ETEL Etelecare Global Solutions ADS (MM)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

Form 10-Q

 

 

 

 

 

Commission File No. 001-33362

 

 

 

 

eTelecare Global Solutions, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

 

 

31 ^st Floor CyberOne Building, Eastwood City, Cyberpark

 

 

Registrant’s telephone number, including area code:

63 (2) 916 5670

 

 

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  þ      No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):  Yes  o      No  þ

 

On May 9, 2008, 29,093,464 shares of the Registrant’s common shares par value 2 Philippine Pesos ($0.04 U.S.) per share, were outstanding.

 

TABLE OF CONTENTS

 

 

 

eTelecare Global Solutions, Inc. and Subsidiaries

 

Consolidated Balance Sheets

(In thousands, except share and per share data)

 

 

See accompanying notes to unaudited consolidated financial statements.

eTelecare Global Solutions, Inc. and Subsidiaries

 

Consolidated Statements of Operations

(In thousands, except per share data)

 

 

See accompanying notes to unaudited consolidated financial statements.

eTelecare Global Solutions, Inc. and Subsidiaries

 

Consolidated Statements of Comprehensive Income (Loss)

(In thousands)

 

 

See accompanying notes to unaudited consolidated financial statements.

eTelecare Global Solutions, Inc. and Subsidiaries

 

Consolidated Statements of Changes in Stockholders’ Equity

(In thousands, except number of shares)

 

 

See accompanying notes to unaudited consolidated financial statements.

eTelecare Global Solutions, Inc. and Subsidiaries

 

Consolidated Statements of Cash Flows

(In thousands)

 

 

See accompanying notes to unaudited consolidated financial statements.

eTelecare Global Solutions, Inc. and Subsidiaries

 

Notes to Unaudited Consolidated Financial Statements

(In thousands, except share and per share data)

 

 

Interim Financial Information

 

The accompanying consolidated financial statements as of March 31, 2008 and for each of the three months ended March 31, 2008 and 2007 are unaudited. The unaudited consolidated financial statements include all adjustments, consisting of normal recurring accruals, which the Company considers necessary for a fair presentation of the financial position and the results of operations for those periods. The consolidated balance sheet information as of December 31, 2007 has been derived from the audited financial statements at that date but does not include all of the financial information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our December 31, 2007 audited financial statements filed with our annual report on Form 10-K on March 14, 2008 with the Securities and Exchange Commission. Operating results for the three months ended March 31, 2008 are not necessarily indicative of the results that may be expected for the entire year ending December 31, 2008.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

For the three months ended March 31, 2008, we had three clients that each contributed more than 10% of our revenue, including AT & T, representing 25% of our revenue, Dell, representing 19% of our revenue, and Sprint, representing 20% of our revenue.

 

 

Income taxes for the interim periods presented have been included in the accompanying financial statements on the basis of an estimated annual effective tax rate. As of March 31, 2008, the estimated annual effective tax rate for 2008 is 12%. The estimated annual effective tax rate for 2008 differs from the Philippines statutory tax rate of 35% primarily as a result of our Philippine income tax holidays, which expire at staggered dates through 2012. Our next anticipated expiring income tax holidays are in the second half of 2008 for two of our delivery center sites. We intend to apply for an extension or conversion to Pioneer holiday status prior to expiration. Although our estimated annual effective tax rate does not assume that the extension or conversion will be approved, we understand it is the current practice of the Philippine government to grant extensions on such tax holidays as a means of attracting foreign investment in specified sectors, including the outsourcing industry. If the extensions or conversion to Pioneer holiday status of the two expiring tax holidays are approved before their expiration in the second half of 2008, our estimated annual effective tax rate for 2008 would decrease to approximately 11% at the time of Philippine governmental approval.

 

As of March 31, 2008, we had unrecognized tax benefits of approximately $1,500. The entire amount of unrecognized tax benefits at March 31, 2008 would, if recognized, reduce our annual tax expense. The Company anticipates approximately $800 of the March 31, 2008 balance will be recognized in the next 12 months due to expiration of the statute of limitations.

 

We recognize interest and penalties relating to unrecognized tax benefits in income tax expense. As of March 31, 2008, we have accrued approximately $200 of accrued interest and penalties related to uncertain tax positions at March 31, 2008 which are included as a component of the total unrecognized tax benefit of approximately $1,500.

 

eTelecare Global Solutions, Inc. and Subsidiaries

 

Notes to Unaudited Consolidated Financial Statements — (Continued)

 

 

The Company operates in and files income tax returns in various jurisdictions in the Philippines and the United States which are subject to examination by tax authorities. With few exceptions, the Company is no longer subject to US federal and state or Philippine income tax examinations before 2004. As of March 31, 2008, the Company was under income tax audit in the State of Arizona for our 2004-2006 years. Although there can be no assurance as to the ultimate disposition, we believe that the outcome of this audit will not have a material effect on our financial position, results of operation or cash flows.

 

 

Although substantially all of the Company’s revenue is derived principally from client contracts that are invoiced and collected in U.S. dollars, a significant portion of the Company’s cost of services and selling and administrative expenses is incurred and paid in Philippine pesos. Accordingly, the Company’s results of operations and cash flows are affected by an increase in the value of the Philippine peso relative to the U.S. dollar, the functional and reporting currency of eTelecare and its subsidiaries. To partially hedge against currency changes between the Philippine peso and the U.S. dollar, eTelecare has implemented a hedging strategy, beginning in August 2007. This strategy consists of a rolling hedge program that entails contracting with third-party financial institutions to acquire zero cost, non-deliverable forward contracts that are expected to cover approximately 80% of Philippine peso-denominated forecasted expenses for the current quarter, 60% of the forecasted peso expenses for the next quarter, 40% of the forecasted peso expenses for two quarters out and finally, 20% of forecasted peso expenses for three quarters out. For 2008, however, we modified the application of this strategy to hedge approximately 90% of our forecasted Philippine peso-denominated expenses. We will continue to reevaluate our hedge strategy and adjust the percentage of expenses hedged depending on certain external and economic factors and indicators.

 

The foreign currency forward contracts that are used to hedge this exposure are designated as cash flow hedges in accordance with the criteria established in Statement of Financial Accounting Standards (“SFAS”) No. 133 “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”). SFAS 133 requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting treatment. For accounting purposes, effectiveness refers to the cumulative changes in the fair value of the derivative instrument being highly correlated to the inverse changes in the fair value of the hedged item. Based on the criteria established by SFAS 133, all of the Company’s cash flow hedge contracts are deemed effective. If any ineffectiveness arises, it will be recorded within Foreign Exchange Gain (Loss) on the Consolidated Statement of Operations. The derivative instrument is recorded in the Company’s Consolidated Balance Sheets as either an asset or liability measured at its fair value, with changes in the fair value of qualifying hedges recorded in Accumulated Other Comprehensive Income (Loss), a component of Stockholders’ Equity. The settlement of these derivatives will result in reclassifications from Accumulated Other Comprehensive Income (Loss) to earnings in the period during which the hedge transaction affects earnings. While the Company expects that its derivative instruments will continue to meet the conditions for hedge accounting, if the hedges did not qualify as highly effective or if the Company did not believe that forecasted transactions would occur, the changes in the fair value of the derivatives used as hedges would be reflected currently in earnings.

 

As of March 31, 2008, the notional amount of the outstanding derivative instruments designated for hedge accounting is summarized as follows:

 

 

These derivatives are classified as Fair Value of Derivatives of ($1,168) and $3,153 as of March 31, 2008, and December 31, 2007, respectively, in the accompanying Consolidated Balance Sheets.

 

A total of $1,168 of deferred losses, net of tax of $0, on derivative instruments as of March 31, 2008, was recorded in Accumulated Other Comprehensive Income (Loss) in the accompanying Consolidated Balance Sheets. The Company expects that all of this deferred loss will be reclassified into earnings within the next 12 months.

 

eTelecare Global Solutions, Inc. and Subsidiaries

 

Notes to Unaudited Consolidated Financial Statements — (Continued)

 

For the quarter ended March 31, 2008, the Company recorded a gain of $1,791 for settled hedge contracts. This gain is reflected in Cost and Expenses in the accompanying Consolidated Statements of Operations.

 

The Company also entered into foreign exchange forward contracts to reduce the short-term effect of foreign currency fluctuations related to approximately $16 million of accrued liabilities that are denominated in Philippine peso. The gains and losses on these forward contracts are intended to offset the transaction gains and losses on the Philippine Peso obligations. These gains and losses are recognized in earnings as the Company elected not to classify the contracts for hedge accounting treatment. The value of these contracts was ($544) and $376 as of March 31, 2008 and December 31, 2007, respectively, and is recorded as a component of Fair Value of Derivatives in the accompanying Consolidated Balance Sheets. We realized $235 of losses on these contracts for the quarter ended March 31, 2008, which are recorded within Foreign Exchange Gain (Loss) on the Statement of Operations.

 

 

The Company adopted Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”) on January 1, 2008 for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. SFAS 157 defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. SFAS 157 does not change the accounting for those instruments that were, under previous GAAP, accounted for at cost or contract value. In February 2008, the FASB issued staff position No. 157-2 (“FSP 157-2”), which delays the effective date of SFAS 157 one year for all non-financial assets and non-financial liabilities, except those recognized or disclosed at fair value in the financial statements on a recurring basis. The company has no non-financial assets and liabilities that are required to be measured at fair value on a recurring basis as of March 31, 2008.

 

The Company holds derivatives, which must be measured using the SFAS 157 prescribed fair value hierarchy and related valuation methodologies. SFAS 157 specifies a hierarchy of valuation techniques based on whether the inputs to each measurement are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s assumptions about current market conditions. The prescribed fair value hierarchy and related valuation methodologies are as follows:

 

Level 1  — Quoted prices for identical instruments in active markets.

 

Level 2  — Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations, in which all significant inputs are observable in active markets.

 

Level 3  — Valuations derived from valuation techniques, in which one or more significant inputs are unobservable.

 

As of March 31, 2008, the fair value of the Company’s financial assets and liabilities was as follows:

 

 

Valuation Methodologies

 

In determining the fair value of the Company’s foreign currency derivatives, the Company uses forward contract and option valuation models employing market observable inputs, such as spot and forward currency rates, and time value. Since the Company only uses observable inputs in its valuation of its derivative assets and liabilities, they are considered Level 2.

 

eTelecare Global Solutions, Inc. and Subsidiaries

 

Notes to Unaudited Consolidated Financial Statements — (Continued)

 

 

The computation of basic and diluted earnings per share is as follows (in thousands except per share data):

 

 

Potential common shares issuable upon exercise of stock options exclude 0.9 million and 0.7 million shares for the three months ended March 31, 2008 and 2007, respectively, as the effect was antidilutive.

 

 

On September 3, 2007 (the “Effective Date”), the Company amended its Articles of Incorporation to reflect a change in the number of its authorized common shares from 130,000,000 common shares to 65,000,000 common shares to enable us to effect a two-for-one reverse split of the outstanding common shares.

 

On the Effective Date, every two outstanding common shares of the Company were reconstituted into one common share of the Company. This modification to the authorized and outstanding common shares did not affect the rights or the number of the Company’s outstanding American Depositary Shares (“ADSs”), except that each outstanding ADS now represents one common share, resulting in an ADS-to-common shares ratio of one-to-one instead of the prior ADS-to-common shares ratio of one-to-two.

 

All references contained in these financial statements to amounts of outstanding shares of common stock or ADSs give effect to this two-for-one reverse stock split.

 

 

We are the defendant in the employment matter of James Dreyfuss vs. ETelecare Global Solutions-US, Inc. filed in the United States District Court, Southern District of New York on February 4, 2008. In the matter, James Dreyfuss, who served as our Regional Vice President of Sales, has asserted the following claims against the company: (1) two counts of breach of contract; (2) violation of New York Labor Law Sections 190 et seq. (3) quantum merit; (4) unjust enrichment; (5) breach of covenant of good faith and fair dealing; and (6) promissory estoppel. Mr. Dreyfuss seeks compensatory damages in an amount to be proven at trial, penalties under New York Labor Law Section 198, pre- and post-judgment interest and costs and expenses for such suit, including attorney’s fees. We filed a motion to compel arbitration on April 7, 2008 which motion will be briefed by May 27, 2008. We are now in the early stages of discovery. While we cannot predict with certainty the outcome of the litigation, we believe the ultimate outcome of this matter will not have a material adverse impact on the financial position or our results of operations. Accordingly, no liability has been recorded in the financial statements.

 

The Company is subject to other legal proceedings and claims, which have arisen in the ordinary course of its business. Although there can be no assurance as to the ultimate disposition of these matters and the proceedings disclosed above, it is the opinion of the Company’s management, based upon the information available at this time, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the Company’s results of operations or financial position.

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read together with the unaudited consolidated financial statements and related notes appearing in Item 1 of this report on Form 10-Q and the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited financial statements for the year-ended December 31, 2007 included in our annual report on Form 10-K previously filed with the Securities and Exchange Commission on March 14, 2008.

 

This report on Form 10-Q contains forward-looking statements. These statements include but are not limited to our expectations that clients are increasingly looking for vendors that provide business process outsourcing, or BPO, services from multiple locations, our anticipated growth in our business, anticipated increase in our selling and administrative expenses, our anticipated effective tax rate for 2008, the potential to obtain extensions on Philippine tax holidays, our anticipated capital expenditures in 2008, and our belief regarding the adequacy of our capital resources over the next 12 months. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those discussed in these forward-looking statements. These risks and uncertainties include, but are not limited to, our ability to attract and retain enough sufficiently trained customer service associates and other personnel, our ability to maintain our pricing, utilize our employees and assets efficiently and maintain and improve the current mix of services that we deliver from our offshore locations, our ability to compete effectively with onshore and offshore BPO companies and with information technology companies that also offer BPO services and our ability to manage our growth effectively and maintain effective internal processes. Additional risks and uncertainties include those listed under Item 1A, “Risk Factors.” eTelecare Global Solutions, Inc. expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained in this report to conform these statements to actual results or changes in our expectations or in events, conditions or circumstances on which any such statement is based. You should not place undue reliance on these forward-looking statements, which apply only as of the date hereof.

 

Introduction

 

Our Management’s Discussion and Analysis is intended to facilitate an understanding of our business and results of operations and consists of the following sections:

 

 

Overview

 

We are a leading provider of business process outsourcing, or BPO, services focusing on the complex, voice-based segment of customer care services delivered from both onshore and offshore locations. We provide a range of services including technical support, financial advisory services, warranty support, customer service, sales and customer retention. Our services are delivered from seven delivery centers in the Philippines and six delivery centers in the United States, with approximately 10,600 employees in the Philippines and approximately 2,800 employees in the United States as of March 31, 2008.

 

We completed our initial public offering in the United States on April 2, 2007 in the form of 5,500,000 American Depositary Shares, or ADSs. Our ADSs are listed on the NASDAQ Global Market. Our initial public offering raised $69.1 million, net of underwriting discounts and commissions and offering costs. On April 5, 2007, we received additional proceeds of $10.3 million, net of underwriting discounts and commissions and offering costs of $844,000, as a result of the exercise by our underwriters of their over-allotment option to purchase an additional 825,000 ADSs from us. In April 2007, we used an aggregate of $36.3 million from these proceeds to repay outstanding debt. In late November 2007, we completed our listing by way of introduction on the Philippine Stock Exchange. We currently are a foreign private issuer under the applicable rules and regulations in the United States.

However, we voluntarily elect to file our periodic and current company reports under the Exchange Act in accordance with the rules and regulations applicable to a U.S. issuer.

 

Results of Operations for the Three Months Ended March 31, 2008 and 2007

 

The following table sets forth our unaudited historical operating results, as a percentage of revenue for the periods indicated:

 

 

Service Revenue.   We generate revenue from the customer care and other BPO programs we administer for our clients. We provide our services to clients under contracts that typically consist of a master services agreement, which contains the general terms and conditions of our client relationship, and a statement of work, which describes in detail the terms and conditions of each program we administer for a client. Our contracts with our clients typically have a term of one year and can be terminated earlier by our clients or us without cause, typically upon 30 to 90 days’ notice. Although the contractual commitments from our clients are short, our client relationships tend to be longer-term given the scale and complexity of the services we provide coupled with the risk and costs to our clients associated with bringing business processes in-house or outsourcing them to another provider. For the same reasons, our sales cycle tends to range from six to 12 months.

 

The outsourcing industry is extremely competitive, and outsourcers have historically competed based on pricing terms. Accordingly, we could be subject to pricing pressure and may experience a decline in our average selling prices for our services. We attempt to mitigate this pricing pressure by differentiating ourselves from our competition based on the value we bring to our clients through the quality of our services and our ability to provide quantifiable results that our clients can measure against our competitors. We provide a sales proposition to a client based on quantifiable value per dollar spent by the client on our services. For example, we work with the client to quantify the costs to the client of activities such as the time it takes to handle a call, repeat calls, parts dispatches and cancelled sales. We similarly work with a client to quantify the value from initial product sales, sales of products complimentary or more expensive than the products in which a customer is originally interested and repeat purchasing based on customer satisfaction. This information on costs and value created is combined to develop a value created per dollar spent model on which both the client and we agree in order to set the price for our services in

our contract. We then assess our performance against this model on a quarterly basis and share our results measured by these metrics with our client on a quantified scorecard. This gives our client a means of comparing the value we created per dollar spent on us to the same metrics for our clients’ internal business process centers or other outsourcers.

 

We derive our revenue primarily through time-delineated or session-based fees, including hourly or per-minute charges and charges per interaction, which are separately negotiated on a client-by-client basis. In some contracts, we are paid higher rates if we meet specified performance criteria, which are based on objective performance metrics that our client agrees would add quantifiable value to their operations. These payment arrangements can take many forms, including additional payments to us based on the number of confirmed sale transactions we make on behalf of a client or based on meeting customer satisfaction targets. Bonuses are typically 5% to 10% of revenue for a program. Conversely, some of our contracts include provisions that provide for downward revision of our prices under certain circumstances, such as if the average speed required to answer a call is longer than agreed to with the client. Downward revisions are typically limited to a maximum of 5% of revenue for a program. All of our bonus and downward revision provisions are negotiated at the time that we sign a statement of work with a client and our revenue from our contracts is thus fixed and determinable at the end of each month.

 

We currently derive substantially all of our revenue from U.S.-based clients. We receive most of our revenue from a small number of clients, with an aggregate of approximately 81% and 84%, respectively, of our revenue from our five largest clients for the three months ended March 31, 2008 and 2007. For the three months ended March 31, 2008, we had three clients that each contributed more than 10% of our revenue, including AT & T, representing 25% of our revenue, Dell, representing 19% of our revenue, and Sprint, representing 20% of our revenue. We often administer multiple programs for a single client with separate contracts or statements of work that sometimes are negotiated with separate parts of the client organization, which we view as being different clients for practical purposes. For example, we perform four separate programs for AT & T for two separate AT & T business units.

 

 

Our revenue growth was primarily driven by an expansion of work with existing clients delivered from our Philippine locations which accounted for 65% of our first quarter 2008 revenue compared to 54% of our first quarter 2007 revenue. For example, services performed for one of our largest clients increased to approximately 20% from 9% of our global revenue in the first quarters of 2008 and 2007, respectively, due to the expansion of services delivered from our Philippine delivery centers and with the addition of programs delivered from our U.S. delivery centers.

 

Cost of services.   Cost of services consists primarily of the salaries, payroll taxes and employee benefit costs of our customer service associates and other operations personnel. Cost of services also includes direct communications costs, rent expense, information technology costs, facilities support and customer management support costs related to the operation of our delivery centers. We expense these costs as incurred.

 

Our cost of services is most heavily impacted by prevailing salary levels. Although we have not been subject to significant wage inflation in the Philippines or the United States, any significant increase in the market rate for wages could harm our operating results and our operating margin.

 

We often incur significant costs in the early stages of implementation or in anticipation of meeting a current client’s forecasted demand for our services, with the expectation that these costs will be recouped over the life of the program, thereby enabling us to achieve our targeted returns. Similarly, we may also be required to increase recruiting and training costs to prepare our customer service associates for a specific type of service. Such costs are expensed as incurred. If we undertake additional recruiting and training programs and our client terminates a program early or does not meet its forecasted demand, our operating margin could decline.

 

Our cost of services is also impacted by our ability to manage and employ our customer service associates efficiently. Our workforce management group continuously monitors staffing requirements in an effort to ensure

efficient use of these employees. Although we generally have been able to reallocate our customer service associates as client demand has fluctuated, an unanticipated termination or significant reduction of a program by a major client may cause us to experience a higher-than-expected number of unassigned customer service associates.

 

Our efficient use of customer service associates is also impacted by seasonal changes in the operations of our clients, which impact the level of services our clients require. For example, the amount of technical support and financial services we provide has traditionally been greater during the fourth quarter of each year driven by increased customer spending during the holiday season. Demand for these same services typically declines significantly during the first quarter of each year. As a result, the fourth quarter of each year is typically our period of highest efficiency, while the first quarter of each year is typically our period of lowest efficiency.

 

We believe that our clients are increasingly looking for vendors that provide BPO services from multiple geographic locations. This allows clients to manage fewer vendors while minimizing geopolitical risk and risk to operations from natural disasters. Moreover, clients ultimately willing to have service operations offshore may not be willing to do so initially or at any time completely. To address this demand and to supplement our offshore delivery, in May 2004, we acquired Phase 2. An important element of our multi-shore service offering is our ability to migrate clients offshore over time. This allows clients to gain confidence in the quality of our services before shifting services to our offshore delivery locations. This migration strategy both lowers costs for our clients and improves our financial performance. Our costs associated with our U.S. operations are higher than those we experience in the Philippines. If we fail to migrate our clients to our offshore delivery locations or if our offshore growth rates decline compared to our onshore growth rates, our operating margin could decline.

 

 

The absolute dollar increase in cost of services in the first quarter of 2008 over the first quarter of 2007 was primarily to support the 18% increase in service revenue in the first quarter of 2008 over the first quarter of 2007. The increase in cost of services as a percentage of revenue was primarily due to the significant strengthening of the Philippine peso compared to the U.S. dollar which resulted in an increase of approximately 5% of our total operating expenses and primarily impacting our cost of services. Because substantially all of our service revenue is denominated in U.S. dollars and 54% and 39% of our cost of services in the first quarters of 2008 and 2007, respectively, were denominated in Philippine pesos, the effective net costs of our services has increased as the peso strengthens against the U.S. dollar. This increase was offset for the most part by the expanded use of our lower-cost Philippine operations, which despite the strengthening peso continues to show significant cost advantages over our U.S. operations. To a lesser extent, other increases included:

 

 

Selling and administrative expenses.   Selling and administrative expenses consist primarily of our sales and administrative employee-related expenses, sales commissions, professional fees, travel costs, marketing programs and other corporate expenses. Substantially all of our share-based compensation expense is included in selling and administrative expenses. We expect selling and administrative expenses to increase as we add personnel and incur

additional fees and costs related to the growth of our business and our operation as a publicly traded company in the United States and the Philippines.

 

 

The absolute dollar increase in selling and administrative expenses in the first quarter of 2008 over the first quarter of 2007 was primarily due to additional salaries, wages and benefits, consulting fees, travel expenses, and equity compensation expenses. We hired additional personnel to support our growth and to enhance our executive team and professional staff as we expanded our Philippine operations and became a publicly traded company in the United States and the Philippines. Share-based compensation included in selling and administrative expenses was $0.8 million and $0.4 million in the three months ended March 31, 2008 and 2007, respectively, which represented 1% of revenue in both periods.

 

Selling and administrative costs increased as a percentage of revenue due to increases in our service delivery administrative expenses as we invested in the management teams of our centers and finance functions as we began operations as a publicly traded company in the U.S. We expect selling and administrative expenses will increase in the remaining of 2008 in absolute dollars as we add personnel to support our growth and incur additional costs related to our operation as a publicly traded company in the United States.

 

Impact of Foreign Currency.   As a result of our multi-shore delivery model, our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Philippine peso. Substantially all of our revenue is denominated in U.S. dollars, but a significant amount of our expenses is denominated in Philippine pesos. In the three months ended March 31, 2008 and 2007, 51% and 37%, respectively, of our cost of services and selling and administrative expenses were denominated in the Philippine peso.

 

Prior to our initial public offering, our outstanding debt included covenants that prohibited the Company from entering foreign currency hedging transactions. Upon completion of the initial public offering in the first quarter of 2007, the Company used a portion of the proceeds to pay off the outstanding debt and negotiated terms that allowed foreign currency hedging. As a result, in the third quarter of 2007, we initiated a strategy to hedge against short-term foreign currency fluctuations. This strategy consists of a rolling hedge program that entails contracting with third-party financial institutions to acquire zero cost, non-deliverable forward contracts.

 

Depreciation and amortization.   We currently purchase substantially all of our equipment. We record property and equipment at cost and calculate depreciation using the straight-line method over the estimated useful lives of our assets, which generally range from three to five years. We amortize leasehold improvements on a straight-line basis over the shorter of the lease term or the estimated useful life of the asset. If the actual useful life of any asset is less than its estimated depreciable life, we would record additional depreciation expense or a loss on disposal to the extent the net book value of the asset is not recovered upon sale.

 

Our depreciation is primarily driven by large investments in capital equipment required for our continued expansion, including the build-out of seats, which we define as workstations where customer service associates generate revenue. These expenditures include tenant improvements to new facilities, furniture, information technology infrastructure, computers and software licenses and generally range from $8,000 to $12,000 per seat depending on specific client requirements. These costs are generally depreciated over a period of three to five years and are substantially the same in the United States and the Philippines. The effect of our depreciation and amortization on our operating margin is impacted by our ability to manage and utilize our seats efficiently. We seek to expand our seat capacity only after receiving contractual commitments from our clients. However, we have in the past increased our seat capacity based on forecasted demand projections from our clients, which are not contractual commitments. This has resulted in a surplus of seats, which has increased our depreciation and, to a limited extent,

reduced our operating margin. As a general matter, the efficiency of our use of seats has had less of an impact on our operating margin than the efficiency of our deployment of our customer service associates.

 

 

The increase in depreciation and amortization was due to continued expansion of our facilities and infrastructure to support the growth of our operations.

 

Income from operations; operating margin

 

 

The decrease in operating margin in the first quarter of 2008 over the first quarter of 2007 was principally the result of an increase in our cost of services, which increased at a faster rate than did revenues. The operating margin was primarily impacted by the increase in cost of services due to the significant strengthening of the Philippine peso compared to the U.S. dollar. Other decreases to the operating margin were due to:

 

 

These decreases to our operating margin were partially offset by the expanded use of our lower-cost Philippine operations, which despite the strengthening peso continues to show significant cost advantages over our U.S. operations.

 

Other Income (Expenses).   Interest and other income (expense), net includes mainly interest income, interest expense and gains and losses on foreign currency transactions.

 

Interest expense and financing charges decreased significantly in the first quarter of 2008 compared to the first quarter of 2007 because of the repayment of our debt using the proceeds of our initial public offering. Correspondently, interest income increased due to investing of the excess cash maintained from the proceeds to support future growth.

 

We are exposed to short-term currency fluctuations with respect to Philippine peso-denominated accrued liabilities on our balance sheet. The volatility of our foreign exchange (loss) gain relating from these fluctuations was reduced in the first quarter of 2008 due to our hedging strategy which we initiated in the third quarter of 2007. During the first quarter of 2008, the Philippine peso weakened slightly, compared to the U.S. dollar, from a rate of P41.5 at the end of December 2007 to rates ranging from P39.7 to P41.9 during the first quarter of 2008 and compared to exchange rates ranging from P46.35 to P49.08 during the first quarter of 2007.

 

Provision for income taxes.   For the first quarter of 2008, our effective tax rate was 12%, compared to 7% for the first quarter of 2007. The increase in the effective tax rate over the prior year results primarily from the tax benefits we received in 2007 for the one quarter of interest expense deductions we have before we repaid our debt with the proceeds of our initial public offering, as well as the 2007 utilization of net operating losses and tax credit carry-forwards from prior years.

 

Liquidity and Capital Resources

 

We have financed our operations primarily with cash from operations, proceeds from our initial public offering in the United States, proceeds from our loan agreements and, to a lesser extent, with proceeds from the issuance of our common shares through our employee stock option program.

 

Net cash provided by our operating activities was $11.8 million and $0.9 million during the three months ended March 31, 2008 and 2007, respectively. Cash flows from our operating activities in the first quarter of 2008 increased compared to the first quarter of 2007. Decreases in net income and increases in depreciation and amortization expenses in 2008 were offset by a smaller increase in trade and other receivables, increases in trade payables and accrued expenses, and a decrease in prepaid and other current assets.

 

Net cash used in our investing activities was $5.2 million and $7.2 million during the three months ended March 31, 2008 and 2007, respectively. The primary use of cash in our investing activities for each year is for our purchase of property and equipment, including information technology equipment, furniture, fixtures and leasehold improvements for expansion of available seats.

 

Net cash provided by our financing activities was $0.1 million in the first quarter of 2008 compared to $6.8 million in the first quarter of 2007. The significant decrease in cash provided by financing activities in 2008 primarily resulted from a reduction in the net proceeds from our revolving line of credit following our public offering.

 

We expect to incur $30 to $35 million in the remainder of 2008 for facilities improvements and expansion based on our current estimates of our facilities requirements necessary to support the anticipated growth in our business. We believe that we will be able to finance our working capital needs and currently planned facilities improvements and expansion for at least the next 12 months from cash balances, cash generated from operations, and borrowings under our revolving line of credit. Our available line of credit as of March 31, 2008 was $25,000.

 

Our long-term future capital requirements will depend on many factors, including our level of revenue, the timing and extent of our spending to support the maintenance and growth of our operations, the expansion of our sales and marketing activities, continued market acceptance of our services, and potential merger and acquisition activities. We expect to continue to have significant capital requirements associated with the maintenance and growth of our operations, including the lease and build-out of additional facilities primarily to support an increase in the number of our customer service associates and the purchase of computer equipment and software, telecommunications equipment and furniture, fixtures and office equipment to support our operations. These additional long-term expenses may require us to seek other sources of financing, such as additional borrowings or public or private equity or debt capital. The availability of these other sources of financing will depend upon our financial condition and results of operations as well as prevailing market conditions, and may not be available on terms reasonably acceptable to us or at all.

Recent Accounting Pronouncements

 

The Financial Accounting Standards Board (“FASB”) has issued Statements of Financial Accounting Standard (“SFAS”) and Interpretations (“FIN”) some of which the required implementation dates have not yet become effective. The new standards that will likely impact us are discussed below.

 

The Company adopted FASB SFAS No. 157, “Fair Value Measurements” (“SFAS 157”) on January 1, 2008 for financial assets and liabilities, and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. SFAS 157 defines fair value, establishes a framework for measuring fair value as required by other accounting pronouncements and expands fair value measurement disclosures. The provisions of SFAS 157 are applied prospectively upon adoption and did not have a material impact on the Company’s condensed consolidated financial statements. In February 2008, the FASB issued staff position No. 157-2 (“FSP 157-2”), which delays the effective date of SFAS 157 one year for all non-financial assets and non-financial liabilities, except those recognized or disclosed at fair value in the financial statements on a recurring basis. Following FSP 157-2, the Company is assessing the impact of SFAS 157 for non-financial assets and non-financial liabilities on its consolidated financial statements and will measure such assets and liabilities no later than the first quarter of 2009. The disclosures required by SFAS 157 are included in Note 4, “Fair Value Measurements,” to the Company’s condensed consolidated financial statements.

 

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (“SFAS 141(R)”), which replaces FAS 141. SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. FAS 141(R) is to be applied prospectively to business combinations for which the acquisition date is on or after an entity’s fiscal year that begins after December 15, 2008. We will assess the impact of SFAS 141(R) if and when a future acquisition occurs.

 

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133” (“SFAS 161”). SFAS 161 requires enhanced disclosures about an entity’s derivative and hedging activities and is effective for fiscal years and interim periods beginning after November 15, 2008. The Company is currently evaluating the additional disclosures required by SFAS 161.

 

 

Foreign Currency Exchange Risk

 

Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Philippine peso. In the first quarters of 2008 and 2007, approximately 51% and 37%, respectively, of our cost of services and selling and administrative expenses were generated in the Philippines substantially all of which were paid in Philippine pesos. We bill substantially all of our revenue in U.S. dollars. The average exchange rate excluding the impact of our foreign currency hedges used to translate pesos to U.S. dollars was 40.97 during the first quarter of 2008. If we did not hedge our foreign currency exposure, a 10% increase in the value of the U.S. dollar relative to the Philippine peso would reduce our annual expenses associated with our offshore operations by approximately $13.3 million, whereas a 10% decrease in the relative value of the U.S. dollar would increase the annual cost associated with these operations by approximately $13.3 million. Expenses relating to our offshore operations increased in the first quarters of 2008 and 2007 due to increased costs associated with higher revenue generation and customer management services.

 

Payments for employee-related costs, facilities management, other operational expenses and capital expenditures are incurred in Philippine pesos on a monthly basis. Based upon prior credit agreements, we were not allowed to enter into hedging contracts. Therefore, when our loans were paid off, we initiated in the third quarter of 2007 a strategy to hedge against short-term foreign currency fluctuations. This strategy consists of a rolling hedge program that entails contracting with third-party financial institutions to acquire zero cost, non-deliverable forward contracts. For the first quarter of 2008, we have hedged approximately 90% of our forecasted 2008 Philippine peso

denominated expenses. We will continue to reevaluate our hedge strategy and adjust the percentage of expenses hedged depending on certain external economic factors and indicators.

 

Interest Rate Sensitivity

 

We have interest rate exposure arising from borrowings under our revolving line of credit, which has variable interest rates. These variable interest rates are affected by changes in short-term interest rates. Assuming the current level of borrowings, a hypothetical one-percentage point increase in interest rates would not increase our annual interest expense as we repaid the entire March 31, 2007 balance of our term loans and line of credit on April 3, 2007 and have not borrowed on our existing line of credit.

 

Inflation Rate Sensitivity

 

In the first quarters of 2008 and 2007, approximately 51% and 37%, respectively, of our cost of services and selling and administrative expenses were generated in the Philippines. Although the Philippines has historically experienced periods of high inflation, the inflation rate has been below 10% since 1999. For the year ended December 31, 2007, inflation averaging 2.8% kept prices generally stable. Inflation in the Philippines has not affected our operating results because the Philippines has historically experienced deflationary pressure on wages due to a fast-growing population and high unemployment. A reversal of these trends, increased wage pressure due to increased competition as our industry expands or higher rates of inflation in the Philippines could result in increased costs and harm our operating results. A number of our leases in the Philippines have escalation clauses triggered by Philippine inflation above negotiated thresholds.

 

 

Evaluation of disclosure controls and procedures.

 

We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our chief executive officer and chief financial officer have concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

 

Changes in internal control over financial reporting.

 

There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the period covered by this quarterly report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

We are the defendant in the employment matter of James Dreyfuss vs. ETelecare Global Solutions-US, Inc. filed in the United States District Court, Southern District of New York on February 4, 2008. In the matter, James Dreyfuss, who served as our Regional Vice President of Sales, has asserted the following claims against us: (1) two counts of breach of contract; (2) violation of New York Labor Law Sections 190 et seq. (3) quantum merit; (4) unjust enrichment; (5) breach of covenant of good faith and fair dealing; and (6) promissory estoppel. Mr. Dreyfuss seeks compensatory damages in an amount to be proven at trial, penalties under New York Labor Law Section 198, pre- and post-judgment interest and costs and expenses for such suit, including attorney’s fees. We filed a motion to compel arbitration on April 7, 2008 which motion will be briefed by May 27, 2008. We are now in the early stages of discovery. While we cannot predict with certainty the outcome of the litigation, we believe the ultimate outcome of this matter will not have a material adverse impact on the financial position or our results of operations.

 

 

Investing in our securities involves a high degree of risk. In addition to the other information contained in this report, you should consider the following risk factors before investing in our securities.

 

Risks Related to Our Business

 

If we fail to attract and retain enough sufficiently trained customer service associates and other personnel to support our operations, our business, results of operations and financial condition will be seriously harmed.

 

We rely on large numbers of customer service associates, and our success depends to a significant extent on our ability to attract, hire, train and retain qualified customer service associates. Companies in the business process outsourcing, or BPO, market, including us, experience high employee attrition. In 2007, our attrition rate for our customer service associates who remained with us following a 45-day training and orientation period was on average approximately 6.3% per month in the United States, a decrease of approximately 0.4% from 2006 and approximately 1.9% per month in the Philippines, an increase of approximately 0.2%. A significant increase in the attrition rate among our customer service associates could decrease our operating efficiency and productivity. There is significant competition in the Philippines and the United States for employees with the skills necessary to perform the services we offer to our clients. Increased competition for these employees, in the BPO market or otherwise, could harm our business. Our failure to attract, train and retain customer service associates with the qualifications necessary to fulfill the needs of our existing and future clients would seriously harm our business, results of operations and financial condition.

 

A few major clients account for most of our revenue and a loss of business from these clients could reduce our revenue and seriously harm our business.

 

We have derived and believe that we will continue to derive in the near term most of our revenue from a few major clients. We received an aggregate of approximately 81% of our revenue from our five largest clients for the three months ended March 31, 2008. We do not have long term contracts with any of our clients. Our contracts with our clients typically have a term of one year and can be terminated earlier by our clients or us without cause, typically upon 30 to 90 days’ notice. A number of factors could cause us to lose business or revenue from a client, and some of these factors are not predictable and are beyond our control. For example, a client may demand price reductions, change its outsourcing strategy, move work in-house or reduce previously forecasted demand. In addition, the volume of work we perform for specific clients is likely to vary from year to year, since our contractual commitments only last one year and we usually are not the exclusive outsourced service provider for our clients. In most cases, if a client terminates its contract with us or does not meet its forecasted demand, we have no contractual recourse even if we have hired and trained customer service associates to provide services to the client. Thus, a major client in one period may not provide the same level of revenue in any subsequent period. For example, in the

third quarter of 2007, one of our largest clients terminated one of its significant programs with us. The loss of some or all of the business from any large client could harm our business, results of operations and financial condition.

 

Our operating margin will suffer if we are not able to maintain our pricing, utilize our employees and assets efficiently or maintain and improve the current mix of services that we deliver from our offshore locations.

 

Our operating income as a percentage of our revenue, which we refer to as our operating margin, is largely a function of the prices that we are able to charge for our services, the efficient use of our assets and the location from which we deliver services. Our business model is predicated on our ability to objectively quantify the value that we provide to our clients. We must also manage our employees and assets efficiently. In addition, we must continue to sell new programs for and migrate existing programs to our offshore delivery locations. If we fail to succeed on any of these objectives, we may not be able to sustain our current operating margin. If a client terminates a program with us we may be unable to re-assign customer service associates who worked on that program in a timely manner, which could harm our operating results.

 

The rates we are able to recover for our services, our ability to manage our assets efficiently and the location from which we deliver our services are affected by a number of factors, including:

 

 

During 2007, our margins declined despite the benefit of a higher mix of lower cost Philippine-generated revenue in 2007 compared to 2006, due to the significant appreciation of the Philippine peso.

 

Our revenue is highly dependent on a few industries and any decrease in demand for outsourced business processes in these industries could reduce our revenue and seriously harm our business.

 

Most of our clients are concentrated in the communications and technology services industries. In the three months ended March 31, 2008 and March 31, 2007, we derived 79% and 76%, respectively, of our revenue from clients in these industries. The success of our business largely depends on continued demand for our services from clients in these industries, as well as on trends in these industries to outsource business processes. A downturn in any of our targeted industries, a slowdown or reversal of the trend to outsource business processes in any of these industries or the introduction of regulations that restrict or discourage companies from outsourcing could result in a decrease in the demand for our services, which in turn could harm our business, results of operations and financial condition.

 

Other developments may also lead to a decline in the demand for our services in these industries. For example, the industries we primarily serve, particularly the communications industry, have experienced a significant level of consolidation in recent years. Consolidation in any of these industries or acquisitions, particularly involving our clients, may decrease the potential number of buyers of our services. Any significant reduction in, or the elimination of, the use of the services we provide within any of these industries would reduce our revenue and harm our business. Our clients may experience rapid changes in their prospects, substantial price competition and pressure on their results of operations. This may result in increasing pressure on us from clients in these key industries to lower our prices, which could negatively affect our business, results of operations and financial condition.

One of our major clients is Vonage, who has been and may in the future be, subject to damaging and disruptive intellectual property litigation that could adversely affect its business and its continued viability, which, in turn, could harm our business, results of operations and financial condition.

 

For the three months ended March 31, 2008 and 2007, we derived 9% and 12%, respectively, of our revenue from Vonage. Vonage has been named as a defendant in several lawsuits that relate to alleged patent infringement and may be subject to infringement claims in the future. In October 2007, Vonage entered into an agreement to settle its patent infringement litigation with each of Sprint, Verizon Services Corp. and AT & T which included aggregate cash payments by Vonage of approximately $240 million over specified terms. The recent agreements to pay up to an aggregate of $240 million combined with the potential impact of future patent litigation could materially and adversely affect Vonage’s business, results of operations and financial condition, as well as the continued viability of Vonage. In addition, Vonage has $253 million in convertible debt which can be put to Vonage in December 2008 if the terms of this debt are not otherwise amended prior to this time. On April 18, 2008, Vonage announced that it had entered into a letter of intent for additional financing to replace this debt but has not announced its completion to date. As a result of our significant client relationship with Vonage, any determination against Vonage in patent litigation, the agreement by Vonage to make large settlement payments and the maturity of its outstanding debt obligations could, in turn, harm our business, results of operations and financial condition.

 

We face competition from onshore and offshore business process outsourcing companies and from information technology companies that also offer business process outsourcing services. Our clients may also choose to run their business processes themselves.

 

The market for business process outsourcing services is very competitive and we expect competition to intensify and increase from a number of sources. We face significant competition from our clients’ own in-house groups, including, in some cases, in-house departments operating offshore. For example, one of our clients did not renew its contract with us in 2006 as a result of its decision to move the services we previously provided them to an in-house department. We also face competition from onshore and offshore business process outsourcing and information technology services companies. The trend toward offshore outsourcing, international expansion by foreign and domestic competitors and continuing technological changes will result in new and different competitors entering our markets. These competitors may include entrants from the communications, software and data networking industries or entrants in geographic locations with lower costs than those in which we operate.

 

Some of these existing and future competitors have greater financial, human and other resources, longer operating histories, greater technological expertise, more recognizable brand names and more established relationships than we do in the industries that we currently serve or may serve in the future. Some of our competitors may enter into strategic or commercial relationships among themselves or with larger, more established companies in order to increase their ability to address client needs. Increased competition, pricing pressure or loss of market share could reduce our operating margin, which could harm our business, results of operations and financial condition.

 

We may be unable to manage our growth effectively and maintain effective internal processes, which could harm our business, results of operations and financial condition.

 

Since we were founded in 1999, we have experienced rapid growth and significantly expanded our operations. We have seven delivery centers in the Philippines and six in the United States. The number of our employees has increased from 3,041 as of December 31, 2003 to approximately 13,400 as of March 31, 2008. In 2004, we acquired Phase 2, which contributed significantly to our growth during this period. In 2007, we added approximately 1,100 employees due to our acquisition of AOL Philippines. We have a geographically dispersed workforce with approximately 10,600 employees in the Philippines and approximately 2,800 employees in the United States as of March 31, 2008. We intend to continue expansion to pursue existing and potential market opportunities. Depending on client demand and the speed at which clients migrate our services to offshore locations, we may be required to set up more delivery locations both onshore and offshore.

 

This rapid growth across international offices places significant demands on our management and operational resources. In order to manage our growth effectively, we must implement and improve operational systems and

procedures on a timely basis. If we fail to implement these systems and procedures on a timely basis, we may not be able to service our clients’ needs, hire and retain new employees, pursue new business, complete future acquisitions or operate our business effectively. Failure to transfer new client business to our delivery centers effectively, properly budget transfer costs or accurately estimate operational costs associated with new contracts could result in delays in executing client contracts and reduce our operating margin. Any of these problems associated with expansion could harm our business, results of operations and financial condition.

 

We may not succeed in identifying suitable acquisition targets or integrating any acquired business into our operations, which could significantly harm our business, results of operations and financial condition.

 

Our growth strategy involves gaining new clients and expanding our service offerings, both organically and possibly through strategic acquisitions. Historically, we have expanded some of our service offerings and gained new clients through strategic acquisitions, such as our acquisition of Phase 2 in 2004 and AOL Philippines in 2007. It is possible that in the future we may not succeed in identifying suitable acquisition targets available for sale on reasonable terms, have access to the capital required to finance potential acquisitions or be able to consummate any acquisition. The inability to identify suitable acquisition targets or investments or the inability to complete such transactions may affect our competitiveness and our growth prospects. Our management may not be able to successfully integrate any acquired business into our operations and any acquisition we do complete may not result in long-term benefits to us. For example, if we acquire a company, we could experience difficulties in assimilating that company’s personnel, operations, technology and software. In addition, the key personnel of the acquired company may decide not to work for us. The dilutive nature of any of our acquisitions could significantly harm our operating results. Future acquisitions may also result in our incurrence of indebtedness or our issuance of additional equity securities, which could dilute your investment. Acquisitions also typically involve a number of other risks, including diversion of management’s attention, legal liabilities and the need to amortize acquired intangible assets, any of which could significantly harm our business, results of operations and financial condition.

 

Our senior management team has worked at the Company for a limited period of time, and the failure of our senior management team to integrate effectively could harm our business, results of operations and financial condition.

 

Members of our senior management team have worked together for a limited period of time. For example, we appointed our current senior vice president, global operations and our current senior vice president and chief information officer in August 2007. Our success depends to a significant extent on the ability of our executives to function effectively in their roles and to work together successfully. If our executives do not function and work together successfully or if we lose the services of one or more of our executives, our business, results of operations and financial condition could be harmed.

 

If our clients are not successful, the amount of business that they outsource and the prices that they are willing to pay for our services may diminish, which could harm our business, results of operations and financial condition.

 

Our revenue depends on the success of our clients. If our clients are not successful, the amount of business that they outsource and the prices that they are willing to pay for our services may diminish. In the past, we have experienced declining business and have faced problems collecting fees from clients for services we already performed as a result of a decline in our client’s business or financial condition. For example, one of our clients declared bankruptcy in 2006, and we recorded a reserve for $212,450 for our services to that client. In substantially all of our client programs, we generate revenue based, in large part, on the amount of time our customer service associates devote to our clients’ customers. Consequently, the amount of revenue generated from any particular client program is dependent upon customers’ interest in, and use of, our clients’ products or services. Our clients’ decisions about how much money to budget for outsourced services is directly impacted by their own financial success and forecasts of their customers’ needs. If our clients’ products or services do not attract sufficient customer attention, our revenue could decline and our results of operations and financial condition could suffer.

We normally encounter a lengthy sales cycle and may not recover the investments we must make in order to obtain a new client.

 

Our sales cycle typically lasts between six and 12 months and requires us to spend a considerable amount of resources that we may never recover. Potential clients require that we spend substantial time and money educating them as to the value of our services and assessing the feasibility of integrating our systems and processes with theirs. Our pricing structure and the competitive nature of our industry typically precludes us from charging our customers for these initial costs. Decisions relating to outsourcing business processes generally involve the evaluation of our services by our clients’ senior management and a significant number of client personnel in various functional areas, each having specific and often conflicting requirements. We may spend significant funds and management resources during our sales cycle and ultimately the client may not decide to use our services. If we are unsuccessful in closing sales after spending significant funds and management resources, or if we experience delays in our sales cycle, it could harm our business, results of operations and financial condition.

 

Once we obtain a new client, our implementation cycle is long and may require us to make significant resource commitments.

 

The implementation of our programs involves significant resource commitments by us and our clients. When we are engaged by a client after the sales cycle, it generally takes us from four to six weeks to integrate the client’s systems with ours and up to three months thereafter to ramp up our services to the client’s initial requirements. Our contracts typically allow our clients to terminate a program without cause upon 30 to 90 days’ notice. If our client terminates a program after we have completed the implementation cycle, we may not be able to recoup the costs we have incurred in connection with that program, which could significantly harm our business, results of operations and financial condition.

 

Our operating results may differ from period to period, which may make it difficult for us to prepare accurate internal financial forecasts.

 

Our operating results may differ significantly from period to period due to factors such as:

 

 

For example, some of our clients experience seasonal changes in their operations in connection with the year-end holiday season and the school year. Transaction volumes can be impacted by market conditions affecting the technology, communications and financial industries, as well as other events such as natural disasters and terrorist attacks. In addition, most of our contracts do not commit our clients to providing us with a specific volume of business. All of these factors make it difficult for us to prepare accurate internal financial forecasts.

We recognize revenue when it is probable that the economic benefits associated with the transactions will flow to us and the amount of revenue can be measured reliably. Accordingly, the financial benefit of our gaining a new client or program may be delayed due to delays in the implementation of our services. Due to these factors, it is possible that in some future quarters our operating results may be significantly below the expectations of the public market, analysts and investors.

 

Some of our client contracts contain provisions that could reduce our anticipated revenue and harm our business.

 

The billing structure for some of our largest client contracts includes provisions that vary our billing rates depending on our performance levels. Some of these provisions have the effect of reducing our revenue in periods in which we fail to meet certain performance criteria. Other provisions in some of our contracts require us to give our clients the best price for a particular program that we give to our other clients for similar programs. Any of these provisions could reduce our revenue and could harm our business, results of operations and financial condition.

 

We have incurred losses in the past and have a limited operating history. We may not be profitable in the future and may not be able to secure additional business.

 

We incurred net losses of $5.6 million, $1.5 million and $1.8 million in 2001, 2002 and 2005, respectively. In future periods, we expect our selling and administrative expenses to continue to increase. If our revenue does not grow at a faster rate than these expected increases in our expenses, or if our operating expenses are higher than we anticipate, we may incur additional losses. We have a limited operating history in providing the business process outsourcing services we currently provide and continue to explore opportunities to provide other outsourced services that we have never provided. We may not be able to secure additional business or retain current business with our current clients or add new clients in the future who wish to use the services we currently offer or may offer in the future. Additionally, factors outside of our control, such as a significant appreciation of the Philippine peso, may reduce our profitability.

 

We are liable to our clients for damages caused by unauthorized disclosure of sensitive and confidential information, whether through a breach of our computer systems, our employees or otherwise.

 

We are typically required to manage, utilize and store sensitive or confidential client data in connection with the services we provide. Some of our clients are subject to U.S. federal and state regulations requiring the protection of sensitive customer information and pending legislation would increase the range of possible penalties for certain entities that fail to protect this information. Under the terms of our client contracts, we are required to keep sensitive customer information strictly confidential. We employ measures to protect sensitive and confidential client data and have not experienced any material breach of confidentiality to date. However, if any person, including any of our employees, penetrates our network security or otherwise mismanages or misappropriates sensitive or confidential client data, we could be subject to significant liability and lawsuits from our clients or their customers for breaching contractual confidentiality provisions or privacy laws. Although we have insurance coverage for mismanagement or misappropriation of this information by our employees, that coverage may not continue to be available on reasonable terms or in sufficient amounts to cover one or more large claims against us and our insurers may disclaim coverage as to any future claims. Penetration of the network security of our data centers or any failure to protect confidential information could have a negative impact on our reputation, which would harm our business.

 

Our clients may adopt technologies that decrease the demand for our services, which could harm our business, results of operations and financial condition.

 

We target clients that need our BPO services and we depend on their continued need of our services. However, over time, our clients may adopt new technologies that decrease the need for live customer interaction, such as interactive voice response, web-based self-help and other technologies used to automate interactions with customers. The adoption of these technologies could reduce the demand for our services, create pricing pressure and harm our business, results of operations and financial condition.

Our business may not develop in ways that we currently anticipate due to negative public reaction to offshore outsourcing and recently proposed legislation.

 

We have based our growth strategy on certain assumptions regarding our industry, services and future demand in the market for our services. However, the trend to outsource business processes may not continue and could reverse. Offshore outsourcing is a politically sensitive topic in the United States and elsewhere. For example, many organizations and public figures in the United States have publicly expressed concern about a perceived association between offshore outsourcing providers and the loss of jobs in the United States.

 

There has been recent publicity about some negative experiences that organizations have had with offshore outsourcing, such as theft and misappropriation of sensitive client data. Current or prospective clients may elect to perform such services themselves or may be discouraged from transferring these services from onshore to offshore providers to avoid negative perceptions that may be associated with using an offshore provider. Any slowdown or reversal of existing industry trends towards offshore outsourcing would seriously harm our ability to compete effectively with competitors that operate solely out of facilities located in the United States.

 

A variety of U.S. federal and state legislation has been proposed that, if enacted, could restrict or discourage U.S. companies from outsourcing services outside the United States. For example, legislation has been proposed that would require offshore providers of services requiring direct interaction with clients’ customers to identify to clients’ customers where the offshore provider is located. Because substantially all of our clients are located in the United States, any expansion of existing laws or the enactment of new legislation restricting offshore outsourcing could harm our business, results of operations and financial condition. It is possible that legislation could be adopted that would restrict U.S. private sector companies that have federal or state government contracts from outsourcing their services to offshore service providers. This would also affect our ability to attract or retain clients that have these contracts.

 

Our failure to adhere to regulations that govern our business could hinder our ability to effectively perform our services. Our failure to adhere to regulations that govern our clients’ businesses could result in breaches of our contracts with our clients.

 

Our clients’ business operations are subject to certain rules and regulations in the United States, such as the Gramm-Leach-Bliley Act and the customer privacy provisions of the Communication Act. Our clients may contractually require that we perform our services in a manner that would enable them to comply with such rules and regulations. Failure to perform our services in compliance with these laws could result in breaches of contracts with our clients and, in some limited circumstances, civil fines and criminal penalties for us. Our operations are also subject to various U.S. federal and state regulations. The Federal Telemarketing and Consumer Fraud and Abuse Prevention Act of 1994 broadly authorizes the FTC to issue regulations restricting certain telemarketing practices and prohibiting misrepresentations in telephone sales. A portion of our revenue is based on outbound marketing sales, which subjects us to these regulations. In addition, we are required under various Philippine laws to obtain and maintain permits and licenses for the conduct of our business. If we do not maintain our licenses or other qualifications to provide our services, we may not be able to provide services to existing clients or be able to attract new clients and could lose revenue, which could harm our business.

 

The international nature of our business exposes us to several risks, such as unexpected changes in the regulatory requirements of multiple jurisdictions.

 

We have operations in the Philippines and United States. Our corporate structure also spans multiple jurisdictions, with our parent company incorporated in the Philippines and operating subsidiaries incorporated in the United States. As a result, we are exposed to risks typically associated with conducting business internationally, many of which are beyond our control. These risks include:

 

 

 

The occurrence of any of these events could significantly harm our business, results of operations and financial condition.

 

We also face challenges in managing a geographically dispersed workforce. As of March 31, 2008, we had approximately 10,600 employees in the Philippines and approximately 2,800 employees in the United States. Our management is often required to manage employees remotely and must take into account diverse local laws and customs. If we are unable to manage our dispersed workforce and other resources effectively, our business, results of operations and financial condition could be significantly harmed.

 

If the operations of our delivery centers are interrupted, the amount of revenue we receive under our client contracts could decline and our results of operations and financial condition could suffer.

 

We operate delivery centers in the Philippines and the United States, which requires us to maintain active data and voice communications between our delivery centers and our clients’ offices. Although we maintain redundant facilities and communications links, disruptions could result from, among other things, technical and electricity breakdowns, computer glitches and viruses and adverse weather conditions. For example, in 2006 one of our delivery centers in the Philippines was shut down for several hours as a result of damage to telecommunication lines servicing that delivery center. Our operational facilities and communication hubs may also be damaged in natural disasters such as earthquakes, floods, monsoons, tsunamis and typhoons. For example, in 2003 and 2004, the operations in our Philippine delivery centers were periodically interrupted as a result of heavy rains. Such natural disasters may lead to disruption of information systems and telephone service for sustained periods. Most of our client contracts are structured so that we are paid based on the amount of time our employees dedicate to providing services to our clients. Any significant failure of our equipment or systems, or any major disruption to basic infrastructure like power and telecommunications in the locations in which we operate, could impede our ability to provide services to our clients, have a negative impact on our reputation, cause us to lose clients, reduce our revenue and harm our business.

 

Governmental authorities may challenge our intercompany pricing policies or may change or seek to apply their laws in a manner that could increase our effective tax rate or otherwise harm our business.

 

We are a Philippine corporation doing business in the Philippines and, through subsidiaries, in the United States, and are subject to the tax rules of multiple jurisdictions. Our intercompany pricing policies address the pricing of transactions within our multi-entity organization, particularly cross-border transactions, including the transfer of goods and services and intercompany financing. Authorities in the United States and in the Philippines may examine our intercompany pricing policies and other aspects of our operations. As a result of such examinations, our effective tax rate could increase. In addition, it may be asserted that we are a resident for tax purposes of the United States and, as a consequence, subject to U.S. tax on income earned in the Philippines. Legislative proposals in the United States, if enacted, could also bring about this result.

 

We will incur increased costs as a result of being a public company subject to the Philippine Securities Regulation Code and the Sarbanes-Oxley Act of 2002, and our management faces challenges in implementing those requirements.

 

We expect to continue to incur additional legal, accounting and other expenses associated with operating as a public company. We must comply with applicable laws, rules and regulations in the Philippines, the country in which we are incorporated, and the United States, where we have publicly listed our ADSs. The Philippine Securities Regulation Code and the U.S. Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the U.S. Securities and Exchange Commission and the NASDAQ Global Market, have imposed increased regulation and required enhanced corporate governance practices of public companies. We are committed to maintaining high standards of corporate governance and public disclosure, and our efforts to comply with evolving laws, regulations and standards in this regard are likely to result in increased selling and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance

activities. For example, we are in the process of evaluating and testing our internal financial reporting controls in anticipation of compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and have not yet completed this process. We have formed internal evaluation committees and engaged consultants and expect to upgrade our computer software systems to assist us in such compliance. If we do not implement and comply with the requirements of Section 404 in a timely manner, we might be subject to sanctions or investigation by regulatory authorities, such as the SEC. Any such action could harm our business or investors’ confidence in us and could cause our share price to fall.

 

Future litigation may result in significant costs for defense purposes or for settlement purposes, both of which may or may not be covered by our current insurance policies. Litigation may also divert management focus from our business and could significantly impact our financial results.

 

From time to time, we are subject to litigation proceedings. For example, we settled a claim in 2006 relating to our acquisition of Phase 2 and we recently settled a litigation claim brought by a former employee. Although this specific litigation was resolved, we cannot predict whether any other material suits, claims or investigations may arise in the future. Irrespective of the outcome of any potential lawsuits or potential actions, claims or investigations, we may incur substantial legal costs and possibly settlement costs, which may or may not be covered by insurance. Litigation may also divert management’s attention from our business, which could also harm our business, results of operations and financial condition.

 

Our current tax holidays in the Philippines will expire within the next several years.

 

We currently benefit from income tax holiday incentives in the Philippines pursuant to our registrations with the Philippine Economic Zone Authority, or PEZA, which provide that we pay no income tax in the Philippines for four or six years pursuant to our PEZA registrations. Our current income tax holidays expire at staggered dates through 2012. One of our delivery center sites’ income tax holidays that was set to expire in the second half of 2007 was approved by PEZA in December 2007 for conversion to Pioneer holiday status. This allows for an additional two years of tax holiday for that site with expiration in 2009. We anticipate income tax holidays for two of our delivery center sites to expire in the second half of 2008. We intend to apply for an extension or conversion to Pioneer holiday status prior to expiration.

 

We believe that as our Philippine tax holidays expire, gross income attributable to activities covered by our PEZA registrations will be taxed at a 5% preferential rate and our Philippine net income attributable to all other activities will be taxed at the regular Philippine corporate income tax rates of 35%. For the year ended December 31, 2007, we had an effective income tax rate of 2.0% for the Philippine portion of our consolidated profit before income taxes. The expiration of our tax holidays will increase our effective income tax rate and may impair our competitive position against BPO companies based outside of the Philippines.

 

Risks Related to Doing Business in the Philippines

 

We may face wage inflation in the Philippines and increased competition for our Philippine employees, which could increase our employment costs and our attrition.

 

We have not historically experienced significant wage inflation with our Philippine employees. We are faced, however, with increasing competition in the Philippines for customer service associates, and we expect this competition will continue to increase as additional outsourcing companies enter the market and expand their operations. In particular, there may be limited availability of qualified middle and upper management candidates. We have benefited from an excess supply of college graduates in the Philippines. If this favorable imbalance changes due to increased competition, it could affect the availability and the cost of customer service associates and increase our attrition rate.

 

The Philippines has experienced political and economic instability as well as civil unrest and terrorism, which could disrupt our operations and cause our business to suffer.

 

The Philippines has experienced significant inflation, currency declines and shortages of foreign exchange. We are exposed to the risk of rental and other cost increases due to inflation in the Philippines, which has historically

been at a much higher rate than in the United States. The Philippines also periodically experiences civil unrest and terrorism and U.S. companies in particular may experience greater risk. These conditions could disrupt our operations and cause our business to suffer.

 

Further Strengthening of the Philippine peso relative to the U.S. dollar could increase our expenses.

 

Substantially all of our revenue is denominated in U.S. dollars, and a significant portion of our costs is incurred and paid in Philippine pesos. We are therefore exposed to the risk of an increase in the value of the Philippine peso relative to the U.S. dollar, which would increase our reported expenses. We initiated in the third quarter of 2007 a strategy to hedge against short-term foreign currency fluctuations. For 2008, we plan to hedge approximately 90% of our 2008 forecasted Philippine peso-denominated expenses using non-deliverable forward contracts that are designated as cash flow hedges in accordance with the criteria established in Statement of Financial Accounting Standards (“SFAS”) No. 133 “Accounting for Derivative Instruments and Hedging Activities”. While we expect that our derivative instruments will continue to meet the conditions for hedge accounting, if the hedges did not qualify as highly effective or if we did not believe that forecasted transactions would occur, the changes in the fair value of the derivatives used as hedges would be recorded immediately into earnings, which may harm our financial condition. We will continue to reevaluate our hedge strategy and adjust the percentage of expenses hedged depending on certain external economic factors and indicators. Our hedging strategy, however, may not sufficiently protect us from further strengthening of the Philippine peso, which could increase our expenses and harm our operating results. Additionally, if the U.S. dollar strengthens against the Philippine peso, our hedging strategy could reduce the potential benefits we would otherwise expect from a strengthening U.S. dollar.

 

It may be difficult for you to effect service of process and enforce legal judgments against us or our affiliates.

 

We are incorporated in the Philippines. Some of our directors are not residents of the United States and a significant portion of our assets are located outside the United States. As a result, it may not be possible for you to effect service of process within the United States upon some of our directors or us. In addition, you may be unable to enforce judgments obtained in courts of the United States against those persons outside the jurisdiction of their residence, including judgments predicated solely upon the securities laws of the United States.

 

Our stockholders may have more difficulty protecting their interests than they would as stockholders of a U.S. corporation.

 

Our corporate affairs are governed by our articles of incorporation and by-laws and by the laws governing corporations incorporated in the Philippines. Legal principles such as a director’s or officer’s duty of care and loyalty, and the fiduciary duties of controlling stockholders exist in the Philippines. However, these principles are relatively untested in Philippine courts, and their application is uncertain, in comparison to their application in U.S. courts. As a result, our U.S and Philippine stockholders may have more difficulty protecting their interests in connection with actions taken by our management, members of our board of directors or our controlling stockholders than they would as stockholders of a corporation incorporated in the United States.

 

Risks Related to our ADSs and Common Shares

 

We listed our common shares on the Philippine Stock Exchange, which could increase the volatility of the market price for our ADSs.

 

We completed the process to list our common shares on the Philippine Stock Exchange, or PSE, in late November 2007. Our outstanding common shares could become more liquid as a result of our listing of our common shares on the PSE. Following our PSE listing, our shareholders may decide to sell their common shares on the PSE for tax or other reasons. Any sales of our common shares on the PSE could increase the volatility of the market price for our ADSs in the United States.

The market price for our ADSs has been volatile.

 

The market price for our ADSs has been volatile. For example, in the three months ended March 31, 2008, the closing price of our ADSs ranged from a low of $5.06 on March 20, 2008 to a high of $8.84 on January 10, 2008. The market price for our ADSs could continue to be subject to wide fluctuations in response to many factors including the following:

 

 

In addition, securities markets generally and from time to time experience significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also have a material adverse effect on the market price of our ADSs.

 

You may not be able to participate in rights offerings and may experience dilution of your holdings as a result.

 

We may from time to time distribute rights to our stockholders, including rights to acquire our securities. Under the deposit agreement for the ADSs, the Depositary will not offer those rights to ADS holders unless both the rights and the underlying securities to be distributed to ADS holders are either registered under the Securities Act or The Philippine Securities Regulation Code, or exempt from registration under the Securities Act or The Philippine Securities Regulation Code with respect to all holders of ADSs. We are under no obligation to file a registration statement with respect to any such rights or underlying securities or to endeavor to cause such a registration statement to be declared effective. In addition, we may not be able to take advantage of any exemptions from registration under the Securities Act or The Philippine Securities Regulation Code. Accordingly, holders of our ADSs may be unable to participate in our rights offerings and may experience dilution in their holdings as a result.

 

Our corporate actions could be substantially influenced by officers, directors, principal stockholders and affiliated entities.

 

Our directors and executive officers and their affiliated entities beneficially own a substantial amount of our outstanding common shares. These stockholders, if they acted together, could exert substantial influence over matters requiring approval by our stockholders, including electing directors and approving mergers and acquisitions. This concentration of ownership may also discourage, delay or prevent a change in control of our company, which could deprive our stockholders of an opportunity to receive a premium for their ADSs as part of a sale of our company and might reduce the market price for our ADSs. These actions may be taken even if they are opposed by our other stockholders.

 

You may be subject to limitations on transfer of your ADSs.

 

ADSs are transferable on the books of the Depositary. However, the Depositary may close its transfer books at any time or from time to time when it deems expedient in connection with the performance of its duties. In addition, the Depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the Depositary are closed, or at any time if we or the Depositary deem it necessary or advisable to do so because of any requirement of law, any government, governmental body or commission or any securities exchange on which our ADSs or our common shares are listed, or under any provision of the deposit agreement or provisions of, or governing, the deposited securities or any meeting of our stockholders, or for any other reason.

 

 

None.

 

None.

 

 

None.

 

 

None.

 

 

 

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

eTELECARE GLOBAL SOLUTIONS, INC.

 

John R. Harris

President, Chief Executive Officer and Director

(Principal Executive Officer)

 

J. Michael Dodson

Chief Financial Officer and Accounting Officer

(Principal Financial Officer)

 

DATED: May 14, 2008

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