##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-Q (Mark One) x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
 For the quarterly period ended September 30, 2004 or o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
 For the transition period from              
      to Commission File Number: 333-115328 PeopleSupport, Inc.  Delaware
(State or other jurisdiction
of incorporation or organization)
    
    95-4695021
(I.R.S. Employer Identification No.)
 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 x Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes o   No x 17,951,358 shares of common stock were outstanding as of November 11,
2004.




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PEOPLESUPPORT, INC.
FORM 10-Q
FOR THE QUARTER ENDED
September 30, 2004
INDEX PagePART IFINANCIAL INFORMATIONITEM 1. Financial Statements
    
    
    3Consolidated Balance Sheets as of September 30, 2004 (unaudited) and December 31, 2003
    
    
    3Consolidated Statements of Operations for the three and nine months ended September 30, 2004 and 2003
(unaudited)
    
    
    4Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003 (unaudited)
    
    
    5Notes
to Unaudited Consolidated Financial Statements
    
    
    6ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    32ITEM 4. Controls and Procedures
    
    
    32PART IIOTHER INFORMATIONITEM 1. Legal Proceedings
    
    
    34ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    34ITEM 3. Defaults Upon Senior Securities
    
    
    34ITEM 4. Submission of Matters to a Vote of Security Holders
    
    
    34ITEM 5. Other Information
    
    
    35ITEM 6. Exhibits
    
    
    35Signature
    
    
    36Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
 2




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##### Table of Contents



PART IFINANCIAL INFORMATION 
 ITEM 1. Financial
Statements
 PEOPLESUPPORT, INC. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
 (In thousands)
 September 30,
    
    December 31,2004
    
    2003(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    10,979
    
    
    $
    12,151Restricted short-term cash equivalent
    
    
    512
    
    
    
    101Accounts receivable, net of allowance for doubtful accounts of $582 (unaudited) and
$553
    
    
    7,020
    
    
    
    2,476Investment in receivable portfolios
    
    
    127
    
    
    
    622Prepaid expenses and other current assets
    
    
    1,040
    
    
    
    1,217Total current assets
    
    
    19,678
    
    
    
    16,567Property and equipment, net
    
    
    8,616
    
    
    
    4,829Restricted long-term cash equivalent
    
    
    
    
    
    
    550Deferred offering costs
    
    
    3,000
    
    
    
    Deferred compensation costs
    
    
    845
    
    
    
    Other long term assets
    
    
    1,028
    
    
    
    589Total assets
    
    $
    33,167
    
    
    $
    22,535LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    2,733
    
    
    $
    1,031Accrued liabilities
    
    
    4,522
    
    
    
    2,478Management incentive plan obligation
    
    
    4,786
    
    
    
    Deferred revenue
    
    
    1,883
    
    
    
    1,235Reserve for restructuring
    
    
    
    
    
    
    25Total current liabilities
    
    
    13,924
    
    
    
    4,769Management incentive plan obligation
    
    
    845
    
    
    
    Deferred rent
    
    
    270
    
    
    
    267Total liabilities
    
    
    15,039
    
    
    
    5,036Commitments and contingenciesRedeemable convertible preferred stock, $.003 par value; authorized 11,227 shares:Convertible Series A preferred stock  $.003 par value; designated 712 shares; 712
shares issued and outstanding at September 30, 2004 and December 31, 2003,
liquidation preference over common stockholders of
$1,302
    
    
    1,286
    
    
    
    1,286Convertible Series B preferred stock  $.003 par value; designated 3,848 shares;
3,311 shares issued and outstanding at September 30, 2004 and 2,239 at December 31,
2003, liquidation preference over common stockholders of $6,134
    
    
    6,255
    
    
    
    6,098Convertible Series C preferred stock  $.003 par value; designated 3,289 shares;
3,289 shares issued and outstanding at September 30, 2004 and December 31, 2003,
liquidation preference over common stockholders of
$17,571
    
    
    17,515
    
    
    
    17,515Convertible Series D preferred stock  $.003 par value; designated 3,378 shares;
3,149 shares issued and outstanding at September 30, 2004 and December 31, 2003,
liquidation preference over common stockholders of
$49,268
    
    
    49,211
    
    
    
    49,211Stockholders equity (deficit)Common stock, $.003 par value; authorized 16,975 shares; 2,134 and 2,536 shares
issued and outstanding at September 30, 2004 and December 31, 2003,
respectively
    
    
    6
    
    
    
    7Additional paid-in capital
    
    
    6,691
    
    
    
    6,399Accumulated deficit
    
    
    (60,968
    )
    
    
    (61,367
    )Accumulated other comprehensive income
    
    
    225
    
    
    
    224Deferred stock compensation
    
    
    (2,093
    )
    
    
    (1,874
    )Total stockholders equity (deficit)
    
    
    (56,139
    )
    
    
    (56,611
    )Total liabilities, preferred stock and stockholders equity (deficit)
    
    $
    33,167
    
    
    $
    22,535
 See accompanying notes to consolidated financial statements. 3




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PEOPLESUPPORT, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
 Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(unaudited)
    
    (unaudited)
    
    (unaudited)
    
    (unaudited)Revenues
    
    $
    11,936
    
    
    $
    7,720
    
    
    $
    31,932
    
    
    $
    21,449Cost of revenues (exclusive of depreciation shown below)
    
    
    6,606
    
    
    
    3,064
    
    
    
    17,155
    
    
    
    9,123Selling, general and administrative
    
    
    2,306
    
    
    
    1,520
    
    
    
    6,727
    
    
    
    4,531Depreciation and amortization
    
    
    1,049
    
    
    
    684
    
    
    
    2,893
    
    
    
    2,456Management incentive plan
    
    
    4,786
    
    
    
    
    
    
    
    4,786
    
    
    
    Restructuring charges
    
    
    
    
    
    
    366
    
    
    
    (22
    )
    
    
    366Income (loss) from operations
    
    
    (2,811
    )
    
    
    2,086
    
    
    
    393
    
    
    
    4,973Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2Interest income
    
    
    (24
    )
    
    
    (20
    )
    
    
    (57
    )
    
    
    (54
    )Other expense (income)
    
    
    (1
    )
    
    
    5
    
    
    
    4
    
    
    
    (6
    )Income (loss) before provision for income taxes
    
    
    (2,786
    )
    
    
    2,101
    
    
    
    446
    
    
    
    5,031Provision (benefit) for income taxes
    
    
    (56
    )
    
    
    59
    
    
    
    47
    
    
    
    140Net income (loss)
    
    
    (2,730
    )
    
    
    2,042
    
    
    
    399
    
    
    
    4,891Foreign currency translation adjustment
    
    
    (5
    )
    
    
    (2
    )
    
    
    1
    
    
    
    Comprehensive income (loss)
    
    $
    (2,735
    )
    
    $
    2,040
    
    
    $
    400
    
    
    $
    4,891Basic earnings (loss) per share
    
    $
    (1.28
    )
    
    $
    0.81
    
    
    $
    0.17
    
    
    $
    1.93Diluted earnings (loss) per share
    
    $
    (1.28
    )
    
    $
    0.16
    
    
    $
    0.03
    
    
    $
    0.40Basic weighted average shares outstanding
    
    
    2,136
    
    
    
    2,533
    
    
    
    2,330
    
    
    
    2,533Diluted weighted average shares outstanding
    
    
    2,136
    
    
    
    12,464
    
    
    
    13,878
    
    
    
    12,281
 See accompanying notes to consolidated financial statements. 4




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PEOPLESUPPORT, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 Nine months endedSeptember 30,2004
    
    2003(unaudited)OPERATING ACTIVITIES:Net income
    
    $
    399
    
    
    $
    4,891Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization
    
    
    2,893
    
    
    
    2,456Provision for doubtful accounts
    
    
    29
    
    
    
    291Stock-based compensation
    
    
    1,367
    
    
    
    14Non-cash restructuring charges
    
    
    
    
    
    
    283Reduction of excess accrual for restructuring
    
    
    (22
    )
    
    
    Changes in operating assets and liabilities:Accounts receivable
    
    
    (4,574
    )
    
    
    (415
    )Prepaid expenses and other assets
    
    
    167
    
    
    
    (136
    )Other long term assets
    
    
    (444
    )
    
    
    (129
    )Accounts payable and accrued liabilities
    
    
    1,983
    
    
    
    969Management incentive plan
    
    
    4,786
    
    
    
    Deferred revenue
    
    
    648
    
    
    
    207Cash payments on restructuring reserve
    
    
    (3
    )
    
    
    (327
    )Net cash provided by operating activities
    
    
    7,229
    
    
    
    8,104INVESTING ACTIVITIES:Purchases of receivable portfolios
    
    
    
    
    
    
    (346
    )Collections applied to principal of receivable portfolios
    
    
    495
    
    
    
    16Purchase of property and equipment
    
    
    (6,671
    )
    
    
    (1,608
    )Restricted cash equivalent
    
    
    139
    
    
    
    351Net cash used in investing activities
    
    
    (6,037
    )
    
    
    (1,587
    )FINANCING ACTIVITIES:Payments of capital lease obligation
    
    
    
    
    
    
    (59
    )Repayments of note payable
    
    
    
    
    
    
    (166
    )Repurchase of common stock
    
    
    (1,350
    )
    
    
    Proceeds from the exercise of warrants to purchase redeemable preferred stock
    
    
    157
    
    
    
    Deferred offering costs
    
    
    (1,227
    )
    
    
    Proceeds from the exercise of stock options
    
    
    55
    
    
    
    Net cash used in financing activities
    
    
    (2,365
    )
    
    
    (225
    )Effect of exchange rate changes on cash
    
    
    1
    
    
    
    3Net increase (decrease) in cash and cash equivalents
    
    
    (1,172
    )
    
    
    6,295Cash and cash equivalents, beginning of year
    
    
    12,151
    
    
    
    5,179Cash and cash equivalents, end of period
    
    $
    10,979
    
    
    $
    11,474SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:Interest paid for the period
    
    $
    
    
    
    $
    2Taxes paid for the period
    
    
    392
    
    
    
    15
 See accompanying notes to consolidated financial statements. 5




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PEOPLESUPPORT, INC. AND SUBSIDIARIES 
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
 Note 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements of
PeopleSupport, Inc. and its subsidiaries (the Company) have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the U.S. for complete
financial statements. In the opinion of management, all adjustments considered
necessary for a fair presentation (consisting of normal recurring accruals)
have been included. The information at September 30, 2004, and for the three
and nine months ended September 30, 2004 and 2003, is unaudited. Operating
results for the nine months ended September 30, 2004 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2004. For further information, refer to the consolidated financial statements
and footnotes thereto for the year ended December 31, 2003 included in the
Companys Registration Statement on Form S-1. On August 5, 2004, the Companys Board of Directors effected a 1 for 2.74
reverse stock split of the Companys common and preferred stock. The financial
statements have been retroactively restated for the effects of the reverse
stock split. The Company operates in one reportable segment. Note 2. Comprehensive Income The components of comprehensive income (loss) are as follows (in
thousands): Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income (loss)
    
    $
    (2,730
    )
    
    $
    2,042
    
    
    $
    399
    
    
    $
    4,891Foreign currency translation adjustment
    
    
    (5
    )
    
    
    (2
    )
    
    
    1
    
    
    
    Comprehensive income (loss)
    
    $
    (2,735
    )
    
    $
    2,040
    
    
    $
    400
    
    
    $
    4,891
 Note 3. Stock Compensation The Company accounts for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principles Board Opinion No. 25 (APB
25), Accounting for Stock Issued to Employees, and related interpretations
and complies with the disclosure provisions of Statement of Financial
Accounting Standard No. 123, Accounting for Stock-Based Compensation (SFAS
123). Compensation expense is based on the difference, if any, on the date of
grant, between the fair value of the Companys stock price and the exercise
price. The Company accounts for stock issued to non-employees in accordance
with the provisions of SFAS No. 123 and related interpretations. The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted
average assumptions used for grants for the three and nine months ended
September 30, 2004 and 2003: Three months
    
    Nine monthsended
    
    endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Risk-free interest rate
    
    
    4.0
    %
    
    
    2.71
    %
    
    
    4.00
    %
    
    
    2.71
    %Expected option life (years)
    
    
    5.0
    
    
    
    5.00
    
    
    
    5.00
    
    
    
    5.00Volatility
    
    
    31.7
    %
    
    
    0.00
    %
    
    
    31.70
    %
    
    
    0.00
    %Dividend rate
    
    
    0.0
    %
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %Weighted Average Fair Value
    
    
    
    
    
    $
    2.19
    
    
    $
    11.00
    
    
    $
    1.29
 6




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data) The Black-Scholes option-pricing model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are
fully transferable. Because the Companys employee and director stock option
plans have characteristics significantly different from those of traded
options, the resulting pro forma compensation cost may not be representative of
the compensation cost expected in future years. If compensation cost for the
Companys stock option plans were determined based on the fair value at the
grant date for awards for the three and nine months ended September 30, 2004
and 2003, consistent with the provisions of SFAS No. 123, the Companys net
income (loss) and income (loss) per share would have been as indicated below
(in thousands, except per share data): Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income (loss)as reported
    
    $
    (2,730
    )
    
    $
    2,042
    
    
    $
    399
    
    
    $
    4,891Add: Stock  based compensation expense
included in reported net income, net of
related tax effects
    
    
    457
    
    
    
    12
    
    
    
    1,367
    
    
    
    14Deduct: Total stock-based compensation
expense determined under fair value based
methods for all awards, net of related tax
effects
    
    
    (474
    )
    
    
    (165
    )
    
    
    (1,422
    )
    
    
    (495
    )Net income (loss)pro forma
    
    $
    (2,747
    )
    
    $
    1,889
    
    
    $
    344
    
    
    $
    4,410Basic earnings (loss) per shareas reported
    
    $
    (1.28
    )
    
    $
    0.81
    
    
    $
    0.17
    
    
    $
    1.93Diluted earnings (loss) per shareas reported
    
    
    (1.28
    )
    
    
    0.16
    
    
    
    0.03
    
    
    
    0.40Basic earnings (loss) per sharepro forma
    
    
    (1.29
    )
    
    
    0.75
    
    
    
    0.15
    
    
    
    1.74Diluted earnings (loss) per sharepro forma
    
    
    (1.29
    )
    
    
    0.15
    
    
    
    0.02
    
    
    
    0.36
 Options granted during the nine months ended September 30, 2004 resulted
in deferred compensation of $1,728, which was included in deferred stock
compensation, a component of stockholders equity (deficit). Deferred
compensation expense was amortized ratably using an accelerated method over the
vesting period. During the nine months ended September 30, 2004 and 2003, such
non-cash stock-based compensation expense included in the consolidated
statement of operations amounted to $1,367 and $14 respectively, recorded in
cost of revenues and selling, general and administrative as follows: For the quarter endedSeptember 30,
    
    June 30,
    
    March 31,
    
    December 31,
    
    September 30,
    
    June 30,
    
    March 31,2004
    
    2004
    
    2004
    
    2003
    
    2003
    
    2003
    
    2003Cost of revenues
    
    $
    145
    
    
    $
    153
    
    
    $
    146
    
    
    $
    54
    
    
    $
    6
    
    
    $
    1
    
    
    $
    Selling, general &
administrative
    
    
    312
    
    
    
    316
    
    
    
    295
    
    
    
    51
    
    
    
    6
    
    
    
    1
    
    
    
    $
    457
    
    
    $
    469
    
    
    $
    441
    
    
    $
    105
    
    
    $
    12
    
    
    $
    2
    
    
    $
    
 Note 4. Computation of Earnings Per Share Basic earnings per share excludes dilution and is computed by dividing net
earnings by the weighted average number of common shares outstanding during the
period. Diluted earnings per share reflects the potential dilution that could
occur if securities or other contracts to issue common stock (i.e., convertible
preferred stock, warrants to purchase common stock and common stock options
using the treasury stock method) were exercised or converted into common stock. 7




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data) The following is a summary of the number of shares of securities
outstanding during the respective periods that have been excluded from the
calculation because the effect on net income (loss) per share would have been
antidilutive (in thousands). Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Convertible preferred stock
    
    
    10,461
    
    
    
    
    
    
    
    
    
    
    
    Options
    
    
    1,104
    
    
    
    148
    
    
    
    
    
    
    
    181Preferred stock warrants
    
    
    42
    
    
    
    1,604
    
    
    
    31
    
    
    
    1,604Common stock warrants
    
    
    96
    
    
    
    96
    
    
    
    
    
    
    
    96
 The following is a reconciliation of the numerators and denominators of
the basic and diluted earnings per share computations: Nine Months Ended September 30,2004
    
    2003Income
    
    Shares
    
    Per Share
    
    Income
    
    Shares
    
    Per Share(Numerator)
    
    (Denominator)
    
    Amount
    
    (Numerator)
    
    (Denominator)
    
    AmountBasic earnings per share:Income to common
stockholders
    
    $
    399
    
    
    
    2,330
    
    
    $
    0.17
    
    
    $
    4,891
    
    
    
    2,533
    
    
    $
    1.93Effect of dilutive securities:Options
    
    
    
    
    
    
    950
    
    
    
    
    
    
    
    
    
    
    
    360Warrants
    
    
    
    
    
    
    829
    
    
    
    
    
    
    
    
    
    
    
    Convertible preferred
stock
    
    
    
    
    
    
    9,769
    
    
    
    
    
    
    
    
    
    
    
    9,388Income available to common
stockholders
    
    $
    399
    
    
    
    13,878
    
    
    $
    0.03
    
    
    $
    4,891
    
    
    
    12,281
    
    
    $
    0.40
 Three Months Ended September 30,2004
    
    2003Loss
    
    Shares
    
    Per Share
    
    Income
    
    Shares
    
    Per Share(Numerator)
    
    (Denominator)
    
    Amount
    
    (Numerator)
    
    (Denominator)
    
    AmountBasic earnings (loss) per share:Income (loss) to common
stockholders
    
    $
    (2,730
    )
    
    
    2,136
    
    
    $
    (1.28
    )
    
    $
    2,042
    
    
    
    2,533
    
    
    $
    0.81Effect of dilutive securities:Options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    543Warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Convertible preferred
stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,388Income (loss) available to
common
stockholders
    
    $
    (2,730
    )
    
    
    2,136
    
    
    $
    (1.28
    )
    
    $
    2,042
    
    
    
    12,464
    
    
    $
    0.16
 Note 5. Stockholders Equity During the nine months ended September 30, 2004, 145,393 shares of common
stock were issued due to the exercise of common stock options, resulting in
proceeds to the Company of approximately $55. In April 2004, the Company purchased 547,445 of its common stock from one
of its stockholders for $2.47 per share for a total purchase price of $1.35
million. 8




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




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##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data) Note 10. Significant Customers Revenue and net accounts receivable from significant customers were as
follows: For the three months
    
    For the nine months
    
    As ofended September 30,
    
    ended September 30,
    
    September 30, 20042004
    
    2003
    
    2004
    
    2003% of Revenue
    
    % of Revenue
    
    % of A/R, netCustomerA
    
    
    32
    %
    
    
    54
    %
    
    
    33
    %
    
    
    53
    %
    
    
    22
    %B
    
    
    6
    
    
    
    22
    
    
    
    8
    
    
    
    30
    
    
    
    3C
    
    
    27
    
    
    
    12
    
    
    
    28
    
    
    
    10
    
    
    
    30D
    
    
    10
    
    
    
    
    
    
    
    11
    
    
    
    
    
    
    
    20E
    
    
    11
    
    
    
    7
    
    
    
    10
    
    
    
    2
    
    
    
    9
 Note 11. Management Incentive Plan Effective July 1, 2002, the Company adopted its 2002 Management Incentive
Plan (the Plan) under which the Company became obligated to make payments to
senior management and key employees upon completion of certain significant
transactions, including the sale of our Company or an initial public offering
pursuant to the Securities Act of 1933. Under the Plan, certain key employees
designated by the Companys Board of Directors were entitled to receive cash
payments based on the aggregate net proceeds received by the Company and
selling stockholders from the offering. The registration statement relating to the Companys initial public
offering was declared effective on September 30, 2004, and the sale of
4,745,727 shares by the Company and 2,072,455 shares by existing shareholders
closed on October 6, 2004. Based on the net offering proceeds received by the
Company and selling stockholders, the Company was obligated to pay $5,631 to
senior management and other key employees. The Company paid $4,786 (or 85%)
upon completion of the offering and intends to pay $845 (or 15%) over time
after the offering based on continued service or other performance criteria.
The $0.8 million is reflected as a long term liability, offset by an asset for
the deferred compensation costs. Note 12. Initial Public Offering The registration statement relating to the Companys initial public
offering was declared effective by the Securities and Exchange Commission on
September 30, 2004. On October 6, 2004, the Company completed the initial
public offering whereby 4,745,727 shares of common stock were sold by the
Company and 2,072,455 shares were sold by existing shareholders at $7.00 per
share. The Company generated approximately $27.8 million of net proceeds (net
of underwriting discounts and $3.1 million of offering expenses). Existing
shareholders generated approximately $13.5 million of net proceeds (net of
underwriting discounts). Pursuant to the preferred conversion rights, as discussed in Note 6,
10,460,942 preferred shares converted, on a one-to-one basis, to common shares
upon the closing of the initial public offering. In connection with the Companys initial public offering, the Company
amended and restated its Certificate of Incorporation to increase the Companys
authorized capitalization, reduce the par value per share of common and
preferred stock from $0.003 to $0.001, and make certain other changes. Under
the Companys Amended and Restated Certificate of Incorporation, as filed with
the Delaware Secretary of State on October 6, 2004, the Company is authorized
to issue 91,000,000 shares of capital stock, including 87,000,000 shares of
common stock, par value $0.001 per share, and 4,000,000 shares of preferred
stock, par value $0.001 per share. On October 19, 2004, the Company was notified that, pursuant to section 3
of the Underwriting Agreement, the Underwriters exercised their over-allotment
option in the amount of 603,000 additional shares. On October 25, 2004, the
Company completed the sale of the 603,000 additional shares, and generated
approximately $3.9 million of net proceeds. Under the terms of the management
incentive plan, the Company is obligated to pay $465 upon closing of the
over-allotment option exercise and intends to pay $181 over time after the
offering based on continued service or other performance criteria. 10




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##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data) The following pro forma balance sheet and earnings per share calculations
give effect to the preferred shares converting to common, the amended and
restated Certificate of Incorporation, the initial public offering, and the
Underwriters over-allotment exercise as if they had occurred on January 1, 2003
or the later dates on which some of the shares of preferred stock were issued. CONSOLIDATED PRO FORMA BALANCE SHEET Actual
    
    Pro Forma Adjustments
    
    Pro FormaAs of
    
    Conversion of
    
    
    
    
    
    Underwriter
    
    As ofSeptember 30,
    
    Preferred to
    
    Effect of Initial
    
    Exercise of
    
    September 30,2004
    
    Common Shares
    
    Public Offering
    
    Over-Allotment
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    10,979
    
    
    $
    
    
    
    $
    24,236
    
    
    $
    3,461
    
    
    $
    38,676Restricted short-term cash equivalent
    
    
    512
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    512Accounts receivable, net of allowance
for doubtful accounts of $582
    
    
    7,020
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,020Investment in receivable portfolios
    
    
    127
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    127Prepaid expenses and other current assets
    
    
    1,040
    
    
    
    
    
    
    
    
    
    
    
    13
    
    
    
    1,053Total current assets
    
    
    19,678
    
    
    
    
    
    
    
    24,236
    
    
    
    3,474
    
    
    
    47,388Property and equipment, net
    
    
    8,616
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,616Restricted long-term cash equivalent
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Deferred offering costs
    
    
    3,000
    
    
    
    
    
    
    
    (3,000
    )
    
    
    
    
    
    
    Deferred compensation costs
    
    
    845
    
    
    
    
    
    
    
    
    
    
    
    181
    
    
    
    1,026Other long term assets
    
    
    1,028
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,028Total assets
    
    $
    33,167
    
    
    $
    
    
    
    $
    21,236
    
    
    $
    3,655
    
    
    $
    58,058
 11




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##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data) CONSOLIDATED PRO FORMA BALANCE SHEET Actual
    
    Pro Forma Adjustments
    
    Pro FormaAs of
    
    Conversion of
    
    
    
    
    
    Underwriter
    
    As ofSeptember 30,
    
    Preferred to
    
    Effect of Initial
    
    Exercise of
    
    September 30,2004
    
    Common Shares
    
    Public Offering
    
    Over-Allotment
    
    2004LIABILITIES AND STOCKHOLDERS
EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    2,733
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    2,733Accrued liabilities
    
    
    4,522
    
    
    
    
    
    
    
    (1,773
    )
    
    
    
    
    
    
    2,749Management incentive plan obligation
    
    
    4,786
    
    
    
    
    
    
    
    (4,786
    )
    
    
    
    
    
    
    Deferred revenue
    
    
    1,883
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,883Reserve for restructuring
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total current liabilities
    
    
    13,924
    
    
    
    
    
    
    
    (6,559
    )
    
    
    
    
    
    
    7,365Management incentive plan obligation
    
    
    845
    
    
    
    
    
    
    
    
    
    
    
    181
    
    
    
    1,026Deferred rent
    
    
    270
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    270Total liabilities
    
    
    15,039
    
    
    
    
    
    
    
    (6,559
    )
    
    
    181
    
    
    
    8,661Redeemable convertible preferred stock, $.003 par value and $.001 par value
pro forma; authorized 11,227 shares and 4,000 shares pro forma:Convertible Series A preferred stock  $.003 par value actual and $.001
pro forma; designated 712 shares; 712 shares issued and outstanding at
September 30, 2004, 0 shares issued and outstanding, pro forma
    
    
    1,286
    
    
    
    (1,286
    )
    
    
    
    
    
    
    
    
    
    
    Convertible Series B preferred stock  $.003 par value and $.001 par
value pro forma; designated 3,848 shares; 3,311 shares issued and
outstanding at September 30, 2004 and 0 shares issued and outstanding, pro
forma
    
    
    6,255
    
    
    
    (6,255
    )
    
    
    
    
    
    
    
    
    
    
    Convertible Series C preferred stock  $.003 par value and $.001 par
value pro forma; designated 3,289 shares; 3,289 shares issued and
outstanding at September 30, 2004 and 0 shares issued and outstanding, pro
forma
    
    
    17,515
    
    
    
    (17,515
    )
    
    
    
    
    
    
    
    
    
    
    Convertible Series D preferred stock  $.003 par value and $.001 par
value pro forma; designated 3,378 shares; 3,149 shares issued and
outstanding at September 30, 2004 and 0 shares issued and outstanding, pro
forma
    
    
    49,211
    
    
    
    (49,211
    )
    
    
    
    
    
    
    
    
    
    
    Stockholders equity (deficit)Common stock, $.003 par value and $.001 par value pro forma; authorized
16,975 shares and 87,000 shares pro forma; 2,134 issued and outstanding at
September 30, 2004 and 17,944 issued and outstanding, pro forma
    
    
    6
    
    
    
    28
    
    
    
    5
    
    
    
    1
    
    
    
    40Additional paid-in capital
    
    
    6,691
    
    
    
    74,239
    
    
    
    27,790
    
    
    
    3,925
    
    
    
    112,645Accumulated deficit
    
    
    (60,968
    )
    
    
    
    
    
    
    
    
    
    
    (452
    )
    
    
    (61,420
    )Accumulated other comprehensive income
    
    
    225
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    225Deferred stock compensation
    
    
    (2,093
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,093
    )Total stockholders equity (deficit)
    
    
    (56,139
    )
    
    
    74,267
    
    
    
    27,795
    
    
    
    3,474
    
    
    
    49,397Total liabilities, preferred stock and stockholders
equity (deficit)
    
    $
    33,167
    
    
    $
    
    
    
    $
    21,236
    
    
    $
    3,655
    
    
    $
    58,058
 12




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##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data) PRO FORMA EARNINGS PER SHARE CALCULATIONS For the three months ended
    
    For the nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income (loss)
    
    $
    (2,730
    )
    
    $
    2,042
    
    
    $
    399
    
    
    $
    4,891Basic earnings (loss) per share
    
    $
    (1.28
    )
    
    $
    0.81
    
    
    $
    0.17
    
    
    $
    1.93Diluted earnings (loss) per share
    
    $
    (1.28
    )
    
    $
    0.16
    
    
    $
    0.03
    
    
    $
    0.40Basic weighted average shares outstanding
    
    
    2,136
    
    
    
    2,533
    
    
    
    2,330
    
    
    
    2,533Diluted weighted average shares outstanding
    
    
    2,136
    
    
    
    14,464
    
    
    
    13,878
    
    
    
    12,281Pro Forma basic earnings (loss) per share
    
    $
    (0.15
    )
    
    $
    0.12
    
    
    $
    0.02
    
    
    $
    0.28Pro Forma diluted earnings (loss) per share
    
    $
    (0.15
    )
    
    $
    0.11
    
    
    $
    0.02
    
    
    $
    0.28Pro Forma basic weighted average shares outstanding
    
    
    17,946
    
    
    
    17,270
    
    
    
    17,448
    
    
    
    17,270Pro Forma diluted weighted average shares
outstanding
    
    
    17,946
    
    
    
    17,813
    
    
    
    19,227
    
    
    
    17,630
 13




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##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS This report on Form 10-Q contains forward-looking statements within the meaning
of the federal securities laws that involve material risks and uncertainties,
including without limitation, statements about our expectations regarding our
revenues, our clients, our expenses, our anticipated cash needs, our estimates
regarding our capital requirements and our needs for additional financing. We
generally identify forward-looking statements by using such terms as may,
will, could, should, potential, continue, expect, intend, plan,
estimate, anticipate, believe, or similar phrases or the negatives of
such terms. We base these statements on our beliefs as well as assumptions we
made using information currently available to us. These forward-looking
statements are subject to risks, uncertainties and assumptions, including those
identified below in Managements Discussion and Analysis of Financial
Condition and Results of Operation  Risk Factors, as well as other matters
not yet known to us or not currently considered material by us. Should one or
more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from those
anticipated, estimated or projected. These risks, uncertainties and assumptions
include, but are not limited to, our dependence on a limited number of clients,
negative public reaction to offshore outsourcing and the effect of recently
proposed legislation, competitive conditions in the markets we serve, our
ability to manage our growth, the risks associated with our operations in the
Philippines, and other risks discussed in Managements Discussion and Analysis
of Financial Condition and Results of Operations  Risk Factors in this
report. These forward-looking statements represent our estimates and
assumptions only as of the date of this report and, unless required by law, we
undertake no obligation to update or revise these forward-looking statements.
You should, however, review the factors and risks we describe in other reports
and registration statements that we file from time to time with the Securities
and Exchange Commission (the SEC). 
 ITEM 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations In this quarterly report, all references to us, our and our company
refer to PeopleSupport and its subsidiaries. The following discussion should be read in conjunction with the unaudited
consolidated financial statements and accompanying notes, which appear
elsewhere in this Form 10-Q. This discussion contains forward-looking
statements based on current expectations that involve risks and uncertainties.
Our actual results could differ materially from those anticipated in these
forward-looking statements as a result of various factors, including those
discussed below in Risk Factors and elsewhere in this report. Overview We provide business process outsourcing, or BPO, services from our
facilities in the Philippines. We provide customer management services for
U.S.-based clients who wish to outsource this function. As of September 30,
2004, we service 32 U.S.- based clients in a variety of industries. Our four
largest customer management service clients during the periods covered by this
report collectively accounted for more than 80% and 82% of our revenues,
respectively, for the three and nine months ended September 30, 2004. Expedia,
our largest client, and EarthLink, our second largest client, together
accounted for approximately 59% and 61% of our revenues, respectively, for the
three and nine months ended September 30, 2004. In July 2003, we also began providing accounts receivable management
services for past due receivables, which consist of defaulted accounts that our
clients have written off their books, and accounts that are in default but have
not yet been written off by our clients. We plan to focus our accounts
receivable management services primarily on collecting defaulted consumer
receivables on a contingent basis that have been written off by the creditor.
We also perform early-stage accounts receivable collection services on
defaulted consumer accounts that have not been written off by managing
collection of accounts receivables of at-risk customers. On October 6, 2004, we completed an initial public offering in which we
sold 4,745,727 shares of common stock at $7.00 per share. On October 25, 2004,
we sold 603,000 additional shares of common stock at $7.00 per share in
connection with the exercise of the underwriters over-allotment option. The
total aggregate proceeds from these transactions were $37,441,089.
Underwriters discounts and other costs relating to the offering were
approximately $5,720,876, resulting in net proceeds to us of approximately
$31,720,213. Upon the closing of our offering on October 6, 2004, all of our
previously outstanding preferred stock automatically converted into 10,460,942
shares of common stock. 14




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##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS Sources of Revenues For the three and nine months ended September 30, 2004, we derived
substantially all of our revenues from customer management fees, which include:  
    
    Time-delineated or session based fees, including hourly or per
minute charges and charges per interaction, which are separately
negotiated on an individual client basis; and
    
    Implementation fees, including revenues associated with
installation and integration of new clients into our
telecommunications, information technology and client reporting
structures. Substantially all of our revenues consisted of time-delineated or session
based fees. Implementation fees accounted for a small portion of our revenues.
Also, for the three and nine months ended September 30, 2004, all of our
revenues were derived from U.S.-based clients. Key Expense Categories Cost of Revenues.Cost of revenues consists primarily of salaries, payroll
taxes and employee benefit costs of professionals in the Philippines.
Additionally, cost of revenues includes: telecommunications costs; information
technology costs; rent expense, facilities support and customer management
support costs related to the operation of outsourcing and data centers; and
consulting services related to our customer management consulting group in the
United States. Cost of revenues does not include depreciation of assets used in
the production of revenues. Selling, general and administrative.Selling, general and administrative
expenses consist primarily of expenses incurred at our U.S.-based corporate
headquarters, including sales and administrative employee-related expenses,
sales commissions, professional fees, information technology costs, travel,
marketing programs (which include product marketing expenses, corporate
communications, conferences, other brand building and advertising) and other
corporate expenses. Selling, general and administrative expenses increased in
the three and nine months ended September 30, 2004, as compared with selling,
general and administrative expenses incurred in corresponding periods of the
preceding fiscal year. We expect these expenses to continue to increase as we
add personnel and incur additional fees and costs related to the growth of our
business and operations. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States. The preparation
of these consolidated financial statements requires us to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues,
costs and expenses and related disclosures. On an ongoing basis, we evaluate
our estimates and assumptions. Our actual results may differ from these
estimates. We believe that, of our significant accounting policies described in
our notes to our consolidated financial statements, the following accounting
policies involve a greater degree of judgment and complexity. Accordingly,
these are the policies we believe are the most critical to assist investors in
fully understanding and evaluating our consolidated financial condition and
results of operations. Revenues and Deferred Revenue Recognition Revenues are recognized pursuant to applicable accounting standards,
including Securities and Exchange Commission Staff Accounting Bulletin No. 101
Revenue Recognition in Financial Statements, or SAB 101, and Staff Accounting
Bulletin 104, Revenue Recognition or SAB 104, SAB 101, as amended, and SAB
104 summarize certain of the Securities and Exchange Commission, or SEC,
staffs views in applying generally accepted accounting principles to revenue
recognition in financial statements and provide guidance on revenue
recognition issues in the absence of authoritative literature addressing a
specific arrangement or a specific industry. We primarily recognize our revenues from services as those services are
performed under a signed contract. We recognize:  
    
    Customer management fees, excluding implementation fees, as those services are performed;
    
    Implementation fees ratably over the life of the contract; 15




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##### Table of Contents



PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS  
    
    First party collection service fees for accounts receivable management as those services are performed; and
    
    Commission revenues for contingent accounts receivable management contracts upon receipt of collected funds. Deferred revenue represents amounts billed or cash received in advance of
revenue recognition. As of September 30, 2004 and December 31, 2003, our
balance sheets reflect $1.9 million and $1.2 million in deferred revenues,
respectively. Accounting for Stock-based Awards We have adopted the disclosure only provisions of Statement of Financial
Accounting Standards, or SFAS, No. 123, Accounting for Stock-Based
Compensation. Under SFAS No. 123, companies have the option to measure
compensation costs for stock options using the intrinsic value method
prescribed by the Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, or APB No. 25. Under APB No. 25, compensation
expense is generally not recognized when both the exercise price is the same as
the market price and the number of shares to be issued is set on the date the
employee stock option is granted. We have chosen to use the intrinsic value
method to measure our compensation costs. In the past, we awarded a limited number of stock options to employees and
non-employees at exercise prices that were subsequently determined to have been
below fair market value. For these options, we record deferred stock-based
compensation charges in the amount by which the exercise price of an option is
less than the deemed fair value of our common stock at the date of grant. We
amortize the deferred compensation charges on an accelerated method over the
vesting period of the underlying option awards. The following table shows, by quarter, the non-cash stock based
compensation expense recognized by the Company during 2003 and 2004. For the quarter endedSeptember 30,
    
    June 30,
    
    March 31,
    
    December 31,
    
    September 30,
    
    June 30,
    
    March 31,2004
    
    2004
    
    2004
    
    2003
    
    2003
    
    2003
    
    2003Cost of revenues
    
    $
    145
    
    
    $
    153
    
    
    $
    146
    
    
    $
    54
    
    
    $
    6
    
    
    $
    1
    
    
    $
    Selling, general &
administrative
    
    
    312
    
    
    
    316
    
    
    
    295
    
    
    
    51
    
    
    
    6
    
    
    
    1
    
    
    
    $
    457
    
    
    $
    469
    
    
    $
    441
    
    
    $
    105
    
    
    $
    12
    
    
    $
    2
    
    
    $
    
 We issue both incentive and nonqualified stock options. Most of the
options granted to date have been incentive stock options. We receive a tax
deduction at exercise of nonqualified stock options for the excess of market
value over the exercise price, the tax benefit of which is recorded directly as
an increase to stockholders equity. The exercise of incentive stock options
does not create any tax deduction for us. Accounting for Income Taxes We use the liability method to account for income taxes. Under this
method, deferred taxes are determined based on the difference between the
financial statement and tax bases of assets and liabilities and are measured at
the enacted tax rates that will be in effect when those differences are
expected to reverse. Valuation allowances are established, when necessary, to
reduce deferred tax assets up to the amount expected to be realized. Long-lived Asset Impairment Long-lived assets, including fixed assets and intangibles, are reviewed
for impairment as events or changes in circumstances occur indicating that
carrying amounts may not be recoverable. When these events or changes in
circumstances indicate that the carrying amount would be impaired, undiscounted
cash flow analyses would be used to assess other long-lived impairment. The
estimation of future cash flows involves considerable management judgment.
Included in the restructuring charges for the nine months ended September 30,
2003 are charges for the write down of long-lived assets in the amounts of $0.4
million. 16




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS Results of Operations The following table shows the listed items from our consolidated
statements of operations as a percentage of revenues for the periods presented
(percentages may not aggregate due to rounding). Three Months Ended
    
    Nine Months EndedSeptember
30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(unaudited)Revenues
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %Cost of revenues
    
    
    55
    
    
    
    40
    
    
    
    54
    
    
    
    43Selling, general, and administrative
    
    
    19
    
    
    
    20
    
    
    
    21
    
    
    
    21Depreciation and amortization
    
    
    9
    
    
    
    9
    
    
    
    9
    
    
    
    11Management incentive plan
    
    
    40
    
    
    
    
    
    
    
    15
    
    
    
    Restructuring charges
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    2Income (loss) from operations
    
    
    (24
    )
    
    
    27
    
    
    
    1
    
    
    
    23Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Interest income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other expense (income)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Income (loss) before provision for income taxes
    
    
    (23
    )
    
    
    27
    
    
    
    1
    
    
    
    23Provision (benefit) for income taxes
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    1Net income (loss)
    
    
    (23
    %)
    
    
    26
    %
    
    
    1
    %
    
    
    23
    %
 Three Months Ended September 30, 2003 compared with Three Months Ended
September 30, 2004 Revenues Our revenues increased by $4.2 million, or 55%, from $7.7 million for the
three months ended September 30, 2003 to $11.9 million for the three months
ended September 30, 2004. This increase was primarily attributable to an
increase of $1.6 million in customer management fees associated with a higher
volume of services to new and existing clients. We believe this increase
resulted from our ability to capture a larger share of our clients outsourcing
needs, as well as a general increase in our clients demand for outsourcing
services, particularly in the travel and hospitality industry. The increase in
revenues also resulted, in part, from an increase of $2.5 million in customer
management fees associated with services provided to nine new clients in the
financial, telecommunications and technology industries. We anticipate that customer management fees will continue to comprise a
substantial majority of our revenues for the foreseeable future. As more
companies enter the BPO market in the Philippines, we anticipate increases in
competition and price pressure that could reduce our rate of revenue growth in
the balance of 2004 and adversely impact revenues in future periods, as
compared with our performance in 2003 and the first six months of 2004. In
addition, we offer some of our clients volume-related discounts, which could
impact our revenues as we expand volume. Cost of Revenues Our cost of revenues increased by $3.5 million, or 113%, from $3.1 million
for the three months ended September 30, 2003 to $6.6 million for the three
months ended September 30, 2004. The increase was primarily attributable to
increased costs of approximately $3.0 million (or 25% of revenue) associated
with the expansion of our outsourcing operations in the Philippines and an
increase in the number of customer management professionals and $0.1 million
(or 1% of revenue) of stock based compensation expense. We anticipate that
these costs will continue to increase in those quarters when we expand our
operations and increase the volume of customer management services we provide.
We believe this trend will continue due to increased demand for our outsourced
services by our existing clients, particularly those engaged in the travel and
hospitality industry, and our ability to attract new clients. Our cost of
revenues as a percentage of revenues increased from 40% for the three months
ended September 30, 2003 to 55% for the three months ended September 30, 2004. 17




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS As more companies enter the BPO market in the Philippines, we anticipate
increases in competition for qualified professionals and management personnel.
This increasing competition could result in higher cost of revenues in the
balance of 2004 and future periods, as compared with our performance in 2003
and the first nine months of 2004, and could increase employee turnover. Selling, General, and Administrative Selling, general and administrative expenses (SG&A) increased by $5.6
million, or 373%, from $1.5 million for the three months ended September 30,
2003, to $7.1 million for the three months ended September 30, 2004. The
increase is primarily attributable to the $4.8 million (or 40% of revenue) cost
associated with the management incentive plan in the current period, $0.6
million (or 6% of revenue) related to salaries and wages, and $0.3 million (or
3% of revenue) of stock based compensation expense. Our SG&A as a percentage of
revenues increased from 20% for the three months ended September 30, 2003 to
59% for the three months ended September 30, 2004. Nine months ended September 30, 2003 compared with nine months ended September
30, 2004 Revenues Our revenues increased by $10.5 million, or 49% from $21.4 million for the
nine months ended September 30, 2003 to $31.9 million for the nine months ended
September 30, 2004. The increase was primarily attributable to $5.1 million of
customer management fees associated with services provided to six new clients.
The increase was also attributable to an increase of $4.9 million in customer
management fees associated with a higher volume of services rendered to
existing clients. We believe this increase resulted from our ability to
capture a larger share of our clients outsourcing needs, as well as a general
increase in our clients demand for outsourced services. The increase in
revenues was partially offset by a 57% decline in revenues from Network
Solutions for the nine months ended September 30, 2004, as compared with the
nine months ended September 30, 2003. We believe this decline was primarily
due to Network Solutions improvement of its web-based, self-help technology,
automation of its telephone inquiry system and expansion of its in-house
customer management operations, which reduced Network Solutions demand for our
services. Costs of Revenues Our cost of revenues increased by $8.1 million, or 89%, from $9.1 million
for the nine months ended September 30, 2003 to $17.2 million for the nine
months ended September 30, 2004. The increase was primarily due to increased
costs associated with the expansion of our outsourcing operations in the
Philippines to meet increased demand from new and existing customers during the
first three quarters of 2004, and to add capacity for anticipated future
increases in demand. In the nine months ended September 30, 2004, we
strategically invested in expanding our outsourcing delivery capabilities. The
costs of expansion primarily include $5.0 million of compensation and training
of additional outsourcing and support personnel, including middle and upper
management, $1.4 million of expenses associated with the rental of facilities
and expenses related to facilities, and $1.5 million of expenses associated
with information technology, telecommunications and transmission rights. Other
investments in capitalized infrastructure expansion, including build out of
facilities, purchase of computers, information technology and
telecommunications equipment have been capitalized and will be expensed over
time as depreciation and amortization, which is classified separately from cost
of revenues. Primarily as a result of our strategic investment in expanding our
capacity, our cost of revenues as a percentage of revenues increased from 43%
for the nine months ended September 30, 2003 to 54% for the nine months ended
September 30, 2004 (including $0.4 million, or 1%, of non-cash, stock based
compensation expense). Although our strategic investment in developing client
service capacity may result in near term overcapacity and reduced operating
margins, we believe the investment is essential to attract and retain
additional clients. The success of this approach depends on our ability to
correctly anticipate and continue building demand for our services. We plan to
continue investing to expand our capacity through the remainder of 2004 and
into 2005 when we commence operations at the PeopleSupport Center, a new
build-to-suit 163,000 square feet leased facility that is schedule to commence
operations in August 2005. We also intend that increases in demand for our
services from new and existing clients will enable us to utilize our 2004
capacity enhancements beginning at the end of 2004 and early 2005. 18




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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 expense (SG&A) increased $7.0 million,
or 156%, from $4.5 million for the nine months ended September 30, 2003 to
$11.5 million for the nine months ended September 30, 2004. The increase was
primarily due to the following increased or additional expenses in 2004: $4.8
million of expense (or 15% of revenue) related to the management incentive
plan, $0.9 million of expense (or 3% of revenue) related to stock based
compensation and the recognition of $0.6 million of commission expense (or 2%
of revenue). Our SG&A expense as a percentage of revenues was 21% and 36% for
the nine months ended September 30, 2003 and 2004, respectively. Liquidity and Capital Resources We have historically financed our operations primarily through cash flows
from operations, sales of equity securities, equipment financings, and interest
income earned on cash, cash equivalents and investments. As of September 30,
2004, we have working capital of $5.8 million including cash and cash
equivalents totaling $11.0 million (excluding a restricted cash equivalent) and
accounts receivable of $7.0 million. Operating Activities Net cash provided by operating activities was $7.2 million for the nine
months ended September 30, 2004, which was greater than our net income of $0.4
million for the same period. The difference is primarily due to $2.9 million
of depreciation and amortization, $1.4 million of non-cash stock based
compensation expense, and an aggregate increase in working capital of $2.7
million. Net cash provided by operating activities was $8.1 million for the
nine months ended September 30, 2003, which was greater than our net income of
$4.9 million for the same period. The difference is primarily attributable to
$2.5 million of depreciation and amortization, $0.3 million provision for
doubtful accounts, $0.3 million of non-cash restructuring charges and an
aggregate increase in working capital of $0.2 million. Investing Activities Net cash used in investing activities during the nine months ended
September 30, 2003 and 2004 was $1.6 million and $6.0 million, respectively.
During the nine months ended September 30, 2004, we incurred $6.7 million of
capital expenditures associated with the expansion of the Philippine operations
which was offset by $0.5 million of receivable portfolio collections. Cash
used in investing activities for nine months ended September 30, 2003 was
primarily comprised of $1.6 million of capital expenditures associated with the
continuing expansion of the Philippine operating facilities, and $0.3 million
related to the purchase of receivable portfolios offset by a $0.4 reduction in
restricted cash equivalents. We estimate that our capital expenditures, including expenditures already
made, for 2004 will be approximately $8.0 million, primarily for
telecommunications equipment, leasehold improvements, computer hardware and
software, and furniture and fixtures in support of expanding our
infrastructure, which we may adjust based on trends in revenue and personnel in
the Philippines. In 2005, we expect to move into a build-to-suit leased data
and outsourcing center in Manila, Philippines (the PeopleSupport Center). We
estimate potential build out costs for this facility of $6.4 million for
telecommunications equipment, leasehold improvements, computer hardware and
software, and furniture and fixtures. In addition to the PeopleSupport Center,
we estimate further build out costs in 2005 of our infrastructure of $2.0
million to $4.0 million primarily for telecommunications equipment, leasehold
improvements, computer hardware and software, and furniture and fixtures in
support of expanding our infrastructure, which we may adjust based on trends in
revenue and personnel in the Philippines. We anticipate using cash on hand and
the net proceeds from our recently completed offering to fund these
expenditures. Financing Activities Net cash used in financing activities during the nine months ended
September 30, 2003 and 2004 was $0.2 million and $2.4 million, respectively.
The increase in cash used in financing activities for the nine months ended
September 30, 2004 was primarily attributable to $1.2 million of deferred
offering costs and the $1.4 million repurchase of common stock from one of our
founders, offset by the absence of debt payments and $0.2 million of proceeds
from the exercise of stock options and warrants. 19




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS In May 2003, we renewed standby letters of credit in the aggregate amount
of $0.7 million related to the lease of one of our offices in the Philippines
and the lease or our headquarters in Los Angeles. In connection with these
renewals, we granted a security interest in a certificate of deposit with a
commercial bank to secure performance of our obligations under the standby
letters of credit. Pursuant to the terms of the letters of credit,
approximately $0.1 million of our security interest was released in August 2004
and approximately $0.5 million will be released in August 2005. At September 30, 2004, we had a restricted cash equivalent in the amount
of approximately $0.5 million, held in a certificate of deposit as collateral
for our lending facilities, which will be released as discussed above. Based on our current level of operations, we expect that our cash flow
from operations, together with the proceeds of the current working capital and
recently completed public offering on October 6, 2004, will be adequate to meet
our anticipated cash needs at least through 2005. Although we currently have
no specific plans to do so, to the extent we decide to pursue one or more
significant strategic acquisitions, we will likely incur debt or sell
additional equity to finance those acquisitions. Rescission Offer and Reporting Obligations For the first time at the end of any fiscal year, on December 31, 2002,
options granted under our 1998 stock plan were held by more than 500 holders.
As a result, we became subject to the registration requirements under section
12(g) of the Securities Exchange Act of 1934, as amended, which requires every
issuer having total assets of more than $10 million, and a class of equity
security held of record by more than 500 or more persons, to register that
class of equity security under the Exchange Act. We were required to comply
with the registration requirements within 120 days after the end of the first
fiscal year when we first met these assets and holder tests, and were required
pursuant to Section 12 of the Exchange Act to file periodic and other reports
under Section 13(a) of the Exchange Act. As a result of not having registered our securities under Section 12 and
not having filed reports under Section 13(a) of the Exchange Act beginning in
2003, grants of certain options under our 1998 plan between January 1, 2003
through April 28, 2004 may not have been exempt from registration or
qualification under federal and state securities laws, and we did not obtain
any required registration or qualification. As a result, we intend to make a
rescission offer to the U.S. holders of these options. In order to comply with
California securities laws, we will offer to repurchase these options. Before
the completion of its initial public offering, the Company applied to the
California Department of Corporations for approval of the terms of the
repurchase offer. By order dated October 28, 2004, the California Department
of Corporations approved the Companys repurchase application as to form
pursuant to section 25507(b) of the California Corporations Code. Pursuant to
the terms of our repurchase application, we intend to offer to repurchase the
options at 20% of the option exercise price multiplied by the number of shares
underlying the option, plus interest at an annual rate of 7% from the grant
date. Under these terms, we would be required to pay approximately $0.1
million, plus statutory interest at an annual rate of 7% if all persons
entitled to have their options repurchased elect to do so. Federal securities
laws do not expressly provide that a rescission offer will terminate a
purchasers right to rescind a sale of stock that was not registered as
required. If any or all of the offerees reject our offer to repurchase the
options, we may continue to be liable under federal and state securities laws.
We do not believe that this rescission offer will have a material effect on our
results of operations, cash flows or financial positions. In addition, our failure to file past required reports under the Exchange
Act of 1934 could conceivably give rise to potential claims by present or
former stockholders based on the theory that such holders were harmed by the
absence of such public reports. If any such claim is asserted, we could incur
expenses and divert managements attention in defending them, even if we have
no liability. On November 1, 2004, we filed a registration statement on Form S-8 under
the Securities Act covering shares of common stock under outstanding options
under our 1998 stock plan, including those that optionees do not elect to sell
back to us, in the rescission offer. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements, investments in special
purpose entities or undisclosed borrowings or debt. In addition, we have not
entered into any derivative contracts or synthetic leases. 20




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS RISK FACTORS Risks Related to Our Business Our revenues are highly dependent on four major clients that collectively
accounted for 82% of our revenues in the first nine months of 2004, and any
loss of business from our major clients would reduce our revenues and seriously
harm us. In recent years, we have generated, and expect that at least for the near
term we will continue to generate, almost all of our revenues from a limited
number of clients. Expedia, EarthLink, StarNumber (a subsidiary of InPhonic),
and ConsumerInfo.com have been our largest clients
in 2004 and accounted for 80% and 82% of our revenues for the three and nine
months ended September 30, 2004, respectively. Expedia, our largest client,
and EarthLink, our second largest client, together accounted for 59% and 61% of
our revenues for the three and nine months ended September 30, 2004,
respectively. Our contract with Expedia expires in May 2007 and our contract
with StarNumber expires in November 2005. Our contract with EarthLink expires
in January 2006, but will automatically renew each year for a one year period
unless terminated by EarthLink or us prior to the end of the term. Our
contract with ConsumerInfo.com expires in July 2006, but will automatically
renew each year for a one year period unless terminated by ConsumerInfo.com or
us prior to the end of the term. If we fail to renew or extend our contracts
with our clients, or if these contracts are terminated for cause or
convenience, our clients will have no obligation to purchase services from us. The loss of, or any significant decline in business from, one or more of
these clients likely would lead to a significant decline in our revenues and
operating margins, particularly if we are unable to make corresponding
reductions in our expenses in the event of any such loss or decline. We may
not be able to retain our major clients or, if we were to lose any of our major
clients, we may not be able to timely replace the revenue generated by the lost
clients. In addition, the revenue we generate from our major clients may
decline or grow at a slower rate in future periods than it has in the past. If
we lose any of our major clients, or if they reduce their volume with us, we
may suffer from the costs of underutilized capacity because of our inability to
eliminate all of the costs associated with conducting business with them, which
could exacerbate the harm that any such loss or reduction would have on our
operating results and financial condition. A reversal of industry trends toward offshore outsourcing due to negative
public reaction in the United States and recently proposed legislation may
adversely affect demand for our services. Our customer management and accounts receivable management services and
our growth depend in large part on U.S. industry trends towards outsourcing
these business processes offshore. The trend to outsource business processes
may not continue and could reverse. Offshore outsourcing has become a
politically sensitive topic in the United States, particularly in light of the
recent Presidential election. Recently, many organizations and public figures
have publicly expressed concerns about a perceived association between offshore
outsourcing providers and the loss of jobs in the United States. In addition,
there has been recent publicity about the negative experience of certain
companies that use offshore outsourcing, particularly in India. Current or
prospective clients may elect to perform such services themselves or may be
discouraged from transferring these services to offshore providers to avoid any
negative perception that may be associated with using an offshore provider.
Any slowdown or reversal of existing industry trends would harm our ability to
compete effectively with competitors that operate out of facilities located in
the United States. Estimates of the growth in the offshore outsourcing market
in this prospectus do not assume any such slowdown or reversal of recent
trends. A variety of federal and state legislation has been proposed that could
restrict or discourage U.S. companies from outsourcing their services to
companies outside the United States. For example, legislation has been
proposed that would require offshore providers to identify where they are
located and in certain cases to obtain consent to handling calls or sending
customer information offshore. It is also possible that legislation could be
adopted that would restrict U.S. private sector companies that have federal or
state government contracts from outsourcing their services to offshore service
providers. In addition, various federal tax changes that could adversely
impact the competitive position of offshore outsourcing services are also under
consideration. Any expansion of existing laws or the enactment of new
legislation directly or indirectly restricting offshore outsourcing may
adversely impact our ability to do business with U.S. clients, particularly if
these changes are widespread. 21




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS Our clients may adopt technologies that decrease the demand for our services,
which could reduce our revenues and seriously harm our business. We target clients with a high need for our customer management services
and we depend on their continued need of our services, especially our major
clients who generate the substantial majority of our revenues. However, over
time, our clients may adopt new technologies that decrease the need for live
customer interactions, such as interactive voice response, web-based self-help
and other technologies used to automate interactions with customers. The
adoption of such technologies could reduce the demand for our services,
pressure our pricing, cause a reduction in our revenues and harm our business.
For example, in 2003, one of our major clients, Network Solutions, which
accounted for over 10% of our 2003 revenues, improved its web-based self-help
technology and automated its telephone inquiry system, which we believe was a
contributing factor behind a reduction in revenues by 57% for the nine months
ended September 30, 2004 compared with the nine months ended September 30,
2003. Our revenues are highly dependent on a few industries and any decrease in
demand for outsourced services in these industries could reduce our revenues
and seriously harm our business. Our major clients are concentrated in the travel and hospitality,
technology and telecommunications industries. Our business and growth largely
depends on continued demand for our services from clients in these industries
and other industries we may target in the future and on trends in these
industries to purchase outsourced business process services. A downturn in any
of our targeted industries, particularly the travel and hospitality or Internet
service provider industry, or a slowdown or reversal of the trend in any of
these industries to outsource business processes could result in a decrease in
the demand for our services. Rapid change in and competition between
technology clients, particularly Internet service providers, could result in a
decrease in demand for our services within the technology industry. Other adverse changes also may lead to a decline in the demand for our
services in these industries. For example, consolidation in any of these
industries, particularly involving our clients, may decrease the potential
number of buyers of our services. Any significant reduction in or the
elimination of the use of the services we provide within any of these
industries would result in reduced revenues and harm our business. Our
clients, particularly those in the technology and telecommunications
industries, have frequently experienced rapid changes in their prospects,
substantial price competition and pressure on their profitability. Although
such pressures can encourage outsourcing as a cost reduction measure, they may
also result in increasing pressure on us from clients in these key industries
to lower our prices, which could negatively affect our operating results and
harm our business. We serve markets that are highly competitive and we may be unable to compete
with businesses that have greater resources than we do. We currently face significant competition for outsourced business process
services and expect that competition will increase. We believe that, in
addition to prices, the principal competitive factors in our markets are
service quality, sales and marketing skills, the ability to develop customized
solutions and technological and industry expertise. While numerous companies
provide a range of outsourced business process services, we believe our
principal competitors include our clients own in-house customer service
groups, including, in some cases, in-house groups operating offshore, offshore
outsourcing companies and U.S.-based outsourcing companies. Our principal
competitors in customer management services include Sykes Enterprises,
Convergys Corporation and TeleTech Holdings, each publicly traded U.S.
companies, and eTelecare International, ClientLogic, and Ambergris Solutions,
each privately held companies. Wipro LTD, a large publicly held outsourcer of
IT and IT related services based in India, recently announced plans to expand
its operations into the Philippines. The trend towards offshore outsourcing,
international expansion by foreign and domestic competitors and continuing
technological changes will result in new and different competitors entering our
markets. These competitors may include entrants from the communications,
software and data networking industries or entrants in geographic locations
with lower costs than those in which we operate. We have existing competitors, and may in the future have new competitors,
with greater financial, personnel and other resources, longer operating
histories, more technological expertise, more recognizable brand names and more
established relationships in industries that we currently serve or may serve in
the future. Increased competition, our inability to compete successfully
against current or future competitors, pricing pressures or loss of market
share could result in increased costs and reduced operating margins, which
could harm our business, operating results, financial condition, and future
prospects. 22




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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, it takes
from four to six weeks to integrate the clients systems with ours, and up to
three months thereafter to ramp-up our services to the clients requirements. We have incurred substantial losses in the past and may not be profitable in
the future. We did not become profitable until 2003 and incurred significant losses in
each of the five fiscal years through 2002. This was mainly the result of
excess capacity and high costs of our former U.S. outsourcing centers. We
found it necessary to restructure our operations and move to the Philippines in
order to become profitable. We may incur significant operating losses in the
future. As a result of our operating losses, we had an accumulated deficit of
$61.0 million at September 30, 2004. We expect our marketing, sales and other
operating expenses to increase in the future as we seek to expand our business.
If our revenues do not grow at a faster rate than these expected increases in
our expenses or if our operating expenses are higher than we anticipate, we may
not be profitable and we may incur additional losses. 23




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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 in our accounts receivable
management services, which we commenced in April 2003, our business and future
prospects are difficult to evaluate. We have limited experience providing
accounts receivable management services and we are exploring opportunities to
provide other outsourced services that we have not provided to date. You
should consider the challenges, risks, and uncertainties frequently encountered
by early-stage companies using new and unproven business models in rapidly
evolving markets. These challenges include our ability to:  
    
    Attract and retain clients;  
    
    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;  
    
    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. 24




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS We may experience significant employee turnover rates in the future and we may
be unable to hire and retain enough sufficiently trained employees to support
our operations, which could harm our business. The business process outsourcing industry is very labor intensive and our
success depends on our ability to attract, hire, and retain qualified
employees. We compete for qualified personnel with companies in our industry
and in the other industries and this competition is increasing in the
Philippines as the BPO industry expands. Our growth requires that we
continually hire and train new personnel. The BPO industry, including the
customer management services industry, has traditionally experienced high
employee turnover. A significant increase in the turnover rate among our
employees would increase our recruiting and training costs and decrease
operating efficiency and productivity, and could lead to a decline in demand
for our services. If this were to occur, we would be unable to service our
clients effectively and this would reduce our ability to continue our growth
and operate profitably. We may be unable to continue to recruit, hire, train,
and retain a sufficient labor force of qualified employees to execute our
growth strategy or meet the needs of our business. Our senior management team is important to our continued success and the loss
of members of senior management could negatively affect our operations. The loss of the services of Lance Rosenzweig, our Chief Executive Officer;
Caroline Rook, our Chief Financial Officer; Rainerio Borja, our President of
PeopleSupport (Philippines); or Parham Farahnik, our Vice President of Sales
and Marketing, could seriously impair our ability to continue to manage and
expand our business. Our success depends on the continued service and
performance of our executive officers, and we cannot guarantee that we will be
able to retain these individuals. Our executive officers are at-will
employees that are not subject to employment agreements providing for any
specified term of employment. We do not have key man insurance, nor are our
U.S.-based executive officers subject to non-compete restrictions. The planned move of our operations to our new facility in Manila could result
in interruptions in service, which could reduce our revenues and harm our
business. We plan to relocate our regional headquarters in the Philippines and at
least one of our outsourcing locations to a facility to be built in Manila,
which we expect to be operational in 2005. The relocation of our operations to
this new facility will involve a number of logistical and technical challenges.
We may encounter complications associated with the migration of our systems
and computing equipment to our new facility, which could result in
interruptions of our services. If such interruptions occur, they could result
in financial or other damages to our clients, for which we could incur claims
and liabilities and which could damage our reputation and cause us to lose
significant business from one or more of our major clients. This would harm
our business and operating performance. Our facilities are at risk of damage by earthquakes and other natural
disasters. We currently rely on the availability and condition of our leased Los
Angeles, Manila, and Cebu facilities to provide service and support to our
clients. These facilities are located in regions that are susceptible to
earthquakes and other natural disasters, which may increase the risk of
disruption of information systems and telephone service for sustained periods.
Damage or destruction that interrupts our provision of outsourcing services
could damage our relationship with our clients and may cause us to incur
substantial additional expense to repair or replace damaged equipment or
facilities. While we currently have commercial liability insurance, our
insurance coverage may not be sufficient. Furthermore, we may be unable to
secure such insurance coverage or to secure such insurance coverage at premiums
acceptable to us in the future. Prolonged disruption of our services as a
result of natural disasters may entitle our clients to terminate their
contracts with us. Our operations could suffer from telecommunications or technology downtime,
disruptions or increased costs. We are highly dependent on our computer and telecommunications equipment
and software systems. In the normal course of our business, we must record and
process significant amounts of data quickly and accurately to access, maintain
and expand the databases we use for our services. We are also dependent on
continuous availability of voice and electronic communication with customers.
If we experience interruptions of our telecommunications network with our
clients, we may experience data loss or a reduction in revenues. These
disruptions could be the result of errors by our vendors, clients, or third
parties, electronic or physical attacks by persons seeking to disrupt our
operations, or the operations of our vendors, clients, or others. For example,
we currently depend on two significant vendors for facility storage and related
maintenance of our main technology equipment and data at our U.S. data centers.
Any failure of these vendors to perform these services could result in
business disruptions and impede our ability to provide services to our clients.
A significant interruption of service could have a negative impact on our
reputation and could lead our 25




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 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. 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 26




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 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 regulation that could limit or restrict
our activities and impose financial requirements or limitations on the conduct
of our business. The BPO industry has become subject to an increasing amount of federal and
state regulation in the past five years. Despite our focus on inbound customer
management, we are subject to regulations governing communications with
consumers due to the activities we undertake on behalf of our clients to
encourage customers to purchase higher value, additional or complementary
products and services offered by our clients. For example, the Federal
Telemarketing and Consumer Fraud and Abuse Prevention Act of 1994 broadly
authorizes the Federal Trade Commission to issue regulations prohibiting
misrepresentations in telephone sales. In addition, limits on the transport of
personal information across international borders such as those now in place in
the European Union (and proposed elsewhere) may limit our ability to obtain
customer data. We are also subject to significant federal and state laws and regulations
applicable to our accounts receivable management services, including the Fair
Debt Collection Practices Act, which imposes significant limitations and
restrictions on our debt collection practices including licensing requirements.
These laws and regulations may limit our ability to recover and enforce
defaulted consumer receivables regardless of any act or omission on our part.
Some laws and regulations applicable to credit cards, debit cards, checks and
other negotiable items may preclude us from collecting on defaulted consumer
receivables we purchase or obtain through contingency placements from
originators if they or others failed to comply with applicable law in
generating or servicing those receivables. Additional federal, state, local or
international legislation, or changes in regulatory implementation, could
further limit our activities or those of our clients in the future or
significantly increase the cost of regulatory compliance. Our ability to raise capital in the future, if and when needed, may be limited,
and could prevent us from executing our business strategy. The sale of
additional equity securities would result in further dilution to our
stockholders. We believe that our existing cash and cash equivalents, together with the
net proceeds from our recently completed offering, will be sufficient to
support our anticipated cash needs at least through 2005. However, the timing
and amount of our working capital and capital expenditure requirements may vary
significantly depending on numerous factors, including:  
    
    Market acceptance of and demand for our offshore outsourced
services which may be affected by political and public relations
reactions to offshore outsourcing;  
    
    Access to and availability to sufficient management, technical, marketing, and financial personnel;  
    
    The need to enhance our operating infrastructure;  
    
    The continued development of new or enhanced services and hosted solutions; 27




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS  
    
    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 may face potential claims under federal and state securities laws. On December 31, 2002, options granted under our 1998 stock plan were held
by more than 500 holders. As a result, we became subject to the registration
requirements under Section 12(g) of the Securities Exchange Act of 1934. We
were required to file periodic reports, such as 10-Ks and 10-Qs, under Section
13(a) of the Exchange Act beginning in 2003. We did not file any such reports
until we filed a Form 10 registration statement in June 2004. As a result
of our failure to file the reports, grants of certain options under
our 1998 stock plan between January 1, 2003 and April 28, 2004 may not have been
exempt from registration or qualification under federal and state securities
laws, and we did not obtain any required registration or qualification. To
address this matter, we intend to make a rescission offer to the holders of
these options. Under the rescission offer, we intend to offer to repurchase the
options at 20% of the option exercise price multiplied by the number of shares
underlying the option, plus interest at an annual rate of 7% from the grant
date. We would be required to pay approximately $0.1 million, plus statutory
interest at an annual rate of 7% if all persons entitled to have their options
repurchased elect to do so. Federal securities laws do not expressly provide
that a repurchase offer will terminate a purchasers right to rescind a sale of
stock that was not registered as required. If any or all of the offerees reject
our offer to repurchase the options, we may continue to be liable under federal
securities laws. In addition, our failure to file required Exchange Act reports could
conceivably give rise to potential claims by present or former stockholders
based on the theory that such holders were harmed by the absence of such public
reports. If any such claim is asserted, we could incur expenses and divert
managements attention in defending them, even if we have no liability. 28




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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. 29




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS Other Risks Related to Us Our stock price may be volatile, and you may not be able to resell shares of our
common stock at or above the price you paid, or at all. Before our recently completed initial public offering, our common stock was not
traded in a public market. Since the completion of our initial public offering,
our stock price has been and may continue to be volatile. We cannot predict the
extent to which the trading market will continue to develop or how liquid that
market might become. Prices for our common stock could be influenced by a
variety of factors, including the depth and liquidity of the market for our
common stock, investor perception of us, our business and our industry, the
consumer credit and outsourcing industries, and general economic and market
conditions. The trading price of our common stock could be subject to wide
fluctuations due to the factors discussed in this risk factors section and
elsewhere in this report. In addition, the stock market in general and the
Nasdaq National Market have experienced extreme price and volume fluctuations.
Trading prices and valuations may not be sustainable. Broad market and industry
factors may decrease the market price of our common stock, regardless of our
actual operating performance. In addition, following periods of volatility in
the overall market and a decline in the market price of a companys stock,
securities class action litigation has often been instituted. This litigation,
if instituted against us, could result in substantial costs and a diversion of
our managements attention and resources. If securities or industry analysts cease publishing research or reports about
our business or if they change negatively their recommendations regarding our
stock, our stock price and trading volume could decline. The trading market for our common stock is influenced by the research and
reports that industry or securities analysts publish about us or our business.
If one or more of the analysts who cover us publishes negative research on us or
our industry, or downgrades our stock, our stock price would likely decline. If
one or more of these analysts cease or limit coverage of us or our industry, or
fail to regularly publish reports on us, we could lose visibility in the
financial markets, which in turn could cause our stock price or trading volume
to decline. Substantial future sales of our common stock in the public market could cause
our stock price to fall. Substantial future sales of our common stock in the
public market, or the perception that these sales could occur, could cause the
market price of our common stock to decline. At November 11, 2004, 17,951,259
shares of common stock were outstanding and 1,424,505 shares were to be issued
upon the exercise of outstanding warrants and options. The shares sold in our
initial public offering are freely transferable without restriction or
additional registration under the U.S. Securities Act of 1933, as amended, or
the Securities Act. The remaining shares of common stock outstanding after our
initial public offering are available for sale, subject to volume and other
restrictions as applicable under Rules 144 and 701 under the Securities Act.
Additionally, our directors, executive officers and certain principal
stockholders entered into lock up agreements with the underwriters in
connection with our initial public offering, in which they agreed to refrain
from selling their shares for a period of 180 days after our initial public
offering. Approximately 9,819,831 of these shares will become available for sale
at various times upon the expiration of holding periods and lock-up agreements.
We also may be required to issue additional shares upon the exercise of
previously granted options or warrants that are currently outstanding. Increased sales of our common stock in the market 180 days after our initial
public offering could exert significant downward pressure on our stock price.
These sales also may make it more difficult for us to sell equity or
equity-related securities in the future at a time and price we deem appropriate. We will incur increased costs as a result of being a public company. As a public company, we will incur significant legal, accounting and other
expenses that we did not incur as a private company. We estimate that these
costs will be approximately $2.0 million annually, but they could be higher.
The Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented
by the Securities and Exchange Commission and the Nasdaq National Market, have
required changes in corporate governance practices of public companies. We
expect these new rules and regulations to increase our legal and financial
compliance costs and to make some activities more time-consuming and costly.
For example, as a result of becoming a public company, we created additional
board committees and adopted policies regarding internal controls and
disclosure controls and procedures. In addition, we will incur additional costs
associated with our public company reporting requirements. We also expect these
new rules and regulations to make it more difficult and more expensive for us
to obtain director and officer liability insurance and we may be required to
accept reduced policy limits and coverage or incur substantially higher costs
to obtain the same or similar coverage. As a result, it may be more difficult
for us to attract and retain qualified candidates to serve on our board of
directors or as executive officers. We are currently evaluating and monitoring
developments with respect to these new rules, which may result in additional
costs in the future. Delaware law and our amended and restated certificate of incorporation and
bylaws will contain anti-takeover provisions that could delay or discourage
business combinations and takeover attempts that stockholders may consider
favorable. Our certificate of incorporation and bylaws contain provisions that may
make it more difficult, expensive or otherwise discourage a tender offer or a
change in control or takeover attempt by a third-party that is opposed by our
board of directors. These provisions may have the effect of delaying or
preventing a change of control or changes in management that stockholders
consider favorable. In particular, our certificate of incorporation and bylaws
include provisions that:  
    
    Classify our board of directors into three groups, each of
which, after an initial transition period, will serve for staggered
three-year terms;  
    
    Permit the board of directors to elect a director to fill a vacancy created by the expansion of the board of directors;  
    
    Permit stockholders to remove our directors only for cause;  
    
    Permit a special stockholders meeting to be called only by our
chairman of the board of directors, president, or chief executive
officer, a majority of our board of directors or two-thirds of the
independent directors;  
    
    Require stockholders to give us advance notice to nominate
candidates for election to our board of directors or to make
stockholder proposals at a stockholders meeting;  
    
    Permit our board of directors to issue, without approval of our
stockholders, up to 4,000,000 shares of preferred stock with terms
that our board of directors may determine and that may be senior to
the terms of our common stock;  
    
    Prohibit cumulative voting in the election of directors that
would otherwise allow less than a majority of stockholders to elect
directors;  
    
    Permit the board of directors to alter certain provisions of
our amended and restated bylaws without obtaining stockholder
approval;  
    
    Require approval of at least 75% of the shares entitled to vote
at an election of directors to adopt, amend or repeal our amended and
restated bylaws or amend or repeal the provisions of our amended and
restated certificate of incorporation regarding the election and
removal of directors and the ability of stockholders to take action;
and  
    
    Eliminate the right of stockholders to call a special meeting
of stockholders and to take action by written consent. Additionally, because we are incorporated in Delaware, we are subject to
Section 203 of the Delaware General Corporation Law. These provisions may
prohibit large stockholders, in particular those owning 15% or more of our
outstanding voting stock, from merging or combining with us. These provisions
in our amended and restated certificate of incorporation, amended and restated
bylaws and under Delaware law could discourage potential takeover attempts and
could reduce the price that investors might be willing to pay for shares of our
common stock in the future and result in the market price being lower than they
would without these provisions. Our corporate actions are substantially influenced by officers, directors,
principal stockholders and affiliated entities. Our directors, executive officers and their affiliated entities
beneficially own approximately 25.7% of our outstanding common stock. These
stockholders, if they were to act together, could exert substantial influence
over matters requiring approval by 30




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 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. 31




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 
 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk Foreign Currency Exchange Risk Our results of operation and cash flows are subject to fluctuations due to
changes in foreign current exchange rates, particularly changes in the
Philippine peso. For the nine months ended September 30, 2004 and 2003,
approximately 52% and 46%, respectively, of our expenses were generated in the
Philippines. We derive all of our revenues in US dollars. A 10% increase in the
value of the U.S. dollar relative to the Philippine peso would reduce the
expenses associated with the operations of our overseas operation by
approximately $1.4 million, whereas a 10% decrease in the relative value of the
dollar would increase the cost associated with these operations by
approximately $1.4 million. Expenses relating to our operation outside the
United States increased in the nine months ended September 30, 2004 when
compared to the nine months ended September 30, 2003 due to increased costs
associated with higher revenue generation and customer management services,
partially offset by the increase in the value of the U.S. dollar relative to
the Philippine peso. We fund our Philippine subsidiary on a bi-monthly basis through U.S.
dollar denominated accounts held in the Philippines. Payments for
employee-related costs, facilities management, other operational expenses and
capital expenditures are converted into Philippine pesos on an as-needed basis.
To date, we have not entered into any hedging contracts. Historically, we have
benefited from the ongoing decline in the Philippine peso against the U.S.
dollar. Interest Rate Sensitivity We had cash, cash equivalents and restricted cash equivalents totaling
$11.5 million at September 30, 2004. These amounts were invested primarily in
money market funds. The unrestricted cash and cash equivalents are held for
working capital purposes. We do not enter into investments for trading or
speculative purposes. We believe that we have no material exposure to changes
in the fair value of our investment portfolio as a result of changes in
interest rates. Declines in interest rates, however, would reduce future
investment income. A 1% decrease in short term rates would reduce our interest
income by approximately $0.1 million. The interest income from these funds
will be subject to fluctuations due to changes in interest rates. Inflation Rate Sensitivity For the nine months ended September 30, 2004 and 2003, approximately 52%
and 46%, respectively, of our expenses were generated in the Philippines. The
Philippines has historically experienced periods of high inflation but the
inflation rate has been below 10% since 1999. For the six months ended June 30,
2004 inflation averaging 4.1% kept prices generally stable. However, we are
currently experiencing higher inflation and expected this trend to continue in
2005. Inflation in the Philippines has not affected our operating results for
two reasons. First, the Philippines has historically experienced deflationary
pressure on wages due to a fast growing population, high unemployment (13.7%
for the three month period ended March 31, 2004) and 385,000 college graduates
a year entering a market that cannot absorb all of them. Second, our pesos
denominated expenses have decreased in dollar terms due to the decline in the
value of the peso relative to the dollar, discussed above. A reversal of these
trends, increased wage pressure due to increased competition as the BPO
industry expands or higher rates of inflation in the Philippines could result
in increased costs and harm our operating results. A number of our leases in
the Philippines have escalation clauses triggered by Philippine inflation above
negotiated thresholds, as discussed above. 
 ITEM 4. Controls and Procedures (a) Evaluation of disclosure controls and procedures.We maintain
disclosure controls and procedures, as such term is defined in Rule 13a-15(e)
under the Securities Exchange Act of 1934 (the Exchange Act), that are
designed to ensure that information required to be disclosed by us in reports
that we file or submit under the Exchange Act is recorded, processed,
summarized, and reported within the time periods specified in Securities and
Exchange Commission rules and forms, and that such information is accumulated
and communicated to our management, including our Chief Executive Officer and
Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure. In designing and evaluating our disclosure controls and
procedures, management recognized that disclosure controls and procedures, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the disclosure controls and
procedures are met. Additionally, in designing disclosure controls and
procedures, our management necessarily was required to apply its judgment in
evaluating the cost- 32




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 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 to ensure that material
information relating to us, including our consolidated subsidiaries, is made
known to them by others within those entities, particularly during the period
in which this quarterly report on Form 10-Q was being prepared. (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. 33




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2004 
 PART II OTHER INFORMATION 
 ITEM 1. Legal Proceedings From time to time, the Company may be involved in claims in lawsuits that
arise in the ordinary course of business. Accruals for claims or lawsuits have
been provided for to the extent that losses are deemed probable and estimable.
Although the ultimate outcome of these claims or lawsuits cannot be
ascertained, on the basis of present information and advice received from
counsel, the Company accrues for the estimated minimum probable loss as the
liability. Management believes that the disposition or ultimate determination
of all such claims or lawsuits will not have a material adverse effect on the
Company. 
 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds On September 30, 2004, the SEC declared effective the Companys
Registration Statement on Form S-1 (File No. 333- 115328) (Registration
Statement) for our initial public offering. Under the Registration Statement,
we registered 7,840,909 shares of our common stock for an aggregate offering
size of $54.9 million. 5,348,727 shares (including 603,000 shares sold by us
upon exercise of the underwriters over-allotment option) were sold by us and
2,072,455 shares were sold by certain selling stockholders. All of the
7,421,182 shares sold in this offering were sold at $7.00 per share. The
offering closed on October 6, 2004 (and the sale of the 603,000 additional
shares pursuant to the exercise of the over-allotment option closed on October
25, 2004). The managing underwriters were SG Cowen & Co., Piper Jaffray & Co.,
A.G. Edwards & Sons and JMP Securities. The aggregate gross proceeds from the sale of 5,348,727 shares of common
stock sold by us (including the 603,000 shares sold in the over-allotment) was
$37,441,089. The aggregate gross proceeds from the sale of 2,072,455 shares
sold by the selling stockholders was $14,507,185. The aggregate net proceeds to
us after the offering were $31,720,213, after deducting an aggregate of
$2,620,876 in underwriting discounts and commissions paid to the underwriters
and an estimated $3,100,000 in other expenses incurred in connection with this
offering. The aggregate net proceeds to the selling stockholders were
$13,491,682 after deducting an aggregate of $1,015,503. On October 6, 2004, we invested all of our net proceeds in short-term,
interest-bearing instruments. 
 ITEM 3. Defaults Upon Senior Securities None. 
 ITEM 4. Submission of Matters to a Vote of Security Holders During the three months ended September 30, 2004, we solicited the written
consent of our stockholders pursuant to Section 228 of the General Corporation
Law of the State of Delaware in connection with the following proposals: 1. In July 2004, we sent a written consent to certain of our stockholders
requesting approval to the taking of the following actions in connection with
the initial public offering of our common stock: a. The approval of a reverse 1 for 2.74 stock split of our common stock
and preferred stock, and the filing of an amendment to our certificate of
incorporation to reflect the reverse stock split. b. The approval of our amended and restated certificate of incorporation
and amended and restated bylaws that were filed and went into effect upon
the completion of our initial public offering on October 6, 2004. c. The approval of the form of indemnification agreements with our
officers and directors. d. The approval of our 2004 Stock Incentive Plan. 34




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PEOPLESUPPORT, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2004 e. The approval of our 2004 Employee Stock Purchase Plan. A total of 7,721,612 post split shares, representing no less than 61% of
our capital stock on an as-converted basis (including 6,722,795 post split
shares of preferred stock, representing no less than 64% of our preferred
stock) voted in favor of these matters. The resolutions for the
above-described approvals were adopted as of July 21, 2004. 2. In August 2004, we sent a written consent to certain of our
stockholders requesting approval of an amendment to our certificate of
incorporation to lower the minimum price at which shares of our preferred stock
would be automatically converted upon the completion of our initial public
offering from $9.59 to $6.95 per share. A total of 8,498,592 post split shares,
representing no less than 71.96% of our capital stock on an as-converted basis
(including 7,263,424 post split shares of preferred stock, representing no less
than 75% of our preferred stock) voted in favor of this matter. The resolutions
for the above-described approval were adopted as of August 24, 2004. 
 ITEM 5. Other Information None. 
 ITEM 6. Exhibits ExhibitNumber31.1
    
    Certification by Chief Executive Officer of Registrant pursuant
to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification by Chief Financial Officer of Registrant pursuant
to Section 302 of the Sarbanes-Oxley Act of 200232.1*
    
    Certification by Chief Executive Officer of Registrant pursuant
to Section 906 of the Sarbanes-Oxley Act of 200232.2*
    
    Certification by Chief Financial Officer of Registrant pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
 * 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. 35




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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 November 15, 2004. PeopleSupport, Inc.By:
    
    /s/ Caroline RookCaroline RookChief Financial Officer(Principal Financial and Accounting Officer)
 36