Summary of APAC CUSTOMER SERVICE INC

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Our management's discussion and analysis of financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes thereto appearing elsewhere in this report and our audited consolidated financial statements which appear in Item 8 of Part II of our Annual Report on Form 10-K for the fiscal year ended December 28, 2008. Our management's discussion and analysis contains "forward-looking statements". All forward-looking statements are inherently uncertain as they are based on various expectations and assumptions about future events and are subject to known and unknown risks and uncertainties, and other factors that may cause our actual results, performance, or achievements to be materially different from those expressed or implied by the forward-looking statements. See "Forward Looking Statements and Factors That May Affect Future Results" on page 3 of this Quarterly Report on Form 10-Q and Item 1A in Part II of this Quarterly Report on Form 10-Q.
Overview
We are a leading provider of customer care services and solutions to market leaders in the healthcare, business services, communications, publishing, travel and entertainment, and financial services industries. Our services are provided through customer care centers staffed with skilled customer service representatives in domestic, off-shore, and client-owned locations. As of March 29, 2009, we operated nine customer care centers in the United States, two of which are client-owned facilities, and four off-shore customer care centers in the Philippines. As of March 29, 2009, our domestic operations consisted of approximately 4,800 workstations and our off-shore operations consisted of approximately 3,400 workstations.
Early in 2008, our Board of Directors selected Michael P. Marrow as President and CEO, bringing 25 years of industry experience to our company. Since joining us, Mr. Marrow has assembled a team of talented mid- and senior-level managers, many of whom have deep experience in running successful outsourced call center operations, as well as senior-level managers with significant turnaround experience. The entire organization, under Mr. Marrow's leadership, has transformed our Company into what we believe to be a more efficient and productive operation, which we believe has returned us to a profitable operating model. During 2008, we restructured operations resulting in the reduction of overhead costs and headcount, refinanced our debt, and took steps to improve our operating efficiencies. We saw an immediate impact from these and other cost savings initiatives resulting in us being profitable on a full year basis for fiscal year 2008. Additionally, our focus on improving our financial performance also resulted in increased gross profit margins, improved cash flow and lower levels of debt in fiscal year 2008.
During the 2009 first quarter, we continued to see a favorable impact from the initiatives launched in 2008 and prior years. Our gross profit margin was 25.3% for the first quarter of 2009, as compared to 18.8% for the fourth quarter of 2008 and well above the 12.2% gross profit margin for the first quarter of 2008. Net income for the first quarter of 2009 was $10.6 million, a 108% increase over the fourth quarter of 2008 and a $14.6 million improvement over the first quarter of 2008.

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Critical Accounting Policies and Estimates The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires us to make estimates and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. Certain of our accounting policies are considered critical, due to the level of subjectivity and judgment necessary in applying these policies and because the impact of these estimates and assumptions on our financial conditions and operating performance may be material. On an ongoing basis, we evaluate our estimates and judgments in these areas based on historic experience and other relevant factors. The estimates as of the date of the financial statements reflect our best judgment giving consideration to all currently available facts and circumstances. We believe our estimates and judgments are reasonable, however, actual results and the timing of the recognition of such amounts could differ from those estimates. We have used methodologies that are consistent from year to year in all material respects. We have identified the following accounting policies and estimates that we believe are most critical in the preparation of our condensed consolidated financial statements: accounting for derivatives, allowance for doubtful accounts, accounting for employee benefits, revenue recognition, intangible assets, restructuring charges, accounting for stock-based compensation and income taxes. For details concerning these critical accounting policies and estimates see Item 7 of Part II of our Annual Report on Form 10-K for the fiscal year ended December 28, 2008, under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates" and Note 3 to our audited consolidated financial statements which appears in Item 8 of Part II of our Annual Report on Form 10-K for the fiscal year ended December 28, 2008. Any deviation from these policies or estimates could have a material impact on our condensed consolidated financial statements.

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Results of Operations
The following table sets forth selected information about our results of
operations for the thirteen weeks ended March 29, 2009 and March 30, 2008,
respectively. Certain additional components of cost of services have been
included as we believe they would enhance an understanding of our results of
operations. All amounts in the table below are presented in thousands.

                                                               Thirteen Weeks Ended
                                                   March 29,        March 30,        Fav (Unfav)
                                                     2009             2008            % Change
Net Revenue:                                      $    73,246      $    63,517               15.3 %

Cost of Services:
Direct labor                                           38,308           37,530               (2.1 )
Other facility expenses                                16,388           18,216               10.0

Total cost of services                                 54,696           55,746                1.9

Percentage of revenue                                    74.7 %           87.8 %                -


Gross profit                                           18,550            7,771              138.7
Gross profit margin                                      25.3 %           12.2 %                -

Operating Expenses:
Selling, general & administrative expenses              7,754            8,568                9.5
Restructuring and other charges (reversals)               (56 )          2,341              102.4

Total operating expenses                                7,698           10,909               29.4

Operating income (loss)                                10,852           (3,138 )            445.8
Other income                                               (7 )            (32 )            (78.1 )
Interest expense                                           89              922               90.3

Income (loss) before income taxes                      10,770           (4,028 )            367.4
Income tax provision                                      151                -                  *

Net income (loss)                                 $    10,619      $    (4,028 )            363.6 %

* Means that the percentage change is not meaningful

Non-GAAP Financial Measures
To supplement our Condensed Consolidated Financial Statements presented in accordance with GAAP, we use EBITDA, which is defined as a non-GAAP financial measure. The presentation of this non-GAAP financial measure is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. The items excluded from this non-GAAP financial measure are significant components of our financial statements and must be considered in performing a comprehensive analysis of our overall financial results.
We believe this non-GAAP financial measure provides meaningful supplemental information and is useful in understanding our results of operations and analyzing trends because it excludes certain charges such as interest, taxes and depreciation and amortization expenses that are not part of our ordinary business operations.
EBITDA is a measure used by our lenders, investors and analysts to evaluate our financial performance and our ability to pay interest and repay debt. This measure is also indicative of our ability to fund the capital investments necessary for our continued growth. We use this measure, together with our GAAP financial metrics, to assess our financial performance, allocate resources, measure our performance against debt covenants, determine management bonuses and evaluate our overall progress towards meeting our long-term financial objectives.

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We believe that this non-GAAP financial measure is useful to investors and analysts in allowing for greater transparency with respect to the supplemental information used by us in our financial and operational decision making. In addition, we believe investors, analysts and lenders benefit from referring to this non-GAAP financial measure when assessing our performance and expectations of our future performance. However, this information should not be used as a substitute for our GAAP financial information; rather it should be used in conjunction with financial statement information contained in our Condensed Consolidated Financial Statements presented in accordance with GAAP. We use consistent methods for computation of non-GAAP financial measures. Our calculations of non-GAAP financial measures may not be consistent with calculations of similar measures used by other companies. The accompanying notes have more details on the GAAP financial measure that is most directly comparable to our non-GAAP financial measure and the related reconciliation between these financial measures.

                                                                      Thirteen Weeks Ended (1)
                                                      March 29,                March 30,              Fav (Unfav)
                                                         2009                     2008                 % Change
                                                      (Dollars in thousands except statistical data and notes)
EBITDA (2)                                        $           13,688       $              365                3650.1 %

Statistical information:
Number of customer care centers:
Domestic                                                           9                        9
Off-shore                                                          4                        3

Total                                                             13                       12

Number of workstations, end of period:
Domestic                                                       4,848                    4,537
Off-shore                                                      3,380                    2,965

Total                                                          8,228                    7,502

Notes to Non-GAAP Financial Measures

(1) We operate on a thirteen-week fiscal quarter that ends on the Sunday closest to March 31.

(2) We define EBITDA as net income
(loss) plus the provision (benefit) for income taxes, depreciation and amortization, and interest expense.

EBITDA is a measure used by our lenders, investors and analysts to evaluate our financial performance and our ability to pay interest and repay debt. This measure is also indicative of our ability to fund the capital investments necessary for our continued growth. We use this measure, together with our GAAP financial metrics, to assess our financial performance, allocate resources, measure our performance against debt covenants, determine management bonuses and evaluate our overall progress towards meeting our long-term financial objectives.

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EBITDA is not intended to be considered in isolation or used as a substitute for net income (loss) or cash flow from operations data presented in accordance with GAAP or as a measure of liquidity. The items excluded from EBITDA are significant components of our statements of operations and must be considered in performing a comprehensive assessment of our overall financial results. EBITDA can be reconciled to net income (loss), which we believe to be the most directly comparable financial measure calculated and presented in accordance with GAAP, as follows:

                                                 Thirteen Weeks Ended
                                              March 29,        March 30,
                                                2009             2008
                                                (Dollars in thousands)
             Net income (loss)               $    10,619      $    (4,028 )

             Interest expense                         89              922
             Income tax provision                    151                -
             Depreciation and amortization         2,829            3,471

             EBITDA                          $    13,688      $       365

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Comparison of Results of Operations for the Thirteen Weeks Ended March 29, 2009 and March 30, 2008
Net revenue increased 15.3% to $73.2 million for the thirteen weeks ended March 29, 2009, as compared to $63.5 million for the thirteen weeks ended March 30, 2008. The increase in revenue of $9.7 million is primarily driven by growth with existing and new clients of $17.4 million driven by increased volume across the communications, healthcare, publishing, and travel and entertainment verticals. This was partially offset by the decline in revenue of $5.2 million from the seasonal Medicare Part D program, $1.4 million from the exit of a retail client in 2008, $0.6 million from the financial services vertical and $0.5 million of other business.
Cost of services decreased $1.0 million, or 1.9%, to $54.7 million for the thirteen weeks ended March 29, 2009, from $55.7 million for the thirteen weeks ended March 30, 2008. Direct labor increased $0.8 million, or 2.1%, primarily driven by higher volume off-shore and in the domestic communications vertical, partially offset by lower direct wage rates both domestically and off-shore. Facility and other costs decreased $1.8 million, or 10.0%, primarily due to $0.8 million of reduced information technology costs resulting from the 2008 workforce reduction, $0.5 million of lower domestic facility costs and $0.5 million of other continued cost savings initiatives. Off-shore facility and other costs decreased $0.4 million, partially offset by $0.3 million of costs associated with the opening of our fourth facility in the Philippines. Cost of services as a percentage of revenue declined to 74.7% for the thirteen weeks ended March 29, 2009 from 87.8% for the thirteen weeks ended March 30, 2009 driven by cost savings initiatives.
Gross profit increased $10.8 million, or 138.7%, to $18.6 million for the thirteen weeks ended March 29, 2009, as compared to $7.8 million for the thirteen weeks ended March 30, 2008, primarily due to an increase in off-shore and domestic volume, lower domestic direct wages and a decline in facility and other costs. These factors also contributed to the improvement in the gross profit margin which increased to 25.3% for the thirteen weeks ended March 29, 2009 from 12.2% for the thirteen weeks ended March 30, 2008.
Selling, general and administrative expenses were $7.8 million for the thirteen weeks ended March 29, 2009, a decrease of $0.8 million from $8.6 million for the thirteen weeks ended March 30, 2008. The decrease is primarily due to a $0.2 million reduction in rent and other facility charges resulting from the relocation of our corporate office, a $0.2 million decrease in compensation and benefits and $0.4 million of other cost savings obtained through continuing efforts to maintain expense control.
Restructuring and other charges decreased $2.4 million, or 102.4%, to a negative $0.1 million for the thirteen weeks ended March 29, 2009, as compared to $2.3 million for the thirteen weeks ended March 30, 2008. We recorded $2.3 million of severance charges for the thirteen weeks ended March 30, 2008 related to the elimination of approximately 100 operations and administrative positions and the accrual of payment obligations to Robert Keller, our former CEO, upon his retirement. For more information regarding restructuring and other charges, see Note 9 of our condensed consolidated financial statements appearing elsewhere in this Quarterly Report on Form 10-Q.
Operating income was $10.9 million for the thirteen weeks ended March 29, 2009, as compared to an operating loss of $3.1 million for the thirteen weeks ended March 30, 2008. The $14.0 million improvement was the result of a $10.8 million increase in gross profit, a $2.4 million decrease in restructuring and other charges and a $0.8 million decrease in selling, general and administrative expenses as noted above.
Net interest expense decreased $0.8 million, or 90.3%, to $0.1 million for the thirteen weeks ended March 29, 2008, as compared to $0.9 million for the thirteen weeks ended March 30, 2008. The decrease is primarily related to a $0.6 million reduction in interest expense resulting from lower average debt balances and $0.2 million related to the amortization of points on forward contracts.
EBITDA was $13.7 million for the thirteen weeks ended March 29, 2009, an increase of $13.3 million, as compared to $0.4 million for the thirteen weeks ended March 30 2008. The increase was primarily due to a $10.1 million increase in gross profit, excluding a change in depreciation and amortization expense of $0.7 million, a $2.4 million decrease in restructuring and other charges and a $0.8 million decrease in selling, general and administrative expenses as noted above. More information concerning this non-GAAP financial measure, including the definition of EBITDA and a reconciliation of this measure to the most directly comparable financial measure calculated and presented in accordance with GAAP, can be found under the heading "Non-GAAP Financial Measures" and the accompanying notes thereto appearing elsewhere in this Management's Discussion and Analysis of Financial Condition and Results of Operations.

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The tax provision for the thirteen weeks ended March 29, 2009 was $0.2 million. This is driven by a gross income earned tax of 5% on a portion of our Philippine results and state income taxes on our domestic results. The Federal tax provision is fully offset by the utilization of net operating loss carryforwards and work opportunity tax credits. This resulted in a 1.4% effective income tax rate for the thirteen weeks ended March 29, 2009. The effective tax rate for the thirteen weeks ended March 30, 2008 was zero.
Net income for the thirteen weeks ended March 29, 2009 was $10.6 million, a $14.6 million increase from the net loss of $4.0 million for the thirteen weeks ended March 30, 2008.
Liquidity and Capital Resources
The following table sets forth our condensed consolidated statements of cash flow data for the thirteen weeks ended March 29, 2009 and March 30, 2008, respectively.

                                                            Thirteen Weeks Ended
                                                         March 29,        March 30,
                                                           2009             2008
                                                           (Dollars in thousands)
 Net cash provided by operating activities              $     3,183      $     7,458
 Net cash used in investing activities                       (3,370 )           (758 )
 Net cash used in financing activities                          (37 )         (6,097 )
 Effect of exchange rate changes on cash                        407             (680 )

 Net increase (decrease) in cash and cash equivalents   $       183      $       (77 )

Operating Activities
Net cash provided by operating activities was $3.2 million for the thirteen weeks ended March 29, 2009, a $4.3 million decrease from $7.5 million for the thirteen weeks ended March 30, 2008. The net decrease was primarily due to an $11.5 million increase in accounts receivable driven by increased net revenue and the timing of collections, a $3.0 million decrease in accrued payroll due to the timing of payments, a $2.9 million decrease in accrued severance costs and a $2.8 decrease in other accrued expenses and other liabilities, partly offset by the $14.6 million increase in net income. Investing Activities
Net cash used in investing activities increased $2.6 million for the thirteen weeks ended March 29, 2009, as compared to the thirteen weeks ended March 30, 2008. Cash used in investing activities for the thirteen weeks ended March 29, 2009 consisted primarily of $1.7 million in capital expenditures related to the build-out of our fourth customer care center in the Philippines, $1.4 million in capital expenditures related to client implementations and $0.3 million in continued investment in operational and information technology equipment. Cash used in investing activities for the thirteen weeks ended March 30, 2008 consisted primarily of $0.4 million in continued investment in information technology equipment and $0.3 million in capital expenditures related to our third customer care center in the Philippines. Financing Activities
Net cash used in financing activities of less than $0.1 million for the thirteen weeks ended March 29, 2009 relates to payments made against the Revolving Loan Facility. Net cash used in financing activities of $6.1 million for the thirteen weeks ended March 30, 2008 primarily relates to payments of $5.8 million against the Revolving Loan Facility and payments of $0.6 million against the Term Loan, offset by $0.2 million in financing costs and $0.1 million in cash received from the exercise of stock options.

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Bank Financing
During the thirteen weeks ended March 29, 2009, we were party to a Revolving Credit and Security Agreement (Revolving Loan Agreement) with PNC Bank National Association (PNC), as agent, and the financial institutions from time to time parties thereto as lenders. The Revolving Loan Agreement provides us with a $40.0 million revolving loan facility which expires in May 2011. The Revolving Loan Agreement contains certain financial covenants including limits on the amount of capital expenditures and maintenance of a minimum fixed charge coverage ratio. Other covenants in the Revolving Loan Agreement prohibit us (with limited exceptions) from incurring additional indebtedness, repurchasing outstanding common shares, permitting liens, acquiring, selling or disposing of certain assets, engaging in certain mergers and acquisitions, paying dividends or making certain restricted payments.
Our ability to borrow under the Revolving Loan Agreement depends on the amount of eligible accounts receivable from our clients. In addition to borrowing against our eligible receivables, we may borrow an additional $9.0 million which is supported by a letter of credit (Credit Enhancement Letter of Credit) which was provided by TCS Global Holdings, L.P. (TCS), an affiliate of Theodore G. Schwartz, our Chairman and principal shareholder. In connection with the issuance of the Credit Enhancement Letter of Credit, we and TCS entered into a Reimbursement and Security Agreement, dated May 5, 2008 (Reimbursement Agreement).
The Company's financial results for the fiscal year ended December 28, 2008 met each of the necessary requirements under the Credit Enhancement Letter of Credit and PNC released the Credit Enhancement Letter of Credit on March 20, 2009. Borrowings under the Revolving Loan Agreement totaled $6.1 million as of March 29, 2009. We had approximately $30.6 million of undrawn capacity under the Revolving Loan Agreement as of March 29, 2009, of which $18.6 million was available based upon borrowing base calculations. We were in compliance with our financial covenants as of March 29, 2009. Future Liquidity
We expect that our cash balances, cash flows from operations and available borrowings under our Revolving Loan Agreement will be sufficient to meet projected operating needs, fund any planned capital expenditures, and repay debt obligations for the next twelve months. Our cash flow is significantly impacted by our ability to collect our clients' accounts receivable on a timely basis. To the extent that our business with a single client or small group of clients represents a more significant portion of our revenue, a delay in receiving payment could materially and adversely affect the availability of cash to fund operations.
A significant change in operating cash flow or a failure to maintain profitability could have a material adverse effect on our liquidity and our ability to comply with the covenants in our Revolving Loan Agreement. In addition, our failure to adhere to the financial and other covenants could give rise to a default under the Revolving Loan Agreement which would have a material adverse effect on our liquidity and financial condition. There can be no assurances that we will be able to meet the financial and other covenants in our Revolving Loan Agreement.

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