**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

 

| **(Mark One)**                                                                                                                                                             |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ý                                                                                                                                                                     | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934.** |
|                                                                                                                                                                       |
| **For the quarterly period ended June  29, 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           ** |

 

**Commissionfile number 0-26786**

 

**APACCustomer Services, Inc.**

(Exact name ofregistrant 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 by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months(or for such shorter periods that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.

 

| Yes  ý |   | No  **o** |
|------------------|--------|----------------|

 

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

 

| Yes  ý |   | No  **o** |
|------------------|--------|----------------|

 

There were49,441,592 common shares, $0.01 par value outstanding as of August 11, 2003.

 

 

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**Index**

 
| **Part I.  Financial  Information**                                                                   | **Page**                                                                                                                        |
|------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                       |
| Item 1.  Financial Statements (Unaudited):                                                            |
|                                                                                                       |
|                                                                                                       | Consolidated Condensed  Balance Sheets as of June 29, 2003, and December 29, 2002.                                              | 3 |
|                                                                                                       |                                                                                                                            |
|                                                                                                       | Consolidated  Condensed Statements of Operations for the Thirteen and  Twenty-Six Weeks Ended June 29, 2003, and June 30, 2002. | 4 |
|                                                                                                       |                                                                                                                            |
|                                                                                                       | Consolidated  Condensed Statements of Cash Flows for the  Twenty-Six Weeks Ended June 29, 2003, and June 30, 2002.              | 5 |
|                                                                                                       |                                                                                                                            |
|                                                                                                       | Notes  to Consolidated Condensed Financial Statements                                                                           | 6 |
|                                                                                                       |
| Item 2.   Management’s Discussion and Analysis of Financial Condition and  Results of Operations | 9                                                                                                                               |
|                                                                                                       |
| Item 3.   Quantitative and Qualitative Disclosures About Market Risk                                  | 14                                                                                                                              |
|                                                                                                       |
| Item 4.   Controls and Procedures                                                                     | 15                                                                                                                              |
|                                                                                                       |
| **Part  II.  Other Information**                                                                      |
|                                                                                                       |
| Item 1.   Legal Proceedings                                                                           | 16                                                                                                                              |
|                                                                                                       |                                                                                                                            |
| Item 4.   Submission of Matters to a Vote of Security Holders                                         | 16                                                                                                                              |
|                                                                                                       |
| Item 5.   Other Information                                                                           | 16                                                                                                                              |
|                                                                                                       |
| Item 6.   Exhibits and Reports on Form 8-K                                                            | 16                                                                                                                              |

 

2

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**APACCustomer Services, Inc. and Subsidiaries**

**Consolidated Condensed Balance Sheets**

**(Unaudited)**

**(In thousands)**

 
|                                                                                                                             |   | **June 29,  2003** |       | **December  29,  2002** |       |
|----------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|-------------------------|------------|
| **Assets**                                                                                                                       |   |               | ** ** |                    | ** ** |
| **Current  assets:**                                                                                                             |   |               |       |                    |       |
| Cash  and cash equivalents                                                                                                       |   | $                  | 12,200     |                    | $          | 14,530 |   |
| Accounts  receivable, net                                                                                                        |   | 48,505             |       | 51,508                  |       |
| Other  current assets                                                                                                            |   | 11,639             |       | 12,646                  |       |
| Total  current assets                                                                                                            |   | 72,344             |       | 78,684                  |       |
|                                                                                                                             |   |               |       |                    |       |
| **Property  and equipment, net**                                                                                                 |   | 24,897             |       | 25,680                  |       |
|                                                                                                                             |   |               |       |                    |       |
| **Goodwill**                                                                                                                     |   | 23,876             |       | 23,876                  |       |
|                                                                                                                             |   |               |       |                    |       |
| Customer  relationships                                                                                                          |   | 28,493             |       | 28,493                  |       |
| Less–accumulated  amortization                                                                                              |   | 12,284             |       | 11,111                  |       |
| **Customer relationships, net**                                                                                                  |   | 16,209             |       | 17,382                  |       |
|                                                                                                                             |   |               |       |                    |       |
| **Deferred taxes**                                                                                                               |   | 2,283              |       | 2,207                   |       |
| **Other assets**                                                                                                                 |   | 1,386              |       | 1,565                   |       |
| Total  assets                                                                                                                    |   | $                  | 140,995    |                    | $          | 149,394 |   |
|                                                                                                                             |   |               |       |                    |       |
| **Liabilities  and  Shareholders’ Equity**                                                                                  |   |               |       |                    |       |
| **Current  liabilities:**                                                                                                        |   |               |       |                    |       |
| Current  maturities of long-term debt                                                                                            |   | $                  | 610        |                    | $          | 656 |   |
| Accounts  payable                                                                                                                |   | 2,891              |       | 3,627                   |       |
| Other  current liabilities                                                                                                       |   | 38,430             |       | 37,034                  |       |
| Total  current liabilities                                                                                                       |   | 41,931             |       | 41,317                  |       |
|                                                                                                                             |   |               |       |                    |       |
| **Long-term  debt, less current maturities**                                                                                     |   | 17,595             |       | 28,872                  |       |
|                                                                                                                             |   |               |       |                    |       |
| **Other  liabilities**                                                                                                           |   | 1,503              |       | 2,778                   |       |
|                                                                                                                             |   |               |       |                    |       |
| **Commitments  and contingencies**                                                                                               |   | —             |       | —                  |       |
|                                                                                                                             |   |               |       |                    |       |
| **Shareholders’  equity**                                                                                                   |   |               |       |                    |       |
| Common  shares, $0.01 par value; 200,000,000 shares authorized; 49,695,699 shares  issued at June 29, 2003 and December 29, 2002 |   | 497                |       | 497                     |       |
| Additional  paid-in capital                                                                                                      |   | 99,620             |       | 99,690                  |       |
| Accumulated  deficit                                                                                                             |   | (19,258            | )          | (22,752                 | )          |
| Treasury  shares: 254,107 and 286,871 shares, respectively, at cost                                                              |   | (893               | )          | (1,008                  | )          |
| Total  shareholders’ equity                                                                                                 |   | 79,966             |       | 76,427                  |       |
| Total  liabilities and shareholders’ equity                                                                                 |   | $                  | 140,995    |                    | $          | 149,394 |   |

 

Seenotes to consolidated condensed financial statements

 

3

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

**Consolidated Condensed Statements ofOperations**

**(Unaudited)**

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

 
|                                                  |   | **Thirteen Weeks Ended** |       | **Twenty-Six Weeks Ended** |       |
|-------------------------------------------------------|--------|--------------------------|------------|----------------------------|------------|
|                                                  |   | **June 29,  2003**       |       | **June 30,  2002**         |       | **June 29,  2003** |   | **June 30,  2002** |   |
|                                                  |   |                     | ** ** |                       | ** ** |   | ** ** |   | ** ** |
| **Net revenue**                                       |   | $                        | 82,084     |                       | $          | 94,043 |   | $ | 168,281 |   | $ | 198,362 |   |
|                                                  |   |                     |       |                       |       |   |   |   |   |
| **Operating expenses:**                               |   |                     |       |                       |       |   |   |   |   |
|                                                  |   |                     |       |                       |       |   |   |   |   |
| Cost of services                                      |   | 66,645                   |       | 74,764                     |       | 136,073 |   | 157,943 |   |
| Selling, general and administrative  Expenses         |   | 12,919                   |       | 12,270                     |       | 25,915 |   | 26,625 |   |
| Restructuring and other charges                       |   | —                   |       | 2,536                      |       | — |   | 2,536 |   |
| Asset impairment charges                              |   | —                   |       | 510                        |       | — |   | 510 |   |
| Total operating expenses                              |   | 79,564                   |       | 90,080                     |       | 161,988 |   | 187,614 |   |
| **Operating income**                                  |   | 2,520                    |       | 3,963                      |       | 6,293 |   | 10,748 |   |
|                                                  |   |                     |       |                       |       |   |   |   |   |
| Interest expense, net                                 |   | 306                      |       | 1,451                      |       | 659 |   | 3,057 |   |
|                                                  |   |                     |       |                       |       |   |   |   |   |
| **Income before income taxes**                        |   | 2,214                    |       | 2,512                      |       | 5,634 |   | 7,691 |   |
| Provision  for income taxes                           |   | 840                      |       | 979                        |       | 2,140 |   | 2,999 |   |
|                                                  |   |                     |       |                       |       |   |   |   |   |
| **Net income**                                        |   | $                        | 1,374      |                       | $          | 1,533 |   | $ | 3,494 |   | $ | 4,692 |   |
|                                                  |   |                     | ** ** |                       | ** ** |   | ** ** |   | ** ** |
| **Net Income per share:**                             |   |                     | ** ** |                       | ** ** |   | ** ** |   | ** ** |
| Basic                                                 |   | $                        | 0.03       |                       | $          | 0.03 |   | $ | 0.07 |   | $ | 0.10 |   |
| Diluted                                               |   | $                        | 0.03       |                       | $          | 0.03 |   | $ | 0.07 |   | $ | 0.10 |   |
|                                                  |   |                     |       |                       |       |   |   |   |   |
| **Weighted average number of****shares outstanding:** |   |                     |       |                       |       |   |   |   |   |
| Basic                                                 |   | 49,439                   |       | 48,995                     |       | 49,430 |   | 48,993 |   |
| Diluted                                               |   | 49,487                   |       | 49,472                     |       | 49,461 |   | 49,250 |   |

 

See notes to consolidatedcondensed financial statements.

 

4

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**APACCustomer Services, Inc. and Subsidiaries**

**Consolidated Condensed Statements ofCash Flows**

**(Unaudited)**

**(In thousands)**

 
|                                                     |   | **Twenty-Six  Weeks Ended** |   |
|----------------------------------------------------------|--------|-----------------------------|--------|
|                                                     |   | **June 29,  2003**          |   | **June 30,  2002** |   |
|                                                     |   |                        |   |   |   |
| **Operating  activities:**                               |   |                        |   |   |   |
|                                                     |   |                        |   |   |   |
| Net  income                                              |   | $                           | 3,494  |   | $ | 4,692 |   |
| Depreciation  and amortization                           |   | 6,165                       |   | 8,526 |   |
| Non-cash  restructuring charges                          |   | —                      |   | 165 |   |
| Asset  impairment charges                                |   | —                      |   | 510 |   |
| Deferred  income taxes                                   |   | 131                         |   | 588 |   |
| Change  in operating assets and liabilities              |   | 3,366                       |   | 11,215 |   |
| Net  cash provided by operating activities               |   | 13,156                      |   | 25,696 |   |
|                                                     |   |                        |   |   |   |
| **Investing  activities:**                               |   |                        |   |   |   |
|                                                     |   |                        |   |   |   |
| Purchases  of property and equipment, net                |   | (4,208                      | )      | (2,032 | ) |
| Net  cash used by investing activities                   |   | (4,208                      | )      | (2,032 | ) |
|                                                     |   |                        |   |   |   |
| **Financing  activities:**                               |   |                        |   |   |   |
|                                                     |   |                        |   |   |   |
| Payments  on long-term debt                              |   | (323                        | )      | (17,269 | ) |
| Repayments  under revolving credit facility, net         |   | (11,000                     | )      | — |   |
| Stock  and warrant transactions                          |   | 45                          |   | 67 |   |
| Net  cash used by financing activities                   |   | (11,278                     | )      | (17,202 | ) |
|                                                     |   |                        |   |   |   |
| **Net (decrease) increase in cash and cash equivalents** |   | (2,330                      | )      | 6,462 |   |
|                                                     |   |                        |   |   |   |
| **Beginning cash balance**                               |   | 14,530                      |   | 21,213 |   |
|                                                     |   |                        |   |   |   |
| **Ending cash balance**                                  |   | $                           | 12,200 |   | $ | 27,675 |   |

 

See notes toconsolidated condensed financial statements

 

5

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**APAC Customer Services, Inc. andSubsidiaries**

**Notes to Consolidated CondensedFinancial Statements**

**(Dollars in thousands, except asotherwise indicated)**

**(Unaudited)**

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

 

The accompanyingunaudited consolidated condensed financial statements have been prepared inaccordance with generally accepted accounting principles for interim financialinformation and the instructions to Form 10-Q and Article 10 ofRegulation S-X.  Accordingly, theydo not include all of the information and footnotes required by generallyaccepted accounting principles for complete financial statements.  In the opinion of management, alladjustments (consisting of normal recurring accruals) considered necessary fora fair presentation have been included. Operating results for the twenty-six week period ended June 29, 2003,are not necessarily indicative of the results that may be expected for thefiscal year ending December 28, 2003. The balance sheet at December 29, 2002, has been derived from theaudited financial statements at that date but does not include all of theinformation and footnotes required by generally accepted accounting principlesfor complete financial statements.  Foradditional information, refer to the financial statements and footnotes theretoincluded in the Company’s Annual Report on Form 10-K for the year endedDecember 29, 2002.

 

**2.****                 OtherCurrent Liabilities**

 

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

 

|                        |   | **June 29,  2003** |   | **December 29,  2002** |   |
|-----------------------------|--------|--------------------|--------|------------------------|--------|
|                        |   |               |   |                   |   |
| Payroll and related items   |   | $                  | 19,836 |                   | $      | 19,634 |   |
| Income taxes payable        |   | 7,153              |   | 5,184                  |   |
| Accrued insurance           |   | 3,199              |   | 3,251                  |   |
| Restructuring reserves      |   | 2,059              |   | 2,150                  |   |
| Accrued professional fees   |   | 943                |   | 1,168                  |   |
| Accrued relocation          |   | 765                |   | 616                    |   |
| Client  related liabilities |   | 89                 |   | 977                    |   |
| Other                       |   | 4,386              |   | 4,054                  |   |
| Total                       |   | $                  | 38,430 |                   | $      | 37,034 |   |

 

The change inrestructuring reserves from year end represents payments required under leasesfor closed centers and severance.

 

6

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**3.****                 Accounting forStock-Based Compensation**

 

For stock-based employee compensation plans, theCompany has elected to use the intrinsic value method prescribed by AccountingPrinciples Board Opinion No. 25 “Accounting for Stock Issued to Employees”(“APB No. 25”).  In accordance with APBNo. 25, no compensation expense is recognized for stock options issued toemployees when the option price equals or exceeds the fair market value of theCompany’s common shares at the date of grant. Stock-based compensation expense for non-employees is recognized inaccordance with Statement of Financial Accounting Standards No. 123“Accounting for Stock Based Compensation” (“SFAS No.123”).

 

The following table illustrates the effect on netincome and earnings per share if the Company had adopted the fair valuerecognition provisions of SFAS No. 123.

 
|                                                                  |   | **Thirteen Weeks Ended** |   | **Twenty-Six Weeks Ended** |   |
|-----------------------------------------------------------------------|--------|--------------------------|--------|----------------------------|--------|
|                                                                  |   | **June 29,  2003**       |   | **June 30,  2002**         |   | **June 29,  2003** |   | **June 30,  2002** |   |
|                                                                  |   |                     |   |                       |   |   |   |   |   |
| Net income as reported                                                |   | $                        | 1,374  |                       | $      | 1,533 |   | $ | 3,494 |   | $ | 4,692 |   |
| Less-compensation expense on stock options, net of income tax benefit |   | (458                     | )      | (1,161                     | )      | (1,430 | ) | (1,741 | ) |
| Net income pro forma                                                  |   | $                        | 916    |                       | $      | 372 |   | $ | 2,064 |   | $ | 2,951 |   |
| Earnings per share – basic                                       |   |                     |   |                       |   |   |   |   |   |
| As reported                                                           |   | $                        | 0.03   |                       | $      | 0.03 |   | $ | 0.07 |   | $ | 0.10 |   |
| Pro forma                                                             |   | $                        | 0.02   |                       | $      | 0.01 |   | $ | 0.04 |   | $ | 0.06 |   |
| Earnings  per share – diluted                                    |   |                     |   |                       |   |   |   |   |   |
| As  reported                                                          |   | $                        | 0.03   |                       | $      | 0.03 |   | $ | 0.07 |   | $ | 0.10 |   |
| Pro  forma                                                            |   | $                        | 0.02   |                       | $      | 0.01 |   | $ | 0.04 |   | $ | 0.06 |   |

 

In order tocalculate the pro forma information set forth above, the fair value of eachoption is estimated on the date of grant based on the Black-Scholesoption-pricing model.   Assumptionsinclude no dividend yield, risk-free interest rates ranging from 5% to 7%,expected volatility ranging between 70% and 90%, and an expected life rangingfrom 7 years to 10 years.

 

**4.****                 ComprehensiveIncome**

 

Comprehensive income is as follows:

 
|                        |   | **Thirteen Weeks Ended** |   | **Twenty-Six Weeks Ended** |   |
|-----------------------------|--------|--------------------------|--------|----------------------------|--------|
|                        |   | **June 29,  2003**       |   | **June 30,  2002**         |   | **June 29,  2003** |   | **June 30,  2002** |   |
|                        |   |                     |   |                       |   |   |   |   |   |
| Net  income                 |   | $                        | 1,374  |                       | $      | 1,533 |   | $ | 3,494 |   | $ | 4,692 |   |
| Other  comprehensive income |   | —                   |   | 37                         |   | — |   | 528 |   |
| Total  comprehensive income |   | $                        | 1,374  |                       | $      | 1,570 |   | $ | 3,494 |   | $ | 5,220 |   |

 

Other comprehensive income in fiscal 2002 representedthe change in the unrealized loss on a swap agreement.   This swap agreement was terminated inDecember 2002 when the Company refinanced its debt and repaid the term loanrelated to the swap agreement.

 

7

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**5.****                 LegalProceedings**

 

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

 

**6.****                 LongTerm Debt**

 

On December 20, 2002, the Company entered into anAmended and Restated Credit Agreement (“Credit Agreement”) replacing theprevious Amended and Restated Credit Facility. Under the terms of the Credit Agreement, the Company has a revolvingcredit facility, which expires December 2005. The facility initially provided $65.0 million of creditavailability.  Beginning on March 31,2003, the facility is being reduced by $1.25 million of availability eachquarter until the facility reaches $55.0 million at December 31, 2004.  Availability is also reduced by outstandingborrowings and any outstanding letters of credit.  As of June 29, 2003, there were $16.5 million of outstandingborrowings under the facility and approximately $6.4 million was utilizedthrough the issuance of standby letters of credit primarily to supportself-insurance reserves.  Netavailability as of June 29, 2003, under the Credit Agreement was $40.9 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 revolving facilityas well as quarterly fees on the outstanding letters of credit.

 

8

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# **Item 2**. Management’s Discussion and Analysis ofFinancial Condition and Results of Operations

 

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.

 

**Results of Operations**

 

The following table setsforth consolidated condensed statements of income data as a percent of netrevenue from services provided by the Company for the thirteen and twenty-sixweek periods ended June 29, 2003 and June 30, 2002.

 
|                                         |   | **Thirteen  Weeks Ended** |   | **Twenty-Six Weeks Ended** |   |
|----------------------------------------------|--------|---------------------------|--------|----------------------------|--------|
|                                         |   | **June 29,  2003**        |   | **June 30,  2002**         |   | **June 29,  2003** |   | **June 30,  2002** |   |
|                                         |   |                      |   |                       |   |   |   |   |   |
| **Net  revenues**                            |   | 100.0                     | %      | 100.0                      | %      | 100.0 | % | 100.0 | % |
|                                         |   |                      |   |                       |   |   |   |   |   |
| **Operating  expenses:**                     |   |                      |   |                       |   |   |   |   |   |
| Cost  of services                            |   | 81.2                      |   | 79.5                       |   | 80.9 |   | 79.6 |   |
| Selling, general and administrative expenses |   | 15.7                      |   | 13.0                       |   | 15.4 |   | 13.4 |   |
| Restructuring  and other charges             |   | —                    |   | 2.7                        |   | — |   | .3 |   |
| Asset  impairment charges                    |   | —                    |   | 0.5                        |   | — |   | 0.3 |   |
| Total  operating expenses                    |   | 96.9                      |   | 95.7                       |   | 96.3 |   | 94.6 |   |
| Operating  income                            |   | 3.1                       |   | 4.3                        |   | 3.7 |   | 5.4 |   |
| **Interest expense, net**                    |   | 0.4                       |   | 1.6                        |   | 0.4 |   | 1.5 |   |
|                                         |   |                      |   |                       |   |   |   |   |   |
| Income  before income taxes                  |   | 2.7                       |   | 2.7                        |   | 3.3 |   | 3.9 |   |
| **Provision for income taxes**               |   | 1.0                       |   | 1.1                        |   | 1.2 |   | 1.5 |   |
| **Net  income**                              |   | 1.7                       | %      | 1.6                        | %      | 2.1 | % | 2.4 | % |

 

9

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**Comparison of Results of Operations for the thirteen weeksended June 29, 2003 and June 30, 2002**

 

Net revenuedecreased 12.7% to $82.1 million in the second quarter of fiscal 2003 from$94.0 million in the same quarter of fiscal 2002.  The decline was primarily due to the reduction of customer careservices performed under the terms of a facility management contract renewed inOctober 2002.

 

Cost of servicesdecreased $8.2 million in the second quarter of fiscal 2003, or 10.9%, to $66.6million from $74.8 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 81.2%from 79.5% and gross profit margins decreased to 18.8 % from 20.5% primarily asa result 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 increased to $12.9 million in the second quarter offiscal 2003 from $12.3 million in the second quarter of fiscal 2002, anincrease of $0.6 million or 5.3%. The increase was largely due to higheremployee related expenses.  As a percentof net revenue, selling, general and administrative expenses were 15.7% infiscal 2003 versus 13.0% in fiscal 2002 due to the effect of volume relatedrevenue reductions.

 

Duringthe second quarter of fiscal 2002, the Company implemented a plan to furtherimprove operational efficiencies and to reduce excess capacity.  As a result, the Company recorded $2.4million of restructuring charges related to the closure of seven CustomerInteraction Centers and the elimination of certain administrative and supportpositions. Other charges of $0.1 million associated with other centerdownsizings were also recorded in the second quarter of fiscal 2002. Assetimpairment charges of $0.5 million, which were also recorded in the secondquarter of fiscal 2002, primarily related to the write off oftelecommunications equipment.

 

The Companygenerated operating income of $2.5 million in the second quarter of fiscal 2003compared to $4.0 million for the same period of fiscal 2002.  The decrease is primarily due to the effectof lower volumes and gross profit margins and an increase in selling, generaland administrative expenses, as previously discussed, partially offset by theabsence of restructuring and other charges and asset impairment chargesrecorded in the second quarter of 2002.

 

Net interestexpense for the second quarter of fiscal 2003 decreased $1.2 million comparedto the same period in fiscal 2002.  Thisdecrease reflects a reduction of $39.4 million in average debt for the secondquarter of fiscal 2003 versus the second quarter of fiscal 2002, and lowerinterest rates.

 

The Company’seffective income tax rate is 38.0% for the second quarter of fiscal 2003,versus 39.0% in the prior year period.

 

**Comparison of Results of Operationsfor the twenty-six weeks ended June 29, 2003 and June 30, 2002**

 

Net revenuedecreased 15.2% to $168.3 million in the first half of fiscal 2003 from $198.4million in the same period of fiscal 2002. Approximately 80% of the revenue decline was attributable to threeclients due to a reduction of customer care services under the renewal terms ofa facility management contract and a reduction of customer acquisition servicesprovided by the Company to two of its clients.

 

Cost of servicesdecreased $21.8 million in the first half of fiscal 2003, or 13.8%, to $136.1million from $157.9 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 80.9% from 79.6%.  Gross profit margins decreased to 19.1% from 20.4% 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 $25.9 million in the first halfof fiscal 2003 from $26.6 million in the first half of fiscal 2002, a decreaseof $0.7 million or 2.7%.  The decreasewas primarily due to

 

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lower professional fees($0.4 million) and selling and facility expenses ($0.2 million).  As a percent of net revenue, selling,general and administrative expenses were 15.4% in the first half of fiscal 2003versus 13.4% in the same period of fiscal 2002 due to the effect of volume relatedreductions.

 

The Companygenerated operating income of $6.3 million in the first half of fiscal 2003compared to $10.7 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 the reduction inselling, general and administrative expenses, as previously discussed, and theabsence of restructuring and other charges and asset impairment chargesrecorded in the first half of 2002.

 

Net interestexpense for the first half of fiscal 2003 decreased $2.4 million compared tothe same period in fiscal 2002.  Thisdecrease reflects a reduction of $42.0 million in average debt for the firsthalf of fiscal 2003 versus the same period of fiscal 2002, and lower interestrates.

 

**CriticalAccounting Policies and Estimates**

 

The preparation ofthe Company’s financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the amounts reported in the consolidated financial statements andaccompanying notes. The Company believes its estimates and assumptions arereasonable; however, actual results and the timing of the recognition of suchamounts could differ from those estimates. The Company has identified thefollowing critical accounting policies and estimates utilized by management inthe preparation of the Company’s financial statements: revenue recognition,accounting for long-lived assets, allowance for doubtful accounts, employeebenefit accounting and income taxes. Any deviation from these policies orestimates could have a material impact on the financial statements of theCompany.

 

**Revenuerecognition**

 

The Company recognizes customer services revenue asservices are performed for our clients in accordance with Staff AccountingBulletin (SAB) No. 101 “Revenue Recognition.” Client contracts generallyrequire that clients be billed for the Company’s services on the basis of timespent by Company representatives providing services. The Company’s services arealso occasionally priced on a pay-for-performance basis, pursuant to which theCompany typically receives fees that are a combination of base-rate plus feeper sale. The Company is often subject to performance standards, such as salesper hour, average handle time, occupancy rate and abandonment rate.  The Company’s performance against suchstandards may provide bonus opportunities or conversely may subject the Companyto penalties, which are recognized as earned or incurred.

 

**Accountingfor long-lived assets**

 

The Company’slong-lived assets consist primarily of property and equipment, capitalizedsoftware and intangible assets. In addition to the original cost of theseassets, their recorded value is impacted by a number of policy elections madeby 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 the assetwill be used in the Company’s operations and estimated salvage values.

 

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**Allowancefor doubtful accounts**

 

The Company records an allowancefor doubtful accounts based on a quarterly assessment of the probable estimatedlosses in trade accounts receivable. This estimate is based on specificallowances for identified problem receivables and a general allowance for allother receivables based on their age and collection history.

 

**Accountingfor employee benefits**

 

The Company records an accrued liability for grouphealth and workers compensation claims based on an estimate of claims incurred,but not reported, as well as asserted claims at the end of the period. Thisestimate is derived from an analysis performed by actuaries hired by theCompany who have expertise in this area. However, although these estimates are generally reliable, changes in theemployee mix and unforeseen events could result in an adjustment to theseestimates.

 

**IncomeTaxes**

 

The Company accounts for income taxes using the assetand liability approach.  Under the assetand liability method, deferred tax assets and liabilities are recognized forthe future tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective tax bases.  Valuationallowances are recorded when it is more likely than not that some portion orall of the deferred tax assets will not be 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 thetwenty-six week periods ended June 29, 2003 and June 30, 2002, respectively.

 
|                                       |   | **2003**            |   | **2002** |   |
|--------------------------------------------|--------|---------------------|--------|----------|--------|
|                                       |   | **(In  thousands)** |   |
|                                       |   |                |   |     |   |
| Net  cash provided by operating activities |   | $                   | 13,156 |     | $      | 25,696 |   |
| Net  cash used by investing activities     |   | (4,208              | )      | (2,032   | )      |
| Net  cash used by financing activities     |   | (11,278             | )      | (17,202  | )      |
| Net  increase (decrease) in cash           |   | $                   | (2,330 | )        | $      | 6,462 |   |

 

Cash from operatingactivities decreased $12.5 million versus the first half of fiscal 2002primarily due to a $10.8 million reduction in accounts receivable, whichoccurred in the first half of fiscal 2002 versus a $3.0 million reduction in thesame period of fiscal 2003. The decrease in accounts receivable in the firsthalf of fiscal 2002 was primarily due to lower volumes. Cash generated fromoperations was slightly lower in fiscal 2003 due to lower operating margins anda reduction in depreciation and amortization.

 

Net cash used byinvesting activities increased $2.2 million from the same period of fiscal 2002due to expenditures related to the buildout of a facility in the Philippinesand equipment upgrades. Capital expenditures of $2.0 million in the first halfof fiscal 2002 were primarily related to the purchase of IT hardware, softwareand equipment.

 

Net cash used byfinancing activities primarily related to the repayment of $11.0 million and$17.0 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.

 

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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 cause futureresults to differ materially from historical results or those anticipated. Thewords “believe,” “expect,” “anticipate,” “intend,” “estimate,” “goals,”“would,” “could,” “should,” and other expressions which indicate future eventsand trends identify forward-looking statements. Readers are cautioned not toplace undue reliance on these forward-looking statements, which speak only asof their dates. If no date is provided, such statements speak only as of thedate of this Report on Form 10-Q. Except as required under the Federal securities laws and rules andregulations of the SEC, the Company undertakes no obligation to publicly updateor revise any forward-looking statements in connection with new information orfuture events or otherwise. 

 

Factors that could 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; improved technologyhaving the effect of reducing overall call volumes; changes in governmentregulations affecting industries of our clients; control by principalshareholder; war and terrorist attacks and competition from other outsideproviders of customer interaction solutions and in-house customer interactionoperations.

 

See the Company’s filingswith the Securities and Exchange Commission for further discussion of the risksand uncertainties associated with the Company’s business, in particular thediscussion under the caption “Information Regarding Forward-Looking Statements”in Item 7 (Management’s Discussion and Analysis of Financial Condition andResults of Operations) of the Company’s Annual Report on Form 10-K for thefiscal year ended December 29, 2002.

 

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

 

The Company is exposed to the impact of U.S. interestrate changes directly related to its normal operating and funding activities.From time to time, the Company enters into derivatives in order to minimizethese risks but not for trading purposes.

 

The Company prepared a sensitivityanalysis of its debt assuming a one-percentage point adverse change in interestrates for the quarter ended June 29, 2003. Holding all other variables constant,the hypothetical adverse change would not significantly increase interestexpense. The sensitivity analysis assumes no changes in the Company’s financialstructure.

 

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**Item 4. Controlsand Procedures**

 

(a)           *Disclosure Controls andProcedures*.  The Company’s management, with theparticipation of the Company’s Chief Executive Officer and Chief FinancialOfficer, has evaluated the effectiveness of the Company’s disclosure controlsand procedures (as such term is defined in Rules 13a-14(c) and 15d-14(c) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of theend of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer andChief Financial Officer have concluded that, as of the end of such period, theCompany’s disclosure controls and procedures are effective.

 

**(b)****          ***Internal Controls OverFinancial Reporting*.  There have not been any changes in theCompany’s internal control over financial reporting (as such term is defined inRules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarterto which this report relates that have materially affected, or are reasonablylikely to materially effect, the Company’s internal control over financialreporting.

 

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**PartII****. Other Information**

 

**Item 1****.****           LegalProceedings**

 

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

 

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

 

(a)          The Annual Meeting of Shareholders of the Company washeld on June 6, 2003.

 

(b)         Not applicable

 

(c)          Set forth below is the tabulation of the votes foreach nominee for election as a director of the Company.

 
|                  |   | **For**    |   | **Withhold Authority  (Including Broker non-vote)** |   |
|-----------------------|--------|------------|--------|-----------------------------------------------------|--------|
|                  |   |       |   |                                                |   |
| Robert  F. Bernard    |   | 45,927,095 |   | 1,400,419                                           |   |
|                  |   |       |   |                                                |   |
| Thomas M. Collins     |   | 45,942,945 |   | 1,384,569                                           |   |
|                  |   |       |   |                                                |   |
| John  W. Gerdelman    |   | 45,949,165 |   | 1,378,349                                           |   |
|                  |   |       |   |                                                |   |
| Theodore  G. Schwartz |   | 45,837,625 |   | 1,489,889                                           |   |
|                  |   |       |   |                                                |   |
| Paul G. Yovovich      |   | 45,964,225 |   | 1,363,289                                           |   |

 

**Item 5****.  Other Information**

 

On July 30, 2003, the Company issued a pressrelease setting forth the Company’s appointment of Paul Liska and SamuelSkinner as members of the board of directors.

 

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

 

(a)          Exhibits

 

Exhibit10.2 Second Amendment to the APAC Customer Services, Inc. Second Amended andRestated 1995 Incentive Stock Plan.

 

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.

 

Exhibit32.0 Section 1350 Certifications.

 

(b)         Reports on Form 8-K

 

OnMay 1, 2003, the Company filed a current report on Form 8-K setting forth theearnings release for the fiscal quarter ended March 30, 2003.

 

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**Signatures**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the Registrant has duly caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 

 
|                                                      |   | **APAC Customer Services, Inc.**                                                                                |
|-----------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------|
|                                                      |   |                                                                                                            |
|                                                      |   |                                                                                                            |
| Date:      August  12, 2003 | By:    | /s/ Marc T. Tanenberg                                                                                           |
|                                                      |   | Senior Vice  President and  Chief Financial Officer  (Principal Financial Officer  and duly authorized officer) |
|                                                      |   |                                                                                                            |
|                                                      |   |                                                                                                            |
| Date:      August  12, 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**                                                                                                           |
|---------------------|--------|---------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                      |
| 10.2                |   | Exhibit 10.2 Second Amendment to the APAC Customer Services, Inc.  Second Amended and Restated 1995 Incentive Stock Plan. |
|                |   |                                                                                                                      |
| 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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