##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-Q (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2005 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 18,122,747 shares of common stock were outstanding as of April 29, 2005.




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PEOPLESUPPORT, INC.
FORM 10-Q
FOR THE QUARTER ENDED
March 31, 2005 INDEX PagePART IFINANCIAL INFORMATIONITEM 1. Financial Statements
    
    
    3Consolidated Balance Sheets as of December 31, 2004 and March 31, 2005 (unaudited)
    
    
    3Consolidated Statements of Operations and Other Comprehensive Income for the three months ended
March 31, 2004 and 2005 (unaudited)
    
    
    4Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2005 (unaudited)
    
    
    5Notes
to Consolidated Financial Statements (unaudited)
    
    
    6ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    28ITEM 4. Controls and Procedures
    
    
    28PART IIOTHER INFORMATIONITEM 1. Legal Proceedings
    
    
    30ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    30ITEM 3. Defaults Upon Senior Securities
    
    
    30ITEM 4. Submission of Matters to a Vote of Security Holders
    
    
    30ITEM 5. Other Information
    
    
    30ITEM 6. Exhibits
    
    
    30Signature
    
    
    31Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
  2




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PART IFINANCIAL INFORMATION 
 ITEM 1. Financial Statements
 PEOPLESUPPORT, INC. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
 (Unaudited, in thousands)
 December 31,
    
    
    March 31,2004
    
    
    2005ASSETSCurrent assets:Cash and cash equivalents
    
    $
    41,583
    
    
    $
    40,183Restricted short-term cash equivalent
    
    
    422
    
    
    
    422Accounts receivable, net of allowance for doubtful accounts of $451 and $202
    
    
    5,560
    
    
    
    5,758Marketable securities
    
    
    
    
    
    
    5,966Investment in receivable portfolios
    
    
    7
    
    
    
    Deferred tax assets
    
    
    668
    
    
    
    597Prepaid expenses and other current assets
    
    
    1,633
    
    
    
    1,895Total current assets
    
    
    49,873
    
    
    
    54,821Property and equipment, net
    
    
    7,407
    
    
    
    7,932Deferred management incentive plan compensation
    
    
    940
    
    
    
    855Deferred tax assets
    
    
    6,161
    
    
    
    6,232Other long-term assets
    
    
    699
    
    
    
    642Total assets
    
    $
    65,080
    
    
    $
    70,482LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,346
    
    
    $
    1,623Accrued payroll and payroll related
    
    
    1,218
    
    
    
    1,638Accrued liabilities
    
    
    1,309
    
    
    
    1,918Management incentive plan obligation
    
    
    342
    
    
    
    342Deferred revenue
    
    
    1,888
    
    
    
    2,690Other current liabilities
    
    
    106
    
    
    
    94Total current liabilities
    
    
    6,209
    
    
    
    8,305Management incentive plan obligation
    
    
    684
    
    
    
    684Deferred rent
    
    
    117
    
    
    
    174Other long-term liabilities
    
    
    135
    
    
    
    187Total liabilities
    
    
    7,145
    
    
    
    9,350Commitments and contingenciesStockholders equity:Common stock, $.001 par value; authorized 87,000 shares; 18,015 and
18,052 shares issued and outstanding at December 31, 2004 and March 31,
2005, respectively
    
    
    18
    
    
    
    18Additional paid-in capital
    
    

    112,514
    
    
    
    112,540Accumulated deficit
    
    
    (53,043
    )
    
    
    (50,287
    )Accumulated other comprehensive income
    
    
    80
    
    
    
    235Deferred stock compensation
    
    
    (1,634
    )
    
    
    (1,374
    )Total stockholders equity
    
    
    57,935
    
    
    
    61,132Total liabilities and stockholders equity
    
    $
    65,080
    
    
    $
    70,482
 See accompanying notes to consolidated financial statements. 3




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PEOPLESUPPORT, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 AND OTHER COMPREHENSIVE INCOME
 (Unaudited, in thousands, except per share data)
 Three Months EndedMarch 31,2004
    
    
    2005Revenues
    
    $
    9,551
    
    
    $
    14,056Cost of revenues (exclusive of management incentive plan and depreciation
expense shown below)
    
    
    4,627
    
    
    
    7,723Management incentive plan  cost of revenues
    
    
    

    
    
    
    68Selling, general and administrative (exclusive of management incentive
plan expense shown below)
    
    
    2,247
    
    
    
    2,664Management incentive plan  selling, general and administrative
    
    
    
    
    
    
    17Depreciation and amortization
    
    
    796
    
    
    
    1,016Income from operations
    
    
    1,881
    
    
    
    2,568Interest income
    
    
    (14
    )
    
    
    (237
    )Other expense
    
    
    5
    
    
    
    10Income before provision for income taxes
    
    
    1,890
    
    
    
    2,795Provision for income taxes
    
    
    51
    
    
    
    39Net income
    
    
    1,839
    
    
    
    2,756Foreign currency translation adjustment
    
    
    3
    
    
    
    177Unrealized loss on securities:Unrealized holding losses arising during period
    
    
    
    
    
    
    (22
    )Comprehensive income
    
    $
    1,842
    
    
    $
    2,911Basic earnings per share
    
    $
    0.71
    
    
    $
    0.15Diluted earnings per share
    
    $
    0.13
    
    
    $
    0.15Basic weighted average shares outstanding
    
    
    2,575
    
    
    
    18,027Diluted weighted average shares outstanding
    
    
    14,180
    
    
    
    18,946
 See accompanying notes to consolidated financial statements. 4




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PEOPLESUPPORT, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited, in thousands)
 Three Months EndedMarch 31,2004
    
    
    2005OPERATING ACTIVITIESNet income
    
    $
    1,839
    
    
    $
    2,756Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization
    
    
    796
    
    
    
    1,016Provision for doubtful accounts
    
    
    50
    
    
    
    (249
    )Stock-based compensation
    
    
    441
    
    
    
    247Amortization of deferred compensation costs
    
    
    
    
    
    
    85Changes in operating assets and liabilities:Accounts receivable
    
    
    (1,236
    )
    
    
    (39
    )Prepaid expenses and other assets
    
    
    63
    
    
    
    (190
    )Other long-term assets
    
    
    (195
    )
    
    
    75Accounts payable and accrued liabilities
    
    
    1,543
    
    
    
    604Deferred revenue
    
    
    395
    
    
    
    802Cash payments on restructuring reserve
    
    
    (3
    )
    
    
    Net cash provided by operating activities
    
    
    3,693
    
    
    
    5,107INVESTING ACTIVITIESCollections applied to principal of receivable portfolios
    
    
    229
    
    
    
    7Purchases of property and equipment
    
    
    (3,053
    )
    
    
    (568
    )Purchases of marketable securities
    
    
    
    
    
    
    (6,000
    )Net cash used in investing activities
    
    
    (2,824
    )
    
    
    (6,561
    )FINANCING ACTIVITIESProceeds from the exercise of stock options
    
    
    49
    
    
    
    39Proceeds from the exercise of warrants to purchase redeemable preferred stock
    
    
    38
    
    
    
    Public offering costs
    
    
    (125
    )
    
    
    Net cash provided by (used in) financing activities
    
    
    (38
    )
    
    
    39Effect of exchange rate changes on cash
    
    
    3
    
    
    
    15Net increase (decrease) in cash and cash equivalents
    
    
    834
    
    
    
    (1,400
    )Cash and cash equivalents, beginning of period
    
    
    12,151
    
    
    
    41,583Cash and cash equivalents, end of period
    
    $
    12,985
    
    
    $
    40,183NON-CASH INVESTING ACTIVITIESUnrealized holding gains/(losses) on marketable securities
    
    $
    
    
    
    $
    (22
    )Construction in progress costs incurred but not paid
    
    
    
    
    
    
    818SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATIONInterest paid for the period
    
    $
    
    
    
    $
    Taxes paid for the period
    
    
    150
    
    
    
    
 See accompanying notes to consolidated financial statements. 5




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PEOPLESUPPORT, INC. AND
SUBSIDIARIES 
 NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
 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 March 31, 2005, and for the three
months ended March 31, 2004 and 2005, is unaudited. The balance sheet data at December 31, 2004 is
derived from the audited consolidated financial statements for the year ended December 31, 2004.
Operating results for the three months ended March 31, 2005 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2005. For further information, refer
to the consolidated financial statements and footnotes thereto for the year ended December 31, 2004
included in the Companys Annual Report on Form 10-K. 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. Recent Accounting Pronouncements In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. This statement is a
revision to SFAS No. 123, Accounting for Stock-Based Compensation and APB Opinion No. 25,
Accounting for Stock Issued to Employees. This statement establishes standards for the accounting
for transactions in which an entity exchanges its equity instruments for goods or services,
primarily focusing on the accounting for transactions in which an entity obtains employee services
in share-based payment transactions. Entities will be required to measure the cost of employee
services received in exchange for an award of equity instruments based on the grant-date fair value
of the award (with limited exceptions). That cost will be recognized over the period during which
an employee is required to provide service, the requisite service period (usually the vesting
period), in exchange for the award. The grant-date fair value of employee share options and similar
instruments will be estimated using option-pricing models. If an equity award is modified after the
grant date, incremental compensation cost will be recognized in an amount equal to the excess of
the fair value of the modified award over the fair value of the original award immediately before
the modification. This statement is effective as of the beginning of the first annual reporting
period that begins after June 15, 2005. The Company is currently assessing the impact of this
accounting standard on the Companys results of operations and financial position. Note 3. Significant Customers Revenue and net accounts receivable from significant customers were as follows: As of and for the Three Months Ended March 31,2004
    
    
    2005
    
    
    2004
    
    
    2005% of Revenue
    
    
    % of A/R, netCustomer A
    
    
    34
    %
    
    
    28
    %
    
    
    2
    %
    
    
    0
    %Customer B
    
    
    28
    
    
    
    21
    
    
    
    52
    
    
    
    34Customer C
    
    
    12
    
    
    
    4
    
    
    
    22
    
    
    
    2Customer D
    
    
    11
    
    
    
    7
    
    
    
    18
    
    
    
    11Customer E
    
    
    9
    
    
    
    13
    
    
    
    1
    
    
    
    3
 6




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 4. Cash, Cash Equivalents and Marketable Securities The following table summarizes the fair value of the Companys cash and available-for-sale
securities held in its investment portfolio, recorded as cash, cash equivalents or marketable
securities as of December 31, 2004 and March 31, 2005: Fair Value
    
    
    Amortized CostDecember 31,
    
    
    March 31,
    
    
    December 31,
    
    
    March 31,2004
    
    
    2005
    
    
    2004
    
    
    2005Cash, money market and certificate of
deposits
    
    $
    8,612
    
    
    $
    8,254
    
    
    $
    8,612
    
    
    $
    8,254U.S. agency securities
    
    
    20,971
    
    
    
    22,932
    
    
    
    20,975
    
    
    
    22,924Municipal bonds
    
    
    12,000
    
    
    
    7,000
    
    
    
    12,000
    
    
    
    7,000Corporate securities
    
    
    
    
    
    
    1,997
    
    
    
    
    
    
    
    1,997Total cash and cash equivalents
    
    
    41,583
    
    
    
    40,183
    
    
    
    41,587
    
    
    
    40,175U.S. agency securities
    
    
    
    
    
    
    5,966
    
    
    
    
    
    
    
    6,000Total marketable securities
    
    
    
    
    
    
    5,966
    
    
    
    
    
    
    
    6,000Total cash, cash equivalents,
and marketable securities
    
    $
    41,583
    
    
    $
    46,149
    
    
    $
    41,587
    
    
    $
    46,175
 Unrealized gains and losses on investment securities by type as of March 31, 2005 were as
follows: Unrealized Gains
    
    
    Unrealized LossesDecember 31,
    
    
    March 31,
    
    
    December 31,
    
    
    March 31,2004
    
    
    2005
    
    
    2004
    
    
    2005U.S. agency securities
    
    $
    
    
    
    $
    8
    
    
    $
    4
    
    
    $
    34
 Contractual maturities of investment securities as of March 31, 2005 were as follows: Fair
    
    
    AmortizedFixed maturities
    
    Value
    
    
    CostDue in 90 days or less
    
    $
    31,929
    
    
    $
    31,921Due after 1 year through 2 years
    
    
    5,966
    
    
    
    6,000Total
    
    $
    37,895
    
    
    $
    37,921
 Note 5. Comprehensive Income The components of comprehensive income are as follows: Foreign
    
    
    UnrealizedCurrency
    
    
    Loss onItems
    
    
    Securities
    
    
    TotalBalance, December 31, 2004
    
    $
    84
    
    
    $
    (4
    )
    
    $
    80Quarterly change
    
    
    177
    
    
    
    (22
    )
    
    
    155Balance, March 31, 2005
    
    $
    261
    
    
    $
    (26
    )
    
    $
    235
 7




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 6. Realizability of Deferred Tax Assets In assessing the realizability of deferred tax assets, management considers whether it is more
likely than not that some portion or all of the deferred tax assets will be realized. Management
considers projected future taxable income, customer contract terms and customer concentrations in
making this assessment. Management reassesses the realizability of deferred tax assets on a
periodic basis. At such times as Management determines that the recoverability of any remaining
portion of deferred tax assets is more likely realizable than not, the Company will further release
a portion of the deferred tax valuation allowances, record an income tax benefit and subsequently
record a provision for income taxes for financial statement purposes based on the amount of taxable
net income. Management reassessed the realizability of the net deferred tax assets and determined
that no additional adjustment to the deferred tax valuation allowance was appropriate or required
as of March 31, 2005. Note 7. 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 estimated weighted average fair value of options granted during the three months ended
March 31, 2004 and 2005 was $9.23 and $3.28, respectively. The fair value of each option grant was
estimated on the date of grant using the Black-Scholes valuation model using the following weighted
average assumptions used for grants for the three months ended March 31, 2004 and 2005: Three monthsEnded March 31,2004
    
    
    2005Risk-free interest rate
    
    
    4.00
    %
    
    
    4.00
    %Expected option life (years)
    
    
    5.0
    
    
    
    4.1Volatility
    
    
    31.7
    %
    
    
    30.0
    %Dividend rate
    
    
    0.0
    %
    
    
    0.0
    %
 The Black-Scholes valuation model was developed for use in estimating the fair value of traded
options that have no vesting restrictions and are fully transferable. If compensation cost for the
Companys stock option plans were determined based on the fair value at the grant date of awards
for the three months ended March 31, 2004 and 2005, consistent with the provisions of SFAS No. 123,
the Companys net income and income per share would have been as indicated below: Three Months EndedMarch 31,2004
    
    
    2005Net income as reported
    
    $
    1,839
    
    
    $
    2,756Add: Stock  based compensation expense included
in reported net income, net of related tax
effects
    
    
    441
    
    
    
    247Deduct: Total stock-based compensation expense
determined under fair value based methods for all
awards, net of related tax effects
    
    
    (455
    )
    
    
    (332
    )Net income pro forma
    
    $
    1,825
    
    
    $
    2,671Basic earnings per shareas reported
    
    $
    0.71
    
    
    $
    0.15Diluted earnings per shareas reported
    
    $
    0.13
    
    
    $
    0.15Basic earnings per sharepro forma
    
    $
    0.71
    
    
    $
    0.15Diluted earnings per sharepro forma
    
    $
    0.13
    
    
    $
    0.14
 8




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Deferred compensation expense is amortized ratably using an accelerated method over the
vesting period. During the three months ended March 31, 2004 and 2005, non-cash stock-based
compensation expense included in the consolidated statement of operations amounted to $441 and
$247, respectively, and was recorded in cost of revenues and selling, general and administrative as
follows: Three Months EndedMarch 31,2004
    
    
    2005Cost of revenues
    
    $
    146
    
    
    $
    79Selling, general & administrative
    
    
    295
    
    
    
    168$
    441
    
    
    $
    247
 Note 8. 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., warrants to purchase common stock and common stock options using the treasury stock
method) were exercised or converted into common stock. 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. Three Months EndedMarch 31,2004
    
    
    2005Options
    
    
    
    
    
    
    55Common stock warrants
    
    
    127
    
    
    
    127
 The following is a reconciliation of the numerators and denominators of the basic and diluted
earnings per share computations: Three Months Ended March 31,2004
    
    
    2005Income
    
    
    Shares
    
    
    Per Share
    
    
    Income
    
    
    Shares
    
    
    Per Share(Numerator)
    
    
    (Denominator)
    
    
    Amount
    
    
    (Numerator)
    
    
    (Denominator)
    
    
    AmountBasic earnings per share:Income to common stockholders
    
    $
    1,839
    
    
    
    2,575
    
    
    $
    0.71
    
    
    $
    2,756
    
    
    
    18,027
    
    
    $
    0.15Effect of dilutive securities:Options
    
    
    
    
    
    
    998
    
    
    
    
    
    
    
    
    
    
    
    919Warrants
    
    
    
    
    
    
    1,215
    
    
    
    
    
    
    
    
    
    
    
    Convertible preferred stock
    
    
    
    
    
    
    9,392
    
    
    
    
    
    
    
    
    
    
    
    Income available to common
stockholders
    
    $
    1,839
    
    
    
    14,180
    
    
    $
    0.13
    
    
    $
    2,756
    
    
    
    18,946
    
    
    $
    0.15
 Note 9. Stockholders Equity During the three months ended March 31, 2005, 37 shares of common stock were issued due to the
exercise of common stock
options resulting in proceeds to the Company of approximately $39. 9




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 10. 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. Following approval of our repurchase application, we issued shares upon exercise
of certain of these options granted between January 1, 2003 through April 28, 2004. Accordingly,
we plan to re-apply to the California Department of Corporations for expanded approval to
repurchase both options and these shares issued upon exercise of options. We also intend to file a
registration statement on Form S-1 to register the offer to repurchase the options and shares.
Pursuant to the terms of our previously approved 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. We intend to
offer to repurchase shares issued upon exercise of options at the full exercise price paid for the
shares, plus interest at an annual rate of 7% from the date of exercise of the underlying options.
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. 10




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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 Operations  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, Inc. 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 March 31, 2005, we service 27 U.S.-based clients in a variety of industries.
Our three largest customer management service clients during the period covered by this report
collectively accounted for approximately 62% of our revenues for the three months ended March 31,
2005. Expedia, our largest client, and EarthLink, our second largest client, together accounted for
approximately 49% of our revenues for the three months ended March 31, 2005. 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 perform early-stage
accounts receivable collection services on defaulted consumer accounts that have not been written
off by managing collection of accounts receivable of at-risk customers. Sources of Revenues For the three months ended March 31, 2005, 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, and training fees all of which are separately negotiated on an
individual client basis; and 11




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS  
    implementation fees, including revenues associated with the 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.
Approximately 6% of our revenues for the three months ended March 31, 2004 and 2005, were comprised
of implementation and training fees. For the three months ended March 31, 2004 and 2005, 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 our 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, costs associated with Sarbanes Oxley compliance, other brand building
and advertising) and other corporate expenses. Selling, general and administrative expenses
increased in the three months ended March 31, 2005, as compared with selling, general and
administrative expenses for the three months ended March 31, 2004. 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
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; and
    commission revenues for contingent accounts receivable management contracts upon receipt of collected funds. For purchased accounts receivable portfolios, due to the Companys limited experience in
assessing its collection trends, the Company only recognizes revenue to the extent of cash
collected in excess of the portfolios purchase price. The Company periodically assesses the
collections experience trend curve to determine if a change in revenue recognition treatment is
appropriate. Deferred revenue represents amounts billed or cash received in advance of revenue recognition.
As of December 31, 2004 and March 31, 2005, our balance sheets reflect $1.9 million and $2.7
million in deferred revenues, respectively. 12




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 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. Prior to our initial public offering, 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. During the three months ended March 31, 2004 and 2005, non-cash stock-based compensation
expense included in the consolidated statement of operations amounted to $441 and $247 respectively
and was recorded in cost of revenues and selling, general and administrative as follows: Three Months Ended March 31,2004
    
    
    2005Cost of revenues
    
    $
    146
    
    
    $
    79Selling, general & administrative
    
    
    295
    
    
    
    168$
    441
    
    
    $
    247
 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, unless the option holder does not meet certain required
holding periods under the income tax laws. 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. This method involves the assessment of our net operating loss
carryforwards, as well as estimating the actual current tax liability together with assessing
temporary differences resulting from differing treatment of items, such as reserves and accrued
liabilities, for tax and accounting purposes. We then assess the likelihood that deferred tax
assets, consisting primarily of our net operating loss carryforwards, will be realized or recovered
from future taxable income. In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the deferred tax assets
will be realized. Management considers projected future taxable income, customer contract terms and
customer concentrations in making this assessment. Management reassesses the realizability of
deferred tax assets on a periodic basis. At such times as we determine that the recoverability of
any remaining portion of deferred tax assets is more likely realizable than not, we will further
release a portion of the deferred tax valuation allowances, record an income tax benefit and
subsequently record a provision for income taxes for financial statement purposes based on the
amount of taxable net income. To the extent we believe that recoverability of our deferred tax
assets is not likely, we are required to establish a valuation allowance. Based on the financial results for the quarter ended March 31, 2005, the projected results for
the quarter ended March 31, 2005, the projected results for fiscal 2005, current customer
concentrations and contract terms, the Company concluded that there has not been a change in the
positive and negative evidence that warrants an adjustment to the deferred tax valuation allowance
at March 31, 2005. 13




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS Long-lived Asset Impairment Fixed assets 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. 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 EndedMarch 31,2004
    
    
    2005Revenues
    
    
    100
    %
    
    
    100
    %Cost of revenues (exclusive of management incentive plan and
depreciation expense shown below)
    
    
    48
    
    
    
    55Management incentive plan  cost of revenues
    
    
    
    
    
    
    Selling, general, and administrative (exclusive of management
incentive plan expense shown below)
    
    
    24
    
    
    
    19Management incentive plan  selling, general, and administrative
    
    
    
    
    
    
    Depreciation and amortization
    
    
    8
    
    
    
    7Income from operations
    
    
    20
    
    
    
    18Interest income
    
    
    
    
    
    
    2Other expense (income)
    
    
    
    
    
    
    Income before provision for income taxes
    
    
    20
    
    
    
    20Provision for income taxes
    
    
    1
    
    
    
    Net income
    
    
    19
    %
    
    
    20
    %
 Three Months Ended March 31, 2005 compared with Three Months Ended March 31, 2004 Revenues Our revenues increased by $4.5 million, or 47%, from $9.6 million for the three months ended
March 31, 2004 to $14.1 million for the three months ended March 31, 2005. This increase was
primarily attributable to an increase of $3.7 million in customer management fees associated with
services provided to 15 new clients in the financial, telecommunications and technology industries
and an increase of $0.8 million in customer management fees associated with a higher volume of
services 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 outsourcing services. Cost of Revenues Our cost of revenues increased by $3.2 million, or 70%, from $4.6 million for the three months
ended March 31, 2004 to $7.8 million for the three months ended March 31, 2005. The increase was
primarily attributable to increased costs of approximately $3.0 million (or 21% of revenue)
associated with the expansion of our outsourcing operations in the Philippines and an increase in
the number of customer management professionals, partially offset by a decrease of $0.1 million of
stock-based compensation expense. We anticipate that these costs will continue to increase in
quarters when we expand our operations and increase the volume of customer management services we
provide. We believe this trend of expansion will continue due to increased demand for our
outsourced services by our existing clients, and our ability to attract new clients. Our cost of
revenues as a percentage of revenues increased from 48% for the three months ended March 31, 2004
to 55% for the three months ended March 31, 2005. 14




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS Selling, General, and Administrative Selling, general and administrative expenses (SG&A) increased by $0.5 million, or 23%, from
$2.2 million for the three months ended March 31, 2004, to $2.7 million for the three months ended
March 31, 2005. The increase is primarily attributable to $0.4 million (or 3% of revenue) related
to salaries and wages and $0.4 million (or 3% of revenue) related to public company costs, partially
offset by a decrease of $0.1 million of stock-based compensation expense and a decrease of $0.2
million (or 1% of revenues) related to adjustments to our allowance for doubtful accounts. Our SG&A
as a percentage of revenues decreased from 24% for the
three months ended March 31, 2004 to 19% for the three months ended March 31, 2005. 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 March 31, 2005, we have working capital of $46.5 million
including cash and cash equivalents totaling $40.2 million, marketable securities of $6.0 million
and accounts receivable of $5.8 million. Operating Activities Net cash provided by operating activities was $3.7 million for the three months ended March
31, 2004, which was greater than our net income of $1.8 million for the same period. The
difference is primarily due to $0.8 million of depreciation and amortization, $0.4 million of
non-cash stock-based compensation expense, and an aggregate change in operating assets and
liabilities of $0.6 million. Net cash provided by operating activities was $5.1 million for the
three months ended March 31, 2005, which was greater than our net income of $2.8 million for the
same period. The difference is primarily due to $1.0 million of depreciation and amortization,
$0.2 million of non-cash stock-based compensation expense, and an aggregate change in operating
assets and liabilities of $1.3 million. Investing Activities Net cash used in investing activities during the three months ended March 31, 2004 and 2005
was $2.8 million and $6.6 million, respectively. During the three months ended March 31, 2004 we
incurred $3.1 million of capital expenditures associated with the expansion of the Philippine
operations which was offset by $0.2 million of receivable portfolio collections. Cash used in
investing activities for the three months ended March 31, 2005 was primarily comprised of $6.0
million related to the purchase of marketable securities and $0.6 million of capital expenditures
associated with the continuing expansion of the Philippine operating facilities. We used proceeds
from our initial public offering to purchase the $6.0 million of marketable securities. Our capital expenditures during the three months ended March 31, 2005 were approximately $0.6
million, primarily for telecommunications equipment, leasehold improvements, computer hardware and
software, and furniture and fixtures in support of expanding our infrastructure. In the second half
of 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
$7.4 million for telecommunications equipment, leasehold improvements, computer hardware and
software, and furniture and fixtures. We intend to build out approximately 60% of the PeopleSupport
Centers total production capacity for use in 2005 and the remaining portion in early 2006. The
estimated capital expenditure for 2005 reflects the 60% build out of the PeopleSupport Centers
total production capacity. In addition to the PeopleSupport Center, we estimate further build out
costs in 2005 of our infrastructure of $2.1 million to $3.1 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, cash equivalents and marketable
securities 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 three months ended March 31, 2004 was less
than $0.1 million and net cash provided by financing activities was less than $0.1 million for the
three months ended March 31, 2005. Net cash used in financing activities for the three months
ended March 31, 2004 was comprised of $0.1 million of public offering costs. 15




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS At March 31, 2005, we had a restricted cash equivalent in the amount of approximately $0.4
million, held in a certificate of deposit as collateral for our lending facilities, which will be
released in the second half of 2005. 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 cash, cash equivalents and marketable
securities, will be adequate to meet our anticipated cash needs at least through 2006. 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. In order to comply with California securities law, we
intend to make a rescission offer to the U.S. holders of 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. Following approval of our repurchase
application, we issued shares upon exercise of certain of these options granted between January 1,
2003 through April 28, 2004. Accordingly, we plan to re-apply to the California Department of
Corporations for expanded approval to repurchase both options and these shares issued upon exercise
of options. We also intend to file a registration statement on Form S-1 to register the offer to
repurchase the options and shares. Pursuant to the terms of our previously approved 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. We intend to offer to repurchase shares issued upon exercise of options at the
full exercise price paid for the shares, plus interest at an annual rate of 7% from the date of
exercise of the underlying options. 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. 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. Recent Accounting Pronouncements In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. This statement is a
revision to SFAS No. 123, Accounting for Stock-Based Compensation and APB Opinion No. 25,
Accounting for Stock Issued to Employees. This statement establishes standards for the accounting
for transactions in which an entity exchanges its equity instruments for goods or services,
primarily focusing on the accounting for transactions in which an entity obtains employee services
in share-based payment 16




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS transactions. Entities will be required to measure the cost of employee
services received in exchange for an award of equity instruments based on the grant-date fair value
of the award (with limited exceptions). That cost will be recognized over the period during which
an employee is required to provide service, the requisite service period (usually the vesting
period), in exchange for the award. The grant-date fair value of employee share options and similar
instruments will be estimated using option-pricing models. If an equity award is modified after the
grant date, incremental compensation cost will be recognized in an amount equal to the excess of
the fair value of the modified award over the fair value of the original award immediately before
the modification. This statement is effective as of the beginning of the first annual reporting
period that begins after June 15, 2005. In accordance with the standard, we will adopt SFAS No.
123R effective January 1, 2006. The Company is currently assessing the impact of this accounting
standard on the Companys results of operations and financial position. RISK FACTORS Risks Related to Our Business Our revenues are highly dependent on three major clients that collectively accounted for 62% of our
revenues in the first three months of 2005, 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 and ConsumerInfo.com were our largest clients in the first three months of 2005 and
accounted for 62% of our revenues for the first three months of 2005. Expedia, our largest client,
and EarthLink, our second largest client, together accounted for 49% of our revenues for the three
months ended March 31, 2005. Our contract with Expedia expires in May 2007. 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. 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 and 2004, 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 of 55% from this client for the year ended December 31, 2004 as compared with
the year ended December 31, 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 17




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 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. 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. In customer
management services, our principal competitors with operations in the Philippines 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. 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. There has been recent publicity
about the negative experience of 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 Quarterly Report on Form 10-Q 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. 18




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 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. 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, typically it takes from
four to six weeks to integrate the clients systems with ours, and up to six 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 $50.3 million at
March 31, 2005. 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. 19




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 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 2003, and in our accounts receivable management services, which we commenced
in July 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;
    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; 20




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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 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 who 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 recently built in Manila, which we expect to be operational
during the third quarter of 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 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. 21




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 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. We also may be required to pay penalties 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 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. 22




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 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 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 regulations 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. 23




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 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 2006. 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;
    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 shares, and may face
potential claims under federal and state securities laws. On December 31, 2002, options granted under our 1998 stock incentive 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 and shares issued upon the exercise of certain 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 intend to offer to repurchase the shares at the full exercise price we
received for the shares plus interest at an annual rate of 7% from the date of exercise. We would
be required to pay approximately $0.1 million, plus statutory interest at an annual rate of 7% if
all persons currently entitled to have their options and shares repurchased elect to do so. We
could be required to pay a higher amount if more options are exercised. 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 and shares, 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. 24




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 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. 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 25




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 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 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 March 31,
2005, 18,051,511 shares of common stock were outstanding and 1,462,010 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. We also may be
required to issue additional shares upon the exercise of previously granted options or warrants
that are currently outstanding. 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 $3.0 million
for fiscal 2005, 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. Delaware law and our amended and restated certificate of incorporation and bylaws 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; 26




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS  
    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 and 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 it would be without these provisions. 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
22.8% 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. 27




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2005 
 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk Foreign Currency Exchange Risk Our results of operations and cash flows are subject to fluctuations due to changes in foreign
currency exchange rates, particularly changes in the Philippine peso. For the three months ended
March 31, 2004 and 2005, approximately 56% and 67%, respectively, of our expenses were generated in
the Philippines. We derive all of our revenues in U.S. 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 $0.7 million for the three months ended March
31, 2005, whereas a 10% decrease in the relative value of the dollar would increase the cost
associated with these operations by approximately $0.7 million for the three months ended March 31,
2005. Expenses relating to our operations outside the United States increased in the three months
ended March 31, 2005 when compared to the three months ended March 31, 2004 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 and cash equivalents totaling $40.2 million and marketable securities totaling
$6.0 million at March 31, 2005. These amounts were invested primarily in money market funds,
certificates of deposit, municipal bonds and federal agency securities. Cash, cash equivalents and
marketable securities are held for potential acquisitions of complementary businesses or assets,
working capital requirements and general corporate purposes. We do not enter into investments for
trading or speculative purposes. Declines in interest rates would impact the carrying value of our
cash equivalents and available for sale marketable securities as well as reduce future investment
income. A 1% change in short term rates would have changed the carrying value of our cash
equivalents and marketable securities by $5,000 as of March 31, 2005 and would have changed our
interest income for the three months ended March 31, 2005 by approximately $1,000. The interest
income from these funds will be subject to fluctuations due to changes in interest rates. Inflation Rate Sensitivity For the three months ended March 31, 2004 and 2005, approximately 56% and 67%, 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 three
months ended March 31, 2005, inflation averaged 8.5%. We anticipate this inflation trend to
continue in 2005. Inflation in the Philippines has not affected our operating results because the
Philippines has historically experienced deflationary pressure on wages due to a fast growing
population, high unemployment (11.3% for the three months ended March 31, 2005) and a high number
of college graduates a year entering a market that cannot absorb all of them. A reversal of this
trend, 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 28




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2005 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 have concluded that, subject to the
limitations noted above, our disclosure controls and procedures were effective. (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. 29




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2005 
 PART IIOTHER INFORMATION 
 Item 1. Legal Proceedings From time to time, we are involved in various legal proceedings, which are incidental to the
ordinary course of our business. We do not believe that these routine matters represent a
substantial volume of our accounts or that, individually or in the aggregate, they are material to
our business or financial condition. 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None. 
 Item 3. Defaults Upon Senior Securities None. 
 Item 4. Submission of Matters to a Vote of Security Holders During the three months ended March 31, 2005, there were no matters submitted to a vote of
security holders. 
 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
   *       The material contained in this exhibit is not deemed filed with the SEC and is not to be
incorporated by reference into any filing of the Registrant under the Securities Act of 1933 or the
Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of
any general incorporation language contained in such filing, except to the extent that the
Registrant specifically incorporates it by reference. 30




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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 April 29, 2005 PeopleSupport, Inc.By:
    
    /s/ Caroline RookCaroline RookChief Financial Officer(Principal Financial and Accounting Officer)
 31