##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-Q/A Amendment #1
 (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2004 or o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from                      to Commission File Number: 333-115328 PeopleSupport, Inc.  Delaware
    
    95-4695021(State or other jurisdiction
    
    (I.R.S. Employer Identification No.)of incorporation or organization)
 1100 Glendon Ave., Suite 1250 Los Angeles, California 90024
(Address of principal executive offices) (310) 824-6200
(Registrants telephone number, including area code)   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 o No þ Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). Yes o No þ 17,951,358 shares of common stock were outstanding as of November 11, 2004.




---



PEOPLESUPPORT, INC.
FORM 10-Q/A
FOR THE QUARTER ENDED
September 30, 2004 INDEX* PagePART IFINANCIAL INFORMATIONITEM 1. Financial Statements
    
    
    4Consolidated Balance Sheets as of September 30, 2004 (unaudited) and December 31, 2003
    
    
    4Consolidated Statements of Operations for the three and nine months ended September 30,
2004 and 2003 (unaudited)
    
    
    5Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003
(unaudited)
    
    
    6Notes to Unaudited Consolidated Financial Statements
    
    
    7ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    37ITEM 4. Controls and Procedures
    
    
    38PART IIOTHER INFORMATIONITEM 1. Legal Proceedings
    
    
    39ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    39ITEM 3. Defaults Upon Senior Securities
    
    
    39ITEM 4. Submission of Matters to a Vote of Security Holders
    
    
    39ITEM 5. Other Information
    
    
    40ITEM 6. Exhibits
    
    
    40Signature
    
    
    41Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
  * This quarterly report on Form 10-Q/A amends only certain information in Items 1, 2 and 4 of Part
I and Item 6 of Part II identified in the Index, and no other information included in PeopleSupport
Inc.s original quarterly report on Form 10-Q for the third quarter ended September 30, 2004 is
amended or updated hereby. 2




---



##### Table of Contents



Explanatory Note This amended quarterly report on Form 10-Q/A is being filed to reflect the restatement of
PeopleSupport, Inc.s consolidated financial statements for the third quarter of 2004. The
restatement was originally reported in the companys current report on Form 8-K filed January 11,
2005, and the press release issued on the same date that was filed as Exhibit 99.1 of such current
report. The purpose of the restatement is to exclude a charge related to payment obligations of
$4.8 million under the companys management incentive plan in connection with its initial public
offering and to make other adjustments related to obligations under the plan, as discussed in Note
13 of the financial statements included under Part I, Item 1 of this report. This amended quarterly
report also reflects corresponding changes to other information included in the original quarterly
report on Form 10-Q, which was filed with the Securities and Exchange Commission on November 11,
2004. As reported in the press release in PeopleSupport, Inc.s current report on Form 8-K filed January
11, 2005, in preparing the companys financial statements for the quarter ended September 30, 2004,
the charge of $4.8 million under the management incentive plan was recorded on September 30 because
by September 30 the registration statement for the offering had been declared effective by the SEC,
the offering had priced and the management payments were highly probable. The decision to record
the charge in the third quarter was made after consultation with, and the concurrence, of the
companys independent registered public accounting firm. Subsequently, upon further analysis, the
company concluded that the event triggering the payment obligations was the closing of, and the
receipt of funds from, the offering and the charge of $4.8 million should have been recorded on
October 6, 2004. Accordingly, the charge related to the payment obligations recorded in the third
quarter of 2004 will instead be reflected in the fourth quarter of 2004 and reported when the
company reports its 2004 year-end results. As a result of the adjustments, restated net income
calculated in accordance with GAAP for the third quarter of 2004 was $1.9 million, or $0.14 per
diluted share, as compared with a previously reported net loss of $2.7 million, or $(1.28) per
diluted share. Except for information relating to the restatement in Items 1, 2 and 4 of Part I and the updated
certifications in Item 6 of Part II, no other information included in the original quarterly report
on Form 10-Q is amended or updated by this Form 10-Q/A. You should not rely on the financial
statements and other financial information contained in Items 1, 2 and 4 of Part I of the companys
original quarterly report on Form 10-Q for the quarterly period ended September 30, 2004. This
quarterly report on Form 10-Q/A only reflects the effects of the restatement and does not otherwise
reflect events occurring after the filing of the original quarterly report on Form 10-Q or
otherwise modify or update those disclosures. 3




---



##### Table of Contents



PART IFINANCIAL INFORMATION 
 ITEM 1. Financial Statements
 PEOPLESUPPORT, INC. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands)
 September 30,
    
    
    December 31,2004
    
    

    2003(As restated,See Note 13)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    10,979
    
    
    $
    12,151Restricted short-term cash equivalent
    
    
    512
    
    
    
    101Accounts receivable, net of allowance for doubtful accounts of
$582 (unaudited) and $553
    
    
    7,020
    
    
    
    2,476Investment in receivable portfolios
    
    
    127
    
    
    
    622Prepaid expenses and other current assets
    
    
    926
    
    
    
    1,217Total current assets
    
    
    19,564
    
    
    
    16,567Property and equipment, net
    
    
    8,616
    
    
    
    4,829Restricted long-term cash equivalent
    
    
    
    
    
    
    550Deferred offering costs
    
    
    3,000
    
    
    
    Other long term assets
    
    
    1,028
    
    
    
    589Total assets
    
    $
    32,208
    
    
    $
    22,535LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    2,733
    
    
    $
    1,031Accrued liabilities
    
    
    4,532
    
    
    
    2,478Deferred revenue
    
    
    1,883
    
    
    
    1,235Reserve for restructuring
    
    
    
    
    
    
    25Total current liabilities
    
    
    9,148
    
    
    
    4,769Deferred rent
    
    
    270
    
    
    
    267Total liabilities
    
    
    9,418
    
    
    
    5,036Commitments and contingencies Redeemable convertible preferred
stock, $.003 par value; authorized 11,227 shares:Convertible Series A preferred stock  $.003 par value;
designated 712 shares; 712 shares issued and outstanding at
September 30, 2004 and December 31, 2003, liquidation preference
over common stockholders of $1,302
    
    
    1,286
    
    
    
    1,286Convertible Series B preferred stock  $.003 par value;
designated 3,848 shares; 3,311 shares issued and outstanding at
September 30, 2004 and 2,239 at December 31, 2003, liquidation
preference over common stockholders of $6,134
    
    
    6,255
    
    
    
    6,098Convertible Series C preferred stock  $.003 par value;
designated 3,289 shares; 3,289 shares issued and outstanding at
September 30, 2004 and December 31, 2003, liquidation preference
over common stockholders of $17,571
    
    
    17,515
    
    
    
    17,515Convertible Series D preferred stock  $.003 par value;
designated 3,378 shares; 3,149 shares issued and outstanding at
September 30, 2004 and December 31, 2003, liquidation preference
over common stockholders of $49,268
    
    
    49,211
    
    
    
    49,211Stockholders equity (deficit)Common stock, $.003 par value; authorized 16,975 shares; 2,134
and 2,536 shares issued and outstanding at September 30, 2004
and December 31, 2003, respectively
    
    
    6
    
    
    
    7Additional paid-in capital
    
    
    6,691
    
    
    
    6,399Accumulated deficit
    
    
    (56,306
    )
    
    
    (61,367
    )Accumulated other comprehensive income
    
    
    225
    
    
    
    224Deferred stock compensation
    
    
    (2,093
    )
    
    
    (1,874
    )Total stockholders equity (deficit)
    
    
    (51,477
    )
    
    
    (56,611
    )Total liabilities, preferred stock and stockholders equity (deficit)
    
    $
    32,208
    
    
    $
    22,535
 See accompanying notes to consolidated financial statements. 4




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share data)
 Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2004
    
    
    2003
    
    
    2004
    
    
    2003(As restated,
    
    
    
    
    
    

    (As restated,See Note 13)
    
    
    
    
    
    

    See Note 13)Revenues
    
    $
    11,936
    
    
    $
    7,720
    
    
    $
    31,932
    
    
    $
    21,449Cost of revenues (exclusive of
depreciation shown below)
    
    
    6,606
    
    
    
    3,064
    
    
    
    17,155
    
    
    
    9,123Selling, general and administrative
    
    
    2,306
    
    
    
    1,520
    
    
    
    6,727
    
    
    
    4,531Depreciation and amortization
    
    
    1,049
    
    
    
    684
    
    
    
    2,893
    
    
    
    2,456Restructuring charges
    
    
    
    
    
    
    366
    
    
    
    (22
    )
    
    
    366Income from operations
    
    
    1,975
    
    
    
    2,086
    
    
    
    5,179
    
    
    
    4,973Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2Interest income
    
    
    (24
    )
    
    
    (20
    )
    
    
    (57
    )
    
    
    (54
    )Other expense (income)
    
    
    (1
    )
    
    
    5
    
    
    
    4
    
    
    
    (6
    )Income before provision for income taxes
    
    
    2,000
    
    
    
    2,101
    
    
    
    5,232
    
    
    
    5,031Provision for income taxes
    
    
    68
    
    
    

    59
    
    
    
    171
    
    
    
    140Net income
    
    
    1,932
    
    
    
    2,042
    
    
    
    5,061
    
    
    
    4,891Foreign currency translation adjustment
    
    
    (5
    )
    
    
    (2
    )
    
    
    1
    
    
    
    Comprehensive income
    
    $
    1,927
    
    
    $
    2,040
    
    
    $
    5,062
    
    
    $
    4,891Basic earnings per share
    
    $
    0.90
    
    
    $
    0.81
    
    
    $
    2.17
    
    
    $
    1.93Diluted earnings per share
    
    $
    0.14
    
    
    $
    0.16
    
    
    $
    0.37
    
    
    $
    0.40Basic weighted average shares outstanding
    
    
    2,136
    
    
    
    2,533
    
    
    
    2,330
    
    
    
    2,533Diluted weighted average shares outstanding
    
    
    13,564
    
    
    
    12,464
    
    
    
    13,854
    
    
    
    12,281
 See accompanying notes to consolidated financial statements. 5




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
 Nine months endedSeptember 30,2004
    
    
    2003(As restated,See Note 13)OPERATING ACTIVITIES:Net income
    
    $
    5,061
    
    
    $
    4,891Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization
    
    
    2,893
    
    
    
    2,456Provision for doubtful accounts
    
    
    29
    
    
    
    291Stock-based compensation
    
    
    1,367
    
    
    
    14Non-cash restructuring charges
    
    
    
    
    
    
    283Reduction of excess accrual for restructuring
    
    
    (22
    )
    
    
    Changes in operating assets and liabilities:Accounts receivable
    
    
    (4,574
    )
    
    
    (415
    )Prepaid expenses and other assets
    
    
    281
    
    
    
    (136
    )Other long term assets
    
    
    (444
    )
    
    
    (129
    )Accounts payable and accrued liabilities
    
    
    1,993
    
    
    
    969Deferred revenue
    
    
    648
    
    
    
    207Cash payments on restructuring reserve
    
    
    (3
    )
    
    
    (327
    )Net cash provided by operating activities
    
    
    7,229
    
    
    
    8,104INVESTING ACTIVITIES:Purchases of receivable portfolios
    
    
    
    
    
    
    (346
    )Collections applied to principal of receivable portfolios
    
    
    495
    
    
    
    16Purchase of property and equipment
    
    
    (6,671
    )
    
    
    (1,608
    )Restricted cash equivalent
    
    
    139
    
    
    
    351Net cash used in investing activities
    
    
    (6,037
    )
    
    
    (1,587
    )FINANCING ACTIVITIES:Payments of capital lease obligation
    
    
    
    
    
    
    (59
    )Repayments of note payable
    
    
    
    
    
    
    (166
    )Repurchase of common stock
    
    
    (1,350
    )
    
    
    Proceeds from the exercise of warrants to purchase redeemable preferred stock
    
    
    157
    
    
    
    Deferred offering costs
    
    
    (1,227
    )
    
    
    Proceeds from the exercise of stock options
    
    
    55
    
    
    
    Net cash used in financing activities
    
    
    (2,365
    )
    
    
    (225
    )Effect of exchange rate changes on cash
    
    
    1
    
    
    
    3Net increase (decrease) in cash and cash equivalents
    
    
    (1,172
    )
    
    
    6,295Cash and cash equivalents, beginning of year
    
    
    12,151
    
    
    
    5,179Cash and cash equivalents, end of period
    
    $
    10,979
    
    
    $
    11,474SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:Interest paid for the period
    
    $
    
    
    
    $
    2Taxes paid for the period
    
    
    392
    
    
    
    15
 See accompanying notes to consolidated financial statements. 6




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES 
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
 Note 1. Basis of Presentation The accompanying unaudited consolidated financial statements of PeopleSupport, Inc. and its
subsidiaries (the Company) have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to Form 10-Q and Article 10
of Regulation S-X. Accordingly, they do not include all of the information and footnotes required
by accounting principles generally accepted in the U.S. for complete financial statements. In the
opinion of management, all adjustments considered necessary for a fair presentation (consisting of
normal recurring accruals) have been included. The information at September 30, 2004, and for the
three and nine months ended September 30, 2004 and 2003, is unaudited. The information reflected as
of December 31, 2003 is derived from the audited financial statements. Operating results for the
nine months ended September 30, 2004 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2004. For further information, refer to the consolidated
financial statements and footnotes thereto for the year ended December 31, 2003 included in the
Companys Registration Statement on Form S-1. On August 5, 2004, the Companys Board of Directors effected a 1 for 2.74 reverse stock split
of the Companys common and preferred stock. The financial statements have been retroactively
restated for the effects of the reverse stock split. The Company operates in one reportable segment. Note 2. Comprehensive Income The components of comprehensive income are as follows (in thousands): Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2004
    
    
    2003
    
    
    2004
    
    
    2003Net income
    
    $
    1,932
    
    
    $
    2,042
    
    
    $
    5,061
    
    
    $
    4,891Foreign currency translation adjustment
    
    
    (5
    )
    
    
    (2
    )
    
    
    1
    
    
    
    Comprehensive income
    
    $
    1,927
    
    
    $
    2,040
    
    
    $
    5,062
    
    
    $
    4,891
 Note 3. Stock Compensation The Company accounts for stock-based employee compensation arrangements in accordance with
provisions of Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued
to Employees, and related interpretations and complies with the disclosure provisions of Statement
of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation (SFAS 123).
Compensation expense is based on the difference, if any, on the date of grant, between the fair
value of the Companys stock price and the exercise price. The Company accounts for stock issued to
non-employees in accordance with the provisions of SFAS No. 123 and related interpretations. The fair value of each option grant was estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions used for grants for the three
and nine months ended September 30, 2004 and 2003: Three months
    
    
    Nine monthsended
    
    
    endedSeptember 30,
    
    
    September 30,2004
    
    
    2003
    
    
    2004
    
    
    2003Risk-free
interest rate
    
    
    4.0
    %
    
    
    2.7
    %
    
    
    4.0
    %
    
    
    2.7
    %Expected option life (years)
    
    
    5.0
    
    
    
    5.0
    
    
    
    5.0
    
    
    
    5.0Volatility
    
    
    31.7
    %
    
    
    0.0
    %
    
    
    31.7
    %
    
    
    0.0
    %Dividend rate
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %Weighted
Average Fair Value
    
    
    
    
    
    $
    2.19
    
    
    $
    11.00
    
    
    $
    1.29
 7




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data) The Black-Scholes option-pricing model was developed for use in estimating the fair value
of traded options that have no vesting restrictions and are fully transferable. Because the
Companys employee and director stock option plans have characteristics significantly different
from those of traded options, the resulting pro forma compensation cost may not be representative
of the compensation cost expected in future years. If compensation cost for the Companys stock
option plans were determined based on the fair value at the grant date for awards for the three and
nine months ended September 30, 2004 and 2003, consistent with the provisions of SFAS No. 123, the
Companys net income and income per share would have been as indicated below (in
thousands, except per share data): Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2004
    
    
    2003
    
    
    2004
    
    
    2003Net income as reported
    
    $
    1,932
    
    
    $
    2,042
    
    
    $
    5,061
    
    
    $
    4,891Add: Stock  based compensation
expense included in reported net
income, net of related tax effects
    
    
    457
    
    
    
    12
    
    
    
    1,367
    
    
    
    14Deduct: Total stock-based
compensation expense determined under
fair value based methods for all
awards, net of related tax effects
    
    
    (474
    )
    
    
    (165
    )
    
    
    (1,422
    )
    
    
    (495
    )Net income pro forma
    
    $
    1,915
    
    
    $
    1,889
    
    
    $
    5,006
    
    
    $
    4,410Basic earnings per shareas reported
    
    $
    0.90
    
    
    $
    0.81
    
    
    $
    2.17
    
    
    $
    1.93Diluted earnings per shareas reported
    
    
    0.14
    
    
    
    0.16
    
    
    
    0.37
    
    
    
    0.40Basic earnings per sharepro forma
    
    
    0.90
    
    
    
    0.75
    
    
    
    2.15
    
    
    
    1.74Diluted earnings per sharepro forma
    
    
    0.14
    
    
    
    0.15
    
    
    
    0.36
    
    
    
    0.36
 Options granted during the nine months ended September 30, 2004 resulted in deferred
compensation of $1,728, which was included in deferred stock compensation, a component of
stockholders equity (deficit). Deferred compensation expense was amortized ratably using an
accelerated method over the vesting period. During the nine months ended September 30, 2004 and
2003, such non-cash stock-based compensation expense included in the consolidated statement of
operations amounted to $1,367 and $14 respectively, recorded in cost of revenues and selling,
general and administrative as follows: For the quarter endedSeptember 30,
    
    
    June 30,
    
    
    March 31,
    
    
    December 31,
    
    
    September 30,
    
    
    June 30,
    
    
    March 31,2004
    
    
    2004
    
    
    2004
    
    
    2003
    
    
    2003
    
    
    2003
    
    
    2003Cost of revenues
    
    $
    145
    
    
    $
    153
    
    
    $
    146
    
    
    $
    54
    
    
    $
    6
    
    
    $
    1
    
    
    $
    Selling, general &
administrative
    
    
    312
    
    
    
    316
    
    
    
    295
    
    
    
    51
    
    
    
    6
    
    
    
    1
    
    
    
    $
    457
    
    
    $
    469
    
    
    $
    441
    
    
    $
    105
    
    
    $
    12
    
    
    $
    2
    
    
    $
    
 Note 4. Computation of Earnings Per Share Basic earnings per share excludes dilution and is computed by dividing net earnings by the
weighted average number of common shares outstanding during the period. Diluted earnings per share
reflects the potential dilution that could occur if securities or other contracts to issue common
stock (i.e., convertible preferred stock, warrants to purchase common stock and common stock
options using the treasury stock method) were exercised or converted into common stock. 8




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data) The following is a summary of the number of shares of securities outstanding during the
respective periods that have been excluded from the calculation because the effect on net income
per share would have been antidilutive (in thousands). Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2004
    
    
    2003

    
    
    2004
    
    
    2003Options
    
    
    
    
    
    
    148
    
    
    
    
    
    
    
    181Preferred stock warrants
    
    
    31
    
    
    
    1,604
    
    
    
    31
    
    
    
    1,604Common stock warrants
    
    
    96
    
    
    
    96
    
    
    
    96
    
    
    
    96
 The following is a reconciliation of the numerators and denominators of the basic and diluted
earnings per share computations: Nine Months Ended September 30,2004
    
    
    2003Income
    
    
    Shares
    
    
    Per Share
    
    
    Income
    
    
    Shares
    
    
    Per Share(Numerator)
    
    
    (Denominator)
    
    
    Amount
    
    
    (Numerator)
    
    
    (Denominator)
    
    
    AmountBasic earnings per share:Income to common stockholders
    
    $
    5,061
    
    
    
    2,330
    
    
    $
    2.17
    
    
    $
    4,891
    
    
    
    2,533
    
    
    $
    1.93Effect of dilutive securities:Options
    
    
    
    
    
    
    950
    
    
    
    
    
    
    
    
    
    
    
    360Warrants
    
    
    
    
    
    
    805
    
    
    
    
    
    
    
    
    
    
    
    Convertible preferred stock
    
    
    
    
    
    
    9,769
    
    
    
    
    
    
    
    
    
    
    
    9,388Income available to common
stockholders
    
    $
    5,061
    
    
    
    13,854
    
    
    $
    0.37
    
    
    $
    4,891
    
    
    
    12,281
    
    
    $
    0.40
 Three Months Ended September 30,2004
    
    
    2003Income
    
    
    Shares
    
    
    Per Share
    
    
    Income
    
    
    Shares
    
    
    Per Share(Numerator)
    
    
    (Denominator)
    
    
    Amount
    
    
    (Numerator)
    
    
    (Denominator)
    
    
    AmountBasic earnings per share:Income to common stockholders
    
    $
    1,932
    
    
    
    2,136
    
    
    $
    0.90
    
    
    $
    2,042
    
    
    
    2,533
    
    
    $
    0.81Effect of dilutive securities:Options
    
    
    
    
    
    
    959
    
    
    
    
    
    
    
    
    
    
    
    543Warrants
    
    
    
    
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    Convertible preferred stock
    
    
    
    
    
    
    10,461
    
    
    
    
    
    
    
    
    
    
    
    9,388Income available to common
stockholders
    
    $
    1,932
    
    
    
    13,564
    
    
    $
    0.14
    
    
    $
    2,042
    
    
    
    12,464
    
    
    $
    0.16
 Note 5. Stockholders Equity During the nine months ended September 30, 2004, 145,393 shares of common stock were issued
due to the exercise of common stock options, resulting in proceeds to the Company of approximately
$55. In April 2004, the Company purchased 547,445 of its common stock from one of its stockholders
for $2.47 per share for a total purchase price of $1.35 million. 9




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data) Note 6. Preferred Conversion Right From August 1998 through April 2000, the Company issued shares of convertible preferred stock,
which were issued and outstanding immediately before the completion of the initial public offering
of the Companys common shares. The Companys certificate of incorporation, as previously in
effect, provided for conversion of the preferred stock, on a one to one basis, upon the closing of
an underwritten public offering of the Companys common shares at a price of not less than $9.59
per share that would generate gross proceeds to the Company and/or selling stockholders of no less
than $40 million. On September 28, 2004, the Company amended its certificate of incorporation to
reduce the minimum price per share for converting the preferred shares from $9.59 to $6.95. Note 7. Warrants During the nine months ended September 30, 2004, seven holders of Series B warrants exercised
their right to purchase 1,553,723 shares. Of the seven warrant holders who exercised during the
nine months ended September 30, 2004, three holders elected a cashless exercise resulting in the
net issuance of 1,072,580 shares of Series B convertible preferred stock. Note 8. Rescission Offer Grants of certain unexercised options under the Companys 1998 Incentive Stock Plan between
January 1, 2003 through April 28, 2004, may not have been exempt from registration or qualification
under federal and state securities laws and the Company did not obtain any required registration or
qualification. As a result, the Company intends to make a rescission offer to the U.S. holders of
these options. In order to comply with California securities law, the Company will offer to
repurchase these unexercised options. Before completion of its initial public offering, the Company
applied to the California Department of Corporations for approval of the terms of the repurchase
offer. By order dated October 28, 2004, the California Department of Corporations approved the
Companys repurchase application as to form pursuant to section 25507(b) of the California
Corporations Code. Pursuant to the terms of our repurchase application, the Company intends to
offer to repurchase these options at 20% of the option exercise price multiplied by the number of
shares underlying the option, plus interest at an annual rate of 7% from the grant date.
Accordingly, if this rescission offer is accepted, the Company could be required to make payments
to the holders of these options of 20% of the option exercise price multiplied by the number of
shares subject to such options, which would approximate $0.1 million, plus statutory interest at an
annual rate of 7 percent. Federal securities laws do not expressly provide that a rescission offer
will terminate a purchasers right to rescind a sale of stock that was not registered as required.
If any or all of these offerees reject our offer to repurchase the options, the Company may
continue to be liable under federal and state securities laws. Management does not believe that
this rescission offer will have a material effect on the Companys results of operations, cash
flows or financial positions. Note 9. Restructuring The following table sets forth the balances at the beginning of 2004 and the activities during
the nine months ended September 30, 2004 related to certain reserves for streamlining operations
into the Companys lower-cost operating centers in Manila. AssetSeverance and
    
    
    Lease
    
    
    Write-Related Cost
    
    
    Termination
    
    
    Down
    
    
    TotalReserve for restructuring, at December 31, 2003
    
    $
    25
    
    
    $
    
    
    
    $
    
    
    
    $
    25Cash payments
    
    
    (3
    )
    
    
    
    
    
    
    
    
    
    
    (3
    )Reduction of excess accruals
    
    
    (22
    )
    
    
    
    
    
    
    
    
    
    
    (22
    )Reserve for restructuring, at September 30, 2004
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
 10




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data) Note 10. Significant Customers Revenue and net accounts receivable from significant customers were as follows: For the three months
    
    
    For the nine months
    
    
    As ofended September 30,
    
    
    ended September 30,
    
    
    September 30, 20042004
    
    
    2003
    
    
    2004
    
    
    2003% of Revenue
    
    
    % of Revenue
    
    
    % of A/R, netCustomerA
    
    
    32
    %
    
    
    54
    %
    
    
    33
    %
    
    
    53
    %
    
    
    22
    %B
    
    
    6
    
    
    
    22
    
    
    
    8
    
    
    
    30
    
    
    
    3C
    
    
    27
    
    
    
    12
    
    
    
    28
    
    
    
    10
    
    
    
    30D
    
    
    10
    
    
    
    
    
    
    
    11
    
    
    
    
    
    
    
    20E
    
    
    11
    
    
    
    7
    
    
    
    10
    
    
    
    2
    
    
    
    9
 Note 11. Management Incentive Plan Effective July 1, 2002, the Company adopted its 2002 Management Incentive Plan (the Plan)
under which the Company became obligated to make payments to senior management and key employees
upon completion of certain significant transactions, including the sale of our Company or an
initial public offering pursuant to the Securities Act of 1933. Under the Plan, certain key
employees designated by the Companys Board of Directors were entitled to receive cash payments
based on the aggregate net proceeds received by the Company and selling stockholders from the
offering. The registration statement relating to the Companys initial public offering was declared
effective on September 30, 2004, and the sale of 4,745,727 shares by the Company and 2,072,455
shares by existing shareholders closed on October 6, 2004. Based on the net offering proceeds
received by the Company and selling stockholders, the Company became obligated to pay up to $5,631
to senior management and other key employees. The Company paid $4,786 (or 85%) upon completion of
the offering and intends to pay $845 (or 15%) over time after the offering based on continued
service or other performance criteria. Note 12. Initial Public Offering The registration statement relating to the Companys initial public offering was declared
effective by the Securities and Exchange Commission on September 30, 2004. On October 6, 2004, the
Company completed the initial public offering whereby 4,745,727 shares of common stock were sold by
the Company and 2,072,455 shares were sold by existing shareholders at $7.00 per share. The Company
generated approximately $27.8 million of net proceeds (net of underwriting discounts and $3.1
million of offering expenses). Existing shareholders generated approximately $13.5 million of net
proceeds (net of underwriting discounts). Pursuant to the preferred conversion rights, as discussed in Note 6, 10,460,942 preferred
shares converted, on a one-to-one basis, to common shares upon the closing of the initial public
offering. In connection with the Companys initial public offering, the Company amended and restated its
Certificate of Incorporation to increase the Companys authorized capitalization, reduce the par
value per share of common and preferred stock from $0.003 to $0.001, and make certain other
changes. Under the Companys Amended and Restated Certificate of Incorporation, as filed with the
Delaware Secretary of State on October 6, 2004, the Company is authorized to issue 91,000,000
shares of capital stock, including 87,000,000 shares of common stock, par value $0.001 per share,
and 4,000,000 shares of preferred stock, par value $0.001 per share. 11




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data) On October 19, 2004, the Company was notified that, pursuant to section 3 of the Underwriting
Agreement, the Underwriters exercised their over-allotment option in the amount of 603,000
additional shares. On October 25, 2004, the Company completed the sale of the 603,000 additional
shares, and generated approximately $3.9 million of net proceeds. Under the terms of the management
incentive plan, the Company is obligated to pay $465 upon closing of the over-allotment option
exercise and intends to pay $181 over time after the offering based on continued service or other
performance criteria. The following pro forma balance sheet gives effect to the preferred shares converting to
common, the amended and restated Certificate of Incorporation, the initial public offering, and the
Underwriters over-allotment exercise as if they had occurred on September 30, 2004. The earnings
per share calculations give effect to the preferred shares converting to common as if they had
occurred on January 1, 2003 or the later dates on which some of the shares of preferred stock were
issued. CONSOLIDATED PRO FORMA BALANCE SHEET Actual
    
    
    Pro Forma Adjustments
    
    
    Pro FormaAs of
    
    
    Conversion of
    
    
    
    
    
    
    Underwriter
    
    
    As ofSeptember 30,
    
    
    Preferred to
    
    
    Effect of Initial
    
    
    Exercise of
    
    
    September 30,2004
    
    
    Common Shares
    
    
    Public Offering
    
    
    Over-Allotment
    
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    10,979
    
    
    $
    
    
    
    $
    24,236
    
    
    $
    3,461
    
    
    $
    38,676Restricted short-term
cash equivalent
    
    
    512
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    512Accounts receivable, net
of allowance for doubtful
accounts of $582
    
    
    7,020
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,020Investment in receivable
portfolios
    
    
    127
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    127Prepaid expenses and
other current assets
    
    
    926
    
    
    
    
    
    
    
    114
    
    
    
    13
    
    
    
    1,053Total current assets
    
    
    19,564
    
    
    
    
    
    
    
    24,350
    
    
    
    3,474
    
    
    
    47,388Property and equipment, net
    
    
    8,616
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,616Restricted long-term cash
equivalent
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Deferred offering costs
    
    
    3,000
    
    
    
    
    
    
    
    (3,000
    )
    
    
    
    
    
    
    Deferred compensation costs
    
    
    
    
    
    
    
    
    
    
    845
    
    
    
    181
    
    
    
    1,026Other long term assets
    
    
    1,028
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,028Total assets
    
    $
    32,208
    
    
    $
    
    
    
    $
    22,195
    
    
    $
    3,655
    
    
    $
    58,058
 12




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data) CONSOLIDATED PRO FORMA BALANCE SHEET Actual
    
    
    Pro Forma Adjustments
    
    
    Pro FormaAs of
    
    
    Conversion of
    
    
    
    
    
    
    Underwriter
    
    
    As ofSeptember 30,
    
    
    Preferred to
    
    
    Effect of Initial
    
    
    Exercise of
    
    
    September 30,2004
    
    
    Common Shares
    
    
    Public Offering
    
    
    Over-Allotment
    
    
    2004LIABILITIES AND STOCKHOLDERS EQUITY
(DEFICIT)Current liabilities:Accounts payable
    
    $
    2,733
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    2,733Accrued liabilities
    
    
    4,532
    
    
    
    
    
    
    
    (1,783
    )
    
    
    
    
    
    
    2,749Management incentive plan obligation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Deferred revenue
    
    
    1,883
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,883Reserve for restructuring
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total current liabilities
    
    
    9,148
    
    
    
    
    
    
    
    (1,783
    )
    
    
    
    
    
    
    7,365Management incentive plan obligation
    
    
    
    
    
    
    
    
    
    
    845
    
    
    
    181
    
    
    
    1,026Deferred rent
    
    
    270
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    270Total liabilities
    
    
    9,418
    
    
    
    
    
    
    
    (938
    )
    
    
    181
    
    
    
    8,661Redeemable convertible preferred stock,
$.003 par value and $.001 par value pro
forma; authorized 11,227 shares and 4,000
shares pro forma:Convertible Series A preferred stock
 $.003 par value actual and $.001
pro forma; designated 712 shares; 712
shares issued and outstanding at
September 30, 2004, 0 shares issued
and outstanding, pro forma
    
    
    1,286
    
    
    
    (1,286
    )
    
    
    
    
    
    
    
    
    
    
    Convertible Series B preferred stock
 $.003 par value and $.001 par value
pro forma; designated 3,848 shares;
3,311 shares issued and outstanding
at September 30, 2004 and 0 shares
issued and outstanding, pro forma
    
    
    6,255
    
    
    
    (6,255
    )
    
    
    
    
    
    
    
    
    
    
    Convertible Series C preferred stock
 $.003 par value and $.001 par value
pro forma; designated 3,289 shares;
3,289 shares issued and outstanding
at September 30, 2004 and 0 shares
issued and outstanding, pro forma
    
    
    17,515
    
    
    
    (17,515
    )
    
    
    
    
    
    
    
    
    
    
    Convertible Series D preferred stock
 $.003 par value and $.001 par value
pro forma; designated 3,378 shares;
3,149 shares issued and outstanding
at September 30, 2004 and 0 shares
issued and outstanding, pro forma
    
    
    49,211
    
    
    
    (49,211
    )
    
    
    
    
    
    
    
    
    
    
    Stockholders equity (deficit)Common stock, $.003 par value and
$.001 par value pro forma; authorized
16,975 shares and 87,000 shares pro
forma; 2,134 issued and outstanding
at September 30, 2004 and 17,944
issued and outstanding, pro forma
    
    
    6
    
    
    
    28
    
    
    
    5
    
    
    
    1
    
    
    
    40Additional paid-in capital
    
    
    6,691
    
    
    
    74,239
    
    
    
    27,790
    
    
    
    3,925
    
    
    
    112,645Accumulated deficit
    
    
    (56,306
    )
    
    
    
    
    
    
    (4,662
    )
    
    
    (452
    )
    
    
    (61,420
    )Accumulated other comprehensive income
    
    
    225
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    225Deferred stock compensation
    
    
    (2,093
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,093
    )Total stockholders equity (deficit)
    
    
    (51,477
    )
    
    
    74,267
    
    
    
    23,133
    
    
    
    3,474
    
    
    
    49,397Total liabilities, preferred stock and
stockholders equity (deficit)
    
    $
    32,208
    
    
    $
    
    
    
    $
    22,195
    
    
    $
    3,655
    
    
    $
    58,058
 13




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data) PRO FORMA EARNINGS PER SHARE CALCULATIONS For the three months ended
    
    
    For the nine months endedSeptember 30,
    
    
    September 30,2004
    
    
    2003
    
    
    2004
    
    
    2003Net income
    
    $
    1,932
    
    
    $
    2,042
    
    
    $
    5,061
    
    
    $
    4,891Basic earnings per share
    
    $
    0.90
    
    
    $
    0.81
    
    
    $
    2.17
    
    
    $
    1.93Diluted earnings per share
    
    $
    0.14
    
    
    $
    0.16
    
    
    $
    0.37
    
    
    $
    0.40Basic weighted average shares outstanding
    
    
    2,136
    
    
    
    2,533
    
    
    
    2,330
    
    
    
    2,533Diluted weighted average shares outstanding
    
    
    13,564
    
    
    
    12,464
    
    
    
    13,854
    
    
    
    12,281Pro Forma basic earnings per share
    
    $
    0.15
    
    
    $
    0.17
    
    
    $
    0.42
    
    
    $
    0.41Pro Forma diluted earnings per share
    
    $
    0.14
    
    
    $
    0.16
    
    
    $
    0.37
    
    
    $
    0.40Pro Forma basic weighted average shares
outstanding
    
    
    12,597
    
    
    
    11,921
    
    
    
    12,099
    
    
    
    11,921Pro Forma diluted weighted average shares
outstanding
    
    
    13,564
    
    
    
    12,464
    
    
    
    13,854
    
    
    
    12,281
 Note 13. Restatement Subsequent to the issuance of the Companys financial statements for the quarter ended September
30, 2004, the Company has decided to restate its financial statements for the quarter ended
September 30, 2004 to exclude payment obligations of $4,786 under its management incentive plan in
connection with the companys initial public offering (IPO) and make other adjustments related to
obligations under the plan. The initial decision to record the charge in the third quarter was
made after consultation with, and the concurrence, of the companys independent registered public
accounting firm. Subsequently, upon further analysis, the company concluded that the event
triggering the payment obligations was the closing of, and the receipt of funds from, the offering
and the charge of $4,786 should have been recorded on October 6, 2004. The obligations and
corresponding payments will instead be reflected in the fourth quarter of 2004 and reported when
the company reports its 2004 year-end results. 14




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data) A summary of the significant effects of the restatement is as follows: September 30,
    
    
    September 30,2004
    
    
    2004(As reported)
    
    
    (As restated)DescriptionCurrent assets:Prepaid expenses and other current assets
    
    $
    1,040
    
    
    $
    926Deferred compensation costs
    
    
    845
    
    
    
    Total assets
    
    
    33,167
    
    
    
    32,208Current liabilities:Accrued liabilities
    
    
    4,522
    
    
    
    4,532Management incentive plan obligation
    
    
    4,786
    
    
    
    Total current liabilities
    
    
    13,924
    
    
    
    9,148Management incentive plan obligation
    
    
    845
    
    
    
    Total liabilities
    
    
    15,039
    
    
    
    9,418Accumulated deficit
    
    
    (60,968
    )
    
    
    (56,306
    )Total stockholders equity (deficit)
    
    $
    (56,139
    )
    
    $
    (51,477
    )
 Three months endedSeptember 30, 2004(As reported)
    
    
    (As restated)DescriptionManagement incentive plan
    
    $
    4,786
    
    
    $
    Income (loss) from operations
    
    
    (2,811
    )
    
    
    1,975Provision (benefit) for income taxes
    
    
    (56
    )
    
    
    68Net income (loss)
    
    
    (2,730
    )
    
    
    1,932Basic earnings (loss) per share
    
    $
    (1.28
    )
    
    $
    0.90Diluted earnings (loss) per share
    
    $
    (1.28
    )
    
    $
    0.14
 Nine months endedSeptember 30, 2004(As reported)
    
    
    (As restated)DescriptionManagement incentive plan
    
    $
    4,786
    
    
    $
    Income (loss) from operations
    
    
    393
    
    
    
    5,179Provision (benefit) for income taxes
    
    
    47
    
    
    
    171Net income (loss)
    
    
    399
    
    
    
    5,061Basic earnings (loss) per share
    
    $
    0.17
    
    
    $
    2.17Diluted earnings (loss) per share
    
    $
    0.03
    
    
    $
    0.37
 15




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS This report on Form 10-Q contains forward-looking statements within the meaning of the federal
securities laws that involve material risks and uncertainties, including without limitation,
statements about our expectations regarding our revenues, our clients, our expenses, our
anticipated cash needs, our estimates regarding our capital requirements and our needs for
additional financing. We generally identify forward-looking statements by using such terms as
may, will, could, should, potential, continue, expect, intend, plan, estimate,
anticipate, believe, or similar phrases or the negatives of such terms. We base these
statements on our beliefs as well as assumptions we made using information currently available to
us. These forward-looking statements are subject to risks, uncertainties and assumptions, including
those identified below in Managements Discussion and Analysis of Financial Condition and Results
of Operation  Risk Factors, as well as other matters not yet known to us or not currently
considered material by us. Should one or more of these risks or uncertainties materialize, or
should underlying assumptions prove incorrect, actual results may vary materially from those
anticipated, estimated or projected. These risks, uncertainties and assumptions include, but are
not limited to, our dependence on a limited number of clients, negative public reaction to offshore
outsourcing and the effect of recently proposed legislation, competitive conditions in the markets
we serve, our ability to manage our growth, the risks associated with our operations in the
Philippines, and other risks discussed in Managements Discussion and Analysis of Financial
Condition and Results of Operations  Risk Factors in this report. These forward-looking
statements represent our estimates and assumptions only as of the date of this report and, unless
required by law, we undertake no obligation to update or revise these forward-looking statements.
You should, however, review the factors and risks we describe in other reports and registration
statements that we file from time to time with the Securities and Exchange Commission (the SEC). 
 ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations In this quarterly report, all references to us, our and our company refer to
PeopleSupport and its subsidiaries. The following discussion should be read in conjunction with the unaudited consolidated
financial statements and accompanying notes, which appear elsewhere in this Form 10-Q. This
discussion contains forward-looking statements based on current expectations that involve risks and
uncertainties. Our actual results could differ materially from those anticipated in these
forward-looking statements as a result of various factors, including those discussed below in Risk
Factors and elsewhere in this report. Overview We provide business process outsourcing, or BPO, services from our facilities in the
Philippines. We provide customer management services for U.S.-based clients who wish to outsource
this function. As of September 30, 2004, we service 32 U.S.- based clients in a variety of
industries. Our four largest customer management service clients during the periods covered by this
report collectively accounted for more than 80% and 82% of our revenues, respectively, for the
three and nine months ended September 30, 2004. Expedia, our largest client, and EarthLink, our
second largest client, together accounted for approximately 59% and 61% of our revenues,
respectively, for the three and nine months ended September 30, 2004. In July 2003, we also began providing accounts receivable management services for past due
receivables, which consist of defaulted accounts that our clients have written off their books, and
accounts that are in default but have not yet been written off by our clients. We plan to focus our
accounts receivable management services primarily on collecting defaulted consumer receivables on a
contingent basis that have been written off by the creditor. We also 16




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS perform early-stage accounts receivable collection services on defaulted consumer accounts
that have not been written off by managing collection of accounts receivables of at-risk customers. On October 6, 2004, we completed an initial public offering in which we sold 4,745,727 shares
of common stock at $7.00 per share. On October 25, 2004, we sold 603,000 additional shares of
common stock at $7.00 per share in connection with the exercise of the underwriters over-allotment
option. The total aggregate proceeds from these transactions were $37,441,089. Underwriters
discounts and other costs relating to the offering were approximately $5,720,876, resulting in net
proceeds to us of approximately $31,720,213. Upon the closing of our offering on October 6, 2004,
all of our previously outstanding preferred stock automatically converted into 10,460,942 shares of
common stock. Sources of Revenues For the three and nine months ended September 30, 2004, we derived substantially all of our
revenues from customer management fees, which include:  
    Time-delineated or session based fees, including hourly or per minute charges and
charges per interaction, which are separately negotiated on an individual client basis; and
    Implementation fees, including revenues associated with installation and integration of
new clients into our telecommunications, information technology and client reporting
structures. Substantially all of our revenues consisted of time-delineated or session based fees.
Implementation fees accounted for a small portion of our revenues. Also, for the three and nine
months ended September 30, 2004, all of our revenues were derived from U.S.-based clients. Key Expense Categories Cost of Revenues.Cost of revenues consists primarily of salaries, payroll taxes and employee
benefit costs of professionals in the Philippines. Additionally, cost of revenues includes:
telecommunications costs; information technology costs; rent expense, facilities support and
customer management support costs related to the operation of outsourcing and data centers; and
consulting services related to our customer management consulting group in the United States. Cost
of revenues does not include depreciation of assets used in the production of revenues. Selling, general and administrative.Selling, general and administrative expenses consist
primarily of expenses incurred at our U.S.-based corporate headquarters, including sales and
administrative employee-related expenses, sales commissions, professional fees, information
technology costs, travel, marketing programs (which include product marketing expenses, corporate
communications, conferences, other brand building and advertising) and other corporate expenses.
Selling, general and administrative expenses increased in the three and nine months ended September
30, 2004, as compared with selling, general and administrative expenses incurred in corresponding
periods of the preceding fiscal year. We expect these expenses to continue to increase as we add
personnel and incur additional fees and costs related to the growth of our business and operations. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these consolidated financial statements
requires us to make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues, costs and expenses and related disclosures. On an ongoing basis, we evaluate
our estimates and assumptions. Our actual results may differ from these estimates. We believe that,
of our significant accounting policies described in our notes to our consolidated 17




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS financial
statements, the following accounting policies involve a greater degree of judgment and complexity.
Accordingly, these are the policies we believe are the most critical to assist investors in fully
understanding and evaluating our consolidated financial condition and results of operations. Revenues and Deferred Revenue Recognition Revenues are recognized pursuant to applicable accounting standards, including Securities and
Exchange Commission Staff Accounting Bulletin No. 101 Revenue Recognition in Financial
Statements, or SAB 101, and Staff Accounting Bulletin 104, Revenue Recognition or SAB 104, SAB
101, as amended, and SAB 104 summarize certain of the Securities and Exchange Commission, or SEC,
staffs views in applying generally accepted accounting principles to revenue recognition in
financial statements and provide guidance on revenue recognition issues in the absence of
authoritative literature addressing a specific arrangement or a specific industry. We primarily recognize our revenues from services as those services are performed under a
signed contract. We recognize:  
    Customer management fees, excluding implementation fees, as those services are performed;
    Implementation fees ratably over the life of the contract;
    First party collection service fees for accounts receivable management as those
services are performed; and
    Commission revenues for contingent accounts receivable management contracts upon
receipt of collected funds. Deferred revenue represents amounts billed or cash received in advance of revenue recognition.
As of September 30, 2004 and December 31, 2003, our balance sheets reflect $1.9 million and $1.2
million in deferred revenues, respectively. Accounting for Stock-based Awards We have adopted the disclosure only provisions of Statement of Financial Accounting Standards,
or SFAS, No. 123, Accounting for Stock-Based Compensation. Under SFAS No. 123, companies have the
option to measure compensation costs for stock options using the intrinsic value method prescribed
by the Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, or APB
No. 25. Under APB No. 25, compensation expense is generally not recognized when both the exercise
price is the same as the market price and the number of shares to be issued is set on the date the
employee stock option is granted. We have chosen to use the intrinsic value method to measure our
compensation costs. In the past, we awarded a limited number of stock options to employees and non-employees at
exercise prices that were subsequently determined to have been below fair market value. For these
options, we record deferred stock-based compensation charges in the amount by which the exercise
price of an option is less than the deemed fair value of our common stock at the date of grant. We
amortize the deferred compensation charges on an accelerated method over the vesting period of the
underlying option awards. The following table shows, by quarter, the non-cash stock based compensation expense
recognized by the Company during 2003 and 2004. 18




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS For the quarter endedSeptember 30,
    
    
    June 30,
    
    
    March 31,
    
    
    December 31,
    
    
    September 30,
    
    
    June 30,
    
    
    March 31,2004
    
    
    2004
    
    
    2004
    
    
    2003
    
    
    2003
    
    
    2003
    
    
    2003Cost of revenues
    
    $
    145
    
    
    $
    153
    
    
    $
    146
    
    
    $
    54
    
    
    $
    6
    
    
    $
    1
    
    
    $
    Selling, general &
administrative
    
    
    312
    
    
    
    316
    
    
    
    295
    
    
    
    51
    
    
    
    6
    
    
    
    1
    
    
    
    $
    457
    
    
    $
    469
    
    
    $
    441
    
    
    $
    105
    
    
    $
    12
    
    
    $
    2
    
    
    $
    
 We issue both incentive and nonqualified stock options. Most of the options granted to date
have been incentive stock options. We receive a tax deduction at exercise of nonqualified stock
options for the excess of market value over the exercise price, the tax benefit of which is
recorded directly as an increase to stockholders equity. The exercise of incentive stock options
does not create any tax deduction for us. Accounting for Income Taxes We use the liability method to account for income taxes. Under this method, deferred taxes are
determined based on the difference between the financial statement and tax bases of assets and
liabilities and are measured at the enacted tax rates that will be in effect when those differences
are expected to reverse. Valuation allowances are established, when necessary, to reduce deferred
tax assets up to the amount expected to be realized. Long-lived Asset Impairment Long-lived assets, including fixed assets and intangibles, are reviewed for impairment as
events or changes in circumstances occur indicating that carrying amounts may not be recoverable.
When these events or changes in circumstances indicate that the carrying amount would be impaired,
undiscounted cash flow analyses would be used to assess other long-lived impairment. The estimation
of future cash flows involves considerable management judgment. Included in the restructuring
charges for the nine months ended September 30, 2003 are charges for the write down of long-lived
assets in the amounts of $0.4 million. Results of Operations The following table shows the listed items from our consolidated statements of operations as a
percentage of revenues for the periods presented (percentages may not aggregate due to rounding). Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2004
    
    
    2003
    
    
    2004
    
    
    2003(unaudited)Revenues
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %Cost of revenues
    
    
    55
    
    
    
    40
    
    
    
    54
    
    
    
    43Selling, general, and administrative
    
    
    19
    
    
    
    20
    
    
    
    21
    
    
    
    21Depreciation and amortization
    
    
    9
    
    
    
    9
    
    
    
    9
    
    
    
    11Restructuring charges
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    2Income from operations
    
    
    17
    
    
    
    27
    
    
    
    16
    
    
    
    23Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Interest income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other expense (income)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Income before provision for income
taxes
    
    
    17
    
    
    
    27
    
    
    
    16
    
    
    
    23Provision for income taxes
    
    
    1
    
    
    
    1
    
    
    
    1
    
    
    
    1Net income
    
    
    16
    %
    
    
    26
    %
    
    
    16
    %
    
    
    23
    %
 19




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS Three Months Ended September 30, 2003 compared with Three Months Ended September 30, 2004 Revenues Our revenues increased by $4.2 million, or 55%, from $7.7 million for the three months ended
September 30, 2003 to $11.9 million for the three months ended September 30, 2004. This increase
was primarily attributable to an increase of $1.6 million in customer management fees associated
with a higher volume of services to new and existing clients. We believe this increase resulted
from our ability to capture a larger share of our clients outsourcing needs, as well as a general
increase in our clients demand for outsourcing services, particularly in the travel and
hospitality industry. The increase in revenues also resulted, in part, from an increase of $2.5
million in customer management fees associated with services provided to nine new clients in the
financial, telecommunications and technology industries. We anticipate that customer management fees will continue to comprise a substantial majority
of our revenues for the foreseeable future. As more companies enter the BPO market in the
Philippines, we anticipate increases in competition and price pressure that could reduce our rate
of revenue growth in the balance of 2004 and adversely impact revenues in future periods, as
compared with our performance in 2003 and the first six months of 2004. In addition, we offer some
of our clients volume-related discounts, which could impact our revenues as we expand volume. Cost of Revenues Our cost of revenues increased by $3.5 million, or 113%, from $3.1 million for the three
months ended September 30, 2003 to $6.6 million for the three months ended September 30, 2004. The
increase was primarily attributable to increased costs of approximately $3.0 million (or 25% of
revenue) associated with the expansion of our outsourcing operations in the Philippines and an
increase in the number of customer management professionals and $0.1 million (or 1% of revenue) of
stock based compensation expense. We anticipate that these costs will continue to increase in those
quarters when we expand our operations and increase the volume of customer management services we
provide. We believe this trend will continue due to increased demand for our outsourced services by
our existing clients, particularly those engaged in the travel and hospitality industry, and our
ability to attract new clients. Our cost of revenues as a percentage of revenues increased from 40%
for the three months ended September 30, 2003 to 55% for the three months ended September 30, 2004. As more companies enter the BPO market in the Philippines, we anticipate increases in
competition for qualified professionals and management personnel. This increasing competition could
result in higher cost of revenues in the balance of 2004 and future periods, as compared with our
performance in 2003 and the first nine months of 2004, and could increase employee turnover. Selling, General, and Administrative Selling, general and administrative expenses (SG&A) increased by $0.8 million, or 53%, from
$1.5 million for the three months ended September 30, 2003, to $2.3 million for the three months
ended September 30, 2004. The increase is primarily attributable to $0.5 million (or 4% of revenue)
related to salaries and wages, and $0.3 million (or 3% of revenue) of stock based compensation
expense. Our SG&A as a percentage of revenues decreased from 20% for the three months ended
September 30, 2003 to 19% for the three months ended September 30, 2004. 20




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS Nine months ended September 30, 2003 compared with nine months ended September 30, 2004 Revenues Our revenues increased by $10.5 million, or 49% from $21.4 million for the nine months ended
September 30, 2003 to $31.9 million for the nine months ended September 30, 2004. The increase was
primarily attributable to $5.1 million of customer management fees associated with services
provided to six new clients. The increase was also attributable to an increase of $4.9 million in
customer management fees associated with a higher volume of services rendered to existing clients.
We believe this increase resulted from our ability to capture a larger share of our clients
outsourcing needs, as well as a general increase in our clients demand for outsourced services.
The increase in revenues was partially offset by a 57% decline in revenues from Network Solutions
for the nine months ended September 30, 2004, as compared with the nine months ended September 30,
2003. We believe this decline was primarily due to Network Solutions improvement of its web-based,
self-help technology, automation of its telephone inquiry system and expansion of its in-house
customer management operations, which reduced Network Solutions demand for our services. Costs of Revenues Our cost of revenues increased by $8.1 million, or 89%, from $9.1 million for the nine months
ended September 30, 2003 to $17.2 million for the nine months ended September 30, 2004. The
increase was primarily due to increased costs associated with the expansion of our outsourcing
operations in the Philippines to meet increased demand from new and existing customers during the
first three quarters of 2004, and to add capacity for anticipated future increases in demand. In
the nine months ended September 30, 2004, we strategically invested in expanding our outsourcing
delivery capabilities. The costs of expansion primarily include $5.0 million of compensation and
training of additional outsourcing and support personnel, including middle and upper management,
$1.4 million of expenses associated with the rental of facilities and expenses related to
facilities, and $1.5 million of expenses associated with information technology, telecommunications
and transmission rights. Other investments in capitalized infrastructure expansion, including build
out of facilities, purchase of computers, information technology and telecommunications equipment
have been capitalized and will be expensed over time as depreciation and amortization, which is
classified separately from cost of revenues. Primarily as a result of our strategic investment in expanding our capacity, our cost of
revenues as a percentage of revenues increased from 43% for the nine months ended September 30,
2003 to 54% for the nine months ended September 30, 2004 (including $0.4 million, or 1%, of
non-cash, stock based compensation expense). Although our strategic investment in developing client
service capacity may result in near term overcapacity and reduced operating margins, we believe the
investment is essential to attract and retain additional clients. The success of this approach
depends on our ability to correctly anticipate and continue building demand for our services. We
plan to continue investing to expand our capacity through the remainder of 2004 and into 2005 when
we commence operations at the PeopleSupport Center, a new build-to-suit 163,000 square feet leased
facility that is schedule to commence operations in August 2005. We also intend that increases in
demand for our services from new and existing clients will enable us to utilize our 2004 capacity
enhancements beginning at the end of 2004 and early 2005. Selling, General and Administrative Selling, general and administrative expense (SG&A) increased $2.2 million, or 49%, from $4.5
million for the nine months ended September 30, 2003 to $6.7 million for the nine months ended
September 30, 2004. The increase was primarily due to the following increased or additional
expenses in 2004: $0.9 million of expense (or 3% of revenue) related to stock based compensation
and the recognition of $0.6 million of commission expense (or 2% of 21




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS revenue). Our SG&A expense as a
percentage of revenues was 21% for both the nine months ended September 30, 2003 and 2004,
respectively. Liquidity and Capital Resources We have historically financed our operations primarily through cash flows from operations,
sales of equity securities, equipment financings, and interest income earned on cash, cash
equivalents and investments. As of September 30, 2004, we have working capital of $10.4 million
including cash and cash equivalents totaling $11.0 million (excluding a restricted cash equivalent)
and accounts receivable of $7.0 million. Operating Activities Net cash provided by operating activities was $7.2 million for the nine months ended September
30, 2004, which was greater than our net income of $5.1 million for the same period. The difference
is primarily due to $2.9 million of depreciation and amortization, $1.4 million of non-cash stock
based compensation expense, and an aggregate decrease in working capital of $2.1 million. Net cash
provided by operating activities was $8.1 million for the nine months ended September 30, 2003,
which was greater than our net income of $4.9 million for the same period. The difference is
primarily attributable to $2.5 million of depreciation and amortization, $0.3 million provision for
doubtful accounts, $0.3 million of non-cash restructuring charges and an aggregate increase in
working capital of $0.2 million. Investing Activities Net cash used in investing activities during the nine months ended September 30, 2003 and 2004
was $1.6 million and $6.0 million, respectively. During the nine months ended September 30, 2004,
we incurred $6.7 million of capital expenditures associated with the expansion of the Philippine
operations which was offset by $0.5 million of receivable portfolio collections. Cash used in
investing activities for nine months ended September 30, 2003 was primarily comprised of $1.6
million of capital expenditures associated with the continuing expansion of the Philippine
operating facilities, and $0.3 million related to the purchase of receivable portfolios offset by a
$0.4 reduction in restricted cash equivalents. We estimate that our capital expenditures, including expenditures already made, for 2004 will
be approximately $8.0 million, primarily for telecommunications equipment, leasehold improvements,
computer hardware and software, and furniture and fixtures in support of expanding our
infrastructure, which we may adjust based on trends in revenue and personnel in the Philippines. In
2005, we expect to move into a build-to-suit leased data and outsourcing center in Manila,
Philippines (the PeopleSupport Center). We estimate potential build out costs for this facility of
$6.4 million for telecommunications equipment, leasehold improvements, computer hardware and
software, and furniture and fixtures. In addition to the PeopleSupport Center, we estimate further
build out costs in 2005 of our infrastructure of $2.0 million to $4.0 million primarily for
telecommunications equipment, leasehold improvements, computer hardware and software, and furniture
and fixtures in support of expanding our infrastructure, which we may adjust based on trends in
revenue and personnel in the Philippines. We anticipate using cash on hand and the net proceeds
from our recently completed offering to fund these expenditures. Financing Activities Net cash used in financing activities during the nine months ended September 30, 2003 and 2004
was $0.2 million and $2.4 million, respectively. The increase in cash used in financing activities
for the nine months ended September 30, 2004 was primarily attributable to $1.2 million of deferred
offering costs and the $1.4 million repurchase of common stock from one of our founders, offset by
the absence of debt payments and $0.2 million of proceeds from the exercise of stock options and
warrants. 22




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS In May 2003, we renewed standby letters of credit in the aggregate amount of $0.7 million
related to the lease of one of our offices in the Philippines and the lease or our headquarters in
Los Angeles. In connection with these renewals, we granted a security interest in a certificate of
deposit with a commercial bank to secure performance of our obligations under the standby letters
of credit. Pursuant to the terms of the letters of credit, approximately $0.1 million of our
security interest was released in August 2004 and approximately $0.5 million will be released in
August 2005. At September 30, 2004, we had a restricted cash equivalent in the amount of approximately $0.5
million, held in a certificate of deposit as collateral for our lending facilities, which will be
released as discussed above. Based on our current level of operations, we expect that our cash flow from operations,
together with the proceeds of the current working capital and recently completed public offering on
October 6, 2004, will be adequate to meet our anticipated cash needs at least through 2005.
Although we currently have no specific plans to do so, to the extent we decide to pursue one or
more significant strategic acquisitions, we will likely incur debt or sell additional equity to
finance those acquisitions. Rescission Offer and Reporting Obligations For the first time at the end of any fiscal year, on December 31, 2002, options granted under
our 1998 stock plan were held by more than 500 holders. As a result, we became subject to the
registration requirements under section 12(g) of the Securities Exchange Act of 1934, as amended,
which requires every issuer having total assets of more than $10 million, and a class of equity
security held of record by more than 500 or more persons, to register that class of equity security
under the Exchange Act. We were required to comply with the registration requirements within 120
days after the end of the first fiscal year when we first met these assets and holder tests, and
were required pursuant to Section 12 of the Exchange Act to file periodic and other reports under
Section 13(a) of the Exchange Act. As a result of not having registered our securities under Section 12 and not having filed
reports under Section 13(a) of the Exchange Act beginning in 2003, grants of certain options under
our 1998 plan between January 1, 2003 through April 28, 2004 may not have been exempt from
registration or qualification under federal and state securities laws, and we did not obtain any
required registration or qualification. As a result, we intend to make a rescission offer to the
U.S. holders of these options. In order to comply with California securities laws, we will offer to
repurchase these options. Before the completion of its initial public offering, the Company applied
to the California Department of Corporations for approval of the terms of the repurchase offer. By
order dated October 28, 2004, the California Department of Corporations approved the Companys
repurchase application as to form pursuant to section 25507(b) of the California Corporations Code.
Pursuant to the terms of our repurchase application, we intend to offer to repurchase the options
at 20% of the option exercise price multiplied by the number of shares underlying the option, plus
interest at an annual rate of 7% from the grant date. Under these terms, we would be required to
pay approximately $0.1 million, plus statutory interest at an annual rate of 7% if all persons
entitled to have their options repurchased elect to do so. Federal securities laws do not expressly
provide that a rescission offer will terminate a purchasers right to rescind a sale of stock that
was not registered as required. If any or all of the offerees reject our offer to repurchase the
options, we may continue to be liable under federal and state securities laws. We do not believe
that this rescission offer will have a material effect on our results of operations, cash flows or
financial positions. In addition, our failure to file past required reports under the Exchange Act of 1934 could
conceivably give rise to potential claims by present or former stockholders based on the theory
that such holders were harmed by the absence of such public reports. If any such claim is asserted,
we could incur expenses and divert managements attention in defending them, even if we have no
liability. 23




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS On November 1, 2004, we filed a registration statement on Form S-8 under the Securities Act
covering shares of common stock under outstanding options under our 1998 stock plan, including
those that optionees do not elect to sell back to us, in the rescission offer. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements, investments in special purpose entities or
undisclosed borrowings or debt. In addition, we have not entered into any derivative contracts or
synthetic leases. RISK FACTORS Risks Related to Our Business Our revenues are highly dependent on four major clients that collectively accounted for 82% of our
revenues in the first nine months of 2004, and any loss of business from our major clients would
reduce our revenues and seriously harm us. In recent years, we have generated, and expect that at least for the near term we will
continue to generate, almost all of our revenues from a limited number of clients. Expedia,
EarthLink, StarNumber (a subsidiary of InPhonic), and ConsumerInfo.com have been our largest
clients in 2004 and accounted for 80% and 82% of our revenues for the three and nine months ended
September 30, 2004, respectively. Expedia, our largest client, and EarthLink, our second largest
client, together accounted for 59% and 61% of our revenues for the three and nine months ended
September 30, 2004, respectively. Our contract with Expedia expires in May 2007 and our contract
with StarNumber expires in November 2005. Our contract with EarthLink expires in January 2006, but
will automatically renew each year for a one year period unless terminated by EarthLink or us prior
to the end of the term. Our contract with ConsumerInfo.com expires in July 2006, but will
automatically renew each year for a one year period unless terminated by ConsumerInfo.com or us
prior to the end of the term. If we fail to renew or extend our contracts with our clients, or if
these contracts are terminated for cause or convenience, our clients will have no obligation to
purchase services from us. The loss of, or any significant decline in business from, one or more of these clients likely
would lead to a significant decline in our revenues and operating margins, particularly if we are
unable to make corresponding reductions in our expenses in the event of any such loss or decline.
We may not be able to retain our major clients or, if we were to lose any of our major clients, we
may not be able to timely replace the revenue generated by the lost clients. In addition, the
revenue we generate from our major clients may decline or grow at a slower rate in future periods
than it has in the past. If we lose any of our major clients, or if they reduce their volume with
us, we may suffer from the costs of underutilized capacity because of our inability to eliminate
all of the costs associated with conducting business with them, which could exacerbate the harm
that any such loss or reduction would have on our operating results and financial condition. A reversal of industry trends toward offshore outsourcing due to negative public reaction in the
United States and recently proposed legislation may adversely affect demand for our services. Our customer management and accounts receivable management services and our growth depend in
large part on U.S. industry trends towards outsourcing these business processes offshore. The trend
to outsource business processes may not continue and could reverse. Offshore outsourcing has become
a politically sensitive topic in the United States, particularly in light of the recent
Presidential election. Recently, many organizations and public figures have publicly expressed
concerns about a perceived association between offshore outsourcing providers and the loss of jobs
in the United States. In addition, there has been recent publicity about the negative experience of 24




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS certain companies that use offshore outsourcing, particularly in India. Current or prospective
clients may elect to perform such services themselves or may be discouraged from transferring these
services to offshore providers to avoid any negative perception that may be associated with using
an offshore provider. Any slowdown or reversal of existing industry trends would harm our ability
to compete effectively with competitors that operate out of facilities located in the United
States. Estimates of the growth in the offshore outsourcing market in this prospectus do not assume
any such slowdown or reversal of recent trends. A variety of federal and state legislation has been proposed that could restrict or discourage
U.S. companies from outsourcing their services to companies outside the United States. For example,
legislation has been proposed that would require offshore providers to identify where they are
located and in certain cases to obtain consent to handling calls or sending customer information
offshore. It is also possible that legislation could be adopted that would restrict U.S. private
sector companies that have federal or state government contracts from outsourcing their services to
offshore service providers. In addition, various federal tax changes that could adversely impact
the competitive
position of offshore outsourcing services are also under consideration. Any expansion of
existing laws or the enactment of new legislation directly or indirectly restricting offshore
outsourcing may adversely impact our ability to do business with U.S. clients, particularly if
these changes are widespread. Our clients may adopt technologies that decrease the demand for our services, which could reduce
our revenues and seriously harm our business. We target clients with a high need for our customer management services and we depend on their
continued need of our services, especially our major clients who generate the substantial majority
of our revenues. However, over time, our clients may adopt new technologies that decrease the need
for live customer interactions, such as interactive voice response, web-based self-help and other
technologies used to automate interactions with customers. The adoption of such technologies could
reduce the demand for our services, pressure our pricing, cause a reduction in our revenues and
harm our business. For example, in 2003, one of our major clients, Network Solutions, which
accounted for over 10% of our 2003 revenues, improved its web-based self-help technology and
automated its telephone inquiry system, which we believe was a contributing factor behind a
reduction in revenues by 57% for the nine months ended September 30, 2004 compared with the nine
months ended September 30, 2003. Our revenues are highly dependent on a few industries and any decrease in demand for outsourced
services in these industries could reduce our revenues and seriously harm our business. Our major clients are concentrated in the travel and hospitality, technology and
telecommunications industries. Our business and growth largely depends on continued demand for our
services from clients in these industries and other industries we may target in the future and on
trends in these industries to purchase outsourced business process services. A downturn in any of
our targeted industries, particularly the travel and hospitality or Internet service provider
industry, or a slowdown or reversal of the trend in any of these industries to outsource business
processes could result in a decrease in the demand for our services. Rapid change in and
competition between technology clients, particularly Internet service providers, could result in a
decrease in demand for our services within the technology industry. Other adverse changes also may lead to a decline in the demand for our services in these
industries. For example, consolidation in any of these industries, particularly involving our
clients, may decrease the potential number of buyers of our services. Any significant reduction in
or the elimination of the use of the services we provide within any of these industries would
result in reduced revenues and harm our business. Our clients, particularly those in the technology
and telecommunications industries, have frequently experienced rapid changes in their prospects,
substantial price competition and pressure on their profitability. Although such pressures can
encourage outsourcing as a cost reduction measure, they may also result in increasing pressure on
us from clients in these key industries to lower our prices, which could negatively affect our
operating results and harm our business. 25




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS We serve markets that are highly competitive and we may be unable to compete with businesses that
have greater resources than we do. We currently face significant competition for outsourced business process services and expect
that competition will increase. We believe that, in addition to prices, the principal competitive
factors in our markets are service quality, sales and marketing skills, the ability to develop
customized solutions and technological and industry expertise. While numerous companies provide a
range of outsourced business process services, we believe our principal competitors include our
clients own in-house customer service groups, including, in some cases, in-house groups operating
offshore, offshore outsourcing companies and U.S.-based outsourcing companies. Our principal
competitors in customer management services include Sykes Enterprises, Convergys Corporation and
TeleTech Holdings, each publicly traded U.S. companies, and eTelecare International, ClientLogic,
and Ambergris Solutions, each privately held companies. Wipro LTD, a large publicly held outsourcer
of IT and IT related services based in India, recently announced plans to expand its operations
into the Philippines. The trend towards offshore outsourcing, international expansion by foreign
and domestic competitors and continuing technological changes will result in new and different
competitors entering our markets. These competitors may include entrants from the
communications, software and data networking industries or entrants in geographic locations
with lower costs than those in which we operate. We have existing competitors, and may in the future have new competitors, with greater
financial, personnel and other resources, longer operating histories, more technological expertise,
more recognizable brand names and more established relationships in industries that we currently
serve or may serve in the future. Increased competition, our inability to compete successfully
against current or future competitors, pricing pressures or loss of market share could result in
increased costs and reduced operating margins, which could harm our business, operating results,
financial condition, and future prospects. Many of our contracts can be terminated by our clients on short notice and in many cases without
penalty. We also generally do not have exclusive arrangements with our clients or a minimum revenue
commitment from our clients, which creates uncertainty about the volume of services we will provide
and the amount of revenues we will generate from any of our clients. We typically enter into written agreements with each client for our services. We seek to sign
multi-year contracts with our clients, but many of our contracts permit our clients to terminate
the contracts upon short notice. The volume and type of services we perform for specific clients
may vary from year to year, particularly since in many cases we are not the exclusive provider of
outsourcing services to our clients. A client in one year may not provide the same level of
revenues in a subsequent year. Many of our clients may terminate their contracts with us before
their expiration with no penalties or limited penalties. Many of our clients could terminate their relationship with us or reduce their demand for our
services due to a variety of factors, including factors that are unpredictable and outside of our
control. The services we provide to a client could be reduced if the client were to change its
outsourcing strategy. Clients may move more customer management functions in-house, to an
affiliated outsourcing provider or to one of our competitors. Clients may reduce spending on
outsourcing services due to changing economic conditions or financial challenges or political or
public relations pressures to reduce or eliminate offshore outsourcing of business processes. If
our clients are not successful or if they experience any significant decrease in their businesses,
the amount of business they outsource and the prices that they are willing to pay for such services
may be diminished and likely would result in reduced revenues for us. Any reduction in revenues
would harm our business, negatively affect operating results and may lead to a decline in the price
of our common stock. 26




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS We often encounter a long sales and implementation cycle requiring significant resource commitments
by our clients, which they may be unwilling or unable to make. The implementation of our customer management service involves significant resource
commitments by us and our clients. Potential clients require that we expend substantial time and
money educating them as to the value of our services and assessing the feasibility of integrating
our systems and processes with theirs. Decisions relating to outsourcing business processes
generally involve the evaluation of the service by our clients senior management and a significant
number of client personnel in various functional areas, each having specific and often conflicting
requirements. We may expend significant funds and management resources during the sales cycle and
ultimately the client may not engage our services. Our sales cycle generally ranges up to six to
twelve months or longer. Our sales cycle for all of our services is subject to significant risks
and delays over which we have little or no control, including:  
    Our clients alternatives to our services, including their willingness to replace their
internal solutions or existing vendors;
    Our clients budgetary constraints, and the timing of our clients budget cycles and
approval process;
    Our clients willingness to expend the time and resources necessary to integrate their
systems with our systems and network; and
    The timing and expiration of our clients current outsourcing agreements for similar
services. If we are unsuccessful in closing sales after expending significant funds and management
resources, or if we experience delays in the sales cycle, it could have a negative impact on our
revenues and margins. This occupies important personnel resources that could otherwise be assisting
other new clients. When we are engaged by a client after the sales process, it takes from four to
six weeks to integrate the clients systems with ours, and up to three months thereafter to ramp-up
our services to the clients requirements. We have incurred substantial losses in the past and may not be profitable in the future. We did not become profitable until 2003 and incurred significant losses in each of the five
fiscal years through 2002. This was mainly the result of excess capacity and high costs of our
former U.S. outsourcing centers. We found it necessary to restructure our operations and move to
the Philippines in order to become profitable. We may incur significant operating losses in the
future. As a result of our operating losses, we had an accumulated deficit of $61.0 million at
September 30, 2004. We expect our marketing, sales and other operating expenses to increase in the
future as we seek to expand our business. If our revenues do not grow at a faster rate than these
expected increases in our expenses or if our operating expenses are higher than we anticipate, we
may not be profitable and we may incur additional losses. We have a limited operating history and our business and future prospects are difficult to
evaluate. Due to our limited operating history, especially in the Philippines where we consolidated our
operations in 2002 and in our accounts receivable management services, which we commenced in April
2003, our business and future prospects are difficult to evaluate. We have limited experience
providing accounts receivable management services and we are exploring opportunities to provide
other outsourced services that we have not provided to date. You should consider the challenges,
risks, and uncertainties frequently encountered by early-stage companies using new and unproven
business models in rapidly evolving markets. These challenges include our ability to:  
    Attract and retain clients; 27




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS  
    Attract and retain key personnel and customer management professionals;
    Generate sufficient revenues and manage costs to maintain profitability;
    Manage growth in our operations; and
    Access additional capital when required and on reasonable terms. Our operating results may fluctuate significantly and could cause the market price of our common
stock to fall rapidly and without notice. Our revenues and operating results are difficult to predict and may fluctuate significantly
from quarter to quarter due to a number of factors, including:  
    The addition or loss of a major client and the volume of services provided to our major
clients;
    The extent to which our services achieve or maintain market acceptance, which may be
affected by political and public relations reactions to offshore outsourcing;
    Our ability to introduce new or enhanced services to our existing and prospective
clients and to attract and retain new clients;
    Long sales cycles and fluctuations in sales cycles;
    The extent to which we incur expenses in a given period in anticipation of increased
demand in future periods, and the extent to which that demand materializes;
    Changes in our pricing policies or those of our competitors, as well as increased price
competition in general;
    Variation in demand for our services and services or products of our major clients,
particularly clients in the travel and hospitality industry; and
    The introduction of new or enhanced services by other outsourced service providers. Results of operations in any quarterly period should not be considered indicative of the
results to be expected for any future period. In addition, our future quarterly operating results
may fluctuate and may not meet the expectations of securities analysts or investors. If this
occurs, the trading price of our common stock could fall substantially, either suddenly or over
time. If we fail to manage our growth effectively, our business may not succeed. We have expanded significantly since our formation and intend to maintain our growth focus.
However, our growth will place demands on our resources and we cannot be sure that we will be able
to manage our growth effectively. In order to manage our growth successfully, we must:  
    Maintain the hiring, training and management necessary to ensure the quality and
responsiveness of our services; 28




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS  
    Expand and enhance our administrative and technical infrastructure, facilities, and
capacities to accommodate increased call volume and other customer management demands; and
    Continue to improve our management, financial and information systems and controls. Continued growth could place a strain on our management, operations, and financial resources.
Our infrastructure, facilities and personnel may not be adequate to support our future operations
or to adapt effectively to future growth. As a result, we may be unable to manage our growth
effectively, in which case our operating costs may increase at a faster rate than the growth in our
revenues, our margins may decline and we may incur losses. We may experience significant employee turnover rates in the future and we may be unable to hire
and retain enough sufficiently trained employees to support our operations, which could harm our
business. The business process outsourcing industry is very labor intensive and our success depends on
our ability to attract, hire, and retain qualified employees. We compete for qualified personnel
with companies in our industry and in the other industries and this competition is increasing in
the Philippines as the BPO industry expands. Our growth requires that we continually hire and train
new personnel. The BPO industry, including the customer management services industry, has
traditionally experienced high employee turnover. A significant increase in the turnover rate among
our employees would increase our recruiting and training costs and decrease operating efficiency
and productivity, and could lead to a decline in demand for our services. If this were to occur, we
would be unable to service our clients effectively and this would reduce our ability to continue
our growth and operate profitably. We may be unable to continue to recruit, hire, train, and retain
a sufficient labor force of qualified employees to execute our growth strategy or meet the needs of
our business. Our senior management team is important to our continued success and the loss of members of senior
management could negatively affect our operations. The loss of the services of Lance Rosenzweig, our Chief Executive Officer; Caroline Rook, our
Chief Financial Officer; Rainerio Borja, our President of PeopleSupport (Philippines); or Parham
Farahnik, our Vice President of Sales and Marketing, could seriously impair our ability to continue
to manage and expand our business. Our success depends on the continued service and performance of
our executive officers, and we cannot guarantee that we will be able to retain these individuals.
Our executive officers are at-will employees that are not subject to employment agreements
providing for any specified term of employment. We do not have key man insurance, nor are our
U.S.-based executive officers subject to non-compete restrictions. The planned move of our operations to our new facility in Manila could result in interruptions in
service, which could reduce our revenues and harm our business. We plan to relocate our regional headquarters in the Philippines and at least one of our
outsourcing locations to a facility to be built in Manila, which we expect to be operational in
2005. The relocation of our operations to this new facility will involve a number of logistical and
technical challenges. We may encounter complications associated with the migration of our systems
and computing equipment to our new facility, which could result in interruptions of our services.
If such interruptions occur, they could result in financial or other damages to our clients, for
which we could incur claims and liabilities and which could damage our reputation and cause us to
lose significant business from one or more of our major clients. This would harm our business and
operating performance. Our facilities are at risk of damage by earthquakes and other natural disasters. We currently rely on the availability and condition of our leased Los Angeles, Manila, and
Cebu facilities to provide service and support to our clients. These facilities are located in
regions that are susceptible to earthquakes 29




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS and other natural disasters, which may increase the
risk of disruption of information systems and telephone service for sustained periods. Damage or
destruction that interrupts our provision of outsourcing services could damage our relationship
with our clients and may cause us to incur substantial additional expense to repair or replace
damaged equipment or facilities. While we currently have commercial liability insurance, our
insurance coverage may not be sufficient. Furthermore, we may be unable to secure such insurance
coverage or to secure such insurance coverage at premiums acceptable to us in the future. Prolonged
disruption of our services as a result of natural disasters may entitle our clients to terminate
their contracts with us. Our operations could suffer from telecommunications or technology downtime, disruptions or
increased costs. We are highly dependent on our computer and telecommunications equipment and software systems.
In the normal course of our business, we must record and process significant amounts of data
quickly and accurately to access, maintain and expand the databases we use for our services. We are
also dependent on continuous availability of voice and electronic communication with customers. If
we experience interruptions of our telecommunications network with our clients, we may experience
data loss or a reduction in revenues. These disruptions could be the result of errors by our
vendors, clients, or third parties, electronic or physical attacks by persons seeking to disrupt
our operations, or the operations of our vendors, clients, or others. For example, we currently
depend on two significant vendors for facility storage and related maintenance of our main
technology equipment and data at our U.S. data centers. Any failure of these vendors to perform
these services could result in business disruptions and impede our ability to provide services to
our clients. A significant interruption of service could have a negative impact on our reputation
and could lead our present and potential clients not to use our services. The temporary or
permanent loss of equipment or systems through casualty or operating malfunction could reduce our
revenues and harm our business. We could cause disruptions to our clients business from inadequate service, and our insurance
coverage may be inadequate to cover this risk. Most of our contracts with our clients contain service level and performance requirements,
including requirements relating to the timing and quality of responses to customer inquiries. The
quality of services that we provide is measured by quality assurance ratings, which are based in
part on the results of customer satisfaction
surveys and direct monitoring of interactions between our professionals and customers.
Failures to meet service requirements of a client could disrupt the clients business and result in
a reduction in revenues or a claim for substantial damages against us. For example, some of our
agreements have standards for service that, if not met by us, result in lower payments to us. In
addition, because many of our projects are business-critical projects for our clients, a failure or
inability to meet a clients expectations could seriously damage our reputation and affect our
ability to attract new business. Under our contracts with major clients and many of our contracts
with other clients, our liability for breaching our obligations is generally limited to actual
damages up to a portion of the fees paid to us. To the extent that our contracts contain
limitations on liability, such contracts may be unenforceable or otherwise may not protect us from
liability for damages. While we maintain general liability insurance coverage, including coverage
for errors and omissions, this coverage may be inadequate to cover one or more large claims, and
our insurer may deny coverage. Unauthorized disclosure of sensitive or confidential client and customer data, whether through
breach of our computer systems or otherwise, could expose us to protracted and costly litigation
and cause us to lose clients. We are typically required to collect and store sensitive data in connection with our services,
including names, addresses, social security numbers, credit card account numbers, checking and
savings account numbers and payment history records, such as account closures and returned checks.
If any person, including any of our employees, penetrates our network security or otherwise
misappropriates sensitive data, we could be subject to liability for breaching contractual
confidentiality provisions or privacy laws. Penetration of the network security of 30




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS our data centers
could have a negative impact on our reputation and could lead our present and potential clients to
choose other service providers. Our ability to use net operating loss carryforwards in the United States may be limited. We intend to use our U.S. net operating loss carryforwards to reduce the U.S. corporate income
tax liability associated with our operations. Section 382 of the U.S. Internal Revenue Code of 1986
generally imposes an annual limitation on the amount of net operating loss carryforwards that may
be used to offset taxable income when a corporation has undergone significant changes in stock
ownership. Based on our analysis, which includes assumptions regarding the respective values of
classes of our stock, we do not believe our net operating losses are currently subject to Section
382 limitations and will not become subject to such limitations solely as a result of our recent
initial public offering. However, no assurance can be given that future events (including, but not
limited to, significant increases during the applicable testing period in the percentage of our
stock owned directly or constructively by (i) any stockholder who owns 5% or more of our stocks or
(ii) some or all of the group of stockholders who individually own less than 5% of our stock) will
not trigger Section 382 limitations and, as a result, adversely affect our ability to use our net
operating loss carryforwards. To the extent our use of net operating loss carryforwards is
significantly limited, our income could be subject to U.S. corporate income tax earlier than it
would if we were able to use net operating loss carryforwards, which could result in lower profits. The current tax holidays in the Philippines will expire within the next several years. We currently benefit from income tax holiday incentives in the Philippines pursuant to our
Philippine subsidiarys registrations with the Board of Investments and Philippine Economic Zone
Authority, which provide that we pay no income tax in the Philippines for four years pursuant to
our Board of Investments non-pioneer status and Philippine Economic Zone Authority registrations,
and six years pursuant to our Board of Investments pioneer status registration. Our current income
tax holidays expire at staggered dates beginning in 2006 and ending in 2008, and we intend to apply
for extensions. However, these tax holidays may or may not be extended. We believe that as our
Philippine tax holidays expire, (i) gross income (defined for this purpose to mean the amount of
our cost-plus transfer payments to our Philippine subsidiary in excess of certain allowable
deductions) attributable to activities covered by our Philippine Economic Zone Authority
registrations will be taxed at a 5% preferential rate, and (ii) our Philippine net income
attributable to all other activities (including activities previously covered by our Board of
Investments registrations) will be taxed at the regular Philippine corporate income tax rates of
32%. Our effective
overall Philippine income tax rate will vary as the revenue generating activity at each
outsourcing center becomes taxable upon expiration of the income tax holiday applicable to that
center. We may choose to expand operations outside of the Philippines and may not be successful. We may consider expanding to countries other than the Philippines. We cannot predict the
extent of government support, availability of qualified workers, or monetary and economic
conditions in other countries. Although some of these factors may influence our decision to
establish operations in another country, there are inherent risks beyond our control, including
exposure to currency fluctuations, political uncertainties, foreign exchange restrictions and
foreign regulatory restrictions. One or more of these factors or other factors relating to
international operations could result in increased operating expenses and make it more difficult
for us to manage our costs and operations, which could harm our business and negatively impact our
operating results. We may make acquisitions that prove unsuccessful or divert our resources. We intend to consider acquisitions of other companies in our industry that could complement
our business, including the acquisition of companies with expertise in other businesses and clients
that we do not currently serve. We have little experience in completing acquisitions of other
businesses, and we may be unable to successfully 31




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS complete an acquisition. If we acquire other
businesses, we may be unable to successfully integrate these businesses with our own and maintain
our standards, controls and policies. Acquisitions may place additional constraints on our
resources by diverting the attention of our management from existing operations. Through
acquisitions, we may enter markets in which we have little or no experience. Any acquisition may
result in a potentially dilutive issuance of equity securities, the incurrence of debt and
amortization of expenses related to intangible assets, all of which could lower our margins and
harm our business. We are subject to extensive laws and regulation that could limit or restrict our activities and
impose financial requirements or limitations on the conduct of our business. The BPO industry has become subject to an increasing amount of federal and state regulation in
the past five years. Despite our focus on inbound customer management, we are subject to
regulations governing communications with consumers due to the activities we undertake on behalf of
our clients to encourage customers to purchase higher value, additional or complementary products
and services offered by our clients. For example, the Federal Telemarketing and Consumer Fraud and
Abuse Prevention Act of 1994 broadly authorizes the Federal Trade Commission to issue regulations
prohibiting misrepresentations in telephone sales. In addition, limits on the transport of personal
information across international borders such as those now in place in the European Union (and
proposed elsewhere) may limit our ability to obtain customer data. We are also subject to significant federal and state laws and regulations applicable to our
accounts receivable management services, including the Fair Debt Collection Practices Act, which
imposes significant limitations and restrictions on our debt collection practices including
licensing requirements. These laws and regulations may limit our ability to recover and enforce
defaulted consumer receivables regardless of any act or omission on our part. Some laws and
regulations applicable to credit cards, debit cards, checks and other negotiable items may preclude
us from collecting on defaulted consumer receivables we purchase or obtain through contingency
placements from originators if they or others failed to comply with applicable law in generating or
servicing those receivables. Additional federal, state, local or international legislation, or
changes in regulatory implementation, could further limit our activities or those of our clients in
the future or significantly increase the cost of regulatory compliance. Our ability to raise capital in the future, if and when needed, may be limited, and could prevent
us from executing our business strategy. The sale of additional equity securities would result in
further dilution to our stockholders. We believe that our existing cash and cash equivalents, together with the net proceeds from
our recently completed offering, will be sufficient to support our anticipated cash needs at least
through 2005. However, the
timing and amount of our working capital and capital expenditure requirements may vary
significantly depending on numerous factors, including:  
    Market acceptance of and demand for our offshore outsourced services which may be
affected by political and public relations reactions to offshore outsourcing;
    Access to and availability to sufficient management, technical, marketing, and financial personnel;
    The need to enhance our operating infrastructure;
    The continued development of new or enhanced services and hosted solutions;
    The need to adapt to changing technologies and technical requirements;
    Increasing costs, particularly in the Philippines; 32




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS  
    The existence of opportunities to acquire businesses or technologies, or opportunities for expansion; and
    Increased competition and competitive pressures. If our capital resources are insufficient to satisfy our liquidity requirements, we may seek
to sell additional equity or debt securities or obtain other debt financing. The sale of additional
equity securities or convertible debt securities would result in additional dilution to our
stockholders. Additional debt would result in increased expenses and could result in covenants that
restrict our operations. We may be unable to secure financing in sufficient amounts or on terms
acceptable to us, if at all, in which case we may not have the funds necessary to finance our
ongoing capital requirements or execute our business strategy. We failed to register our securities under the Securities and Exchange Act of 1934 and, as a
result, we may incur liability to repurchase certain stock options, and may face potential claims
under federal and state securities laws. On December 31, 2002, options granted under our 1998 stock plan were held by more than 500
holders. As a result, we became subject to the registration requirements under Section 12(g) of the
Securities Exchange Act of 1934. We were required to file periodic reports, such as 10-Ks and
10-Qs, under Section 13(a) of the Exchange Act beginning in 2003. We did not file any such reports
until we filed a Form 10 registration statement in June 2004. As a result of our failure to file the reports, grants of certain options under our 1998 stock
plan between January 1, 2003 and April 28, 2004 may not have been exempt from registration or
qualification under federal and state securities laws, and we did not obtain any required
registration or qualification. To address this matter, we intend to make a rescission offer to the
holders of these options. Under the rescission offer, we intend to offer to repurchase the options
at 20% of the option exercise price multiplied by the number of shares underlying the option, plus
interest at an annual rate of 7% from the grant date. We would be required to pay approximately
$0.1 million, plus statutory interest at an annual rate of 7% if all persons entitled to have their
options repurchased elect to do so. Federal securities laws do not expressly provide that a
repurchase offer will terminate a purchasers right to rescind a sale of stock that was not
registered as required. If any or all of the offerees reject our offer to repurchase the options,
we may continue to be liable under federal securities laws. In addition, our failure to file required Exchange Act reports could conceivably give rise to
potential claims by present or former stockholders based on the theory that such holders were
harmed by the absence of such public reports. If any such claim is asserted, we could incur
expenses and divert managements attention in defending them, even if we have no liability. Risks Related to Doing Business in the Philippines We may face wage inflation and additional competition in the Philippines for our professionals,
which could increase the cost of qualified employees and the amount of employee turnover. Wages for our employees in the Philippines are increasing at a faster rate than for our U.S.
employees, which could result in increased costs to employ our outsourcing center professionals. We
also are faced with competition in the Philippines for outsourcing center professionals, and we
expect this competition to increase as additional outsourcing companies enter the market and expand
their operations. In particular, there may be limited availability of qualified middle and upper
management candidates. We have benefited from an excess of supply over demand for college graduates
in the Philippines. If this favorable imbalance changes due to increased competition, it could
affect the availability or cost of qualified professionals, who are critical to our performance.
This could increase our costs and turnover rates. 33




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS The Philippines may experience economic instability, which could increase our costs and harm our
business. The Philippines continues to experience low growth in its gross domestic product, significant
inflation, currency declines and shortages of foreign exchange. We are exposed to the risk of
rental and other cost increases due to inflation in the Philippines, which has historically been at
a much higher rate than in the United States. These conditions could create economic instability
that could harm businesses operating in the Philippines. Currency fluctuations in the Philippine peso relative to the U.S. dollar could increase our
expenses. All of our revenues are denominated in U.S. dollars, and a substantial portion of our costs
are incurred and paid in Philippine pesos. We are therefore exposed to the risk of an increase in
the value of the Philippine peso relative to the U.S. dollar, which would increase our expenses. We
do not currently engage in any transactions as a hedge against risk of loss due to foreign currency
fluctuations. Terrorist attacks could adversely affect the Philippine economy, disrupt our operations and cause
our business to suffer. The Philippines periodically experiences civil unrest and terrorism and U.S. companies in
particular may experience greater risks. We are not insured against terrorism risks. Terrorist
attacks, such as the attacks of September 11, 2001 in the United States, have the potential to
directly impact our clients and the Philippine economy by making travel more difficult,
interrupting lines of communication and curtailing our ability to deliver our services to our
clients. These obstacles may increase our expenses and harm our business. We benefit from Philippine laws granting preferential tax treatment which, if eliminated, could
result in increased operating expenses. We have benefited from significant government assistance in the Philippines, including the
grant of income tax holidays and preferential tax treatments under our registrations with the
Philippine Board of Investments and Philippine Economic Zone Authority, and changes to the
countrys educational curriculum in order to attract foreign investment in specified sectors
including the outsourcing industry. Despite these benefits, the Philippine national and local
governments could alter one or more of these beneficial policies and the Philippine legislature
could amend the laws granting preferential tax treatment. The elimination of any of the benefits
realized by us from our Philippine operations, including tax incentives, could result in increased
operating expenses and impair our competitive advantages over BPO companies based outside of the
Philippines. Other Risks Related to Us Our stock price may be volatile, and you may not be able to resell shares of our common stock at or
above the price you paid, or at all. Before our recently completed initial public offering, our common stock was not traded in a
public market. Since the completion of our initial public offering, our stock price has been and
may continue to be volatile. We cannot predict the extent to which the trading market will continue
to develop or how liquid that market might become. Prices for our common stock could be influenced
by a variety of factors, including the depth and liquidity of the market for our common stock,
investor perception of us, our business and our industry, the consumer credit and outsourcing
industries, and general economic and market conditions. The trading price of our common stock could
be subject to wide fluctuations due to the factors discussed in this risk factors section and
elsewhere in this report. In addition, the stock market in general and the Nasdaq National Market
have experienced extreme price and volume fluctuations. Trading prices and valuations may not be
sustainable. Broad market and industry factors may decrease the market price of our common stock,
regardless of our actual operating performance. In addition, following 34




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS periods of volatility in the
overall market and a decline in the market price of a companys stock, securities class action
litigation has often been instituted. This litigation, if instituted against us, could result in
substantial costs and a diversion of our managements attention and resources. If securities or industry analysts cease publishing research or reports about our business or if
they change negatively their recommendations regarding our stock, our stock price and trading
volume could decline. The trading market for our common stock is influenced by the research and reports that
industry or securities analysts publish about us or our business. If one or more of the analysts
who cover us publishes negative research on us or our industry, or downgrades our stock, our stock
price would likely decline. If one or more of these analysts cease or limit coverage of us or our
industry, or fail to regularly publish reports on us, we could lose visibility in the financial
markets, which in turn could cause our stock price or trading volume to decline. Substantial future sales of our common stock in the public market could cause our stock price to
fall. Substantial future sales of our common stock in the public market, or the perception that
these sales could occur, could cause the market price of our common stock to decline. At November
11, 2004, 17,951,259 shares of common stock were outstanding and 1,424,505 shares were to be issued
upon the exercise of outstanding warrants and options. The shares sold in our initial public
offering are freely transferable without restriction or additional registration under the U.S.
Securities Act of 1933, as amended, or the Securities Act. The remaining shares of common stock
outstanding after our initial public offering are available for sale, subject to volume and other
restrictions as applicable under Rules 144 and 701 under the Securities Act. Additionally, our
directors, executive officers and certain principal stockholders entered into lock up agreements
with the underwriters in connection with our initial public offering, in which they agreed to
refrain from selling their shares for a period of 180 days after our initial public offering.
Approximately 9,819,831 of these shares will become available for sale at various times upon the
expiration of holding periods and lock-up agreements. We also may be required to issue additional
shares upon the exercise of previously granted options or warrants that are currently outstanding. Increased sales of our common stock in the market 180 days after our initial public offering
could exert significant downward pressure on our stock price. These sales also may make it more
difficult for us to sell equity or equity-related securities in the future at a time and price we
deem appropriate. We will incur increased costs as a result of being a public company. As a public company, we will incur significant legal, accounting and other expenses that we
did not incur as a private company. We estimate that these costs will be approximately $2.0 million
annually, but they could be higher. The Sarbanes-Oxley Act of 2002, as well as new rules
subsequently implemented by the Securities and Exchange Commission and the Nasdaq National Market,
have required changes in corporate governance practices of public companies. We expect these new
rules and regulations to increase our legal and financial compliance costs and to make some
activities more time-consuming and costly. For example, as a result of becoming a public company,
we created additional board committees and adopted policies regarding internal controls and
disclosure controls and procedures. In addition, we will incur additional costs associated with our
public company reporting requirements. We also expect these new rules and regulations to make it
more difficult and more expensive for us to obtain
director and officer liability insurance and we may be required to accept reduced policy
limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As
a result, it may be more difficult for us to attract and retain qualified candidates to serve on
our board of directors or as executive officers. We are currently evaluating and monitoring
developments with respect to these new rules, which may result in additional costs in the future. 35




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS Delaware law and our amended and restated certificate of incorporation and bylaws will contain
anti-takeover provisions that could delay or discourage business combinations and takeover attempts
that stockholders may consider favorable. Our certificate of incorporation and bylaws contain provisions that may make it more
difficult, expensive or otherwise discourage a tender offer or a change in control or takeover
attempt by a third-party that is opposed by our board of directors. These provisions may have the
effect of delaying or preventing a change of control or changes in management that stockholders
consider favorable. In particular, our certificate of incorporation and bylaws include provisions
that:  
    Classify our board of directors into three groups, each of which, after an initial
transition period, will serve for staggered three-year terms;
    Permit the board of directors to elect a director to fill a vacancy created by the
expansion of the board of directors;
    Permit stockholders to remove our directors only for cause;
    Permit a special stockholders meeting to be called only by our chairman of the board
of directors, president, or chief executive officer, a majority of our board of directors
or two-thirds of the independent directors;
    Require stockholders to give us advance notice to nominate candidates for election to
our board of directors or to make stockholder proposals at a stockholders meeting;
    Permit our board of directors to issue, without approval of our stockholders, up to
4,000,000 shares of preferred stock with terms that our board of directors may determine
and that may be senior to the terms of our common stock;
    Prohibit cumulative voting in the election of directors that would otherwise allow less
than a majority of stockholders to elect directors;
    Permit the board of directors to alter certain provisions of our amended and restated
bylaws without obtaining stockholder approval;
    Require approval of at least 75% of the shares entitled to vote at an election of
directors to adopt, amend or repeal our amended and restated bylaws or amend or repeal the
provisions of our amended and restated certificate of incorporation regarding the election
and removal of directors and the ability of stockholders to take action; and
    Eliminate the right of stockholders to call a special meeting of stockholders and to
take action by written consent. Additionally, because we are incorporated in Delaware, we are subject to Section 203 of the
Delaware General Corporation Law. These provisions may prohibit large stockholders, in particular
those owning 15% or more of our outstanding voting stock, from merging or combining with us. These
provisions in our amended and restated certificate of incorporation, amended and restated bylaws
and under Delaware law could discourage potential
takeover attempts and could reduce the price that investors might be willing to pay for shares
of our common stock in the future and result in the market price being lower than they would
without these provisions. 36




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS Our corporate actions are substantially influenced by officers, directors, principal stockholders
and affiliated entities. Our directors, executive officers and their affiliated entities beneficially own approximately
25.7% of our outstanding common stock. These stockholders, if they were to act together, could
exert substantial influence over matters requiring approval by our stockholders, including electing
directors and approving mergers and acquisitions. This concentration of ownership may also
discourage, delay or prevent a change in control of our company, which could deprive our
stockholders of an opportunity to receive a premium for their stock as part of a sale of our
company and might reduce our stock price. These actions may be taken even if they are opposed by
our other stockholders. 
 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk Foreign Currency Exchange Risk Our results of operation and cash flows are subject to fluctuations due to changes in foreign
current exchange rates, particularly changes in the Philippine peso. For the nine months ended
September 30, 2004 and 2003, approximately 52% and 46%, respectively, of our expenses were
generated in the Philippines. We derive all of our revenues in US dollars. A 10% increase in the
value of the U.S. dollar relative to the Philippine peso would reduce the expenses associated with
the operations of our overseas operation by approximately $1.4 million, whereas a 10% decrease in
the relative value of the dollar would increase the cost associated with these operations by
approximately $1.4 million. Expenses relating to our operation outside the United States increased
in the nine months ended September 30, 2004 when compared to the nine months ended September 30,
2003 due to increased costs associated with higher revenue generation and customer management
services, partially offset by the increase in the value of the U.S. dollar relative to the
Philippine peso. We fund our Philippine subsidiary on a bi-monthly basis through U.S. dollar denominated
accounts held in the Philippines. Payments for employee-related costs, facilities management, other
operational expenses and capital expenditures are converted into Philippine pesos on an as-needed
basis. To date, we have not entered into any hedging contracts. Historically, we have benefited
from the ongoing decline in the Philippine peso against the U.S. dollar. Interest Rate Sensitivity We had cash, cash equivalents and restricted cash equivalents totaling $11.5 million at
September 30, 2004. These amounts were invested primarily in money market funds. The unrestricted
cash and cash equivalents are held for working capital purposes. We do not enter into investments
for trading or speculative purposes. We believe that we have no material exposure to changes in the
fair value of our investment portfolio as a result of changes in interest rates. Declines in
interest rates, however, would reduce future investment income. A 1% decrease in short term rates
would reduce our interest income by approximately $0.1 million. The interest income from these
funds will be subject to fluctuations due to changes in interest rates. Inflation Rate Sensitivity For the nine months ended September 30, 2004 and 2003, approximately 52% and 46%,
respectively, of our expenses were generated in the Philippines. The Philippines has historically
experienced periods of high inflation but the inflation rate has been below 10% since 1999. For the
six months ended June 30, 2004 inflation averaging 4.1% kept prices generally stable. However, we
are currently experiencing higher inflation and expected this trend to continue in 2005. Inflation
in the Philippines has not affected our operating results for two reasons. First, the Philippines
has historically experienced deflationary pressure on wages due to a fast growing population, high 37




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2004 unemployment (13.7% for the three month period ended March 31, 2004) and 385,000 college
graduates a year entering a market that cannot absorb all of them. Second, our pesos denominated
expenses have decreased in dollar terms due to the decline in the value of the peso relative to the
dollar, discussed above. A reversal of these trends, increased wage pressure due to increased
competition as the BPO industry expands or higher rates of inflation in the Philippines could
result in increased costs and harm our operating results. A number of our leases in the Philippines
have escalation clauses triggered by Philippine inflation above negotiated thresholds, as discussed
above. 
 ITEM 4. Controls and Procedures (a) Evaluation of disclosure controls and procedures.We maintain disclosure controls and
procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934
(the Exchange Act), that are designed to ensure that information required to be disclosed by us
in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and
reported within the time periods specified in Securities and Exchange Commission rules and forms,
and that such information is accumulated and communicated to our management, including our Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure. In designing and evaluating our disclosure controls and procedures, management
recognized that disclosure controls and procedures, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and
procedures are met. Additionally, in designing disclosure controls and procedures, our management
necessarily was required to apply its judgment in evaluating the cost-benefit relationship of
possible disclosure controls and procedures. The design of any disclosure controls and procedures
also is based in part on certain assumptions about the likelihood of future events, and there can
be no assurance that any design will succeed in achieving its stated goals under all potential
future conditions. Based on their evaluation as of the end of the period covered by this quarterly report on Form
10-Q, our Chief Executive Officer and Chief Financial Officer concluded that, subject to the
limitations noted above, our disclosure controls and procedures were effective. In January 2005, we decided to restate our financial statements for the quarter ended
September 30, 2004 to exclude payment obligations of $4.8 million under our management incentive
plan in connection with the companys initial public offering and make other adjustments related to
obligations under the plan. The obligations and corresponding payments will instead be reflected
in the fourth quarter of 2004 and reported when the company reports its 2004 year-end results.
Management believes that the accounting adjustments resulting in the restatement were due to an
interpretation of the event that triggered the contractual obligation and do not reflect a material
weakness in our disclosure controls or procedures. (b) Changes in internal control over financial reporting.There were no changes in our
internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act)
identified in connection with the evaluation described in Item 4(a) above that occurred during the
period covered by this quarterly report on Form 10-Q and that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting. We intend to regularly review and evaluate the design and effectiveness of our disclosure
controls and procedures and internal controls over financial reporting on an ongoing basis and to
improve these controls and procedures over time and to correct any significant deficiencies that we
may discover in the future. While we believe the present design of our disclosure controls and
procedures and internal controls over financial reporting are effective, future events affecting
our business may cause us to modify these controls and procedures in the future. 38




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2004 
 PART II OTHER INFORMATION 
 ITEM 1. Legal Proceedings From time to time, the Company may be involved in claims in lawsuits that arise in the
ordinary course of business. Accruals for claims or lawsuits have been provided for to the extent
that losses are deemed probable and estimable. Although the ultimate outcome of these claims or
lawsuits cannot be ascertained, on the basis of present information and advice received from
counsel, the Company accrues for the estimated minimum probable loss as the liability. Management
believes that the disposition or ultimate determination of all such claims or lawsuits will not
have a material adverse effect on the Company. 
 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds On September 30, 2004, the SEC declared effective the Companys Registration Statement on Form
S-1 (File No. 333-115328) (Registration Statement) for our initial public offering. Under the
Registration Statement, we registered 7,840,909 shares of our common stock for an aggregate
offering size of $54.9 million. 5,348,727 shares (including 603,000 shares sold by us upon exercise
of the underwriters over-allotment option) were sold by us and 2,072,455 shares were sold by
certain selling stockholders. All of the 7,421,182 shares sold in this offering were sold at $7.00
per share. The offering closed on October 6, 2004 (and the sale of the 603,000 additional shares
pursuant to the exercise of the over-allotment option closed on October 25, 2004). The managing
underwriters were SG Cowen & Co., Piper Jaffray & Co., A.G. Edwards & Sons and JMP Securities. The aggregate gross proceeds from the sale of 5,348,727 shares of common stock sold by us
(including the 603,000 shares sold in the over-allotment) was $37,441,089. The aggregate gross
proceeds from the sale of 2,072,455 shares sold by the selling stockholders was $14,507,185. The
aggregate net proceeds to us after the offering were $31,720,213, after deducting an aggregate of
$2,620,876 in underwriting discounts and commissions paid to the underwriters and an estimated
$3,100,000 in other expenses incurred in connection with this offering. The aggregate net proceeds
to the selling stockholders were $13,491,682 after deducting an aggregate of $1,015,503. On October 6, 2004, we invested all of our net proceeds in short-term, interest-bearing
instruments. 
 ITEM 3. Defaults Upon Senior Securities None. 
 ITEM 4. Submission of Matters to a Vote of Security Holders During the three months ended September 30, 2004, we solicited the written consent of our
stockholders pursuant to Section 228 of the General Corporation Law of the State of Delaware in
connection with the following proposals: 1. In July 2004, we sent a written consent to certain of our stockholders requesting approval
to the taking of the following actions in connection with the initial public offering of our common
stock: a. The approval of a reverse 1 for 2.74 stock split of our common stock and preferred stock, and
the filing of an amendment to our certificate of incorporation to reflect the reverse stock
split. b. The approval of our amended and restated certificate of incorporation and amended and
restated bylaws that were filed and went into effect upon the completion of our initial public
offering on October 6, 2004. 39




---



##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2004 c. The approval of the form of indemnification agreements with our officers and directors. d. The approval of our 2004 Stock Incentive Plan. e. The approval of our 2004 Employee Stock Purchase Plan. A total of 7,721,612 post split shares, representing no less than 61% of our capital stock on
an as-converted basis (including 6,722,795 post split shares of preferred stock, representing no
less than 64% of our preferred stock) voted in favor of these matters. The resolutions for the
above-described approvals were adopted as of July 21, 2004. 2. In August 2004, we sent a written consent to certain of our stockholders requesting
approval of an amendment to our certificate of incorporation to lower the minimum price at which
shares of our preferred stock would be automatically converted upon the completion of our initial
public offering from $9.59 to $6.95 per share. A total of 8,498,592 post split shares, representing
no less than 71.96% of our capital stock on an as-converted basis (including 7,263,424 post split
shares of preferred stock, representing no less than 75% of our preferred stock) voted in favor of
this matter. The resolutions for the above-described approval were adopted as of August 24, 2004. 
 ITEM 5. Other Information None. 
 ITEM 6. Exhibits ExhibitNumber31.1
    
    Certification by Chief Executive Officer of Registrant
pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification by Chief Financial Officer of Registrant
pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1*
    
    Certification by Chief Executive Officer of Registrant
pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2*
    
    Certification by Chief Financial Officer of Registrant
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
  
  40




---



##### Table of Contents



SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the
City of Los Angeles, in the State of California, on February 25, 2005. PeopleSupport, Inc.By:
    
    /s/ Caroline RookCaroline RookChief Financial Officer(Principal Financial and Accounting Officer)
 41