PeopleSupport Q4 2007 Earnings Call Transcript

Mar. 7.08 | About: PeopleSupport Inc. (PSPT)

PeopleSupport, Inc. (PSPT) Q4 2007 Earnings Call March 6, 2008 5:30 PM ET

Executives

Peter Hargittay - Marketing & Investor Relations

Lance Rosenzweig - Chairman of the Board, President, Chief Executive Officer & Secretary

Caroline Rook - Chief Financial Officer

Analysts

Mark Zgutowicz- Piper Jaffray

David Scharf – JMP Securities

Cynthia Houlton - RBC Capital Markets

Joseph Foresi - Janney Montgomery Scott

Moshe Katri - Cowen & Co

Matt McCormack - Friedman, Billings, Ramsey

Nate Swanson – ThinkEquity Partners, LLC

Operator

Welcome to the PeopleSupport fourth quarter 2007 earnings results conference call. This conference is being recorded. At this time I’d now like to turn the call over to Mr. Peter Hargittay, with marketing and communications. Please go ahead sir.

Peter Hargittay

Good afternoon everyone. Welcome to PeopleSupport fourth quarter and full year 2007 earnings call. On the call today are Lance Rosenzweig, PeopleSupport’s Founder, Chairman & CEO and Caroline Rook, PeopleSupport’s Chief Financial Officer.

This call is being broadcast from the investor relations portion of our website and a replay of this call will be available shortly. Our fourth quarter 2007 earnings release was issued earlier today. We will start with a brief statement on the performance of the company during the fourth quarter and then provide our outlook for the first quarter and full year 2008. After that we will open up the discussion for questions and answers.

Before I hand the call over to PeopleSupport’s management team I would like to remind you that some of the comments we’ll make today may be forward looking statements and these must be read in conjunction with risk that the company faces. Management may make statements regarding our anticipated future financial results and operating performance. Our business, our expectations regarding our expenses, industry and competitive trends, anticipated marketing conditions and expansion of our service capabilities. We base these types of forward-looking statements and information on our beliefs, projections and expectations and assumptions we made using currently available information. You should not rely on these statements as predictions of future events. Our actual results could differ materially from those projected due to a variety of factors some of which cannot be predicted or quantified or out of PeopleSupport’s control. Risks and uncertainties that could cause our anticipated results to differ from those described in the forward-looking statements include our dependence on a limited number of clients and the potential for client losses or client declines, competitive conditions in our markets, currency exchange rate fluctuations, risks associated with our operations in the Philippines and Cost Rica, our ability to manage growth, technological changes and other risks identified from time-to-time in our SEC filings.

Particular attention is directed to the portion of our filed reports or statements entitled Management’s Discussion and Analysis of Financial Conditions and Results of Operations and Risk Factors. Our comments speak as of today only and you should not rely on them as representing PeopleSupport’s views in the future. We undertake no obligation to update or revise our views following future events or circumstances.

I will now turn the call over to PeopleSupport’s CEO Lance Rosenzweig.

Lance Rosenzweig

Good afternoon everyone. Thank you for joining us today for PeopleSupport’s fourth quarter and full year 2007 earnings call. We enter 2008 with great optimism about our future. Throughout 2007 PeopleSupport made significant progress. Our operations are running well, IT is highly scalable and fault tolerant, our sales team has nearly doubled in size and we established a sales and marketing presence in Europe. Our sales pipeline is the strongest in our history. PeopleSupport reported a solid fourth quarter with better than expected operating margins and with our successful foreign currency contract program significantly better than net income and earnings per share. PeopleSupport’s cash generation was significant for the year with record operating cash flow of nearly $28 million with more than $120 million of cash, cash equivalents and marketable securities and no debt PeopleSupport supported an outstanding balance sheet. This is particularly important to clients and prospects in this uncertain economy.

Revenues for the quarter were within range but slightly disappointing as EarthLink came down more than expected and we felt the seasonality from the travel sector more than in the past. For the full year however revenues increased 28% while our global headcount increased only 6% from a year ago illustrating our operational efficiency and productivity gains garnered throughout the year. We were excited about our operational potential and I believe we are well positioned to continue our forward momentum. Additionally, we made two important strategic decisions in 2007 that we expect to generate significant value for the company and that we now plan to monetize. I am pleased to report that our board of directors has authorized the company to sell the land we purchased in Manila for a substantial gain and to sell our existing Philippines Peso foreign currency forward contracts as we migrate towards an effective foreign currency hedge. We expect to generate over $25 million in pre-tax cash from these two transactions. Furthermore, to underscore our confidence in PeopleSupport’s business our board of directors has approved a second $25 million stock repurchase program.

In today’s call I will cover three key themes. I will then turn the call over to Caroline Rook, PeopleSupport’s chief financial officer to discuss our financials in detail and to give guidance. We will then answer your questions. Our key themes for today’s call are first we are very positive about our long term outlook but with the slowing economy we are cautious about the near term. Second, we are successfully enhancing efficiency and continuing to streamline our operations. And third, PeopleSupport is delivering high performance for our clients.

On to our first theme. We are very positive about our long term outlook but with the slowing economy we are cautious about the near term. We believe we are beginning to see the impact from a slowing economy which affects the outsourcing industry in general and our company in particular. This has different short term and long term implications. As consumer spending declines people buy fewer goods and services and call volumes to call centers decline. However, we expect this slowing economy to lead to an increased demand to offshore outsourcing services as perspective clients have a greater need and urgency to reduce operational costs. Because our services are not a discretionary spend item, we believe our business enjoys some strong counter cyclical elements that we believe will benefit us in a slowing economy as new clients come online by the end of this year and into 2009 and beyond.

Our sales pipeline is the strongest in our history and we believe it is already benefitting from the current macroeconomic environment. Our pipeline 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 opportunities. The qualified portion of our sales pipeline consists of more than 50 qualified prospects up from over 40 at the end the third quarter. Many of these are potentially significant and some are potentially strategic. We define qualified prospects as those who have either visited our centers in the Philippines or those to whom we have submitted proposals or those where PeopleSupport has been short listed.

Our sales team is excellent consisting of senior and highly effective sales directors and an impressive sales support staff. Given our growth prospects we believe this is the right time to invest additional resources in our sales team. We’ve hired two new sales directors since Q3 and now count a total of nine sales directors, nearly double our team a year ago as well as a sales support staff of about 15. I am pleased to report that during Q4 07 we closed one large new client that could potentially generate $5 million or more of annual revenues and two potentially significant clients that could generate over $1 million of annual revenues. We are especially pleased with the diversified nature of these deals. One is our first publishing client which could help to smooth out some of our fourth quarter seasonality. Another is a back office BPO contract with one of our travel clients and one is a new accounts receivable management deal. Captive Services continues to gain momentum. We extended our fist contract and won some additional business in the beginning of this year. We are pleased to see this progress.

We continue to see strong demand in the US for outsourced BPO services and we believe Europe is generally behind the US in terms of taking advantage of offshore outsourcing and we are seeing signs of solid demand there. As we mentioned on our previous call PeopleSupport is initially focusing on opportunities in the UK. According to Garner, the UK currently accounts for more than 50% of the European market for BPO services which is estimated to be approximately $24 billion Euros. In 2006 only 3% of the UK BPO market was delivered from offshore locations.

Now, our second theme. We are successfully enhancing efficiency and continuing to streamline our operations. Our objective is to drive long term value to our shareholder by profitably responding to customer and market requirements. PeopleSupport is taking the necessary actions to further our desired long term success.

We are implementing strategies to substantially improve the utilization of our infrastructure. In fact, we are already moving in the right direction. In Q1 of this year, we were able to add 400 new seats in our flagship PeopleSupport center in Manila without any additional rent expense. While this lowers our peak seat utilization to some extent we believe we are better positioned now to potentially exit out of some older facilities. Our plan is to grow into our unused capacity and to potentially exit some older facilities to more quickly achieve our goals. Specifically, during Q1 2008 we shutdown our Newport Beach, California facility that we acquired during our acquisition of RapidText. We also have the option to exit an older and more expensive facility in the Philippines during Q2 08. If we were to exclude the seats in this facility from our utilization calculation our utilization rate in Q4 07 would have been north of 70%. We have a plan to drive greater productivity and revenue per production seat and it is our goal to grow seat utilization to the mid to high 70s in 2008. We are managing our expansion and growth requirements in a cost effective manner and at the same time are striving to improve margins and deliver long term value for our shareholders.

We made good strategic decisions in 2007 that have generated a significant return and we now plan to realize on this return. In early 07 we purchased land in the Philippines and we entered into a set of currency forward contracts to offset our Peso denominated expenditures. I’m pleased to report that we are near an agreement to sell the land we purchased in Manila for very significant premium over our purchase price. Our board has approved this transaction and it is scheduled to close in Q2 or Q3. We are also exploring various options for our land in Sabu although a final decision has not been made. Our board has also approved the use of an accounting methodology for our foreign currency forward contracts called an effective hedge that is widely used in the outsource industry and which Caroline will discuss in more detail. Between our gains on our land transactions in the Philippines and the sale of our Peso forward contracts we expect to generate over $25 million in pre-tax cash.

Furthermore, to underscore our confidence in our business I am pleased to announce that our board has approved a new $25 million stock repurchase program. PeopleSupport is one of the strongest balance sheets in the industry with over $120 million in cash, cash equivalent and marketable securities and no debt. This strong cash position gives us significant competitive advantage as we navigate an uncertain economy. We believe this balance sheet positions PeopleSupport very well with prospects that want to work with financially sound companies. In addition, having this available cash provides us with the ability to move quickly as opportunities present themselves to acquire assets as valuations come down due to a slow in the economy. We continue to be interested in acquiring businesses that offer back office services that we can provide during our off peak hours when our utilization rates are the lowest and we will opportunistically consider other M&A opportunities as well to potentially supplement the solid organic growth we expect.

We are confident that PeopleSupport will continue to grow rapidly over the long run. The trend of offshore BPO services is stronger than ever and we believe we are still at an early stage of a new growth cycle. We also continue to be encouraged by our new growth initiatives such as targeting the healthcare industry, selling into new geographies such as the UK and expanding our service offerings including our captive offering. Customer satisfaction continues to improve and our prospects understand the high quality and cost effective solution we offer which we believe will lead to continue robust growth for PeopleSupport.

Now, our third theme. PeopleSupport is delivery higher performance for our clients. I am very pleased with how our operations team is responding to our clients. Throughout 2007, we put a tremendous amount of energy into optimizing our operations and delivering high performance services for our clients. In particular, we realigned our operations along industry verticals and we believe that this focus enables us to develop deep domain knowledge which in turn helps us and our clients implement and continually improve their outsourcing strategies. This action has allowed our employees to increase productivity across the board and to delivery high performance services to our clients.

To demonstrate our recent success as a high performance provider, I’d like to talk about our strategic clients, those that represent more than $10 million in annual revenues. Expedia remains our largest client at 20% of revenues up 65% compared to one year ago but down quarter-over-quarter as expected due to fourth quarter seasonality in the travel sector. We expect our business with Expedia to increase in Q108 and in subsequent quarters. Washington Mutual represented approximately 17% of revenues up 37% year-over-year and we continue to make solid progress with WaMu in the Philippines and Costa Rica. JP Morgan Chase now our third largest client represented 13% of revenues, significantly up year-over-year. JPMC is expected to continue to ramp nicely. As a reminder, our mix of business with JPMC includes outsourced and captive services. I’m pleased to report that we extended our captive services contract with JPMC and now expect it to continue throughout the full year. EarthLink represented 10% of revenues down year-over-year as expected and discussed on our previous call. We believe that PeopleSupport has a strategic relationship with EarthLink and we will continue to play a significant role in its efforts to enhance its business model. In fact, during the first quarter 2008 we won several awards from EarthLink, the nevertheless we expect EarthLink’s overall purchases of outsourced services to decrease more than previously expected and we do anticipate that this will result in further reduced volumes with us. Our fifth largest client, a large travel company represented 9% of revenues in the quarter and continues to be a strategic and growing client.

In addition to this group, PeopleSupport provides services to a number of significant client which we define as those clients that are expected to generate between $1 million and $10 million in annual revenues. PeopleSupport had six such strategic significant clients in the fourth quarter.

I would now like to introduce our chief financial officer, Caroline Rook to go over Q4 results in more detail and to provide guidance for Q108 and the full year 2008.

Caroline Rook

Good afternoon everyone. PeopleSupport reported revenue of $35.8 million in the fourth quarter 07 up 15% compared to the year ago quarter. For the full year, revenues were $140.6 million an increase of 28% compared to 06. During the quarter we experienced some downward volume volatility from several clients, in particular within the technology sector. On our Q307 call we disclosed that EarthLink, our third largest client was changing its own corporate direction and that because of this we expected EarthLink’s overall customer management volume to decline. In PeopleSupport’s case we had guided EarthLink’s revenues $1 million lower in Q407 compared to the prior quarter and we primarily saw this. We now expect revenues from EarthLink to decrease even further in 08. In addition, 08 revenues will be impacted by several new client pilots which did not materialize as expected and are instead pursuing a more global call center strategy.

During the fourth quarter we continued to focus on improving operational efficiency and productivity with a goal to improve margins. Cost of revenue as a percentage of revenues was 74% in Q407 compared to 68% in Q406. This change was entirely due to the appreciating Philippine Peso and more than offset any gains from improving operations. Operating income for the fourth quarter was $.2 million, higher than previously forecast for the fourth quarter contributed by some SG&A efficiencies. SG&A in the fourth quarter was 17% as a percentage of revenue compared to over 20% in the year ago period as we continue to see economies of scale. Depreciation and amortization remained essentially flat at roughly 8% of revenues. The Philippine Peso on average appreciated 13% against the US dollar from Q406 to Q407 and continued to impact our operating margins that decreased 17.4% in Q407 compared to the year ago quarter. To offset the impact of the appreciating Peso we entered into foreign currency forward contracts during the first half of 07 to cover through July 09. During the fourth quarter we recognized $18.2 million in other income from these contracts. If we had hedge accounting we would have recognized a large portion of the released gain of $2.5 million into operating income. This realized cash was approximately 7% of revenues in the fourth quarter nearly offsetting the impact of the appreciating Philippine Peso on our operating margin.

For the year, the realized portion of the foreign currency exchange program was $4.6 million. If we included the realized portion of the fx forwards in operating income it would have been $8.8 million or 6.3% for the full year. If we include the realized portion of the fx forward and exclude non-cash stock-based compensation charges, operating margins would have been 13.1% in Q407 as compared to 5.6% in Q406 and illustrates the improvements in the operational efficiencies and productivity gains we have garnered from our business. Beginning in the second quarter 08, PeopleSupport is working on accounting for foreign currency foreign contracts as an effective hedge which will move the realized portion of our gains into operating income and the unrealized portion on to our balance sheet. This change will also lead to an estimated monetization of unrealized gain when we sell our current contracts. We believe this change will more accurately reflect our operations going forward and will be consistent with the outsourcing industry.

Net cash provided by operating activities in the quarter was over $5 million and net cash from operations for the full year was approximately $28 million up about 24% driven by increased revenues. Excluding the land purchase of nearly $9 million in Q107, free cash flow would have been over $15 million for the full year. DSOs were a healthy 42 days at the end of the fourth quarter. As Lance mentioned earlier we believe PeopleSupport has one of the strongest balance sheets in the industry. As of December 31st 07 cash and cash equivalents and marketable securities totaled around $122 million. We spent approximately $11 million to repurchase PeopleSupport stock in the fourth quarter completing our $25 million stock repurchase program in the year. The board has approved an additional $25 million stock repurchase program which dependant on the timing of the repurchase will impact our guidance throughout 08 as we use our cash to purchase shares which would potentially reduce interest income and our share count and potentially affect our EPS calculations. Cap ex was $1.6 million in the fourth quarter and $21.7 million for the full year. As a reminder, cap ex for the year includes approximately $9 million used for land purchased in Manila and Sabu in Q107.

During the quarter PeopleSupport streamlined existing operations and focused on gaining efficiencies from our existing capacity and we will continue to do so in 2008 and beyond. We ended 2007 with approximately 7,500 production seats consistent with the previous quarter and 8,600 employees worldwide, a reduction of roughly 400 employees from the previous quarter and accomplished largely through normal attrition due to revenue seasonality and reassigned employees to new programs with the ramp down from a few technology clients. As Lance mentioned, we are currently working to optimize our operations with a goal to reach utilization rates in the mid to high 70s. We do not have any near term plans to build out new additional facilities. As we see our capacity utilization increase with increase revenues we would typically expect to see a need to build out additional capacity in new facilities towards the end of the year. We generally expect to spend $4 to $5 million on discreet items this year such as a datacenter migration and other maintenance and generally non-facility infrastructure cap ex. If we need to build out towards the end of the year, then there could potentially be an additional $4 to $7 million in cap ex.

As Lance mentioned, we expect to sell our land in Manila for a significant gain. As for the land in Sabu, we are still considering the future use of our land and our need for additional build outs. Our guidance for 2008 reflects the impact from the technology sector as well as some general softness from the slowing economy. The greatest impact is expected to be in the first half of the year as we full cost reduced volumes from our current contractor clients. By the second half of the year we expect new business to come online especially in light of prospects searching for cost cutting measures as the economy enters an uncertain period. As Lance mentioned, we believe our business has counter cyclical elements and we believe we are well positioned to benefit from a slow economy as clients and particularly prospects look to cut costs and potentially with a greater sense of urgency.

Now, for guidance. Our guidance is based on the following: one, we now expect revenue from EarthLink and some other clients we mentioned to decline approximately $12 to $13 million compared to 2007 reducing contributions to fixed costs in the short term; two, an average Philippines Peso rate of $40.5 Pesos to the US Dollar in the first quarter and full year. We continue to estimate that a 1% change in the Peso could impact our operating margins by around .6%. The Peso rate assumption of $40.5 Pesos this quarter compared to Q407’s average of $43.1 Pesos would decrease operating margins by an estimated 3.4% in Q108 which represents the operating margin decline in Q108 from prior quarter on flat revenues. However, in Q108 we expect to pick up and realize gain from our fx forward contracts and other income which partially offsets this reduction to operating margins on the bottom line. No impact from the stock repurchase program is included in our guidance.

With that, for the first quarter 08 we expect revenues to be relatively flat from Q4 at between $35 million to $36 million primarily due to a decrease in revenue from EarthLink. Operating income as a percentage of revenues to be a loss of approximately 2%. This loss is purely a result of the Philippine Peso appreciation as compared to Q407 results. Non-cash FAS 123R expense to be approximately $1.8 million. Given the Philippine Peso rate assumption above we’re forecasting a corresponding fx gain in other income of an estimated $2 million on today’s assume mark-to-market rates for the remaining period. This could swing higher or lower dependant on mark-to-market values at the time of valuation or settlement. Tax charges are around $.2 million assuming no discrete items. Diluted EPS to be $0.11 to $0.12. EPS is based on an average of 22.3 million shares on a diluted basis.

For fiscal year 08 we have taken a cautious view to the impact of the slowing economy as we see it today and as we see the timing of sales wins occur each quarter our guidance might well change. Until that time, our guidance is based on the following: we see the softening in the economy reduce our near term volume expectations from existing clients and especially within our technology clients. Accordingly, we now expect revenues for the year to be between $162 and $170 million, operating income as a percentage of revenues to be approximately 3 to 4%, non-cash FAS 123 our expense to be approximately $7.8 million, effective tax rate at 5% excluding any discreet items such as in the event we sell our land in the Philippines or a change from our ongoing evaluation of our deferred tax assets, diluted EPS to be $0.48 to $0.58. EPS is based on an average of 22.5 million shares on a diluted basis.

With that let me turn the call back to Lance.

Lance Rosenzweig

I’d like to go through three key points before opening up the call to questions. First we are very positive about our long term outlook but with the slowing economy we are cautious about the near term. Second are successfully enhancing efficiency and continuing to streamline our operations. And third PeopleSupport is delivering high performance for our clients.

Thank you for listening and we will now turn the call over to the Operator for the Q&A.

Question-And-Answer Session

Operator

(Operator Instructions) And we’ll take the first question from Mark Marostica of Piper Jaffray.

Mark Zgutowicz- Piper Jaffray

Just relating to your 08 guidance can you give me your assumptions for realized FX gains? I guess that would be looking at Q2 through Q4 and also sales and marketing as a percent of sales.

Caroline Rook

In Q2 to Q4 if we have an effective hedge I think that I would have to rehedge at current rates so what that would mean is that I potentially would hedge whatever the Peso does to our operating costs and therefore our realized gains would just depend on what the Peso does to our operating costs within that period of time. It wouldn’t be our current hedges that we would mark-to-market too. So since I haven’t purchased those effective hedges I can’t really say. But what we’re trying to do is protect our downside risk so the Peso rate’s 40.5 now. To the extent I can protect some of the portion of our Philippine operating expenses with 40.5 the realized gains if I have an effective hedge would basically protect our operating costs at that rate. In terms of the FX both realized and unrealized gained in Q1 with our current hedges we’re expecting about $2 million.

Mark Zgutowicz- Piper Jaffray

And sales and marketing for the year?

Caroline Rook

Sales and marketing in Q4 excluding deferred stock compensation.

Mark Zgutowicz- Piper Jaffray

I’m just trying to get some direction for FY 08. I’m trying to get a sense for –

Caroline Rook

In FY 08, Mark, I generally expect sales and marketing to be about the same percentage excluding deferred stock compensation as potentially Q4.

Mark Zgutowicz- Piper Jaffray

Then I just had a couple quick follow ups. Captive services revenues in Q4 and also your expectations for 08?

Caroline Rook

We don’t disclose that but in general our expectations in 08 would potentially be the same run rate.

Mark Zgutowicz- Piper Jaffray

And the final question, WAMU, just your expectations for 08?

Lance Rosenzweig

WAMU has grown nicely year-over-year and is continuing to grow modestly so we’re not expecting any kind of growth rate as we saw prior year. But with them as with other clients we’re continuing to talk to them about new program. It was possible upside but we’re not baking that into the numbers.

Operator

We’ll next move on to David Scharf of JMP Securities.

David Scharf – JMP Securities

A few things, one just high level in terms of how the business you would expect it to function in the current environment. You hear a lot of companies talk about increased focus on outsourcing, there’s a focus on cost reduction increases in the economy slow – is there any real evidence of this? Can you maybe give us a little 20 second history lesson on perhaps the last cycle whether or not outsource BPO companies or call centers specifically saw that take affect or is it, pardon the expression, a little wishful thinking?

Lance Rosenzweig

David, I think that it’s not wishful thinking. We closed one new $5 million plus client this last quarter. We expect to close another one in the first quarter and our sales pipeline is extremely strong. So there hasn’t been since the offshore outsourcing industry is relatively new, there hasn’t really been a recession since it started. So there’s not the historical precedent but what we’re seeing in the current pipeline and with the current prospects and the existing clients is a much heightened need for cost savings and there’ll be a little lag before it starts impacting the numbers because the client has to close, it has to ramp and then it has to be impactful. But we’re definitely seeing the activity in the pipeline.

David Scharf – JMP Securities

The other side of that coin, the companies that are already outsourcing, do you sense any increased focus on pricing pressure from your existing clients given the turn in the economy?

Lance Rosenzweig

I would say probably yes. Everyone is concerned about their own budgets now and as a result they want to on the one hand save money by moving the business offshore but as they do that they want to do that for the lowest cost that they can. So it’s a continued kind of balancing act between the vendors and the end customers.

David Scharf – JMP Securities

Shifting to the guidance, I just wanted to make sure I understood the facility expansion. Obviously you’re selling the Manila land. I believe last quarter you discussed the new facility in Sabu that was to be constructed. Is that still on track? I think I had cap ex modeled I think upwards of $25 million.

Lance Rosenzweig

We’ve done I think very, very well at increasingly optimizing our volume across our centers and so we’re looking at areas where there was tightness such as Sabu and we’re re-allocating some of that volume and some of the new client volume to newer areas such as Baguio where there’s capacity and so as of this stage we’re not anticipating building out that building at least in the short term or building our additional seats in Sabu in the short term, but we haven’t made a final decision. We’re continuing to monitor it. A lot of clients will be very specific where they want the volume to be and so we’re looking carefully at that. But right now we’re coming into 08 with a much more modest cap ex plan and a much better utilization of our assets anticipated over the course of the year.

David Scharf – JMP Securities

So that’s a big change then. That was going to a 4,000 seat center, $20 to $25 million. So we should we should just be looking at the $4 to $5 million of regular sort of maintenance cap ex this year.

Lance Rosenzweig

At this stage, that’s correct.

Caroline Rook

And when we have the need to build out additional new potentially leased facilities then we’ll update as we go along.

David Scharf – JMP Securities

And as far as the operational seat count this year, by the end of the year we should be applying that mid to high 70% utilization rate to? It looks like you’re ending the year at 7,500. Is it going to be largely at that level or a little higher?

Lance Rosenzweig

I’ll take a general stab and then Caroline can fill in some specifics, but we did in the first quarter of 08 add about 400 new seats in the PeopleSupport center just by reconfiguring the center a bit. So we’ve done it very effectively without any additional rent expense and we’re doing the same in some other buildings kind of an as we go basis. So we’re really optimizing what we have. So there’ll be some incremental growth in seats but at relatively modest cap ex. As we get toward the end of the year depending on how the growth goes and where the growth goes we might be building out additional seats in Baguio and that is not included in that cap ex number that Caroline gave.

David Scharf – JMP Securities

But in general if we’re modeling about a weighted average operational seat kind of 8,000 this year, that’s in the ballpark?

Lance Rosenzweig

I think that’s close, yeah.

David Scharf – JMP Securities

Just a couple more here, the modeling for foreign exchange, just so I understand, Caroline we’ll throw a couple million into the Q1 other income for the realized and unrealized gains on the existing forward contracts. Should we basically have just a zero going forward in Q2 assuming you enter into the new contracts after and have the effective hedging in and just have that reflected in a couple hundred basis points improvement in your operating margin?

Caroline Rook

That would be theory, right David? I haven’t brought forward yet so that would be difficult to say on 40.5 Pesos that I currently have.

David Scharf – JMP Securities

But is the current earnings guidance based on the expectation that there’s effective hedging in place?

Caroline Rook

Correct. At 40.5 so the caveat is if I’m not buying at 40.5 then I’m not hedging 100% of my Peso expenses. There might be a little movement there.

David Scharf – JMP Securities

And then the last question, Lance, just obviously EarthLink there was some contract attrition and we’re seeing some cyclicality kick in, without singling out any clients by name are there verticals that you would expect to be the most challenged in the current environment, with the travel sector being the most discretionary perhaps?

Lance Rosenzweig

I think, David, we’re seeing most softness in our tech and telecomm vertical. The travel vertical is actually seeing some really good growth but that’s not necessarily because there’s more travel going on. I think where with existing clients winning new lines of business and also a very, very strong sales pipeline in that industry. While there is softness generally in the travel industry in the US we think that there’s good opportunity for us.

David Scharf – JMP Securities

I’m sorry, one last one, you mentioned an ARM client, accounts receivable?

Lance Rosenzweig

One our significant closers this last quarter was an ARM client.

David Scharf – JMP Securities

So that’s doing contingency – for a greater at depth purchaser or a contingency collection?

Lance Rosenzweig

It’s not actually, it’s doing more back office services for an ARM company so it’s really an interesting new line of business for us.

Operator

We’ll next go to Cynthia Houlton of RBC Capital Markets.

Cynthia Houlton - RBC Capital Markets

First comment, the utilization including – you gave a utilization number I think that excluded the seats in the facility that you’re not using in Manila, could I just get what it was for the quarter including all the seats?

Lance Rosenzweig

The aggregate utilization rate at the end of the quarter was 64%, that includes all the seats.

Cynthia Houlton - RBC Capital Markets

And then just on the revenue guidance, if I look at kind of the change in guidance at the high and the low end, it’s roughly $20 million or $18 million, I understand you outlined the decline in EarthLink and some other customers about $12 to $13 million, in 2008 versus 2007 and I assume when you set that 08 guidance you weren’t anticipating that. What else is kind of in that lower revenue guidance, is the balance coming from tech and telecomm? And again maybe you can be a bit more granular of where you’re seeing more weakness within tech and telecomm. Is it doing tech support, is it – just to better understand the reduction in guidance.

Lance Rosenzweig

We’re seeing that $12 or $13 million that we mentioned is primarily in tech and telecomm isolated to a few clients. Outside of that it’s really just a general slowdown that we’re seeing really across industries, across verticals where we’re seeing lower call volumes than client expectations and not just seeing it but kind of anticipating it as well in the next couple of quarters.

Cynthia Houlton - RBC Capital Markets

And then is there any pricing assumptions also assumed in the lower revenue guidance or is it more just volumes?

Lance Rosenzweig

A little bit of pricing particularly in one client.

Operator

We’ll move to Joseph Foresi of Janney Montgomery Scott.

Joseph Foresi - Janney Montgomery Scott

My first question is I wonder if you could help us reconcile your commentary on there being a strong pipeline with the lowering of revenue guidance? Again were you going into contract extension talks with EarthLink and then you found out it was going to be lower since you gave the guidance in December? Maybe you could just give us a little walk through of why you’re so bullish on your pipeline yet you’ve lowered the revenue side?

Lance Rosenzweig

EarthLink in particular has really reconfigured its business model and it’s part of that approach, they’re spending a significantly less amount on marketing. They’re driving less volume of people to make calls and so we think we’re actually getting a bigger percentage of EarthLink’s overall call volumes. The call volumes are coming down so significantly, much more expected that we’re seeing that really impact our numbers overall for 2008. The strength of the pipeline is helping us significantly in future quarters and we’re seeing that, for example, this new large client which closed in Q4 is already starting to ramp so we’re seeing some impact in Q1 and particularly in Q2 which is offsetting the loss from EarthLink and others. We expect as I mentioned to close another $5 million plus client in Q1 which will then start ramping into Q2 and Q3 and as these new deals close it’s sort of a couple quarter lag before it really starts having an impact. But it’s driving the pick up that we’re expecting in the second half of the year and more significantly into 09.

Joseph Foresi - Janney Montgomery Scott

So essentially I guess the thought process here is that outsourcing increases because it’s a cost saving method but is direct reconciliation with your present client base even though it is a cost saving method that because it’s more volume based and specific to clients that the revenue guidance had to come in?

Lance Rosenzweig

These clients, and EarthLink in particular, is already kind of optimizing their call center costs by doing it all offshore. Now it’s just a question, how many calls they’re getting and that’s different than the clients have historically either outsourced or maintained call center operations in the US where they have much higher cost operations where even if their call volume comes down it doesn’t affect us because there’s so much more volume that they can move from the US to offshore locations.

Joseph Foresi - Janney Montgomery Scott

So it’s client specific?

Lance Rosenzweig

Correct.

Joseph Foresi - Janney Montgomery Scott

And then just kind of switching gears here to the captive service offering, can you give us a rough idea of the number of seats, the timeframe of this particular project and whether you include it in present utilization?

Lance Rosenzweig

We haven’t broken out the business in terms of seats or revenues, etcetera, but it is a business primarily at this stage with one client but extended throughout the course of 08. So we’re now expecting it to run through the end of 08, that particular contract. We do have increasing pipeline of opportunities for captive services and we’re hoping and are optimistic that we’ll be winning some new pieces of business there too.

Joseph Foresi - Janney Montgomery Scott

Are these finite contracts? In other words is this an annual contract and then after a year the client potentially goes away?

Lance Rosenzweig

In some cases it will be. So in some cases it’s a bridge for a client which may be building their own operations in the Philippines so it’s a way for them to kick off their operations before building it themselves. In other cases it’s a long term strategy for that particular company.

Joseph Foresi - Janney Montgomery Scott

I’m just going to sneak two more quick ones in, are you worried at all that you’re potentially setting yourself up for an increase in competition by helping either your present client base or other potential clients set up facilities in the Philippines?

Lance Rosenzweig

No. I’ll tell you why. That client which has made an internal strategic decision to set up in house operations is going to do it in any event and I’d rather them partner with PeopleSupport. Secondly, what we’ve seen with the one client that we have so far is while we have a big captive services operation with them we also have a bigger outsourcing operation and it enables us to partner with them in a more holistic sense where we can handle their outsourcing operations, some captive services and they can go back and forth a bit over time.

Joseph Foresi - Janney Montgomery Scott

And just one last one here, obviously the captive service offering occupies seats, with a robust pipeline expected for the back half of the year what do you do with those seats, do you increase the amount of seats and reserve those for the captive service offering and then after the captive service offering potentially comes to a close how do you re-allocate those and won’t they be affecting your financials?

Lance Rosenzweig

We hope that it will ultimately help our asset utilization and our cap ex because if a captive services opportunity rolls off and then we allocate those seats to outsourcing operations it lets us utilize the built out seats without having to expend capital and build out new seats ourselves for new capacity. So we think it will help overall in the long run our overall utilization and efficiencies.

Joseph Foresi - Janney Montgomery Scott

So essentially you just will sell those seats with the new business seat mostly? Is that accurate?

Lance Rosenzweig

It’s a question of timing, when the new business comes in versus when the seats are available. But we think that it gives us a lot more flexibility because those seats have the opportunity to be either outsource seats or captive seats and they can change over time.

Joseph Foresi - Janney Montgomery Scott

And sorry for the long questions, but just one last one, do you feel like you have the visibility to control that timing?

Lance Rosenzweig

Some of that’s client dependent and when the new contracts come in. What I would say though in terms of utilization is that while our utilization rate which is the peak hour utilization at the end of the quarter came down in the quarter I will note though that our efficiency and utilizing our seats continues to get better and you can see that in the tracking of our employee headcount versus our revenues. So our headcount came down in the quarter much more significantly than our revenues and so we’re able to push a higher revenue per person and also more effectively utilize our seats over more hours of the day and we’re very happy with our increased operational effectiveness.

Operator

We’ll next go to Moshe Katri of Cowen & Co.

Moshe Katri - Cowen & Co

Lance and Caroline, your financial services vertical seems to be doing relatively well and this is despite all the dire predictions on the Street, you mentioned JP Morgan, we’re familiar with Washington Mutual, can you talk a bit about some of the work that you’re doing for these companies especially now there’s been any change in the nature of the work that you’re doing in the past few months and then on top of that you did mention that your pipeline is pretty robust. Can you quantify which percentage of the pipeline is actually related to financial services?

Lance Rosenzweig

In fact financial services in 07 was our strongest growing vertical with a greater percentage growth than any of our other verticals. If you look at the two clients in particular, WAMU and JP Morgan Chase, it’s a pretty broad range and increasingly broad range of services that we’re providing to them, some general consumer banking, some fraud services, a little bit of mortgage services but more on the servicing side so people calling with inquiries about their mortgages, etcetera. It’s a diversified broad base service. It’s also a service generally across facilities and across geographies. So we’re doing it in Sabu, we’re doing it in Manila, we’re doing it in Costa Rica and we hope to be doing it in Baguio as well, also some credit card operations, some sales and some servicing. So it’s an increasingly broad base and I think it helps to illustrate that again in this slowing economy which to some extent disproportionately hurts the large financial services company you are seeing them move more toward lower cost offshore outsourcing. In terms of the pipeline I think a healthy amount of the companies in the pipeline are in the financial services sector and we are excited about opportunities there both with existing and new clients.

Moshe Katri - Cowen & Co

And then going back to the question about captive services, and I apologize if I’m going to try to ask the question in a different way. One, can we assume that this is basically your highest margin business today?

Lance Rosenzweig

We haven’t, again, broken out the margins from that business but it is a very high margin business.

Moshe Katri - Cowen & Co

This is basically you’re renting real estate for a certain amount of time and you’re already incurring the cost so basically you can always make an argument that this is your most lucrative part of your business and then did you break down the revenue contribution from captive services for Q4 and also did you break down what sort of revenue contributions you’re expecting or factoring in calendar 08 guidance from captive services?

Lance Rosenzweig

We didn’t, Moshe, because it’s not yet material in terms of overall revenues but it is a very attractive and high margin business.

Moshe Katri - Cowen & Co

And I’m saying that because I thought in Q3 it did contribute, I thought it was a pretty meaningful amount to your bottom line. Am I mistaken, Caroline?

Caroline Rook

Yes, I think what we said in Q3 is that the captive services along with some other aspects where we had some catch ups in Q3 in terms of some catch up reversals that it contributed maybe a couple of percentages towards our margin.

Lance Rosenzweig

We’ll check Moshe, maybe ask another question or two. We’ll double check exactly what indication we gave.

Moshe Katri - Cowen & Co

But you are saying at this point your calendar 08 guidance does not factor any revenue or much or material margin contributions because a couple hundred basis points in EBITDA margin is pretty significant so you’re saying that your 08 guidance does not factor any meaningful contributions from captive services?

Lance Rosenzweig

No, that’s not true. It will be consistent with where we were in Q4 of 07 and probably with some growth as well. So we actually have some additional captive services business we won in Q1 of 08 and we’re hoping to have continued steady improvements. Caroline, do you have more information on what we guided?

Caroline Rook

I think what we said during Q2, if I serve, is that the captive services that we recognized in Q3 along with some other aspects contributed around 2% operating margin.

Moshe Katri - Cowen & Co

You mean 200 basis points?

Caroline Rook

Yes.

Moshe Katri - Cowen & Co

And if 08 is consistent with past guidance does that mean that you’re also factoring a couple hundred basis points contributions to 08 as well?

Caroline Rook

To some extent, yes Moshe. Having said that obviously the cost associated with that has been impacted by the Peso. So it’s Peso impacted around that amount.

Moshe Katri - Cowen & Co

And just to confirm a couple of other things that were asked on the call, is 08 guidance factoring pricing pressure you said from one client?

Lance Rosenzweig

That’s correct.

Moshe Katri - Cowen & Co

And then did you disclose your expectations for free cash flows in 08?

Caroline Rook

No I do not believe we did, Moshe.

Moshe Katri - Cowen & Co

And do you have guidance for free cash in 08?

Caroline Rook

No. Well free cash flow would obviously be dependent on cap ex then, right? If we think that the cap ex spend would be dependent on when we would need to build our new facilities.

Operator

We will next move to Matt McCormack of FBR Capital Markets.

Matt McCormack - Friedman, Billings, Ramsey

I kind of want to drill down on your comments over the economy because I would say that they’re probably the most sobering that we’ve heard from any company in the States and I guess the question is how do you know how for certain that you’re seeing lower volumes due to the economy rather than being impacted possibly by vendor consolidation or possibly some client specific issues? There seems to be a few contradictions, you talk about EarthLink and tech clients being weak, EarthLink just went through a major restructuring and I don’t believe you have any other tech clients a large percentage of revenue. In terms of the travel sector you talked about Expedia but yet you expect revenues to increase sequentially throughout the year and then lastly you talked about losing business to global players. So I guess could you just go through why you’re so confident that the volume slow down that you’re seeing is the economy and not specific to you?

Lance Rosenzweig

It’s a number of factors which are affecting the revenues, particularly in the early part of this year. One is, as we mentioned, EarthLink and a couple other clients that I think we mentioned would be about a $12 to $13 million reduction from 07 into 08. So we’ve got to catch up that first. Secondly Expedia did have a seasonal slowdown in Q4 but we are seeing growth in Q1 and we are anticipating growth in subsequent quarters as well, bearing in mind that there’s likely to be seasonality again in Q4 of 08. Also the [inaudible] sectors, the travel sector, to some extent the financial services sector, the tech and telco sector [inaudible] it’s a mixture, it’s a mixture of some specific client situations and some general economic situations.

Matt McCormack - Friedman, Billings, Ramsey

But how do you know that that volume’s coming down isn’t because it’s going to a competitor?

Lance Rosenzweig

For some clients we don’t know, but for a lot of clients we do and we have pretty good insight and pretty good partnerships with our clients. For the most part our strategy, again, is to deal with clients where PeopleSupport is a very significant partner to theirs. We try to focus on clients where we’d be the number one or number two outsourcing partners and for many of our larger clients we are successful at that. And we’ve got good relationships and we can track what they’re doing.

Caroline Rook

I’m not sure any of our clients are saying that they’re growing tremendously in a booming economy for themselves. It’s a reduced economy for them as well.

Matt McCormack - Friedman, Billings, Ramsey

In terms of your I guess your 10-K you say that there’ about 400 employees serving WAMU in Costa Rica and I think that’s down from 450 and please correct me if I’m wrong but could you just kind of characterize the relationship in that country right now?

Lance Rosenzweig

I would characterize our relationship with WAMU in Costa Rica as very, very strong and the quality of the performance of the team is very high as well and there was a bit of a dip in headcount primarily because of some slowdowns in some specific lines of business that we were servicing there. But we are seeing that that’s coming back up and so we’re expecting those temporary book.

Matt McCormack - Friedman, Billings, Ramsey

And then the last question, you did have an unsolicited offer at 15 which was rejected and another one rejected at 17, I believe you provided preliminary or 008 guidance which you’ve now come off of to justify rejecting the first one, but I guess could you talk about your reasons for rejecting it and possibly your willingness of entering back into negotiations with that bidder?

Lance Rosenzweig

We were very transparent in our discussions with that company at that time and I think we actually published all of the correspondence that went back and forth between the companies and ultimately the offer was rejected because there was an inability of the company to demonstrate financing capability to close the deal and PeopleSupport will continue to evaluate any proposals to maximize shareholder value as we mentioned in our release.

Operator

We’ll next go to Nate Swanson of ThinkEquity Partners.

Nate Swanson – ThinkEquity Partners, LLC

Most of my questions have been answered I’m just wondering has your agreement with EarthLink changed in terms of the structure or is this just a reduction in volume?

Lance Rosenzweig

It is not, we’ve not seen a contractual change.

Nate Swanson – ThinkEquity Partners, LLC

And what kind of visibility do you have in terms of out beyond a quarter or two?

Lance Rosenzweig

With EarthLink in particular or with all of our clients?

Nate Swanson – ThinkEquity Partners, LLC

Well, EarthLink in particular I guess. What kind of – is there something where we can be looking at another Vonage type situation?

Lance Rosenzweig

Fortunately the decline that we’re seeing in 08 versus 07 is about the level of what we saw in the Vonage decline but we are very strategic to EarthLink and I think those companies hold each other in very high regard. We’re proud of the JD Power awards that EarthLink has won, we won some call center of the year awards with them recently and we think we’ve got a very strong relationship and EarthLink’s step is to extend that link to ours and we’re very focused on being a great partner for them. So as they modify their business model and as they change their stuff we’d work with them to act accordingly.

Operator

We’ll take a follow up question from Cynthia Houlton of RBC Capital Markets.

Cynthia Houlton – RBC Capital Markets

Just a follow up on a previous question on the captive services, in your last call you did break out the revenues, you said it was about $1.5 million and you talked about 2% contribution margin and from your transcript you said it was only – you didn’t mention other factors contributing to the 2%. In looking out to the current quarter was that around the same level and is that kind of the level that’s in your estimates or has it grown? Maybe just a little bit more granularity on that.

Lance Rosenzweig

I’ll turn it to Caroline, Cynthia, but it was relatively quarter to quarter so it would have had similar impact although you’d need to adjust it for the Peso and going forward we’re hoping for some growth in that business and we have closed some additional volume in Q1.

Operator

We’ll go back to David Scharf.

David Scharf – JMP Securities

Caroline, just a real quick knit, what was the GAAP tax rate that was assumed that underlies these GAAP EPS forecasts.

Caroline Rook

I think we said about 5% excluding any discreet items that may occur.

Operator

And we’ll now to back to Matt McCormack.

Matt McCormack - Friedman, Billings, Ramsey

I actually wanted to revisit the comments about losing clients to the global players and I guess could you comment if that’s going to change your Philippine center strategy going forward or if you might look to partnering with a player or expanding in other geographies so you don’t lose that type of business in the future?

Lance Rosenzweig

That’s an excellent question, Matt, and we have seen in a couple of cases companies which have decided to go with a global outsourcer where they can do multi-lingual and multi-countries and have an aggregate kind of global agreement. PeopleSupport isn’t that, we have discreet operations. However we are focused now on some partnerships with global players where we can be the Philippine element in this global strategy and we think that there’s some great opportunities actually on a partnership basis going forward. We are not ourselves though planning to become, at least in the near term, or in the middle term any kind of multi-lingual, multi-country player. We’re an offshore, low cost outsourcer and we like that niche.

Operator

(Operator Instructions) And there appear to be no questions coming in at this point. I’ll hand things back to you for any additional or closing remarks.

Lance Rosenzweig

Thank you everyone for listening and we look forward to talking again in the next quarter.

Operator

That does conclude this conference call. Thank you all for joining us and have a wonderful day.

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