill for impairment as of January 2, 2005, resulting in no impairmentbeing recorded.

 

## **Allowance for doubtful accounts**

 

The Company records an allowancefor doubtful accounts based on a quarterly assessment of the probable estimatedlosses in trade accounts receivable. This estimate is based on specificallowances for identified problem receivables and an additional allowance forestimated losses on all other receivables based on their age and the Company’scollection history.

 

## **Accounting for employeebenefits**

 

The Company records an accrued liability for group health and workerscompensation claims based on an estimate of claims incurred, but not reported,as well as asserted claims at the end of the period. This estimate is derivedfrom an analysis performed by actuaries hired by the Company who have expertisein this area.  Although these estimatesare generally reliable, changes in the employee mix and unforeseen events couldresult in an adjustment to these estimates.

 

The balances of these accounts at April 3, 2005, and March 28,2004, were:

 
| ** **             | ** ** | **(in thousands)** | ** ** |
|------------------------|------------|--------------------|------------|
| ** **             | ** ** | **2005**           | ** ** | **2004** | ** ** |
| Group Health Insurance |       | $                  | 2,500      |   | $ | 3,519 |   |
| Workers Compensation   |       | $                  | 3,254      |   | $ | 3,097 |   |

 

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The decrease in group health insurance from March 28, 2004 isprimarily due to a reduction in the level of employee participation in thehealth insurance plan offered by the Company.

 

**Income taxes**

 

The Companyaccounts for income taxes using the asset and liability approach.  Under the asset and liability method,deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases.  Valuation allowances are recordedwhen management believes it is more likely than not that some portion or all ofthe deferred tax assets will not be realized in the future.  The Company records a reserve for taxcontingencies until management believes it is probable that the deductionsgiving rise to these contingencies will not be successfully challenged.

 

**Liquidityand Capital Resources**

 

The following table sets forth consolidated statements of cash flowdata for the Company for the thirteen week periods ended April 3, 2005,and March 28, 2004, respectively.

 
| ** **                                        | ** ** | **2005**           | ** ** | **2004** | ** ** |
|---------------------------------------------------|------------|--------------------|------------|----------|------------|
| ** **                                        | ** ** | **(In thousands)** | ** ** |
|                                              |       |               |       |     |       |
| Net cash used by operating activities             |       | $                  | (2,775     | )        | $          | (2,010 | ) |
| Net cash used by investing activities             |       | (2,584             | )          | (2,545   | )          |
| Net cash provided (used) by financing  activities |       | 5,198              |       | (83      | )          |
| Net decrease in cash                              |       | $                  | (161       | )        | $          | (4,638 | ) |

 

Cash fromoperating activities in the first three months of fiscal 2005 decreased $0.8million versus the first three months of fiscal 2004, primarily due to loweroperating margins and an increase in accounts receivable.

 

Net cash used byinvesting activities was $2.6 million in the first three months of fiscal 2005,primarily due to expenditures related to the buildout of additional seats inthe Company’s call center in the Philippines. Capital expenditures of $2.5million in the first three months of fiscal 2004 were primarily related to thebuildout of additional seats in the Philippines and computer equipmentupgrades.

 

Net cash from financingactivities primarily related to the borrowings under the revolving creditagreement in fiscal 2005 partially offset by capital lease payments.  Cash used for financing in fiscal 2004related to capital lease payments.

 

The Company is subject to an existing revolving credit agreement, whichis due to expire December 20, 2005. The Company has received a waiver of various financial covenants setforth in that agreement.  However, thiswaiver is conditional on the Company’s completing its refinancing.  On April 18, 2005 the Company received acommitment from LaSalle Bank National Association to replace its currentrevolving credit agreement.  This newthree year $40 million revolving credit facility will be based on accountsreceivable to determine borrowing capacity. If this facility had been in place on April 3, 2005 the Companywould have had approximately $26 million of borrowing capacity. The Company iscurrently in the process of negotiating the final terms of a definitive loanand security agreement that is expected to be completed by the end of May,2005.  Although the Company believes theagreement will be signed, no assurance to that effect can be given.

 

The Company expects that its cash balances, cash flows from futureoperations and available borrowings under its new credit facility will besufficient to meet normal operating needs, fund any planned capitalexpenditures and repay

 

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debt obligations payable during fiscal 2005.  However, a significant change in operatingcash flow could impact the Company’s ability to meet its cash requirement needsand comply with covenants of its new credit facility.

 

**Forward-Looking Statements**

 

The Private SecuritiesLitigation Reform Act of 1995 provides a “safe harbor” for certain forward-lookingstatements. This Report on Form 10-Q and other documents that the Companyfiles with the SEC contain forward-looking statements that reflect the Company’scurrent views with respect to future events and financial performance. Theseforward-looking statements are subject to certain risks and uncertainties,which could cause future results to differ materially from historical resultsor those anticipated. The words “believe,” “expect,” “anticipate,” “intend,” “estimate,”“goals,” “would,” “could,” “should,” and other expressions which indicatefuture events and trends identify forward-looking statements. Readers arecautioned not to place undue reliance on these forward-looking statements,which speak only as of their dates. If no date is provided, such statementsspeak only as of the date of this Report on Form 10-Q. Except as requiredunder the federal securities laws and rules and regulations of the SEC, theCompany undertakes no obligation to publicly update or revise any forward-lookingstatements in connection with new information or future events or otherwise.Factors that could cause future results to differ materially from historicalresults or those anticipated include, but are not limited to, reliance by theCompany on a small number of principal clients for a substantial proportion ofits total revenue; possible changes in or events affecting the business of theCompany’s clients, including changes in customers’ interest in, and use of,clients’ products and services; the effect of the Company’s operating losses onthe Company’s future prospects; fluctuations in quarterly results of operationsdue to timing of clients’ initiation and termination of large programs; risksin conducting business internationally; changes in competitive conditionsaffecting the Company’s industry; the ability of the Company’s clients toterminate contracts with the Company on a relatively short notice; changes inthe availability and cost of qualified employees; variations in the performanceof the Company’s automated system and other technological factors; additions orchanges to government regulations such as do not call registries, disclosure requirementsor other regulations affecting the teleservices and telecommunicationsindustries; and competition from other outside providers of customerinteraction solutions and in-house customer interaction operations.

 

See the Company’s filingswith the SEC for further discussion of the risks and uncertainties associatedwith the Company’s business, in particular, the discussion under the caption “InformationRegarding Forward-Looking Statements” in Item 7 (Management’s Discussion andAnalysis of Financial Condition and Results of Operations) of the Company’sAnnual Report on Form 10-K for the fiscal year ended January 2, 2005.

 

**Item 3. Quantitative and Qualitative Disclosures About Market Risk**

 

Historically, the Company has been exposed to the impact of U.S.interest rate changes directly related to its normal operating and fundingactivities. From time to time, the Company has entered into derivatives inorder to minimize these risks, but not for trading purposes. The Company doesnot have any derivative agreements at this time.

 

The Company prepared a sensitivity analysis of its average debt for thequarter ended April 3, 2005, assuming a one-percentage point adversechange in interest rates. Holding all other variables constant, thehypothetical adverse change would not significantly increase interest expense.The sensitivity analysis assumes no changes in the Company’s financialstructure.

 

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# **Item 4. Controls andProcedures**

 

# **DisclosureControls and Procedures**

 

The Company’s management, with the participation of the Company’s ChiefExecutive Officer and Chief Financial Officer, has evaluated the effectivenessof the Company’s disclosure controls and procedures (as such term is defined inRules 13a-15(e) under the Securities Exchange Act, as amended (the “ExchangeAct”)) as of the end of the period covered by this report.  Based on such evaluation, the Company’s ChiefExecutive Officer and Chief Financial Officer have concluded that, as of theend of such period, the Company’s disclosure controls and procedures areeffective in recording, processing, summarizing and reporting, on a timelybasis, information required to be disclosed by the Company in the reports thatit files or submits under the Exchange Act.

 

**Inherent Limitations on the Effectiveness ofControls**

 

Our management, including our Chief Executive Officer and ChiefFinancial Officer, does not expect that our disclosure controls and proceduresor our internal controls will prevent or detect all errors and all fraud.  A control system, no matter how wellconceived and operated, can provide only reasonable, not absolute, assurancethat the objectives of the control system are met.  Further, the design of a control system mustreflect the fact that there are resource constraints, and the benefits ofcontrols must be considered relative to their costs.  Because of the inherent limitations in allcontrol systems, no evaluation of controls can provide absolute assurance thatmisstatements due to error or fraud will not occur or that all control issuesand instances of fraud, if any within the Company have been detected.

 

These inherent limitations include the realities that judgments indecision-making can be faulty and that breakdowns can occur because of simpleerror or mistake.  Controls can also becircumvented by the individual acts of some persons, by collusion of two ormore people, or by management override of the controls.  The design of any system of controls is basedin part on certain assumptions about the likelihood of future events, and therecan be no assurance that any design will succeed in achieving its stated goalsunder all potential future conditions. Projections of any evaluation of controls effectiveness to futureperiods are subject to risks.  Over time,controls may become inadequate because of changes in conditions ordeterioration in the degree of compliance with policies or procedures.

 

**InternalControl Over Financial Reporting**

 

There have not been changes in the Company’s internal control overfinancial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f)under the Exchange Act) during the quarter to which this report relates thathave materially affected, or are reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

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## **Part II. OtherInformation**

 

**Item1.  Legal Proceedings**

 

The Company is a party to an arbitrationproceeding with Apogee Enterprises, Inc. and Harmon Glass Solutions, which isdescribed in the Company’s Annual Report on Form 10-K for the fiscal year endedJanuary 2, 2005.

 

TheCompany is subject to occasional lawsuits, governmental investigations andclaims arising out of the normal conduct of its business.  Management does not believe the outcome ofany such pending claims will have a material adverse impact on the Company’sconsolidated financial position, annual results of operations orliquidity.  Although the Company does notbelieve that any of these proceedings will result in a material adverse effect,no assurance to that effect can be given.

 

**Item6.  Exhibits**

 

 (a)The exhibits required by Item 601 of Regulation S-K are listed in the ExhibitIndex attached hereto.

 

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**Signatures**

 

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

 
|               |   | **APAC Customer Services, Inc.**                                                    |   |
|--------------------|--------|-------------------------------------------------------------------------------------|--------|
|               |   | ** **                                                                          |   |
|               |   |                                                                                |   |
| Date: May 13, 2005 | By:    | /s/ Marc T. Tanenberg                                                               |   |
|               |   | Senior Vice President and                                                           |   |
|               |   | Chief Financial Officer  (Principal Financial Officer  and duly authorized officer) |   |
|               |   |                                                                                |   |
|               |   |                                                                                |   |
| Date: May 13, 2005 | By:    | */s/*Kenneth R.  Batko                                                              |   |
|               |   | Vice President and Controller                                                       |   |
|               |   | (Principal Accounting Officer  and duly authorized officer)                         |   |

 

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# **Exhibit Index**

 
| **Exhibit****Number** |   | **Description**                                                                                                                                                                                                                                                          |
|-----------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                  |   |                                                                                                                                                                                                                                                                     |
| 3.1                   |   | Articles of Incorporation of APAC Customer Services, Inc. are  incorporated by reference to APAC Customer Services, Inc.’s Quarterly Report  on Form 10-Q for the Quarter ended October 3, 1999.                                                               |
|                  |   |                                                                                                                                                                                                                                                                     |
| 3.2                   |   | Certificate of Amendment of the Amended and Restated Bylaws of APAC  Customer Services, Inc. as amended March 10, 2004, incorporated by  reference to APAC Customer Services, Inc.’s Quarterly Report on Form 10-Q for  the quarter ended March 28, 2004. |
|                  |   |                                                                                                                                                                                                                                                                     |
| 31.1                  |   | Certification of Chief Executive Officer, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                    |
|                  |   |                                                                                                                                                                                                                                                                     |
| 31.2                  |   | Certification of Chief Financial Officer, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                    |
|                  |   |                                                                                                                                                                                                                                                                     |
| 32.1                  |   | Certification of the Chief Executive Officer and Chief Financial  Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                           |

 

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