**UNITEDSTATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

----

 

**FORM 10-Q**

 

**(Mark One)**

 

| **ý**                                                                                                                                                                                                            |   | **QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.**  |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                  |   |
| **For the quarterly period ended  September 28, 2003**                                                                                                                                                           |
|                                                                                                                                                                                                                  |   |
| **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 Center, Suite 400, Deerfield, Illinois 60015**                      |
| (Address of Principal  Executive Offices, Zip Code)                                      |
|                                                                                     |   |                                  |
| Registrant’s telephone  number, including area code:  **(847)  374-4980** |

 

Indicate by check markwhether registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter periods that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

 

Yes  ý        No  o

 

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

 

Yes  ý        No  o

 

There were 49,441,592common shares, $0.01 par value per share, outstanding as of November 7,2003.

 

 

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## **Index**

 

 
|                                                                                                      | **Page**                                                                                                                                             |
|-----------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                      |                                                                                                                                                 |
| **Part I.  Financial Information**                                                                   |                                                                                                                                                 |
|                                                                                                      |                                                                                                                                                 |
| Item 1.  Financial Statements (Unaudited):                                                           |                                                                                                                                                 |
|                                                                                                      |                                                                                                                                                 |
|                                                                                                      | Consolidated Condensed Balance Sheets as  of September 28, 2003, and December 29, 2002.                                                    | 3 |
|                                                                                                      |                                                                                                                                                 |
|                                                                                                      | Consolidated  Condensed Statements of Operations for the Thirteen and Thirty-Nine Weeks  Ended September 28, 2003, and September 29, 2002. | 4 |
|                                                                                                      |                                                                                                                                                 |
|                                                                                                      | Consolidated  Condensed Statements of Cash Flows for the Thirty-Nine Weeks Ended  September 28, 2003, and September 29, 2002.              | 5 |
|                                                                                                      |                                                                                                                                                 |
|                                                                                                      | Notes  to Consolidated Condensed Financial Statements                                                                                                | 6 |
|                                                                                                      |                                                                                                                                                 |
| Item 2.  Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 10                                                                                                                                                   |
|                                                                                                      |                                                                                                                                                 |
| Item 3.  Quantitative and Qualitative Disclosures  About Market Risk                                 | 15                                                                                                                                                   |
|                                                                                                      |                                                                                                                                                 |
| Item 4.  Controls and Procedures                                                                     | 16                                                                                                                                                   |
|                                                                                                      |                                                                                                                                                 |
| **Part  II.  Other Information**                                                                     |                                                                                                                                                 |
|                                                                                                      |                                                                                                                                                 |
| Item 1.  Legal Proceedings                                                                           | 17                                                                                                                                                   |
|                                                                                                      |                                                                                                                                                 |
| Item 6.  Exhibits and Reports on Form 8-K                                                            | 17                                                                                                                                                   |

 

2

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## **Part I**. Financial Information

 

# **Item 1. Financial Statements**

 

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

**ConsolidatedCondensed Balance Sheets**

**(Unaudited)**

**(In thousands)**

 
|                                                                                                                                            |   | **September 28,  2003** |       | **December 29,  2002** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|------------|-----------------------------|------------|
|                                                                                                                                            |   |                         | ** ** |                        | ** ** |
| **Assets**                                                                                                                                      |   |                         |       |                        |       |
|                                                                                                                                            |   |                         |       |                        |       |
| ** Current  assets:**                                                                                                                      |   |                         |       |                        |       |
| Cash  and cash equivalents                                                                                                                      |   | $                            | 9,709      |                        | $          | 14,530 |   |
| Accounts  receivable, net                                                                                                                       |   | 48,469                       |       | 51,508                      |       |
| Other  current assets                                                                                                                           |   | 11,048                       |       | 12,646                      |       |
| Total  current assets                                                                                                                           |   | 69,226                       |       | 78,684                      |       |
|                                                                                                                                            |   |                         |       |                        |       |
| ** Property  and equipment, net**                                                                                                          |   | 23,701                       |       | 25,680                      |       |
|                                                                                                                                            |   |                         |       |                        |       |
| ** Goodwill**                                                                                                                              |   | 23,876                       |       | 23,876                      |       |
|                                                                                                                                            |   |                         |       |                        |       |
|  Customer  relationships                                                                                                                   |   | 28,493                       |       | 28,493                      |       |
| Less-accumulated  amortization                                                                                                                  |   | 12,871                       |       | 11,111                      |       |
| ** Customer relationships, net**                                                                                                           |   | 15,622                       |       | 17,382                      |       |
|                                                                                                                                            |   |                         | ** ** |                        | ** ** |
| ** Deferred taxes**                                                                                                                        |   | 2,702                        |       | 2,207                       |       |
|  Other  assets                                                                                                                             |   | 1,314                        |       | 1,565                       |       |
| Total  assets                                                                                                                                   |   | $                            | 136,441    |                        | $          | 149,394 |   |
|                                                                                                                                            |   |                         |       |                        |       |
| **Liabilities  and  Shareholders’ Equity**                                                                                                 |   |                         | ** ** |                        | ** ** |
| ** Current  liabilities:**                                                                                                                 |   |                         | ** ** |                        | ** ** |
| Current  maturities of long-term debt                                                                                                           |   | $                            | 581        |                        | $          | 656 |   |
| Accounts  payable                                                                                                                               |   | 2,212                        |       | 3,627                       |       |
| Other  current liabilities                                                                                                                      |   | 39,081                       |       | 37,034                      |       |
| Total  current liabilities                                                                                                                      |   | 41,874                       |       | 41,317                      |       |
|                                                                                                                                            |   |                         |       |                        |       |
| ** Long-term  debt, less current maturities**                                                                                              |   | 12,958                       |       | 28,872                      |       |
|                                                                                                                                            |   |                         | ** ** |                        | ** ** |
| ** Other  liabilities**                                                                                                                    |   | 1,414                        |       | 2,778                       |       |
|                                                                                                                                            |   |                         | ** ** |                        | ** ** |
| ** Commitments  and contingencies**                                                                                                        |   | —                       |       | —                      |       |
|                                                                                                                                            |   |                         | ** ** |                        | ** ** |
| ** Shareholders’  equity**                                                                                                            |   |                         | ** ** |                        | ** ** |
| Common  shares, $0.01 par value; 200,000,000 shares authorized; 49,695,699 shares  issued at September 28, 2003 and December 29, 2002 |   | 497                          |       | 497                         |       |
| Additional  paid-in capital                                                                                                                     |   | 99,620                       |       | 99,690                      |       |
| Accumulated  deficit                                                                                                                            |   | (18,968                      | )          | (22,752                     | )          |
| Accumulated  other comprehensive income                                                                                                         |   | (62                          | )          | —                      |       |
| Treasury  shares: 254,107 and 286,871 shares, respectively, at cost                                                                             |   | (892                         | )          | (1,008                      | )          |
| Total  shareholders’ equity                                                                                                                |   | 80,195                       |       | 76,427                      |       |
| Total  liabilities and shareholders’ equity                                                                                                |   | $                            | 136,441    |                        | $          | 149,394 |   |

 

See notes toconsolidated condensed financial statements 

 

3

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**APAC Customer Services, Inc. andSubsidiaries****Consolidated Condensed Statements of Operations(Unaudited)(In thousands, except per share data)**

** **
|                                               |   | **Thirteen Weeks Ended**       |       | **Thirty-Nine Weeks Ended**    |       |
|----------------------------------------------------|--------|--------------------------------|------------|--------------------------------|------------|
|                                               |   | **September 28,****2003** |       | **September 29,****2002** |       | **September 28,****2003** |   | **September 29,****2002** |   |
|                                               |   |                           | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Net revenue**                                    |   | $                              | 79,658     |                           | $          | 85,092 |   | $ | 247,939 |   | $ | 283,454 |   |
|                                               |   |                           |       |                           |       |   |   |   |   |
| **Operating expenses:**                            |   |                           |       |                           |       |   |   |   |   |
|                                               |   |                           |       |                           |       |   |   |   |   |
| Cost of services                                   |   | 65,338                         |       | 69,199                         |       | 201,411 |   | 227,142 |   |
| Selling, general and administrative Expenses       |   | 12,124                         |       | 11,640                         |       | 38,039 |   | 38,265 |   |
| Restructuring and other charges                    |   | 1,800                          |       | 1,131                          |       | 1,800 |   | 3,667 |   |
| Asset impairment charges                           |   | 108                            |       | —                         |       | 108 |   | 510 |   |
| Total operating expenses                           |   | 79,370                         |       | 81,970                         |       | 241,358 |   | 269,584 |   |
| **Operating income**                               |   | 288                            |       | 3,122                          |       | 6,581 |   | 13,870 |   |
|                                               |   |                           |       |                           |       |   |   |   |   |
| Interest expense, net                              |   | 226                            |       | 1,330                          |       | 885 |   | 4,387 |   |
|                                               |   |                           |       |                           |       |   |   |   |   |
| **Income before income taxes**                     |   | 62                             |       | 1,792                          |       | 5,696 |   | 9,483 |   |
| Provision  (benefit) for income taxes              |   | (228                           | )          | 699                            |       | 1,912 |   | 3,698 |   |
|                                               |   |                           |       |                           |       |   |   |   |   |
| **Net income**                                     |   | $                              | 290        |                           | $          | 1,093 |   | $ | 3,784 |   | $ | 5,785 |   |
|                                               |   |                           | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Net Income per share:**                          |   |                           | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| Basic                                              |   | $                              | 0.01       |                           | $          | 0.02 |   | $ | 0.08 |   | $ | 0.12 |   |
| Diluted                                            |   | $                              | 0.01       |                           | $          | 0.02 |   | $ | 0.08 |   | $ | 0.12 |   |
|                                               |   |                           |       |                           |       |   |   |   |   |
| **Weighted average number of shares outstanding:** |   |                           |       |                           |       |   |   |   |   |
| Basic                                              |   | 49,442                         |       | 49,205                         |       | 49,434 |   | 49,036 |   |
| Diluted                                            |   | 49,475                         |       | 49,489                         |       | 49,465 |   | 49,382 |   |

 

See notes toconsolidated condensed financial statements. 

 

4

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**APAC Customer Services, Inc. andSubsidiaries****Consolidated Condensed Statements of Cash Flows(Unaudited)(In thousands)**

 
|                                                     |   | **Thirty-Nine  Weeks Ended** |   |
|----------------------------------------------------------|--------|------------------------------|--------|
|                                                     |   | **September 28,  2003** |   | **September 29,  2002** |   |
|                                                     |   |                         |   |   |   |
| **Operating  activities:**                               |   |                         |   |   |   |
|                                                     |   |                         |   |   |   |
| Net  income                                              |   | $                            | 3,784  |   | $ | 5,785 |   |
| Depreciation  and amortization                           |   | 9,153                        |   | 12,437 |   |
| Non-cash  restructuring charges                          |   | —                       |   | 222 |   |
| Tax  effect of stock option exercises                    |   | —                       |   | 28 |   |
| Asset  impairment charges                                |   | 108                          |   | 510 |   |
| Deferred  income taxes                                   |   | 130                          |   | 2,579 |   |
| Change  in operating assets and liabilities              |   | 3,517                        |   | 9,365 |   |
| Net  cash provided by operating activities               |   | 16,692                       |   | 30,926 |   |
|                                                     |   |                         |   |   |   |
| **Investing  activities:**                               |   |                         |   |   |   |
|                                                     |   |                         |   |   |   |
| Purchases  of property and equipment, net                |   | (5,571                       | )      | (2,967 | ) |
| Net  cash used by investing activities                   |   | (5,571                       | )      | (2,967 | ) |
|                                                     |   |                         |   |   |   |
| **Financing  activities:**                               |   |                         |   |   |   |
|                                                     |   |                         |   |   |   |
| Payments  on long-term debt                              |   | (488                         | )      | (24,400 | ) |
| Repayments  under revolving credit facility, net         |   | (15,500                      | )      | — |   |
| Stock  and warrant transactions                          |   | 46                           |   | 473 |   |
| Net  cash used by financing activities                   |   | (15,942                      | )      | (23,927 | ) |
|                                                     |   |                         |   |   |   |
| **Net (decrease) increase in cash and cash equivalents** |   | (4,821                       | )      | 4,032 |   |
|                                                     |   |                         |   |   |   |
| **Beginning cash balance**                               |   | 14,530                       |   | 21,213 |   |
|                                                     |   |                         |   |   |   |
| **Ending cash balance**                                  |   | $                            | 9,709  |   | $ | 25,245 |   |

 

See notes toconsolidated condensed financial statements 

 

5

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**APACCustomer Services, Inc. and Subsidiaries****Notes to Consolidated****CondensedFinancial Statements(Dollars in thousands, except as otherwise indicated)(Unaudited)**

** **

**1.****             ****Basis of Presentation**

** **

The accompanyingunaudited consolidated condensed financial statements of APAC CustomerServices, Inc. and its subsidiaries (collectively, the “Company”) havebeen prepared in accordance with generally accepted accounting principles forinterim financial information and the instructions to Form 10-Q andArticle 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by generally accepted accounting principles for complete financialstatements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation have been included.  Operating results for the thirty-nine weekperiod ended September 28, 2003, are not necessarily indicative of theresults that may be expected for the fiscal year ending December 28,2003.  The balance sheet atDecember 29, 2002, has been derived from the audited financial statementsat that date but does not include all of the information and footnotes requiredby generally accepted accounting principles for complete financialstatements.  For additional information,refer to the financial statements and footnotes thereto included in theCompany’s Annual Report on Form 10-K for the year ended December 29, 2002.

 

**2.****             ****Other Current Liabilities**

** **

Thecomponents of other current liabilities included in the consolidated condensedbalance sheets are as follows:

 

|                        |   | **September 28,  2003** |   | **December 29,  2002** |   |
|-----------------------------|--------|------------------------------|--------|-----------------------------|--------|
|                        |   |                         |   |                        |   |
| Payroll  and related items  |   | $                            | 18,840 |                        | $      | 19,634 |   |
| Income  taxes payable       |   | 7,074                        |   | 5,184                       |   |
| Accrued  insurance          |   | 3,293                        |   | 3,251                       |   |
| Restructuring  reserves     |   | 3,337                        |   | 2,150                       |   |
| Accrued  professional fees  |   | 1,454                        |   | 1,168                       |   |
| Accrued  relocation         |   | 786                          |   | 616                         |   |
| Accrued  telecommunications |   | 655                          |   | 713                         |   |
| Other  accrued taxes        |   | 630                          |   | 822                         |   |
| Client  related liabilities |   | 44                           |   | 977                         |   |
| Other                       |   | 2,968                        |   | 2,519                       |   |
| Total                       |   | $                            | 39,081 |                        | $      | 37,034 |   |

 

6

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**3.****             ****Accounting for Stock-BasedCompensation**

 

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 is recognized forstock options issued to employees when the option price equals or exceeds thefair market value of the Company’s common shares at the date of grant.  Stock-based compensation expense fornon-employees is recognized in accordance with Statement of Financial AccountingStandards No. 123, “Accounting for Stock Based Compensation” (“SFAS No.123”).

 

The following tableillustrates the effect on net income and earnings per share if the Company hadadopted the fair value recognition provisions of SFAS No. 123.

 
|                                                                        |   | **Thirteen Weeks Ended**     | ** ** | **Thirty-Nine Weeks Ended**  | ** ** |
|-----------------------------------------------------------------------------|--------|------------------------------|------------|------------------------------|------------|
|                                                                        |   | **September 28,  2003** | ** ** | **September 29,  2002** | ** ** | **September 28,  2003** | ** ** | **September 29,  2002** | ** ** |
|                                                                        |   |                         |       |                         |       |   |   |   |   |
| Net  income as reported                                                     |   | $                            | 290        |                         | $          | 1,093 |   | $ | 3,784 |   | $ | 5,785 |   |
| Less–compensation  expense on stock options, net of income tax benefit |   | (881                         | )          | (672                         | )          | (2,310 | ) | (2,413 | ) |
| Net  income (loss) pro forma                                                |   | $                            | (591       | )                            | $          | 421 |   | $ | 1,474 |   | $ | 3,372 |   |
| Earnings  (loss) per share – basic                                     |   |                         |       |                         |       |   |   |   |   |
| As  reported                                                                |   | $                            | 0.01       |                         | $          | 0.02 |   | $ | 0.08 |   | $ | 0.12 |   |
| Pro  forma                                                                  |   | $                            | (0.01      | )                            | $          | 0.01 |   | $ | 0.03 |   | $ | 0.07 |   |
| Earnings  (loss) per share – diluted                                   |   |                         |       |                         |       |   |   |   |   |
| As  reported                                                                |   | $                            | 0.01       |                         | $          | 0.02 |   | $ | 0.08 |   | $ | 0.12 |   |
| Pro  forma                                                                  |   | $                            | (0.01      | )                            | $          | 0.01 |   | $ | 0.03 |   | $ | 0.07 |   |

 

In order to calculate thepro forma information set forth above, the fair value of each option isestimated on the date of grant based on the Black-Scholes option-pricingmodel.   Assumptions include no dividendyield, risk-free interest rates ranging from 3% to 7%, expected volatilityranging between 70% and 90%, and an expected life ranging from 7 years to10 years.

 

**4.****             ****Comprehensive Income and AccumulatedOther Comprehensive Income (Loss)**

** **

Comprehensiveincome is as follows:

 
|                               |   | **Thirteen Weeks Ended**     |   | **Thirty-Nine Weeks Ended**  |   |
|------------------------------------|--------|------------------------------|--------|------------------------------|--------|
|                               |   | **September 28,  2003** |   | **September 29,  2002** |   | **September 28,  2003** |   | **September 29,  2002** |   |
|                               |   |                         |   |                         |   |   |   |   |   |
| Net  income                        |   | $                            | 290    |                         | $      | 1,093 |   | $ | 3,784 |   | $ | 5,785 |   |
| Unrealized  gain on swap agreement |   | —                       |   | 180                          |   | — |   | 708 |   |
| Foreign  currency translation loss |   | (62                          | )      | —                       |   | (62 | ) | — |   |
| Total  comprehensive income        |   | $                            | 228    |                         | $      | 1,273 |   | $ | 3,722 |   | $ | 6,493 |   |

 

7

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Other comprehensiveincome in fiscal 2002 represented the change in the unrealized loss on a swapagreement.  This swap agreement wasterminated in December 2002 when the Company refinanced its debt andrepaid the term loan related to the swap agreement.

 

The foreign currencytranslation loss in fiscal 2003 relates to the impact of a change in exchangerates on net assets located outside of the United States.

** **

**5.****             ****Legal Proceedings**

 

The Company is subject tooccasional lawsuits, governmental investigations and claims arising out of thenormal conduct of its business. Management does not believe the outcome of any pending claims will havea material adverse impact on the Company’s consolidated financial position,annual results of operations or liquidity. Although the Company does not believe that any of these proceedings willresult in a material adverse effect, no assurance to that effect can be given.

** **

**6.****             ****Long Term Debt**

 

On December 20,2002, the Company entered into an Amended and Restated Credit Agreement(“Credit Agreement”) replacing the previous Amended and Restated CreditFacility.  Under the terms of the CreditAgreement, the Company has a revolving credit facility, which expires inDecember 2005.  The facilityinitially provided $65.0 million of credit availability.  Beginning on March 31, 2003, thefacility is being reduced by $1.25 million of availability each quarter untilthe facility reaches $55.0 million at December 31, 2004.  Availability is also reduced by outstandingborrowings and any outstanding letters of credit.  As of September 28, 2003, there were $12.0 million ofoutstanding borrowings under the facility and approximately $6.6 million wasutilized through the issuance of standby letters of credit primarily to supportself-insurance reserves.  Netavailability as of September 28, 2003, under the Credit Agreement was$43.9 million.

 

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

 

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

 

8

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**7.****             ****Restructuring Charges**

 

Duringthe third quarter of fiscal 2003, the Company recorded restructuring charges of$1.9 million, which related to severance costs due to the elimination of 121administrative, support and call center positions.  Cash charges of $0.2 million have been paid throughSeptember 28, 2003, with the remainder to be paid over the next twelvemonths.  The Company also recorded $0.1million of asset impairment charges related to the write-off of computerhardware.

 

In the second and thirdquarters of fiscal 2002, the Company closed a total of ten Customer InteractionCenters and transitioned one center under a facility management contract.  As a result, the Company recordedrestructuring charges of $3.5 million. Other charges of $0.1 million associated with other center downsizingswere also recorded.  Asset impairmentcharges of $0.5 million recorded in the second quarter of fiscal 2002 relatedto the write-off of telecommunications equipment.  In the third quarter offiscal 2003, the Company reversed $0.1 million into restructuring charges thatwill not be utilized.

 

Following is a summary ofthe fiscal 2003 year-to-date activity in the reserves established in connectionwith the Company’s restructuring initiatives:

 
|                         |   | **Balance****12/29/02** |       | **2003****Charges** |       | **Asset****Write-down** |       | **Cash****Payments** |       | **Balance****9/28/03** |       |
|------------------------------|--------|-------------------------|------------|---------------------|------------|-------------------------|------------|----------------------|------------|------------------------|------------|
|                         |   |                    | ** ** |                | ** ** |                    | ** ** |                 | ** ** |                   | ** ** |
| **2002**                     |   |                    | ** ** |                | ** ** |                    | ** ** |                 | ** ** |                   | ** ** |
| **Employee severance costs** |   | **$**                   | **768**    | ** **          | **$**      | **(252**                | **)**      | **—**           | ** ** | **$**                  | **(358**   | **)** | **$** | **158** | ** ** |
| **Contractual obligations**  |   | **2,240**               | ** ** | **132**             | ** ** | **—**              | ** ** | **(881**             | **)**      | **1,491**              | ** ** |
|                         |   |                    | ** ** |                | ** ** |                    | ** ** |                 | ** ** |                   | ** ** |
| **2003**                     |   |                    | ** ** |                | ** ** |                    | ** ** |                 | ** ** |                   | ** ** |
| **Employee severance costs** |   | **—**              | ** ** | **1,920**           | ** ** | **—**              | ** ** | **(232**             | **)**      | **1,688**              | ** ** |
| Asset impairments            |   | —                  | ** ** | 108                 |       | $                       | (108       | )                    | —     |                   | —     |   |
|                         |   | **$**                   | **3,008**  |                | **$**      | **1,908**               | ** ** | **$**                | **(108**   | **)**                  | **$**      | **(1,471** | **)** | **$** | **3,337** | ** ** |

 

**8.****             ****Income Taxes**

 

In earlyOctober 2003, the Company received an $11.6 million cash tax refund as aresult of carrying back against prior years’ taxable income a $48.1 millionloss reported on its 2002 tax return, which is subject to audit. This lossresulted from the Company taking a $59.9 million deduction to write-off for taxpurposes its remaining investment in ITI Holdings, Inc. (for book purposes theCompany recorded appropriate impairment charges related to ITI in previousfiscal years).   The total combinedliquidity benefit to the Company from this deduction is expected to be $20.9million, which includes the $11.6 million cash tax refund, $3.3 million of cashtax savings 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 current and futureperiods. The potential income statement benefit of this deduction will not berecognized until the Company believes it is probable the deduction will not besuccessfully challenged.

 

The Company’s effectiveincome tax rate is 34.0% for the nine months ended September 28, 2003versus 39.0% in the comparable prior year period.  This decrease is primarily due to the effect of tax credits onlower taxable income in fiscal 2003.

 

9

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**Item 2. Management’s Discussion andAnalysis****of Financial Condition and Results of Operations**

** **

APAC CustomerServices, Inc. and its subsidiaries (collectively, the “Company”) is aleading provider of customer interaction solutions for market leaders intelecommunications, financial services, insurance, logistics and healthcare. Tohelp its clients better manage their customer relationships, the Companydevelops and delivers customer care and customer acquisition programs. TheCompany operates and manages approximately 7,700 workstations in 33 CustomerInteraction Centers. The Customer Interaction Centers are managed centrallythrough the application of telecommunications and computer technology topromote the consistent delivery of quality service.

 

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

 

**Resultsof Operations**

** **

The following table setsforth consolidated condensed statements of income data as a percent of netrevenue from services provided.

 
|                                          |   | **Thirteen Weeks Ended**     |   | **Thirty-Nine Weeks Ended**  |   |
|-----------------------------------------------|--------|------------------------------|--------|------------------------------|--------|
|                                          |   | **September 28,  2003** |   | **September 29,  2002** |   | **September 28,  2003** |   | **September 29,****2002** |   |
|                                          |   |                         |   |                         |   |   |   |   |   |
| **Net  revenues**                             |   | 100.0                        | %      | 100.0                        | %      | 100.0 | % | 100.0 | % |
|                                          |   |                         |   |                         |   |   |   |   |   |
| **Operating  expenses:**                      |   |                         |   |                         |   |   |   |   |   |
| Cost  of services                             |   | 82.0                         |   | 81.3                         |   | 81.2 |   | 80.1 |   |
| Selling,  general and administrative expenses |   | 15.2                         |   | 13.7                         |   | 15.3 |   | 13.5 |   |
| Restructuring  and other charges              |   | 2.3                          |   | 1.3                          |   | .7 |   | 1.3 |   |
| Asset  impairment charges                     |   | .1                           |   | —                       |   | .1 |   | 0.2 |   |
| Total  operating expenses                     |   | 99.6                         |   | 96.3                         |   | 97.3 |   | 95.1 |   |
| Operating  income                             |   | .4                           |   | 3.7                          |   | 2.7 |   | 4.9 |   |
| **Interest expense, net**                     |   | .3                           |   | 1.6                          |   | .4 |   | 1.6 |   |
|                                          |   |                         |   |                         |   |   |   |   |   |
| Income  before income taxes                   |   | .1                           |   | 2.1                          |   | 2.3 |   | 3.3 |   |
| **Provision for income taxes**                |   | (.3                          | )      | .8                           |   | .8 |   | 1.3 |   |
| **Net  income**                               |   | .4                           | %      | 1.3                          | %      | 1.5 | % | 2.0 | % |

 

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**Comparison of Results of Operations for the thirteen weeksended September 28, 2003, and September 29, 2002**

** **

Net revenue decreased6.3% to $79.7 million in the third quarter of fiscal 2003 from $85.1 million inthe same quarter of fiscal 2002.  Thedecline was primarily due to the reduction of customer care services performedunder the terms of a facility management contract renewed in October 2002and reductions in marketing programs by several financial servicesclients.  These reductions werepartially offset by an increase in services provided to certaintelecommunications clients.

 

Cost of servicesdecreased $3.9 million in the third quarter of fiscal 2003, or 5.6%, to $65.3million from $69.2 million in the same period of fiscal 2002.  This decrease is primarily due to volumerelated reductions. Cost of services as a percent of revenue increased to 82.0%from 81.3% and gross profit margins decreased to 18.0% from 18.7% primarily asa result of the impact of lower revenues.

 

Selling, general andadministrative expenses increased to $12.1 million in the third quarter offiscal 2003 from $11.6 million in the third quarter of fiscal 2002, an increaseof $0.5 million or 4.3%. The increase was largely due to higher employeerelated expenses.  As a percent of netrevenue, selling, general and administrative expenses were 15.2% in fiscal 2003versus 13.7% in fiscal 2002 due to the effect of volume related revenuereductions.

 

Duringthe third quarter of fiscal 2003, the Company recorded restructuring charges of$1.9 million, which related to severance costs due to the elimination of 121administrative, support and call center positions.  Cash charges of $0.2 million have been paid throughSeptember 28, 2003, with the remainder to be paid over the next twelvemonths.  The Company also recorded $0.1million of asset impairment charges related to the write-off of computerhardware.

 

Inthe third quarter of 2002, the Company recorded restructuring charges relatedto the closure of three facilities and the costs associated with transitioningone center under a facility management contract.  Restructuring charges of $1.1 million included $0.6 million ofemployee severance, and $0.5 million of lease termination and other costs.  In the third quarter of fiscal 2003, theCompany reversed $0.1 million into restructuring charges that will not be utilized.

 

The Company generatedoperating income of $0.3 million in the third quarter of fiscal 2003 comparedto $3.1 million for the same period of fiscal 2002.  The decrease is primarily due to the effect of lower volumes andgross profit margins, higher restructuring and asset impairment charges and anincrease in selling, general and administrative expenses, as previouslydiscussed.

 

Net interest expense forthe third quarter of fiscal 2003 decreased $1.1 million compared to the sameperiod in fiscal 2002.  This decreasereflects a reduction of $39.9 million in average debt for the third quarter offiscal 2003 versus the third quarter of fiscal 2002, and lower interest rates.

 

The Company recorded a$0.2 million tax benefit for the third quarter of fiscal 2003, versus $0.7million of tax expense in the prior year period.  This benefit recorded in the third quarter of fiscal 2003 is dueto the effect of a change in the year to date estimated effective tax rateresulting from the impact of tax credits on lower taxable income in fiscal2003.

 

**Comparison of Results of Operations for the thirty-nine weeksended September 28, 2003, and September 29, 2002**

 

Net revenue decreased12.6% to  $247.9 million in the firstnine months of fiscal 2003 from $283.5 million in the same period of fiscal2002.  The revenue decline was primarilyattributable to a reduction of customer care services under the renewal termsof a facility management contract and a reduction of customer acquisitionservices provided by the Company to its financial services clients.   These reductions were partially offset byincreased services to certain telecommunications clients.

 

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Cost of servicesdecreased $25.7 million in the first nine months of fiscal 2003, or 11.3%, to$201.4 million from $227.1 million in the same period of fiscal 2002.  This decrease is primarily due to volumerelated reductions.  Cost of services asa percent of revenue increased to 81.2% from 80.1%.  Gross profit margins decreased to 18.8% from 19.9% primarily as aresult of the impact of lower revenues, higher employee related expenses andinvestment spending including costs associated with the start up of theCompany’s Philippine call center.

 

Selling, general andadministrative expenses decreased slightly to $38.0 million in the first ninemonths of fiscal 2003 from $38.3 million in the same period of fiscal 2002, adecrease of $0.3 million or 0.8%.   As apercent of net revenue, selling, general and administrative expenses were 15.3%in the first nine months of fiscal 2003 versus 13.5% in the same period offiscal 2002 due to the effect of volume related reductions.

 

Duringthe third quarter of fiscal 2003, the Company recorded restructuring charges of$1.9 million, which related to severance costs due to the elimination of 121administrative, support and call center positions.  Cash charges of $0.2 million have been paid throughSeptember 28, 2003, with the remainder to be paid over the next twelvemonths.  The Company also recorded $0.1million of asset impairment charges related to the write-off of computerhardware.

 

In the second and thirdquarters of 2002, the Company closed a total of ten Customer InteractionCenters and transitioned one center under a facility management contract.  As a result, the Company recordedrestructuring charges of $3.5 million. Other charges of $0.1 million associated with other center downsizingswere also recorded.  Asset impairmentcharges of $0.5 million recorded in the second quarter of 2002 related to thewrite-off of telecommunications equipment. In the third quarter of fiscal2003, the Company reversed $0.1 million into restructuring charges that willnot be utilized.

 

The Company generatedoperating income of $6.6 million in the first nine months of fiscal 2003compared to $13.9 million for the same period of fiscal 2002.  The decrease is primarily due to the effectof lower volumes, and gross profit margins partially offset by lowerrestructuring and other charges and asset impairment charges.

 

Net interest expense forthe first nine months of fiscal 2003 decreased $3.5 million compared to thesame period in fiscal 2002.  Thisdecrease reflects a reduction of $41.5 million in average debt for the firstnine months of fiscal 2003 versus the same period of fiscal 2002 and lowerinterest rates.

 

The Company’s effectiveincome tax rate is 34.0% for the third quarter of fiscal 2003, versus 39.0% inthe prior year period.  This decrease isprimarily due to the effect of tax credits on lower taxable income in fiscal2003.

 

**Critical Accounting 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, employee benefit accountingand income taxes. Any deviation from these policies or estimates could have amaterial impact on the financial statements of the Company.

 

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**Revenue recognition**

 

TheCompany recognizes customer services revenue as services are performed for ourclients in accordance with Staff Accounting Bulletin (SAB) No. 101 “RevenueRecognition.” 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 occasionally 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 often subject to performancestandards, such as sales per hour, average handle time, occupancy rate andabandonment rate.  The Company’sperformance against such standards may provide bonus opportunities orconversely may subject the Company to penalties, which are recognized as earnedor incurred.

 

**Accounting for long-lived assets**

 

TheCompany’s long-lived assets consist primarily of property and equipment,capitalized software and intangible assets. In addition to the original cost ofthese assets, their recorded value is impacted by a number of policy electionsmade by the Company, including estimated useful lives and salvage values. Inaddition, any decision by the Company to reduce capacity by closing CustomerInteraction Centers or to abandon software may result in a write-off of the netbook value of these affected assets. In accordance with Statement of FinancialAccounting Standards No. 144, “Accounting for the Impairment or Disposalof Long-Lived Assets,” the Company records impairment charges on long-livedassets used in operations when events and circumstances indicate that theassets may be impaired and the undiscounted cash flows estimated to begenerated by those assets are less than the carrying amount of those assets. Inthis circumstance, the impairment charge is determined based upon the amountthe net book value of the assets exceeds their fair market value. In makingthese determinations, the Company utilizes certain assumptions, including, butnot limited to, the estimated fair market value of the assets, which arebased on additional assumptions such as asset utilization, length of time theasset will be used in the Company’s operations and estimated salvage values.

 

**Allowance for doubtful accounts**

 

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

 

**Accounting for employee benefits**

 

TheCompany records an accrued liability for group health and workers compensationclaims based on an estimate of claims incurred, but not reported, as well asasserted claims at the end of the period. This estimate is derived from ananalysis performed by actuaries hired by the Company who have expertise in thisarea.  However, although these estimatesare generally reliable, changes in the employee mix and unforeseen events couldresult in an adjustment to these estimates.

 

**Income Taxes**

 

The Company accounts forincome taxes using the asset and liability approach.  Under the asset and liability method, deferred tax assets andliabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases.  Valuation allowances are recorded when management believes it ismore likely than not that some portion or all of the deferred tax assets will notbe realized in the future.

 

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**Liquidityand Capital Resources**

 

The following table setsforth consolidated statements of cash flow data for the Company for thethirty-nine week periods ended September 28, 2003 and September 29,2002, respectively.

 
|                                       |   | **2003**            |   | **2002** |   |
|--------------------------------------------|--------|---------------------|--------|----------|--------|
|                                       |   | **(In  thousands)** |   |
|                                       |   |                |   |     |   |
| Net  cash provided by operating activities |   | $                   | 16,692 |     | $      | 30,926 |   |
| Net  cash used by investing activities     |   | (5,571              | )      | (2,967   | )      |
| Net  cash used by financing activities     |   | (15,942             | )      | (23,927  | )      |
| Net  increase (decrease) in cash           |   | $                   | (4,821 | )        | $      | 4,032 |   |

 

Cash from operatingactivities decreased $14.2 million versus the first nine months of fiscal 2002,primarily due to a $12.6 million reduction in accounts receivable that occurredin the first nine months of fiscal 2002 versus a $3.0 million reduction in thesame period of fiscal 2003. The decrease in accounts receivable in the firstnine months of fiscal 2002 was primarily due to lower volumes. Cash generatedfrom operations was lower in fiscal 2003 due to lower operating margins and areduction in depreciation and amortization.

 

Net cash used byinvesting activities increased $2.6 million from the same period of fiscal 2002due to expenditures related to the buildout of a facility in the Philippinesand computer equipment upgrades. Capital expenditures of $3.0 million in thefirst nine months of fiscal 2002 were primarily related to the purchase ofcomputer hardware, software and equipment.

 

Net cash used byfinancing activities primarily related to the repayment of $15.5 million and$24.0 million of bank debt in 2003 and 2002, respectively.

 

The Company expects thatits cash balances, cash flows from future operations and available borrowingsunder its Credit Agreement will be sufficient to meet normal operating needs,fund any planned capital expenditures and repay debt obligations payable duringfiscal 2003.  However, a significantchange in operating cash flow could impact the Company’s ability to meet itscash requirement needs and comply with covenants of its Credit Agreement.

 

In early October 2003, the Company received an$11.6 million cash tax refund as a result of carrying back against prior years’taxable income a $48.1 million loss reported on its 2002 tax return, which is subjectto audit. This loss resulted from the Company taking a $59.9 million deductionto 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).   Thetotal combined liquidity benefit to the Company from this deduction is expectedto be $20.9 million, which includes the $11.6 million cash tax refund, $3.3million of cash tax savings related to the 2002 tax year and the release of$6.0 million of tax credits generated and utilized in prior years to be used incurrent and future periods. The potential income statement benefit of thisdeduction will not be recognized until the Company believes it is probable thededuction will not be successfully challenged.

 

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**Forward-Looking Statements**

 

The Private SecuritiesLitigation Reform Act of 1995 provides a safe harbor for certainforward-looking statements. This Report on Form 10-Q and other documentsthat the Company files with the Securities and Exchange Commission (the SEC)contain forward-looking statements that reflect the Company’s current viewswith respect to future events and financial performance. These forward-lookingstatements are subject to certain risks and uncertainties, which could causefuture results to differ materially from historical results or thoseanticipated. The words “believe,” “expect,” “anticipate,” “intend,” “estimate,”“goals,” “would,” “could,” “should,” and other expressions which indicatefuture events and trends identify forward-looking statements. Readers arecautioned not to place undue reliance on these forward-looking statements,which speak only as of their dates. If no date is provided, such statementsspeak only as of the date of this Report on Form 10-Q.  Except as required under the Federalsecurities laws and rules and regulations of the SEC, the Company undertakes noobligation to publicly update or revise any forward-looking statements inconnection with new information or future events or otherwise.

 

Factors that could causefuture results to differ materially from historical results or thoseanticipated include, but are not limited to, reliance by the Company on a smallnumber of principal clients for a substantial proportion of its total revenue;possible changes in or events affecting the business of the Company’s clients,including changes in customers’ interest in, and use of, clients’ products andservices; fluctuations in quarterly results of operations due to timing ofclients’ initiation and termination of large programs; government regulation,including federal and state do not call registries; reliance on telephoneservice; changes in competitive conditions affecting the Company’s industry,including offshore call center operations; the ability of the Company’s clientsto terminate contracts with the Company on relatively short notice; changes inthe availability and cost of qualified employees; variations in the performanceof the Company’s automated system and other technological factors; improvedtechnology having the effect of reducing overall call volumes; changes ingovernment regulations affecting industries of our clients; control byprincipal shareholder; war and terrorist attacks and competition from otheroutside providers of customer interaction solutions and in-house customerinteraction operations.

 

See the Company’s filingswith the SEC for further discussion of the risks and uncertainties associatedwith the Company’s business, in particular the discussion under the caption“Information Regarding Forward-Looking Statements” in Item 7 (Management’sDiscussion and Analysis of Financial Condition and Results of Operations) ofthe Company’s Annual Report on Form 10-K for the fiscal year endedDecember 29, 2002.

 

**Item3. Quantitative and Qualitative****Disclosures About Market Risk**

 

TheCompany is exposed to the impact of U.S. interest rate changes directly relatedto its normal operating and funding activities. From time to time, the Companyenters into derivatives in order to minimize these risks but not for tradingpurposes.

 

TheCompany prepared a sensitivity analysis of its debt assuming a one-percentagepoint adverse change in interest rates for the quarter ended September 28,2003. Holding all other variables constant, the hypothetical adverse changewould not significantly increase interest expense. The sensitivity analysisassumes no changes in the Company’s financial structure.

 

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**Item4. Controls and Procedures**

 

(a)          *DisclosureControls and Procedures*.  TheCompany’s management, with the participation of the Company’s Chief ExecutiveOfficer and Chief Financial Officer, has evaluated the effectiveness of theCompany’s disclosure controls and procedures (as such term is defined in Rules13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended(the “Exchange Act”)) as of the end of the period covered by this report.  Based on such evaluation, the Company’s ChiefExecutive Officer and Chief Financial Officer have concluded that, as of theend of such period, the Company’s disclosure controls and procedures areeffective.

 

*(b)**      **InternalControls Over Financial Reporting*.  There have not been any changes in the Company’s internal controlover financial reporting (as such term is defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) during the fiscal quarter to which thisreport relates that have materially affected, or are reasonably likely tomaterially effect, the Company’s internal control over financial reporting.

 

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## **Part II**. Other Information

 

**Item1. Legal Proceedings**

 

The Company is subject tooccasional lawsuits, governmental investigations and claims arising out of thenormal conduct of its business. Management does not believe the outcome of any pending claims will havea material adverse impact on the Company’s consolidated financial position,annual results of operations or liquidity. Although the Company does not believe that any of these proceedings willresult in a material adverse effect, no assurance to that effect can be given.

 

**Item6. Exhibits and Reports on Form 8-K**

 

(a)          Exhibits

 

Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification- Principal Executive Officer.

 

Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification- Principal Financial Officer.

 

Exhibit 32.0 Section 1350 Certifications.

 

(b)         Reports on Form 8-K

 

On July 31, 2003, the Company filed a currentreport on Form 8-K setting forth the earnings release for the  fiscal quarter ended June 29,2003, and disclosing the Company’s appointment of Paul Liska and Samuel Skinneras members of the Company’s board of directors.

 

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**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:  November 10,  2003 | By:    | /s/ Marc T.  Tanenberg                                                                                          |
|                                     |   | Senior Vice  President and  Chief Financial Officer  (Principal Financial Officer  and duly authorized officer) |
|                                     |   |                                                                                                            |
|                                     |   |                                                                                                            |
| Date:  November 10,  2003 | By:    | */s/*Kenneth R. Batko                                                                                           |
|                                     |   | Vice President  and Controller  (Principal Accounting Officer  and duly authorized officer)                     |

 

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# **Exhibit Index**

 

 
| **Exhibit  Number** |   | **Description**                                                       |
|---------------------|--------|-----------------------------------------------------------------------|
|                |   |                                                                  |
| 31.1                |   | Rule 13a-14(a)/15d-14(a) Certification - Principal Executive Officer. |
|                |   |                                                                  |
| 31.2                |   | Rule 13a-14(a)/15d-14(a) Certification - Principal Financial Officer. |
|                |   |                                                                  |
| 32.0                |   | Section 1350 Certifications.                                     |

 

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