** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

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

 

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**FORM 10-Q**

 

**(MarkOne)**

 
| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.**                                                                                      |
|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                         |
|       | **For the quarterly period ended July 3, 2005**                                                                                                                                         |
|       |                                                                                                                                                                                         |
| ** ** | **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**

 

**APAC Customer Services, Inc.**

(Exact name of registrant as specified in its charter)

 
| **Illinois**                                                    | ** ** | **36-2777140**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction  of incorporation or organization) |       | (I.R.S. Employer  Identification No.) |

 

**Six Parkway North, Deerfield, Illinois 60015**

(Addressof Principal Executive Offices, Zip Code)

 

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

 

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

 

Yes ý                    No  o

 

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

 

Yes ý                    Noo

 

There were 49,454,654 common shares, $0.01 par valueper share, outstanding as of August 10, 2005.

 

 

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## **Index**

 
| **Part I. Financial Information**                                                                                                  |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                    |   |
| Item  1. Consolidated Condensed Financial Statements (Unaudited):                                                                       |   |
|                                                                                                                                    |   |
| Consolidated  Condensed Balance Sheets as of July 3, 2005, and January 2, 2005                                                |   |
|                                                                                                                                    |   |
| Consolidated  Condensed Statements of Operations for the Thirteen and Twenty-Six Weeks  Ended July 3, 2005, and June 27, 2004 |   |
|                                                                                                                                    |   |
| Consolidated  Condensed Statements of Cash Flows for the Twenty-Six Weeks Ended  July 3, 2005, and June 27, 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 4. Submission of Matters to a vote of  Security Holders                                                                            |   |
|                                                                                                                                    |   |
| Item 6. Exhibits                                                                                                                        |   |

 

2

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## **Part I.Financial Information**

## ** **

# **Item1.**Consolidated Condensed Financial Statements

# ** **

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

**Consolidated Condensed BalanceSheets**

**(Unaudited)**

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

 
| ** **                                                                                                                               | ** ** | **July 3,  2005** | ** ** | **January 2,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| **Assets**                                                                                                                               | ** ** | ** **             | ** ** | ** **                | ** ** |
| ** **                                                                                                                               | ** ** | ** **             | ** ** | ** **                | ** ** |
| **Current assets:**                                                                                                                      |       |                   |       |                      |       |
| Cash and cash equivalents                                                                                                                |       | $                      | 865        |                      | $          | 271 |   |
| Accounts receivable, net                                                                                                                 |       | 32,146                 |       | 41,002                    |       |
| Other current assets                                                                                                                     |       | 10,280                 |       | 11,253                    |       |
| Total current assets                                                                                                                     |       | 43,291                 |       | 52,526                    |       |
|                                                                                                                                     |       |                   |       |                      |       |
| **Property and equipment, net**                                                                                                          |       | 24,722                 |       | 24,214                    |       |
|                                                                                                                                     |       |                   |       |                      |       |
| **Goodwill**                                                                                                                             |       | 23,876                 |       | 23,876                    |       |
|                                                                                                                                     |       |                   |       |                      |       |
| **Other intangible assets, net**                                                                                                         |       | 11,515                 |       | 12,688                    |       |
|                                                                                                                                     |       |                   |       |                      |       |
| **Deferred taxes**                                                                                                                       |       | 11,087                 |       | 5,748                     |       |
| ** **                                                                                                                               |       |                   |       |                      |       |
| **Other assets**                                                                                                                         |       | 625                    |       | 481                       |       |
| Total assets                                                                                                                             |       | $                      | 115,116    |                      | $          | 119,533 |   |
| **Liabilities and Shareholders’ Equity**                                                                                            |       |                   |       |                      |       |
| **Current liabilities:**                                                                                                                 |       |                   |       |                      |       |
| Current maturities of long-term debt                                                                                                     |       | $                      | 4,988      |                      | $          | 313 |   |
| Accounts payable                                                                                                                         |       | 3,034                  |       | 3,544                     |       |
| Income taxes payable                                                                                                                     |       | 17,253                 |       | 16,629                    |       |
| Accrued payroll and related items                                                                                                        |       | 13,305                 |       | 15,048                    |       |
| Accrued liabilities                                                                                                                      |       | 8,525                  |       | 8,481                     |       |
| Total current liabilities                                                                                                                |       | 47,105                 |       | 44,015                    |       |
|                                                                                                                                     |       |                   |       |                      |       |
| **Long-term debt, less current maturities**                                                                                              |       | —                 |       | —                    |       |
|                                                                                                                                     |       |                   |       |                      |       |
| **Other liabilities**                                                                                                                    |       | 1,221                  |       | 1,355                     |       |
|                                                                                                                                     |       |                   |       |                      |       |
| **Commitments and contingencies**                                                                                                        |       | —                 |       | —                    |       |
|                                                                                                                                     |       |                   |       |                      |       |
| **Shareholders’ equity**                                                                                                            |       |                   |       |                      |       |
| Common shares, $0.01 par value; 200,000,000 shares  authorized; 49,695,699 shares issued at July 3, 2005, and January 2,  2005 |       | 497                    |       | 497                       |       |
| Additional paid-in capital                                                                                                               |       | 99,598                 |       | 99,598                    |       |
| Accumulated deficit                                                                                                                      |       | (32,307                | )          | (24,912                   | )          |
| Accumulated other comprehensive loss                                                                                                     |       | (151                   | )          | (173                      | )          |
| Treasury shares: 241,045 shares, at cost at July 3,  2005, and January 2, 2005                                                 |       | (847                   | )          | (847                      | )          |
| Total shareholders’ equity                                                                                                          |       | 66,790                 |       | 74,163                    |       |
| Total liabilities and shareholders’ equity                                                                                          |       | $                      | 115,116    |                      | $          | 119,533 |   |

 

See notes to consolidated condensed financialstatements

 

3

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**APAC Customer Services, Inc. andSubsidiaries**

**ConsolidatedCondensed Statements of Ope****rations**

**(Unaudited)**

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

 
| ** **                                          | ** ** | **Thirteen  Weeks Ended** | ** ** | **Twenty-Six  Weeks Ended** | ** ** |
|-----------------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|
| ** **                                          | ** ** | **July 3,  2005**    | ** ** | **June 27,  2004**     | ** ** | **July 3,  2005** | ** ** | **June 27,  2004** | ** ** |
| ** **                                          | ** ** | ** **                | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net revenue**                                     |       | $                         | 58,159     |                        | $          | 68,006 |   | $ | 123,833 |   | $ | 139,410 |   |
| Cost of services                                    |       | 55,335                    |       | 58,496                      |       | 114,309 |   | 118,626 |   |
| **Gross Profit**                                    |       | 2,824                     |       | 9,510                       |       | 9,524 |   | 20,784 |   |
|                                                |       |                      |       |                        |       |   |   |   |   |
| **Operating expenses:**                             |       |                      |       |                        |       |   |   |   |   |
| Selling, general and  administrative  expenses |       | 9,111                     |       | 9,682                       |       | 18,972 |   | 20,501 |   |
| Restructuring and other  charges                    |       | 860                       |       | 999                         |       | 1,137 |   | 1,850 |   |
| Asset impairment charges                            |       | 124                       |       | 124                         |       | 124 |   | 2,234 |   |
| Total operating expenses                            |       | 10,095                    |       | 10,805                      |       | 20,233 |   | 24,585 |   |
| **Operating loss**                                  |       | (7,271                    | )          | (1,295                      | )          | (10,709 | ) | (3,801 | ) |
|                                                |       |                      |       |                        |       |   |   |   |   |
| Interest expense (income), net                      |       | 457                       |       | (63                         | )          | 639 |   | 97 |   |
|                                                |       |                      |       |                        |       |   |   |   |   |
| **Loss before income taxes**                        |       | (7,728                    | )          | (1,232                      | )          | (11,348 | ) | (3,898 | ) |
| Income tax benefit                                  |       | (2,715                    | )          | (468                        | )          | (3,953 | ) | (1,481 | ) |
|                                                |       |                      |       |                        |       |   |   |   |   |
| **Net loss**                                        |       | $                         | (5,013     | )                           | $          | (764 | ) | $ | (7,395 | ) | $ | (2,417 | ) |
| ** **                                          | ** ** | ** **                | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net loss per share:**                             | ** ** | ** **                | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                          | ** ** | ** **                | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                               |       | $                         | (0.10      | )                           | $          | (0.02 | ) | $ | (0.15 | ) | $ | (0.05 | ) |
| Diluted                                             |       | $                         | (0.10      | )                           | $          | (0.02 | ) | $ | (0.15 | ) | $ | (0.05 | ) |
|                                                |       |                      |       |                        |       |   |   |   |   |
| **Weighted average number of  shares outstanding:** |       |                      |       |                        |       |   |   |   |   |
| Basic                                               |       | 49,455                    |       | 49,454                      |       | 49,455 |   | 49,451 |   |
| Diluted                                             |       | 49,455                    |       | 49,454                      |       | 49,455 |   | 49,451 |   |

 

See notes to consolidated condensed financial statements.

 

4

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**APAC Customer Services, Inc. andSubsidiaries**

**ConsolidatedCondensed Statements of Cas****h Flows**

**(Unaudited)**

**(In thousands)**

 
| ** **                                             | ** ** | **Twenty-Six Weeks Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|
| ** **                                             | ** ** | **July 3,  2005**     | ** ** | **June 27,  2004** | ** ** |
|                                                   |       |                       |       |   |   |
| **Operating activities:**                              |       |                       |       |   |   |
|                                                   |       |                       |       |   |   |
| Net loss                                               |       | $                          | (7,395     | ) | $ | (2,417 | ) |
| Depreciation and amortization                          |       | 5,950                      |       | 5,423 |   |
| Non-cash restructuring charges                         |       | 22                         |       | 190 |   |
| Asset impairment charges                               |       | 124                        |       | 2,200 |   |
| Deferred income taxes                                  |       | (4,235                     | )          | 32 |   |
| Change in operating assets and liabilities             |       | 7,237                      |       | (2,277 | ) |
| Net cash provided by operating activities              |       | 1,703                      |       | 3,151 |   |
|                                                   |       |                       |       |   |   |
| **Investing activities:**                              |       |                       |       |   |   |
|                                                   |       |                       |       |   |   |
| Purchases of property and equipment, net of  disposals |       | (5,307                     | )          | (4,227 | ) |
| Net cash used by investing activities                  |       | (5,307                     | )          | (4,227 | ) |
|                                                   |       |                       |       |   |   |
| **Financing activities:**                              |       |                       |       |   |   |
|                                                   |       |                       |       |   |   |
| Borrowings under revolving credit facility             |       | 4,882                      |       | — |   |
| Payments on long-term debt                             |       | (207                       | )          | (192 | ) |
| Financing costs                                        |       | (477                       | )          | — |   |
| Stock and warrant transactions                         |       | —                     |       | 24 |   |
| Net cash provided (used) by financing activities       |       | 4,198                      |       | (168 | ) |
|                                                   |       |                       |       |   |   |
| **Net change in cash and cash equivalents**            |       | 594                        |       | (1,244 | ) |
| ** **                                             |       |                       |       |   |   |
| **Cash and cash equivalents:**                         |       |                       |       |   |   |
| ** **                                             |       |                       |       |   |   |
| **Beginning balance**                                  |       | 271                        |       | 11,428 |   |
| ** **                                             |       |                       |       |   |   |
| **Ending balance**                                     |       | $                          | 865        |   | $ | 10,184 |   |

 

See notes to consolidated condensed financial statements

 

5

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

**Notes toConsolidated Condensed Financia****l Statements**

**(Unaudited)**

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

 

**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 accounting principlesfor interim 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 and twenty-six week periods ended July 3,2005, are not necessarily indicative of the results that may be expected forthe fiscal year ending January 1, 2006. The balance sheet at January 2, 2005, has been derived from theaudited financial statements at that date but does not include all of theinformation and footnotes required by generally accepted accounting principlesfor complete financial statements.  Foradditional information, refer to the financial statements and footnotes theretoincluded in the Company’s Annual Report on Form 10-K for the year ended January 2,2005.  Copies of the Company’s filingsare available on a web site maintained by the SEC at http://www.sec.gov.

 

The Company has sustained significant losses in fiscal 2004 and in thefirst six months of fiscal 2005. In particular, the Company incurred a net lossof $7.4 million for the first six months of fiscal 2005, compared to a net lossof $2.4 million for the same period in fiscal 2004, and an overall net loss of$6.5 million for the fiscal year ended January 2, 2005. In an effort to returnthe Company to profitability, the Company has initiated a restructuring plan toexit virtually all of its outbound customer acquisition business, close overhalf of its Customer Interaction Centers, eliminate 400 salaried positions andpursue other operational improvements as discussed in Note 11. To facilitateits restructuring plan, the Company entered into a waiver and amendment to itscredit agreement with LaSalle Bank on July 27, 2005, which is described in Note8. The Company expects that its cash balances, cash flows from future operationsand available borrowings under its credit facility will be sufficient to meetnormal operating needs, fund any planned capital expenditures, fund anyexpenditures related to the Company’s restructuring plan and repay debtobligations payable during fiscal 2005. However, a significant change inoperating cash flow or in the implementation of the Company’s restructuringplan could negatively impact the Company’s ability to meet its cash requirementneeds and comply with the covenants in the Credit Agreement.

 

**2.   AccruedLiabilities**

 

The components of other accrued liabilities included in theconsolidated condensed balance sheets are as follows:

 

| ** **                         | ** ** | **July 3,** | ** ** | **January 2,** | ** ** |
|------------------------------------|------------|------------------|------------|---------------------|------------|
| ** **                         | ** ** | **2005**         | ** ** | **2005**            | ** ** |
|                               |       |             |       |                |       |
| Accrued worker’s compensation |       | $                | 3,134      |                | $          | 3,122 |   |
| Accrued professional fees          |       | 879              |       | 1,007               |       |
| Restructuring charges              |       | 849              |       | 391                 |       |
| Accrued relocation                 |       | 514              |       | 400                 |       |
| Accrued property tax               |       | 559              |       | 752                 |       |
| Telecommunications expenses        |       | 421              |       | 523                 |       |
| Other                              |       | 2,169            |       | 2,286               |       |
| Total                              |       | $                | 8,525      |                | $          | 8,481 |   |

 

**3.   Other Intangible Assets**

 

The identifiable otherintangible assets of the Company represent acquired customer relationships witha gross carrying value of $28,493 and accumulated amortization of $16,979 and$15,805 as of July 3, 2005, and January 2, 2005, respectively.  Under the provisions of Statement ofFinancial Accounting Standards No. 142, “Goodwill and Other IntangibleAssets” (“SFAS No. 142”), identifiable intangible assets with finite livesare amortized.  The customer relationshipintangible assets are amortized on a straight-line basis over the expectedperiod of benefit of 12 years. Total amortization expense related tointangible assets as of July 3, 2005, and June 27, 2004, was $587 forthe quarter and $1,174 year to date. Annual amortization expense is expected tobe $2,348 for fiscal 2005 through 2009 and $958 in fiscal 2010.

 

Under SFAS No. 142,the Company is required to test all existing goodwill and intangible assets forimpairment at least annually.  TheCompany’s policy is to test goodwill for impairment as of the end of the fiscalyear. Given the restructuring plan described in Note 11, the Company willperform an interim impairment test of goodwill and intangible assets in thethird quarter that could result in a potential impairment charge related tothose assets.

 

6

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

 

For stock-based employeecompensation plans, the Company has elected to use the intrinsic value methodprescribed by Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees” (“APB No. 25”). In accordance with APB No. 25, no compensation expense isrecognized for stock options issued to employees when the option price equalsor exceeds the fair market value of the Company’s common shares at the date ofgrant.  Stock-based compensation expensefor non-employees is recognized in accordance with Statement of FinancialAccounting Standards No. 123, “Accounting for Stock Based Compensation” (“SFASNo. 123”).

 

The following table illustratesthe effect on net income and earnings per share if the Company had adopted thefair value recognition provisions of SFAS No. 123.

 
| ** **                                                             | ** ** | **Thirteen Weeks Ended** | ** ** | **Twenty-Six Weeks Ended** | ** ** |
|------------------------------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                                             | ** ** | **July 3,**         | ** ** | **June 27,**          | ** ** | **July 3,** | ** ** | **June 27,** | ** ** |
| ** **                                                             | ** ** | **2005**                 | ** ** | **2004**                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                   |       |                     |       |                       |       |   |   |   |   |
| Net loss as reported                                                   |       | $                        | (5,013     | )                          | $          | (764 | ) | $ | (7,395 | ) | $ | (2,417 | ) |
| Less-compensation expense on stock options, net of  income tax benefit |       | (249                     | )          | (326                       | )          | (533 | ) | (746 | ) |
| Net loss pro forma                                                     |       | $                        | (5,262     | )                          | $          | (1,090 | ) | $ | (7,928 | ) | $ | (3,163 | ) |
| Loss per share – basic                                            |       |                     |       |                       |       |   |   |   |   |
| As reported                                                            |       | $                        | (0.10      | )                          | $          | (0.02 | ) | $ | (0.15 | ) | $ | (0.05 | ) |
| Pro forma                                                              |       | $                        | (0.11      | )                          | $          | (0.02 | ) | $ | (0.16 | ) | $ | (0.06 | ) |
| Loss per share – diluted                                          |       |                     |       |                       |       |   |   |   |   |
| As reported                                                            |       | $                        | (0.10      | )                          | $          | (0.02 | ) | $ | (0.15 | ) | $ | (0.05 | ) |
| Pro forma                                                              |       | $                        | (0.11      | )                          | $          | (0.02 | ) | $ | (0.16 | ) | $ | (0.06 | ) |

 

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 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 of2004, the Financial Accounting Standards Board (“FASB”) issued Statement No. 123(revised 2004), or SFAS No. 123(R), “Share-Based Payment”, which replacesSFAS No. 123 “Accounting for Stock-Based Compensation”, and supersedesAccounting Principles Board Opinion No. 25 (“APB 25”), “Accounting forStock Issued to Employees.” SFAS No. 123(R) establishes accountingstandards for equity instruments that an entity exchanges for goods orservices. It also addresses transactions where an entity incurs liabilities inexchange for goods or services that are based on the fair value of the entity’sequity instruments or that may be settled by the issuance of those equityinstruments. This Statement focuses primarily on accounting for share-basedpayment transactions as it relates to employee services. SFAS No. 123(R)requires a public entity to measure the cost of employee services received inexchange for an award of equity instruments based on the grant-date fair valueof the award. That cost is to be recognized over the period during which anemployee is required to provide service in exchange for the award (usually thevesting period). No compensation cost is recognized for equity instruments forwhich employees do not

 

7

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render the requisiteservice. The grant-date fair value of share options and similar instruments isto be estimated using option-pricing models adjusted for the uniquecharacteristics 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.Under ABP 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 disclosurewill no longer be allowed.

 

Although alternativephase-in methods are allowed under Statement No. 123(R), the Company hasnot yet determined the phase-in method it will use.  The Company believes that whatever phase-inmethod is selected, the adoption of SFAS No. 123(R) is likely to have amaterial effect on the Company’s results of operations and financial position.On April 14, 2005, the Securities and Exchange Commission (SEC) announcedthe adoption of a rule that defers the required effective date of SFAS123(R).  The SEC rule provides that Statement 123(R) is now effectivefor registrants as of the beginning of the first fiscal year beginning after June 15,2005, instead of at the beginning of the first fiscal quarter after June 15,2005 (as prescribed originally by the FASB Statement).

 

**6.   Comprehensive Loss**

 

Comprehensive loss is asfollows:

 
| ** **                               | ** ** | **Thirteen Weeks Ended** | ** ** | **Twenty-Six Weeks Ended** | ** ** |
|------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                               | ** ** | **July 3,**         | ** ** | **June 27,**          | ** ** | **July 3,** | ** ** | **June 27,** | ** ** |
| ** **                               | ** ** | **2005**                 | ** ** | **2004**                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                     |       |                     |       |                       |       |   |   |   |   |
| Net loss                                 |       | $                        | (5,013     | )                          | $          | (764 | ) | $ | (7,395 | ) | $ | (2,417 | ) |
| Foreign currency translation gain (loss) |       | (19                      | )          | —                     |       | 22 |   | (47 | ) |
| Total comprehensive loss                 |       | $                        | (5,032     | )                          | $          | (764 | ) | $ | (7,373 | ) | $ | (2,464 | ) |

 

Foreign currency translation gains and losses relate to the impact of achange in exchange rates on net assets located outside of the United States.

 

**7.  Legal Proceedings**

 

The Company has reached a settlement inits arbitration proceeding with Apogee Enterprises, Inc. and Harmon GlassSolutions, which was described in the Company’s Annual Report on Form 10-Kfor the fiscal year ended January 2, 2005. As a result, the Company has accrued $200 related to the settlement.

 

8

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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.   Long Term Debt**

 

OnJune 2, 2005, the Company entered into a Loan and Security Agreement (“CreditAgreement”) with LaSalle Bank National Association, as Agent (“LaSalle”) andthe Financial Institutions from time to time a party thereto as Lendersreplacing the Company’s previous credit facility.  The terms of the Credit Agreement provide forup to a $40.0 million revolving credit facility that expires in June 2008.Currently, the outstanding revolving loan commitment under the Credit Agreementis $25.0 million based on the Company’s anticipated cash requirements.Borrowing availability is based on accounts receivable and is subject tocertain restrictions and limitations set forth in the Credit Agreement.

 

TheCredit Agreement is secured principally by a grant of a security interest inall personal property and fixtures of the Company. Under the terms of theCredit Agreement, the Company is also required to maintain certain financialand restrictive covenants which limit, among other things, the Company’sability to incur additional indebtedness, repurchase outstanding common shares,create liens, acquire, sell or dispose of certain assets, engage in certainmergers and acquisitions, pay dividends and to make certain restrictedpayments.

 

Borrowingsunder the Credit Agreement incur a floating interest rate based on the LIBORindex rate or an alternate base rate defined in the agreement. In addition, theCompany pays a commitment fee on the unused portion of the revolving facilityas well as fees on outstanding letters of credit.

 

On July 27, 2005, in connection with itsrecently announced restructuring plan, described in Note 11, the Companyentered into Waiver and Amendment No. Three (“Amendment”) to the CreditAgreement.  Under the terms of theAmendment, LaSalle agreed to waive certain existing and anticipated events ofdefault under the Credit Agreement, provide an overadvance facility in anamount not to exceed $11.0 million and amend the financial covenants containedin the original Credit Agreement. Had this amendment been in place on July 3,2005, the Company would have had approximately $11.7 million of unusedborrowing capacity.

 

TheodoreG. Schwartz, the Chairman of the Board of Directors of the Company, hasguaranteed fifty percent of the overadvance facility, plus certain costs andexpenses.

 

9

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# **9.  Restructuring and Other Charges/Asset Impairment Charges**

# ** **

The Company recorded$1,022 of restructuring charges in the first half of fiscal 2005 related to theclosure of two Customer Interaction Centers and the elimination of certainpositions. These charges included severance costs of $859 related to theelimination of 58 administrative and support positions and $163 for the writedown of property and lease termination and other costs. Cash charges totaling$437 paid through July 3, 2005. The remaining $563 of cash charges,primarily related to lease costs, are payable over the next year.  Restructuring and other charges in the firsthalf of fiscal 2005 include $410 of other severance charges which werepartially offset by a $295 sales and use tax refund.  The Company recorded $124 of asset impairmentcharges in the second quarter of fiscal 2005 related to the write down ofunutilized software.

 

The Company recorded$2,031 of restructuring charges in the first half of fiscal 2004 related to theclosure of two Customer Interaction Centers, the transition of one center to aclient and the elimination of certain administrative and support positions.These charges included severance costs of $1,519 resulting from the eliminationof 37 administrative and support positions and $512 for the write down ofproperty and lease termination and other costs. Restructuring and other chargesin fiscal 2004 include the reversal of $181 of prior year charges, which werenot utilized.   The Company also recorded$2,234 of asset impairment charges during the first half of fiscal 2004relating to the write-off of unutilized software and telecommunicationsequipment.

 

Following is a summary ofthe fiscal 2005 year-to-date activity in the reserves established in connectionwith the Company’s restructuring initiatives:

 
| ** **                           | ** ** | ** **                | ** ** | **2005**                 | ** ** | ** **              | ** ** |
|--------------------------------------|------------|---------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                           | ** ** | **January 2,  2005** | ** ** | **Charges  (Reversals)** | ** ** | **Asset****Write-down** | ** ** | **Cash****Payments** | ** ** | **July ****3,  2005** | ** ** |
|                                 |       |                      |       |                     |       |                    |       |   |   |   |   |
| 2002 Restructuring Initiatives       |       |                      |       |                     |       |                    |       |   |   |   |   |
| Lease obligations and other          |       | $                         | 12         |                     | $          | —                  |       | $ | — |   | $ | (2 | ) | $ | 10 |   |
|                                 |       |                      |       |                     |       |                    |       |   |   |   |   |
| 2003 Restructuring Initiatives       |       |                      |       |                     |       |                    |       |   |   |   |   |
| Employee severance costs             |       | 302                       |       | —                   |       | —                  |       | (80 | ) | 222 |   |
| Lease obligations and other          |       | 4                         |       | —                   |       | —                  |       | — |   | 4 |   |
|                                 |       |                      |       |                     |       |                    |       |   |   |   |   |
| 2004 Restructuring Initiatives       |       |                      |       |                     |       |                    |       |   |   |   |   |
| Employee severance costs             |       | 260                       |       | —                   |       | —                  |       | (102 | ) | 158 |   |
| Lease obligations and other          |       | 65                        |       | —                   |       | —                  |       | (58 | ) | 7 |   |
|                                 |       |                      |       |                     |       |                    |       |   |   |   |   |
| 2005 Restructuring Initiatives       |       |                      |       |                     |       |                    |       |   |   |   |   |
| Employee severance costs             |       | —                    |       | 859                      |       | —                  |       | (375 | ) | 484 |   |
| Write down of property and equipment | ** ** | **—**                |       | 22                       |       | (22                     | )          | **—** | ** ** | **—** | ** ** |
| Lease obligations and other          |       | —                    |       | 141                      |       | —                  |       | (62 | ) | 79 |   |
| Total                                |       | $                         | 643        |                     | $          | 1,022                   |       | $ | (22 | ) | $ | (679 | ) | $ | 964 |   |

 

10

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# **10.    IncomeTaxes**

# ** **

The Company accounts for income taxes using the assetand liability approach.  Under the assetand liability method, deferred tax assets and liabilities are recognized forthe future tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective tax bases.  Valuationallowances are recorded when management believes it is more likely than notthat some portion or all of the deferred tax assets will not be realized in thefuture.  The Company records a reservefor tax contingencies until management believes it is probable that thedeductions giving rise to these contingencies will not be successfullychallenged.  The Company’seffective income tax rate is 34.8% and 38.0% for the six months ended July 3,2005, and June 27, 2004, respectively.

 

In October 2003, theCompany received an $11.6 million cash tax refund as a result of carrying backagainst prior years’ taxable income a $48.1 million loss reported on its 2002tax return. This loss resulted from the Company taking a $59.9 milliondeduction to write-off, for tax purposes, its remaining investment in ITI Holdings,Inc. (for book purposes the Company recorded appropriate impairment chargesrelated to ITI in previous fiscal years). The total combined liquidity benefitto the Company from this deduction could be as much as $20.9 million, which includesthe $11.6 million cash tax refund already received, $3.3 million of cash taxsavings related to the 2002 tax year and the release of $6.0 million of taxcredits generated and utilized in prior years to be used in future periods.Although it has not yet done so, the Company intends to recognize the potentialincome statement benefit of this deduction and eliminate the associated incometax liability once it believes it is probable the deduction will not besuccessfully challenged.

 

The Internal RevenueService is currently auditing the 2002 tax return. On August 1, 2005, the fieldagent for the Internal Revenue Service notified the Company that he intends toissue a notice of proposed audit adjustment to disallow the deduction relatedto the Company’s investment in ITI Holdings, Inc.  The Company believes that it has sufficientsupport for the deduction and intends to contest the proposed adjustment andpursue its available administrative remedies. Although the Company has not recognized the income tax benefit relatedto this deduction and has previously recorded a liability for this amount,should the Company not prevail in this matter, the repayment of the previouslyreceived refund of $11.6 million, as well as interest related thereto, couldhave a material adverse effect on the liquidity of the Company.

 

# **11.   Subsequent Event**

# ** **

On July 26, 2005,the Company’s Board of Directors approved a restructuring of the Company.   Pursuant to the restructuring plan, theCompany will exit virtually all of its outbound customer acquisition business,close over half of its Customer Interaction Centers, eliminate 400 salariedpositions and pursue other operational improvements.    The Company is exiting non-strategic andunprofitable client relationships in order to focus on profitable clientrelationships in a limited number of industries in an effort to improve itsnear term financial performance and position the Company for long-termgrowth.  The Company expects the restructuringplan to be substantially completed by December 31, 2005, however, thewind-down of a limited number of client applications may continue into 2006.

 

The Company expects toincur approximately $10.0 million to $15.0 million in restructuring charges,including approximately $3.0 million to $6.0 million of one-time terminationbenefit charges, approximately $3.0 million to $4.0 million of leasetermination charges and approximately $4.0 million to $5.0 million in assetimpairment charges.  The Company expectsthat approximately $6.0 million to $10.0 million of such costs will result infuture cash expenditures.

 

# **Tofacilitate its restructuring plan, the Company entered into a waiver andamendment to its credit agreement with LaSalle Bank on July 27, 2005,which is described in Note 8.**

 

11

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# **Item 2. Management’sDiscussion and Anal**ysis of Financial Condition and Results of Operations

# ** **

The Company is a leading provider of customerinteraction solutions for market leaders in the communications, financialservices, health care, logistics, publishing, insurance and travel andhospitality industries. To help its clients better manage their customerrelationships, APAC Customer Services develops and delivers customer care andcustomer acquisition programs. At the end of the second quarter, the Companyoperated and managed approximately 7,400 workstations in 22 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.

 

On July 26, 2005,the Company’s Board of Directors approved a restructuring of the Company.   Pursuant to the restructuring plan, theCompany will exit virtually all of its outbound customer acquisition business,close over half of its Customer Interaction Centers, eliminate 400 salariedpositions and pursue other operational improvements. The Company is exitingnon-strategic and unprofitable client relationships in order to focus onprofitable client relationships in a limited number of industries in an effortto improve its near term financial performance and position the Company for long-termgrowth.  The Company expects therestructuring plan to be substantially completed by December 31, 2005,however, the wind-down of a limited number of client applications may continueinto 2006.

 

The Company expects toincur approximately $10 - $15 million in restructuring charges, includingapproximately $3 - $6 million of one-time termination benefit charges,approximately $3 - $4 million of lease termination charges and approximately $4- $5 million in asset impairment charges. The Company expects that approximately $6 - $10 million of such costswill result in future cash expenditures.

 

To facilitate its restructuring plan, the Companyentered into a waiver and amendment to its credit agreement with LaSalle Bankon July 27, 2005, which is described in Note 8.

 

The following discussionof the Company’s results of operations and liquidity and capital resourcesshould be read in conjunction with the Consolidated Condensed FinancialStatements of the Company and related notes thereto appearing elsewhere in thisreport.

 

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**Resultsof Operations**

 

The following table setsforth the Consolidated Condensed Statements of Operations data as a percent ofnet revenue for the thirteen week and twenty-six periods ended July 3,2005, and June 27, 2004, respectively.

 
| ** **                                   | ** ** | **Thirteen Weeks Ended** | ** ** | **Twenty-Six Weeks Ended** | ** ** |
|----------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                   | ** ** | **July 3,  2005**   | ** ** | **June 27,  2004**    | ** ** | **July 3,  2005** | ** ** | **June 27,  2004** | ** ** |
|                                         |       |                     |       |                       |       |   |   |   |   |
| **Net revenues**                             |       | 100.0                    | %          | 100.0                      | %          | 100.0 | % | 100.0 | % |
| Cost of services                             |       | 95.1                     |       | 86.0                       |       | 92.3 |   | 85.1 |   |
| **Gross Profit**                             |       | 4.9                      |       | 14.0                       |       | 7.7 |   | 14.9 |   |
|                                         |       |                     |       |                       |       |   |   |   |   |
| **Operating expenses:**                      |       |                     |       |                       |       |   |   |   |   |
| Selling, general and administrative expenses |       | 15.7                     |       | 14.2                       |       | 15.3 |   | 14.7 |   |
| Restructuring and other charges              |       | 1.5                      |       | 1.5                        |       | .9 |   | 1.3 |   |
| Asset impairment charges                     | ** ** | .2                       |       | .2                         |       | .1 |   | 1.6 |   |
| Total operating expenses                     |       | 17.4                     |       | 15.9                       |       | 16.3 |   | 17.6 |   |
| **Operating loss**                           |       | (12.5                    | )          | (1.9                       | )          | (8.6 | ) | (2.7 | ) |
|                                         |       |                     |       |                       |       |   |   |   |   |
| Interest (income) expense, net               |       | .8                       |       | (.1                        | )          | .6 |   | .1 |   |
|                                         |       |                     |       |                       |       |   |   |   |   |
| **Loss before income taxes**                 |       | (13.3                    | )          | (1.8                       | )          | (9.2 | ) | (2.8 | ) |
| Income tax benefit                           |       | (4.7                     | )          | (.7                        | )          | (3.2 | ) | (1.1 | ) |
|                                         |       |                     |       |                       |       |   |   |   |   |
| **Net loss**                                 |       | (8.6                     | )%         | (1.1                       | )%         | (6.0 | )% | (1.7 | )% |

 

**Comparisonof Results of Operations for the thirteen weeks ended July 3, 2005, and June 27,2004**

 

Net revenue decreased 14.5% to $58.2 millionin the second quarter of fiscal 2005 from $68.0 million in the same periodof fiscal 2004, a decrease of $9.8 million. The revenue decline from the secondquarter of fiscal 2004 is primarily attributable to reduced customeracquisition volumes related to customer cutbacks in marketing programs andlower revenue rates resulting from competitive pressure.

 

Cost of servicesdecreased $3.2 million in the second quarter of fiscal 2005, or 5.4%, to$55.3 million from $58.5 million in the same period of fiscal 2004. Thisdecrease is due to lower direct costs associated with the decline in revenueand lower overhead expenses partially offset by higher direct expensesprimarily related to training.

 

Gross profit marginsdecreased to 4.9% in the second quarter of fiscal 2005 versus 14.0% in thecomparable period of fiscal 2004.  Thisdecrease is principally due to the effect of lower revenue rates as previouslydiscussed, lower capacity utilization and higher labor costs.

 

Selling, general andadministrative expenses decreased to $9.1 million in the second quarter offiscal 2005 from $9.7 million in the same period of fiscal 2004, a decrease of$0.6 million or 5.9%. Expenses declined from the prior year primarily dueto lower employee incentive expenses. As a percent of net revenue, selling,general and administrative expenses increased to 15.7% in the second quarter offiscal 2005 versus 14.2% in the same period of fiscal 2004 due to adisproportionately higher decrease in revenue.

 

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The Company recorded $0.9million of restructuring charges in the second quarter of fiscal 2005 relatedto the closure of one Customer Interaction Center and the elimination ofcertain positions. These charges included severance costs of $0.8 millionprimarily related to the elimination of 47 administrative and support positionsand $0.1 million for the write down of property and lease termination and othercosts. Cash charges totaling $0.3 million relating to the restructuringhave been paid through July 3, 2005. The remaining $0.5 million of cashcharges, primarily related to lease costs, are payable over the next year.  The Company also recorded $0.1 million ofasset impairment charges in the second quarter of fiscal 2005 related to thewrite down of unutilized software.

 

The Company recorded $1.1million of restructuring charges in the second quarter of fiscal 2004 relatedto the closure of one Customer Interaction Center, the transition of one centerto a client and the elimination of certain administrative and supportpositions. These charges included severance costs of $0.7 million resultingfrom the elimination of 15 administrative and support positions, and $0.4million for the write down of property and lease termination and other costs.The Company also recorded $0.1 million of asset impairment charges relating tothe write off of telecommunications equipment.

 

Interest expense in thesecond quarter of fiscal 2005 increased primarily as a result of the write offof $0.2 million of financing fees related to the previous credit agreement andinterest related to borrowings under the current and previous credit agreementsin fiscal 2005.

 

The Company generated anet loss of $5.0 million in the second quarter of fiscal 2005 compared to a$0.8 million loss for the same period of fiscal 2004. The increase in the netloss from the prior year is primarily due to lower revenue and gross profitmargins, partially offset by a reduction in selling, general and administrativeexpenses and restructuring charges, as previously discussed.

 

**Comparisonof Results of Operations for the twenty-six weeks ended July 3, 2005, and June 27,2004**

 

Net revenue decreased 11.2% to $123.8 millionin the first half of fiscal 2005 from $139.4 million in the same period offiscal 2004, a decrease of $15.6 million. The revenue decline from the firsthalf of fiscal 2004 is primarily attributable to reduced customer acquisitionvolumes related to customer cutbacks in marketing programs and lower revenuerates resulting from competitive pressure.

 

Cost of servicesdecreased $4.3 million in the first half of fiscal 2005, or 3.6%, to $114.3million from $118.6 million in the same period of fiscal 2004. Thisdecrease is primarily due to lower direct costs associated with the decline inrevenue partially offset by increased training and information technologycosts.

 

Gross profit marginsdecreased to 7.7% in the first six months of fiscal 2005 versus 14.9% in thecomparable period of fiscal 2004.  Thisdecrease is principally due to the effect of lower revenue rates as previouslydiscussed, lower capacity utilization and higher labor costs.

 

Selling, general andadministrative expenses decreased to $19.0 million in the first half of fiscal2005 from $20.5 million in the same period of fiscal 2004, a decrease of $1.5million or 7.5%. Expenses declined from the prior year primarily due to loweremployee incentive expenses. As a percent of net revenue, selling, general andadministrative expenses were 15.3% in the first half of fiscal 2005 versus14.7% in the same period of fiscal 2004 due to a disproportionately higherdecrease in revenues.

 

The Company recorded $1.0million of restructuring charges in the first half of fiscal 2005 related tothe closure of two Customer Interaction Centers and the elimination of certainpositions. These charges included severance costs of $0.9 million, primarilyrelated to the elimination of 58 administrative and support positions, and$0.1million for the write down of property and lease termination and othercosts. Cash charges totaling $0.4 million have been paid through July 3,2005. The remaining $0.6 of cash charges, primarily related to lease costs, arepayable over the next year. Restructuring and other charges in the first half of fiscal 2005 include$0.4 of other severance charges which were partially offset by a

 

14

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$0.3 million sales anduse tax refund.  The Company alsorecorded $0.1 million of asset impairment charges related to the write down ofunutilized software in the second quarter of fiscal 2005.

 

The Company recorded $2.0million of restructuring charges in the first half of fiscal 2004 related tothe closure of two Customer Interaction Centers, the transition of one centerto a client and the elimination of certain administrative and supportpositions. These charges included severance costs of $1.5 million resultingfrom the elimination of 37 administrative and support positions, and $0.5million for the write down of property and lease termination and other costs.Restructuring and other charges in fiscal 2004 include the reversal of $0.2million of prior year charges, which were not utilized.  The Company also recorded $2.2 million ofasset impairment charges during the first half of fiscal 2004 relating to thewrite-off of unutilized software and telecommunications equipment.

 

Interest expense in thefirst half of fiscal 2005 increased primarily due to the write off, in thesecond quarter, of $0.2 million of financing fees related to the previouscredit agreement and interest related to borrowings under the current andprevious credit agreements in fiscal 2005.

 

The Company generated anet loss of $7.4 million in the first half of fiscal 2005 compared to a$2.4 million loss for the same period of fiscal 2004. The increase in net lossfrom the prior year period 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 effectiveincome rate is 34.8% for the six months ended July 3, 2005 versus 38% inthe prior year period primarily as a result of an increase in permanentdifferences effecting taxable income.

 

**CriticalAccounting Policies and Estimates**

 

The preparation of theCompany’s financial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe amounts reported in the consolidated financial statements and accompanyingnotes. The Company believes its estimates and assumptions are reasonable;however, actual results and the timing of the recognition of such amounts coulddiffer from those estimates. The Company has identified the following criticalaccounting policies and estimates utilized by management in the preparation ofthe Company’s financial statements: revenue recognition, accounting forlong-lived assets, allowance for doubtful accounts, accounting for employeebenefits and income taxes. Any deviation from these policies or estimates couldhave a material impact on the financial statements of the Company.

 

## **Revenuerecognition**

## ** **

The Company recognizescustomer services revenue as services are performed for our clients. Clientcontracts generally require that clients be billed for the Company’s serviceson the basis of time spent by Company representatives providing services. TheCompany’s services are also increasingly priced on a pay-for-performance basis,pursuant to which the Company typically receives fees that are a combination ofbase-rate plus fee per sale. The Company is generally subject to varying clientperformance standards, such as average handle time, occupancy rate, abandonmentrate and sales per hour.  The Company’sperformance against such standards may provide bonus opportunities, orconversely, may subject the Company to penalties, which are recognized asearned or incurred.

 

## **Accounting forlong-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 ofestimates made by the Company, including estimated useful lives and salvagevalues. In addition, any decision by the Company to reduce capacity by closingCustomer Interaction Centers or to abandon software may result in a write-offof the net book value of the affected assets. In accordance with SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived

 

15

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Assets,” the Company records impairment charges on long-lived assetsused in operations when events and circumstances indicate that the assets maybe impaired and the undiscounted cash flows estimated to be generated by thoseassets are less than the carrying amount of those assets. In this circumstance,the impairment charge is determined based upon the amount the net book value ofthe assets exceeds their fair market value. In making these determinations, theCompany utilizes certain assumptions, including, but not limited to,the estimated fair market value of the assets, which are based onadditional assumptions such as asset utilization, length of time the asset willbe used in the Company’s operations and estimated salvage values.

 

Under the provisions ofSFAS No. 142, “Goodwill and Other Intangible Assets,” the Companyevaluates the remaining useful life of the customer relationships balance atleast annually to determine whether events or circumstances warrant a revisionto the remaining period of amortization.

 

The amortization expenserelated to customer relationships as of July 3, 2005, and June 27,2004, was $0.6 million for the quarter and $1.2 million year to date.  Annual amortization expense is expected to be$2.3 million for fiscal years 2005 through 2009 and $1.0 million in fiscal2010.

 

Under SFAS No. 142,the Company is required to test all existing goodwill for impairment at leastannually.  The Company’s policy is totest goodwill for impairment as of the end of the fiscal year.  The Company tested the goodwill forimpairment as of January 2, 2005, resulting in no impairment beingrecorded. Given the restructuring plan described in Note 11 the Company willperform an interim impairment test of goodwill and intangible assets in thethird quarter that could result in a potential impairment charge related tothose assets.

 

## **Allowance fordoubtful accounts**

## ** **

The Company records an allowance for doubtfulaccounts based on a quarterly assessment of the probable estimated losses intrade accounts receivable. This estimate is based on specific allowances foridentified problem receivables and an additional allowance for estimated losseson all other receivables based on their age and the Company’s collectionhistory.

 

## **Accounting foremployee benefits**

## ** **

The Company records anaccrued liability for group health and workers compensation claims based on anestimate of claims incurred, but not reported, as well as asserted claims atthe end of the period. This estimate is derived from an analysis performed byactuaries hired by the Company who have expertise in this area.  Although these estimates are generallyreliable, changes in the employee mix and unforeseen events could result in anadjustment to these estimates.

 

Thebalances of these accounts at July 3, 2005, and June 27, 2004, were:

 
| ** **             | ** ** | **(in thousands)** | ** ** |
|------------------------|------------|--------------------|------------|
| ** **             | ** ** | **2005**           | ** ** | **2004** | ** ** |
| Group Health Insurance |       | $                  | 2,431      |   | $ | 2,905 |   |
| Workers Compensation   |       | $                  | 3,134      |   | $ | 3,092 |   |

 

The decrease in grouphealth insurance from June 27, 2004, is primarily due to a reduction inthe level of employee participation in the health insurance plan offered by theCompany.

 

16

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**Incometaxes**

 

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 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.

 

**Liquidity and Capital Resources**

 

The following table setsforth consolidated statements of cash flow data for the Company for thetwenty-six week periods ended July 3, 2005, and June 27, 2004,respectively.

 
| ** **                                       | ** ** | **2005**           | ** ** | **2004** | ** ** |
|--------------------------------------------------|------------|--------------------|------------|----------|------------|
| ** **                                       | ** ** | **(In thousands)** | ** ** |
|                                             |       |               |       |     |       |
| Net cash provided by operating activities        |       | $                  | 1,703      |     | $          | 3,151 |   |
| Net cash used by investing activities            |       | (5,307             | )          | (4,227   | )          |
| Net cash provided (used) by financing activities |       | 4,198              |       | (168     | )          |
| Net change in cash                               |       | $                  | 594        |     | $          | (1,244 | ) |

 

Cash from operating activities in the first half of fiscal 2005decreased $1.4 million versus the first half of fiscal 2004, primarily due tolower operating margins substantially offset by a reduction in accountsreceivable.

 

Net cash used byinvesting activities was $5.3 million in the first half of fiscal 2005,primarily due to expenditures related to the buildout of additional seats inthe Company’s call center in the Philippines. Net cash used by investing activities of $4.2 million in the first halfof fiscal 2004 were primarily due to expenditures related to the buildout ofadditional seats in the Philippines and computer equipment upgrades.

 

Net cash fromfinancing activities primarily related to the borrowings under the revolvingcredit agreement in fiscal 2005, partially offset by capital leasepayments.  Cash used for financingactivities in fiscal 2004 related to capital lease payments.

 

On June 2, 2005, theCompany entered into a Loan and Security Agreement (“Credit Agreement”) withLaSalle Bank National Association, as Agent (“LaSalle”) and the FinancialInstitutions from time to time a party thereto as Lenders replacing theCompany’s previous credit facility.  Theterms of the Credit Agreement provide for up to a $40.0 million revolvingcredit facility that expires in June 2008. Currently, the outstanding revolving loan commitment under the CreditAgreement is $25.0 million based on the Company’s anticipated cashrequirements.  Borrowing availability isbased on accounts receivable and is subject to certain restrictions andlimitations set forth in the Credit Agreement.

 

TheCredit Agreement is secured principally by a grant of a security interest inall personal property and fixtures of the Company. Under the terms of theCredit Agreement, the Company is also required to maintain certain financialand restrictive covenants which limit, among other things, the Company’sability to incur additional indebtedness, repurchase outstanding common shares,create liens, acquire, sell or dispose of certain assets, engage in certainmergers and acquisitions, pay dividends and to make certain restrictedpayments.

 

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Borrowingsunder the Credit Agreement incur a floating interest rate based on the LIBORindex rate or an alternate base rate defined in the agreement. In addition, theCompany pays a commitment fee on the unused portion of the revolving facilityas well as fees on outstanding letters of credit.

 

On July 27, 2005, in connection with itsrecently announced restructuring plan, described above, the Company enteredinto Waiver and Amendment No. Three (“Amendment”) to the Credit Agreement.Under the terms of the Amendment, LaSalle agreed to waive certain existing andanticipated events of default under the Credit Agreement, provide anoveradvance facility in an amount not to exceed $11.0 million and amend thefinancial covenants contained in the original Credit Agreement. Had thisamendment been in place on July 3, 2005, the Company would have hadapproximately $11.7 million of unused borrowing capacity.

 

TheodoreG. Schwartz, the Chairman of the Board of Directors of the Company, hasguaranteed fifty percent of the overadvance facility, plus certain costs andexpenses.

 

In October 2003, theCompany received an $11.6 million cash tax refund as a result of carrying backagainst prior years’ taxable income a $48.1 million loss reported on its 2002tax return. This loss resulted from the Company taking a $59.9 milliondeduction to write-off, for tax purposes, its remaining investment in ITI Holdings,Inc. (for book purposes the Company recorded appropriate impairment charges relatedto ITI in previous fiscal years). The total combined liquidity benefit to theCompany from this deduction could be as much as $20.9 million, which includesthe $11.6 million cash tax refund already received, $3.3 million of cash taxsavings related to the 2002 tax year and the release of $6.0 million of taxcredits generated and utilized in prior years to be used in future periods.Although it has not yet done so, the Company intends to recognize the potentialincome statement benefit of this deduction and eliminate the associated incometax liability once it believes it is probable the deduction will not besuccessfully challenged.

 

The Internal RevenueService is currently auditing the 2002 tax return. On August 1, 2005, the fieldagent for the Internal Revenue Service notified the Company that he intends toissue a notice of proposed audit adjustment to disallow the deduction relatedto the Company’s investment in ITI Holdings, Inc.  The Company believes that it has sufficientsupport for the deduction and intends to contest the proposed adjustment andpursue its available administrative remedies. Although the Company has not recognized the income tax benefit relatedto this deduction and has previously recorded a liability for this amount,should the Company not prevail in this matter, the repayment of the previouslyreceived refund of $11.6 million, as well as interest related thereto, couldhave a material adverse effect on the liquidity of the Company.

 

The Company expects thatits cash balances, cash flows from future operations and available borrowingsunder its credit facility will be sufficient to meet normal operating needs,fund any planned capital expenditures, fund any expenditures related to theCompany’s restructuring plan and repay debt obligations payable during fiscal2005.  However, a significant change inoperating cash flow or the implementation of the Company’s restructuring plancould negatively impact the Company’s ability to meet its cash requirementneeds and comply with the covenants in the Credit Agreement.

 

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**Forward-LookingStatements**

 

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 indicate futureevents and trends identify forward-looking statements. Readers are cautionednot to place undue reliance on these forward-looking statements, which speakonly as of the date made.  If no date isprovided, such statements speak only as of the date of this Report on Form 10-Q.Except as required under the federal securities laws and rules andregulations of the SEC, the Company undertakes no obligation to publicly updateor revise any forward-looking statements in connection with new information orfuture events or otherwise. Factors that could cause future results to differmaterially from historical results or those anticipated include, but are notlimited to, the reaction of the Company’sclients and employees to the announcement of its restructuring including,without limitation, the exit of non-strategic and unprofitable clientrelationships, the closing of Customer Interaction Centers and the reduction inthe number of employees; the Company’s ability to successfully manage therestructuring and the costs and expenses associated with these****activities and generate sufficient cashflow from operations during the transition; the Company’s ability to complywith the various covenants under the Credit Agreement in order to maintain itsborrowing capacity thereunder; the impact of the restructuring on the Company’sneed for telephone and data services which it purchases under multi-yearcontracts containing volume commitments; reliance by the Company on asmall number of principal clients for a substantial proportion of its totalrevenue; possible changes in or events affecting the business of the Company’sclients, including changes in customers’ interest in, and use of, clients’products and services; the effect of the Company’s operating losses on the Company’sfuture prospects; fluctuations in quarterly results of operations due to timingof clients’ initiation and termination of large programs; risks in conductingbusiness internationally; changes in competitive conditions affecting theCompany’s industry; the ability of the Company’s clients to terminate contractswith the Company on a relatively short notice; changes in the availability andcost of qualified employees; variations in the performance of the Company’sautomated system and other technological factors; additions or changes togovernment regulations such as do not call registries, disclosure requirementsor other regulations affecting the teleservices and telecommunicationsindustries and competition from other outside providers of customer interactionsolutions and in-house customer interaction operations.

 

See the Company’sfilings with the SEC for further discussion of the risks and uncertaintiesassociated with the Company’s business, in particular, the discussion under thecaption “Information Regarding Forward-Looking Statements” in Item 7(Management’s Discussion and Analysis of Financial Condition and Results ofOperations) of the Company’s Annual Report on Form 10-K for the fiscalyear ended January 2, 2005.

 

**Item 3. Quantitative and Qualitative Dis****closures About Market Risk**

 

Historically, the Companyhas been exposed to the impact of U.S. interest rate changes directly relatedto its normal operating and funding activities. From time to time, the Companyhas entered into derivatives in order to minimize these risks, but not fortrading purposes. The Company does not have any derivative agreements at thistime.

 

The Company prepared asensitivity analysis of its average debt for the quarter ended July 3,2005, assuming a one-percentage point adverse change in interest rates. Holdingall other variables constant, the hypothetical adverse change would notsignificantly increase interest expense. The sensitivity analysis assumes nochanges in the Company’s financial structure.

 

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# **Item 4. Controls andProcedures**

# ** **

# **Disclosure Controls and Procedures**

# ** **

The Company’s management,with the participation of the Company’s Chief Executive Officer and ActingChief Financial Officer, has evaluated the effectiveness of the Company’sdisclosure controls and procedures (as such term is defined in Rules 13a-15(e) underthe Securities Exchange Act, as amended (the “Exchange Act”)) as of the end ofthe period covered by this report.  Basedon such evaluation, the Company’s Chief Executive Officer and Acting ChiefFinancial Officer have concluded that, as of the end of such period, theCompany’s disclosure controls and procedures are effective in recording,processing, summarizing and reporting, on a timely basis, information requiredto be disclosed by the Company in the reports that it files or submits underthe Exchange Act.

 

**InherentLimitations on the Effectiveness of Controls**

 

The Company’s management,including its Chief Executive Officer and Acting Chief Financial Officer, donot expect that the Company’s disclosure controls and procedures or internalcontrols 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 inherentlimitations include the realities that judgments in decision-making can befaulty and that breakdowns can occur because of simple error or mistake.  Controls can also be circumvented by theindividual acts of some persons, by collusion of two or more people or bymanagement override of the controls.  Thedesign of any system of controls is based in part on certain assumptions aboutthe likelihood of future events, and there can be no assurance that any designwill succeed in achieving its stated goals under all potential futureconditions.  Projections of anyevaluation of controls effectiveness to future periods are subject torisks.  Over time, controls may become inadequatebecause of changes in conditions or deterioration in the degree of compliancewith policies or procedures.

 

**InternalControl Over Financial Reporting**

** **

There have not beenchanges in the Company’s internal control over financial reporting (as suchterm is defined in Rules 13a-15(f) and 15d-15(f) under theExchange Act) during the quarter to which this report relates that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

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## **Part II.Other Information**

## ** **

**Item 1. Legal Proceedings**

 

The Company has reached a settlement inits arbitration proceeding with Apogee Enterprises, Inc. and Harmon GlassSolutions, which was described in the Company’s Annual Report on Form 10-Kfor the fiscal year ended January 2, 2005. As a result, the Company has accrued $200 related to the settlement.

 

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.

 

# **Item 4.  Submission of Matters to a Vote of SecurityHolders**

# ** **

(a) TheAnnual Meeting of Shareholders of the Company was held on June 3, 2005.

 

(b)         Not applicable

 

(c)

 

1. Setforth below is the tabulation of the votes for each nominee for election as adirector of the Company.

 
| ** **           | ** ** | ** ** | ** ** | **Withhold Authority**          | ** ** |
|----------------------|------------|------------|------------|---------------------------------|------------|
| ** **           | ** ** | **For**    | ** ** | **(Including Broker non-vote)** | ** ** |
|                 |       |       |       |                            |       |
| Cindy K. Andreotti   |       | 46,596,884 |       | 1,534,653                       |       |
| Robert F. Bernard    |       | 47,076,819 |       | 1,054,718                       |       |
| Thomas M. Collins    |       | 46,598,644 |       | 1,532,893                       |       |
| John W. Gerdelman    |       | 46,299,244 |       | 1,832,293                       |       |
| Robert J. Keller     |       | 47,082,653 |       | 1,048,884                       |       |
| John J. Park         |       | 47,082,253 |       | 1,049,284                       |       |
| Theodore G. Schwartz |       | 46,772,156 |       | 1,359,381                       |       |

 

2. Set forth is the tabulation of the votes for theproposal to approve the APAC Customer Services, Inc. 2005 Incentive StockPlan.

 
| For                                            |   | 33,645,765 |   |
|------------------------------------------------|--------|------------|--------|
| Against                                        |   | 6,904,835  |   |
| Withhold Authority (Including Broker non-vote) |   | 7,580,937  |   |

 

3. Set forth is the tabulation of the votes for theproposal to approve the APAC Customer Services, Inc Management Incentive Plan.

 
| For                                            |   | 38,738,922 |   |
|------------------------------------------------|--------|------------|--------|
| Against                                        |   | 1,814,685  |   |
| Withhold Authority (Including Broker non-vote) |   | 7,577,930  |   |

 

(d) Not applicable

 

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**Item 6. Exhibits**

 

The exhibits required by Item 601 of Regulation S-Kare listed in the Exhibit Index attached hereto.

 

 

**Signatures**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

 
|                        |   | **APAC  Customer Services, Inc.**                                                                                                          |
|-----------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------|
|                        |   |                                                                                                                                            |
|                        |   |                                                                                                                                            |
| Date: August 10,  2005 | By:    | /s/ Robert J. Keller                                                                                                                            |   |
|                        |   | President and                                                                                                                                   |   |
|                        |   | Chief Executive Officer  (Principal Executive Officer  and duly authorized officer)                                                             |   |
|                        |   |                                                                                                                                            |   |
|                        |   |                                                                                                                                            |   |
| Date: August 10,  2005 | By:    | */s/*Kenneth R. Batko                                                                                                                           |   |
|                        |   | Vice  President and Controller,  and Acting Chief Financial  Officer (Principal Financial  and 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., 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. |
|                |       |                                                                                                                                                                                                                                                                                     |
| 10.1                |       | Employment  agreement dated June 1, 2005, with Pamela Schneider.                                                                                                                                                                                                                    |
|                |       |                                                                                                                                                                                                                                                                                     |
| 10.2                |       | Employment  agreement dated May 28, 2005, with Karen Tulloch.                                                                                                                                                                                                                       |
|                |       |                                                                                                                                                                                                                                                                                     |
| 31.1                |       | Certification of  Chief Executive Officer, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                   |
|                |       |                                                                                                                                                                                                                                                                                     |
| 31.2                |       | Certification of  Acting 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 Acting 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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