PeopleSupport Q3 2007 Earnings Call Transcript

Nov. 6.07 | About: PeopleSupport Inc. (PSPT)

PeopleSupport Inc. (PSPT) Q3 2007 Earnings Call November 6, 2007 5:30 PM ET

Executives

Peter Hargittay - Marketing andCommunications

Lance Rosenzweig - Chairman andCEO

Caroline Rook - CFO

Analysts

David Scharf - JMP

Joseph Foresi - Janney Montgomery Scott

Moshe Katri - Cowen

Matt McCormack - FBR CapitalMarkets

Josh Vogel - Sidoti & Company

Dan Wimsatt - AD Capital

Cynthia Houlton - RBC CapitalMarkets

Mark Marostica - Piper Jaffray

Barry Caplin - Maple Tree Capital

Brad Manuilow - American Technology Research

Operator

Good day and welcome everyone tothe PeopleSupport Third Quarter 2007 Earnings Result Conference Call. Today'scall is being recorded.

At this time, I would like toturn the call over to Mr. Peter Hargittay with Marketing and Communications.Please go ahead, sir.

Peter Hargittay

Great. Thank you and goodafternoon everyone. Welcome to PeopleSupport's third quarter 2007 earnings call.On the call today are Lance Rosenzweig, PeopleSupport's Founder, Chairman, andCEO and Caroline Rook, PeopleSupport's Chief Financial Officer. This call isbeing broadcast from the Investor Relations portion of our website, and areplay of this call will be available shortly.

Our third quarter 2007 earningsrelease was issued earlier today. We will start with a brief statement on theperformance of the company during the third quarter and then provide ouroutlook for the fourth quarter 2007. After that, we will open up the discussionfor question-and-answers.

Before I hand the call over toPeopleSupport's management team, I would like to remind you that some of thecomments we'll make today may be forward-looking statements, and these must beread in conjunction with the risks that the company faces. Management may makestatements regarding our anticipated future financial results and operatingperformance, our business, our expectations regarding our expenses, industryand competitive trends, anticipated market conditions and expansion of ourservice capabilities.

We base these types offorward-looking statements and information on our beliefs, projections andexpectations, and assumptions we made using currently available information.You should not rely on these statements as predictions of future events. Ouractual results could differ materially from those projected due to a variety offactors, some of which cannot be predicted or quantified, or are out ofPeopleSupport's control.

Risks and uncertainties thatcould cause our anticipated results to differ from those described in theforward-looking statements include, our dependence on a limited number ofclients and a potential for client losses or client declines, competitiveconditions in our markets, currency exchange-rate fluctuations, risksassociated with our operations in the Philippines and Costa Rica, our abilityto manage growth, technological changes, and other risks identified from time-to-timein our SEC filings. Particular attention is directed to the portions of ourfiled reports or statements entitled, "Management's Discussion andAnalysis of Financial Condition and Results of Operations" and "RiskFactors."

Our comments speak as of todayonly, and you should not rely on them as representing PeopleSupport's views inthe future. We undertake no obligation to update or revise our views followingfuture events or circumstances.

I will now turn the call over toPeopleSupport's CEO, Lance Rosenzweig.

Lance Rosenzweig

Thank you, Peter, and goodafternoon, everyone. Thank you for joining us today for PeopleSupport's thirdquarter 2007 earnings call.

PeopleSupport delivered a strongquarter. We continued our topline growth with revenues of $36.9 million, up 23%year-over-year and 8% quarter-over-quarter. In addition to this increaseddemand for our services, our focus on improving operational efficiency andproductivity drove substantially higher margins in profitability.

Operating margins improved to6.5% up significantly from 1.5% in the previous quarter. Normalized operatingincome adjusting for non-cash stock-based compensation charges related to FAS123R was 10.3% in Q3 '07.

Net income was $6.4 million asignificant improvement over $3.5 million in the same quarter last year. Cashflow from operations was strong at $10.5 million for the quarter and $22.6million year-to-date.

Last quarter, we announced a $25million stock-repurchase program underscoring our confidence in PeopleSupportand our business model. I am pleased to report that as of today we havecompleted our $25 million stock-repurchase program.

In today's call I will coverthree key themes. I will then turn the call over to Caroline Rook,PeopleSupport's Chief Financial Officer, to discuss our financials in detailand guidance for the year. We will then answer your questions.

Our key themes are, one,PeopleSupport is executing increasing well for our clients. Two, demands forPeopleSupport's high quality BPO services is strong and growing. And three,PeopleSupport is enhancing our business model to become a higher marginconsistent growth company with less volatility.

On to our first theme,PeopleSupport is executing increasing well for our clients. In 2007, we put atremendous amount of energy into optimizing our operations and delivering forour clients.

We worked closely with ourclients, we empowered our employees and they rose to the occasion, through thisprocess we made several substantial improvements to our operations.

First: PeopleSupport realignedour operations along industry verticals, travel and consumer, financialservices, tech and telecom, health care and media services. Our focus onindustry verticals, allows us to develop deep domain knowledge, which in turnhelps us and our clients implement and continually improve their outsourcingstrategies.

Second: we began to reconfigureour seats to achieve increased operational efficiencies and productivity. Thisaction has allowed our employees to increase productivity across the board.

And third: we have enhanced ourquality program through the hiring of the of Six Sigma black belt experts,along with the other people with industry-level process expertise. I am happyto report that these efforts are paying off, as demonstrated by our strongoperating and financial performance in the quarter and we expect more to come.

I will now talk about PeopleSupport'sstrategic clients, those that represent more than $10 million in annualrevenues. Overall, we made excellent improvements in terms of customersatisfaction, and we strengthened our strategic relationships with our clientsin the quarter.

Expedia remains our largestclient at 23% of revenues, up over 70% year-over-year which is the result ofpaying attention to their requirements and responding accordingly. We werepleased with this performance during the quarter. Given the fourth quarter seasonalslowdown in the travel sector, we expect Expedia to be in the high teens as apercent of our overall revenue in Q4.

Washington Mutual representedapproximately 16% of revenues, up 40% year-over-year. As an example of ourenhanced customer satisfaction, our Costa Rican operation has achievedexcellent results. For the third month in a row, we are WAMU's top vendor site.In Manila,where we do most of our business with WAMU, there was a significant growthwhich I attribute to our team's ability to continue to deliver excellentservice levels.

EarthLink represented 13% ofrevenues, up slightly year-over-year. We believe that PeopleSupport has astrategy relationship with EarthLink, and will play a significant role in theirefforts to enhance their business model. We are proud of our partnership, andwe congratulate EarthLink for recently winning the J.D. Power Award forcustomer service, and several other measures of customer satisfaction. We areworking closely with EarthLink's new management team as they review and improvetheir processes.

At this time we expectEarthLink's overall purchases of outsourced services to decrease, and we doanticipate that this will result in reduced volume with us. I am excited toannounce, the JP Morgan Chase is now our fourth largest client at 11% ofrevenues. PeopleSupport began supporting JPMC in thesecond quarter of 2006, and we recently won additional business from them aswell. JPMC is expected to continue to ramp nicely. Our mix of business withJPMC includes outsourced and captive services, some of which is short-term innature.

I will comment more about ourexciting new captive services offering momentarily. And our fifth largestclient, a large travel company, with under 10% of revenues in the quarter andcontinues to be strategic client. PeopleSupportrecently achieved the highest customer satisfaction level ever achievedin-house or through any outsourcing relationship in this company's history.

In addition to this group, PeopleSupport provides services to a number of significantclients, which we define as those clients that are expected to generate between$1 million and $10 million in annual revenues. PeopleSupporthad six such significant clients in the third quarter, one of these clients isVonage.

Earlier this year, we mentionedthat Vonage was substantially reducing its business with PeopleSupport.Recently, PeopleSupport has agreed with the newmanagement team of Vonage to maintain an ongoing relationship as a significantclient, but with improved terms.

Additionally, our more recentclient wins, such as the high tech and healthcare clients we announced lastquarter are ramping nicely. In summary, I am very pleased with how ouroperations team is responding to our current and new customers, and I lookforward to continued progress in the quarters ahead.

Now our second theme: Demand for PeopleSupport's high quality BPO services is strong andgrowing. The trend of offshore BPO services is stronger than ever. We seeincreased gross demands in the countries where PeopleSupportoperates. As we move forward into 2008, I am confident that are commitment topartnering with our clients to improve the quality of their services andcustomer satisfaction while providing a cost effective solution will lead tocontinued strong growth for PeopleSupport.

Even with the normal seasonalvariations, the business trend is clear. Only a small portion of the potentialBPO market is being served. Therefore, PeopleSupport iswell positioned to benefit substantially from this trend. PeopleSupporthas placed a great focus on building out the main knowledge and processexpertise for specific vertical industries, which help us to deliver an evenhigher quality of service. And this is well received by our clients andprospects alike. I am confident that our success in expanding within our keyvertical industries will continue. In addition, we will continue to explore verticalsthat open new opportunities for PeopleSupport.

Our sales pipeline is thestrongest in our history and consists of both small and large prospects in the US and in other English speaking countries,including the UK.In total, we have identified several hundred new opportunities that qualifiedportion of our sales pipeline consists of more than 40 qualified prospects, andmany of these are potentially significant. We define qualified prospects asthose who have either visited our centers in the Philippines, to whom we havesubmitted proposals or those where PeopleSupport hasbeen short-listed.

Our sales team is excellent andhighly effective. In the third quarter PeopleSupportwon five new clients that are potentially significant, with the ability todeliver over $1 million in revenue per year when fully ramped. Additionally, wehave already seen healthy activity in the fourth quarter. Due to growingdemand, PeopleSupport is investing in its sales team.Our sales organization consists of approximately 25 professionals includingseven sales directors who are focused on specific vertical industries.

In the third quarter, we announcedthe appointment of MichaelDonegan as Director of Sales for Europe, andwe expect to continue to add to our sales team going forward. Europeis an exciting market opportunity for PeopleSupport. Europe has a large English speaking population, and ofcourse has a need for BPO services in Spanish as well, although, PeopleSupport will initially focus on Englishopportunities.

According to Gardner, the UKcurrently accounts for more than 50% of the European market for BPO services,which is estimated to be approximately EUR24 billion.

In 2006, only 3% of the UK BPOmarket was delivered from offshore locations. The demand is growing for alltypes of BPO services in Europe. Indian basedIT service providers have experienced significant success in Europe and Europe is now ready for voice related BPO services.

We have several years ofexperience supporting UKcustomers for US based clients with operations in Europeand we are looking to include a number of EU customers to our portfolio ofsatisfied clients. Again, the addressable market for high quality offshore BPOservices is fairly large and growing rapidly and PeopleSupport is wellpositioned to benefit from these trends.

And now our third theme,PeopleSupport is enhancing our business model to become a higher marginconsistent growth company with less volatility. Our objective is to drivelong-term value for our shareholders by profitably responding to customer andmarket requirements.

PeopleSupport is taking thenecessary action to further our desired long-term success. In response toclient demand, PeopleSupport is launching a new service offering called CaptiveServices, which consists of outsourcing our facilities, technology andtelecommunications to customers who want to manage their own call center andback office operations. In other words, we allow our clients to run their ownoperations using their own people but utilizing PeopleSupport's facilities anddata and telecom networks.

We believe that the Philippines is the premier location for offshoreoperations for both captive and outsource services, and we are seeingparticularly strong demand for captive services in Manila. US companies who chose to establishcaptive centers in the Philippineswill benefit greatly from working with PeopleSupport. They will have access toworld class facilities with excellent and highly scalable technology in telecominfrastructure, including redundancy and dedicated lines to the US.

PeopleSupport makes it extremelyeasy for US companies to set up a captive centre in the Philippines and to do it quickly.This supplemental service offering creates a significant amount of value forPeopleSupport. These new clients include short-term projects, which willprovide us with great flexibility to smooth out and optimize the utilization ofour facilities.

Improved utilization will lead tohigher margins, which we're already seeing. This new service will also allowPeopleSupport to work with new strategic prospects that might have a need forPeopleSupport's full BPO offering in the future.

PeopleSupport has alreadydemonstrated its success with Captive Services, which generated approximately$1.5 million in revenues in the third quarter, with enhanced margins. To put itin another way, PeopleSupport's revenues in Q3 increased by $2.6 million fromthe prior quarter, while our headcount fell modestly and margins increased.

This illustrates the greaterscalability and tangible improvements to our operating margins, throughexpanded business model and operational efforts. Going forward, we're confidentthat our Captive Services will enable us to diversify our client base, improveour utilization rates and achieve margin enhancements.

At PeopleSupport, we're focusedon increasing the utilization of our production seats, which we define as theworkstations we use to deliver our services. Our production seat utilizationrate in Q3 was 64%, up from roughly 60% in the prior quarter. We're continuingto reconfigure our operations and add production seats to existing space, whichresults in improved performance. We're also focused on maximizing our occupancyrates and revenues generated for each of our seats. All of these efforts arepaying off as illustrated in our expanded margins.

I would now like to comment onour facilities strategy. Early this year, PeopleSupport acquired land in Cebu andManila, as we assessedhow we would deal with our expansion and growth requirements in a costeffective manner and at the same time improve margins and deliver long-termvalue for our shareholders.

The purchase of land has providedus with flexibility given the growth dynamics in the Philippines. We could construct ourown facilities or partner with another party, or just seek a leasingarrangement as we have done in the past. In any event over the last few months,we believe that the value of our land has increased substantially, which willprovide us with greater flexibility in developing our facilities strategy.Peoplesupport remains focused on minimizing our facility cost going forwardwith the highest return on assets.

Now let's talk about thesituation in Cebu, which has been a highlysuccessful location for PeopleSupport. We are seeing extremely strong clientdemand for services from this city. In fact, we are near full capacity and yethave a great deal of interest from prospects. The lease for a large portion ofour current space in Cebu expires in 2009, atwhich time we must exit current facilities since they will be physically torn down.

Commercial office space islimited in Cebu and not as well developed as in Manila. PeopleSupport is developing plans tobuild a 4,000 seat center on the land we repurchased that will be the mostefficient BPO facility in the region. Our clients and prospects are highlyenthusiastic about PeopleSupport making this investment in Cebu,which will be a key differentiator for us and at the same time allow us to protectour margins. We anticipate that construction will begin in early 2008 and willbe finished within two years.

We plan to move our existingoperations in Cebu into the new center. Ourexisting operations alone could take up to 60% of the total capacity. Theincremental capital expenditure for this operation excluding build out costs,which must be borne, whether we own or lease facilities will be $20 million to$25 million over a two year period.

Now for an update on Manila: PeopleSupport purchased land in the Fort Bonifacioarea of Manila.Land, which has appreciated measurably over the past few months.

PeopleSupport is now consideringvarious sale-leaseback and other strategic arrangements regarding this land tomeet the growing requirements for cost effective space in Manila. We believe the fact that we have somevery desirable land in Manila,will allow us to achieve the required margin protection as we continue to grow.The sale-leaseback proposition is looking very encouraging as a cost effectivestrategy that takes advantage of our current position and appreciated landvalue.

PeopleSupport has great potentialto become a large diversified and global outsourcing firm known for its highperformance services. Over the course of 2007, PeopleSupport took the rightsteps to deliver long-term value to our shareholders. We restructured ouroperations along industry verticals, driving higher service levels in clientsatisfaction and deepening our domain knowledge.

We scaled back our capitalexpansion driving enhanced asset utilization and we reconfigured our seatsfostering improved productivity. We implemented a currency strategy that hasyielded very positive returns given the strengthing Philippine Peso. We boughtland at attractive prices enabling us to lock-in long-term savings and facilitycosts, and we completed a $25 million stock repurchase program underscoring ourconfidence in our business.

Now we are excited about ourfuture, we are investing in our sales organization to take advantage of thestrong secular growth trends. We are expanding our service offerings to improvethe scalability and margin structure of our business. We continue to optimizeour infrastructure and focus on improving margins. And most importantly, we arepassionate about delivering excellent value and service levels for our clients.The strategy is in place and our team is capable and focused on achieving ourgoals.

I would now like to introduce ourChief Financial Officer, Caroline Rook to go over Q3 results in more detail andto provide the guidance for the remainder of the year.

Caroline Rook

Thank you, Lance, and goodafternoon, everyone. As Lance, has already mentioned PeopleSupport deliveredrecord revenues of $36.9 million in third quarter '07. Net income was $6.4million in the third quarter a significant increase year-over-year andquarter-over-quarter. PeopleSupport benefited primarily from strong demand forBPO services, as well as improved infrastructure utilization, operationalefficiency gains, and a net gain in other income from our forwardforeign-currency contracts.

Quarterly diluted EPS was $0.27based on $23.8 million diluted weighted-average shares outstanding, compared to$0.18 in the year ago quarter, based on $19.1 million diluted weighted-averageshares outstanding. And $0.16 in the second quarter '07, based on $24 milliondiluted weighted-average shares outstanding.

Operating income for the thirdquarter was $2.4 million and an operating margin of 6.5%, compared to secondquarter of '07 with operating income of $0.5 million and an operating margin of1.5%. We're working hard to improve operating income margins overtime, althoughit is expected to be impacted near-term by our usual expected seasonal decreasein revenues in the fourth quarter, primarily from our clients in the travel andsomewhat technology verticals.

Year-over-year operating marginsremained lower as expected, primarily resulting from an unfavorable currencyexchange-rate and to a lesser extent increased FAS 123R non-cash stock-basedcompensation expense, and build out of additional operational capacityincluding our new centre in Baguio, Philippines.

Normalized operating incomeadjusting for non-cash stock-based compensation charges related to FAS 123R was10.3% in Q3 '07, 15.6% in 'Q3' 06 and 5.5% in Q2 '07 and that we adjustoperating margins for the Peso impact relative to Q3 of '06 Peso rate of 51Pesos to the US dollar as well as exclude the FAS 123R stock-based compensationcosts, operating margins would have been 15.8% in Q3 '07 as compared to 15.6%in Q3 '06 and 10% in Q2 '07.

Our operating margins pick upthis quarter, benefited from a higher value short-term Captive Servicesproject, which Lance described, in which we outsource BPO infrastructure tocaptive providers. This contributed over 2% margin this quarter with thisproject currently expected to expire in early '08.

Also cost of sales reduced by$0.4 million as a result of an adjustment to our pension plan assumptions aftera third-party [actuarial announces]. Furthermore there was $0.3 million benefitfrom the management incentive plan largely impacting cost of sales, as wereleased the accrual for the unused portion of the plan, upon plan termination.These two later items contributing around 2% margin for the quarter.

To give you some further foreignexchange details, the average exchange-rate for the Peso in the third quarter'07 was 45.9 Pesos to the US dollar, up approximately 2.1% compared to anaverage 46.9 Pesos in the second quarter of '07. And up about 10.5% compared toan average of 51.3 Pesos in the year ago quarter.

The 2.1% depreciation from Q2 '07impacted operating margins by approximately 1.1% whereas the 10.5% depreciationyear-over-year impacted operating margins by approximately 5.5%. As a reminder,a positive impact from our forward foreign currency contracts is recorded inother income.

As we mentioned in our previouscall, our forward foreign currency contracts go through mid 2009, coveringapproximately 80% to 100% of estimated Philippine Peso operating expenses.Current contracts range from an average Peso to US dollar rate of around 48Pesos in the remainder of '07, 46 Pesos in 2008 and 45 Pesos in the first halfof '09. This program helped to mitigate the Peso impact in the third quarter byapproximately $2.2 million recorded in other income below the operating line,or an estimated $0.08 diluted EPS.

If we add the actual realized FXforward gains of $1.1 million to operating margins, this addition would haveincreased operating margins by 3.1% in Q3 '07, and Q2 '07 realized FX forwardgains would have increased operating margins by 2.7% in that period. I wouldlike to point out that our forward foreign currency contract program has workedto our benefit, since we initiated the program. These programs are intended tominimize the downside risk of a decline in the US dollar to the PhilippinePeso. However, there might be periodic financial statement losses as theforward contracts are measured at fair value at period ends. Should theexchange rate between the Philippine Peso and US dollar shift directions, PeopleSupportwould face a loss in recording our FX forward program, both in the realizedportion for the period, as well as the unrealized future portion.

Our future FX forwards are valuedto market on the last day of the each period. If on that day, themark-to-market rates were 1% below the previous mark-to-market rates used in theprior period end, and on our existing remaining forward contracts at the end ofSeptember ’07 of around $180 million, the impact on other income could be anestimated $2 million expense. On the next day as the mark-to-market rates swungback, the FX forward contracts would then be recorded as a gain of $2 million.

Non-cash FAS 123R stock-basedexpense was $1.4 million in the quarter, compared to $0.7 million in the yearago quarter, and $1.4 million in the second quarter of '07. FAS 123R reduced operatingmargins by 3.8% in the third quarter of '07, 2.4% in the third quarter of '06,and 4% in the second quarter of '07. As of September 30, '07, cash and cash equivalentsand marketable securities totaled a $129.4 million, slightly lower than thesecond quarter of '07 as a result of $13.6 million used to repurchase PeopleSupport stock in the quarter.

Net cash used for financingactivities included $13.6 million in acquisition of PeopleSupportcommon stock, as a part of the Company’s $25 million common stockrepurchase program. As of today, PeopleSupport is donewith the stock repurchase program, having repurchased $25 million of stock andslightly over 2 million shares through the present. Per our expectations, sincethe repurchase program was initiated mid-quarter, the program had a minimalimpact on EPS with interest income forgone, offsetting the impact of the reductionin average shares outstanding for the period.

CapEx for the quarter was $2.6million in line with expectations, compared to $3.1 million in the previousquarter. Year-to-date CapEx was $20.1 million. Total CapEx including the landpurchase of $9 million in Q1 '07 for the year is now expected to be around $22million to $24 million, primarily for least production capacity build, IT infrastructureexpansion and upgrades.

Net cash provided by operatingactivities was $10.5 million for the quarter, resulting in the net cash fromoperations of $22.6 million for the first nine months. Excluding the landpurchase of $9 million in Q1 '07, free cash flow would have been $11.5 millionfor the first nine months of the year. DSOs were a healthy 43 days.

During the quarter, PeopleSupportstreamlined existing operations and focused on gaining efficiencies from ourexisting capacity. We entered the quarter with approximately 7,500 productionseats worldwide. This is a slight increase from the previous quarter. We didnot add rented space. In fact we're overhauling our PeopleSupport center floorplan in order to optimize our operations.

PeopleSupport ended the quarterwith over 9,000 employees, a reduction of approximately 300 employees from theprevious quarter end. And yet, we improved revenue significantly due toimproving the efficiency of our operations, the productivity of our people andthe outsourcing of our technology platform.

And now for guidance. For Q4guidance, we assumed the following aspects. One, our usual downward seasonalitywith reduced revenues driving a similar impact on our operating forecast forthe quarter. Typically, we see a downward fourth quarter, due to both revenueand expense seasonality with the usual pickup after seasonality in followingquarters. Our largest vertical namely travel is seasonally low in Q4.

Whilst revenue seasonally tickeddown within the quarter, we continue to maintain headcount for some of theseaccounts, resulting in lower margins as we usually see a pickup to normalizedactivity in the following quarters. We're forecasting that revenues in thissector be down from Q3 '07, by a percentage around the low-to-mid teens, whichis consistent with prior year.

We forecast around $1 milliondecline in Earthlink revenues, given the client's refocusing of its operations,reducing contribution to our fixed costs. A continuous decline in the US dollarin the quarter and then average and period end Philippine Peso rate of 44 Pesosto the US dollar. We estimate that a 1% change in the Peso could impact ouroperating margins by 0.6%. The Peso rate assumption of 44 Pesos this quartercompared to Q3 '07's average of 45.9 Pesos is an estimate of 4% and would equateto an approximate reduction of 2% of operating margins, with pickup from our FXforward contracts conversely in other income.

Following on, I have point five,which is FAS 123R non-cash stock compensation costs increased from Q3 of $0.35million, from both retention and annual grants in Q4 '07.

Point six, we have substantiallycompleted with our $25 million stock-repurchase program as of this call,reducing both interest income before free cash flow, and average sharesoutstanding. Per our expectations the associated interest income forgone isforecasted to primarily offset the impact of the reduction in average sharesoutstanding for this year.

With Q4 diluted EPS forecast tobe slightly accretive by $0.01 from this program. With that for the fourthquarter of '07, we expect revenue to be slightly down from Q3 between $35.7million and $36.5 million, operating income to be almost breakeven in the rangeof loss of $0.5 million, to a loss of $0.1 million, non-cash FAS 123R expenseto be approximately $1.8 million. Given the Philippine Peso rate assumptionabove, we are forecasting our corresponding FX gain and other income of $5.9million on today's assumed mark-to-market rates for the remaining period or $0.23diluted EPS impact.

Diluted EPS to be $0.28 to $0.29range. EPS is based on an average of 22.3 million shares on a diluted basis.Tax charge of around $0.8 million. As a reminder, fiscal year 2008 guidancewill be given along with our Q4 '07 conference call in the first quarter of2008.

With that let me turn the callback to Lance.

Lance Rosenzweig

Thank you, Caroline. I would liketo conclude with three key points before opening the call for questions. First:PeopleSupport is executing increasingly well for our clients. Second: demandsfor PeopleSupport's high quality BPO services is strong and growing, and third:PeopleSupport is enhancing our business model to become a higher marginconsistent growth company with less volatility.

Thank you for listening and wewill now turn the call over to the operator for the Q&A.

Question-and-AnswerSession

Operator

Thank you, sir. Today's question-and-answer session will beconducted electronically. (Operator Instructions). And we'll go first to withDavid Scharf of JMP.

David Scharf - JMP

Hi, good afternoon.

Lance Rosenzweig

Hi. David.

David Scharf - JMP

Lance, few things, obviously there is terrific top line andbottom line results for the quarter, just trying to get a little more clarityon the numbers in between. Can you talk about the cost of revenues that seem tobe the biggest variants in from expectations? It looks like sequentially yourrevenue was up 7%, 8% on an absolute dollar basis, your cost of revenueactually went down. I know you said headcount was down a little bit, but canyou help us understand how to think about that gross profit number?

Caroline Rook

Sure. I mean, David, I'll take this question. So, cost ofsales did go down from both operational efficiencies as well as some analysisthat we had cost benefits from that I talked about. One of them being thepension expenses in the Philippinesabout $0.4 million was the cost benefit in cost of sales and also about $0.3million of the management incentive plan accrual reversal, was primarily in thecost of sales. So, that's about $0.7 million there. Also, we benefited from afull quarter's worth of our Captive Services, which was as Lance mentionedthere was about $1.5 million in revenues where we had some very, very highmargins David which also contributed towards our reduction in costs of sales.

So those three aspects as well as, we don't want to takeaway from operations really beginning to hit their stride, really contributed to the cost of sales before FAS123R reducing from about 74% in Q2 this year to, a shade less than 70% in Q3.

David Scharf - JMP

So the pension benefit in the accrual, but those are sort ofone-time, should we think of this 31% kind a gross margin level as a fairlystable number going forward?

Caroline Rook

Well, it's not expected to be there in Q4, of course justgiven…

David Scharf - JMP

…on an annual basis though?

Caroline Rook

Seasonality, as I said, that's about $0.7 million ofbenefits that we saw. The Captive Services also helped contribute to our margins,as we said and that's expected to terminate in early '08. And also the Peso, itdepends what the Peso does to us as, you know, we record the Peso at whateverthe cost it is, operating cost of sales. And that's a variable that we can'tpredict and we get the benefit on our current programs in other income.

Lance Rosenzweig

David, I would add as well, that we're working hard atimproving our margins on a client-by-client basis. And in some cases thatinvolves productivity improvements or efficiency improvements and in anothercases it involves price increases, which we've been very focused on given thestrength of the Peso. And so, we think the fundamental margins of the businessare improving.

David Scharf - JMP

Okay. Can you talk a little more about Captive Services, isit essentially outsourcing your facilities, your seats during non peak-hourswhen you are not incurring any labor expense?

Lance Rosenzweig

Not really. Let me give maybe an example of what we didduring the quarter, one of our clients has several lines of business. In somelines of business it wants to do with its own in-house employees and otherlines it wants to do with outsourced employees. So we were able to offer thatclient a combination of full outsourced services with PeopleSupport teammembers, as well as captive space where they're riding on the PeopleSupportinfrastructure and facilities in telecom and data lines in an integrated sense.

And it enables us to provide a more holistic outsourcingoffering to this company. So it's not just on the off-hours, but they have bothcaptive space and captive facilities for their people as well as outsourcedspace and facilities for our people.

David Scharf - JMP

So when you provided a 64% utilization figure. Does thattake into account seats that are being occupied by these Captive Services ownemployees?

Lance Rosenzweig

Yes.

David Scharf - JMP

Okay. And how visible is this, are there any longer termrelationships with the $1.5 million, should that be viewed near-term as kind ofone-time project oriented or is this something that's going to be prettyregular, I mean, do you have a pipeline, so to speak?

Lance Rosenzweig

Right. So the existing client that we talked about is moreshort-term oriented. But we are turning it really into a longer term orientedbusiness. So we are building a pipeline, we see some good opportunities. Wethink it's just a great way for us to improve our asset utilization, improveour facilities utilization and boost our margins with greater flexibility, anda greater mix of clients.

David Scharf - JMP

Okay. Now relative to your revenue guidance, looks like wasVonage a surprise during the quarter. Is that a relatively new development oryou've decided to retain some of that business?

Lance Rosenzweig

Relatively new development, what we saw is that Vonage hasput in place a very new management team and at the same time has improved a lotof its own business issues and legal issues, and we agreed with the newmanagement team, that it would make sense for us to maintain an ongoingrelationship. Nothing like the scale of what we had before, and with muchbetter terms than we had before, but, we think it makes sense on an ongoingbasis.

David Scharf - JMP

Okay. So it's no where near a 10% customer going forward,but more than a rounding area it sounds like?

Lance Rosenzweig

Yeah, correct. We call it a significant customer, whichshould be a customer with $1 million to $10 million of annual revenues.

David Scharf - JMP

Okay. And one last financial question, I'll let others hopon. The foreign exchange contracts, I'm just having, I mean these are wonderfulresults, but I'm just having a hard time as I look at the last couple ofquarters, and then I look at the guidance going forward really understanding,just inherently what a stabilized level of profitability this company issupposed to have.

I mean just looking at the second half of the year it lookslike 40% of your pre-tax earnings are coming from foreign exchange gains. And Irealize that the appreciating Peso should put pressure on cost of revenues, andthat should may be a proportionate pick up below the line. Then we move to thefourth quarter and there is a $6 million gain.

Can you give a little more granularity on how we are tothink about what sort of normalized operating margins are, when you factor inboth your expected currency gains and gross margin pressures from the Peso,because it's just tremendously valuable from quarter-to-quarter?

Lance Rosenzweig

David, yes. So the normalized operating margins that wetalked about for this quarter 10.3% were without any currency forwards. Sothat's pure operating profit adjusted for FAS 123R. The impact of the foreign exchangeforwards are in the other income line below the operating income line, andthere will be quite a bit of volatility with that, as the Peso moves. And theway we think about it internally is that there is two elements of it, there'rerealized and there are unrealized gains and losses. And the realized gains andlosses are what we realized in the actual quarter, and the unrealized is ourmarking-to-market, all the future forwards that we have in taking that impactin the quarter as well. And so, I think kind of a way of looking at it togetherwith operating margins is maybe to look at the realized portion in thatquarter. If the Peso flips around, you could see equally large swings in theopposite direction.

David Scharf - JMP

I understand that, I guess looking to the fourth quarterit's such a huge tick up, $6 million of gains. Does it say how much of that isrealized or unrealized?

Caroline Rook

We don't split that out.

David Scharf - JMP

I expected it to be, because it looks like over half of yourpre-tax earnings this year are foreign exchange gains?

Caroline Rook

Yeah. We picked up a pretty good rate earlier in the year, whenwe first hedged out 12 months at 49 Pesos, David, but that expires in early ‘08and as we hedged back in, those are at lower rates. So I generally expect thatas our 49 is [tolled] away that you would have less of a pickup. But just togive you an idea, in Q3 we had $1.1 million of realized gains as I haddiscussed, which is I think it's a shade less than 3% of revenues.

David Scharf - JMP

Right. Okay. Thanks so much.

Lance Rosenzweig

Thank you.

Operator

And we will take our next question from Joseph Foresi of JanneyMontgomery Scott.

Joseph Foresi - JanneyMontgomery Scott

Hi gentlemen, just my first question here, again with takingthe Captive Services and sort of reducing the headcount, what can we extrapolatefrom this? First of all, how was the headcount reduced? And secondly, was therea considerable amount of excess capacity here that sort of, is now being takencare of, in sort of the short-term until you can fill that with maybe your ownpersonal contracts?

Lance Rosenzweig

Yeah, Joe. What I would say is that, but, first of all,again, those numbers that we give out at period end. So there are notnecessarily averages or anything like that for the quarter. But we are as anoperating team very, very focused on our productivity and our utilization. Andwe're kind of maximizing the potential of our people and really delivering wellfor our clients, and where we can increase our revenues without havingincreased our headcount, that's great.

Joseph Foresi -Janney Montgomery Scott

Sure. But I guess what I am saying here is that obviouslyyou had the capacity available to sell rather quickly, and then the headcount,was there something happening on the client base were the 300 people due toattrition, any color on any of those two areas?

Lance Rosenzweig

I see what you're saying. I mean, remember where ourcapacity was at the end of the quarter was 64%. So we still have quite a bit ofcapacity available for expansion. And most of this would have been fromattrition, it just would have been we hired fewer than we attrited during thequarter.

Joseph Foresi -Janney Montgomery Scott

Okay. And just your plans for next quarter as far as organicseat build outs, and any plans for maybe the organic utilization andconditions?

Caroline Rook

I don't, we generally expect any organic seat build outs.What we are doing this quarter, and maybe forthcoming in the next quarter, butprimarily this quarter. We have some seats in the PeopleSupport center in ourbig lease built-to-suit center in the Philippines that are being used fornon-operational staff, and we're very focused on the expense of that. So we arespending a little bit of money, not a lot, converting those seats tooperational seats that can be used during peak hours by operational folks. Andthen the same non-operational folks would be using those seats that used to bethere all the time in the non peak hours. So there would be some build out inmore operational seats that we would have in the foreseeable future.

Joseph Foresi -Janney Montgomery Scott

Okay, and how many seats are in that particular area? Imean, this isn't really actually new seats are just sort of converting them inpart?

Caroline Rook

Yes, so no new facility. It would just be a little bit ofCapEx spend, and associated depreciation, but, I want to say, now you caughtme. I want to say it's more than 200 and it's probably less than 500. So, it'ssomething like that.

Joseph Foresi -Janney Montgomery Scott

Okay. And at the conclusion of the Captive Servicesarrangement, what then takes place? Is that -- those employees then return tothe -- I mean how is that dissolved? I guess that's what I'm asking.

Lance Rosenzweig

Yeah. The employees are our client's employees. Right, so,they are depending on the arrangement with them. It could be for a temporaryproject, it could be somebody moving into their own facility or it could be anongoing kind of relationship, and then we have maximum flexibility, because wecan use that space for area of our operations. We can use it for other CaptiveServices operations. It's just a great way for us to improve our utilization ofassets and really provide a value that our clients are really certainly lookingfor.

Joseph Foresi -Janney Montgomery Scott

Okay. And just my last question, here: Did I hear itcorrect, that you said on the real estate front you are going to build in Cebu,and then in Manila there is going be a sale lease pack? Is that correct firstof all? And, secondly, why the divergence in those of the two arrangements andthanks?

Lance Rosenzweig

Yeah, that's essentially correct, although we haven'tfinalized the arrangements in either city yet. But that, it steps directionallywhere we are heading, and the difference is, that in Cebuour leases are expiring and the buildings are actually being torn down, and sowe have to move to new space. And there is very, very limited space available.There are also, not the sophisticated real estate markets that you find in Manila, which is really a world class city and Cebu. And so, we find that in Cebu, we can construct ourown center do it very efficiently have a great operations for our clients anddo at a relatively minimal CapEx about $20 million to $25 million ofincremental CapEx. In Manila,where the land is much more valuable and where there is much more establishedreal estate market. We believe that we can work with a third party real estatedeveloper and more of sale leased back transaction and utilize on a leasingbasis the seats and the floors that we need.

Joseph Foresi -Janney Montgomery Scott

Okay, thank you.

Caroline Rook

Joe, about the PeopleSupport center is mores like 400 seatsthat we would convert from non-operational to operational.

Joseph Foresi -Janney Montgomery Scott

Okay. Then, I imagine the cost would be much less, may behalf of which you spend on normalcy?

Caroline Rook

It's not a huge amount.

Joseph Foresi -Janney Montgomery Scott

Okay. But headcounts are going to stay static?

Caroline Rook

Yeah.

Joseph Foresi -Janney Montgomery Scott

Okay, thank you.

Operator

And we'll go next to Moshe Katri of Cowen.

Moshe Katri - Cowen

Thanks. Going back to some of the one-time contributors tothe quarter and again, I apologize if I am asking the same question again.Going back to the Captive Services engagement, can you quantify thecontribution to revenues? And then, just I think you said the operating incomecontribution was $1.5 million. Can you confirm that?

Caroline Rook

Yes. Sorry, the revenue contribution was $1.5 million andthe contribution to operating margins was a shade over 2%.

Moshe Katri - Cowen

So it's about 200 basis points.

Caroline Rook

Yes.

Moshe Katri - Cowen

Okay. And that engagement ends when?

Caroline Rook

Early '08.

Moshe Katri - Cowen

Okay. That's fair. And then, there are some other items maybe Caroline you could repeat them in cost of sales that also helped there werealso, some sort of reversal there?

Caroline Rook

Sure. So, we did an actuarial analysis of what we needed forpension costs in the Philippines which is required by law given ourestablishment age there and the number of people that we have and that resultedin a benefit of around $400,000 in the quarter and also the managementincentive plan which was triggered by the IPO three years ago have beenaccrued, and we had not paid back around $300,000 worth of that plan, so wereleased that accrual. So that was again a benefit there.

Moshe Katri - Cowen

Okay. And then, there is also a pension adjustment for $1.5million as well?

Caroline Rook

No, no. I just talked about pension adjustment Moshe ofabout $400,000.

Moshe Katri - Cowen

That's $400,000. Okay. And then, you didn't pay any taxesduring the quarter?

Caroline Rook

Very little. I want to say it's like $200,000 or $300,000net.

Moshe Katri - Cowen

Is that sort of we are kind of factoring roughly 15% to 20%in terms of an effective tax rate?

Caroline Rook

Yeah, so Moshe weare very tight positioned at the moment where most of our taxable income isbeing recorded not in the US.It's being primarily recorded in countries where we have tax holidays. Andtherefore, the USeffective tax rate is very minimal.

Moshe Katri - Cowen

And is that sustainable until next year and to Q4 as well?

Caroline Rook

I think that it is a tax strategy that we would try toimplement as long as we could.

Moshe Katri - Cowen

So is that sustainable into next year?

Caroline Rook

Next year tax rate Moshe, we would give you updated guidanceon that during our Q1 conference call.

Moshe Katri - Cowen

Okay. And then, Lance, you spoke about different areas thatyou wanted to invest in on a forward basis. Is there anyway to quantify theimpact of these investments on margins? And again, this is something that if yourecall, we had some controversy about this early this year when you providedguidance for '07. So, does it make sense for you to talk a bit about theinvestments that you need to actually put in place into the business to get toactually expand these services? Thanks.

Lance Rosenzweig

Sure. I think, we were really talking about just kind ofexcitement given the demand trends for the business. So, we're investing oursales team. We are adding additional sales directors, we added one in Europe recently and we're looking for more. We're addingnew managing directors in our vertical markets.

But these are people that are driving real value toPeopleSupport. In terms of facilities investment, we had as we talked in priorquarters a new building being constructed in Baguio. And that building will be complete inthe early part of next year. However, we don't anticipate actually building outthe floors of that building until the demand is required for that space. Sothat CapEx would follow demand. And then, the only other investment which Italked about was the center in Cebu which is atwo year roughly project at about $20 million to $25 million.

Caroline Rook

Yeah. And just to the $20 million to $25 million, if we didsell our land in Manila,we could potentially reduce that cost by almost 50% potentially. So, it's notthat big net-net if you look at total spend.

Moshe Katri - Cowen

But again, I think, what a lot ofus are trying to do here is trying to understand what's sustainable, what sortof an EBIT margin is sustainable for this company on a normalized basis thoughwe have 6.5% EBIT margins for the quarter about 200 basis points came from ashort-term engagement that ends at the beginning of '08. And then, you had someother one time gains that also helped operating margin during the quarter. So,we are really probably talking about 3% to 4%, what will drive the 3% to 4%operating margin on ongoing basis you have been able to increase utilizationrates about 64%. Do you think, are you planning to get it to 70%-75%? May beyou can talk about some of the drivers that can actually help you get this3%-4% EBIT margin to 10% or maybe above that number? Thanks.

Lance Rosenzweig

Yeah. Absolutely, and bear inmind that EBIT margin is not normalized. So, that's after FAS 123R charge.

Moshe Katri - Cowen & Company

But that’s normalized, that'sGAAP. We have to look at GAAP EBIT margins line?

Lance Rosenzweig

Correct. Yes. I'm justclarifying, Moshe. That's GAAP EBIT margins. So, going forward we see a numberof things which I think can help us to sustain and improve that marginovertime. First: as we mentioned the captive services, we do have a project nowwhich ends early next year. But we're looking to expand that offering to othercompanies, so that we can take further advantage of that overtime.

Secondly: we are focused onimproving our utilization rates. So, we have made good progress in the quarterfrom 60% up to 64% and we are looking to continue to push that north and wewould like to be in the 70s, which I think would help to drive additionalmargins longer-term as well.

And third: as we work withclients and prospects, we are continuing to push higher prices. And we feelgiven what's happened in the market and with the peso, that there is a good opportunityfor us to have margin expansion through price increases as well.

Moshe Katri - Cowen & Company

Thanks.

Lance Rosenzweig

Thank you.

Operator

And we will take our nextquestion from Matt McCormack of FBR Capital Markets.

Matt McCormack - FBR Capital Markets

Hi. Good evening. In terms ofthis Cebu facility, the 4,000 seats, that 20million to 25 million, you said that's incremental. Does that include buildingthe building and then also building out the workstations or is that justbuilding out the workstation?

Lance Rosenzweig

Yeah, Matt, that's building thebuilding itself.

Matt McCormack - FBR Capital Markets

Okay.

Lance Rosenzweig

If we were to lease a building,we will have to build those workstations, and if we were to use our own buildings,we would have to build that workstation. So, that's the incremental CapEx thatwe anticipate by building the building. Maybe Caroline, can give some clarityon the build out costs.

Caroline Rook

Yeah. We generally see at themoment anywhere between 5,000 to 7,000 per operational feet. So, if we can getsome economies here at that lower end, you might be at the high-teens to earlyto mid-20s on the build out. But we don't need to do that entire build out atone go. You obviously have to build the building in one go, you can't add extrafloors. But as we needed you can scale the build out in.

Matt McCormack - FBR Capital Markets

All right. So, in terms of yourplans right now, so the building is going up in '08 and then what percentage ofthe build out do you think is going to be done in '08 versus '09?

Lance Rosenzweig

I think the building won't beopened until '09.

Matt McCormack - FBR Capital Markets

Right.

Lance Rosenzweig

So, really none of the build outwill be done in '08, and we will build that out as demand requires, then we areready to move in.

Matt McCormack - FBR Capital Markets

So, you are not going to spendany cash until '09?

Caroline Rook

No, no. We have to spend theconstruction cash. If you are asking how much is that, 20-25 is being, or isgoing to be, spent in '08. We are still evaluating that and hopefully, we cangive you some further aspects during our Q4 conference call.

Matt McCormack - FBR Capital Markets

Okay. And so in terms of the saleleaseback, you'll get cash back if you sell it. But you still have a similarCapEx, call it, 25 million or so to build that out, would you have either wayif you don’t release. Is that correct?

Lance Rosenzweig

So, the sale leaseback would besomething that we would do in Manila.

Matt McCormack - FBR Capital Markets

Right.

Lance Rosenzweig

And so in Manila, we wouldreceive cash for the land and then a third-party would build the building atit's expense and PeopleSupport would a tenant in thebuilding, and would pay for the build outs of the space that we require in thatbuilding.

Matt McCormack - FBR Capital Markets

Right andthat's about 5,000 to 6,000 proceed?

Lance Rosenzweig

Yeah. Thatwould be the capacity of the entire building but we would not anticipate takingthe entire building ourselves.

Matt McCormack - FBR Capital Markets

Right. Okay.In terms of I guess, looking out into '08, after the last call, you put out therelease saying margins would come in between 1% and 5%. Can you provide us anyupdate on that?

Lance Rosenzweig

Yeah. As Caroline mentioned, wedo plan to give '08 guidance in our next earnings call, but otherwise we're notcommenting on that today.

Matt McCormack - FBR Capital Markets

Okay. And then lastly, you fileda poison pill during the quarter and that’s arguable if that benefits anybodyother than management and the Board. So, I guess could you walk us through whatyour logic was in doing that?

Lance Rosenzweig

Sure, yeah. I think we commentedon our last call that I'm happy to talk about that again. We found ourselveslast quarter with a very concentrated shareholder base; with our largestshareholder owning almost 25% of the company. Our Board, after doing a lot ofreviewing of it, and consulting with the legal advisors and financial advisors,decided to go ahead and implement the shareholder rights plan, and there arereally three reasons that drove that.

First, is to have a preferencefor a more diversified shareholder base. And second is that, greater liquidityin our company stock. And third is, so that the Board can more effectivelyexercise its fiduciary obligations to all shareholders.

It's not designed to award atakeover. It's not designed to help management. It's designed really with thosegoals in mind. If someone wants to acquire the company, we believe that theyshould do that at a full and fair value as negotiated with the company.

Matt McCormack - FBR Capital Markets

Okay, great. Thank you.

Lance Rosenzweig

Thank you.

Operator

And we'll go next to Josh Vogelof Sidoti & Company.

Josh Vogel - Sidoti & Company

Hey, good afternoon. I was justhoping for a little bit of more clarity here. I understand you have someseasonal weakness in Q4, and you mentioned the one-time gains of 700,000 in Q3.But, you are expecting the captive, the short-term contract to roll-off inearly '08, and it just seems that there is a really big fall-off in your EBITguidance for Q4 versus Q3, and I was wondering if you could give just a littlebit more clarity, why you're looking for an operating loss?

Caroline Rook

I'll take that Josh. First ofall, the peso we are expecting was currently forecasting at 44 pesos, which Ithink was about 4% drop, which is about 2% drop on the operating margins fromQ3 to Q4, which is a main driver of that. We did have some one-time pickups inQ3. Revenue was seasonally lower. We do have some fixed cost of course, Josh,so the contribution to fixed costs also are impacted in Q4. In fact, 1, 2, 3years up slightly from some retention in annual grants that we normally do, byabout $0.35 million in Q4. And I think that's pretty much it. Some interestincome from our stock buyback is forgone, although we are net cash flowpositive. So, that's probably less with an impact.

Josh Vogel - Sidoti & Company

Okay. With this captive services,are these can it be primarily dedicated seats or are you going to have accessto this seats during off peak hours?

Lance Rosenzweig

No, seats would be reserved forthe particular clients.

Josh Vogel - Sidoti & Company

Okay. So, you can't do anydaytime work there, is there an option then?

Lance Rosenzweig

No, but we have plenty of our owncapacity for that daytime work.

Josh Vogel - Sidoti & Company

Okay. As far as your leases in Manila, are there anynotable ones expiring in 2008, there you have to renegotiate?

Caroline Rook

There are none expiring in 2008.There isn't much older facility that we have, that it's potentially expiring in'09.

Josh Vogel - Sidoti & Company

Okay. And I don’t know, maybe I'mjust reading this wrong, but with your guidance, it just seems that your fullyear EPS, if you're in $0.28 or $0.29 in Q4, that come out to $0.70 - $0.88 foryour further guidance to $0.84 - $0.85. Am I just reading this wrong?

Caroline Rook

Full year guidance is $0.84 to$0.85, Josh.

Josh Vogel - Sidoti & Company

Right. But if you're going toearn $0.28 or $0.29 in Q4, I'm coming out to $0.87 or $0.88?

Caroline Rook

Just checking on that Josh.

Josh Vogel - Sidoti & Company

Okay.

Caroline Rook

Yeah, that is right.

Josh Vogel - Sidoti & Company

Okay. Thank you.

Operator

And we'll go next to MichaelPerna of AD Capital.

Dan Wimsatt - AD Capital

Hi, this is Dan Wimsatt for MikePerna. Good afternoon and congrats on a good quarter.

Lance Rosenzweig

Thank you, Dan.

Dan Wimsatt - AD Capital

Two or three unrelated questions:The captive is very interesting; there hasn’t been a lot of discussion aboutthis until now. Lance, can you talk about, do you look at this as -- take thisfrom your clients perspective. Do they start with services that have caused youto divest, that they are less excited about outsourcing, and so they will paymore to you with the wrong people, just because they want to keep it forsecurity or quality or whatever reasons? And then ultimately, once they try,they are getting used to the Philippinesand after that, they either make a decision and do something themselves or theygive you more on the labor side. Is that way that works, you think? And, whycouldn’t this be a significant basis for you? And can you talk about how muchbetter margins are, given that the equipment's are already there?

Lance Rosenzweig

Yeah. I think that’s a greatquestion. I see two elements for it. First, I'll clarify that, in the US,the market for call center services is predominantly in-house or captive; it'snot outsourced. So, I think something like three-quarters of all call centersin the USare done in-house. And a lot a companies just have a philosophy of keepingtheir call center work with their own employees. And as these companies look tooutsource offshore, we have a really great offering for them to do that muchmore rapidly, much more efficiently through a very established infrastructure.

Secondly, there is also a base ofcompanies that want to mix, and some might want to start with their own captiveseats and then expand to outsource seats. Some might want to have ongoing ofboth types. And we believe that it’s a great way digging entree into new typesof clients that otherwise we would not be able to tackle. And overtime, many ofthem we may be able to up sell into outsourced services as well.

Dan Wimsatt - AD Capital

How tough is it for these clientsto get their own people over there? I mean, obviously they are trying it out.It seems like it's temporary?

Lance Rosenzweig

Right. It probably depends onyour sophistication and skill. And would say that depending on clientrequirements, PeopleSupport could very well offer its recruiting services tohelp them in recruiting the teams that they need as well, we have anoutstanding and very well established recruiting team throughout the country,and we'd be happy to offer that to our clients also.

Dan Wimsatt - AD Capital

And Lance, can you talk about, Iunderstand if you can't, but any sense in terms of incremental margins on thecaptive business?

Lance Rosenzweig

Yes. Margins on captive businessare definitely higher than the margins on the labor intensive businesses.Revenues are not as high, because we are not getting a mark-up on labor. Butmargins are definitely higher, but we haven’t given specific percentages there.

Dan Wimsatt - AD Capital

Maybe next year.

Lance Rosenzweig

Yeah. Actually, Caroline didmention that the project that we had in the quarter was about $1.5 million ofrevenues, and about 200 basis points of operating margin. So, we did give somemargin information.

Dan Wimsatt - AD Capital

Okay. And then, is Sabu, that’sin round numbers 1,200 seats right now?

Lance Rosenzweig

Well, we said about of 40% of the4,000. So, about 1,600 seats.

Dan Wimsatt - AD Capital

Okay. I missed the 40. Sorry.

Lance Rosenzweig

Yeah.

Dan Wimsatt - ADCapital

So 1,600 seats, and as I recall, this was ramping slowly.

Lance Rosenzweig

Hey, Dan, sorry. Correction, it's 60% of the current seats.So that will be 2,400 seats that we currently utilize in Cebu.

Dan Wimsatt - ADCapital

Okay. Utilization in Cebu relative to Manila, or do I even care about that? Are themargins higher/lower in Cebu than in Manila?

Lance Rosenzweig

Utilization rates probably on average are higher than Manila and margins areprobably a bit higher as well.

Dan Wimsatt - ADCapital

Okay. But again people are -- it's starting to -- the uptakeis now greater than it was?

Lance Rosenzweig

Yes, very strong demand for Cebu.Excellent employee base, very loyal, excellent attrition statistics, greatperformance. We've seen some really, really good progress in Cebu.

Dan Wimsatt - ADCapital

Okay. Utilization, I've had this discussion more than oncejust in terms of what that number can and should be, and I think that 86 wasyour previous high watermark. Just about every other publicly traded companyhas 7, if not an 8, in front of their number. Why is 64 good? Why is 70 good?Why not something higher than that? And does there come a point in time youtalked about adding resources in Europe, et cetera, but I think it's a littlefrustrating for us trying to understand and maybe there is a good reason whyutilization is so low for you relative to everybody else?

Lance Rosenzweig

Right. Utilization is -- I would say that 64 is better than60, but not really where we like it to be. Utilization became in the 60sbecause of the capacity expansion that we did earlier this year together withthe loss of seats from Vonage, and those are really the two things that drovethat low utilization rates.

We are pushing to increase that. We would like it to be inthe 70s. We think once it gets close to 80, there is really a demand foradditional seats. We also think about it on a regional basis. So aggregateutilization may be in the 60s or low 70s, but we might be out in a certain citywhere there are client demand requirements.

And also to a certain extent, our utilization is adverselyaffected by our new center in Baguio,which will take some of additional time to fill. But we're working hard to fillthat, both with out outsource services and we think we'll even have bettersuccess at it now that we have captive services as well.

Dan Wimsatt - ADCapital

And I think you said, last call, that until the utilizationrate was, there was a seven in front of it, that you wouldn't add capacity; somaybe that implicitly suggests where you hope you will be by the time Cebu is up and running with the new seats?

Lance Rosenzweig

Yeah. I mean it's a couple of years away.

Dan Wimsatt - ADCapital

Yeah.

Lance Rosenzweig

So we think we can make a lot of progress between now andthen.

Dan Wimsatt - ADCapital

Okay. And there's anything on the Earthlink you mentionedjust down a little bit, $1 million, Caroline?

Caroline Rook

Yeah. Our estimate for Q4 is about $1 million. We don't knowwhat the translation is for '08 yet, and hopefully, we can add better clarityonce we give our Q4 conference call.

Dan Wimsatt - ADCapital

Okay. And nothing new in Puerto Rico?That's had big financial services client that seems to be in the news a lot.

Caroline Rook

Puerto Rico?

Lance Rosenzweig

Dan, we do nothing in Puerto Rico.

Caroline Rook

Costa Rica.

Dan Wimsatt - ADCapital

You know what I mean. It's been a long day.

Lance Rosenzweig

We got a great operation in Costa Rica, hitting, winningcustomer services awards, team is doing very, very well.

Dan Wimsatt - ADCapital

Great, congratulations.

Lance Rosenzweig

Thank you very much.

Caroline Rook

And just to clarify with Josh's comments on the full yearforecast, don't forget we've got a different average for the year on the sharesas opposed to just adding each quarter. But we're currently looking at $0.86 to$0.88 EPS.

Operator

And we'll take our next question from Cynthia Houlton of RBCCapital Markets.

Cynthia Houlton - RBCCapital Markets

Hi. Just a couple of quick questions: First, you mentionedJP Morgan as a new 10% customer and you said that there is an opportunity forthat client to continue to ramp. Could you just provide a little bit moredetail on the nature of the work that you're doing with them? How large thisclient is? Whether its seat count or revenue contribution, kind of whatexpectations are there? And just a little more detail would be great.

Lance Rosenzweig

Sure. We're very excited about our new work with JP MorganChase. It's a pretty broad based relationship, and we're servicing a number ofdifferent areas of the bank. We think that there is good opportunity for growthwithin other categories of services that we're offering for them, but we don'tbreakout the types of business because of confidentiality requirements. Wedon't breakout the type of businesses that we do for them.

Cynthia Houlton - RBCCapital Markets

And no visibility on, you know, is this going to be 15% to20% or right now, I mean, you must have a sense of where they plan on rampingwith your current project?

Lance Rosenzweig

Yeah, we hope to be able to provide much more informationinto '08 in our next earnings call.

Cynthia Houlton - RBCCapital Markets

Okay. And then just a follow-up. You talked about some priceincreases that you're getting from clients based on, obviously, the movement ofthe Peso. In these contracts, I would assume clients also want concession ifthe Peso goes in the other direction. Is that correct or do they just willinglyaccept higher rates without any protection if the Peso goes the otherdirection?

Lance Rosenzweig

Yeah. Our clients for the most part are very largesophisticated companies, and I would not say that they willingly accept priceincreases. We work really, really hard to maximize our situations really to befair with our clients. They're sophisticated. They're following in bothdirections. I'm sure if it reverses, they'll be on the phone to us as well.

Cynthia Houlton - RBCCapital Markets

Is that how the contracts are configured, meaning that isthere a provision in place when you put on these price increases based on Peso?

Lance Rosenzweig

It varies by clients. So in someof the newer cases, we're building in co-lo provisions or we are having shorterterm pricing arrangements where, for example except for a year, and thenrenegotiated at the end of the year.

Cynthia Holton - RBC Capital Markets

Okay. Thank you.

Lance Rosenzweig

Thank you.

Operator

And we'll go next to MarkMarostica of Piper Jaffray.

Mark Marostica - Piper Jaffray

Good evening, just a follow-up onthe EarthLink question. Can you just clarify whether we're strictly talkingabout reduction in volumes or if they given you indications of a reduction inseat count?

Lance Rosenzweig

You know, EarthLink it would beboth, right, they attract each other. Reduced volumes would result in reducedemployees; that will result in reduced seats counts.

Mark Marostica - Piper Jaffray

Okay. Can you give maybe a littlebetter granularity then, as to sort of how that tracks then in to the nextcouple of quarters, I mean, you mentioned $1 million next quarter. But is thissort of a steady decline into '08 or are we looking at more of a steep drop offat some point in '08?

Lance Rosenzweig

Yeah, we are expecting about $1million decline from Q3 to Q4 this year, and again we hope to give much moreinformation in our next earnings call about '08.

Mark Marostica - Piper Jaffray

Okay. And just couple of housekeeping things, I might have missed. Q4 what is the tax rate assumption?

Caroline Rook

We said that the actual dollaramount for the tax rate was about $0.8 million.

Mark Marostica - Piper Jaffray

Okay, thanks. And then, also thecaptive contribution to utilization Q3?

Caroline Rook

You know, I generally expect Q4to be the same as Q3.

Mark Marostica - Piper Jaffray

Okay, excellent. Thank you.

Lance Rosenzweig

Thank you.

Operator

And we'll go next to [BarryCaplin] of [Maple Tree Capital].

Barry Caplin - Maple Tree Capital

Thanks. Could you talk a littlebit, if you have already, I got right about wage pressures in Philippines andalso the extent to which it's differs in every city?

Lance Rosenzweig

Hey, Barry, just repeat thesecond part of your question, you said wage pressures and what was the secondpart?

Barry Caplin - Maple Tree Capital

Wage pressures in general in the Philippines,and the extent to which it differs in every city. Then in the Philippines that are you payingmaterially different wages?

Lance Rosenzweig

Yes, I see. Yes, wages have beenrunning, wage inflation has been running, pretty consistently in the past fewyears, in the high single digits. And we see really nothing that’s changingthat going forward. Unfortunately with the Peso appreciating, it's kind ofmagnifying the impact on us. It was very different when the Peso was going theother direction.

So now we are seeing, kind ofhigh single digit wage pressures in Peso denominated terms, which is obviouslymuch more in dollar denominated terms. There were regional nuances within thecountry and people who tend to follow, wage patterns as is appropriate in eachof the cities in which it operates.

Barry Caplin - Maple Tree Capital

Okay, the only other questionsjust for the clarification, I think air line bad debt that was lean [6 million]actually in '09 in Manila.What it's potentially be?

Caroline Rook

Well we obviously have the optionto pick it up should we need it at that time.

Barry Caplin - Maple Tree Capital

Okay so you could risk space.

Lance Rosenzweig

Yeah we have flexibility we canpotentially extend the leases we can move out and consolidate into other centerswe can move into new locations etcetera.

Barry Caplin - Maple Tree Capital

Thank you.

Lance Rosenzweig

Thank you.

Operator

And we’ll take our next questionfrom Brad Manuilow ofAmerican Technology Research.

Brad Manuilow- American Technology Research

Thanks. Just one quick questionon, do you guys expect the same level of contribution from captive services inQ4 as you saw in Q3. Thanks.

Caroline Rook

Yes I believe I did indicatethat.

Brad Manuilow- American Technology Research

Okay, thanks.

Lance Rosenzweig

Thank you

Operator

And we will go to a follow-upquestion from David Scharfof JMP.

David Scharf- JMP

Hi Lance just wanted to delveinto some client specific data points again. I guess following up on JP MorganChase, and somebody asked earlier. I guess a month ago when our findingssuggested you were doing inbound fraud work for their card division but I hadn'trealize this has been a client going back to early '06 are there otherdivisions within the bank you are working for?

Lance Rosenzweig

Yeah, I mentioned David,unfortunately, we can't comment on the specific lines of business that we areworking on with the bank.

David Scharf- JMP

Well, what about yourrelationship today in terms of vendors. I mean, I was hearing they were doingsome cut inbound hard work in the Philippines with Convergys. Are youregarded as the primary vendor for whatever service you're delivering to themin the Philippines?

Lance Rosenzweig

We are very, very excited withthat relationship and with the extent that we are working with the firm and theopportunities we have going forward. But we can't comment on anything they dowith any other companies.

David Scharf- JMP

Okay. Switching to EarthLink, themillion dollar reduction. Is that demand-related or is that a specificcontract, because we had heard the internet cable contract went away?

Lance Rosenzweig

EarthLink is doing a very, verysignificant amount of restructuring of its business. And I think, part of thatis to deemphasize certain lines of business and to have some lower marketingexpenses which will drive lower call volumes. And it's really, I think, kind ofacross the board, affect to cross EarthLink's lines of business. And asEarthLink then shifts these around with different countries and different locations,there will be some new answers and movements and we won't necessarily kind oftrack overall call volumes, but its sort of indicative that, I think thegeneral call volumes that they are receiving are declining.

David Scharf- JMP

Okay. Can you expand a little onhealthcare? I know you mentioned a few new clients in that area last quarter ortwo. We had come across the bunch of job postings particularly in Sabu thatseemed to be medical-related, are these insurance companies that managed care providersand are these clients that by '08 are expected to be pumping up against 10%?

Lance Rosenzweig

Sure. We are actually, as we mentioned last quarter, veryexcited about long-term opportunities in the healthcare industry. It's anindustry that is really right for offshore outsourcing, and we think thePhilippines with its very, very closely aligned medical system to Latin Americais particularly well suited from medical-related work in the Philippines. We dohave some new clients in that area that we mentioned, and while it's somewhatbroadly based, we think that there is particularly a strong opportunities inmore of the payor side.

David Scharf - JMP Securities

Got you. And lastly, the names may be shifting around everyyear, but when we look out a year from now, based on what you expect to sign upand additional work from existing clients, would you expect the same level ofclient concentration from your top three, four, five customers regardless ofwho they actually are? The rankings may shift, but would we probably be lookingat about 60% of revenue from maybe the top four clients a year from now, doesit sound about right?

Lance Rosenzweig

I think that's really hard to predict right now, becausesome of the existing accounts we have are potentially rapid growers, othersnot. Hard to predict the news closes that will come in, I think we will be ableto give much more detail there in our next call when we give '08 guidance.

David Scharf - JMP Securities

Okay, great. Thank you.

Lance Rosenzweig

You are welcome.

Operator

And we will go next to a follow-up from Moshe Katri ofCowen.

Moshe Katri - Cowen& Co.

Hi, thanks. Caroline, can you quantify to us what a 100basis point improvement in utilization rate could actually -- how much will itimpact EBIT margin. Do you have that sensitivity analysis in front of you?

Caroline Rook

I have that sensitivity analysis Moshe. But, we don't sharethat because the Peso is so impactive to us and also dependent on the program,the pricing and the margin of that program would give us different swings.

Moshe Katri - Cowen& Co.

Yeah. Well, assuming the Peso is flat and assuming maybe youcan give us a range?

Caroline Rook

You know may be that is something that we can look at forour next conference call.

Moshe Katri - Cowen& Co.

Understood, thanks

Lance Rosenzweig

Thank you

Operator

And we'll go next to a follow-up from Josh Vogel of Sidoti& Company

Josh Vogel - Sidoti& Company

Thank you. Caroline, I just wanted to touch on something yousaid earlier, did you say that you have less favorable Peso rates locked inbeginning in '08?

Caroline Rook

Yes. When we locked in, we started our foreign exchangeprogram in early '07 and we locked in at around 49 pesos for around 12 months,I want to say. So that's coming to an end, and as we lock in over a period oftime that you can appreciate just given the Peso appreciation, the rates thatwe could lock in was less than 49.

Josh Vogel - Sidoti& Company

Okay. So basically, if we just assume that the Pesoappreciate, let's say 2% a quarter, your benefits from FX is going to decreasesignificantly from what you are expecting, say in Q4, when you look out into'08 and beyond?

Caroline Rook

Potentially.

Josh Vogel - Sidoti& Company

Okay. Thank you.

Operator

And ladies and gentlemen, we have no further questions atthis time. Mr. Rosenzweig, I would like to turn the call back over to you forany additional or closing remarks.

Lance Rosenzweig

Great, thank you very much. And we look forward to catching upwith everyone in our next quarterly call. Thank you.

Operator

And that does conclude today's conference call. Thank foryour participation. You may disconnect at this time.

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