Item 1.
Business
All references to “we,” “our,” and “us” in this Annual Report on Form 10-K refer to PeopleSupport, Inc. and its subsidiaries.
Overview
We are a leading provider of offshore business process outsourcing, or BPO, services which we deliver primarily to U.S.-based clients from our facilities in the Philippines. Based on the size of our Filipino workforce, we believe we are one of the largest providers of BPO services operating from the Philippines. We provide cost-effective, complex, value-added customer management services to clients in the travel and hospitality, financial services, technology, telecommunications and consumer products industries. We also provide transcription and captioning and other BPO services in the healthcare and insurance, law enforcement, entertainment and education markets. Our Filipino employees are familiar with U.S. consumer preferences and are highly trained to understand our clients’ products and services and maximize the quality of every customer interaction, while generating incremental revenues for our clients by up-selling and cross-selling additional products and services. In the large and rapidly growing global BPO market, we believe these strengths distinguish us from our competitors in India, the Philippines and other offshore locations, and facilitate the development of long-term strategic partnerships between us and our clients. From 2003 to 2006, our annual revenues increased from $30.0 million to $110.1 million.
We target clients and industries that have broad customer bases with complex customer interaction needs. We provide customer management services to approximately 40 principally U.S.-based clients. Our customer management services involve handling calls and e-mails to order goods and services, making and changing travel reservations, addressing billing questions, processing loans and warranty claims, collecting overdue consumer receivables and providing technical support. We also provide transcription and captioning services through a network of transcriptionists in the Philippines and the United States. Our transcription and captioning business includes transcribing voice recordings and captioning television, film and educational content. Other BPO services we offer include credit application processing, data verification, account activation and mortgage servicing. We perform our services through a variety of channels, including inbound and outbound telephone calls, e-mail and webchats. We perform over 100 processes and manage over 4.5 million customer communications per month for our clients.
We have developed a flexible, secure, integrated “hub and spoke” delivery platform that provides for rapid dissemination of information to and from our outsourcing centers. Our outsourcing centers act as “spokes” connected to data center “hubs” in the United States where applications and data are stored. This platform has the ability to shift transmissions among several major carriers for consistent, highly secure and reliable service and allows us to bring online additional outsourcing centers quickly and efficiently. In 2006, we expanded our delivery platform with a new outsourcing center in Costa Rica with approximately 450 employees, from which we provide bilingual Spanish-English customer management services to Washington Mutual, Inc.
We believe the Philippines offers significant cultural and language advantages over other offshore outsourcing locations such as India. The Philippines has the third largest English-speaking population in the world and has long-standing ties to the United States. It has modeled many of its government and accounting systems after those of the United States, and English is used to teach mathematics, science and health beginning in the third grade and is the primary language of instruction in college. We require that our Filipino service professionals have completed at least two years of college. The Philippines has a large pool of skilled college-educated applicants who are attuned to U.S. culture and speak fluent English with minimal accents.
As we continue to expand our customer management and transcription and captioning businesses, we are developing plans to offer other complementary BPO services that leverage our low cost, off-shore model. This may include financial services, legal support and healthcare. We have also been in discussions with our clients to assess their demand for additional services and geographic diversification. We are also considering strategic acquisitions as a way of entering or expanding into new markets.
Corporate Background and History
We were incorporated in 1998 under Delaware law. We began providing outsourced customer management services in 1998 from our Los Angeles outsourcing center. In an effort to reduce operating costs and gain a competitive advantage, in 2000 and 2001, we restructured our business by relocating our outsourcing operations first to St. Louis, Missouri and then to the Philippines. In connection with our relocation to the Philippines, in 2000, we purchased the assets of a Philippine-based outsourcing company and formed PeopleSupport (Philippines), Inc., to function as our operating subsidiary in the Philippines. In 2003, we completed the migration of our outsourcing operations to the Philippines and closed our facility in St. Louis. The restructuring of our operations resulted in significant cost savings due to reductions in labor and lease expenses. We benefited from substantially lower wage rates in the Philippines and gained access to a large pool of skilled, college-educated, English-speaking professionals. We also benefited from abundant and cost-effective telecommunications capacity linking the Philippines with our data centers in the United States. As the demand for our offshore outsourced services grew, we expanded our outsourcing operations in the Philippines. We currently maintain eight outsourcing facilities and, as of the date of this filing, employ approximately 8,400 personnel in the Philippines.
In January 2006, we began providing transcription and captioning services through our acquisition of Rapidtext, Inc. and its subsidiary, The Transcription Company. We service hundreds of transcription and captioning customers in the healthcare and insurance, law enforcement, entertainment and education markets. We provide these services through our operations in the U.S. and the Philippines, and through a network of independent contractors.
The BPO Industry - Overview
Business process outsourcing involves contracting with an external organization to take primary responsibility for providing a business process or function. The BPO market includes several functionally-oriented submarkets, such as customer management, transcription and captioning, processing services, human resources, procurement, logistics support, finance and accounting, engineering, facilities management, information technology and training. Within these submarkets, we primarily participate in customer management outsourcing, which we generally define as outsourcing any customer service, sales, marketing, technical support or accounts receivable functions, and transcription and captioning.
Current Trends in Customer Management
The scope of customer management outsourcing consists of complex and varied customer management services capable of duplicating and enhancing all of the functionality of a client’s internal customer service team. The delivery platform has evolved into large, high volume customer management centers that use advanced technology and require customized training programs tailored to each client’s needs, systems and technology. Companies are now focused on optimizing their brands through improved customer management and increasing the value of their customer relationships by encouraging the purchase of higher value, additional or complementary products and services. At the same time, global competition, pricing pressures and rapid changes in technology make it increasingly difficult for companies to cost-effectively maintain the in-house personnel and infrastructure necessary to handle all of their customer management needs. We believe these trends, combined with rapidly expanding consumer use of alternative communications, such as the Internet, e-mail, fiber optic telecom and Voice over Internet Protocol, or VoIP, have allowed providers of outsourced customer management services to satisfy clients’ needs in an efficient and cost-effective manner.
We believe that the majority of customer management services that could be outsourced are still performed in-house, representing a significant opportunity for us. In addition, we believe the following factors will continue to influence companies to outsource their business processes, including their customer management functions:
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significant cost benefits;
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best practices in leveraging learned experiences across multiple clients in an efficient and effective manner, particularly within the client’s specific industries;
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the importance of professionally managed customer communications to retain and grow customer relationships;
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the ability to free available resources and management to focus on developing core products and services;
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the use of highly skilled professionals by the outsourcing industry;
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the extensive and ongoing staff training and associated costs required for maintaining in-house technical support and customer service solutions; and
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the ability to avoid capital requirements for the sophisticated communications technology needed to provide timely, high quality customer service.
Offshore Delivery of BPO Services
According to Gartner, an international research firm, the offshore BPO market is projected to grow from $6.4 billion to $42.9 billion from 2005 to 2009.
We believe that, to attain high quality BPO services at a lower cost, many companies are moving selected front- and back-office processes to providers with offshore delivery capabilities. In recent years, fiber optic telecommunications have become widely available at affordable rates. At the same time, we believe offshore providers have become more accepted by businesses in the U.S. and continue to grow in recognition and sophistication. As a result, a large number of BPO services companies have established offshore operations or operate exclusively offshore. Potential clients, in requests for proposals, frequently require significant detail about offshore delivery capabilities.
India currently accounts for the largest share of the offshore BPO market; however, the offshore industry is expanding beyond India to countries such as the Philippines, Costa Rica, China and Russia. We believe the Philippines has emerged as an attractive alternative to India as a destination for offshore outsourcing services, particularly BPO services that require complex, value-added voice interactions in English.
Competitive Strengths
We believe the following competitive strengths have allowed us to successfully create a sustainable and scalable position as a leading offshore BPO services provider.
Offshore Delivery Model
The Philippines, where the majority of our BPO centers are located, is an attractive and growing market for offshore business process outsourcing services. As an early entrant in the Philippines, we successfully established ourselves as one of the market leaders. The Philippines, with a large pool of skilled, college-educated professionals, has the third largest English-speaking population in the world, and English is used to teach mathematics, science and health beginning in the third grade and is the primary language of instruction in college. Many Filipinos are familiar with Western business practices and have an affinity for American culture, which we believe offers a substantial advantage in interacting with U.S. consumers and processing their business transactions. In addition, the Philippines has a well-developed telecommunications and utility infrastructure and is an attractive business environment for BPO companies. For instance, we have direct fiber optic lines to all of our outsourcing centers in the Philippines. The Philippine government has encouraged foreign investment and provided significant assistance to the BPO industry through tax holidays, changes to the country’s educational curriculum and relaxation of certain regulatory restrictions. We believe our English-speaking workforce enables us to provide consistent high quality outsourcing services at costs generally comparable to other offshore locations and substantially lower than those in the United States.
Our scalable platform allows us to bring additional outsourcing centers online quickly and efficiently. In the first half of 2006, we opened an outsourcing center in Costa Rica where we currently have approximately 450 personnel serving bilingual English and Spanish needs of Washington Mutual, Inc.
Deep Industry Expertise with a Focus on Developing Collaborative Client Relationships
Our industry-focused sales and client development structure has allowed our sales personnel and client service directors to focus on specific industries, and acquire a thorough understanding of our clients’ business issues and customer needs. As a result, we have developed substantial expertise in the key industries where we do business, which require complex customer management services. For example, we believe that we are the only offshore BPO company accredited by IATA, the International Air Transport Association, which provides us special travel and hospitality benefits as well as attractive recruiting and retention advantages. We collaborate with each of our clients to understand their outsourcing needs and jointly create solutions and service offerings. As part of these efforts, many of our clients visit our facilities in the Philippines to participate directly in the training of our professionals. Our clients also invest resources to integrate their processes and technologies with ours to make our services transparent to their customers and provide real-time access to data and reports. We believe that by collaborating with our clients on training programs and integrating our processes, IT and reporting systems, we will continue to develop long-term strategic relationships.
Sales and Service Delivery Effort Focused on Every Step of the Customer Interaction
We focus on providing cost-effective solutions that maximize the quality of every customer interaction and generate incremental revenues for our clients by up-selling and cross-selling additional products and services. We have extensive experience in recruiting qualified professionals, providing them uniform training and tracking their performance with detailed, metric-rich performance reports. In addition, we focus on customer retention for our clients. For example, we employ a variety of measures and strategies to retain customers who may be considered at risk for cancellation or defection. Through our emphasis on customer satisfaction and incremental revenue generation, we improve sales of our clients’ products and services, strengthen their relationships with their customers and increase the likelihood of repeat sales.
Scalable Delivery and Technology Platform
We provide communications between customers in the United States and our professionals in the Philippines and Costa Rica by using dedicated fiber lines leased from major fiber optic network providers. We securely route inbound, multi-channel communications to the optimal location based on our professionals’ skill sets and availability. We also use a uniform “hub and spoke” information technology platform that is scalable. Applications and data are stored at our data center “hubs” in the United States, and deployed to our “spokes” in the Philippines and Costa Rica. This architecture allows us to expand to meet the needs of our existing and new clients, optimize our seat and workforce utilization and add additional locations. In addition, we have security capabilities to conduct customer transactions in confidence and we actively monitor our systems and networks for any service disruptions or downturns in performance, so we can identify and address issues quickly and efficiently.
Attractive Employment Culture
We believe we have established a corporate culture that enables us to attract and retain talented professionals. We have developed an extensive recruiting network to attract high quality talent, primarily from universities, throughout the Philippines. Our reputation allows us to attract high quality candidates and be highly selective in our recruiting. We also offer a broad range of programs for enhancing employee retention and encouraging career development, including creating rewards and recognition for performance, stressing professional development through continuing education, offering attractive compensation and comprehensive benefits packages and encouraging open communication between employees and management.
Growth Strategy
In order to build on our position as a leading offshore BPO services provider, we are focusing on the following strategies:
Continue to Drive Strong Organic Growth
We have a demonstrated history of driving sales and profitability by expanding services to existing clients and to new clients. We intend to use our expertise to identify additional BPO opportunities within our existing client base as well as targeting other prospective clients that have large customer bases and complex customer management needs. Additionally, we believe that a majority of customer management services that could be outsourced are still performed in-house, representing a significant growth opportunity for us. We have developed a highly targeted marketing strategy for future client acquisition involving direct calls, Internet-based advertising, search engine optimization, trade shows and industry publications. As we identify and engage potential clients, we work in a collaborative manner to match our clients’ service needs with our capabilities. Our client development efforts focus on U.S.-based companies, but also extend to potential clients in other English- and Spanish-speaking countries.
Broaden Service Offerings to Leverage Existing Infrastructure
We seek to enhance our portfolio of services by focusing on client requirements, emerging trends and new technologies that will create the need for additional BPO services. We believe we can drive our return on invested capital by leveraging our existing base of skilled professionals and infrastructure. Currently, our customer management services are performed predominantly in the Philippine nighttime (the U.S. daytime). We are focusing on expanding services that we can provide during the Philippine daytime in order to better utilize our seat capacity. For example, we have used customer service seats to perform non-voice services during customer call down-times. We believe we can offer off-peak services using our existing BPO facilities, without the need for significant additional capital expenditures.
Expand to Additional Countries
We conduct the majority of our outsourcing services in the Philippines and, although the Philippines is an attractive offshore BPO services market in which we have a strong competitive position, we continue to evaluate new geographic markets. With our recent expansion to Costa Rica, we see the potential to increase our Spanish and bilingual English-Spanish services and provide geographic diversification.
We believe that other regions and countries that have an educated, English-speaking or bilingual workforce at reasonable wage rates, such as other parts of Latin America, Asia, Eastern Europe, Africa, India and the Caribbean, would be the most likely areas for further geographic diversification of our operations. We believe that our technology and operations platform will allow us to efficiently add new outsourcing centers in multiple locations.
Pursue Selective Strategic Acquisitions
In January 2006, we began providing transcription and captioning services through the acquisition of Rapidtext, Inc. and its subsidiary, The Transcription Company, which have operations based in the United States. Since then, we have built transcription and captioning operations in the Philippines and are currently providing these services in both the United States and the Philippines. We believe that pursuing selective acquisitions of additional BPO services companies could expand our breadth of services, facilitate expansion into new markets and locations, and increase our client base. We will evaluate opportunities to add new outsourcing center facilities, new skill sets and additional offshore operations. We will consider acquiring additional complementary BPO businesses or assets, such as companies focused on back-office processing services, companies located in new geographic regions, or select client contracts of other outsourcing companies that can be better served by our platform.
Services
Customer Management Services
We offer a wide range of customer management services to our clients. We have a consulting services group dedicated to designing and customizing services for each client. Our consulting services group collaborates with each client to ensure their solution is both successfully deployed and specific to their business needs and requirements. We partner with each client to design, deploy and maintain efficient, integrated services between our technology infrastructure and our clients’ systems. We address our clients’ service strategies, anticipated volume and service levels, reporting and analytical requirements, networking and security, back-end system integration, and training and staffing needs.
Our fee arrangements are generally customized for each client on a case-by-case basis and depend on a variety of factors, including the types and complexity of services we render for the client, service level requirements, the number of personnel assigned to provide the services, the complexity of training our personnel to provide the services and the information technology and telecommunications requirements necessary to render the services. Our customer management fees generally consist of time-delineated or session-based fees, including hourly or per-minute charges and charges per interaction, and implementation fees, including charges for installing and integrating new clients into our telecommunications, information technology and client reporting structure.
We provide the following types of customer management services through multiple integrated communications channels:
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Customer service. Our customer service support services are initiated by inbound calls and e-mail from our clients’ customers and address a wide range of questions regarding their account billing, changes in services, reservation changes, delivery updates on goods or services, complaint and issue resolution and general product or service inquiries.
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Inbound sales. We handle inbound calls from customers purchasing products and services from our clients, including travel reservations, telecommunications services, Internet services and consumer products and services. Our professionals are specifically trained to identify opportunities to sell other products and services offered by our clients. For some clients, an important aspect of our sales activity includes seeking to retain customers who are at risk for cancellation or defection.
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Technical support. Our technical support services include handling troubleshooting calls, responding to software and hardware problems, providing support for Internet service problems, managing corporate help desks and providing warranty or post-warranty support.
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Direct response sales services. Our direct response services involve handling inbound telephone orders or inquiries for clients in the direct marketing industry, including those calls received in response to print advertisements, infomercials and other electronic media. Our professionals answer questions and process orders for the purchase of our clients’ products or services and identify opportunities to sell other products and services.
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Accounts Receivable Management Services. We collect consumer receivables in the financial services, telecommunications and utilities industries. We manage receivables that have already been written off by the creditor and also manage receivables that are past due but have not yet been written off by our clients.
Our reporting and analytical systems play an important role in the customer management services we provide. Our system captures and analyzes data received through multiple communications channels and generates client-specific interaction reports on an hourly, daily, weekly and monthly basis. These reports are accessible to our clients through our web-based and secure reporting portal, Intellicenter. Intellicenter offers our clients access to data generated through customer management interactions and allows them to analyze the customer interaction database, which includes all e-mail and live webchat transcripts for feedback on the types of questions raised by customers. The system also provides historical trend information to help clients monitor the volume and effectiveness of our interactions with their customers, including revenue generation.
Transcription and Captioning Services
Our transcription services involve transcribing voice recordings into customized client reports. Our captioning services include both real-time and offline captioning of television, film and classroom content for the healthcare and insurance, entertainment and education, and law enforcement markets. In many cases, we use proprietary software to provide these services. We provide transcription and captioning services through a network of transcriptionists in the Philippines and the United States. We typically charge for transcription services by the line and captioning services by the recording hour.
Other BPO Services
We also provide a broad range of additional BPO services, including credit application processing, mortgage processing, title searches and data verification, which consists of verifying an individual’s credit, employment, identity or other borrower information. Additionally, we conduct product and fraud detection, manage refunds, warranties and applications, and conduct preparations for serving legal papers. These services are also offered during the Philippine daytime (U.S. nighttime), which allows us to leverage an existing base of skilled professionals and infrastructure and should allow us to improve our return on invested capital.
Clients
We provide customer management services to companies in a variety of industries, and we are focused on developing long-term strategic outsourcing relationships with clients in these industries because of the volume of customer interactions, complexity of services, anticipated growth of their market segments and increasing need for high quality and cost-effective customer management services. Our clients benefit from our customer management experience, industry expertise, technical infrastructure and trained professionals. By outsourcing their customer management to us, our clients entrust us with an important aspect of their business, and can focus on their core competency.
For additional information on our clients, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Overview - Sources of Revenues.
Delivery Platform
We have developed and deployed a customized information technology infrastructure to efficiently and securely deliver our services. Our redundant systems reduce the risk of data loss and transmission failure and allow us to quickly scale to meet increased demand. Key components of our infrastructure include the following.
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“Hub and spoke” architecture. Our data centers located in the United States and the Philippines use a technical infrastructure designed to facilitate rapid expansion and consistency in delivering services to and from any of our outsourcing centers. Our data centers are connected to each other using multiple, redundant communication lines, which are dedicated International Private Lines (IPLs). Our “hub and spoke” operating model allows us to provide consistent and scalable business processes across multiple outsourcing centers. Applications and data are stored at our data center “hubs” in the United States and deployed at our “spokes” offshore. This allows us to quickly and efficiently handle additional volume and services for our new and existing clients and to expand our outsourcing network by establishing new “spokes” virtually anywhere in the world that is accessible with a fiber optic network.
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Robust data security. We use several layers of information security protection, including applications and devices designed to prevent unauthorized access to data residing in our systems and aggressive monitoring of audit trails at application and network layers. All outside connections to our network must pass through a sophisticated security system that is supported by multiple firewalls. Data access to client back-end systems is also protected by these security measures. We constantly monitor the network for attacks by potential hackers. As required by our clients, we apply best practices to prevent our professionals from copying or transmitting customer data.
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Dedicated telecommunications network. We have designed and deployed a dedicated telecommunications system which enables us to securely route multi-channel communications between the United States and our
offshore outsourcing centers. Our system transmits communications traffic with minimal latency and high transmission quality over a private network leased from major telecommunications providers. Our lease agreements with these providers generally provide for annual terms and fixed fees based on the levels of capacity dedicated to our usage. Customer traffic is initially received by one of our U.S. data centers where we seamlessly route calls to the optimal location in the Philippines or Costa Rica based on our professionals’ skill sets and availability. In most cases, these communications between the United States and our offshore centers are indistinguishable from domestic communications between points within the United States.
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Integrated customer communications channels. We provide customer management services through multiple communications channels, including inbound telephone calls, e-mail and webchats. Our customer management professionals are trained to offer services through each of these communications channels. Our customer interaction systems are also integrated with our workforce management system, which is used to manage optimal staffing and service levels. These systems are all linked to a proprietary reporting system that is updated hourly for all interactions occurring in our outsourcing centers. This provides our clients with a single view of all interactions between our professionals and their customers. We also offer real-time reporting capabilities to our clients.
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Proprietary integrated Intellicenter feedback system. Intellicenter is our proprietary reporting and analytical system that generates client-specific interaction reports. These reports are accessible to our clients on an hourly, daily, weekly and monthly basis. Intellicenter also provides access to customer contact transcripts and allows our clients to review the customer interaction database of all e-mail and webchat transcripts. The system provides historical trend information to help clients monitor the volume and effectiveness of our interactions with customers.
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24/7 client helpdesk. We have a helpdesk staffed 24/7, which offers our clients complete coverage in the event of any system issues. We have established standardized procedures to identify, track, categorize and prioritize inquiries by order of importance to our clients. We also operate an information technology calling tree which allows us to escalate issues up the personnel chain of command as the situation warrants.
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Quality assurance. Our quality assurance analysts use our quality management software to monitor service level compliance and randomly sample customer interactions. The system is configured for voice, data and computer screen capture to record the total customer experience and provide live monitoring and playback via a web browser from any location.
Sales and Marketing
We market our services through our sales and marketing organization, which is divided into sales and marketing support, client development and client services.
Sales and Marketing Support
Our sales and marketing support group is primarily responsible for increasing the awareness of our services in the marketplace and generating meetings with prospective clients through leads, sales calls, membership in industry associations, web-based marketing, public relations activity, attendance at trade shows and participation in industry conferences and events. Our sales and marketing support group also maintains contact with industry analysts and tracks competitor and industry information. These efforts allow us to stay abreast of trends in our target vertical industries. We plan to increase the number of personnel in our sales and marketing support group in 2007.
Client Development
Our client development group consists of experienced sales directors responsible for initiating relationships and closing engagements with the prospective clients identified by our sales and marketing support group. This group uses specific industry expertise and knowledge of our service delivery capabilities to:
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develop client relationships;
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help define the scope, deliverables and execution strategies for proposals;
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prepare pricing estimates and margin analysis for proposed client contracts;
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finalize sales proposals and assist in the negotiation and closing of new client engagements; and
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assist in the negotiation and closing of new client arrangements.
Sales directors work closely with our consulting services group, and we plan to increase the size and capabilities of our client development team in 2007.
Client Services
After our sales directors have successfully closed an engagement, a client services manager from our services group is assigned to the client. Sales directors maintain high level client relationships. Client services managers are primarily responsible for managing the day-to-day aspects of our client relationships, as well as expanding the existing relationships and assuring client satisfaction. They also develop a strong understanding of our clients’ business models and needs. Client services managers work with our clients to identify potential new business opportunities, based on their assessment of the clients and trends in their specific industry. Our sales directors and client services managers work as a team to understand and communicate our clients’ strategic business needs, align our offerings and services to meet our clients’ long-term objectives and help grow our relationships at multiple levels within our clients’ organizations.
Employees
At December 31, 2006, we had approximately 8,100 employees with approximately 7,500 employees in the Philippines, 450 in Costa Rica and 150 in the United States. As of the date of this filing we had added more than 1,000 employees, primarily in the Philippines, and now have more than 9,100 employees. All of our employees sign confidentiality agreements. In addition, our employees in the Philippines sign employment agreements containing non-compete provisions. We consider our relations with our employees to be good.
Hiring and Recruiting
We recognize that our professionals are critical to the success of our business as a majority of our support and service efforts involve direct interaction with customers. We believe the tenure and productivity of our professionals are directly related. Attracting, hiring, training and retaining our professionals are major areas of focus. Nearly all of our Philippine-based professionals are college educated. We pay our professionals competitive wages and offer a benefits program that includes comprehensive medical, dental and life insurance, meal allowance, overtime pay and paid time off, as well as a variety of employee incentives including a retirement benefit plan. Additionally, in a compensation component uncommon for the Philippine labor market, we award equity incentives to certain of our tenured professionals, which are subject to vesting based on continued service.
We believe we have developed effective strategies and a strong track record in recruiting. We created an Applicant Information Management System to receive applications through the Internet and track the progress of our applicants. Successful candidates must undergo numerous tests and interviews before we extend offers for employment. We also have an active employee referral program that provides us with a cost-effective way of accessing qualified candidates.
Competition
We encounter aggressive competition in all areas of our business activities. We believe that the principal competitive factors in our business include the ability to:
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provide high quality professionals with strong customer interaction skills, including English language fluency with minimal accents;
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offer cost-effective pricing of services;
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deliver value-added and reliable solutions to clients;
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provide industry specific knowledge and expertise;
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generate revenues for clients;
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secure our client’s confidential data; and
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provide a technology platform that offers a seamless customer experience.
We believe that we compete effectively on all of these factors. In providing outsourcing services to U.S.-based clients, we believe the location from which services are performed is also a competitive factor. U.S. companies may use domestic providers of outsourcing services or keep additional work in-house, despite the additional cost savings available through offshore providers of these services.
The global BPO services companies with whom we compete include both offshore and U.S.-based companies. These offshore companies may be based in locations such as India, the Philippines, South America, China, Latin America, the Caribbean, Africa or Eastern Europe.
We position ourselves as a Philippine-based outsourcing provider, with high quality service offerings and a college-educated workforce attuned to U.S. culture, and with an emphasis on lower cost structure and revenue generation for our clients.
In customer management services, our principal competitors include publicly traded U.S. companies IBM Global Services, Sykes Enterprises, Convergys Corporation, West Corp., WNS Global Services, ExlService Holdings, Inc. and TeleTech Holdings. Privately held competitors include eTelecare International and ClientLogic. In addition to our direct competitors, many companies choose to perform some or all of their customer service, technical support, collections and back-office processes internally. Their employees provide these services as part of their regular business operations. Some companies have moved portions of their in-house customer management functions offshore, including to offshore affiliates.
We believe our key advantage over in-house business processes is that we give companies the opportunity to focus on their core products and services while we focus on the specialized function of managing their customer relationships, transcriptions and captioning and additional back-office services.
Proprietary Rights
Our principal intellectual property consists of our company logo (hand design), the trademarks “PeopleSupport,” “The Power of Experience,” “Recovery with Respect” and “Rapidtext” which are registered with the United States Patent and Trademark Office. We do not hold any patents and we do not have any other registered trademarks or copyrights. We do rely on proprietary software, including our Intellicenter reporting portal and the know-how of our management. To establish and protect our other intellectual property rights, we rely on common law protection of copyrights, trademarks, and trade secrets, as well as confidentiality agreements used during the course of business. We consider our business processes and implementation methodologies confidential, proprietary information constituting trade secrets. Customers and business partners sign a nondisclosure agreement requiring confidential treatment of our information. Our employees are also required to sign confidentiality agreements as a condition to their employment. We have non-compete agreements with our employees in the Philippines.
Regulation
Our corporate legal department manages general corporate legal matters, including contract and document preparation and review, regulatory and statutory compliance, collections, obtaining and maintaining multi-state licensing, bonding and insurance, dispute and complaint resolution and litigation management. We have attorneys based in Los Angeles and Manila, qualified in U.S. and Philippine law, respectively.
Federal, state and international laws and regulations impose a number of requirements and restrictions on our business. For example, our accounts receivable management services are subject to the Fair Debt Collection Practices Act, which imposes numerous restrictions and obligations on our debt collection practice. Additionally, many states require a debt collector to apply for, be granted and maintain a license to engage in debt collection activities within the state. There are state and federal consumer protection laws that apply to our customer management services business, such as laws limiting telephonic sales or mandating special disclosures, and laws
that apply to information that may be captured, used, shared and/or retained when sales are made and/or collections are attempted. State and federal laws also impose limits on credit account interest rates and fees, and their disclosure, as well as the time frame in which judicial actions may be initiated to enforce the collection of consumer accounts. There are numerous other federal, state, local and even international laws and regulations related to, among other things, privacy, identity theft, telephonic and electronic communications, sharing and use of consumer information that apply to our business and to our employees’ interactions and communications with others. For example, the Federal Trade Commission’s Telemarketing Sales Rule applies a number of limitations and restrictions on our ability to make outbound calls on behalf of our clients and our ability to encourage customers to purchase higher value products and services on inbound calls. Similarly, the Telephone Consumer Protection Act of 1991, which among other things governs the use of certain automated calling technologies, applies to calls to customers. Many states also have telemarketing laws that may apply to our business, even if the call originates from outside the state. Additionally, some of the laws directed toward credit originators, such as the Truth in Lending Act and the Fair Credit Billing Act, can affect our operations because our receivables were originated through credit transactions. These laws, among others, may give consumers a legal cause of action against us or may limit our ability to recover amounts owed with respect to the receivables.
Federal and state regulators are empowered to examine and take enforcement actions for violations of these laws and regulations or for practices, policies or procedures they deem non-compliant, unfair, unsafe or unsound. Moreover, lawsuits may be brought by appropriate regulatory agencies, attorneys general and private parties for non-compliance with these laws and regulations. Accordingly, a failure to comply with the laws and regulations applicable to our business could have a material adverse effect on us.
New consumer protection and privacy protection laws or regulations are likely to impose additional requirements on the enforcement of and recovery on consumer credit card or installment accounts, telephonic sales, Internet communications and other portions of our business. We cannot ensure that some of the receivables were not established as a result of identity theft or unauthorized use of credit and, accordingly, we will not be able to recover the amount of these and other defaulted consumer receivables. As a purchaser of defaulted consumer receivables, we may acquire receivables subject to legitimate defenses on the part of the consumer. In general, our account purchase contracts allow us to return to the debt seller certain defaulted consumer receivables that may not be collectible, due to these and other circumstances. Upon return, the debt sellers are required to replace the receivables with similar receivables or repurchase the receivables. These provisions limit, to some extent, our potential losses on such accounts.
Our transcription business in the medical services area is governed in part by the Health Insurance Portability and Accountability Act (“HIPAA”), a federal law that governs the storage and protection of patient data. The transcriptionists we use to type patient reports are trained in the appropriate handling of patient data as defined under HIPAA.
Available Information
Copies of this Annual Report on Form 10-K and each of our other periodic and current reports, and amendments to all such reports, that we file or furnish pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge on our website (www.peoplesupport.com) as soon as reasonably practicable after the material is electronically filed with, or furnished to, the SEC. The information contained on our website is not incorporated by reference into this Annual Report on Form 10-K and should not be considered part of this Annual Report on Form 10-K. Our SEC filings are also available to the public at the SEC web site at http://www.sec.gov.
Item 1A.
Item 1A.
Risk Factors
Set forth below, elsewhere in this Annual Report on Form 10-K and in other documents we file with the SEC are important risks and uncertainties that could cause our actual results of operations, business and financial condition to differ materially from the results contemplated by the forward looking statements contained in this Annual Report on Form 10-K. You should consider carefully the following risk factors before deciding whether to invest in our common stock. Our business, including our operating results and financial condition, could be harmed by any of these risks. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may
materially and adversely affect our business. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. In assessing these risks you should also refer to the other information contained in our filings with the SEC, including our financial statements and related notes.
Risks Related to Our Business
Our revenues are highly dependent upon several major clients, and any loss of business from our major clients would reduce our revenues and seriously harm us.
For the three months period ended December 31, 2006, our three largest clients, EarthLink, Expedia and Washington Mutual, accounted for 43% of our revenues, and our customer concentration has been even higher for prior periods. For the twelve months ended December 31, 2006, our three largest clients, Expedia, EarthLink and Vonage, accounted for 46% of our revenues. 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. Our clients may from time to time conduct a request for proposal, or RFP, process to solicit bids for outsourcing services, including from our competitors, and we may not be successful in retaining or expanding our relationship with this client. Vonage recently went through such an RFP process, as a result, of which they elected not to renew their current contract with us and allow it to expire in May 2007. In 2004, 2005 and 2006, our revenues from Vonage were approximately $0.4 million, $5.6 million and $14.0 million, respectively. It is unlikely the lost revenue from a major client would be entirely offset by corresponding reductions in expenses. 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.
Our revenues are highly dependent on a few industries and any decrease in demand for outsourced services in these industries would likely reduce our revenues and seriously harm our business.
Our major clients are concentrated in the travel and hospitality, financial services, technology, telecommunications and consumer products industries. Increased competition, consolidation, a downturn, or a reversal of the trend toward outsourcing in any of these industries, would likely result in a decrease in the demand for our services or the cancellation or non-renewal of existing contracts. In addition, we are dependent in large part on the projected growth of these industries, which may not materialize. These industries have been cyclical and vulnerable to significant downturns in the past, and adverse developments in these industries could unfavorably affect our business.
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 and from year to year. In particular, demand for the services or products of our major clients in the travel and hospitality industry typically drops in the fourth quarter as compared to other periods, and therefore the need for our services is reduced as well. Recent results of operations 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.
A reversal of industry trends toward offshore outsourcing due to negative public reaction in the United States would harm our ability to compete effectively with competitors that operate facilities located in the United States.
Our revenues and growth depend in large part on U.S. industry trends towards outsourcing customer management and other business processes offshore. The trend to outsource business processes may not continue and could reverse. There has been recent publicity about the negative experience of certain companies that use offshore outsourcing, particularly in India. Current or prospective clients may elect to perform services themselves or may be discouraged from transferring services to offshore providers to avoid any negative perception that may be associated with using an offshore provider. Our risk is compounded by the fact that the majority of BPO services we provide involve interaction with the general public (e.g., our clients’ customers), which may be more sensitive to negative public reaction to offshore outsourcing. Any slowdown or reversal of existing industry trends would harm our ability to compete effectively with competitors who operate out of facilities located in the United States.
We serve markets that are highly competitive, and 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.
We currently face significant competition from our clients’ and our potential clients’ in-house customer service groups and growing competition from other BPO companies, including those in the United States, the Philippines, India and elsewhere. We expect this competition to continue to increase. New competitors may include entrants from the communications, software and data networking industries or entrants from other geographic locations with lower costs than those in which we operate. These companies also may have greater financial, personnel and other resources, longer operating histories, more recognizable brand names and more established client relationships. Many of these companies compete with us primarily on price and are often able to offer lower costs to potential clients.
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.
Many of our clients could terminate their relationship with us or significantly reduce their demand for our services due to a variety of factors, including factors that are unpredictable and outside of our control. In addition, in many cases, we are not the exclusive provider of outsourcing services to our clients. The services we provide to a client could be reduced for a variety of reasons, including our client’s decision to move more customer management functions in-house, or to an affiliated outsourcing provider or one of our competitors, changing economic factors, internal financial challenges or political or public relations reasons. Any significant reduction in client demand for our service would harm our business, negatively affect operating results and would likely 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 sales and implementation of our customer management services involves significant resource commitments by us and our clients. We generally expend substantial time and money addressing potential clients’ service and operational questions 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 resources, including funds and management time, during the sales cycle. Ultimately, the client may not engage our services or may cancel services before we have recovered the resources expended during the sales and implementation cycle, which may range from six to twelve months or longer. Unsuccessful or delayed sales and implementations may negatively impact our revenues and margins.
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. As a result of our operating losses, we had an accumulated deficit of $16.1 million at December 31, 2006. Further, we expect our marketing, sales and other operating expenses to increase in the future as we seek to expand our business. If our revenues do not grow at a faster rate than these expected increases in our expenses, or if our operating expenses are higher than we anticipate, we may not be profitable and we may incur additional losses.
We have a limited operating history and our business and future prospects are difficult to evaluate.
We have a limited operating history. We consolidated our operations in the Philippines in 2002 and 2003, and commenced our accounts receivable management services in July 2003. We acquired our transcription and captioning business in January 2006. We began developing new BPO facilities in Costa Rica in the first quarter of 2006. As a result of our recent entry into these markets, our business and future prospects are difficult to evaluate.
We are also 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:
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attract and retain clients;
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attract and retain key personnel and qualified professionals;
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generate sufficient revenues and manage costs to maintain profitability;
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integrate acquisitions, adjust to new businesses and develop operating procedures for new countries;
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manage growth in our operations; and
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access additional capital when required and on reasonable terms.
If we fail to manage our growth effectively, the quality of our services may decline, our revenue and margins may be reduced and we may incur losses.
We have expanded significantly since our formation and intend to maintain our growth focus. 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 our growth. As a result, we may be unable to manage our growth effectively, in which case the quality of our services may decrease and clients may become dissatisfied and reduce demand for our services. As a result, our operating costs may increase at a faster rate than the growth in our revenues, our margins may decline and we may incur losses.
We may experience significant employee turnover rates in the future and we may be unable to hire and retain enough sufficiently trained employees to support our operations, which could harm our business.
The business process outsourcing industry is very labor intensive and our success depends on our ability to attract, hire and retain qualified employees. We focus in particular on recruiting college-educated personnel and compete for candidates with companies in our industry and in other industries. As the BPO industry expands in the Philippines, this competition is increasing. 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.
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, or Rainerio Borja, our President of PeopleSupport (Philippines), Inc., as well as other executive personnel, could seriously impair our ability to continue to manage and expand our business. Our success depends on the continued service and performance of our executive officers, and we cannot guarantee that we will be able to retain these individuals. Our executive officers are “at-will” employees who are not subject to employment agreements providing for any specified term of employment. We do not have “key man” insurance, nor are our U.S.-based executive officers subject to non-compete restrictions.
Our facilities are at risk of damage by earthquake, typhoons, tsunamis and other natural disasters.
We are dependent on our facilities in Southern California, the Philippines and Costa Rica to provide service and support to our clients. These facilities are located in regions that are susceptible to earthquakes and other natural disasters, including, in the Philippines, typhoons and volcanic eruptions. These dangers increase the risk of disruption of information systems and telephone service for sustained periods. Damage or destruction that interrupts our ability to perform outsourcing services could damage our relationship with our clients and may cause us to incur substantial additional expense to provide alternative services to repair or replace damaged equipment or facilities
and may subject us to penalties during such disruption. Prolonged disruption of our services as a result of natural disasters may entitle our clients to terminate their contracts with us. Our insurance policies specifically exclude certain natural disasters, such as earthquakes, and may not be sufficient even if we do have coverage. Furthermore, we may be unable to secure such insurance coverage or to secure such insurance coverage at premiums acceptable to us in the future.
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 natural disasters, 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 a limited number of vendors for facility storage and related maintenance of our main technology equipment and data at our U.S. data centers. Any failure of these vendors to perform these services could result in business disruptions and impede our ability to provide services to our clients. We also may be required to pay penalties to our clients. A significant interruption of service could have a negative impact on our reputation and could lead our present and potential clients not to use our services. The temporary or permanent loss of equipment or systems through casualty or operating malfunction could reduce our revenues and harm our business.
We could cause disruptions to our clients’ business from inadequate service, and our insurance coverage may be inadequate to cover this risk.
Most of our contracts with our clients contain service level and performance requirements, including requirements relating to the timing and quality of responses to customer inquiries. The quality of services that we provide is measured by quality assurance ratings, which are based in part on the results of customer satisfaction surveys and direct monitoring of interactions between our professionals and customers. Failure 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. While we maintain commercial 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, medical records, personal credit card account numbers, checking and savings account numbers and payment history records, such as account closures and returned checks. Some of our clients are subject to U.S. federal and state regulations requiring the protection of sensitive customer information, and new legislation could increase the range of possible penalties for certain entities that fail to protect such information. If any person, including any of our employees, misappropriates or mismanages sensitive data, we could be subject to liability for breaching contractual confidentiality provisions or privacy laws which could have a negative impact on our reputation and could lead our present and potential clients to choose other service providers.
Our clients may adopt technologies that decrease the demand for our services, which could reduce our revenues and seriously harm our business.
Our clients may adopt new technologies that decrease the need for live customer interactions, such as interactive voice response, web-based self-help, voice recognition software for transcription and other technologies used to automate interactions with customers. The adoption of such technologies could reduce the demand for our services, put downward pressure on our pricing, cause a reduction in our revenues and harm our business.
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 value of our stock, we believe that our net operating losses are subject to limitation under Section 382. While no assurance can be given, based on our current analysis we do not anticipate that a Section 382 limitation will significantly delay the use of our net operating loss carryforwards. No assurance can be given, however, that future events (including, but not limited to, substantially increased forecast income, impact of acquisitions and 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 stock or (ii) some or all of the group of stockholders who individually own less than 5% of our stock) will not trigger additional 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 under the rules of Section 382 (as a result of our November 2006 secondary offering or otherwise), 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.
We may choose to expand operations to other countries and may not be successful.
In the first half of 2006, we began operations in a new BPO center in Costa Rica. We may consider expanding to countries other than the Philippines and Costa Rica. 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 will 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.
In the first quarter of 2006, we acquired Rapidtext, Inc. and its subsidiary, The Transcription Company, which added transcription and captioning to our service offerings. We are still integrating Rapidtext into our offshore operating platform. We intend to consider acquisitions of other companies 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. We may incur expenses and be unable to successfully complete future acquisitions. If we acquire other businesses, we may be unable to successfully integrate these businesses with our own and maintain our standards, controls and policies. Acquisitions may place additional constraints on our resources by diverting the attention of our management from existing operations. Through acquisitions, we may enter markets in which we have little or no experience. Any acquisition may result in a potentially dilutive issuance of equity securities, the incurrence of debt and amortization of expenses related to intangible assets, all of which could lower our margins and harm our business.
We are subject to extensive laws and regulations that could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business.
The BPO industry has become subject to an increasing amount of federal and state regulation in the past five years. Despite our focus on inbound customer management, we are subject to regulations governing communications with consumers due to the activities we undertake on behalf of our clients to encourage customers to purchase higher value, additional or complementary products and services offered by our clients. For example, the Federal Trade Commission’s Telemarketing Sales Rule, issued pursuant to the Federal Telemarketing and Consumer Fraud and Abuse Prevention Act of 1994, applies a number of limitations and restrictions on our sales activities during inbound calls as well as on our ability to make outbound calls on behalf of our clients. Similarly, the Telephone Consumer Protection Act of 1991 and regulations issued by the Federal Communications Commission restrict various telemarketing practices, including the use of automated dialing technology. Many states also have telemarketing laws that may apply to our business. A violation of such federal and state regulations could result in civil penalties or lawsuits by consumers, which in turn could have a negative impact on our reputation and could lead our present and potential clients to choose other service providers. 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.
Our clients’ business operations are subject to certain rules and regulations in the United States, such as the Gramm-Leach-Bliley Act, the HIPAA, and the customer privacy provisions of the Communications Act. Our clients may contractually require that we perform our services in a manner that would enable them to comply with such rules and regulations. Failure to perform our services in compliance with these laws could result in breaches of contract with our clients and, in some limited circumstances, civil fines and criminal penalties for us.
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 laws 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.
New consumer protection and privacy protection laws or regulations are likely to impose additional requirements on the enforcement of and recovery on consumer credit card or installment accounts, telephonic sales, Internet communications and other portions of our business. As a purchaser of defaulted consumer receivables, we may acquire receivables subject to legitimate defenses on the part of the consumer. New federal and state legislation may be enacted that could restrict or discourage U.S. companies from outsourcing their services to companies outside the United States.
Complying with new laws and regulations could significantly increase our cost of doing business and adversely impact our financial condition.
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.
If our capital resources are insufficient to satisfy our liquidity requirements for acquisitions, expansion or other purposes, 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. Bank debt or debt securities 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 to execute our business strategy.
Terrorist attacks could adversely affect the economy, disrupt our operations and cause our business to suffer.
The risks of civil unrest and terrorism exists and U.S. companies in particular may experience greater risks. We are not insured against terrorism risks. Terrorist attacks have the potential to directly impact our clients and the 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.
Risks Related to Doing Business in the Philippines
We may face competition in the Philippines for our professionals, which could increase the cost of qualified employees and the amount of employee turnover.
We are faced with competition in the Philippines for outsourcing center professionals, and we expect this competition to increase as additional outsourcing companies, and other companies with a demand for college-educated personnel, 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 periodically experiences political or economic instability, which could disrupt our operations, increase our costs and harm our business.
The Philippines continues to experience low growth in its gross domestic product, significant inflation 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 political or economic instability that could harm businesses operating in the Philippines.
In addition, the Philippines has and may continue to experience political instability, including strikes, demonstrations, protests, marches, coups d’état, guerilla activity or other types of civil disorder. Potential demonstrations associated with the mid-term elections in May 2007 could disrupt commerce. These instabilities and any adverse changes in the political environment in the Philippines could increase our operational costs, increase our exposure to legal and business risks and make it more difficult for us to operate our business in the Philippines.
Currency fluctuations in the Philippine peso relative to the U.S. dollar has increased and could continue to 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. In 2005 and through December 31, 2006, appreciation in the Philippine peso has increased our expenses, and future appreciation in the peso will continue to increase expenses.
In January 2007 to offset recent declines in the value of the U.S. dollar against the Philippine peso, we entered into various forward foreign currency contracts covering approximately $60.0 million at an average exchange rate of 49 Philippine pesos per U.S. dollar. While we intend for these contracts to decrease the impact of foreign currency fluctuations, they may result in increased fluctuations.
The current tax holidays in the Philippines may not be extended.
We currently benefit from income tax holiday incentives in the Philippines. Our current income tax holidays expire at staggered dates beginning in the fourth quarter of 2007 and ending in 2009. While we fully intend to apply for extensions of these holidays, it is possible that such extensions could be denied, or that due to changes in the government of the Philippines that these holidays could be removed entirely. Should either of these events occur, our Philippine tax liability could increase.
Risks Related to Doing Business in Costa Rica
We have limited experience with operations in Costa Rica and are subject to particular risks associated with the development of operations in Costa Rica.
Costa Rica, while regarded as a relatively stable Central American country, has been subject to economic and political challenges present in Latin America in general and in Central America in particular. Costa Rica has often experienced high internal and external debt and significant inflation, as well as pressure from political instability in the neighboring Central American countries of Nicaragua and Panama. Economic instabilities and adverse changes in the political environment in Costa Rica could increase our operational costs, increase our exposure to legal and business risks and make it more difficult for us to operate our business in Costa Rica.
Some of the significant risks we face in our Costa Rican operations include the following:
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we may be unable to find, hire or retain, at rates attractive to us, a sufficient number of qualified employees;
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currency fluctuations in the Costa Rican colon relative to the U.S. dollar could significantly increase our expenses;
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we are dependent on telecommunications service provided by a limited number of available vendors in order to conduct our business, and if the telecommunications service were to fail, experience problems or be interrupted or unreliable, we may be unable to service our client or fulfill our contractual obligations;
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our facilities are at risk of damage by earthquakes, typhoons and other natural disasters; and
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we may have overestimated the demand for Spanish language BPO services which may not be sufficient to expand our Costa Rican operations.
Our Costa Rican operations are dependent on a single client, Washington Mutual, which has the option to acquire the operations from us and therefore deprive us of our presence in Latin America.
Our Costa Rican options are dependent on a single financial services client, Washington Mutual. Under the terms of our contract, Washington Mutual may acquire our Costa Rican operations from us with 30 days notice at anytime prior to the expiration of its contract with us in 2009 by paying a termination fee that is intended to cover our costs of transferring our operations to Washington Mutual. If Washington Mutual were to acquire the operations from us, we would not have a presence in Latin America unless we establish other Latin American operations, which could require significant time and new investment. If Washington Mutual purchases our Costa Rican operations from us, this could be a setback in our ability to provide bilingual English-Spanish services. In addition, the contract allows a reconciliation of actual allowable costs to invoiced amounts from inception of our services to Washington Mutual’s acquisition of the operations from us. To the extent that actual allowable costs are less than corresponding invoiced costs, we must repay this overage to Washington Mutual at that time.
Government regulations and various bureaucratic constraints have increased and may continue to increase operational costs in Costa Rica beyond budgeted expectations.
Primarily due to government regulations and various bureaucratic constraints, we have experienced, and may continue to experience, higher than expected costs of doing business in Costa Rica. These additional costs may adversely affect our operations, result in delays that cause us to be unable to fulfill our contractual obligations and could have an adverse impact on our financial statements. Current Costa Rican tax holidays through 2013, from which we benefit, may be changed. Any change or revocation of the current tax holidays may subject us to greater taxes.
Risks Related to Our Stock
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 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 herein. In addition, the stock market in general and the NASDAQ Global 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, as has occurred, our stock price may 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.
We will continue to incur increased costs as a result of being a public company.
As a public company, we incur significant legal, accounting and other expenses. Compliance with the Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the Securities and Exchange Commission and the NASDAQ Global Market, has required changes in corporate governance practices of public companies. These rules and regulations have increased and may continue to increase our legal and financial compliance costs and make some activities more time-consuming and costly.
Delaware law and our amended and restated certificate of incorporation and bylaws contain anti-takeover provisions that could delay or discourage business combinations and takeover attempts that stockholders may consider favorable.
Our certificate of incorporation and bylaws contain provisions that may make it more difficult, expensive or otherwise discourage a tender offer or a change in control or takeover attempt by a third-party that is opposed by our board of directors. These provisions may have the effect of delaying or preventing a change of control or changes in management that stockholders consider favorable. In particular, our certificate of incorporation and bylaws include provisions that:
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classify our board of directors into three groups, each of which will serve for staggered three-year terms;
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permit the board of directors to elect a director to fill a vacancy created by the expansion of the board of directors;
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permit stockholders to remove our directors only for cause;
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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;
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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;
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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;
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prohibit cumulative voting in the election of directors that would otherwise allow less than a majority of stockholders to elect directors;
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permit the board of directors to alter certain provisions of our amended and restated bylaws without obtaining stockholder approval;
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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
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eliminate the right of stockholders to call a special meeting of stockholders and to take action by written consent.
Additionally, because we are incorporated in Delaware, we are subject to Section 203 of the Delaware General Corporation Law. These provisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us. These provisions in our amended and restated certificate of incorporation and amended and restated bylaws and under Delaware law could discourage potential takeover attempts and could reduce the price that investors might be willing to pay for shares of our common stock in the future and result in the market price being lower than it would be without these provisions.
Future sales of our common stock in the public market could cause our stock price to fall.
As of December 31, 2006, 23,478,658 shares of our common stock were outstanding and approximately 2,125,627 shares were issuable upon the exercise of outstanding stock options and vesting of restricted shares. As of December 31, 2006, the number of shares of our outstanding common stock freely tradeable on the NASDAQ Global Market and not owned by our officers, directors or other affiliates was approximately 22,449,115 shares. In addition, we have filed with the Securities and Exchange Commission a registration statement on Form S-3 authorizing us to issue up to $100 million of public equity or debt in the future, we issued $96.6 million of that amount on November 10, 2006, and we may offer an additional $3.4 million under that registration statement.
Additional common stock in public or private offerings to raise capital or any stock issuance in connection with an acquisition may result in future sales of stock in the public market. 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.
Item 1B.
Item 1B.
Unresolved Staff Comments
None.
Item 2.
Item 2.
Properties
Our corporate headquarters are located at 1100 Glendon Ave., Suite 1250, Los Angeles, California 90024, where we lease approximately 11,000 square feet. This lease was renewed on January 13, 2005 and will expire on July 31, 2008. In addition, we lease two production centers in Southern California totaling approximately 15,000 square feet and lease three data centers located throughout the western United States, totaling approximately 1,000 square feet.
We lease eight facilities in the Philippines. Our largest facility in the Philippines is the PeopleSupport Center in Manila with approximately 162,000 square feet. Our other seven facilities are located in three cities on two islands in the Philippines. The total square footage of these seven facilities is approximately 255,000 square feet. These leases expire at various times over the next ten years. In January 2007, we acquired two undeveloped lots through our controlled Philippine corporation. The ownership structure satisfies Philippine legal requirements and we intend to build outsourcing facilities on the properties. In February 2006, we signed two leases in Costa Rica totaling approximately 35,000 square feet, which will expire in 2012. We believe these facilities and additional or alternative space available to us will be adequate to meet our needs in the near term.
Item 3.
Item 3.
Legal Proceedings
From time to time, we are involved in various legal proceedings, which are incidental to the ordinary course of our business. We do not believe that these routine matters represent a substantial volume of our accounts or that, individually or in the aggregate, they are material to our business or financial condition.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of 2006.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Performance Graph
This graph shall not be deemed incorporated by reference by any general statement incorporating by reference this Annual Report on Form 10-K into any filing under the Securities Act of 1933 or under the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates this information by reference, and shall not otherwise be deemed filed under such Acts.
The comparison of the total return on investment (change in year end stock price plus reinvested dividends) for each of the periods assumes that $100 was invested on October 1, 2004 in each of the Company, the NASDAQ Stock Market Index and the NASDAQ Computer and Data Processing Index. The following results and comparisons shown in the graph below are based upon historical data and are not indicative of, nor intended to forecast future performance of, the our common stock.
ASSUMES $100 INVESTED ON OCTOBER 1, 2004
ASSUMES DIVIDENDS REINVESTD
Year Ended December 31, 2006
Total Return Analysis
Sources: NASDAQ Online and Center for Research in Security Prices (CRSP) at the University of Chicago.
Price Range of Common Stock
Our common stock is traded on the NASDAQ Global Market under the symbol “PSPT.” The following table sets forth the range of high and low closing prices for our common stock during each quarter:
As of March 12, 2006, there were 200 stockholders of record and 23,513,261 shares of our stock outstanding. Based on information provided by our transfer agent and registrar, we believe that there are approximately 7,800 beneficial owners of our common stock.
Dividend Policy
We have not declared or paid cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. We expect to retain future earnings, if any, to fund the growth and expansion of our business. Our board of directors will determine future dividends, if any.
Item 6.
Item 6.
Selected Financial Data
The following table presents selected historical consolidated financial data as of, and for the years ended December 31, 2006, 2005, 2004, 2003 and 2002, which has been derived from our audited consolidated financial statements. Our consolidated financial statements were audited by BDO Seidman, LLP. You should read this information together with “Summary Historical Consolidated Financial Data,” “Management’s Discussion and
Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements and related notes for the years ended December 31, 2006, 2005 and 2004 which are included elsewhere in this Annual Report on Form 10-K. Historical results are not necessarily indicative of the results to be expected in the future.
(1)
Included in expenses above are non-cash stock based compensation charges of:
(2)
Under our Management Incentive Plan, we expensed $0.3, $0.3 and $5.3 million in years 2006, 2005 and 2004, respectively. We did not incur any expenses under the Management Incentive Plan in 2003 and 2002. For additional information on the Management Incentive Plan, please refer to Footnote 5 of the Financial Statements.
(3)
Gain on sale of receivable portfolios is the net amount we earned on the sale of two accounts receivable portfolios by our subsidiary, ProArm Management, Inc., during 2004.
(4)
Restructuring charges are comprised of estimated and actual obligations for various non-cancelable leases, the write-down of abandoned leasehold improvements and fixed assets at customer service centers in the United States where we terminated operations, and severance and other U.S. employee-related costs in connection with the movement of our operations, first to St. Louis, and then to the Philippines. We did not use the entire estimated amount and reduced the estimated amounts in 2003 and 2004,
(5)
Gain on the extinguishment of debt relates to the extinguishment of an equipment loan.
(6)
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Accounting for Income Taxes” for additional information.
(7)
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a comparison of net income for 2006, 2005 and 2004.
(8)
For information regarding the computation of per share amounts, refer to Note 6 to the Consolidated Financial Statements included in Item 15 in this Annual Report on Form 10-K. The basic and diluted share and per share amounts in the consolidated statement of operations table above have been restated to give retroactive effect to the 1 for 2.74 reverse stock split that was effected on August 5, 2004.
(9)
The Consolidated Statement of Operations Data for the year ended December 31, 2006 and the Consolidated Balance Sheet Data as of December 31, 2006, include the effects of the Rapidtext acquisition (See Note 13) and the adoption of SFAS 123(R) “Share Based Payment” (See Note 6). Therefore, the years presented prior to fiscal year 2006 may not be comparable to fiscal year 2006.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Future Uncertainties
Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) provides supplemental information which sets forth the major factors that have affected our financial condition and results of operation and should be read in conjunction with the consolidated financial statements and accompanying notes, which appear elsewhere in this Annual Report on Form 10-K. This section contains forward-looking statements 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 and elsewhere in this Annual Report on Form 10-K, particularly under the heading “Risk Factors.”
Overview
We were formed in 1998 and incorporated in the State of Delaware on July 2 of that year. In October 2004 we completed our initial public offering and raised approximately $31.6 million, net of expenses. In January 2006, we acquired Rapidtext and its subsidiary, The Transcription Company, for approximately $9.0 million. In November 2006 we closed a secondary offering that raised, net of expenses, approximately, $90.9 million. Our revenues have grown from $1.9 million in 1999 to $110.1 million in 2006. During the same period our net income grew from losses of $8.3 million in 1999 and $46.0 million in 2000 to a profit of $14.2 million in 2006. Net income for 2006 included a $0.1 million income tax benefit primarily associated with the reduction of the deferred tax asset valuation allowance. Excluding the income tax benefits, the increase in net income was primarily attributable to growth in our customer management business, which enabled us to build revenues, and our move to the Philippines, which allowed us to reduce our operating costs, improve our margins and offer cost savings to our clients.
Quarterly Results of Operations and Performance Trends
(1)
The decrease in fourth quarter 2006 income from operations as compared to the previous 2006 quarters was primarily due to the following items which total approximately $2.5 million - increased information technology infrastructure costs and various credits associated with our contract in Costa Rica with a single anchor client, increased depreciation expense due to overall capacity and infrastructure build, additional amortization related to our software licenses, increased Sarbanes Oxley compliance and audit costs, increased non-cash compensation charges and an increase to our allowance for doubtful accounts.
(2)
During the year ended December 31, 2006, we assessed the deferred tax asset valuation allowance each quarter and decreased the allowance by $0.5 million and $1.0 million in the second and fourth quarters. The allowance was increased in the third quarter by $0.1 million, for a net tax effect for all of 2006 of $1.4 million.
(3)
During the year ended December 31, 2005, we assessed the deferred tax asset valuation allowance each quarter and released $0.7 million, $0.4 million, $3.2 million and $10.3 million in the first, second, third and fourth quarters, respectively.
Quarterly and year-to-date computations of earnings per share amounts are made independently, therefore, the sum of the per share amounts for the quarters may not agree with the per share amounts for the year.
Sources of Revenues
For the three and twelve month periods ended December 31, 2006, we derived a majority of our revenue from fees, which include:
•
time-delineated or production-based fees, including hourly or per minute charges and charges per interaction or transaction, and training fees, all of which are separately negotiated on an individual client basis; and
•
implementation fees, including revenue associated with the installation and integration of new clients into our telecommunications, information technology and client reporting structures.
We recently revised our pricing with one of our largest clients from a per session fee to an hourly rate. We believe this will allow us to staff for this client more efficiently. We do not currently expect this transition to impact revenues or overall margins for this client although the ultimate impact of this change cannot be predicted with certainty.
Substantially all of our revenue consisted of time-delineated or production-based fees. For the twelve month periods ended December 31, 2005 and 2006, approximately 5% of our revenue was comprised of implementation and training fees. For the three and twelve month periods ended December 31, 2005 and 2006, substantially all of our revenue was derived from U.S.-based clients.
Revenue Trends
Our revenue growth is primarily driven by organic growth from sales to new and existing clients. We believe our sales will continue to increase as we expand our sales team and leverage our success with existing clients. We believe the increase in sales to existing clients is primarily due to our clients’ satisfaction with our service and the increase in their demand for our services. We also expect to increase revenue by expanding into new markets and are looking for opportunities to expand into new geographic areas and new service offerings.
Historically, revenue has been concentrated among three clients. While this percentage has been declining, for the three and twelve month periods ending December 31, 2006, our three largest clients collectively accounted for approximately 43% and 46% of our revenue, respectively. This is a significant reduction from the three and twelve month periods ending December 31, 2005, when our three largest clients collectively accounted for 57% and 59% of our revenue, respectively. For the year ended December 31, 2006, three clients, EarthLink, Expedia and Vonage, each accounted for more than 10% of our revenue. For the three months ended December 31, 2006, four clients, EarthLink, Expedia, Vonage and Washington Mutual, accounted for more than 10% of our revenue. For the three and twelve month periods ending December 31, 2005, three clients, Expedia, EarthLink and ConsumerInfo.com, each accounted for more than 10% of our revenue.
We have continued to increase revenues from our largest customers but their percentage of our overall revenues has declined because we have increased our client base. We expect these percentages to continue their long-term decline in 2007 as we continue to diversify our customer base.
Status of Key Revenue Contracts
Our contract with Expedia expires in September 2009. Our contract with EarthLink expires in January 2008, and will automatically renew each year for a one year period unless terminated by EarthLink or us before the end of the term. Our contract with Vonage was extended to May 2007 and would have automatically renewed, however, Vonage elected to end the contract and it will terminate in May 2007. Although we are in discussions with Vonage to continue providing a small portion of the services we currently are performing after our contract expires in May 2007, these discussions may or may not be successful and there is no assurance that we will continue to perform
services for Vonage. In 2004, 2005, and 2006, our revenues from Vonage were approximately $0.4 million, $5.6 million and $14.0 million, respectively. Our contracts with Washington Mutual expire over the course of the next three years. Many of our clients may terminate their contracts with us before their expiration with no penalties or limited penalties or they may refuse to extend their contracts after the contracts expire.
Key Expense Categories
Cost of revenues. Cost of revenues consist primarily of salaries, payroll taxes and employee benefit costs paid to the approximately 8,100 professionals we employed in the Philippines, Costa Rica and the United States as of December 31, 2006. Our employee related costs are primarily incurred in the Philippines where we employ approximately 7,500 of our personnel. Employee costs, which account for approximately two-thirds of our cost of revenues, are paid in the local currency. Because our revenue is in U.S. dollars and most employee related costs are paid in the local currency, we are exposed to the risk of foreign currency fluctuations. Recently, the Philippine peso has strengthened against the dollar, resulting in increased costs. We are not certain if this strengthening will continue. With the acquisition of the U.S.-based Rapidtext and our expansion into Costa Rica, we are now operating in regions with a higher wage structure than the Philippines and increased our compensation expense.
The non-employee related portion of our cost of revenues include 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 do not include depreciation of assets used in the production of revenue.
In 2006 we continued to strategically invest in expanding our outsourcing delivery capabilities to meet anticipated increases in demand from new and existing clients. The costs of expansion primarily include compensation and training of additional outsourcing and support personnel, including middle and upper management, rental of facilities and expenses related to tenant improvements and facilities, information technology, telecommunications and transmission rights. Our strategic investments in expanded client service capacity will generally occur ahead of anticipated increases in client demand. We believe this is necessary for us to be prepared to quickly provide additional high quality services when demand increases, even though we generally do not have specific commitments from existing or prospective clients for increased volume. As a result, we have experienced, and expect in the future to experience, periods of overcapacity and higher costs of revenues, which we intend will be followed by lower costs of revenues as increases in demand enable us to utilize our expanded capacity. Although our 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.
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, costs associated with Sarbanes-Oxley compliance, marketing programs (which include product marketing expenses, corporate communications, conferences and other brand building and advertising) and other corporate expenses. Selling, general and administrative expenses increased in the three and twelve months ended December 31, 2006, as compared with selling, general and administrative expenses for the three and twelve months ended December 31, 2005. 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. Because of our growth we continue to invest in both capital and personnel in order to meet our growing infrastructure needs. While we have recently been able to leverage selling, general and administrative expenses and achieve economies of scale, during this period of investment and growth our expenses may precede the associated revenue.
Depreciation and amortization. We currently purchase substantially all of our equipment. We record property and equipment at cost and calculate depreciation using the straight-line method over the estimated useful lives of assets, which range from one to five years. We amortize leasehold improvements on a straight-line basis over the shorter of the lease term or the estimated useful life of the asset. If the actual useful life of any such asset is less than the estimated depreciable life, we would record additional depreciation expense or a loss on disposal to the extent the net book value of such asset is not recovered upon sale.
Restructuring charges. From 2000 to 2004, we reorganized to reduce future operating costs by streamlining operations and moving to lower-cost operating centers in the Philippines. As a result of these reorganizations, we recorded a charge of approximately $3.9 million during the year ended December 31, 2002. During the year ended December 31, 2003, we released $0.3 million of the restructuring reserve. The restructuring was completed in 2004 and we released the remaining $0.1 million of the restructuring reserve. During the years ended December 31, 2005 and 2006, we did not recognize any restructuring related costs or gains.
Certain Charges and Gains
Compensation obligations. Under our Management Incentive Compensation plan, we made payments of $5.3 million to senior executives and key employees in connection with the closing of our initial public offering. We also recorded a deferred compensation liability of $1.0 million related to the unpaid portion of the obligation as of December 31, 2004. For the years ended December 31, 2005 and 2006, we made additional payments of approximately $0.1 and $0.3 million, respectively. We are obligated to make additional payments of approximately $0.6 million to key employees based on continued service or other performance criteria. Those payments will be made by October 2007. As of December 31, 2006, the remaining deferred obligation under the Management Incentive Plan was $0.6 million. Due to the amortization of the deferred compensation, $0.3 million and $0.3 million was expensed for the years ended December 31, 2005 and 2006, respectively.
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. The following accounting policies 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 SEC 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 SEC staff’s views in applying generally accepted accounting principles to revenue recognition in financial statements and provide guidance on revenue recognition issues in the absence of authoritative literature addressing a specific arrangement or a specific industry.
We primarily recognize our revenues from services as those services are performed under a signed contract. We recognize:
•
customer management fees, excluding implementation fees, as those services are performed;
•
implementation fees ratably over the life of the contract; and
•
commission revenues for contingent accounts receivable management contracts upon receipt of collected funds.
The Company uses primarily time and contractual targets achieved to recognize revenue. The Company does not provide customer discounts or extended credit terms.
Deferred revenue represents amounts billed or cash received in advance of revenue recognition. As of December 31, 2006 and 2005 our balance sheets reflect $4.5 million and $3.5 million in deferred revenues, respectively.
Our allowance for doubtful accounts is based primarily on credit matters we are aware of with specific customers. The allowance is reviewed monthly to ensure that there is a sufficient reserve to cover any potential write-offs. Account balances are charged off against the allowance when we feel it is probable the receivable will not be collected.
Accounting for Stock based Awards
Effective January 1, 2006, we adopted Statement of Financial Accounting Standard (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment” (“SFAS 123(R)”) which requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is expected to vest is recognized as expense over the requisite service periods. Prior to the adoption of SFAS 123(R), we accounted for stock-based awards to employees and directors using the intrinsic value method.
Under SAFS 123(R), the pool of windfall tax benefits at adoption consists of the net credits to APIC that a company would have recorded under FAS 123(R) (subject to potential adjustment for NOL carryforwards). Effective January 1, 2006, we recognize windfall tax benefits associated with the exercise of stock options directly to stockholders’ equity only when realized. A windfall tax benefit occurs when the actual tax benefit realized by the Company upon an employee’s disposition of an equity based award exceeds the deferred tax asset, if any, associated with the award that we had previously recorded. When assessing whether a tax benefit relating to share-based compensation has been realized, we follow the tax law ordering method, under which current year share-based compensation deductions are assumed to be utilized before net operating loss carryforwards and other tax attributes.
There are a number of assumptions and estimates used in calculating the fair value of options. These include the expected term of the option, the expected volatility and the risk free interest rate. These assumptions are included in the chart below. The basis for our expected volatility and expected term estimates is a combination of our historical information and the historical experiences of a peer group. The companies in the peer group were selected based upon their industry, operations, market capitalization, revenue and other factors. The risk-free interest rate is based upon yields of U.S. Treasury strips with terms equal to the expected life of the option or award being valued. PeopleSupport does not currently pay a dividend nor does the Company expect to pay a dividend. The fair value of each option was estimated on the date of grant using the following weighted average assumptions used for grants for the years ended December 31, 2006, 2005 and 2004:
Our Consolidated Financial Statements as of and for the year ended December 31, 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, our Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R).
For the years ended December 31, 2006, 2005 and 2004, we recorded approximately $2.8 million, $0.9 million and $1.8 million, respectively, in non-cash, stock-based compensation expense. See Note 6 to our Consolidated Financial Statements included in Item 15 of this Annual Report on Form 10-K for additional information.
Accounting for Income Taxes
We account for income taxes in accordance with SFAS 109. At December 31, 2006, we had U.S. and California net operating loss carryforwards of approximately $48.2 and $34.3 million, respectively, which may be used to offset future taxable income. Our carryforwards expire from 2012 through 2026 and are subject to review and possible adjustment by tax authorities. During the year ended December 31, 2006, we assessed the deferred tax asset valuation allowance and released the remaining allowance, primarily in the fourth quarter, resulting in a $1.4 million tax benefit for the year.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. Management considers projected future taxable income, customer contract terms and customer concentrations in making this assessment. Management reassesses the realizability of deferred tax assets on a periodic basis.
Long-lived Asset Impairment
Fixed assets are reviewed for impairment as events or changes in circumstances occur indicating that carrying amounts may not be recoverable. When these events or changes in circumstances indicate that the carrying amount would be impaired, undiscounted cash flow analyses would be used to assess other long-lived impairment. The estimation of future cash flows involves considerable management judgment.
Results of Operations
The following table shows the listed items from our consolidated statements of operations as a percentage of revenues for the periods presented (percentages may not aggregate due to rounding).
Year Ended December 31, 2006 Compared with Year Ended December 31, 2005
Revenues
Our revenues in 2006 increased by $48.0 million or of 77%, to $110.1 million from $62.1 million in 2005. The increase was volume driven and primarily attributable to increased sales to existing clients of $22.0 million, new client growth of $15.0 million and additional revenue of $11.0 associated with the acquisition of Rapidtext. Due to our implementation cycle, which may range from six to twelve months or longer, revenue from contracts initiated in 2005 were not fully realized until 2006. We expect revenues to increase as we continue to develop existing clients and market our services to potential new clients, however, the timing and amount of revenue from each of these sources is uncertain.
Cost of Revenues
Our cost of revenues in 2006 increased $34.5 million or 97%, to $70.2 million from $35.7 million in 2005. The increase was primarily due to increased costs associated with the expansion of our outsourcing operations in the Philippines and Costa Rica. We added approximately 3,900 employees and increased our salary and benefits expenses by $24.3 million. Our travel and entertainment expenses increased approximately $2.8 million. Our facilities costs increased approximately $2.7 million as we opened six new facilities in 2006. We also increased our professional services fees $2.1 million and our computer and telecommunications costs by $2.0 million. The adoption of SFAS 123(R) increased costs by approximately $0.5 million.
Selling, General and Administrative
In 2006, our selling, general and administrative costs increased approximately $8.1 million or 65%, to $20.7 million from $12.6 million in 2005. Administrative costs increased primarily due to the addition of new employees and increased salary expenses of approximately $2.9 million. Professional fees increased approximately $2.3 million. The adoption of SFAS 123(R) increased costs by approximately $1.5 million over 2005. Administrative facilities costs increased approximately $0.5 million over last year. Travel expenses increased approximately $0.3 million and computer and telephone expenses also increased approximately $0.3 million. Bad debt
expense increased $0.4 million and other costs increased $0.2 million. As a percentage of revenue, selling, general and administrative expenses declined to 19% in 2006 from 20% in 2005.
Depreciation and Amortization
Our depreciation and amortization costs in 2006 increased $3.1 million or 69% to $7.5 million from $4.4 million in 2005. The increase was primarily due to purchases of property and equipment, specifically the opening of our new facilities in Costa Rica, the two U.S.-based facilities acquired through our purchase of Rapidtext and the continued build-out of approximately 1,500 new production seats in the Philippines and Costa Rica.
Interest Income
In 2006, interest income increased $1.1 million to $2.5 million from $1.4 million in 2005. The increase in interest income was primarily due to increased cash due to profits and proceeds from our secondary offering.
Income from Operations
In 2006, income from operations increased $2.3 million or 24% to $11.7 million from $9.4 million in 2005.
Benefit for Income Taxes
The benefit for income taxes decreased to $0.1 million in 2006, compared to a $12.1 million benefit in 2005. The effective tax rate changed in 2006 to (0.7)% from (112)% in 2005. Our effective tax rate differs from the U.S. federal statutory rate in 2006 and 2005 primarily due to our tax holiday in the Philippines, state income taxes and the release of the valuation allowance against deferred tax assets. During the year ended December 31, 2006, we assessed the deferred tax asset valuation allowance and released the remaining allowance.
Year Ended December 31, 2005 Compared with Year Ended December 31, 2004
Revenues
Our revenues in 2005 increased by $17.6 million, or 40%, to $62.1 million from $44.5 million in 2004. The increase was volume driven and primarily attributable to $11.6 million in customer management fees received from clients acquired in 2004. Due to our implementation cycle, which may range from six to twelve months or longer, revenue from contracts initiated in 2004 were not fully realized until 2005. The increase was also attributable to an increase of $0.4 million of customer management fees associated with services provided to new clients, a $3.9 million increase in revenue from established clients and an increase in our accounts receivable management business of $1.7 million. We expect revenues to increase as we continue to develop existing clients and market our services to potential new clients, however, the timing and amount of revenue from each of these sources is uncertain.
Cost of Revenues
Our cost of revenues in 2005 increased by $10.4 million or 41%, to $35.7 million from $25.3 million in 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 fiscal year ended 2005, and to add capacity for anticipated future increases in demand. Costs increased at a higher rate than revenues primarily due to strategic capacity increases associated with the opening of the PeopleSupport Center. Including the cost of transferring operations, the build-out of the facilities, computers, equipment, information technology and telecommunications, opening the PeopleSupport Center increased costs by approximately $2.1 million. These costs were partially offset by savings associated with the closing of other facilities totaling approximately $0.3 million. Although our strategic investment in developing client service capacity may result in near term overcapacity and increased cost of revenues, 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.
Selling, General and Administrative
In 2005 our selling, general and administrative costs decreased $1.7 million or 12%, to $12.6 million from $14.3 million in 2004. Administrative costs declined primarily due to a $4.5 million decrease in expenses associated with the Management Incentive Plan and a $0.6 million decrease in stock amortization costs. These decreases were offset by increased costs due to Sarbanes-Oxley related compliance costs of approximately $1.3 million, processing the rescission offer which cost approximately $0.5 million, increased audit fees of approximately $0.3 million, a net increase in salary costs associated with accounting, finance and operations of approximately $0.4 million, increased Directors’ and Officers’ insurance cost of approximately $0.3 million and reductions of 2004 vendor accruals of approximately $0.7 million. As a percentage of revenue, selling, general and administrative expenses declined to 20% in 2005.
Depreciation and Amortization
Our depreciation and amortization costs in 2005 increased $0.5 million or 12% to $4.4 million from $3.9 million in 2004. The increase was primarily due to purchases of property and equipment associated with the opening of the PeopleSupport Center which increased depreciation expense by approximately $0.9 million. This increase was offset by an increase in the number of fully depreciated assets that caused depreciation expense to decrease by $0.4 million.
Interest Income
In 2005, interest income increased $1.2 million to $1.4 million from $0.2 million in 2004. The significant increase in interest income was primarily due to having the proceeds from our initial public offering for a full year versus having the funds for three months in 2004. In addition, we have used profits generated from operations to purchase additional securities.
We did not incur any interest expense in the years ending December 31, 2005 or 2004.
Income from Operations
In 2005, income from operations increased $8.2 million or 662% to $9.4 million from $1.2 million in 2004. The largest change was the cost of the Management Incentive Plan associated with the initial public offering which decreased cost of revenues by $0.5 million and selling, general and administrative expenses by $4.5 million from 2004 to 2005. The remainder of the increase was due to selling, general and administrative expenses growing at a slower rate than revenue as we were able to leverage existing administrative resources across the increased revenue.
Benefit for Income Taxes
In 2005, the net benefit from income taxes increased $5.2 million or 76% to $12.1 million from $6.9 million in 2004. Primarily due to our continued profitability, during the year ended December 31, 2005, we assessed the deferred tax asset valuation allowance each quarter and released $0.7 million, $0.4 million, $3.2 million and $10.3 million in the first, second, third and fourth quarters, respectively. For the year ending December 31, 2005, $2.1 million of the release of the deferred tax valuation is related to current utilization of deferred tax assets and the remaining amount is related to expected future utilization.
The effective tax rate changed in 2005 to (112)% from (470)% in 2004. The effective tax rates in both 2005 and 2004 differ from the U.S. federal statutory rate primarily due to our tax holiday in the Philippines, state income taxes, and the release of valuation allowance against deferred tax assets.
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 December 31, 2006, we have working capital of $124.2 million, including $80.9 million of cash and cash equivalents, $39.5 million of marketable securities and net accounts receivable of $18.1 million. Management believes existing funds will be sufficient to fund working capital needs for at least the next twelve months.
Year ended December 31, 2006
Operating Activities: Net cash provided by operating activities was $22.5 million for the year ended December 31, 2006, which was greater than our net income of $14.2 million for the same period. The difference is primarily due to increases in accounts payable and accrued liabilities of approximately $11.0 million. Adding non-cash expenses such as depreciation and amortization, stock based compensation and Management Incentive Plan charges to net income increased cash provided by operating activities by $7.5, $2.8 and $0.3 million, respectively. These increases were partially offset by an $8.9 million increase in accounts receivable, a $1.4 million increase in prepaid expenses, a $1.3 million increase in other assets and tax benefits from the exercise of stock options of approximately $1.0 million.
Our net accounts receivable balance increased approximately $9.7 million, or 115%, to $18.1 million as of December 31, 2006 from $8.4 million as of December 31, 2005. This increase is due to revenue growth, a delayed payment and to the maturation of our business that includes longer payment terms.
Investing Activities: Net cash used in investing activities for the year ended December 31, 2006 was $62.1 million. This is primarily due to $57.8 million of purchases of marketable securities, purchases of property and equipment of $17.3 million and the $9.0 million acquisition of Rapidtext. These amounts were partially offset by the maturing of approximately $22.0 million of our marketable securities.
As in 2005, our capital expenditures in 2006 were primarily for telecommunications equipment, leasehold improvements, computer hardware and software, and furniture and fixtures in support of expanding our infrastructure. We expect capital expenditures to increase in 2007 as we continue to expand. Excluding building out our undeveloped property, we expect capital expenditures in 2007 will be between $20-25 million. The cost to develop our recently purchased land will be spread over multiple years and is currently estimated at approximately $40 million.
Financing Activities: Net cash from financing activities for the year ended December 31, 2006, was $92.6 million. This was due to the secondary offering that closed in November 2006 and raised $90.9 million. Cash proceeds from the exercise of employee stock options and related income tax benefits contributed $2.1 million. Payments of $0.4 million on the capital leases acquired through our purchase of Rapidtext offset these increases.
Year ended December 31, 2005
Operating Activities: Net cash provided by operating activities was $16.7 million for the year ended December 31, 2005. This was less than our net income of $22.8 million. The difference is primarily due to increases in deferred income tax assets of $12.3 million and accounts receivable of $3.0 million, offset by $4.4 million of depreciation and amortization expense, a $3.2 million increase in accounts payable and accrued liabilities and a $1.6 million increase in deferred revenue.
Investing Activities: Net cash used in investing activities for the year ended December 31, 2005 was $30.8 million. This is primarily due to the investment of $29.6 million in marketable securities, which had been held in cash and cash equivalents as of December 31, 2004. During the year ended December 31, 2005, we incurred $7.3 million of capital expenditures, most of which was associated with the build out of four of the five floors in the PeopleSupport Center in Manila that opened in June 2005. These expenditures were offset by the maturing of marketable securities of $3.6 million and proceeds from short term investments of $2.0 million.
Our capital expenditures in 2005 were primarily for telecommunications equipment, leasehold improvements, computer hardware and software, and furniture and fixtures in support of expanding our infrastructure.
Financing Activities: Net cash from financing activities for the year ended December 31, 2005, was $0.3 million and was due solely to the exercise of employee stock options. Cash from the exercise of employee stock options increased $0.2 million from $0.1 million in 2004 due to the lifting of the blackout periods in effect for much of that year.
Credit Agreement
In July 2006, we entered into a loan agreement with Citibank (West), FSB that provides a revolving line of credit for general corporate purposes and allows us to borrow up to $25 million. The line of credit terminates on July 28, 2008 and any amounts borrowed must be repaid at that time. Loans outstanding under the agreement bear interest at either the prime rate minus .25% or at LIBOR plus .65%. We do not have any borrowings outstanding under the Loan Agreement as of this time.
Contractual Obligations, Commitments and Off-balance Sheet Arrangements
Currently our only debt consists of the capital leases we acquired through Rapidtext. As of December 31, 2006, we owe less than $0.1 million on the leases, which expire by May 2008. Due to prepayment penalties, we do not expect to pre-pay these leases and will incur nominal amounts of interest expense in 2007 and 2008. We have no other debt and no off-balance sheet arrangements.
The following summarizes our contractual obligations at December 31, 2006, all of which represent operating lease payment obligations. The amounts in the table below do not include any adjustment that may result from increases in certain contractual obligations in the event inflation in the Philippines exceeds contractually negotiated levels. We generally do not enter into binding purchase commitments. Our principal commitments consist of obligations under leases for office space and equipment.
We have the option to renew two leases under various terms, ranging from five to six years, at various rates as specified within each lease agreement. The table above does not assume any such renewals.
Our obligations under four leases may change due to inflation in the Philippines or fluctuations in the value of the Philippine peso relative to the value of the U.S. dollar. These leases provide for increases in lease payments in the case of extraordinary inflation or a significant decline in the value of the Philippine peso compared to the US dollar, generally in excess of 25%. Such occurrences are unusual. For 2007, the Philippine Central Bank has set a target inflation rate of 4-5%.
In December 2006, PeopleSupport (Philippines) created and approved a pension plan to benefit our Philippine employees. Prior to the creation of the pension plan, we had a statutory obligation to pay certain amounts to our employees. The pension plan allows us to fund this obligation over time and segregate the assets from those of the company. As of December 31, 2006, the projected benefit recognized as a long-term liability on our balance sheet was approximately $1.2 million. As of December 31, 2006, the plan did not have any assets. In the first quarter of 2007, we began funding the plan with approximately $0.5 million, primarily invested in Philippines securities.
Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting and disclosure for uncertainty in tax positions. FIN 48 seeks to reduce the diversity in practice associated with certain aspects of the recognition and measurement related to accounting for income taxes. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company is currently in the process of evaluating the financial impact of this statement.
In September 2006, the FASB issued statement No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, with earlier application encouraged. Any amounts recognized upon adoption as a cumulative effect adjustment will be recorded to the opening balance of retained earnings in the year of adoption. We have not yet determined the impact of this Statement on its financial position and results of operations.
In September 2006, the FASB issued Statement No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (an amendment of FASB Statements No. 87, 88, 106, and 132R)” (“SFAS 158”). SFAS 158 requires companies to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. SFAS 158 requires companies to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. The Company adopted SFAS 158 effective for the fiscal year ended December 31, 2006. The impact on fiscal 2006 operating results was a $0.6 million charge to other comprehensive income. This minimum pension liability adjustment increased our pension liability to approximately $1.2 million.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115” (“SFAS 159”), which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value, nor eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in SFAS 157, “Fair Value Measurements,” and SFAS 107, “Disclosures about Fair Value of Financial Instruments.” SFAS 159 is effective for our fiscal year beginning after November 15, 2007. We are currently assessing the impact that the adoption of SFAS 159 will have on our consolidated financial statements.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
Foreign Currency Exchange Risk
Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Philippine peso. For the years ended December 31, 2006, 2005 and 2004, approximately 59%, 67% and 57%, respectively, of our expenses were generated in the Philippines. We derive all of our revenues in U.S. dollars. At our current rate of expenditure, 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 $3.2 million, whereas a 10% decrease in the relative value of the dollar would increase the cost associated with these operations by approximately $3.2 million. Expenses relating to our operations outside the United States increased for the year ended December 31, 2006 when compared with the year ended December 31, 2005 due to increased costs associated with higher revenue generation and customer management services and the decrease in the value of the U.S. dollar relative to the Philippine peso.
We fund our Philippine subsidiary 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. Effective January 2007, we entered into forward contracts in an attempt to partially offset the increased operating costs resulting from the continued strengthening of the Philippine peso.
Interest Rate Sensitivity
We had cash and cash equivalents totaling $80.9 million and marketable securities totaling $59.7 million at December 31, 2006. These amounts were invested primarily in money market funds, certificates of deposit, municipal bonds and federal agency securities. The cash and cash equivalents are held for potential acquisitions of complementary businesses or assets, working capital requirements and general corporate purposes. We do not enter into investments for trading or speculative purposes. 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. The interest income from these funds will be subject to fluctuations due to changes in interest rates. Declines in interest rates would reduce future investment income. A 1% decrease in short term rates would reduce our interest income for the year ended December 31, 2006 by approximately $0.6 million.
Inflation Rate Sensitivity
For the years ended December 31, 2006, 2005, and 2004, approximately 59%, 67%, and 57% 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 years ended December 31, 2006, 2005 and 2004 average annual inflation rates of 4.3%, 7.6% and 5.5%, respectively, kept prices generally stable. For 2007, the Philippine Central Bank has set a target inflation rate of 4-5%. As of January 2007, the most recent report from the Philippine Central Bank expects 2007 inflation will fall within the targeted band.
Item 8.
Item 8.
Financial Statements and Supplementary Data
The consolidated financial statements and supplementary data required by this item are set forth at the pages indicated in Item 15.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A.
Controls and Procedures
Management’s Report on Internal Control Over Financial Reporting. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) and for assessing the effectiveness of our internal control over financial reporting. Our internal control system is designed to provide reasonable assurance to our management and Board of Directors regarding the preparation and fair presentation of published financial statements in accordance with United States’ generally accepted accounting principles. Our internal control over financial reporting is supported by written policies and procedures that:
•
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
•
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that our receipts and expenditures are being made only in accordance with authorizations of our management and our Board of Directors; and
•
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.
Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2006 using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Management’s assessment included an evaluation of the design of our internal control over financial reporting and testing of the operational effectiveness of our internal control over financial reporting. Based on this assessment, our Chief Executive Officer and Chief Financial Officer
have concluded that as of December 31, 2006, our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, were effective.
Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable assurance and may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions and that the degree of compliance with the policies or procedures may deteriorate.
BDO Seidman, LLP, the independent registered public accounting firm that audited the financial statements included in this Annual Report on Form 10-K, was engaged to attest to and report on management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006. A copy of this report is included at page of this Annual Report on Form 10-K.
Changes in internal control over financial reporting. There were no material 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 9(a) above that occurred during the fiscal quarter ended December 31, 2006 and that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B.
Other Information
None
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
The information required by this item is incorporated by reference from the information under Proposal 1 - Election of Directors contained in our Proxy Statement.
Item 11.
Item 11.
Executive Compensation
The information required by this item is incorporated by reference from the information under the captions “Executive Compensation” and “Director Compensation,” contained in our Proxy Statement.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item is incorporated by reference from the information under the captions “Related Stockholder Matters” and “Security Ownership of Certain Beneficial Owners and Management” contained in our Proxy Statement.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
The information required by this item is incorporated by reference from the information under the captions, “Corporate Governance - Director Independence” and “Transactions with Related Persons” contained in our Proxy Statement.
Item 14.
Item 14.
Principal Accountant Fees and Services
The information required by this item is incorporated by reference from the information under the caption “Independent Public Registered Accounting Firm” contained in our Proxy Statement.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
The following documents are filed as part of this Annual Report on Form 10-K:
Financial Statements
The consolidated financial statements required by this item are submitted in a separate section beginning on page of this Report.
Consolidated Financial Statements of PeopleSupport, Inc.
Financial Statement Schedule
The financial statement schedule required by this item is a part of this Annual Report on Form 10-K and should be read in conjunction with our consolidated financial statements:
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
PeopleSupport, Inc.
Los Angeles, California
The audits referred to in our report dated March 16, 2007 relating to the consolidated financial statements of PeopleSupport, Inc., which is presented on the page set forth in Item 15 of this Annual Report on Form 10-K, included the audit of the financial statement schedule presented below. This financial statement schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion on this financial statement schedule based upon our audits.
In our opinion, such financial statement schedule presents fairly, in all material respects, the information set forth therein.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
Los Angeles, California
March 16, 2007
Schedule II - Valuation and Qualifying Accounts (in thousands)
Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the financial statements or notes thereto.
Exhibits with each management contract or compensatory plan or arrangement required to be filed identified. See below.
Exhibits
*
Indicates management employment contract or compensatory plans or arrangements.

Confidential treatment has been requested for portions of this exhibit. Portions of this document have been omitted and submitted separately to the Securities and Exchange Commission.
(1)
Incorporated by reference to the Registrant’s Registration Statement on Form S-1, File No. 333-115328, originally filed with the Securities and Exchange Commission on May 10, 2004, as amended.
(2)
Incorporated by reference to the Registrant’s Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 31, 2005.
(3)
Incorporated by reference to the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on October 26, 2005.
(4)
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 12, 2006.
(5)
Incorporated by reference to the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission May 31, 2006.
(6)
Incorporated by reference to the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on August 2, 2006.
(7)
Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 1, 2006.
(8)
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.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of PeopleSupport, Inc.
Los Angeles, California
We have audited the accompanying consolidated balance sheets of PeopleSupport, Inc. and subsidiaries (the “Company”) as of December 31, 2006 and 2005 and the related consolidated statements of operations and comprehensive income, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PeopleSupport, Inc. and subsidiaries as of December 31, 2006 and 2005 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America.
As more fully described in Note 2 to the consolidated financial statements, effective January 1, 2006 the Company adopted Statement of Financial Accounting Standard (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment.” Also, as more fully described in Note 2, the Company adopted SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.”
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 16, 2007 expressed an unqualified opinion thereon.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
Los Angeles, CA
March 16, 2007
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of PeopleSupport, Inc.
Los Angeles, California
We have audited management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing in Item 9A of the accompanying Annual Report on Form 10-K, that PeopleSupport, Inc. and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2006 is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of PeopleSupport, Inc. as of December 31, 2006 and 2005 and the related consolidated statements of operations and comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2006 and our report dated March 16, 2007 expressed an unqualified opinion thereon.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
Los Angeles, California
March 16, 2007
PEOPLESUPPORT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
PEOPLESUPPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
PEOPLESUPPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
Years Ended December 31, 2004, 2005 and 2006
(In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
PEOPLESUPPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
1 - Description of the Company
PeopleSupport, Inc. (the “Company”) was incorporated in the State of Delaware on July 2, 1998 and is a leading provider of offshore business process outsourcing, (“BPO”), services which we primarily deliver to U.S.-based clients from our facilities in the Philippines. Based on the size of our workforce of college-educated, fluent English-speaking Filipino employees, we believe we are one of the largest providers of BPO services operating from the Philippines. We provide cost-effective, complex, value-added customer management services to clients in the travel and hospitality, financial services, technology, telecommunications and consumer products industries. We also provide transcription and captioning and other BPO services.
2 - Summary of Significant Accounting Policies
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include valuation reserves for accounts receivable, income taxes, and valuation of marketable securities and goodwill and recoverability of long-term assets. Actual results could differ from those estimates.
Concentrations of Risk
Financial instruments that potentially subject the Company to concentration of credit risk consist of cash and cash equivalents and accounts receivable. Cash and cash equivalents are deposited or managed by major financial institutions and at times are in excess of FDIC insurance limits.
The Company performs ongoing credit evaluations of its customers’ financial condition and limits the amount of credit extended when deemed necessary, but generally does not require collateral. The Company maintains an allowance for potential credit losses and write-offs of accounts receivable, which amounted to $947 and $487 at December 31, 2006 and 2005, respectively.
This allowance is our best estimate of the amount of probable credit losses in our existing accounts receivable balance based on our historical experience, in addition to any credit matters we are aware of with specific customers. The allowance is reviewed monthly to ensure that there is a sufficient reserve to cover any potential write-offs. Account balances are charged off against the allowance when we feel it is probable the receivable will not be collected.
Revenue and accounts receivable from significant customers, who in any one or more of the years shown accounted for 10% or more of the Company’s revenue for the year were as follows:
Vonage, our third largest client in 2006 and our fourth largest client in 2005, has elected not to renew their contract.
The Company maintains operational and technical facilities for its global operations, including maintaining a relationship with two significant vendors who provide the storage and related maintenance of the Company’s main technology equipment and data. Any significant events leading to systems and operations unavailability before the Company’s contingency plans are deployed could potentially lead to a disruption of service and associated financial impact.
The Company’s revenues are dependent on clients in the travel, hospitality, technology and communications industries, and a material decrease in demand for outsourced services in these industries could result in decreased revenues. Additionally, the Company has significant operations in the Philippines, and is subject to risks associated with operating in the Philippines including political, social and economic instability and increased security concerns, fluctuation in currency exchange rates and exposure to different legal standards. Carrying amount of total assets used in our Philippine operations were $16,564 and $11,995 at December 31, 2006 and 2005, respectively.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries. Intercompany transactions and balances have been eliminated.
Cash, Cash Equivalents and Marketable Securities
Cash and cash equivalents consist of cash on hand and short-term investments with maturities of three months or less. Cash equivalents at December 31, 2006 and 2005 consist of money-market funds, corporate bonds, municipal bonds and federal agency securities. Marketable securities include corporate bonds, municipal bonds, federal agency securities and mortgage backed assets. All investments are considered available for sale.
Property and Equipment
Property and equipment are stated at cost and depreciated using the straight-line method based on the following period for each asset category:
Leasehold improvements are amortized over the shorter of the asset’s useful life or the remaining lease term.
Impairment of Long-lived Assets
Long-lived assets, including fixed assets and intangibles, are reviewed for impairment annually. An undiscounted cash flow analysis is utilized to determine whether impairment has occurred. If impairment is determined, the asset is written down to its estimated fair value. The estimation of future cash flows and fair values involves considerable management judgment.
Revenue Recognition
Implementation fees include revenues associated with new customers, which are deferred and recognized ratably over the life of the contract. Session fees, including revenues associated with voice, email and live help transactions and with hosting and maintaining software applications for customer service, are recognized as these services are provided. Revenues are recognized when there are no significant Company obligations remaining, fees are fixed and determinable and collection of the related receivable is reasonably assured.
Commission revenues for contingent accounts receivable management contracts are recognized upon receipt of the collected funds.
Cost of Revenues
Cost of revenues consists primarily of employee-related costs associated with the services rendered on behalf of a client, as well as telecommunications costs, information technology costs associated with providing services, facilities support and customer management support costs related to the operation of outsourcing and data centers and consulting services.
Net Income Per Share
Basic earnings per share (EPS) excludes dilution and is computed by dividing net income or loss by the weighted average number of common shares outstanding for the period. Diluted EPS 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, awards of restricted common stock and grants of common stock options using the treasury stock method) were exercised or converted into common stock.
The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations:
The following is a summary of the number of shares or securities outstanding during the respective periods that have been excluded from the calculations because the effect on net income per share would have been antidilutive (in thousands):
Segments of an Enterprise
The Company reports segment information in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”). Under SFAS 131, all publicly traded companies are required to report certain information about the operating segments, products, services and geographical areas in which they operate and their major customers. The Company operates as two business segments: customer management services and transcription and captioning services. Our transcription and captioning segment is not separately
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
presented as it currently represents less than ten percent of the combined revenues and substantially less than ten percent of profit and assets of the total reported operating segments.
Income Taxes
The Company accounts for income taxes in accordance with SFAS 109-“Accounting for Income Taxes” (“SFAS 109”). Under this method, deferred taxes are determined based on the differences 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 and released as the amount of the deferred tax assets expected to be realized changes.
Comprehensive Income
The components of accumulated other comprehensive income, net of tax are as follows:
Fair Value of Financial Instruments
The Company’s financial instruments, including cash, accounts receivable, accounts payable and accrued liabilities, are carried at cost, which approximates their fair value. The Company carries cash equivalents, consisting primarily of short term investments in money-market funds, certificates of deposit, municipal bonds and federal agency securities, at market value.
Foreign Currency
The Company’s Philippine subsidiary used its local currency as its functional currency through September 30, 2006. Assets and liabilities were translated into U.S. dollars at exchange rates prevailing at the balance sheet dates. Revenues and expenses were translated into U.S. dollars at average exchange rates for the period. The resultant cumulative translation adjustments were included in accumulated other comprehensive income or loss, which is a separate component of stockholders’ deficit. Gains and losses from foreign currency transactions were recognized as a component of net income or loss as incurred and were not material for any of the years presented.
Beginning October 1, 2006 the Company’s Philippine subsidiary changed its functional currency to the U.S. dollar. Under the guidelines of Statement of Financial Standards No. 52, Foreign Currency Translation, the Philippines subsidiary had a significant change in facts and circumstances which resulted in a reassessment of their functional currency in the fourth quarter of fiscal 2006. This accounting change was primarily due to the Philippine subsidiary contracting, invoicing and collecting payment in U.S. dollars directly with two significant customers. Assets and liabilities were translated into U.S. dollars at exchange rates prevailing at that time. This change resulted in a $0.2 million pre-tax gain in the fourth quarter of fiscal 2006. Revenues and expenses are transacted using the
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
prevailing U.S. dollar exchange rate and the resulting gain or loss is recognized as a component of net income or loss as incurred.
Our Costa Rican subsidiary uses the U.S. dollar as its functional currency.
Accounting for Stock Based Compensation
Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (Revised 2004), “Share-Based Payment” (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options, based on estimated fair values. SFAS 123(R) supersedes the Company’s previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) for periods beginning in fiscal 2006. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R).
In accordance with the modified prospective transition method, the accompanying Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is expected to vest is recognized as expense over the requisite service periods in the Company’s Consolidated Statement of Operations. We use the Black-Scholes pricing model to determine the fair value of our stock-based compensation. Prior to the adoption of SFAS 123(R), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25.
Under SAFS 123(R), the pool of windfall tax benefits at adoption consists of the net credits to APIC that a company would have recorded under FAS 123(R) (subject to potential adjustment for NOL carryforwards). Effective January 1, 2006, we recognize windfall tax benefits associated with the exercise of stock options directly to stockholders’ equity only when realized. A windfall tax benefit occurs when the actual tax benefit realized by the Company upon an employee’s disposition of an equity based award exceeds the deferred tax asset, if any, associated with the award that we had previously recorded. When assessing whether a tax benefit relating to share-based compensation has been realized, we follow the tax law ordering method, under which current year share-based compensation deductions are assumed to be utilized before net operating loss carryforwards and other tax attributes.
For the years ended December 31, 2006, 2005 and 2004, we recorded approximately $2.8 million, $0.9 million and $1.8 million, respectively, in non-cash, stock-based compensation expense. See Note 6 for additional information on accounting for stock based compensation.
Comprehensive Income
The Company follows the reporting and disclosure requirements of SFAS 130, “Reporting Comprehensive Income.” SFAS 130 requires the disclosure of total non-stockholder changes in equity and its components, which would include all changes in equity during a period except those resulting from investments by and distributions to stockholders. The components of other comprehensive income applicable to the Company are translation gains and losses on foreign currency and unrealized gains and losses on securities.
Accounting for Pension Plans
The Company accounts for its recently adopted Philippine pension plan in accordance with SFAS 87, 88, 106, 132R and 158. SFAS 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (an amendment of FASB Statements No. 87, 88, 106, and 132R)” (“SFAS 158”) effective December 2006. SFAS 158 requires us to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
liability in our statement of financial position and to recognize changes to the funded status in the year in which the changes occur through comprehensive income. The adoption of this statement resulted in the recognition of a long-term liability of approximately $1.2 million and a decrease of $0.6 million to comprehensive income. Please see Note 7 for additional information.
Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting and disclosure for uncertainty in tax positions. FIN 48 seeks to reduce the diversity in practice associated with certain aspects of the recognition and measurement related to accounting for income taxes. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company is currently in the process of evaluating the financial impact of this statement.
In September 2006, the FASB issued statement No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, with earlier application encouraged. Any amounts recognized upon adoption as a cumulative effect adjustment will be recorded to the opening balance of retained earnings in the year of adoption. We have not yet determined the impact of this Statement on its financial position and results of operations.
In September 2006, the FASB issued Statement No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (an amendment of FASB Statements No. 87, 88, 106, and 132R)” (“SFAS 158”). SFAS 158 requires companies to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. SFAS 158 requires companies to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. The Company adopted SFAS 158 effective for the fiscal year ending December 31, 2006. The impact on fiscal 2006 operating results was a $0.6 million charge to other comprehensive income. This minimum pension liability adjustment increased our pension liability to approximately $1.2 million.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115” (“SFAS 159”), which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value, nor eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in SFAS 157, “Fair Value Measurements,” and SFAS 107, “Disclosures about Fair Value of Financial Instruments.” SFAS 159 is effective for our fiscal year beginning after November 15, 2007. We are currently assessing the impact that the adoption of SFAS 159 will have on our consolidated financial statements.
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
3 - Cash and Cash Equivalents
The following tables summarize the value of the Company’s cash and marketable securities held in its investment portfolio, recorded as cash, cash equivalents or marketable securities as of December 31, 2006 and 2005:
As of December 31, 2006, our holdings were as follows:
As of December 31, 2006, our holdings matured as follows:
As of December 31, 2005 our holdings were as follows:
As of December 31, 2005 our holdings matured as follows:
All investments are classified as available for sale.
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
4 - Property and Equipment
As of December 31, net property and equipment consists of the following balances:
5 - Commitments and Contingencies
Leases
The following summarizes our contractual obligations at December 31, 2006, all of which represent operating lease payment obligations.
For the years ended December 31, 2005 and 2004, the Company did not incur any interest expense associated with capital lease obligations. In January 2006 we acquired two capital leases through the acquisition of Rapidtext. As of December 31, 2006, we owe $29 and $40 on the leases, which expire on May 2008 and December 2007, respectively. The interest rate on the leases is approximately 8%. Due to prepayment penalties, we do not expect to pre-pay these leases. We paid $8 in interest expense in the year ended December 31, 2006. We expect to pay $3 in interest expense in 2007 and less than $1 of interest expense in 2008.
The Company records rental expense on a straight-line basis over the base, non-cancelable lease terms. Any difference between the calculated expense and the amount actually paid are reflected as a liability in the accompanying consolidated balance sheet and totaled $1,812 and $978 at December 31, 2006 and 2005, respectively. Rent expense for the years ended December 31, 2006, 2005 and 2004 was $4,254, $2,667, and $1,943, respectively.
Contractual Compensation Obligation
Effective July 1, 2002, the Company adopted its 2002 Management Incentive Plan (the “Plan”) under which the Company is obligated to make payments to senior management and key employees upon completion of certain significant transactions, including the sale of the 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 received cash
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
payments based on the aggregate net proceeds received by the Company and selling stockholders from the initial public offering. The Company paid $5,337 under the Plan upon the closing of our initial public offering on October 6, 2004. Payments of $77 and $320 were made in 2005 and 2006, respectively. The remaining payments of $629 will be made in 2007. The amounts expensed in 2004, 2005 and 2006 were $5,337, $342 and $342, respectively.
Litigation
The Company is, from time to time, a defendant or plaintiff in litigation related to claims arising out of its operations in the ordinary course of business. The Company believes that no claims should have a material adverse impact on its financial condition or results of operations.
6 - Equity and Stock Based Compensation
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. At this time, the Company only common stock issued and outstanding. Upon the conclusion of the Company’s initial public offering in October 2004, all preferred stock converted to common stock. Prior to the Company’s initial public offering we had granted warrants. None of the warrants were exercised and as of June 5, 2006, all previously issued warrants had expired.
Stock-Based Compensation Plans
The Company’s stock incentive plans provide for grants of options to purchase shares of common stock, awards of restricted stock, stock appreciation rights and stock units. Incentive stock options are generally granted to employees. Grants of nonstatutory stock options and other stock-based awards may be granted to employees, non-employee directors, advisors and consultants. The board of directors may amend or modify the 2004 stock incentive plan at any time, with stockholder approval, as required. All grants and awards are settled in equity and settled through the issuance of shares that have been authorized and were previously unissued.
Stock Incentive Plan
The 2004 stock incentive plan was adopted by the Company’s board of directors in July 2004 and, following stockholder approval, became effective upon the completion of the Company’s initial public offering. The 2004 stock incentive plan is administered by the board of directors or the compensation committee of the board and provides for the issuance of stock options at prices not less than 85% (110% if the award is issued to a 10% stockholder) of the fair market value at the date of issue. The 2004 stock incentive plan provides for the grant of options to purchase shares of common stock, restricted stock, stock appreciation rights and stock units. Incentive stock options may be granted only to employees. Nonstatutory stock options and other stock-based awards may be granted to employees, non-employee directors, advisors and consultants. The board of directors may amend or modify the 2004 stock incentive plan at any time, with stockholder approval, as required.
Under the 2004 stock incentive plan, no participant may receive option grants, restricted shares, stock units, or stock appreciation rights for more than 180 shares total in any calendar year, or for more than 720 shares total in the first year of service. The number of shares reserved for issuance under the 2004 stock incentive plan will be increased on the first day of each fiscal year during the term of the plan, beginning January 1, 2006, by the lesser of 1,100 shares, 4% of the Company’s outstanding common stock on the last day of the immediately preceding fiscal year or a number of shares determined by the board of directors. An aggregate of 2,759 options were reserved under the Plan, of which 720 options were available for future grant by the Board of Directors at December 31, 2006. On January 1, 2007, an additional 939,146 shares were added to the pool of available shares reserved under the 2004 Stock Incentive Plan.
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
In addition, all shares available for issuance under the Company’s 1998 stock incentive plan that ceased to be available for future grant under that plan upon completion of the Company’s initial public offering instead became available for issuance under the 2004 stock incentive plan. This includes shares subject to outstanding options under our 1998 stock incentive plan that expire, terminate or are cancelled before being exercised and unvested shares that are forfeited pursuant to that plan.
The Plan provides for the grant of nonstatutory and incentive stock options to employees, officers, directors and consultants of the Company. Options granted generally vest 25% after one year of service and ratably over 36 months thereafter and have a maximum life of 10 years. Restricted stock units generally vest in three equal annual installments.
Employee Stock Purchase Plan
The 2004 employee stock purchase plan was adopted by the Company’s board of directors in July 2004 and is intended to qualify under Section 423 of the Internal Revenue Code. A total of 225 shares of common stock have been reserved for issuance under the Company’s employee stock purchase plan. The number of shares reserved for issuance under the employee stock purchase plan will be increased on the first day of each of the Company’s fiscal years from 2006 through 2014 by the lesser of 400 shares, 1.25% of the Company’s outstanding common stock on the last day of the immediately preceding fiscal year, or a number of shares determined by the board of directors. Under the plan, eligible employees may purchase common stock during the designated offering period through accumulated payroll deductions at a price equal to the fair market value less a pre-determined percentage on either the first trading day of the offering period or on the last trading day of the purchase period, whichever is less.
As of December 31, 2006, the 2004 employee stock purchase plan has yet to be implemented, no date has been set for implementation and there has been no activity associated with the plan.
Accounting for Stock Based Compensation
The following table reflects the pro forma net income and earnings per share for the years ended December 31, 2005 and 2004, had we elected to adopt the fair value approach of SFAS 123 as reported in the footnotes to the Company’s financial statements.
The estimated weighted average fair value of options granted during the years ended December 31, 2006, 2005 and 2004 was $7.81, $3.67 and $5.31, respectively. In connection with the acquisition of Rapidtext on January 9,
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
2006, we converted previously vested and unvested Rapidtext options into approximately 10 PeopleSupport stock based awards. The fair value of the options acquired was estimated using the Black-Scholes model at $12.74 and their average exercise price is $1.93. All other options were granted at the fair market value. The fair value of each option was estimated on the date of grant using the following weighted average assumptions for grants for the years ended December 31, 2006, 2005 and 2004:
There are a number of assumptions and estimates used in calculating the fair value of options. These include the expected term of the option, the expected volatility and the risk free interest rate. These assumptions are included in the chart above. The basis for our expected volatility and expected term estimates is a combination of our historical information and the historical experiences of a peer group. The companies in the peer group were selected based upon their industry, operations, market capitalization, revenue and other factors. The risk-free interest rate is based upon yields of U.S. Treasury strips with terms equal to the expected life of the option or award being valued. PeopleSupport does not currently pay a dividend nor does the Company expect to pay a dividend.
Stock option activity for the years ended December 31, 2004, 2005 and 2006 is summarized as follows:
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
The following table summarizes information about stock options outstanding at December 31, 2006.
Stock based compensation expense was classified in the statement of operations as follows:
Restricted stock unit activity for the years ended December 31, 2005 and 2006 is summarized in the chart below. We did not have any outstanding restricted stock units in 2004.
(1)
PeopleSupport withheld 3 of the 17 restricted stock units that vested during the year ended December 31, 2006 to pay income taxes owed by the recipients.
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
As of December 31, 2006 there was $6,370 and $1,709 of unrecognized compensation cost related to unvested stock options and restricted stock units, respectively. Those costs are expected to be recognized over a weighted-average period of 1.48 and 1.54 years, respectively. We expect to continue issuing new shares when our employees convert the options and restricted stock units to shares of common stock. At this time, we do not expect to re-purchase these shares on the open market.
7 - Pension Plan
On December 7, 2006 a retiree benefit plan was approved for the Company’s wholly owned subsidiary, PeopleSupport (Philippines), Inc. The membership in the plan is automatic for all Philippine employees of the Company who are considered to have Regular Employment Status as of the effective date of the Plan. Prior to the approval of the plan, the Company had a statutory obligation to pay certain amounts which were recorded on the balance sheet as long-term liabilities and are reflected in the tables below.
Under the terms of the plan, retirees are classified as either Normal, Early or Late, defined as follows:
Normal Retirement. The Normal Retirement Date of a Member shall be the first day of the month coincident with or next following his sixtieth (60th) birthday, provided he has served the Company for at least five (5) years of Credited Service. The Member’s Normal Retirement Benefit shall be a sum equal to one-half month salary for every year of Credited Service, a fraction of at least six (6) months being considered as one whole year.
Early Retirement. Upon reaching the age of fifty (50) and with ten (10) years of service, a Member may retire and shall be entitled to an Early Retirement Benefit which shall be a sum equal to one-half month salary for every year of Credited Service, a fraction of at least six (6) months being considered as one whole year.
Late Retirement. The Late Retirement Date of a Member shall be the first day of the month coincident with or next following his sixty fifth (65th) birthday, provided he has served the Company for at least five (5) years of Credited Service. The Member’s Normal Retirement Benefit shall be a sum equal to one-half month salary for every year of Credited Service, a fraction of at least six (6) months being considered as one whole year.
Summary of Financial Position
As of December 31, 2006, under the provisions of the plan a total of 7,631 active employees in the Philippines who were, on average 27 years old, were considered eligible participants. The average employee had been with us for just over one year and is expected to work for an additional 16 years. No employees are fully vested in the plan nor are there any retirees or other beneficiaries.
The actuarial calculations are presented in the following table. The difference between the Present Value of Defined Benefit Obligation at the end of 2005 compared to the beginning of 2006 is due to the change in the United States dollar to Philippine peso exchange rate. The actual number in Philippine pesos is 21,360. We used the exchange rates at December 31, 2006 and 2005, 49.045 and 53.090 respectively.
Summary of Membership Data
As of December 31, 2006 and 2005, the pension plan did not have any assets and the recognized liability, $1,236 and $342, respectively, was included in other long term liabilities in the accompanying consolidated balance
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
sheets. No payments were made from the plan in 2005 or 2006. We expect to make payments totalling approximately $15 over the next five years.
The following assumptions were used to calculate the Philippine Pension obligation:
Due to our lack of history, these assumptions are primarily based upon Philippine industry averages and Philippine economic data.
In January 2007, we began funding the Pension Plan with approximately $450. These funds are invested through a trustee with approximately $420 held in Philippine debt and equity securities and an investment of $30 in PeopleSupport Properties Philippines, Inc. (“PSPPI”) See Note 15.
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
8 - Income Taxes
The components of the benefit for income taxes are as follows:
A reconciliation of the statutory federal income tax rate with the Company’s effective income tax rate is as follows:
Income/(loss) before income taxes is as follows:
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
The primary components of temporary differences which give rise to the Company’s deferred tax assets and deferred tax liabilities are as follows:
As of December 31, 2006, the Company had net operating loss carryforwards for federal and state tax purposes of approximately $48,241 and $34,325, respectively. The federal and state net operating loss carryforwards begin to expire in the years 2020 and 2012, respectively. The Company’s ability to use the net operating loss carryforwards is subject to limitations under Section 382 of the U.S. Internal Revenue Code. Based upon the Company’s analysis, management does not believe that these limitations will affect the ability to use these carryforwards. During the year ended December 31, 2006, the Company released the remaining California deferred tax asset valuation allowance, as it was determined that it is more likely than not that the deferred tax assets will provide future tax benefits.
The Company is currently the beneficiary of tax holiday incentives in the Philippines and Costa Rica. The Philippine income tax holidays have durations of four to six years, with the possibility of two to three year extensions. The tax holidays expire at staggered dates beginning in 2006 and ending in 2008, unless extended. Philippine tax rates will then apply to the income earned by the Company’s Philippines subsidiary. The estimated statutory income tax rate in the Philippines for the year ended December 31, 2005 and 2006 would have been 35% or 5% on gross income with respect to income derived from activities covered by our registration with the Philippines Export Zone Authority.
For the years ended December 31, 2006 and 2005, we estimate the benefit of the tax holidays in the Philippines and Costa Rica to be $4,614 and $2,400 respectively, or on both a basic and diluted per share basis, $0.24 and $0.13.
A deferred U.S. tax liability has not been provided on the unremitted earnings of our Philippine or Costa Rican subsidiaries because it is the intent of the Company to permanently reinvest these earnings in each country. Undistributed pre-tax earnings of our subsidiaries, which have been or are intended to be permanently invested in accordance with APB No. 23, “Accounting for Income Taxes - Special Areas,” aggregated approximately $3,795, $8,892 and $21,576 at December 31, 2004, 2005 and 2006, respectively. If such earnings are repatriated in the future, or are no longer deemed to be indefinitely reinvested, the Company would accrue the applicable amounts of taxes associated with such earnings using the effective federal tax rate at the time of repatriation.
9 - Public Offerings
On October 6, 2004, the Company completed its initial public offering, resulting in net proceeds of $31,570. In November 2006, the Company completed a secondary offering that raised a net total of $90,887 through the issuance of 4,830 shares of common stock. At this time, the Company still has an open shelf registration statement under which it may offer up to an additional $3,400 of securities.
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
10 - Geographic and Segment Information
The Company operates as two business segments: customer management services and transcription and captioning services. Our transcription and captioning service segment is not separately presented as it currently represents less than ten percent of the combined revenues and substantially less than ten percent of profit and assets of the total reported operating segments. Substantially all of the Company’s revenue was derived from U.S.-based companies, denominated in U.S. dollars and recognized by the U.S. entity. In October 2006, our Philippine subsidiary began signing contracts directly with clients.
The composition of the Company’s long-lived assets and depreciation and amortization between those in the United States, the Philippines and Costa Rica are set forth below.
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
11 - Quarterly Financial Data (Unaudited)
Summary unaudited quarterly financial data for fiscal 2006 and 2005 is as follows:
(1)
During the year ended December 31, 2006 we assessed the deferred tax asset valuation allowance each quarter and decreased the allowance by $0.5 million and $1.0 million in the second and fourth quarters. The allowance was increased in the third quarter by $0.1 million, resulting in a net effect for all of 2006 of $1.4 million.
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
(2)
During the year ended December 31, 2005, we assessed the deferred tax asset valuation allowance each quarter and released $0.7 million, $0.4 million, $3.2 million and $10.3 million in the first, second, third and fourth quarters, respectively.
Quarterly and year-to-date computations of earnings per share amounts are made independently. Therefore, the sum of the per share amounts for the quarters may not agree with the per share amounts for the year.
12 - Material Fourth Quarter Adjustments
During the quarter ended December 31, 2006, the Company recorded several adjustments that impacted income before income taxes as follows: additional amortization expense of $0.4 million related to software licenses, an increase to the allowance for doubtful accounts of approximately $0.4 million and approximately $0.2 million of sales credits and customer concessions.
Approximately $0.6 million of the above adjustments relate to various periods prior to the fourth quarter of fiscal 2006 but are not material to any prior period affected.
13 - Credit Agreements
In July 2006, the Company entered into a loan agreement with Citibank (West), FSB that provides a revolving line of credit for general corporate purposes and allows the Company to borrow up to $25,000 from time to time as needed. The line of credit terminates on July 28, 2008 and any amounts borrowed must be repaid at that time. Loans outstanding under the agreement bear interest, at the Company’s election, either at the prime rate minus .25% or at LIBOR plus .65%. The Company has no borrowings outstanding under the Loan Agreement as of December 31, 2006.
14 - Rapidtext Acquisition
On January 9, 2006, the Company expanded into a new BPO market by acquiring all of the outstanding capital stock of Rapidtext, Inc. (“Rapidtext”), a privately held transcription and captioning service company based in Newport Beach, CA. The Company paid $8,968 in cash from existing cash reserves and assumed $22 worth of unvested stock options. The purchase price includes transaction costs of approximately $525. As part of the purchase agreement, $1,300 of cash was held in escrow to satisfy indemnification obligations. In addition, there was a net working capital holdback of $350. An earnout provision could have resulted in the issuance of up to 113 shares valued at purchase at approximately $966. Rapidtext did not meet the earnout provisions and no additional shares were issued.
The Company’s allocation of purchase price for the acquisition is as follows:
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
The intangible assets of $860 are comprised of customer lists, non-compete agreements, internally developed software, and trademarks and tradenames. Intangible assets associated with the Rapidtext acquisition are accounted for in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” Goodwill has an indefinite life and is not amortized. The Company does not expect to deduct goodwill for tax purposes. The intangible assets are amortized using the straight line method over their estimated useful lives of six years. This will result in annual amortization expenses of approximately $143 through 2011. In the fourth quarter of 2006, we performed our annual impairment test of goodwill and other intangible assets. In accordance with SFAS 142, we used undiscounted cash flow projections and determined that no impairment exists.
Results subsequent to the acquisition of Rapidtext are included in the Company’s consolidated financial statements for the year ended December 31, 2006.
Pro Forma Financial Data (unaudited)
The following selected unaudited pro forma consolidated results of operations are presented as if the Rapidtext acquisition had occurred as of January 1, 2005, after giving effect to certain adjustments. The pro forma data is for informational purposes only and does not necessarily reflect the results of operations had the businesses operated as one during the period. No effect has been given for synergies, if any, that may have been realized through the acquisition. Amounts are not shown for 2006 as, due to the effective date of the acquisition, the pro forma results of operations would not be materially different from the actual results.
15 - Related Party Transactions
With the acquisition of Rapidtext by the Company on January 9, 2006 (see Note 13), Jerome Woods, the founder of Rapidtext, was made an officer of the Company. In addition, Mr. Woods is a co-owner of a building rented to a Rapidtext subsidiary. At the time of the acquisition, the Company signed a three year agreement to continue to lease approximately 10,000 square feet of office space in Burbank, CA. Under the terms of the agreement, the Company pays rent of approximately $10 per month, which the Company believes to be the market rate for the area. The lease will expire in February 2009 and may be terminated on six months written notice at any time by the Company. The lease was approved by both management and the Board of Directors. The obligations under the acquired leases have been included in the Company’s contractual obligations as described in Note 5.
PEOPLESUPPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except per share data)
16 - Subsequent Events
In December 2006, the Company created a joint venture between PSPI and the Company’s newly created pension plan. The new company, PeopleSupport Properties Philippines, Inc. (“PSPPI”), was created in such a way that it is legally able to own property in the Philippines and, on January 11, 2007, acquired a 29,000 square foot property in metropolitan Manila for approximately $6,800. The Company intends to build an outsourcing facility on the property. On January 26, 2007 PeopleSupport Properties acquired a second parcel of land for approximately $1,200. This property is located in Cebu and is approximately 39,000 square feet. The Company intends to build an outsourcing facility on this property. PeopleSupport Properties did not have any income or expenses in 2006. As of December 31, 2006, the investment by the pension plan in PeopleSupport Properties Philippines, Inc., is shown as a minority interest on the accompanying consolidated balance sheet.
In February 2007, the Company purchased approximately $60,000 of forward contracts to purchase Philippine pesos at approximately 49 pesos per United States dollar. The Company will post a gain if the peso appreciates and a loss if the peso depreciates. These contracts have not been designated as a hedge and, therefore, will be marked to market at the end of each period with the gain or loss recognized as other income. As of January 31, 2007, the Company had an unrecognized gain of approximately $200.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
PEOPLESUPPORT, INC.
By:
/s/ LANCE ROSENZWEIG
Lance Rosenzweig
Chief Executive Officer, and
Chairman of the Board of Directors
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.