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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

Commission file number 1-12793

StarTek, Inc.

(303) 399-2400

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

      Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes þ          No o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).     Yes þ          No o

      Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock, $0.01 Par Value — 14,466,071 shares as of August 5, 2004

STARTEK, INC.

FORM 10-Q

INDEX

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PART I. FINANCIAL INFORMATION

STARTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

See notes to condensed consolidated financial statements.

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STARTEK, INC. AND SUBSIDIARIES

See notes to condensed consolidated financial statements.

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STARTEK, INC. AND SUBSIDIARIES

See notes to condensed consolidated financial statements.

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STARTEK, INC. AND SUBSIDIARIES

      The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In management’s opinion, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results during the three and six months ended June 30, 2004 are not necessarily indicative of operating results that may be expected during any other interim period of 2004 or the year ended December 31, 2004.

      The consolidated balance sheet as of December 31, 2003 was derived from audited financial statements, but does not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the StarTek, Inc. (the “Company”) annual report on Form 10-K for the year ended December 31, 2003.

      The Company’s stock options plans are accounted for under the intrinsic value recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, and related Interpretations. As the exercise price of all options granted under these plans was equal to the market price of the underlying stock on the grant date, no stock-based employee compensation cost was recognized in net income. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”.

      For purposes of this pro forma disclosure, the estimated fair value of the options is assumed to be amortized to expense over the options’ vesting periods.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations”. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and associated asset retirement costs. The Company adopted SFAS No. 143 on January 1, 2003, and the adoption of this statement did not result in any material impact on the Company’s consolidated results of operations or financial position.

      In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”, which provides guidance related to accounting for costs associated with disposal activities covered by SFAS No. 144 and with exit or restructuring activities previously covered by Emerging Issues Task Force (“EITF”) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 supercedes EITF Issue No. 94-3 in its entirety. SFAS No. 146 requires that costs related to exiting an activity or to a restructuring not be recognized until the liability is incurred. SFAS No. 146 has been applied prospectively to exit or disposal activities initiated after December 31, 2002, and it had no material impact on the Company’s consolidated results of operations or financial position.

      In December 2002, the FASB issued SFAS No. 148, which provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The transition requirements of SFAS No. 148 are effective for the Company’s fiscal year 2003. SFAS No. 123, “Accounting and Disclosure of Stock-Based Compensation,” establishes an alternative method of expense recognition for stock-based compensation awards to employees based on estimated fair values. The Company elected not to adopt SFAS 123 for expense recognition purposes. It is expected that the FASB will require fair value accounting for stock options beginning in 2005.

      In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (“SFAS No. 150”). SFAS No. 150 clarifies the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity and requires that those instruments be classified as liabilities (or assets in certain circumstances) in statements of financial position. SFAS No. 150 also requires disclosures about alternative ways of settling the instruments and the capital structure of entities — all of whose shares are mandatorily redeemable. SFAS No. 150 is generally effective for all financial instruments entered into or modified after May 31, 2003. The adoption of SFAS 150 had no impact on the Company’s consolidated results of operations or financial position.

      On December 17, 2003, the Staff of the Securities and Exchange Commission issued Staff Accounting Bulletin No. 104 (“SAB 104”), Revenue Recognition, which supercedes SAB 101, Revenue Recognition in Financial Statements. SAB 104’s primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, which was superseded as a result of the issuance of EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. SAB 104 did not have a significant impact on the Company’s consolidated results of operations or financial position.

      In January 2003, the FASB issued Interpretation, or FIN, No. 46, “Consolidation of Variable Interest Entities,” an interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements.” FIN 46 applies to any business enterprise that has a controlling interest, contractual relationship or other business relationship with a variable interest entity, or VIE, and establishes guidance for the consolidation of VIE’s that function to support the activities of the primary beneficiary. FIN 46 was effective immediately for enterprises with VIE’s created after January 31, 2003, and was effective March 31, 2004 for enterprises with

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

VIE’s created before February 1, 2003. The adoption of FIN 46 did not have a significant impact on the Company’s consolidated results of operations or financial position.

      Basic earnings per share is computed on the basis of the Company’s weighted average number of common shares outstanding. Diluted earnings per share is computed on the basis of the Company’s weighted average number of common shares outstanding plus the effect of outstanding stock options using the “treasury stock” method.

      As of December 31, 2003, investments available for sale consisted of:

      As of June 30, 2004, investments available for sale consisted of:

      As of June 30, 2004, amortized costs and estimated fair values of investments available for sale by contractual maturity were:

      Equity securities primarily consisted of publicly traded common stock of domestic companies, equity mutual funds, and real estate investment trusts.

      As of December 31, 2003, the Company was also invested in trading securities, which, in the aggregate, had an original cost and fair market value of $4,042 and $5,857, respectively. As of June 30, 2004, the Company was also invested in trading securities, with, in the aggregate, an original cost and fair market value of $3,988 and $5,968, respectively. Trading securities consisted primarily of alternative investment partnerships and option contracts sold. Certain investments include hedging and derivative securities. Trading

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

securities were held to meet short-term investment objectives. As part of trading securities and as of June 30, 2004, the Company had sold put options for a total of 19,000 shares of domestic equity securities, with in the aggregate, a basis and fair market value of $12 and $11, respectively. The foregoing put options expire between July 17, 2004 and August 21, 2004.

      Risk of loss to the Company in the event of nonperformance by any party is not considered substantial. The foregoing put options may involve elements of credit and market risks in excess of the amounts recognized in the Company’s financial statements. A substantial decline and/or change in value of equity securities, equity prices in general, international equity mutual funds, investment limited partnerships, and/or call and put options could have a material adverse effect on the Company’s portfolio of trading securities. Also, trading securities could be materially and adversely affected by increasing interest and/or inflation rates or market expectations thereon, poor management, shrinking product demand, and other risks that may affect single companies, as well as groups of companies.

      The Company purchases components of its clients’ products as an integral part of its supply chain management services. At the close of an accounting period, packaged and assembled products (together with other associated costs) are reflected as finished goods inventories pending shipment. The Company generally has the right to be reimbursed from its clients for unused inventories. Client-owned inventories are not valued in the Company’s consolidated balance sheet. Inventories consisted of:

      Property, plant and equipment are stated at cost. Additions, improvements, and major renewals are capitalized. Maintenance, repairs, and minor renewals are expensed as incurred. Depreciation and amortization is computed using the straight-line method based on their estimated useful lives as follows:

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Property, plant and equipment consisted of:

      The following table represents revenue concentrations of the Company’s principal clients:

      The loss of a principal client and/or changes in timing or termination of a principal client’s product launch or service offering would have a material adverse effect on the Company’s business, revenue, operating results, and financial condition. AT&T Wireless Services has announced that it has entered into an agreement to be acquired by Cingular Wireless LLC. The term of the Company’s agreement with AT&T Wireless was recently extended to December 31, 2006, and is not subject to termination for convenience or without cause.

      To limit the Company’s credit risk, management performs ongoing credit evaluations of its clients. Although the Company is directly impacted by the economic conditions in which its clients operate, management does not believe substantial credit risk existed as of June 30, 2004.

      SFAS No. 130, “Reporting Comprehensive Income”, establishes standards for the reporting and display of comprehensive income. Comprehensive income is defined essentially as all changes in stockholders’ equity, exclusive of transactions with owners. Comprehensive income was $5,662 and $5,614 for the three months ended June 30, 2003 and 2004, respectively. Comprehensive income was $9,846 and $12,445 for the six months ended June 30, 2003 and 2004, respectively.

      The Company leased office space from a related party at an annual rent of $165 until the building was sold to an unrelated third party on October 27, 2003. Management believes the terms of the lease were consistent with prevailing market conditions.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      In February 2004, the Company entered into a secured equipment loan with Wells Fargo Equipment Finance, Inc. in the amount of $10,000. The loan bears interest at a rate of 3.65% per annum. Principal and interest are payable in 48 monthly installments in an amount of $224. The loan is secured by certain furniture, telephone and computer equipment.

      In the three months ended June 30, 2004, the Company paid dividends of $0.39 per share, aggregating $5,629. In the six months ended June 30, 2004, the Company paid dividends of $0.77 per share, aggregating $11,083. On July 28, 2004, the Company declared a dividend of $0.40 per share, aggregating approximately $5,786, payable August 24, 2004 to stockholders of record on August 11, 2004.

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      All statements contained in this Form 10-Q that are not statements of historical facts are forward-looking statements that involve substantial risks and uncertainties. Forward-looking statements are preceded by terms such as “may,” “will,” “should,” “anticipates,” “expects,” “believes,” “plans,” “future,” “estimate,” “continue,” “intends,” “budgeted,” “projections,” “outlook” and similar expressions. The following are important factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. These factors include, but are not limited to, loss of our principal clients, concentration of our client base in a few select industries, highly competitive markets, risks related to our contracts, decreases in numbers of vendors used by clients or potential clients, lack of success of our clients’ products or services, considerable pricing pressure, risks relating to fluctuations in the value of our investment securities portfolio, risks associated with advanced technologies, inability to grow our business, inability to effectively manage growth, dependence on qualified employees and key management personnel, potential future declines in revenue, lack of a significant international presence, and risks relating to conducting business in Canada and the United Kingdom. These factors include risks and uncertainties beyond our ability to control, and in many cases we cannot predict the risks and uncertainties that could cause actual results to differ materially from those indicated by use of forward-looking statements. Similarly, it is impossible for management to foresee or identify all such factors. As such, investors should not consider the foregoing list to be an exhaustive statement of all risks, uncertainties, or potentially inaccurate assumptions. All forward-looking statements herein are made as of the date hereof, and we undertake no obligation to update any such forward-looking statements. All forward-looking statements herein are qualified in their entirety by information set forth in our annual report on Form 10-K for the year ended December 31, 2003 entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk Factors.”

Basis of Presentation

      We recognize revenue as business process management services are completed. We recognize revenue on supply chain management services when products are shipped. The results of our supply chain management services include the results of our European operations and insignificant revenue from other operations, including our Domain.com subsidiary. Substantially all of our significant arrangements with business process management services clients generate revenue based on the number and duration of customer inquiries. Substantially all of our significant arrangements with supply chain management services clients generate revenue based on the volume, complexity and type of components involved in the handling of clients’ products.

      Our cost of services for business process management services includes labor, telecommunications, lease, depreciation and other expenses for facilities, and expenses related to maintaining information systems to meet clients’ needs. Our cost of services for supply chain management services includes materials and freight expenses that are variable in nature, labor and certain facility expenses.

      Selling, general and administrative expenses, which generally tend to be either semi-variable or fixed, include all other operating expenses, including expenses related to technology support, sales and marketing, human resources, and other administrative functions not allocable to specific client services.

      Net interest income and other includes certain realized and unrealized gains and losses in our portfolio of investment securities, interest income and dividends from our portfolio of investment securities, net rental income from our facility in Aurora, Colorado, foreign currency exchange gains and losses, and interest expense.

Critical Accounting Policies and Judgments

      In preparing our financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We evaluate our estimates and judgments on an ongoing basis, including those related to bad debts, inventory valuations, property, plant and equipment, intangible assets, income taxes, restructuring costs, contingencies, and litigation. We base our estimates and judgments on historical experience and on various other factors that

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      We exercise judgment in evaluating our long-lived assets for impairment. Management believes our businesses will generate sufficient undiscounted cash flow to more than recover the investments we have made in property, plant and equipment.

      As part of cash management and in addition to holding cash and money market funds, we invest in investment grade and non-investment grade corporate bonds, convertible bonds, mutual funds, alternative investment partnerships, real estate investment trusts and various forms of equity securities. These investments are classified as trading securities, investments held to maturity or investments available for sale, based on our intent at the date of purchase. Trading securities are liquid investments bought principally for selling in the near term. Debt securities that we have both the intent and ability to hold to maturity are classified as held to maturity. We currently have no investments classified as held to maturity. All other investments not deemed to be trading securities or held to maturity are classified as investments available for sale.

      Trading securities and investments available for sale are carried at fair market values. Fair market values are determined by the most recently traded price of the security or underlying investment at the balance sheet date. Due to the potential limited liquidity of some of these financial instruments, the most recently traded price may be different from the value that might be realized if we were to sell or close out the transactions. We do not believe such differences are substantial to our results of operations, financial condition, or liquidity.

      Changes in the fair market value of trading securities are reflected in net interest income and other. Temporary changes in the fair market value of investments available for sale are reflected in stockholders’ equity. We exercise judgment in periodically evaluating investments for impairment. Investments are evaluated for other-than-temporary impairment if the fair value of such investment is below our cost for six months. We then consider additional factors such as market conditions, the industry sectors in which the issuer of the investment operates, and the viability and prospects of each entity. A write-down of the related investment is recorded and is reflected as a loss on impaired investment when an impairment is considered other-than-temporary.

Results of Operations

      The following table sets forth certain unaudited condensed consolidated income statement data as a percentage of revenue:

Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003

      Revenue. Revenue increased $9.7 million, or 17.8%, from $54.5 million for the three months ended June 30, 2003 to $64.2 million for the three months ended June 30, 2004. Revenue from business process

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      Although revenue and volumes from services provided to AT&T Wireless have increased, our contract extension with AT&T Wireless, which became effective April 1, 2004, includes a tiered pricing structure that provides for lower pricing at higher volumes. As a result, second quarter 2004 revenue was $1.0 million lower than it would have been under the prior contract.

      Cost of Services. Cost of services increased $5.8 million, or 13.9%, from $41.8 million for the three months ended June 30, 2003 to $47.6 million for the three months ended June 30, 2004. Cost of services decreased as a percentage of revenue during the second quarter, from 76.6% in 2003 to 74.1% in 2004.

      Our cost of services as a percentage of revenue decreased because a larger proportion of our revenue was generated by higher gross margin business process management services relative to the lower gross margin supply chain management services. This decrease was partially offset by increased Canadian foreign currency exchange costs in the second quarter of 2004 attributable to the declining value of the US dollar relative to the Canadian dollar.

      Our cost of services increased in dollar terms as a result of four new facilities commencing operations subsequent to June 30, 2003, and increased activity in our business process management services. Costs attributable to our Canadian operations also increased by $0.5 million as a result of a weaker US dollar during the second quarter of 2004. These increased costs were partially offset by $6.0 million less cost in our supply chain management services, which had lower volume during the three months ended June 30, 2004, as compared to the same period in 2003.

      Gross Profit. Gross profit for the three months ended June 30, 2004 increased $3.8 million, or 29.7%, over the same period in 2003, from $12.8 million to $16.6 million. As a percentage of revenue, gross profit increased from 23.4% in the three months ended June 30, 2003 to 25.9% in the three months ended June 30, 2004.

      Selling, General, and Administrative Expenses. Selling, general, and administrative expenses increased $0.1 million, or 0.8%, from $7.2 million in the three months ended June 30, 2003 to $7.3 million in the three months ended June 30, 2004. As a percentage of revenue, selling, general, and administrative expenses were 13.2% and 11.4% during the three months ended June 30, 2003 and 2004, respectively. In dollar terms, second quarter selling, general, and administrative expenses did not increase significantly from the same period in 2003 due to effective cost control and efficient resource allocation.

      Operating Profit. Operating profit increased $3.7 million, or 66.1%, from $5.6 million in the three months ended June 30, 2003 to $9.3 million in the three months ended June 30, 2004. As a percentage of revenue, operating profit was 10.2% and 14.5% during the three months ended June 30, 2003 and 2004, respectively.

      Net Interest Income and Other. Net interest income and other did not change significantly with income of $1.1 million in the three months ended June 30, 2003 and 2004. In 2002 we recorded $6.3 million of impairments of investments available for sale. In the three months ended June 30, 2003, investments on which we recorded impairments of $3.4 million were sold, resulting in more gain than if the investments had been valued at their original cost. In the three months ended June 30, 2004, investments on which we recorded impairments of $0.1 million were sold. If not for the effect of the additional gain in 2003 from the disposal of these impaired investments, net interest income and other would have increased in the second quarter of 2004 over the same period of 2003 due to the improving conditions of capital markets.

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      Income Before Income Taxes. Income before income taxes increased $3.8 million, or 57.5%, from $6.7 million in the three months ended June 30, 2003 to $10.5 million in the three months ended June 30, 2004. As a percentage of revenue, income before income taxes increased from 12.2% to 16.3% during the three months ended June 30, 2003 and 2004, respectively.

      Income Tax Expense. Income tax expense during the three months ended June 30, 2003 and 2004 reflects a provision for federal, state, and foreign income taxes at an effective rate of 37.2% and 38.3% respectively.

      Net Income. Based on the factors discussed above, net income increased $2.3 million, or 54.8%, from $4.2 million to $6.5 million during the three months ended June 30, 2003 and 2004, respectively.

Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003

      Revenue. Revenue increased $23.8 million, or 22.6%, from $105.1 million to $128.9 million during the six months ended June 30, 2003 and 2004, respectively. Revenue from business process management services increased $36.8 million, or 50.8%, from $72.4 million for the six months ended June 30, 2003 to $109.2 million for the three months ended June 30, 2004. Substantially all of this increase was due to higher volumes in services provided to AT&T Wireless Services and T-Mobile. Revenue from supply chain management services declined $12.9 million, or 39.6%, from $32.6 million for the six months ended June 30, 2003 to $19.7 million for the six months ended June 30, 2004. This decrease is primarily attributable to the decrease in services provided to Microsoft compared to the prior year. We anticipate that the supply chain management services we supply to Microsoft will continue to decline in 2004 and may become an insignificant portion of our overall revenue in subsequent years.

      Although revenue and volumes from services provided to AT&T Wireless have increased, our contract extension with AT&T Wireless, which became effective April 1, 2004, includes a tiered pricing structure that provides for lower pricing at higher volumes. As a result, revenue for the first half of 2004 was $1.0 million lower than it would have been under the prior contract.

      Cost of Services. Cost of services increased $13.8 million, or 17.3%, from $80.1 million to $93.9 million during the six months ended June 30, 2003 and 2004, respectively. Cost of services decreased as a percentage of revenue from 76.2% in the six months ended June 30, 2003 to 72.9% in the six months ended June 30, 2004.

      Our cost of services as a percentage of revenue decreased because a larger proportion of our revenue was generated by higher gross margin business process management services relative to the lower gross margin supply chain management services. This decrease was partially offset by increased Canadian foreign currency exchange costs in the second quarter of 2004 attributable to the declining value of the US dollar relative to the Canadian dollar.

      Our cost of services increased in dollar terms as a result of four new facilities commencing operations subsequent to June 30, 2003, and increased activity in our business process management services. Costs attributable to our Canadian operations also increased by $3.1 million as a result of a weaker US dollar during the first six months of 2004. These increased costs were partially offset by $12.1 million less cost in our supply chain management services, which had lower volume during the six months ended June 30, 2004 as compared to the same period in 2003.

      Gross Profit. Due to the foregoing factors, gross profit increased $10.0 million, or 40.0%, from $25.0 million to $35.0 million during the six months ended June 30, 2003 and 2004, respectively. As a percentage of revenue, gross profit was 23.8% and 27.1% during the six months ended June 30, 2003 and 2004, respectively.

      Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $1.5 million, or 11.0%, from $13.6 million to $15.1 million during the six months ended June 30, 2003 and 2004, respectively. As a percentage of revenue, selling, general and administrative expenses were 12.9% and 11.7% during the six months ended June 30, 2003 and 2004, respectively. The increase in dollar terms is primarily due to additional facilities, as described above. The increase in dollar terms also includes

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      Operating Profit. Operating profit increased $8.5 million, or 74.2%, from $11.4 million in the six months ended June 30, 2003 to $19.9 million in the six months ended June 30, 2004. As a percentage of revenue, operating profit was 10.9% and 15.4% during the six months ended June 30, 2003 and 2004, respectively.

      Net Interest Income and Other. Net interest income and other decreased $0.2 million, or 10.5%, from $1.9 million of income in the six months ended June 30, 2003 to $1.7 million of income in the six months ended June 30, 2004. The decrease is primarily the result of a decrease in realized portfolio gains. In 2002 we recorded $6.3 million of impairments of investments available for sale. In the six months ended June 30, 2003, investments on which we recorded impairments of $5.3 million were sold, resulting in more gain than if the investments had been valued at their original cost. In the six months ended June 30, 2004, investments on which we recorded impairments of $0.1 million were sold. If not for the effect of the additional gain in 2003 from the disposal of these impaired investments, net interest income and other would have increased in the second quarter of 2004 over the same period of 2003 due to the improving conditions of capital markets.

      Income Before Income Taxes. Income before income taxes increased $8.3 million, or 62.4%, from $13.3 million in the six months ended June 30, 2003 to $21.6 million during the six months ended 2004. As a percentage of revenue, income before income taxes increased from 12.6% to 16.8% during the six months ended June 30, 2003 and 2004, respectively.

      Income Tax Expense. Income tax expense during the six months ended June 30, 2003 and 2004 reflects a provision for federal, state, and foreign income taxes at an effective rate of 37.2% and 38.3%, respectively.

      Net Income. Based on the factors discussed above, net income increased $5.0 million, or 60.2%, from $8.3 million to $13.3 million during the six months ended June 30, 2003 and 2004, respectively.

Liquidity and Capital Resources

      Since our initial public offering in 1997, we have primarily financed our operations, liquidity requirements, capital expenditures, and capacity expansion through cash flows from operations, and to a lesser degree through various forms of debt and leasing arrangements.

      In addition to funding basic operations, our primary uses of cash relate to capital expenditures to open new facilities, capital expenditures to upgrade our existing information technologies and the payment of dividends. In 2004, we currently have planned $15.9 million in capital expenditures for new facilities (including information technology) and facilities improvements, and $8.9 million in capital expenditures for other information technology. During the six months ended June 30, 2004, we spent $3.1 million in capital expenditures for new facilities (including information technology) and facilities improvements, and $3.0 million for capital expenditures for other information technology. Our actual capital expenditures for new facilities may vary depending on the number and locations of new facilities opened in 2004. We believe our existing facilities are adequate for our current operations, but capacity expansion will be required to support our continued growth. Management intends to maintain a certain amount of excess capacity to enable us to readily provide for the needs of new clients and the increasing needs of existing clients. Our anticipated investment in information technology infrastructure is geared toward remaining competitive in our current business and to acquire additional functionalities necessary for us to be able to compete for new business.

      We began paying a quarterly dividend in August 2003 and we intend to continue to pay quarterly dividends. In the first quarter of 2004 we paid a dividend of $0.38 per share, aggregating $5.5 million. In the second quarter of 2004 we paid a dividend of $0.39 per share, aggregating $5.6 million. On July 28, 2004, we declared a dividend of $0.40 per share, aggregating approximately $5.8 million, payable August 24, 2004 to stockholders of record on August 11, 2004. Assuming we continue to pay a dividend at the same rate and do not issue a substantial number of shares of common stock, we will use approximately $22.7 million of cash to pay dividends in 2004.

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      We maintain a $10.0 million unsecured line of credit with Wells Fargo Bank West, N.A. which we use to finance regular, short-term operating expenses. Borrowing under this line of credit bears interest at the bank’s prime rate minus 1%, which was 3.25% as of June 30, 2004. Interest expense associated with this facility totaled $1,950 in the second quarter of 2004. Under this line of credit, we are not permitted to post net losses in any two consecutive quarterly periods. In addition, we were required to have a minimum tangible net worth of $80.0 million as of December 31, 2003. At the close of each subsequent fiscal year, we will be required to have a minimum tangible net worth equal to the minimum tangible net worth we were required to have at the end of the prior fiscal year plus 25% of net income (if positive) for that year. We may not pay dividends in an amount that would cause a failure to meet our financial covenants. As of June 30, 2004, and the date of this Form 10-Q, we were in compliance with the financial covenants pertaining to the unsecured line of credit and $10.0 million was available under this line of credit. In February 2004, we entered into a secured equipment loan with Wells Fargo Equipment Finance, Inc. in the amount of $10.0 million. The loan bears interest at a rate of 3.65% per annum. Principal and interest are payable in 48 monthly installments of $224,228. The loan is secured by certain furniture, telephone and computer equipment.

      Cash from Operating Activities. Net cash provided by operating activities decreased from $17.2 million for the six months ended June 30, 2003 to $16.6 million for the six months ended June 30, 2004. Growth in net income in the first half of 2004 was offset by a decrease in cash provided by collections of accounts receivable and other net changes in operating assets. For the six months ended June 30, 2004, net accounts receivable collections provided cash of $2.7 million, compared to $6.2 million for the same period in 2003. Accounts receivable have generally increased and net collections on accounts receivable have decreased due to the higher proportion of our revenue attributable to business process management services, which has a longer collections period. In addition, Microsoft receivables decreased $9.0 million in the first half of 2003 as volume decreased and invoices from prior periods were collected.

      Cash from Investing Activities. Net cash used in investing activities decreased from $16.8 million used for the six months ended June 30, 2003 to $3.0 million used for the six months ended June 30, 2004. The change is primarily due to a $9.3 million increase in proceeds from disposition of investments available for sale, net of purchases, from $6.2 million in net purchases for the six months ended June 30, 2003 to $3.1 million in net proceeds for the six months ended June 30, 2004. In addition, purchases of property, plant and equipment decreased $4.5 million, from $10.6 million in the first half of 2003 to $6.1 million in the first half of 2004.

      Cash from Financing Activities. Net cash provided by or used in financing activities increased from $1.3 million used for the six months ended June 30, 2003 to $0.1 million provided for the six months ended June 30, 2004. The increase was primarily due to proceeds from borrowings of $10.0 million and a $1.6 million increase in proceeds from stock options exercised, partially offset by payment of dividends totaling $11.1 million in the first half of 2004. Principal payments on borrowings decreased $0.9 million from the first half of 2003 to the first half of 2004.

      We paid a cash dividend of $0.38 per share on February 24, 2004 and $0.39 on May 24, 2004, aggregating $5.5 million and $5.6 million, respectively. On July 28, 2004, we declared a dividend of $0.40 per share, aggregating approximately $5.8 million, payable August 24, 2004 to stockholders of record on August 11, 2004. We expect to continue to pay quarterly dividends on our common stock. The payment of any dividends, however, will be at the discretion of our board of directors and will depend on, among other things, availability of funds, future earnings, capital requirements, contractual restrictions, our general financial condition and general business conditions.

      Foreign Currency Translation Effects. We are paid for our services with clients and subcontractors typically in U.S. dollars except for certain agreements related to our United Kingdom operations, which accounted for 1.8% of our revenue in the six months ended June 30, 2004. The effect of currency exchange rate changes on translation of revenue from our United Kingdom operations was not significant during the six months ended June 30, 2004.

      Because we translate U.S. dollars into Canadian dollars to pay our expenses in Canada, our financial results in U.S. dollars are affected by changes in the value of the Canadian dollar relative to the U.S. dollar.

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      Expenditures related to our operations in Canada increased $23.2 million Canadian, or 78.7%, from $29.5 million Canadian in the six months ended June 30, 2003 to $52.7 million Canadian in the six months ended June 30, 2004. In U.S. dollars, these expenditures were $20.4 million in the first six months of 2003 and $39.4 million in the first six months of 2004, an increase of $19.0 million, or 93.1%. If Canadian expenditures had remained constant in the first six months of 2004, as compared to 2003, the exchange rate impact from the weakening U.S. dollar in the first six months of 2004 would have been $1.7 million. Increased Canadian expenditures in the first six months of 2004 resulted in an additional exchange rate impact of $1.4 million. Thus the total exchange rate impact of the weakening U.S. dollar from the first six months of 2003 to the first six months of 2004 was $3.1 million.

      If the international portion of our business continues to grow, more revenue and expenses will be denominated in foreign currencies and our exposure to fluctuations in currency exchange rates will increase. See “Quantitative and Qualitative Disclosure About Market Risk” set forth herein for a further discussion of exposure to foreign currency exchange risks in connection with our investments.

      Management believes our cash, cash equivalents, investments, anticipated cash flows from future operations, and line of credit will be sufficient to support our operations, capital expenditures, and various repayment obligations under our debt and lease agreements for at least the next twelve months. Liquidity and capital requirements depend on many factors, including, but not limited to, our ability to retain or successfully and timely replace our principal clients and the rate at which we expand our business, whether internally or through acquisitions and strategic alliances. To the extent funds generated from sources described above are insufficient to support our activities in the short or long-term, we will be required to raise additional funds through public or private financing. Additional financing may not be available, or if available, it may not be available on terms favorable to us.

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Contractual Obligations

      Other than operating leases for certain equipment and real estate and commitments to purchase goods and services in the future, in each case as reflected in the table below, we have no significant off-balance sheet transactions, unconditional purchase obligations or similar instruments, and we are not a guarantor of any other entities’ debt or other financial obligations. The following table presents a summary of our contractual obligations and payments, by period, as of June 30, 2004:

(1)	Long-term debt consists of a $10.0 million 3.65% fixed rate equipment loan, the balance of which was $9.2 million at June 30, 2004, and debt associated with our Greeley North facility, which is forgiven at a rate of $26,136 per year as long as we remain in the facility.
(2)	We lease facilities and equipment under various non-cancelable operating leases.
(3)	Purchase obligations include commitments to purchase goods and services that in some cases may include provisions for cancellation.

New Accounting Pronouncements

      In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.” SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and associated asset retirement costs. We adopted SFAS No. 143 on January 1, 2003, and the adoption of this statement did not result in any material impact on our consolidated results of operations or financial position.

      In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which provides guidance related to accounting for costs associated with disposal activities covered by SFAS No. 144 and with exit or restructuring activities previously covered by Emerging Issues Task Force (“EITF”) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 supercedes EITF Issue No. 94-3 in its entirety. SFAS No. 146 requires that costs related to exiting an activity or to a restructuring not be recognized until the liability is incurred. SFAS No. 146 has been applied prospectively to exit or disposal activities initiated after December 31, 2002, and it had no material impact on our consolidated results of operations or financial position.

      In December 2002, the FASB issued SFAS No. 148, which provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The transition requirements of SFAS No. 148 are effective for our fiscal year 2003. SFAS No. 123, “Accounting and Disclosure of Stock-Based Compensation,” establishes an alternative method of expense recognition for stock-based compensation awards to employees based on estimated fair values. We elected not to adopt SFAS 123 for expense recognition purposes. It is expected that the FASB will require fair value accounting for stock options beginning in 2005.

      In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (“SFAS No. 150”). SFAS No. 150 clarifies the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity and requires

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      On December 17, 2003, the Staff of the Securities and Exchange Commission issued Staff Accounting Bulletin No. 104 (“SAB 104”), Revenue Recognition, which supercedes SAB 101, Revenue Recognition in Financial Statements. SAB 104’s primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, which was superseded as a result of the issuance of EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. SAB 104 did not have a significant impact on our consolidated results of operations or financial position.

      In January 2003, the FASB issued Interpretation, or FIN, No. 46, “Consolidation of Variable Interest Entities,” an interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements.” FIN 46 applies to any business enterprise that has a controlling interest, contractual relationship or other business relationship with a variable interest entity, or VIE, and establishes guidance for the consolidation of VIE’s that function to support the activities of the primary beneficiary. FIN 46 was effective immediately for enterprises with VIE’s created after January 31, 2003, and was effective March 31, 2004 for enterprises with VIE’s created before February 1, 2003. The adoption of FIN 46 did not have a significant impact on our consolidated results of operations or financial position.

Inflation and General Economic Conditions

      Although management cannot accurately anticipate the effects of domestic and foreign inflation on our operations, management does not believe inflation has had, or is likely in the foreseeable future to have, a material adverse effect on our results of operations or financial condition.

Reliance on Principal Client Relationships

      The following table represents revenue concentrations of our principal clients:

      The loss of one or more of our principal clients and/or changes in timing or termination of a principal client’s product launch or service offering may have a material adverse effect on our business, revenue, operating results, and financial condition. There can be no assurance that we will be able to retain our principal clients or, if we were to lose one or more principal clients, that we would be able to timely replace such clients with clients that generate a comparable amount of revenue. Additionally, the amount and growth rate of revenue derived from our principal clients in the past is not necessarily indicative of revenue that may be expected from such clients in the future. Consistent with industry standard contracts, contracts with our current principal clients do not contain volume commitments.

      AT&T Wireless Services has announced that it has entered into an agreement to be acquired by Cingular Wireless LLC. The term of our agreement with AT&T Wireless was recently extended to December 31, 2006, and is not subject to termination for convenience or without cause. The contract extension, effective April 1, 2004, includes a tiered pricing structure that provides for lower pricing at higher volumes. Gross profit will be negatively impacted unless sufficient productivity gains can be realized to offset lower per-minute revenue at higher volume levels.

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      Revenue from T-Mobile increased in the three months ended June 30, 2004 as compared to the same period in 2003. Revenue from wireless number portability was slightly less than the preceding quarter. This trend is congruent with that in the overall industry, which has experienced lower volumes of number porting than initially forecasted, and lower volumes than when wireless number portability first debuted as a choice to consumers in November of 2003.

      We anticipate that the supply chain management services we supply to Microsoft will continue to decline in 2004 and may become an insignificant portion of our overall revenue in subsequent years.

Variability of Quarterly Operating Results

      Our business has been seasonal and is at times conducted in support of product launches for new and existing clients. Historically, our revenue has been substantially lower in the quarters preceding the fourth quarter due to timing of our clients’ marketing programs and product launches, which are typically geared toward the holiday buying season. Due to the recent shift in our business model, including our decreasing reliance on revenue from supply chain management services, growth in our business process management services, and strategic diversification of our client base, we do not currently anticipate that this same pattern will hold true in 2004. For 2004 we anticipate lower seasonal revenue and earnings growth between the first and second half of the year than has historically been the case. Moreover, our revenue and operating results for the six months ended June 30, 2004 are not necessarily indicative of revenue or operating results that may be experienced in future periods. Additionally, we have experienced and expect to continue to experience, quarterly variations in revenue and operating results as a result of a variety of factors, many of which are outside our control, including: (i) timing of existing and future client product launches or service offerings; (ii) expiration or termination of client projects; (iii) timing and amount of costs incurred to expand capacity in order to provide for further revenue growth from existing and future clients; (iv) seasonal nature of certain clients’ businesses; (v) cyclical nature of certain high technology clients’ businesses; and (vi) changes in the amount and growth rate of revenue generated from our principal clients.

      The following discusses our exposure to market risks related to changes in interest rates and other general market risks, equity market prices, and foreign currency exchange rates as of June 30, 2004. All of our investment decisions are supervised or managed by our Chairman of the Board. Our investment portfolio policy, approved by the Board of Directors during 2001, provides for, among other things, investment objectives and portfolio allocation guidelines. This discussion contains forward-looking statements subject to risks and uncertainties. Actual results could vary materially as a result of a number of factors, including but not limited to, changes in interest and inflation rates or market expectations thereon, equity market prices, foreign currency exchange rates, and those factors set forth in our Annual Report on Form 10-K under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk Factors.”

Interest Rate Sensitivity and Other General Market Risks

      Cash and Cash Equivalents. At June 30, 2004, we had $19.8 million in cash and cash equivalents, which consisted of: (i) $15.4 million invested in various money market funds and overnight investments at a combined weighted average interest rate of approximately 0.97%; and (ii) $4.4 million in various non-interest bearing accounts. Cash and cash equivalents are not restricted. We paid a cash dividend to stockholders of $0.38 per share, aggregating $5.5 million, in February 2004, and a cash dividend of $0.39 to stockholders in May 2004, aggregating $5.6 million. We consider cash equivalents to be short-term, highly liquid investments readily convertible to known amounts of cash, and so near their maturity they present insignificant risk of changes in value because of changes in interest rates. We do not expect any substantial loss with respect to our cash and cash equivalents as a result of interest rate changes, and the estimated fair value of our cash and cash equivalents approximates original cost.

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      Outstanding Debt. We believe a hypothetical 10.0% increase in interest rates would not have a material adverse effect on us. Increases in interest rates would, however, increase interest expense associated with future variable-rate borrowings by us, if any. For example, we may from time to time effect borrowings under our $10.0 million line of credit for general corporate purposes, including working capital requirements, capital expenditures, and other purposes related to expansion of our capacity. Borrowings under the $10.0 million line of credit bear interest at the lender’s prime rate less 1%, which was 3.25% as of June 30, 2004. As of June 30, 2004 we were in compliance with the financial covenants pertaining to the line of credit, and no balance was outstanding under the line of credit. In the past, we have not hedged against interest rate changes.

      Investments Available for Sale. At June 30, 2004, we had investments available for sale which, in the aggregate, had a basis and fair market value of $30.6 million and $32.0 million, respectively. At June 30, 2004, investments available for sale generally consisted of investment grade and non-investment grade corporate bonds, convertible bonds, mutual funds, common stock and option contracts. Our investment portfolio is subject to interest and inflation rate risks and will fall in value if market interest and/or inflation rates or market expectations relating to these rates increase.

      A substantial decline in values of equity securities and equity prices in general would have a material adverse effect on our equity investments. Also, prices of common stocks we hold could generally be expected to be adversely affected by increasing inflation or interest rates or market expectations thereon, poor management, shrinking product demand, and other risks that may affect single companies or groups of companies, as well as adverse general economic conditions. We have partially hedged against some equity price changes.

      The fair market value of and estimated cash flows from our investments in corporate bonds are substantially dependent upon the credit worthiness of certain corporations expected to repay their debts to us. If such corporations’ financial condition and liquidity adversely changes, our investments in these bonds would be materially and adversely affected.

      The table below provides information as of June 30, 2004 about maturity dates and corresponding weighted average interest rates related to certain of our investments available for sale: