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Sapient Corporation (NASDAQ:SAPE)

Q4 2008 Earnings Call

February 19, 2009, 4:30 pm ET

Executives

Dean Ridlon - Director, IR

Alan Herrick - President and CEO

Joe Tibbetts - SVP and CFO

Analysts

Rod Bourgeois - Bernstein

Ashwin Shirvaikar - Citigroup Global Markets

Julio Quinteros - Goldman Sachs

Edward Caso - Wachovia

Mark Skitovich - Piper Jaffrey

Operator

Good day, ladies and gentlemen, and welcome to Fourth Quarter 2008 Sapient Earnings Conference Call. My name is Jeri, and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of the today's conference. (Operator instructions). As a reminder this conference is being recorded for replay purposes.

I would now like to turn the call over to Mr. Dean Ridlon, Investor Relations Director. Sir, you may proceed.

Dean Ridlon

Thank you Jeri, and that thank you all for joining us today. I am Dean Ridlon, Sapient's Director of Investor Relations. Our press release announcing this quarter's results is currently available in the investor section of our website, www.sapient.com.

Before we begin, I would like to remind everyone that some of the matters discussed during today's call are considered to be forward-looking statements, as defined by the US Securities and Exchange Commission.

These forward-looking statements are subject to known and unknown risks and uncertainties which could cause actual results to differ from those expressed or implied by such statements. We have described some of these known risks and uncertainties in today's press release and in our annual and quarterly SEC filings, which we strongly urge you to read.

The forward-looking statements included in this call represent the company's views on February 19, 2009. Sapient disclaims any obligation to update these statements to reflect future events or circumstances.

During this call, we will be referring to non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. The most directly comparable financial measures calculated in accordance with GAAP, and a reconciliation of these GAAP measures to these non-GAAP measures are contained in the press release announcing this quarter's results.

I would now like to turn the call over to our CEO, Alan Herrick.

Alan Herrick

Alright. Thanks, Dean, and thanks, everybody for joining us today. So, I'm going to start with press release highlights, I am going to give you an overview of our performance in Q4, and the total year performance of Sapient. I will spend a little more time on market outlook and guidance in this environment, and then I will hand it over to Joe to walk you through the financials.

Starting with press release highlights, service revenues $164.7 million, up by more than 6% over Q4 '07 and 16% in constant currency, flat sequentially versus Q3 in constant currency, down 2.2% in Q4 in constant currency factoring our DCG acquisition, which added a month additional revenue in Q4.

Non-GAAP income from operations $27.9 million, which is a 16.9% operating margin for Q4, it represents 71% increase from $16.3 million in Q4 of '07. GAAP income from operations $26 million representing a 150% increase from $10.4 million in Q4 of '07, non-GAAP diluted income per share $0.21, up from $0.12 in Q4 '07 and GAAP diluted income per share for the quarter was $0.20, up from $0.07 per share in Q4 of '07. And cash from operations was $36.7 million in the quarter, up 16% from year ago.

So overall for the quarter from my perspective it represents very good revenue performance for us and outstanding profit performance, especially if you think about the environment and what unfolded here in last few months. We are very pleased with the performance overall.

We performed within our revenue guidance and over achieved on our profit guidance. If you look at the 16.9% operating margin we posted in Q4, what is in inline with what we have been talking about over the last couple of years, we did have some true ups in Q4.

Adjusting to those true ups, we still performed a solid 15% operating margin. And really the sequential improvement from Q3 to Q4 really came from reductions in erosion of our fixed-price, fixed-time assignment that I always discussed in effective utilization, reduction and contractors and just better expense management overall with the business.

I will give you a quick highlight on the business units. North America represented 63% of service revenues in Q4, or $103 million. Revenues were up 5% year-over-year and down 3% sequentially.

Constant currency growth of 10% year-over-year, and flat sequentially in constant currency. North America was affected by $3 million of sequential currency headwinds based on our Canadian business. Europe represented 33% of our revenues in Q4, or $54.2 million.

Revenues were up 7% year-over-year and down 14%, sequentially. In constant currency, Europe was up 33% year-over-year and flat sequentially. Europe was affected by $9.3 million of sequential currency headwinds in the quarter.

Government services represent 4% of revenue or $6.9 million, revenues up 16% year-over-year and down 4%, sequentially.

Let me move to our people quickly. Total ending people count in Q4 was 6,360, down from 6,440 in Q3 and our turnover in Q4 was 14.1% compared with 15.4% in Q4 '07. Utilization held well at 77%, compared to 80% in Q3, and 73% in Q4 of '07, and the improvement year-over-year in utilization did result in gross margin expansion.

Let me note a couple of key wins in the quarter. Hawaiian Airlines, California Travel and Tourism, Fox television, Allianz Global Investors Distributors, Talbots, The US National Institute of Health, E.ON Energy Trading and Wyeth and just a couple with the highlight more specifically to just give you a little color of the kind of assignments we are seeing with California travel and tourism. We are named interactive AOR for E.ON Energy Trading we are really helping them with the strategic integration program and consolidating. Six or seven different trading floors into one new entity based Dusseldorf, it includes system consolidation, business consulting and outsource support.

We also started a new assignment for Fox TV, which we completed in interactive project to the Fox Television Network series 24 and this shows sponsors strength. We created a new interactive online experience as Operation Instinct. Operation instinct is a game most effectively played when using Sprint Instinct mobile phone.

The only other thing I would point out as acknowledgements in Q4 as we remain the number one interactive marketing agency in United Kingdom, and in annual ranking by New Media Age.

Overall strong quarter, great progress in '08 overall, in Q4 we exceeded our goal of achieving 13% to 15% non-GAAP operating margin as an exit rate. Then if we step back and take a look at the full year of 2008 revenue grew at $160 million year-over-year, 21% or 23% in constant currency.

28% constant currency growth year-over-year, excluding the acquisition of the Derivative Consulting Group, all business units up strongly, we consummated the acquisition of DCG in August. And if you look at the balance and throughout the course of the year, we held win rate consistently high through the year as we mentioned many times on the earnings call.

Non-GAAP operating profit increased $36 million year-over-year from $46.4 million to $82.7 million, or 78% year-over-year increase in operating profit. We grew non-GAAP operating profit from 8.5% to 12.5% year-over-year, and we decreased our general and administrative cost 200 basis points to 17.8% of revenue. People growth was up 2% and voluntary turnover was down to 15% from 17.7% in 2007.

Cash flow from operations $85.1 million, up 46% from $58.2 million in 2007. Cash, cash equivalents and marketable securities balances grew $40 million, $293 million while FX rates have obviously fallen.

And overall, we are very proud of the year. We are proud of our people in India and Europe and North America including both, our client base and people as well as our internal people that just did an outstanding job that really reengineering our G&A structure not just over the course of the year in 2008, but over the course over the last couple years.

And if you just step back for a moment, some more of what we have achieved. We have certainly have the need to do is, if you look at in 2006, we set an internal goal of hitting 13% to 16% on a non-GAAP operating margin in December of 2006 internally.

In 2007 March, externally we share it all with you as the goal that we set out to meet. So, we are very proud of achieving that in Q3 and again here in Q4. If you look '06 to '07 104%, and '07 to '08 by 78% while growing revenue 35% and 21%, respectively.

And if you look at that two-year timeframe, we moved our general and administrative costs with 24% of revenue in 2006, down to 17.8% in 2008. So we think that the Sapient team and our people worldwide did a hack of a job put up last the couple of years and 2008 specifically.

So, with that let me move to guidance and try to give you some views of what we are seeing and thinking about the environment right now. Broadly speaking, when we last talked it was a tough environment, no question. But it has certainly worsen from the last call.

And I think a couple of things have probably worsen, one is in December and January the economic situation, obviously worsened globally. Uncertainty around in new administration and widespread layoffs for our clients and companies around the world really took place in December and January, which really contributed to make a challenging environment even more challenging.

Clients really start to understand the environment starts to reflect the new reality as we are all going to face in '09. If you look across our client base, delays has been almost universal across our clients. Overall budgets looked to be down nearly across the board. We are even seeing flew clients budget month-to-month in this environment based on uncertainty.

We are therefore seeing a resizing of some of our relationship, relationships and delays which have impacted Q1, but we have not seen any cancellations to-date. So if you look at the top level, overall softer demand in Q1 including both, delays and budget cuts in Q1 and look at our pipeline in Q1 lead us to reducing our workforce by 8% as we mentioned in the press release.

And certainly in this environment there is more cost pressure, but different than we have seen in the past and many years ago. The clients are universally recognized, value and price need to go together. And that low rate alone does not lead to a positive effect of result.

And the clients that I have spoken with at length over the last several weeks, if you are funded in an environment like this you need to get a clear outcome and a clear result. So value, price have to work together in the kinds of work that we at least compete forward, we think is a positive environmental factor for us in this market.

We also believe we are obviously well positioned for the bigger picture with, both consulting and interactive capabilities as the market stabilizes. As it relates to Q1 specifically, we are hoping for a reasonable start as we contemplated that many different scenarios that could play out. And in fact, we did not get the reasonable start that we hoped for in fact Q1 to-date and January specifically was just a terrible start for us.

February started to pick-up, but if you look at January it was virtually frozen. As we looked at Q1, and what we are trying to accomplish is the simple goal, post $10 million of non-GAAP operating profit and then look forward to better decision-making environment. And as client settle into the new reality and we moved in Q2, and hopefully continue to pick up some of the better decision-making we have seen here in February.

We think we can do well given our value proposition, our strong winning rates once we get into an environment where decision-making stabilizes, and we have the opportunity to perform in this environment.

The other thing I want to spend a minute on is, as we might imagine, I have looked at our pipeline many, many different ways, but too specifically, I wanted to share with you. First we look to our overall 2009 pipe. And at that level, we see good strength in our pipe. Strength that would indicate we have the opportunity to have a positive year from our Q1 revenue level. We see strong deal flow, but of course we need the decision environment to stabilize and improve as we did begin to see as this year in the first early couple of week of February.

Secondly, we analyzed our pipe is though our key accounts, or health accounts that I discussed many times with many of you, but these really represent our repeat relationships.

So if you take our prosperity accounts, but these are definition and add to them the recurring revenue that we have outside of those top 30 accounts. You get the large majority of our revenue in a year or in quarter. All of our top 30 accounts and our recurring revenue plans are underway and creating Q1 revenue our us.

Of course, we have seen budget cuts across the majority of them, but they are underway at a resize level and we think that that frankly gives us a good platform for stability over the balance of the year, and as I mentioned earlier, we did see deal flow on top of those relationship as we look at 2009 total pipe and the strength of our total pipe in 2009, but we do have to get into an environment where decision are being made, unlike what we saw in January.

So looking at our Q1 guidance at midpoint, we are down from our all time revenue peak in Q3 of 2008 by 12% in constant currency. We are continuing to be focused on profitability in 2009, and specifically delivering $10 million in non-GAAP operating profit in the first quarter, while of course we continue to position Sapient strategically for any environment that might unfold. And as I mentioned, we do see the opportunity to execute on a strong pipeline as the decision processes normalize hopefully here in the next coming month to three.

So just to wrap it up at a high levels, obviously a tough environment that worsened from when we last talk, we do see good strength in the pipe, but we do need a more normal decision-making environment. And overall, we couldn't be more pleased with our performance in the quarter or the year and getting to our operating margin target as well as meeting our growth targets through 2008.

So with that let me wrap it there and hand it over to Joe, who will walk you through the financials.

Joseph Tibbetts

Thanks, Alan. Good evening everyone. I will take you through the details of our fourth quarter results and also share our outlook for Q1. Consolidated service revenues for Q4 were $164.7 million, an increase of 16% from Q4 2007 on a constant currency basis and relatively flat sequentially with Q3 again on a constant currency basis.

Our full year services revenues for 2008 were $662.4 million, which is a 21% increase compared to 2007, and a 23% increase in constant currency. Looking at the revenue broken down by industry financial, services generated 35% of our total revenue this quarter, which is an increase from 31% last quarter. And as you know, we have shown very consistent strengthen in our financial services business, especially over the past two years.

Technology and communications generated 17% of total revenue in Q4, which is consistent with Q3. Consumer and travel was 19% of total revenue in Q4, down slightly from 20% in Q3, and Energy services was 15% of total revenue, which is consistent with Q3. And lastly government health and education was 13% of total revenue in Q4, down from 15% in Q3.

Moving on to recurring revenue, which again includes revenue commitments of a year or more in which the client's committed spending levels, they are cancelable to us though, or they have chosen us as an exclusive provider of certain services, that number was 42% of our revenue in the quarter. That's up from 40% in Q3.

The percentage of service revenues coming from our top five clients in the fourth quarter was 22%, a decrease from 24% in the third quarter and 25% a year ago. Our top ten clients this quarter were 37% that's an increase over the prior quarter of 36%.

46% of our Q4 revenue came from fixed price contracts and 54% came from T&M contracts. Switching to gross margin, operating margin, profit levels. As usual I'll analyze those, using the non-GAAP numbers as we feel more accurate reflection of the company's comparative performance.

Overall, fourth quarter gross margin, excluding non-GAAP items was 37%, consistent with Q3 an increase from 34% a year ago. Selling and marketing expenses were 3.7% of revenues, a seasonal decrease from 4.2% in Q3 and that compares to 5% in Q4 of last year.

G&A expenses were 16.5% of revenues, a decrease from 18% in Q3 and 18.3% in the same quarter a year ago. Total stock-based compensation expense for the quarter was $1.8 million, which is a significant decrease from $4.5 million last quarter and a decrease from $4.7 million a year ago.

Principle reason for the decrease in the stock-based compensation this quarter was an adjustment to the assumed forfeiture rate that we use in expensing some of our past employee equity graphs. Restructuring and other related charges in the quarter were $95,000, compared to a charge of $92,000 in Q3 and a charge of $236,000 in Q4 of last year.

On the operating profit line non-GAAP was very strong $27.9 million, which was 16.9% of service revenues. This compares to $26.1 million in Q3, which was 14.7% of revenue and it's up 71% over last year's Q4 profit of $16.3 million, or 10.5% of revenue. And as Alan mentioned even eliminating some of the Q4 accrual true ups, which helped the quarter are non-GAAP operating income was a solid 15%.

On the GAAP side operating profit was $26 million, or 15.8% of revenue that was up from $20.7 million, or 11.6% of revenue in Q3 and was it was up 150% from last year's Q4 reported operating profit of 10.4 million, or 6.7% of the service revenues. Again eliminating those fourth quarter true ups, the GAAP operating income was approximately 12% in the quarter.

Foreign currency exchange rates were very volatile in the fourth quarter as you know. And while such movements can have a material translation impact on our reported revenues, the impact on our profitability is tempered by our foreign currency hedge strategies and operating practices.

Foreign currency had a net negative impact on quarterly operating profit in Q4 approximately $900,000 the pieces of this were a net translation loss of $2.4 million as compared sequentially to Q3 '08. That loss was primarily driven by the significant depreciation of really all major currencies in which we have operating profits leading to lower margins when translating these foreign profits into US dollars. But they would partially help by the weaken Rupee, which results in lower US Dollar spending when we translate that.

The second piece was a net transaction gain of $740,000 included in G&A expense. This compared to a net transaction loss of 100,000 in Q3 and a net gain of 450,000 in Q4 of last year. And then lastly, we had a net hedging gain of approximately 760,000 that was also included in our G&A expense line.

Moving on interest and other income, we netted $1.3 million in the quarter, compared to $1.5 million in Q3 and $1.8 million in year ago, included in the fourth quarter is the net charge of $300,000 relating to our auction rate securities. The income tax provision for the quarter was $1.5 million, the effective rate for the quarter was 5.6%, including discreet items of about 1% in the quarter and then the catch up adjustment to the effective tax rate for the whole year, which was 12.9%.

The decrease from the prior quarter's rate of 18.4% was primarily driven by very strong earnings in the fourth quarter of US, which is you know due to our full evaluation allowance comes with very little tax expense associated with it.

Our Q4 non-GAAP net income was $27.6 million versus $23.4 million in Q3, and was 84% higher than the $15 million year ago. Our non-GAAP diluted earnings per share were $0.21 per share in Q4 versus $0.18 in Q3 and $0.12 a year ago.

GAAP net income $25.7 million in Q4, compared to $18.1 million last quarter, a 180% higher than the $9.2 million we recorded year ago. And GAAP diluted earnings per share were $0.20 per share in Q4, versus $0.14 in Q3 and $0.07 a year ago.

Weighted average common shares for the third quarter were 126.5 million shares, and 128.9 million shares on a basic and diluted basis, respectively. And the basic shares represent an increase from Q3 is approximate 125.8 basic shares, that's primarily is a result of full quarter impact of some stock option exercises and RSU vesting that occurred in Q3, so you get a full quarter impact to that in Q4.

Switching over to the balance sheet, cash and marketable securities at the end of year was $192.6 million. That was $22 million from the prior quarter, cash flow from operating activities was again very strong in Q4, we generated $36.7 million versus $33.2 million in Q3. Cash generated from operations in Q4, year ago was $31.7 million.

Accounts receivable net of allowances decreased to $88.9 million at the end of Q4 compared to $97.9 million at the end of Q3.

Unbilled revenues at quarter-end were $43.7 million compared to $47.7 million at the end of prior quarter. Deferred revenues totaled $15.4 million in Q4 compared to $16.7 million in Q3.

Our day sales outstanding, DSO was 61 days increased slightly by a day from the last quarter. Our people count at the end of Q4 was 6,360 people with 5,417 in delivery, and of those delivery people 3,502 were India based. As we announced today, we have taken actions to reduce our people count by about 500 people or 8%. Just as a side note we expect to file our quarterly report on Form 10-K between now and the end of business on Monday probably sometime around Monday.

Turning to our current financial outlook, as previously noted by Alan, we expect that our first quarter service revenues will be in the range of $140 million to $145 million assuming the currency rate stay the same from now through the remainder of the quarter, and if they do we expect that the sequential currency impact on revenue in Q1 will be above $3 million reduction or so as compare to fourth quarter. At that level we are showing about 12% decrease compared to Q4 on a constant currency basis.

As I mentioned earlier, currency has affected our revenues significantly over the past six months. So when you look at the Q1 revenue you want to compare that to, if you go back and compare that to Q3 rates so roughly six months ago it was about a $14 million impact that we have absorbed in our revenue as a result of the exchange rate swing.

Q1 non-GAAP operating margin is expected to be at 7% or better reflecting the impact of seasonal payroll expenses as well as the effective lower revenues. And just a few other data points of guidance, stock-based compensation expense is expected to be between $3.2 million and $3.5 million per quarter of 2009. The effective income tax rate is expected to be in the range of 18% to 22% in the first quarter and at this point our best guess for the full-year of 2009. And as you know this is the blended rate which reflects our favorable tax position in India. Our transport pricing arrangements for non-US business and then the favorable effect of our current accounting for US net operating loss carried forwards.

Cash flow from operations for Q1, we expect to be a seasonal outflow of approximately $5 million to $10 million and you will recall that in Q1 we pay our annual bonuses for the prior year. So that reflects payment of the annual bonus for 2008 performance. Capital expenditures for Q1 of 2009 are expected to be in the range of $4 million to $5 million primarily related to office space and computer hardware and software.

And we expect our weighted average basic share count to increase approximately 350,000 shares in Q1 largely the result of RSU vesting date. The weighted average basic shares for the whole year 2009 is expected to be in the neighborhood of $127.5 million.

And with that I will pass the call back to Alan.

Alan Herrick

Alright. Thanks Joe. So just a quick wrap we are obviously very pleased with the results in Q4 and 2008. I think giving you good sense of some of the earnings power and some of the progress, improvement with the company over the last couple of years and obviously we have seen rapid delays starting probably in late Q4 all the way through January with some improvement here in February, but again there we have seen reduced budget levels as well in many of our clients. And we are hopeful that decision making environment can improve as we move forward from here, So, let me wrap it there.

Operator we will turn it over for questions.

Question-and-Answer Session

Operator

(Operator Instructions). And your first question comes from the line of Rod Bourgeois with. Bernstein, you may proceed.

Rod Bourgeois - Bernstein

Yes guys, thanks for the update today and I guess just to focus on kind of quantifying what’s happened in the demand environment. You are guiding to a sequential revenue decline of about 22 million at the mid-point of our guidance. You have explained that 3 million of that is currency and I was wondering if the remaining 19 million could be broken down into some categories that might be useful, one category might be lower spending from your core clients and in other category might be, decision delays on the yields that you are expecting to ramp up that aren’t really ramping up. Is there a way like that that you can breakdown the remaining $19 million of sequential revenue decline?

Alan Herrick

It's hard to see Rod, but I think it is those two factors but when you look at it, you have got most of all clients that we saw just taking huge pause in January. Then on top of that we have seen a lot of our top accounts start to get through that pause where they say, how we are going to un-pause so we got some less money. So you got some that are delays, some that are budget cuts and some that are delays of leading the budget cuts. So it's tough to completely parse that out other than to say that if you look holistically across the install client base we have and new business you are seeing both of the dynamics play out.

The only place that we really haven’t seen that play out in Q1 is really on the marketing services side, we have seen decision continue on that side and obviously we saw a growth there in Q4 and expect to see some more in Q1 and I think that’s largely based on client looking to spend on promotions below the line marketing spend around advertising try to get their acquisition rates up whether that's retail banking or whatever your particular example is. So that’s probably the one spot about to turn a little bit.

Rod Bourgeois - Bernstein

Alright. And then just related to the outlook, I have got the sense that you feel like revenues in Q2 should be higher than in Q1 because you have seen decision making start to return a little bit in February. Can you elaborate on that and can you handicap how likely is it that revenues would not rebound in Q2?

Alan Herrick

Yes, I can try to do some of that. If you look at the pipe for the year, we see good strength that would indicate what we wanted to indicate it. If you look at the price for Q2 it's similar, we see good strength from the pipe in Q2. we have also looked at there is few things to be happened, we look at part that we would be concern with; one, are things delaying from Q1 to Q2, are they more likely to happen in Q2 then Q1. The other thing we have taken a very careful look at is how much net new yield flow and yield growth is coming into Q2. And we have been very positive on that.

So when you really kind of breakdown and say, are we getting yield growth in addition to delays that in Q2 we are getting involved which we think is actually a positive sign of the environment and some of the client getting to a point where they say, yes, we got our new budget, we were through our layoff and we are going to start spending on the things that we think it will move our business forward. So, that gives us encouragement that February is kind of the beginning. We are hoping to see a better March as decisions kind of smooth out and get into Q2 and hopefully that continues new resize environment but our clients are making important decisions. We think we will compete fine in that, but you got to kind of get through this indecision that we saw just terribly in January.

So that’s the part we are concerned with but we do see, we do feel that the price momentum is real because we capture those deals and we have gone back with clients and the fact, that they are continuing to pursue them in this environment. we think is an encouraging sign that they intend to decide. But again we got to get, given the volatility obviously this environment I would still say that we want to kind of see it before we are sure of that given what we saw in January.

Rod Bourgeois - Bernstein

And just real quick, is it safe to say that the pause you saw in January was essentially indiscriminate across your different service lines or was it focused in a particular area of the business?

Alan Herrick

There was indiscriminate. I think generally companies, just you saw such a rational layoff which I think if you go back to Q3 when we talk, we saw clients were kind of more aware, it's just the situation was just bad. And we thought their budgeting will move a little better and then I think bad one to worse and then layoff planning we have seen in a lot companies look at re-cutting compensation structures and all kinds of things that can contribute to that slowness from there. But as far as industry or service lines indiscriminate except for marketing services which is held much better.

Rod Bourgeois - Bernstein

Okay. And then the final question, your 8% layoff is that layoff purely driven by the drop in demand or are you also taking the opportunity to do some extra pruning of your workforce to push towards your longer term margin target. And to just be leaner for this type an environment?

Alan Herrick

Yes, of course, we want to be fiscally fit as they say going into this environment, we done off a lot obviously to get our profitability and our strength in good shape. So, partly obviously the demand environment is just softer and kind of re-growing from a new level here in Q1 but also we are continuing and have continued to transform our mix underneath as we look at kind of long-term pools where we think we got real areas of expertise and strength. So, there is certainly a little bit of that as well, Rob.

Rod Bourgeois - Bernstein

Okay, thanks guys.

Alan Herrick

Thanks Rob.

Operator

And your next question comes from the line of Ashwin Shirvaikar with Citi. You may proceed.

Ashwin Shirvaikar - Citigroup Global Markets

Hi guys, I wanted to follow-up on those revenue questions, it's I guess margin question. If you start the year with lets call it 7%, 7.5% adjusted operating margin, given the cost cutting that you are doing and being fiscally fit as you said. Can we expect a margin profile through the year similar to '08 even with the revenue decline on a year-over-year basis, or how much is the revenue decline going to pressure margins?

Joe Tibbetts

Ashwin, hi it’s Joe. Yes, so I mean clearly as we answer the first quarter we think the usual seasonal payroll hit. We are also in a spot rate this minute in this quarter where we have reduced our cost structure, but we are behind the curve a little bit and whenever you are reducing the revenue and then adjusting your cost structure you are going to be a little bit behind for that changes period.

But as we look forward, I think as Alan kind of feed that, with the pipeline we are looking at, there is certainly an opportunity for us to have a very successful year, and we think that that translates in terms of profitability as well. We didn’t come through, we are committed to the idea that we have done a good job over the last two years of getting to much improved profits. We want to keep our eye and our focus on profitability as we go forward as continued objective. So we would expect to try and grow further as we go through the year. Obviously depends on how the year plays out but, so we are not trying to guide past first quarter but that’s where we are pointing.

Ashwin Shirvaikar - Citigroup Global Markets

Okay and does the first quarter include a partial benefit from the severance?

Joe Tibbetts

Well, yes it does, because a good portion, the largest portion of the action that we took place is completed so we are in the middle of the quarter. So, we will get a half a quarter benefit of that reduced cost structure. But my point was we wont get a whole quarter of it and it's just a matter of timing but we will get the remaining quarter or piece of it, remaining cash.

Ashwin Shirvaikar - Citigroup Global Markets

And just following up on that with the cash flow question. Obviously, Sapient’s quite a different company from the last downturn when had several years of negative operating cash flow, but if revenues got severely draft and do you see a situation where you might slide into a cash burn type of an environment?

Alan Herrick

Well, I think they go hand-in-hand. My comments before about profitability, clearly we are focused on that if we are running a profitable business we will be running a cash flow positive business, so we are have our eyes on both things has been very important to us. Certainly at some level of revenue decline and inability to catch-up with cost structure, we could end up in a burn position but that is not what we are seeing at this point.

Ashwin Shirvaikar - Citigroup Global Markets

But I guess, I shouldn’t assume anything out of the ordinary working capital?

Alan Herrick

I am sorry, I didn’t quite catch that, working capital?

Ashwin Shirvaikar - Citigroup Global Markets

I shouldn’t assume anything out of the ordinary for working capital.

Alan Herrick

Right, I mean I gave you the capital expenditures for the quarter and haven’t given for the rest of the year's specifically but knowing how our business operates, we have little bit have been flow that from, when we may have to move into a new facility and do some capital expenditure, leasehold improvement and that sort of thing. But for the most part we run a pretty steady capital expenditure rate and other factors in our cash flow tend to follow very closely along with profit. So, I think you can kind of make some assumptions from that.

Ashwin Shirvaikar - Citigroup Global Markets

Okay. Great. Thank you guys.

Operator

And your next question comes from the line of Julio Quinteros with Goldman Sachs. You may proceed.

Julio Quinteros - Goldman Sachs

Hi guys. I apologize if I missed this, but do we have the revenue breakouts for the sort of the marketing interactive services versus the IT services.

Alan Herrick

We didn't give that, but I think we have that somewhere.

Julio Quinteros - Goldman Sachs

Okay.

Alan Herrick

It's still roughly half of the business approximately.

Julio Quinteros - Goldman Sachs

Okay. Got it. And maybe just slightly different. Going back to the expense side, what was the benefit of the rupee depreciation in the quarter and euro dollar terms or basis points perspective?

Joe Tibbetts

Isolate just the rupee I think it was around $2 million benefit in the quarter net and then all the other currencies worked against us basically.

Julio Quinteros - Goldman Sachs

Alright. So that was $2 million positive offset by all the other stuff you talked about just now?

Joe Tibbetts

Right.

Julio Quinteros - Goldman Sachs

Okay. And then the resizing of the clients, just looking at the top 30 I guess you are focusing on those. Did all of those top 30 already resized or are there still others that are possibly left to resize, where are you along that line in terms of sort of getting a sensible where that top 30 spending is going to come out at this point?

Alan Herrick

Great question. So wonder we work hard on, trying to understand for ourselves, but we are materially through that from what we have seen. Some of that frankly started back in late November and December and here in January. So, one of comments is that, they are underway, although and obviously some review sizes based on whatever budget cuts they are trying to accomplish. So if you look across that top 30 the large majority or through that process looking straight net off, so obviously what [contributed to this off].

Julio Quinteros - Goldman Sachs

Got it. Okay, great. And then, the environment just been what it is right now and I think we are all kind of going through together here. At this point, my question really is and trying to coming back to Ashwin's question about what happens from here and obviously Sapient versus where we were in the last downturn to where you guys are today. What would be the next few levers that would be left to sort of pull if you will relative to another down take in spending and hopefully that’s not the case, but what would be left to do here kind of looking at the revenue run rate and expense run rate that you have right now. How much further could you go in what areas would those be?

Joe Tibbetts

Yes, so I mean I think, first of all, I like where we are starting compare to where we would have been a year ago, two years ago in terms of outstanding in the face of the storm. I mean we are really in a very good position of understanding where we are spending money and having hands on the levers if you will.

And then secondly, I think there are still some areas that we are able to manage and pull levers on relative to discretionary spending, that’s kind of the first layer always. Our plans assume a certain amount of that. And we want to continue to move with that. From the other hand, there is opportunity to squeeze those down a bit. And then you start to get into some of the less variable but still there cost around some of the fixed cost structure. We are looking very hard at facility's decision as we make them. And those are variable as we make them and there are some that have been recently discussed and dealt with and more to come. As we move through leases around the world and things like that. And then you get to the largest area that we have which is our people and we certainly, we are trying to, we think we have done the right things at this point and we are certainly trying to keep our eye on that as the storm plays out. So would be looking at that. So those are the sort of buckets of levers if you will.

Alan Herrick

(inaudible) very different than '01 which I will obviously agree with. The one of the thing do is that when you look at those top 30 clients that use us for a variety of things. And as I said those are all 30 or under weighing and continuing. One thing that if you look back in 2001, obviously we had a lot of clients and lot of clients just shutdown based on the breadth of our service line fact and so, very different dynamic on that basis for us as well.

Julio Quinteros - Goldman Sachs

That’s a good point. And just to go back and finish on that last thought on the people side. Does the current plan for headcount include any ads, whether you are looking at domestic or the offshore model?

Alan Herrick

Yes it does, not as we are going watch that very closely but that we do see positive movement even in Q1 and marketing services. As we look at the pipe for the rest of the year and we look at our trading and risk business, you look at some of our business around government, heathcare and communications specifically, on a consulting side we think there is opportunity to continue to advance our strategy. So I think that’s where right now, we are focused on where we are targeting, hiring, continue to advance our position and our cost, of course, we will be very thoughtful as we watch this online. But, yes, we do have plans in those areas?

Julio Quinteros - Goldman Sachs

Okay. And just finally, it looks like the revenue guidance, sale of the revenue guidance and profit targets that you guys are setting out, essentially what we are looking for right now is a revenue run rate that hopefully doesn’t fall below the 135 million or so range to kind of, or its more like 133 actually to kind of keep this thing running from a profitable perspective unless that 132.5 or so can be cut further. Is that a way to think about that or is there some other variances that could sort try that expense number up or down as we go beyond the first quarter here?

Alan Herrick

Yes, I think there is a little more room in that number then what you are quoting in terms of staying profitable, because of some of the levers we have but, it's in that order of magnitude.

Julio Quinteros - Goldman Sachs

Okay, great guys. Thanks.

Operator

And your next question comes from the line of Ed Caso with Wachovia. You may proceed.

Edward Caso - Wachovia

Hi, good evening. I think on the last call you talked little bit about semi-consolidation in the interactive side of your business. Can you give us an update there?

Alan Herrick

Yes, absolutely. So I think that, what we are seeing and I think that, that’s also taken a little pause generally in interactive the clients have to go through the budget process, but I think a similar dynamic is when you are looking a market that's driven by efficiency and cost pressures that were obviously across the board right now. We are seeing a lot of large Fortune 500 companies and we just are inefficient and how we interact with our agencies. Too many players with too trumped up or too little portions at work, right. So there is a desire in many, many of our clients the kind of the large scale clients try to consolidate not too eight player and certainly not the kind of idea on the IT services but to consolidate from a very large list to much smaller list to concentrate some of their IP and some of their concepts as well as just get some leverage out of their spend.

So, those conversations obviously hit by the same kind of budget malaise that we saw in early through January but those conversations are still very much alive. And if we are seeing clients talk about how they are going to re-compete agency with that as one of the drivers around that region here. It's not the sole driver but its certainly one of the drivers.

Edward Caso - Wachovia

Last quarter you also talked about another positive quarter on pricing and I don’t think I heard you mention anything about pricing and some of your more IT focused competitors have said the conversation is now shifted to total cost as opposed to a pricing discussion, can you offer some thoughts?

Alan Herrick

Yes, so I think that it’s a little different depending on what part of our portfolio you take a look at, if you look at the consulting side, yeah there's always been a good balance on cost always on the consulting side. But certainly this environment it logically brings more pressure on that.

Now for us and where we are positioned it's very much a trade that we are not competing at the low cost point on the chain, its very much a discussion of, do you have the capabilities and can you get it done, and I want it done to the most effective cost I can get. An effective cost is not rate, time hours, what rate and hours where I really believe it takes to get the job done, right, because achieve a rate with 50% more volume doesn’t actually get to the outcome we are looking for.

So, our conversations have had good balance on that basis. There is certainly more pressure on that side of the equation but it's balanced with, we are going to take a risk of moving our business forward in this environment, you are an executive that’s going to move your business forward in this environment. We want to be sure you get the result. And that might be a little different if you are competing at different parts of the value chamber for the kind of things we can compete for, there was good retention and balance in that, but of course, there is going to be more price pressure. I think it's too early to see it statically for us, but I think it's logically you are going to have the balance consideration in that competition.

Edward Caso - Wachovia

You are one of the few that I have seen, that have talked about layoffs in India. Like other firms I am sure they are doing it, but they are doing it more discretely through performance reviews and other methods like that, but there was a big splash, I guess a week ago about a big layoff. I am curious of your fresher versus lateral hiring in sort of maybe what your morale is and any implications you might have with schools, if you do any fresher hiring?

Alan Herrick

Yes, we really haven't had on fresh side though last one first. We really haven't had much of our pressure program and that’s well communicate, I had a time based on the outlook, so not really an issue on that basis. But as it kind of look to morale and stuff obviously the culture is taking, it's been very differentiated and different in something that we value greatly and all the Q4 on this thought, general thought process could be very clear and very honest and genuine with our people, and we just can't take it in other way. So we thought this was the best choice for us to do it in a way that we did it and since to move on and focus on running the business from here.

Edward Caso - Wachovia

Next question, any ballparks here brackets you want to put on constant currency, organic growth this year and operating margin targets in the 13 to 16 is that still a long-term target. And could you possibly get there this year?

Joe Tibbetts

So two questions there, first of all we are not guiding the whole year, so we really can't start to color that with any sort of quantification. I think we are trying to signal that we think that the outcome could be a very pleasant outcome for everybody. But we are just not ready to put a stake in the ground in terms of what the year looks like publicly.

On the profit side, we look at where we come in and we got to the plateau we said we are going to get to and we know that in a "normal environment" if we were continuing forward on the page we were at, we think there is more opportunity and things that we can do from a system standpoint, additional stuff there, process and all of that. To continue to build the business that will take advantage of scale and we will operate more efficiently and therefore, deliver even more profitability. We are not today setting a new goal for that, its obviously is a different environment right now in terms of doing that anyway and we sort of need to see some dust clear. But we think that the base business is well suited to additional benefit to the bottom-line from those kinds of things if we are allowed to pull those levers.

Edward Caso - Wachovia

Thank you.

Joe Tibbetts

Thanks.

Alan Herrick

Thanks Ed.

Operator

And your next question comes from the line of Mark Marostica with Piper Jaffrey. You may proceed.

Mark Skitovich - Piper Jaffrey

Thanks, its actually Mark Skitovich for Marostica. You mentioned the marketing interactive you are still seeing strength there I am just curious how much you expect that will be up in Q1 sequentially?

Alan Herrick

We want to see it play out, but we do see obviously, statistically an up strength in our [balance] in Q1 to say we think that it will be up. Now lets see how that plays out. And we also as we look out, we look very close to that all of the different parts of our interactive business beyond our marketing services piece, we also look very close at our e-commerce piece and we're seeing a lot of strength there as retailers look at just better economic kind of drive through a better channel extraordinarily tough environment for them. So, we have actually seen some build in momentum there in the last few weeks.

So want to see how that comes through but it's definitely something that we will notice, noticeable in our pipe and attracting growth there.

Mark Skitovich - Piper Jaffrey

Okay, great. And then maybe to make, I mean there has been obviously a lot of discussion here around budgets been reset, but maybe to make that a little more tangible. Can you give us some average of what you seen across your top 30 accounts as to how much budgets are down year-over-year? And then may be explain how the Q2 in that new deal flow that you talk about. Is that enough to offset these budget declines and pricing that you are seeing?

Alan Herrick

Hard to answer precisely I would say, as it relates to kind of budget reducing and sizing I say its generally across our whole portfolio and not just the top 30, I would say generally clients were down closer to 10 and 5, but its hard to get completely précised. There is lot to ins and outs and delays in timing and certain things that go into that and there is obviously a pretty big standard deviation standing on the client and their situation.

As far as new deal flow, I think thing that we can say is, as we compared this point last year, we are in a similar position. So, we feel like it's inline with what we think it should be, and it comes back to we got to get some decisions made here, of course, we had a complete win, but we got to actually get some decision made as our clients kind of come through this tough environment and so.

Mark Skitovich - Piper Jaffrey

Okay. Great. Thank you.

Operator

This now concludes the question and answer portion of your conference. I would now like to turn the call over to Mr. Alan Herrick, CEO for final or closing comments. Sir, you may proceed.

Alan Herrick

Alright. Thanks operator. So, we ran a little long on the questions. I just appreciate everybody for joining and again very pleased with our performance for the year and frankly for two years. And I think the Sapient team should be very proud of all they have accomplished our people around the world. Obviously heading into a different time here, we tried to give you the best view we can of that and look forward in the next call and hopefully to give you some more clearer picture as the rest of the year plays out. And thank you and I appreciate for joining the call.

Operator

Thank you for participating today's conference. This concludes your presentation. You may now disconnect. Good day.

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Source: Sapient Corporation, Q4 2008 Earnings Call Transcript
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