**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

**(Mark One)**

 

| ý                                                                                                                                                                                                                                |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934.**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                  |   |                                                                                                |
| **For the quarterly period ended March 28, 2004**                                                                                                                                                                                |
|                                                                                                                                                                                                                                  |   |                                                                                                |
| **or**                                                                                                                                                                                                                                |
|                                                                                                                                                                                                                                  |   |                                                                                                |
| **o**                                                                                                                                                                                                                                 |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934.** |
|                                                                                                                                                                                                                                  |   |                                                                                                |
| **For the  Transition Period From                     to                ** |

 

**Commission file number 0-26786**

 

**APACCustomer 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 Center, Suite 400, 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            Noo

 

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

 

Yes ý            Noo

 

There were 49,453,092 common shares, $0.01 par value per share,outstanding as of May 5, 2004.

 

 

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**Index**

 
| **Part I.  Financial Information**                                                                    | 3                                                                                                                            |
|------------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                       |                                                                                                                         |
| Item 1.  Financial Statements  (Unaudited):                                                           | 3                                                                                                                            |
|                                                                                                       |                                                                                                                         |
|                                                                                                       | Consolidated Condensed Balance Sheets as of  March 28, 2004, and December 28, 2003.                                | 3 |
|                                                                                                       |                                                                                                                         |   |
|                                                                                                       | Consolidated Condensed Statements of  Operations for the Thirteen Weeks Ended March 28, 2004, and  March 30, 2003. | 4 |
|                                                                                                       |                                                                                                                         |   |
|                                                                                                       | Consolidated Condensed Statements of Cash  Flows for the Thirteen Weeks Ended March 28, 2004, and March 30,  2003. | 5 |
|                                                                                                       |                                                                                                                         |   |
|                                                                                                       | Notes to Consolidated Condensed Financial  Statements                                                                        | 6 |
|                                                                                                       |                                                                                                                         |
| Item 2.   Management’s Discussion and Analysis of Financial Condition and  Results of Operations | 10                                                                                                                           |
|                                                                                                       |                                                                                                                         |
| Item 3.   Quantitative and Qualitative Disclosures About Market Risk                                  | 14                                                                                                                           |
|                                                                                                       |                                                                                                                         |
| Item 4.  Controls and  Procedures                                                                     | 15                                                                                                                           |
|                                                                                                       |                                                                                                                         |
| **Part II.  Other Information**                                                                       | 16                                                                                                                           |
|                                                                                                       |                                                                                                                         |
| Item 1.  Legal Proceedings                                                                            | 16                                                                                                                           |
|                                                                                                       |                                                                                                                         |
| Item 6.   Exhibits and Reports on Form 8-K                                                            | 16                                                                                                                           |

 

2

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**Part I. Financial Information**

 

**Item1. Financial Statements**

 

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

**ConsolidatedCondensed Balance Sheets**

**(Unaudited)**

**(Inthousands)**

 
|                                                                                                                                               |   | **March 28,  2004** |    | **December 28,  2003** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|---------|-----------------------------|--------|
|                                                                                                                                               |   |                     |    |                        |   |
| **Assets**                                                                                                                                         |   |                     |    |                        |   |
| **Current assets:**                                                                                                                                |   |                     |    |                        |   |
| Cash and cash equivalents                                                                                                                          |   | $                        | 6,790   |                        | $      | 11,428 |   |
| Accounts receivable, net                                                                                                                           |   | 45,377                   |    | 46,896                      |   |
| Other current assets                                                                                                                               |   | 10,643                   |    | 9,218                       |   |
| Total current assets                                                                                                                               |   | 62,810                   |    | 67,542                      |   |
|                                                                                                                                               |   |                     |    |                        |   |
| **Property and  equipment, net**                                                                                                                   |   | 22,469                   |    | 24,147                      |   |
|                                                                                                                                               |   |                     |    |                        |   |
| **Goodwill**                                                                                                                                       |   | 23,876                   |    | 23,876                      |   |
|                                                                                                                                               |   |                     |    |                        |   |
| **Other intangible  assets, net**                                                                                                                  |   | 14,448                   |    | 15,035                      |   |
|                                                                                                                                               |   |                     |    |                        |   |
| **Deferred taxes**                                                                                                                                 |   | 3,122                    |    | 3,072                       |   |
| **Other assets**                                                                                                                                   |   | 813                      |    | 921                         |   |
| Total assets                                                                                                                                       |   | $                        | 127,538 |                        | $      | 134,593 |   |
|                                                                                                                                               |   |                     |    |                        |   |
| **Liabilities and  Shareholders’ Equity**                                                                                                     |   |                     |    |                        |   |
| **Current  liabilities:**                                                                                                                          |   |                     |    |                        |   |
| Current maturities of long-term debt                                                                                                               |   | $                        | 397     |                        | $      | 389 |   |
| Accounts payable                                                                                                                                   |   | 2,685                    |    | 4,046                       |   |
| Accrued payroll and related items                                                                                                                  |   | 17,010                   |    | 18,367                      |   |
| Income taxes payable                                                                                                                               |   | 16,082                   |    | 17,952                      |   |
| Other accrued liabilities                                                                                                                          |   | 10,362                   |    | 11,107                      |   |
| Total current liabilities                                                                                                                          |   | 46,536                   |    | 51,861                      |   |
|                                                                                                                                               |   |                     |    |                        |   |
| **Long-term debt,  less current maturities**                                                                                                       |   | 211                      |    | 313                         |   |
|                                                                                                                                               |   |                     |    |                        |   |
| **Other liabilities**                                                                                                                              |   | 1,750                    |    | 1,689                       |   |
|                                                                                                                                               |   |                     |    |                        |   |
| **Commitments and  contingencies**                                                                                                                 |   | —                   |    | —                      |   |
|                                                                                                                                               |   |                     |    |                        |   |
| **Shareholders’  equity**                                                                                                                     |   |                     |    |                        |   |
| Common shares, $0.01 par value;  200,000,000  shares authorized;  49,695,699 shares issued at March 28, 2004, and December 28, 2003 |   | 497                      |    | 497                         |   |
| Additional paid-in capital                                                                                                                         |   | 99,591                   |    | 99,620                      |   |
| Accumulated deficit                                                                                                                                |   | (20,066                  | )       | (18,413                     | )      |
| Accumulated other comprehensive income                                                                                                             |   | (129                     | )       | (82                         | )      |
| Treasury shares: 242,607 and 254,107  shares, respectively, at cost                                                                                |   | (852                     | )       | (892                        | )      |
| Total shareholders’ equity                                                                                                                    |   | 79,041                   |    | 80,730                      |   |
| Total liabilities and shareholders’ equity                                                                                                    |   | $                        | 127,538 |                        | $      | 134,593 |   |

 

See notes to consolidated condensed financialstatements

 

3

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

**ConsolidatedCondensed Statements of Operations**

**(Unaudited)**

**(Inthousands, except per share data)**

 
|                                                |   | **Thirteen Weeks Ended** |   |
|-----------------------------------------------------|--------|--------------------------|--------|
|                                                |   | **March 28,  2004** |   | **March 30,  2003** |   |
|                                                |   |                     |   |   |   |
| **Net  revenue**                                    |   | $                        | 71,404 |   | $ | 86,197 |   |
|                                                |   |                     |   |   |   |
| **Operating  expenses:**                            |   |                     |   |   |   |
|                                                |   |                     |   |   |   |
| Cost of  services                                   |   | 60,130                   |   | 69,428 |   |
| Selling,  general and administrative expenses       |   | 10,819                   |   | 12,996 |   |
| Restructuring  and other charges                    |   | 851                      |   | — |   |
| Asset  impairment charges                           |   | 2,110                    |   |   |   |
| Total  operating expenses                           |   | 73,910                   |   | 82,424 |   |
| **Operating income  (loss)**                        |   | (2,506                   | )      | 3,773 |   |
|                                                |   |                     |   |   |   |
| Interest expense, net                               |   | 160                      |   | 353 |   |
|                                                |   |                     |   |   |   |
| **Income (loss)  before income taxes**              |   | (2,666                   | )      | 3,420 |   |
| Provision  (benefit) for income taxes               |   | (1,013                   | )      | 1,300 |   |
|                                                |   |                     |   |   |   |
| **Net  income (loss)**                              |   | $                        | (1,653 | ) | $ | 2,120 |   |
|                                                |   |                     |   |   |   |
| **Net  income (loss) per share:**                   |   |                     |   |   |   |
| Basic                                               |   | $                        | (0.03  | ) | $ | 0.04 |   |
| Diluted                                             |   | $                        | (0.03  | ) | $ | 0.04 |   |
|                                                |   |                     |   |   |   |
| **Weighted  average number of shares outstanding:** |   |                     |   |   |   |
| Basic                                               |   | 49,447                   |   | 49,422 |   |
| Diluted                                             |   | 49,498                   |   | 49,444 |   |

 

See notes to consolidated condensed financialstatements.

 

4

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

**ConsolidatedCondensed Statements of Cash Flows**

**(Unaudited)**

**(Inthousands)**

 
|                                              |   | **Thirteen  Weeks Ended** |   |
|---------------------------------------------------|--------|---------------------------|--------|
|                                              |   | **March 28,  2004**  |   | **March 30,  2003** |   |
|                                              |   |                      |   |   |   |
| **Operating  activities:**                        |   |                      |   |   |   |
|                                              |   |                      |   |   |   |
| Net income (loss)                                 |   | $                         | (1,653 | ) | $ | 2,120 |   |
| Depreciation and amortization                     |   | 2,720                     |   | 3,131 |   |
| Non-cash restructuring charges                    |   | 47                        |   | — |   |
| Asset impairment charges                          |   | 2,110                     |   | — |   |
| Deferred income taxes                             |   | (78                       | )      | (80 | ) |
| Change in operating assets and liabilities        |   | (5,156                    | )      | (3,541 | ) |
| Net cash provided (used) by operating  activities |   | (2,010                    | )      | 1,630 |   |
|                                              |   |                      |   |   |   |
| **Investing  activities:**                        |   |                      |   |   |   |
|                                              |   |                      |   |   |   |
| Purchases of property and equipment, net          |   | (2,545                    | )      | (2,564 | ) |
| Net cash used by investing activities             |   | (2,545                    | )      | (2,564 | ) |
|                                              |   |                      |   |   |   |
| **Financing  activities:**                        |   |                      |   |   |   |
|                                              |   |                      |   |   |   |
| Payments on long-term debt                        |   | (94                       | )      | (160 | ) |
| Repayments under revolving credit facility,  net  |   | —                    |   | (1,500 | ) |
| Stock and warrant transactions                    |   | 11                        |   | 34 |   |
| Net cash used by financing activities             |   | (83                       | )      | (1,626 | ) |
|                                              |   |                      |   |   |   |
| **Net change in cash  and cash equivalents**      |   | (4,638                    | )      | (2,560 | ) |
|                                              |   |                      |   |   |   |
| **Beginning cash  balance**                       |   | 11,428                    |   | 14,530 |   |
|                                              |   |                      |   |   |   |
| **Ending cash balance**                           |   | $                         | 6,790  |   | $ | 11,970 |   |

 

See notes to consolidated condensed financialstatements

 

5

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**APACCustomer Services, Inc. and Subsidiaries**

**Notesto Consolidated Condensed Financial Statements**

**(Unaudited)**

**(Dollarsin thousands, except as otherwise indicated)**

 

**1.   Basis of Presentation**

 

The accompanying unaudited consolidated condensed financial statementsof APAC Customer Services, Inc. and its subsidiaries (collectively, the“Company”) have been prepared in accordance with generally accepted accountingprinciples for interim financial information and the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by generally accepted accounting principles for complete financialstatements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation have been included.  Operating results for the thirteen weekperiod ended March 28, 2004, are not necessarily indicative of the resultsthat may be expected for the fiscal year ending January 2, 2005.  The balance sheet at December 28, 2003,has been derived from the audited financial statements at that date but doesnot include all of the information and footnotes required by generally acceptedaccounting 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 December 28, 2003.

 

**2.   Other Current Liabilities**

 

The components of other accrued liabilities included in the consolidatedcondensed balance sheets are as follows:

 

|                                   |   | **March 28,  2004** |   | **December 28,  2003** |   |
|----------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
|                                   |   |                     |   |                        |   |
| Accrued workers compensation insurance |   | $                        | 3,097  |                        | $      | 3,097 |   |
| Restructuring charges                  |   | 2,145                    |   | 2,706                       |   |
| Accrued professional fees              |   | 914                      |   | 795                         |   |
| Accrued relocation                     |   | 600                      |   | 607                         |   |
| Accrued telecommunications             |   | 639                      |   | 573                         |   |
| Other                                  |   | 2,967                    |   | 3,329                       |   |
| Total                                  |   | $                        | 10,362 |                        | $      | 11,107 |   |

 

**3.   Intangible Assets**

 

* *Theidentifiable intangible assets of the Company represent acquired customerrelationships with a gross carrying value of $28,493 and accumulatedamortization of $14,045 and $11,698 as of March 28, 2004, andMarch 30, 2003, respectively. Under the provisions of SFAS No. 142, identifiable intangible assetswith finite lives are amortized.  Thecustomer relationship intangible assets have been amortized on a straight-linebasis over the expected period of benefit of 12 years. Total amortizationof intangible assets as of March 28, 2004 and March 30, 2003, was$587 per quarter, respectively. Annual amortization expense is expected to be$2.3 million for fiscal 2004 through 2009 and $1.0 million in fiscal 2010.

 

6

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**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** |   |
|-----------------------------------------------------------------------------|--------|---------------------------|--------|
|                                                                        |   | **March 28,  2004**  |   | **March 30,  2003** |   |
|                                                                        |   |                      |   |   |   |
| Net income (loss) as reported                                               |   | $                         | (1,653 | ) | $ | 2,120 |   |
| Less–compensation expense on stock options,  net of income tax benefit |   | (420                      | )      | (972 | ) |
| Net income (loss) pro forma                                                 |   | $                         | (2,073 | ) | $ | 1,148 |   |
| Earnings (loss) per share – basic                                      |   |                      |   |   |   |
| As reported                                                                 |   | $                         | (0.03  | ) | $ | 0.04 |   |
| Pro forma                                                                   |   | $                         | (0.04  | ) | $ | 0.02 |   |
| Earnings (loss) per share – diluted                                    |   |                      |   |   |   |
| As reported                                                                 |   | $                         | (0.03  | ) | $ | 0.04 |   |
| Pro forma                                                                   |   | $                         | (0.04  | ) | $ | 0.02 |   |

 

In order to calculate the pro forma information set forth above, thefair value of each option is estimated on the date of grant based on theBlack-Scholes option-pricing model.  Assumptions include no dividend yield, risk-free interest rates rangingfrom 4% to 7%, expected volatility ranging between 50% and 90%, and an expectedlife ranging from 7 years to 10 years.

 

**5.  Comprehensive Income (Loss) and Accumulated Other Comprehensive Income(Loss)**

 

Comprehensive income (loss) is as follows:

 
|                                |   | **Thirteen  Weeks Ended** |   |
|-------------------------------------|--------|---------------------------|--------|
|                                |   | **March 28,  2004**  |   | **March 30,  2003** |   |
|                                |   |                      |   |   |   |
| Net income (loss)                   |   | $                         | (1,653 | ) | $ | 2,120 |   |
| Foreign currency translation (loss) |   | (47                       | )      | — |   |
| Total comprehensive income (loss)   |   | $                         | (1,700 | ) | $ | 2,120 |   |

 

7

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The foreign currency translation loss in the first quarter of fiscal2004 relates to the impact of a change in exchange rates on net assets locatedoutside of the United States.

 

**6.   Legal Proceedings**

 

In December of 2000 the Company entered into a contract with ApogeeEnterprises, Inc. to provide call center services and to develop softwareapplications supporting those services for its Harmon Glass Solutions division(“Harmon”).  Apogee sold Harmon to theDwyer Group in 2004.  The Company’srevenues under this contract in fiscal 2003 and the first quarter of fiscal2004 were $5.1 million and $1.1 million, respectively.  Disputes and claims under this contract arethe subject of an arbitration proceeding filed on April 8, 2004, with theAmerican Arbitration Association. Harmon has alleged that the Company breachedits obligations under the contract thereby damaging Harmon’s business. TheCompany contends that it has performed its obligations under the contract, andclaims that Harmon has breached the contract and owes the Company damages and atermination fee as provided for in the contract.  The Company intends to vigorously assert its claims anddefenses.  However, given thepreliminary nature of this matter and the uncertainties inherent in any litigation,it is not possible to predict the outcome of this proceeding and there can beno assurance that the Company will be successful or that an adverse outcomewould not be material.

 

In addition, the Company is subject to occasional lawsuits,governmental investigations and claims arising out of the normal conduct of itsbusiness.  Management does not believethe outcome of any such pending claims will have a material adverse impact onthe Company’s consolidated financial position, annual results of operations orliquidity.  Although the Company doesnot believe that any of these proceedings will result in a material adverseeffect, no assurance to that effect can be given.

 

**7.   Long Term Debt**

 

On December 20, 2002, the Company entered into an Amended andRestated Credit Agreement (“Credit Agreement”) replacing the previous Amended andRestated Credit Facility.  Under theterms of the Credit Agreement, the Company has a revolving credit facility,which expires in December 2005. The facility initially provided $65.0 million of creditavailability.  Beginning onMarch 31, 2003, the facility is being reduced by $1.25 million ofavailability each quarter until the facility reaches $55.0 million atDecember 31, 2004.  Availability isalso reduced by outstanding borrowings and any outstanding letters ofcredit.  As of March 28, 2004,there were no outstanding borrowings under the facility and approximately $3.0million was utilized through the issuance of standby letters of creditprimarily to support self-insurance reserves. Net availability as of March 28, 2004, under the Credit Agreementwas $57.0 million.

 

The Credit Agreement is secured principally by a grant of a securityinterest in all personal property and fixtures of the Company.  Under the terms of the Credit Agreement, theCompany is also required to maintain certain financial covenants which limitthe Company’s ability to incur additional indebtedness, repurchase outstandingcommon shares, create liens, acquire, sell or dispose of certain assets, engagein certain mergers and acquisitions and make certain restricted payments.

 

Borrowings under the Credit Agreement incur a floating interest rateusually based on the LIBOR index rate, although the Company has the option ofusing an alternate base rate defined in the agreement.  In addition, the Company pays a commitmentfee on the unused portion of the revolving facility as well as quarterly feeson the outstanding letters of credit.

 

8

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**8.  Restructuring and Other Charges/Asset Impairment Charges**

 

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. Cash chargestotaling $0.2 million relating to the restructuring have been paid throughMarch 28, 2004. The remaining $0.6 million of cash charges, primarilyrelated to severance costs, is payable over the next two years.  The Company also recorded $2.1 million ofasset impairment charges relating to the write-off of unutilized softwareassets.

 

Following is a summary of the fiscal 2004 year-to-date activity in thereserves established in connection with the Company’s restructuringinitiatives:

 
|                                 |   | **Balance  12/28/03** |   | **2004  Charges** |   | **Asset  Write-down** |   | **Cash  Payments** |   | **Balance  3/28/04** |   |
|--------------------------------------|--------|-----------------------|--------|-------------------|--------|-----------------------|--------|--------------------|--------|----------------------|--------|
|                                 |   |                  |   |              |   |                  |   |               |   |                 |   |
| 2002                                 |   |                  |   |              |   |                  |   |               |   |                 |   |
| Employee severance costs             |   | $                     | 112    |              | $      | (43                   | )      | $                  | — |                 | $      | (36 | ) | $ | 33 |   |
| Lease obligations and other          |   | 1,261                 |   | (26               | )      | —                |   | (246               | )      | 989                  |   |
|                                 |   |                  |   |              |   |                  |   |               |   |                 |   |
| 2003                                 |   |                  |   |              |   |                  |   |               |   |                 |   |
| Employee severance costs             |   | 1,295                 |   | 29                |   | —                |   | (587               | )      | 737                  |   |
| Write down of property and equipment |   | 48                    |   | 35                |   | (72                   | )      | —             |   | 11                   |   |
| Lease obligations and other          |   | 337                   |   | —            |   | —                |   | (87                | )      | 250                  |   |
|                                 |   |                  |   |              |   |                  |   |               |   |                 |   |
| 2004                                 |   |                  |   |              |   |                  |   |               |   |                 |   |
| Employee severance costs             |   | —                |   | 807               |   | —                |   | (195               | )      | 612                  |   |
| Write down of property and equipment |   | —                |   | 12                |   | (12                   | )      | —             |   | —               |   |
| Lease obligations and other          |   | —                |   | 37                |   | —                |   | (34                | )      | 3                    |   |
| Total                                |   | $                     | 3,053  |              | $      | 851                   |   | (84                | )      | $                    | (1,185 | ) | $ | 2,635 |   |
|                                      |        |                       |        |                   |        |                       |        |                    |        |                      |        |  |  |  |  |  |

 

**9.  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 arerecorded when management believes it is more likely than not that some portionor all of the 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 is 38.0% for the three monthsended March 28, 2004 and March 30, 2003.

 

9

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

 

The Company is a leading provider of customer interaction solutions formarket leaders in the communications, financial services, insurance, healthcare, logistics and travel and hospitality industries. To help its clientsbetter manage their customer relationships, APAC Customer Services develops anddelivers customer care and customer acquisition programs. The Company operatesand manages approximately 7,000 workstations in 27 Customer Interaction Centers.The Customer Interaction Centers are managed centrally through the applicationof telecommunications and computer technology to promote the consistentdelivery of quality service.  TheCompany consists of a single operating segment that offers customer interactionsolutions 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 from services provided by theCompany for the quarters ended March 28, 2004, and March 30, 2003,respectively.

 
|                                         |   | **Thirteen  Weeks Ended** |   |
|----------------------------------------------|--------|---------------------------|--------|
|                                         |   | **March 28,  2004**  |   | **March 30,  2003** |   |
|                                         |   |                      |   |   |   |
| **Net revenues**                             |   | 100.0                     | %      | 100.0 | % |
|                                         |   |                      |   |   |   |
| Operating  expenses:                         |   |                      |   |   |   |
| Cost of  services                            |   | 84.2                      |   | 80.5 |   |
| Selling, general and administrative expenses |   | 15.2                      |   | 15.1 |   |
| Restructuring  and other charges             |   | 1.2                       |   | — |   |
| Asset  impairment charges                    |   | 2.9                       |   | — |   |
| Total  operating expenses                    |   | 103.5                     |   | 95.6 |   |
| Operating  income (loss)                     |   | (3.5                      | )      | 4.4 |   |
|                                         |   |                      |   |   |   |
| Interest  expense, net                       |   | .2                        |   | .4 |   |
| Income  (loss) before income taxes           |   | (3.7                      | )      | 4.0 |   |
|                                         |   |                      |   |   |   |
| Provision  (benefit) for income taxes        |   | (1.4                      | )      | 1.5 |   |
| Net income  (loss)                           |   | (2.3                      | )%     | 2.5 | % |

 

10

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**Comparison of Resultsof Operations for the thirteen weeks ended March 28, 2004, and March 30,2003**

 

Netrevenue decreased 17.2% to $71.4 million in the first quarter of fiscal 2004from $86.2 million in the same period of fiscal 2003, a decrease of$14.8 million. The revenue decline from the first quarter of fiscal 2003was attributable to the decision by Comcast, a major client of the Company, tobring in-house certain marketing programs, reduced consumer acquisition volumesrelated to the impact of the rollout of the national Do Not Call (“DNC”)registry on October 1, 2003, and softness in the credit card acquisitionand mortgage servicing business.

 

Cost of services decreased $9.3 million in the first quarter offiscal 2004, or 13.4%, to $60.1 million from $69.4 million in the sameperiod of fiscal 2003. Approximately 70% of the decrease in cost of servicesresulted from lower direct costs associated with the decline in revenue, whilethe remaining reduction related to cutbacks in overhead spending, includingsavings associated with center closings, partially offset by higher wages. As apercent of revenue, cost of services increased to 84.2% in the first quarter offiscal 2004 from 80.5% in the first quarter of fiscal 2003 principally due tothe effect of lower capacity utilization, higher labor costs and softeningprices in certain client programs.

 

Selling, general and administrative expenses decreased to$10.8 million in the first quarter of fiscal 2004 from $13.0 million inthe same period of fiscal 2003, a decrease of $2.2 million or 16.8%.Expenses declined from the prior year primarily due to lower salary expensesresulting from headcount reductions and reduced overhead spending. As a percentof net revenue, selling, general and administrative expenses were 15.2% infirst quarter of fiscal 2004 versus 15.1% in the same period of fiscal 2003.

 

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. Cash chargestotaling $0.2 million relating to the restructuring have been paid throughMarch 28, 2004. The remaining $0.6 million of cash charges, primarilyrelated to severance costs, is payable over the next two years.  The Company also recorded $2.1 million ofasset impairment charges relating to the write-off of unutilized softwareassets.

 

The Company generated a net loss of $1.7 million in the firstquarter of fiscal 2004 compared to $2.1 million of net income for the sameperiod of fiscal 2003. The decrease is primarily due to the lower gross profitmargins, and $3.0 million of restructuring, and asset impairment chargesin the first quarter of fiscal 2004, partially offset by a reduction ofselling, general and administrative expenses, as previously discussed.

 

Net interest expense for the first quarter of fiscal 2004 decreased$0.2 million from the same period of fiscal 2003. This decrease reflectsthe pay down of substantially all debt in fiscal 2003.

 

The Company’s effective income tax rate was 38.0% for the thirteenweeks ended March 28, 2004 and March 30, 2003.

 

**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.

 

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**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 also occasionallypriced on a pay-for-performance basis, pursuant to which the Company typicallyreceives fees that are a combination of base-rate plus fee per sale. TheCompany is often subject to performance standards, such as sales per hour,average handle time, occupancy rate and abandonment rate.  The Company’s performance against suchstandards may provide bonus opportunities or conversely may subject the Companyto penalties, which are recognized as earned or incurred.

 

**Accounting for long-lived assets**

 

The Company’s long-lived assets consist primarily of property andequipment, capitalized software and intangible assets. In addition to theoriginal cost of these assets, their recorded value is impacted by a number ofpolicy elections made by the Company, including estimated useful lives andsalvage values. In addition, any decision by the Company to reduce capacity byclosing Customer Interaction Centers or to abandon software may result in awrite-off of the net book value of these affected assets. In accordance withStatement of Financial Accounting Standards No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets,” the Company records impairmentcharges on long-lived assets used in operations when events and circumstancesindicate that the assets may be impaired and the undiscounted cash flowsestimated to be generated by those assets are less than the carrying amount ofthose assets. In this circumstance, the impairment charge is determined basedupon the amount the net book value of the assets exceeds their fair marketvalue. 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.

 

**Allowance for doubtful accounts**

 

TheCompany records an allowance for doubtful accounts based on a quarterlyassessment of the probable estimated losses in trade accounts receivable. Thisestimate is based on specific allowances for identified problem receivables andan additional allowance for estimated losses on all other receivables based ontheir age and the Company’s collection history.

 

**Accounting for employee benefits**

 

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 March 28, 2004, andMarch 30, 2003, were:

 

|                   |   | **(in  thousands)** |   |
|------------------------|--------|---------------------|--------|
|                   |   | **2004**            |   | **2003** |   |
| Group Health Insurance |   | $                   | 3,519  |   | $ | 3,737 |   |
| Workers Compensation   |   | 3,097               |   | 3,231 |   |
|                        |        |                     |        |  |  |  |  |

 

**Income Taxes**

 

The Company accounts for income taxes using the asset and liabilityapproach.  Under the asset and liabilitymethod, deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between

 

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the financial statement carrying amounts of existing assets andliabilities and their respective tax bases. Valuation allowances are recorded when management believes it is morelikely than not that some portion or all of the deferred tax assets will not berealized in the future.  The Company recordsa reserve for tax contingencies until management believes it is probable thatthe deductions giving rise to these contingencies will not be successfullychallenged.

 

**Liquidity and Capital Resources**

 

The following table sets forth consolidated statements of cash flowdata for the Company for the thirteen-week periods ended March 28, 2004,and March 30, 2003, respectively.

 
|                                              |   | **2004**            |   | **2003** |   |
|---------------------------------------------------|--------|---------------------|--------|----------|--------|
|                                              |   | **(In  thousands)** |   |
|                                              |   |                |   |     |   |
| Net cash provided (used) by operating  activities |   | $                   | (2,010 | )        | $      | 1,630 |   |
| Net cash used by investing activities             |   | (2,545              | )      | (2,564   | )      |
| Net cash used by financing activities             |   | (83                 | )      | (1,626   | )      |
| Net decrease in cash                              |   | $                   | (4,638 | )        | $      | (2,560 | ) |

 

Cash from operating activities decreased $3.6 million versus the firstthree months of fiscal 2003, primarily due to $1.2 million of payments related to restructuring charges in the firstquarter of fiscal 2004, lower operating margins and a reduction in depreciationand amortization.

 

Net cash used by investing activities was $2.5 million in the firstquarter of fiscal 2004 primarily due to expenditures related to the buildout ofadditional seats in the Philippines and computer equipment upgrades. Capitalexpenditures of $2.6 million in the first three months of fiscal 2003 wereprimarily related to the initial buildout of a facility in the Philippines andequipment upgrades.

 

Net cash used by financing activities primarily related to therepayment of capital lease payments in fiscal 2003 and 2004 and $1.5 million ofbank debt in 2003.

 

The Company expects that its cash balances, cash flows from futureoperations and available borrowings under its Credit Agreement will besufficient to meet normal operating needs, fund any planned capitalexpenditures and repay debt obligations payable during fiscal 2004.  However, a significant change in operatingcash flow could impact the Company’s ability to meet its cash requirement needsand comply with covenants of its Credit Agreement.

 

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**Forward-LookingStatements**

 

The Private Securities Litigation Reform Act of 1995 provides a “safeharbor” for certain forward-looking statements. This Report on Form 10-Qand other documents that the Company files with the SEC contain forward-lookingstatements that reflect the Company’s current views with respect to futureevents and financial performance. These forward-looking statements are subjectto certain risks and uncertainties, which could cause future results to differmaterially from historical results or those anticipated. The words “believe,”“expect,” “anticipate,” “intend,” “estimate,” “goals,” “would,” “could,”“should,” and other expressions which indicate future events and trendsidentify forward-looking statements. Readers are cautioned not to place unduereliance on these forward-looking statements, which speak only as of theirdates. If no date is provided, such statements speak only as of the date ofthis Report on Form 10-Q. Except as required under the Federal securitieslaws and rules and regulations of the SEC, the Company undertakes no obligationto publicly update or revise any forward-looking statements in connection withnew information or future events or otherwise. Factors that could cause futureresults to differ materially from historical results or those anticipatedinclude, but are not limited to, reliance by the Company on a small number ofprincipal clients for a substantial proportion of its total revenue; possiblechanges in or events affecting the business of the Company’s clients, includingchanges in customers’ interest in, and use of, clients’ products and services;fluctuations in quarterly results of operations due to timing of clients’initiation and termination of large programs; risks in conducting businessinternationally; changes in competitive conditions affecting the Company’sindustry; the ability of the Company’s clients to terminate contracts with theCompany on a relatively short notice; changes in the availability and cost ofqualified employees; variations in the performance of the Company’s automatedsystem and other technological factors; changes in government regulationsaffecting the teleservices and telecommunications industries; and competitionfrom other outside providers of customer interaction solutions and in-housecustomer interaction operations.

 

See the Company’s filings with the SEC for further discussion of therisks and uncertainties associated with the Company’s business, in particularthe discussion under the caption “Information Regarding Forward-LookingStatements” in Item 7 (Management’s Discussion and Analysis of FinancialCondition and Results of Operations) of the Company’s Annual Report on Form10-K for the fiscal year ended December 28, 2003.

 

**Item 3. Quantitative and QualitativeDisclosures 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 due to the low levels of current borrowings.

 

The Company prepared a sensitivity analysis of its average debt for thefirst quarter of fiscal 2004 assuming a one-percentage point adverse change ininterest rates. Holding all other variables constant, the hypothetical adversechange would not significantly increase interest expense. The sensitivityanalysis assumes no changes in the Company’s financial structure.

 

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**Item4. Controls and Procedures**

 

**Disclosure Controls 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’sChief Executive Officer and Chief Financial Officer have concluded that, as ofthe end 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.

 

**Internal Control 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 first fiscal quarter to which this reportrelates that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

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**PartII. Other Information**

 

**Item 1. Legal Proceedings**

 

In December of 2000 the Company entered into a contract with ApogeeEnterprises, Inc. to provide call center services and to develop softwareapplications supporting those services for its Harmon Glass Solutions division(“Harmon”).  Apogee sold Harmon to theDwyer Group in 2004.  The Company’srevenues under this contract in fiscal 2003 and the first quarter of fiscal2004 were $5.1 million and $1.1 million, respectively.  Disputes and claims under this contract arethe subject of an arbitration proceeding filed on April 8, 2004, with theAmerican Arbitration Association. Harmon has alleged that the Company breachedits obligations under the contract thereby damaging Harmon’s business. TheCompany contends that it has performed its obligations under the contract, andclaims that Harmon has breached the contract and owes the Company damages and atermination fee as provided for in the contract.  The Company intends to vigorously assert its claims anddefenses.  However, given thepreliminary nature of this matter and the uncertainties inherent in anylitigation, it is not possible to predict the outcome of this proceeding and therecan be no assurance that the Company will be successful or that an adverseoutcome would not be material.

 

In addition, the Company is subject to occasional lawsuits,governmental investigations and claims arising out of the normal conduct of itsbusiness.  Management does not believethe outcome of any such pending claims will have a material adverse impact onthe Company’s consolidated financial position, annual results of operations orliquidity.  Although the Company doesnot believe that any of these proceedings will result in a material adverseeffect, no assurance to that effect can be given.

 

**Item 6. Exhibits and Reports on Form 8-K**

 
|   | (a)    | Exhibits                                                                                                                                                            |                                                                                                                                                                                                |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                |                                                                                                                                                                                                |
|   |   | Exhibit 3.2                                                                                                                                                         | Amended and Restated Bylaws of APAC Customer Services, Inc. as  amended through March 10, 2004.                                                                                                |
|   |   |                                                                                                                                                                |                                                                                                                                                                                                |
|   |   | Exhibit 31.1                                                                                                                                                        | Certification of Chief Executive Officer pursuant to Rule 13a-15(e)  and Rule 15d-15(e)  of the Exchange  Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.     |
|   |   |                                                                                                                                                                |                                                                                                                                                                                                |
|   |   | Exhibit 31.2                                                                                                                                                        | Certification of Chief Financial Officer pursuant to Rule 13a-15(e)  and Rule 15d-15(e)  of the Exchange Act, as adopted pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002. |
|   |   |                                                                                                                                                                |                                                                                                                                                                                                |
|   |   | Exhibit 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.      |
|   |   |                                                                                                                                                                |                                                                                                                                                                                                |
|   | (b)    | Reports on Form 8-K                                                                                                                                                 |
|   |   |                                                                                                                                                                |                                                                                                                                                                                                |
|   |   | On February 17, 2004, the  Company filed a current report on Form 8-K setting forth the earnings release  for the fiscal quarter ended December 28, 2003. |
|        |        |                                                                                                                                                                     |                                                                                                                                                                                                     |  |

 

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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 7, 2004 | By:    | /s/ Marc T. Tanenberg                                                                      |   |
|                                     |   | Senior Vice President and                                                                  |   |
|                                     |   | Chief Financial Officer  (Principal Financial Officer  and duly authorized officer)        |   |
|                                     |   |                                                                                       |   |
|                                     |   |                                                                                       |   |
| Date:    May 7, 2004 | 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** |
|-----------------------|--------|-----------------|
|                  |   |            |
| 3.2                   |   |            | Amended and Restated Bylaws of APAC Customer Services, Inc. as  amended through March 10, 2004. |
|                  |   |            |   |
| 31.1                  |   |            | Certification of Chief Executive Officer pursuant to Rule 13a-15(e)  and Rule 15d-15(e) of the Exchange Act, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|                  |   |            |   |
| 31.2                  |   |            | Certification of Chief Financial Officer pursuant to Rule 13a-15(e)  and Rule 15d-15(e) of the Exchange Act, 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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