##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE 
SECURITIES EXCHANGE
ACT OF 1934.
 For the quarterly period ended October 1, 2006
 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.
  Illinois(State or other jurisdiction of
    
    36-2777140incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 Six Parkway North, Deerfield, Illinois 60015
 (847) 374-4980
  þ o
  o þ o
  o þ




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##### 



INDEX
 PageForward-Looking Statements and Factors That May Affect Future Results
    
    
    3Part I.
    
    Financial Information
    
    
    4Item 1.
    
    Condensed Consolidated Financial Statements (Unaudited):Condensed Consolidated Balance Sheets as of October 1, 2006 and January 1, 2006
    
    
    4Condensed Consolidated Statements of Operations for the Thirteen and Thirty-Nine
Weeks Ended October 1, 2006 and October 2, 2005
    
    
    5Condensed Consolidated Statements of Cash Flows for the Thirty-Nine Weeks Ended
October 1, 2006 and October 2, 2005
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of
Operations
    
    
    16Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    26Item 4.
    
    Controls and Procedures
    
    
    26Part II.
    
    Other Information
    
    
    27Item 1A.
    
    Risk Factors
    
    
    27Item 5.
    
    Other Information
    
    
    27Item 6.
    
    Exhibits
    
    
    27Amendment to Amended and Restated Loan and Security Agreement302 Certification of Chief Executive Officer302 Certification of Chief Financial Officer906 Certifications of CEO and CFO
  2




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Forward-Looking Statements and Factors That May Affect Future Results
     Ø
    
    Our revenue is generated from a limited number of clients.Ø
    
    Our success is subject to the terms of our client contracts.Ø
    
    Our success depends on the continued progress of our business turnaround.Ø
    
    Our business may be affected by our cash flows from operations and borrowing availability under our current loan
agreement.Ø
    
    Our financial results depend on our ability to effectively manage our customer care center capacity and our
international expansion.Ø
    
    Our inability to attract and retain a sufficient number of qualified employees could negatively impact our business.Ø
    
    Our business operates in a highly competitive market.Ø
    
    Our future success and competitiveness will depend on our ability to keep our technology up-to-date.Ø
    
    Circumstances outside our control such as acts of God, political instability, equipment malfunction, war, and terrorism
could seriously harm our business.Ø
    
    Our business and our clients businesses are subject to federal and state regulation.Ø
    
    Our financial results may be affected by risks associated with international operations and expansion.Ø
    
    Our liquidity and ability to meet the terms of our current loan agreement could be materially affected should the
Company not prevail in its dispute with the Internal Revenue Service.
  3




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Condensed Consolidated Financial Statements
 APAC CUSTOMER SERVICES, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
 October 1,
    
    
    January 1,2006
    
    
    2006(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    364
    
    
    $
    960Accounts receivable, net
    
    
    32,504
    
    
    
    37,592Other current assets
    
    
    11,263
    
    
    
    9,248Total current assets
    
    
    44,131
    
    
    
    47,800Property and equipment, net
    
    
    23,030
    
    
    
    21,536Goodwill
    
    
    13,338
    
    
    
    13,338Other intangible assets, net
    
    
    8,581
    
    
    
    10,341Deferred taxes
    
    
    18,846
    
    
    
    16,237Other assets
    
    
    694
    
    
    
    1,101Total assets
    
    $
    108,620
    
    
    $
    110,353LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Short-term debt
    
    $
    10,164
    
    
    $
    11,971Accounts payable
    
    
    2,070
    
    
    
    3,558Income taxes payable
    
    
    17,591
    
    
    
    17,377Accrued payroll and related items
    
    
    14,920
    
    
    
    12,769Accrued liabilities
    
    
    15,650
    
    
    
    9,810Total current liabilities
    
    
    60,395
    
    
    
    55,485Other liabilities
    
    
    1,693
    
    
    
    2,994Commitments and contingencies
    
    
    
    
    
    
    Shareholders equity:Common shares, $0.01 per share; authorized 200,000,000 shares;
50,142,109 and 49,695,699 shares issued at October 1,
2006, and January 1, 2006,
respectively; 49,901,064 and 49,454,654 shares
outstanding at October 1, 2006, and
January 1, 2006, respectively
    
    
    501
    
    
    
    497Additional paid-in capital
    
    
    101,241
    
    
    
    99,598Unearned compensation on restricted common shares
    
    
    (542
    )Accumulated deficit
    
    
    (53,849
    )
    
    
    (47,310
    )Accumulated other comprehensive income (loss)
    
    
    28
    
    
    
    (64
    )Treasury shares: 241,045 shares; at cost at October 1, 2006
and January 1, 2006
    
    
    (847
    )
    
    
    (847
    )Total shareholders equity
    
    
    46,532
    
    
    
    51,874Total liabilities and shareholders equity
    
    $
    108,620
    
    
    $
    110,353
  4




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APAC CUSTOMER SERVICES, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except share data)
(Unaudited)
 Thirteen Weeks Ended
    
    
    Thirty-Nine Weeks EndedOctober 1,
    
    
    October 2,
    
    
    October 1,
    
    
    October 2,2006
    
    
    2005
    
    
    2006
    
    
    2005Net Revenue
    
    $
    49,282
    
    
    $
    56,343
    
    
    $
    168,241
    
    
    $
    180,176Cost of services
    
    
    46,146
    
    
    
    50,966
    
    
    
    150,168
    
    
    
    165,275Gross profit
    
    
    3,136
    
    
    
    5,377
    
    
    
    18,073
    
    
    
    14,901Operating expenses:Selling, general and administrative expenses
    
    
    8,182
    
    
    
    8,082
    
    
    
    24,154
    
    
    
    27,054Restructuring and other charges
    
    
    2,329
    
    
    
    2,074
    
    
    
    2,700
    
    
    
    3,211Asset impairment charges
    
    
    
    
    
    
    10,762
    
    
    
    
    
    
    
    10,886Total operating expenses
    
    
    10,511
    
    
    
    20,918
    
    
    
    26,854
    
    
    
    41,151Operating loss
    
    
    (7,375
    )
    
    
    (15,541
    )
    
    
    (8,781
    )
    
    
    (26,250
    )Other income
    
    
    (62
    )
    
    
    (582
    )
    
    
    (56
    )
    
    
    (644
    )Interest expense
    
    
    490
    
    
    
    305
    
    
    
    1,388
    
    
    
    1,006Loss before income taxes
    
    
    (7,803
    )
    
    
    (15,264
    )
    
    
    (10,113
    )
    
    
    (26,612
    )Income tax benefit
    
    
    (2,798
    )
    
    
    (1,757
    )
    
    
    (3,574
    )
    
    
    (5,710
    )Net loss
    
    $
    (5,005
    )
    
    $
    (13,507
    )
    
    $
    (6,539
    )
    
    $
    (20,902
    )Net loss per share:Basic
    
    $
    (0.10
    )
    
    $
    (0.27
    )
    
    $
    (0.13
    )
    
    $
    (0.42
    )Diluted
    
    $
    (0.10
    )
    
    $
    (0.27
    )
    
    $
    (0.13
    )
    
    $
    (0.42
    )Weighted average number of shares outstanding:Basic
    
    
    49,455
    
    
    
    49,455
    
    
    
    49,455
    
    
    
    49,455Diluted
    
    
    49,455
    
    
    
    49,455
    
    
    
    49,455
    
    
    
    49,455
  5




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APAC CUSTOMER SERVICES, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
 Thirty-Nine Weeks EndedOctober 1,
    
    
    October 2,2006
    
    
    2005Operating activities:Net loss
    
    $
    (6,539
    )
    
    $
    (20,902
    )Depreciation and amortization
    
    
    9,094
    
    
    
    9,054Non-cash restructuring charges
    
    
    517
    
    
    
    197Asset impairment charges
    
    
    
    
    
    
    10,886Deferred income taxes
    
    
    (3,834
    )
    
    
    (5,356
    )Stock compensation expense
    
    
    1,105
    
    
    
    Gain on sale of property and equipment
    
    
    
    
    
    
    (398
    )Change in operating assets and liabilities
    
    
    7,239
    
    
    
    8,224Net cash provided by operating activities
    
    
    7,582
    
    
    
    1,705Investing activities:Purchases of property and equipment, net of disposals
    
    
    (6,295
    )
    
    
    (6,023
    )Net proceeds from sale of property and equipment
    
    
    10
    
    
    
    626Net cash used in investing activities
    
    
    (6,285
    )
    
    
    (5,397
    )Financing activities:Borrowings under revolving credit facility, net
    
    
    (1,807
    )
    
    
    5,361Payments on long-term debt
    
    
    
    
    
    
    (313
    )Financing fees
    
    
    
    
    
    
    (768
    )Net cash provided by (used in) financing activities
    
    
    (1,807
    )
    
    
    4,280Effect of exchange rate change on cash
    
    
    (86
    )
    
    
    Net change in cash and cash equivalents
    
    
    (596
    )
    
    
    588Cash and cash equivalents:Beginning balance
    
    
    960
    
    
    
    271Ending balance
    
    $
    364
    
    
    $
    859Supplemental disclosures:Leasehold improvements funded by landlord
    
    $
    3,250
    
    
    $
    Cash paid during the period for interest
    
    
    998
    
    
    
    434Cash paid during the period for income taxes
    
    
    21
    
    
    
    6Income tax refund received
    
    
    
    
    
    
    445
  6




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APAC CUSTOMER SERVICES, INC. AND SUBSIDIARIES
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except as otherwise indicated)
 1. Basis of Presentation
 http://www.sec.gov
 th st
 2. New Accounting Pronouncements
 Transition Election Related to Accounting for the Tax Effects of
Share-Based Payment Awards Share-Based Payment
 Accounting for Uncertainty in Income Taxes: an
interpretation of FASB Statement No. 109 , Accounting for Income Taxes
 7




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APAC CUSTOMER SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except as otherwise indicated)
 3. Accrued Liabilities
  October 1,
    
    
    January 1,2006
    
    
    2006Accrued workers compensation
    
    $
    2,859
    
    
    $
    3,010Accrued restructuring charges
    
    
    3,249
    
    
    
    2,806Accrued professional fees
    
    
    937
    
    
    
    659Accrued property taxes
    
    
    592
    
    
    
    737Deferred rent
    
    
    3,154
    
    
    
    Other
    
    
    4,859
    
    
    
    2,598Total
    
    $
    15,650
    
    
    $
    9,810
  4. Goodwill and Other Intangible Assets
    5. Accounting for Stock-Based Compensation
  8




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APAC CUSTOMER SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except as otherwise indicated)
 Share-Based Payment Accounting for
Stock-Based Compensation Accounting for Stock Issued to Employees
    Transition Election Related to Accounting for
the Tax Effects of Share-Based Payment Awards
 9




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APAC CUSTOMER SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except as otherwise indicated)
  Thirteen Weeks
    
    
    Thirty-NineEnded
    
    
    Weeks EndedOctober 2, 2005
    
    
    October 2, 2005Net loss as reported
    
    $
    (13,507
    )
    
    $
    (20,902
    )Compensation expense on stock options, net of income tax benefit
    
    
    (162
    )
    
    
    (776
    )Pro forma net loss
    
    $
    (13,669
    )
    
    $
    (21,678
    )Loss per share  basicAs reported
    
    $
    (0.27
    )
    
    $
    (0.42
    )Pro forma
    
    $
    (0.28
    )
    
    $
    (0.44
    )Loss per share  dilutedAs reported
    
    $
    (0.27
    )
    
    $
    (0.42
    )Pro forma
    
    $
    (0.28
    )
    
    $
    (0.44
    )
  Options
    
    Restricted Common SharesThirty-Nine Weeks Ended
    
    Thirty-Nine Weeks EndedOctober 1,
    
    October 2,
    
    October 1,
    
    October 2,2006
    
    2005
    
    2006
    
    2005Expected volatility
    
    
    51 - 56
    %
    
    
    45 - 49
    %
    
    
    51 - 55
    %
    
    NARisk-free interest rate
    
    
    4.6 - 5.1
    %
    
    
    4.0 - 4.5
    %
    
    
    4.8 - 5.1
    %
    
    NAExpected life in years
    
    
    2.3 - 5.0
    
    
    
    6.80
    
    
    
    2.2- 4.5
    
    
    NAAnnualized forfeiture rate
    
    
    15.8
    %
    
    
    
    
    
    
    15.8
    %
    
    NAWeighted average grant date fair value
    
    $
    0.85
    
    
    $
    0.74
    
    
    $
    1.51
    
    
    NA
  WeightedWeighted
    
    AverageAverage
    
    RemainingNumber of
    
    Exercise Price
    
    Vesting Period
    
    AggregateShares
    
    Per Share
    
    (in years)
    
    Intrinsic ValueOutstanding on January 1, 2006
    
    
    
    
    
    $
    Granted
    
    
    446,410
    
    
    
    Exercised/Forfeited/Canceled
    
    
    
    
    
    
    Outstanding on October 1, 2006
    
    
    446,410
    
    
    
    
    
    
    
    1.60
    
    
    $
    1,162,898Exercisable on October 1, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 10




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APAC CUSTOMER SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except as otherwise indicated)
  WeightedAverageWeighted
    
    RemainingNumber of
    
    Average Exercise
    
    Contractual Term
    
    AggregateOptions
    
    Price Per Share
    
    (in years)
    
    Intrinsic ValueOutstanding on January 1, 2006
    
    
    7,674,299
    
    
    $
    2.48Granted
    
    
    483,404
    
    
    
    1.96Forfeited/Canceled
    
    
    (630,272
    )
    
    
    5.74Outstanding on October 1, 2006
    
    
    7,527,431
    
    
    
    2.18
    
    
    
    7.53
    
    
    $
    6,299,127Exercisable on October 1, 2006
    
    
    2,812,398
    
    
    
    3.25
    
    
    
    5.79
    
    
    
    1,093,408
 6. Comprehensive Loss
  Thirteen Weeks Ended
    
    
    Thirty-Nine Weeks EndedOctober 1,
    
    
    October 2,
    
    
    October 1,
    
    
    October 2,2006
    
    
    2005
    
    
    2006
    
    
    2005Net loss
    
    $
    (5,005
    )
    
    $
    (13,507
    )
    
    $
    (6,539
    )
    
    $
    (20,902
    )Foreign currency translation gain (loss)
    
    
    170
    
    
    
    (148
    )
    
    
    92
    
    
    
    (126
    )Total comprehensive loss
    
    $
    (4,835
    )
    
    $
    (13,655
    )
    
    $
    (6,447
    )
    
    $
    (21,028
    )
  7. Legal Proceedings
  8. Debt
  11




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APAC CUSTOMER SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except as otherwise indicated)
          12




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APAC CUSTOMER SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except as otherwise indicated)
 9. Restructuring and Other Charges/Asset Impairment Charges
       13




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APAC CUSTOMER SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except as otherwise indicated)
  January 1,
    
    
    Charges
    
    
    Asset
    
    
    Cash
    
    
    October 1,2006
    
    
    (Reversals)
    
    
    Write-off
    
    
    Payments
    
    
    2006Restructuring initiatives prior to 2005:
    
    $
    255
    
    
    $
    
    
    
    $
    
    
    
    $
    197
    
    
    $
    582005 restructuring initiatives:Employee severance costs
    
    
    458
    
    
    
    (276
    )
    
    
    
    
    
    
    158
    
    
    
    24Lease obligations and other costs
    
    
    3,985
    
    
    
    (10
    )
    
    
    
    
    
    
    1,597
    
    
    
    2,3782006 restructuring initiatives:Employee severance costs
    
    
    
    
    
    
    506
    
    
    
    
    
    
    
    192
    
    
    
    314Lease obligations and other costs
    
    
    
    
    
    
    2,480
    
    
    
    (517
    )
    
    
    259
    
    
    
    1,704Total
    
    $
    4,698
    
    
    $
    2,700
    
    
    $
    (517
    )
    
    $
    2,403
    
    
    $
    4,478
 10. Income Taxes
    14




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APAC CUSTOMER SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Amounts in thousands, except as otherwise indicated)
   11. Earnings Per Share
  12. Reclassification
  13. Subsequent Events
 Accounting
for Sales with Leaseback
  15




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
  Overview
   Critical Accounting Policies and Estimates
 Share-Based
Payment
 Accounting for Stock-Based Compensation Accounting for
Stock Issued to Employees
   16




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Results of Operations
  Thirteen Weeks Ended
    
    
    Thirty-Nine Weeks EndedOctober 1,
    
    
    October 2,
    
    
    Fav (Unfav)
    
    
    October 1,
    
    
    October 2,
    
    
    Fav (Unfav)2006
    
    
    2005
    
    
    % Change
    
    
    2006
    
    
    2005
    
    
    % ChangeNet Revenue:Domestic
    
    $
    42,468
    
    
    $
    44,447
    
    
    
    (4.5
    )%
    
    $
    148,550
    
    
    $
    136,108
    
    
    
    9.1
    %Off-shore
    
    
    6,814
    
    
    
    2,831
    
    
    
    140.7
    
    
    
    18,762
    
    
    
    7,314
    
    
    
    156.5Restructured outbound
business
    
    
    
    
    
    
    9,065
    
    
    
    *
    
    
    
    929
    
    
    
    36,754
    
    
    
    (97.5
    )Total net revenue
    
    
    49,282
    
    
    
    56,343
    
    
    
    (12.5
    )
    
    
    168,241
    
    
    
    180,176
    
    
    
    (6.6
    )Cost of Services:Direct labor
    
    
    29,776
    
    
    
    31,880
    
    
    
    6.6
    
    
    
    98,182
    
    
    
    103,915
    
    
    
    5.5Other facility expenses
    
    
    16,370
    
    
    
    19,086
    
    
    
    14.2
    
    
    
    51,986
    
    
    
    61,360
    
    
    
    15.3Total cost of services
    
    
    46,146
    
    
    
    50,966
    
    
    
    9.5
    
    
    
    150,168
    
    
    
    165,275
    
    
    
    9.1Percentage of revenue
    
    
    93.6
    %
    
    
    90.5
    %
    
    
    
    
    
    
    89.3
    %
    
    
    91.7
    %
    
    
    Gross profit
    
    
    3,136
    
    
    
    5,377
    
    
    
    (41.7
    )
    
    
    18,073
    
    
    
    14,901
    
    
    
    21.3Gross profit margin
    
    
    6.4
    %
    
    
    9.5
    %
    
    
    
    
    
    
    10.7
    %
    
    
    8.3
    %
    
    
    Operating Expenses:Selling, general &
administrative expenses
    
    
    8,182
    
    
    
    8,082
    
    
    
    (1.2
    )
    
    
    24,154
    
    
    
    27,054
    
    
    
    10.7Restructuring and other
charges
    
    
    2,329
    
    
    
    2,074
    
    
    
    (12.3
    )
    
    
    2,700
    
    
    
    3,211
    
    
    
    15.9Asset impairment charges
    
    
    
    
    
    
    10,762
    
    
    
    100.0
    
    
    
    
    
    
    
    10,886
    
    
    
    100.0Total operating expenses
    
    
    10,511
    
    
    
    20,918
    
    
    
    49.8
    
    
    
    26,854
    
    
    
    41,151
    
    
    
    34.7Operating loss
    
    
    (7,375
    )
    
    
    (15,541
    )
    
    
    52.5
    
    
    
    (8,781
    )
    
    
    (26,250
    )
    
    
    66.5Other income
    
    
    (62
    )
    
    
    (582
    )
    
    
    (89.3
    )
    
    
    (56
    )
    
    
    (644
    )
    
    
    (91.3
    )Interest expense
    
    
    490
    
    
    
    305
    
    
    
    (60.7
    )
    
    
    1,388
    
    
    
    1,006
    
    
    
    (38.0
    )Loss before income taxes
    
    
    (7,803
    )
    
    
    (15,264
    )
    
    
    48.9
    
    
    
    (10,113
    )
    
    
    (26,612
    )
    
    
    62.0Income tax benefit
    
    
    (2,798
    )
    
    
    (1,757
    )
    
    
    59.2
    
    
    
    (3,574
    )
    
    
    (5,710
    )
    
    
    (37.4
    )Net loss
    
    $
    (5,005
    )
    
    $
    (13,507
    )
    
    
    62.9
    %
    
    $
    (6,539
    )
    
    $
    (20,902
    )
    
    
    68.7
    %
 
 *
    
    Means that the percentage change is not meaningful Non-GAAP Financial Measures
  17




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Thirteen Weeks Ended
    
    
    Thirty-Nine Weeks EndedOctober 1,
    
    
    October 2,
    
    
    Fav (Unfav)
    
    
    October 1,
    
    
    October 2,
    
    
    Fav (Unfav)2006
    
    
    2005
    
    
    % Change
    
    
    2006
    
    
    2005
    
    
    % Change(Amounts in thousands except statistical data and notes)EBITDA
    
    $
    (4,264
    )
    
    $
    (11,855
    )
    
    
    64.0
    %
    
    $
    369
    
    
    $
    (16,552
    )
    
    
    *Adjusted EBITDA
    
    
    (1,935
    )
    
    
    981
    
    
    
    *
    
    
    
    3,069
    
    
    
    (2,455
    )
    
    
    *Adjusted operating loss
    
    
    (5,046
    )
    
    
    (2,705
    )
    
    
    (86.6
    )
    
    
    (6,081
    )
    
    
    (12,153
    )
    
    
    50.0
    %Free cash flow
    
    
    (5,814
    )
    
    
    (12,571
    )
    
    
    53.7
    
    
    
    (5,926
    )
    
    
    (22,575
    )
    
    
    73.8Adjusted free cash flow
    
    
    (3,485
    )
    
    
    265
    
    
    
    *
    
    
    
    (3,226
    )
    
    
    (8,478
    )
    
    
    61.9Statistical information:Number of customer care
centers:Domestic
    
    
    8
    
    
    
    13
    
    
    
    
    
    
    
    8
    
    
    
    13Off-shore
    
    
    2
    
    
    
    1
    
    
    
    
    
    
    
    2
    
    
    
    1Total
    
    
    10
    
    
    
    14
    
    
    
    
    
    
    
    10
    
    
    
    14Number of workstations:Domestic
    
    
    4,625
    
    
    
    5,253
    
    
    
    
    
    
    
    4,625
    
    
    
    5,253Off-shore
    
    
    1,520
    
    
    
    1,214
    
    
    
    
    
    
    
    1,520
    
    
    
    1,214Total
    
    
    6,145
    
    
    
    6,467
    
    
    
    
    
    
    
    6,145
    
    
    
    6,467Annualized net revenue per
average workstation:Domestic
    
    $
    35,543
    
    
    $
    34,596
    
    
    
    
    
    
    $
    38,444
    
    
    $
    36,929Off-shore
    
    
    18,027
    
    
    
    13,320
    
    
    
    
    
    
    
    19,525
    
    
    
    15,150Total
    
    
    31,336
    
    
    
    31,039
    
    
    
    
    
    
    
    34,538
    
    
    
    34,163
 
 *
    
    Means that the percentage change is not meaningful  18




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Notes to Non-GAAP Financial Measures
     Thirteen Weeks Ended
    
    
    Thirty-Nine Weeks EndedOctober 1,
    
    
    October 2,
    
    
    October 1,
    
    
    October 2,2006
    
    
    2005
    
    
    2006
    
    
    2005(Amounts in thousands)Net loss
    
    $
    (5,005
    )
    
    $
    (13,507
    )
    
    $
    (6,539
    )
    
    $
    (20,902
    )Interest expense
    
    
    490
    
    
    
    305
    
    
    
    1,388
    
    
    
    1,006Benefit for income taxes
    
    
    (2,798
    )
    
    
    (1,757
    )
    
    
    (3,574
    )
    
    
    (5,710
    )Depreciation and amortization
    
    
    3,049
    
    
    
    3,104
    
    
    
    9,094
    
    
    
    9,054EBITDA
    
    $
    (4,264
    )
    
    $
    (11,855
    )
    
    $
    369
    
    
    $
    (16,552
    )Restructuring and other charges
    
    
    2,329
    
    
    
    2,074
    
    
    
    2,700
    
    
    
    3,211Asset impairment charges
    
    
    
    
    
    
    10,762
    
    
    
    
    
    
    
    10,886Adjusted EBITDA
    
    $
    (1,935
    )
    
    $
    981
    
    
    $
    3,069
    
    
    $
    (2,455
    )
    Thirteen Weeks Ended
    
    
    Thirty-Nine Weeks EndedOctober 1,
    
    
    October 2,
    
    
    October 1,
    
    
    October 2,2006
    
    
    2005
    
    
    2006
    
    
    2005(Amounts in thousands)Operating loss
    
    $
    (7,375
    )
    
    $
    (15,541
    )
    
    $
    (8,781
    )
    
    $
    (26,250
    )Restructuring and other charges
    
    
    2,329
    
    
    
    2,074
    
    
    
    2,700
    
    
    
    3,211Asset impairment charges
    
    
    
    
    
    
    10,762
    
    
    
    
    
    
    
    10,886Adjusted Operating Loss
    
    $
    (5,046
    )
    
    $
    (2,705
    )
    
    $
    (6,081
    )
    
    $
    (12,153
    )
 19




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Notes to Non-GAAP Financial Measures (continued)
   Thirteen Weeks Ended

    
    
    Thirty-Nine Weeks EndedOctober 1,
    
    
    October 2,
    
    
    October 1,
    
    
    October 2,2006
    
    
    2005
    
    
    2006
    
    
    2005(Amounts in thousands)EBITDA
    
    $
    (4,264
    )
    
    $
    (11,855
    )
    
    $
    369
    
    
    $
    (16,552
    )Capital expenditures
    
    
    (1,550
    )
    
    
    (716
    )
    
    
    (9,545
    )
    
    
    (6,023
    )Leasehold improvements funded by landlord
    
    
    
    
    
    
    
    
    
    
    3,250
    
    
    
    Free Cash Flow
    
    $
    (5,814
    )
    
    $
    (12,571
    )
    
    $
    (5,926
    )
    
    $
    (22,575
    )Restructuring and other charges
    
    
    2,329
    
    
    
    2,074
    
    
    
    2,700
    
    
    
    3,211Asset impairment charges
    
    
    
    
    
    
    10,762
    
    
    
    
    
    
    
    10,886Adjusted Free Cash Flow
    
    $
    (3,485
    )
    
    $
    265
    
    
    $
    (3,226
    )
    
    $
    (8,478
    )
  Thirteen Weeks Ended
    
    
    Thirty-Nine Weeks EndedOctober 1,
    
    
    October 2,
    
    
    October 1,
    
    
    October 2,2006
    
    
    2005
    
    
    2006
    
    
    2005(Amounts in thousands)Net cash provided by operating activities
    
    $
    5,158
    
    
    $
    2
    
    
    $
    7,582
    
    
    $
    1,705Purchase of property and equipment
    
    
    (1,550
    )
    
    
    (716
    )
    
    
    (6,295
    )
    
    
    (6,023
    )Benefit for income taxes
    
    
    (2,798
    )
    
    
    (1,757
    )
    
    
    (3,574
    )
    
    
    (5,710
    )Interest expense
    
    
    490
    
    
    
    305
    
    
    
    1,388
    
    
    
    1,006Gain on sale of property and equipment
    
    
    
    
    
    
    398
    
    
    
    
    
    
    
    398Changes in operating assets and liabilities
    
    
    (9,637
    )
    
    
    (987
    )
    
    
    (7,239
    )
    
    
    (8,224
    )Asset impairment charges
    
    
    
    
    
    
    (10,762
    )
    
    
    
    
    
    
    (10,886
    )Increase in deferred income taxes
    
    
    3,016
    
    
    
    1,121
    
    
    
    3,834
    
    
    
    5,356Stock compensation expense
    
    
    (347
    )
    
    
    
    
    
    
    (1,105
    )
    
    
    Non-cash restructuring charges
    
    
    (146
    )
    
    
    (175
    )
    
    
    (517
    )
    
    
    (197
    )Free Cash Flow
    
    $
    (5,814
    )
    
    $
    (12,571
    )
    
    $
    (5,926
    )
    
    $
    (22,575
    )Restructuring and other charges
    
    
    2,329
    
    
    
    2,074
    
    
    
    2,700
    
    
    
    3,211Asset impairment charges
    
    
    
    
    
    
    10,762
    
    
    
    
    
    
    
    10,886Adjusted Free Cash Flow
    
    $
    (3,485
    )
    
    $
    265
    
    
    $
    (3,226
    )
    
    $
    (8,478
    )
 20




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Comparison of Results of Operations for the Quarters Ended October 1, 2006 and October 2, 2005
         21




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Comparison of Results of Operations for the Thirty-nine Weeks Ended October 1, 2006 and October 2,
2005
      22




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23




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Income Tax Matters
   Liquidity and Capital Resources
  Thirty-Nine Weeks EndedOctober 1,
    
    
    October 2,2006
    
    
    2005(Amounts in thousands)Net cash provided by operating activities
    
    $
    7,582
    
    
    $
    1,705Net cash used in investing activities
    
    
    (6,285
    )
    
    
    (5,397
    )Net cash provided by (used in) financing activities
    
    
    (1,807
    )
    
    
    4,280Effect of exchange rate changes on cash
    
    
    (86
    )
    
    
    Net change in cash and cash equivalents
    
    $
    (596
    )
    
    $
    588
    24




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25




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##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures About Market Risk
   
 Item 4. Controls and Procedures
 Disclosure Controls and Procedures
  Internal Control Over Financial Reporting
  Inherent Limitations on the Effectiveness of Controls
   26




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Part II. Other Information
 
 Item 1A. Risk Factors
   
 Item 5.
Other Information
  
 Item 6. Exhibits
  27




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##### Table of Contents



SIGNATURES
  APAC Customer Services, Inc. and SubsidiariesDate: November 13, 2006
    
    By:
    
    /s/ Robert J. KellerRobert J. KellerPresident andChief Executive Officer(Principal Executive Officer)Date: November 13, 2006
    
    By:
    
    /s/ George H. Hepburn IIIGeorge H. Hepburn IIISenior Vice President andChief Financial Officer(Principal Financial Officer)Date: November 13, 2006
    
    By:
    
    /s/ Joseph R. DoolanJoseph R. DoolanVice President and Controller(Principal Accounting Officer)
 28




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##### Table of Contents



Exhibit Index
 ExhibitNumber
    
    Description3.1.1
    
    Articles of Incorporation of APAC Customer Services, Inc.,
incorporated by reference to APAC Customer Services, Inc.s Annual
Report on Form 10-K for the fiscal year ended January 1, 2006.3.2
    
    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
    
    Amendment No. 4 to Amended and Restated Loan and Security
Agreement, dated as of October 1, 2006, incorporated by reference
to APAC Customer Services, Inc.s current report on Form 8-K,
dated October 25, 2006.10.2
    
    Amendment No. 5 to Amended and Restated Loan and Security
Agreement, dated as of November 10, 2006.31.1
    
    Certification of Chief Executive Officer, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of the Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
 29