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Sapient Corporation (NASDAQ:SAPE)

Q1 2009 Earnings Call

May 7, 2009; 4:30 pm ET

Executives

Alan Herrick - President & Chief Executive Officer

Joe Tibbetts - Senior Vice President & Chief Financial Officer

Dean Ridlon - Director of Investor Relations

Analysts

Rod Bourgeois - Sanford C. Bernstein

Jason Kupferberg - UBS

Ashwin Shirvaikar - Citi

Julio Quinteros - Goldman Sachs

Matt Mccormack - Brigantine Advisors

Chris Whitman - Wachovia Securities

David Grossman - Thomas Weisel

Mark Zutowich - Piper Jaffray

Operator

Good day, ladies and gentlemen and welcome to the Q1 2009 Sapient earnings conference call. My name is Anita and I’ll be your conference coordinator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator instructions)

I would now like to turn the call over to Dean Ridlon, Investor Relations Director. Please proceed.

Dean Ridlon

Thank you, Anita and thank you all for joining us today. I’m 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 at 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 U.S. 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 May 7, 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 those GAAP measures to those 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

Thanks Dean and welcome everybody to the call. I’m going to go through the press release highlights. I’ll give you a quick overview of our Q1 performance. I’ll probably spend a little more time on market outlook and guidance and then hand it over to Joe to walk you through the financials.

Let me start with the press release highlights. Service revenue is $142.4 million, down 8% versus Q1 ’08, up 2% in constant currency; down 14% sequentially versus Q4 and down 11% in constant currency. Non-GAAP income from operations, $11.2 million, which is a 7.9% operating margin for Q1, represents a 50 basis point increase or improvement from 7.4% of Q1 ’08. GAAP income from operations, $5 million; represents a 13% decrease from $5.8 million in Q1 of ’08.

Non-GAAP diluted income per share was $0.08, down from 10% in Q1 ’08 and GAAP diluted income per share for the quarter was $0.03 down from 6% per share in Q1 ’08 and cash from operations was a negative $29.5 million in the quarter, largely due to higher DSO.

So, overall for the quarter we are pleased with our performance in such a challenging environment and being able to hit the top line of our guidance of 140 to 145. We’re also pleased that we did a bit better on the bottom line. If you remember back to the last call, we were really trying to do $10 million or a bit better in non-GAAP operating profit, we were able to achieve that.

Largely Q1, much as we anticipated and discussed on the last call, I’ll get a little more into that when I talk about outlook in a few minutes. Let me spend a couple of minutes just giving you some highlight on our business units and then we’ll get right into the outlook.

North America represented 59% of our service revenues in Q1 or $84.5 million; revenue is down 14% year-over-year 18% sequentially. In constant currency, North America was down 10% year-over-year and 18% sequentially.

Then Europe was 35% of revenues in Q1 or $49.5 million. Revenues were up 1% year-over-year and down 9% sequentially. In constant currency Europe was 26% year-over-year and down 2% sequentially. Government services represented 6% of our revenue or $8.3 million; revenues were up 14% year-over-year and up 19% quarter-over-quarter.

On a people count basis, total ending people count for the quarter was 5922 people, down from 6360 people in Q4 as expected and discussed on our last call. Q1 annualized voluntary turnover was 9.1% compared with 12.3% in Q1 ’08. Utilization was 73% compared to 72% in Q1 ’08 and 77% in Q4 of ’08.

Now let me move to outlook and as I said; Q1, largely we talked about really January being a tough month where budgets were really frozen. When we got to the call, we said we had seen some pick up in February and hopeful some budgets were releasing and some decisions were starting to happen.

As you remember, our clients were in a process of cutting their budget, cutting their own staff level and then as we got towards the end of Q1, we continue to see some big improvement in decision making, because as we have said, in Q1 we did see the pipeline.

Well, the issue was, decisions were not being made to actually start that work and we started to see the beginning of that move positively at about mid to half of Q1 and then continued to pick up over the back half of Q1. I also talked about our top 30 clients providing a strong base for us overall, as they represent the large majority of our revenue and that played out as discussed on the call.

I said, we hope to see the opportunity for growth, if decision making improved and I think our confidence has increased on that basis. We’re now looking at budgets, better flowing and being released, albeit a bit reduce or reduced from the levels we’ve seen in prior years. Decision making is happening and we’re winning new work and I think overall that increases our confidence to execute on the opportunity to grow over the course of the rest of the year.

However, given the uncertain environment and how obviously the last several quarters have been around the environment and the spending changes with our clients, we think it’s very prudent to manage our cost effectively in this environment and we’ll trade a little growth in the short run in order to manage our costs effectively and we think that’s a more responsible place for us. I’m going to spend a couple of minutes walking through our interactive or digital marketing business. I am going to spend a few minutes on consulting.

So, I’ll start with interactive. We’re seeing meaningful expansion on our pipeline driven by clients investing in both digital marketing and digital commerce. Businesses are under pressure and they are increasing their investments in shifting more of their business and more their customer based online. We’re seeing opportunities unfold in both digital and marketing and digital commerce as an outcome of that trend.

We are also seeing clients heavily focused on promotions, sales to award sweepstakes, many different ways to really focus below the line to track customers immediately and helping them to reduce their inventory levels and drive sale, which obviously is pushing digital marketing opportunities for us.

Thirdly, we really see clients consolidating our agency partners. Clients are focused on scaling their marketing capability and scaling their marketing investments overall and looking for partners they can scale effectively with them and as we look at those consolidation efforts by our clients to consolidate agencies, and as we win those competes, our clients have asked us to extent our capability to support their digital campaigns.

So, this summer we’ll release our first major TV campaign to support a digitally centered business and we look forward to telling you more about that when we get to the summer. As you might expect, if you look at these three trends overall and the shift from traditional digital marketing, these opportunities are all right now what we’ll have and that’s what’s creating the pipeline expansion for us.

We’re also named the third largest digital agency in North America by adage and we are the largest independent agency in the rankings. We’re also named the 18 largest of all agencies global, including digital and traditional agencies. Our best I believe is digital marketing capability, our scale, our unmatched depth in implementing complex technology, have us uniquely positioned for what we think is a continued large shift in how marketing dollars are spent.

You’ll also see that we’ve launched a new version of www.sapient.com in Q1, which each week continues to profile a new work from Sapient. So you get to see some of the great work we’ve done for Coca-Cola, Times Online and others that take a look when you get a chance and seek a good updated of the type of work that we’re doing.

Now let me move to the consulting side of our business. We’re also seeing expansion on the consulting side and I’ll start with our TRM business. We’re real seeing significant changes in both financial services and energy services that are creating new priorities and new imparities for our clients. I think probably the best way to give you some flavor for this is to give you a couple of different examples.

Sapient’s now running the program management office with a Depository Trust & Clearing Corp., the DTCC, a leading industry platform for automated confirmation settlement and processing of derivatives transaction. Sapient is helping the DTCC, redesign their processes and systems to meet new requirements and regulations being mandated for derivatives products.

We also began work with the London Clearing House, an intermediary that clears interest rate, derivative products for large bank and institution; and Sapient is working with the London Clearing House, the OTC derivatives in that and their customers, to gather and document the commercial, technical and operational requirements to improve their clearing platform known as swap clear. We also have won key assignment in helping clients with new requirements around compliance and regulatory reporting.

In our Consulting business, overall beyond that, we’re also seeing opportunities emerge in helping government space that we think are a little further out, but beginning to see based on significant changes being discussed in that industry and finally as a broader overall backdrop, clients are universally focused on cost management and effectiveness of their operations.

So with that, let me move to guidance and as I said upfront, we do believe now budgets are releasing, decisions are being made and there’s definitely a better clip of decisions being made, than when last time we talked to you. It’s still choppy, there is no doubt, but it is improved and as I said upfront, we will also continue to be prudent in the short term around managing our capacity and our business in this environment, even if we give up a little short term growth.

So for Q2, we’re guiding revenue flat to a bit up and we’re guiding non-GAAP operating profits to 9% or better and with that I’ll hand it over to Joe to walk you through the financials.

Joe Tibbetts

Thanks Allan. Good evening everyone. I’m going to take you through the details of the first quarter as well as share a little bit of outlook on Q2. So consolidated service revenues for Q1 were $142.4 million and on a constant currency basis, those revenues increased 2% from Q1 of last year and were decreased sequentially of 11% from Q4.

When we look at the revenue by industry, we had another quarter, quite consistent revenue mix among the industries. So, financial services again generated 35% of our revenue consistent with Q4; Consumer and Travel was 19%, that’s also consistent with Q4; Technology and Communications 17% again, that’s consistent with Q4 and then Government, Health and Education jumped up to 15% from 13% in Q4 and Energy Services was at 13% down from 15% in Q4, so a little bit of swap between those two categories.

Moving onto recurring revenue, recurring revenue was 40% in the quarter and that’s down slightly from 42% from the prior quarter. The percentage of service revenues coming from our top five clients in the first quarter was 22%; that’s consistent with the last quarter and the percentage of services revenues coming from our top ten clients was 36%, that’s just down slightly from 37% in the fourth quarter, so again, showing the amount of revenue coming from our top clients remaining fairly stable there.

39% of Q1 revenue came from fixed price contracts and 61% from T&M contract. That mix is slightly different from our historical split as you know and we looked into that primarily. Its due to clients coming out of this reduced spending environment that Alan talked about and as they released their budget, there’s sort of a bias that have a quick start, which lends itself to a T&M structure rather than a fixed price structure to get going quickly and then we’re also a handful of significant new projects, which just happened to be contracted under T&M agreement.

On gross margin and operating margin, I’ll use the non-GAAP numbers. Overall fourth quarter gross margin including non-GAAP stuff was 31%, down from 37% in Q4 and a slight decrease from 32% a year ago. Selling and marketing expenses were 4.7% of revenues, an increase from 3.7% in Q4 and that compares to 6.4% in Q1 of last year.

General and administrative expenses were 18.4% of revenues, an increase from 16.5% in Q4, and roughly flat with 18.3% in the same quarter a year ago. Total stock based compensation expenses for the quarter was $3.5 million, pretty consistent with Q4, after considering the Q4 adjustment that we had for the assumed forfeiture, used in expensing employee equity grants.

Restructuring and other related charges were $2.1 million in the quarter. That compares to a small charge of $95,000 in Q4 and a charge of $143,000 in Q1 of last year. Obviously, this quarter include the cost of our restructuring action that we announced on February 19.

Acquisition costs and other related charges is a new income statement category this quarter, as a result of new accounting rules for acquisitions that became effective for us and all public companies and for us it’s effective on January 1. These new roles require acquisition related expenses to be expense as incurred. So, expenses for Q1 relating to this activity were $600,000.

Let me just head off to the likely questions you’ll have on this. As you know, on an ongoing basis we look at strategic acquisition opportunity that can enhance and extend our ability to provide relevant services to our clients. So, as we incurred expenses on a possible deal during the evaluation stages, we are going to expense those related costs, but we won’t have anything to say about the specifics and that’s for obvious strategic reason. Of course when and if a deal closes, we’ll disclose the appropriate detail.

You will also note that we have excluded these expenses from our non-GAAP operating results, in order to provide a more accurate reflection of the company’s comparative performance.

Q1 non-GAAP operating profit was $11.2 million, which was 7.9% of service revenues and that compares to $27.9 million last quarter, which was 16.9% of revenue and compares to last years Q1 non-GAAP operating profit of $11.4 million or 7.4% of revenue. GAAP operating profit was $5 million or 3.5% of revenue, down from $26 million or 15.8% of revenue last quarter and compared to last years Q1 reported operating profit of $5.8 million or 3.8% of service revenues.

Turning to foreign currency, it had a negative net impact on quarterly operating profit in Q1 of approximately $1.4 million and as usual that’s in three pieces. The net translation loss was $1 million, as compared sequentially to Q4 and this loss was driven primarily by the significant depreciation of really all major non-U.S. currencies in which we have operating profits, which leads to lower margins when translating those profits from foreign currencies into U.S. dollars. Then all of that was partially helped by the weakening rupee which again resulted in lower U.S. dollar spending when we translate that. That was $1 million.

Then the transaction loss was $200,000 that’s included in G&A and compares to a net transaction gain in Q4 of $740,000 and actually a gain last year of about $600,000 and then a net hedging loss this quarter were about $150,000, also included in G&A and that compares to a net hedging gain last quarter of $760,000 and a loss of $60,000 in Q1 of last year.

Moving on, interest and other income netted $1 million for us in Q1, compared to $1.2 million in Q4 and $2.8 million a year ago. Then the income tax provision for Q1 was $1.5 million. The effective tax rate for the quarter was 25.5%.

The increase from last year’s normalized rate, which was nearly 13%, 12.9%, was primarily driven by our particularly strong earnings in the fourth quarter in the U.S. If you recall last year, which due to our full evaluation allowance comes with very little tax expense or at least lower tax expense related to the U.S. This quarter’s rate reflects the mix of income across the various tax jurisdictions, which drove the overall blended tax rate up and for now we expect that to continue in 2009.

Net income and earnings per share, non-GAAP net income was $10.3 million versus $27.6 million in Q4 and $12.7 million a year ago. The non-GAAP diluted EPS was $0.08 per share in Q1 versus $0.21 in Q4 and $0.10 a year ago.

On a GAAP basis, net income was $4.5 million in Q1, compared to $25.7 million last quarter and $7.1 million a year ago and the GAAP diluted earnings per share was $0.03 per share in Q1, compared to $0.20 in Q4 and $0.06 a year ago. Weighed average common shares for the first quarter were 126.9 million shares on a basic basis and then 130.4 million shares on a diluted basis.

Switching over to the balance sheet, cash and marketable securities at year end were $159.5 million; that’s down $33.1 million from the end of the year. Our cash used in operating activities was $29.5 million in Q1 and you’ll recall that’s due primarily to the payment of annual bonuses for 2008 and then also in the case of this quarter, the increase in unbilled revenues. Cash used in operations a year ago was $6.8 million.

Accounts receivable net of allowances decreased to $81.8 million at the end of Q1, compared to $88.9 million at the end of Q4. Unbilled revenues at quarter end were $58.6 million versus $43.7 million at the end of Q4. Deferred revenues totaled $11.2 million in Q1 compared to $15.4 million in Q4.

Our DSO, day sales outstanding was 78 days, increasing from 61 days last quarter. A portion of the increase in DSO is the result of the Q1 T&M seasonality and some specific contractual billing timing. We remain committed to our target DSO of 60 to 65 days and expect to return to this level as these factors reverse and as a result of our ongoing focus on cash flow operating discipline.

Our people count, I think Alan covered was 5,922 at the end of Q1. Of that number, 4,990 are in delivery and of that number, 3,154 were India based delivery people. Again, this reflects the action we took during the quarter, which reduced our people down by about 400 people. Just to note, we filed our Q1 quarterly report on Form 10-Q earlier today.

Turning to the financial outlook, as Alan mentioned we expect that second quarter service revenues will be flat or higher compared to Q1, assuming that currency rates remain the same from today to the end of the quarter. Q2 non-GAAP operating margin is expected to be at 9% or better. A couple of other data points as we look forward, stock based compensation expense is expected to be between $3.2 million and $3.5 million per quarter throughout 2009.

The effective income tax rate is expected to be in the range of 25% to 30% in the second quarter and then as we go through 2009 as thus we complete today, and as you know our tax rate is a blended rate, which reflects our favorable tax position in India and then also the effect of the deferred tax asset valuation of reserve in the U.S.

The rate is higher than last year, partially as a result of the ending of our STPI status of our original India facility in Gurgaon, outside Delhi, which reached the tenure life of the benefit program, as well as the expected relationship of income tax, booked income taxable in foreign locations versus income sheltered by the favorable effect of our current accounting for U.S. net operating loss carry forwards.

The deferred tax assets valuation allowance is still in place and while nothing is guaranteed, I would not expect it to be reserved until at least the end of this year at the earliest. Now just to be clear, as all of that is about tax expense from a cash flow standpoint. We still enjoy the full benefit of the NOL of course.

Capital expenditures for Q2 are estimated to be in the range of $4 million to $5 million, pretty consistent with our quarter-to-quarter spending on office space and computer hardware and software. We expect our weighted-average basic share account to increase by approximately 400,000 shares in Q2, as a result of shares we expected to issue in connection with the DCG acquisition earn out, as well as RSU vesting and stock options exercises. The weighted average basic shares for the whole year of 2009 is expected to be in the neighborhood of $128.1 million.

With all that, I’ll pass the call back to you Alan.

Alan Herrick

Alright, thanks Joe. So, just to wrap up real quick, we are pleased with our operating performance in Q1 given the environment. As I mentioned we are seeing opportunities in digital marketing and consulting that are in our real house. We think we’ve got the opportunity to stabilize and even grow a bit right here and I think that’s a testament to our positioning and are highly differentiate value proposition to our clients.

Let me just spend a second on our longer term philosophy around operating margin and operating performance. As you know, we are committed to strong operating performance and we posted tremendous improvement over the last two years. We continue to be committed as you can see by the way we are managing the business through this time period.

Once we get through what has been a pretty uncertain environment and move into normal environment, we expect to continue our operating profit expansion. As we said at the end of ’08, we think there is more improvement in front of us in a normalized world. So with that let me wrap there and operator will open it up to you Q-and-A.

Question-and-Answer Session

Operator

(Operator Instructions) our first question comes from the line of Rod Bourgeois, please proceed.

Rod Bourgeois – Sanford C. Bernstein

Yes, Rod Bourgeois here. I just wanted to talk a little bit about what’s happen in the last three months, since the last time you guys kind of spoke to the street here. I think the last time you guys spoke on the conference call, you were pretty confident in positive sequential growth in Q2 and I know your guidance is staying flat to positive.

Over the last three months has the budget finalization process and the decision making environment declines progress about inline with what you were expecting or has there been any additional hick ups there, since the last time you guys spoke to the street.

Alan Herrick

I think its really what we were expecting, which is your going to get some budget release, you’re still going to have some choppiness in this environment even if you’re through the original budgeting process. I think we also said you know, as we looked out in the call we saw the opportunity to have a positive year for the rest of the year from here and kind of have a chance to stabilize right here and obviously we think that’s actually taken place and we’ve got that opportunity in front of us.

Rod Bourgeois – Sanford C. Bernstein

Right is the remaining obstacle that deals aren’t starting this fast, but you’re not seeing much headwind from existing relationships being down the scope and the bigger risk is new deals not starting, as opposed to existing deals falling off a cliff.

Alan Herrick

Yes, I think that as we said, we thought even on the last call that really all of our large clients were through, obviously reduced budgets, but their through, they are flowing, they are engaging and work is underway. So, now I think you just got to try to take the best view you can in this environment on the further decisions that are made and what pace they are.

We obviously have a view that pace has improved over the last few months, but you’ve still got a plan for some choppiness in the environment, but again I do think that’s more to new things starting, its not a comment relative to the things that are now underway.

Rod Bourgeois – Sanford C. Bernstein

Alright and one another question related to the demand. You’ve built a pretty good presence in the web advertising business and growth in that market has declined, but you’re clearly seeing still a shift to online media and so on. How is that affecting you? I mean there is a mix shift in the industry in your favor, but the overall growth rate of that market is still slowing? Is that affecting your pipeline in any major way or is your pipeline still pretty stacked in that advertising space?

Alan Herrick

Yes, so I think that that’s a positive fact and we try to understand I guess how we think about it. When you said the growth is slowing, I think you’re probably referring to people taking down online advertising spend.

Rod Bourgeois – Sanford C. Bernstein

Correct.

Alan Herrick

I think, my view is that’s a function of what’s happening there. As you’re seeing reduced rates for online advertising, when you’re actually buying the media, I think what you’re also seeing is clients continue to focus on that as a more affected channel.

Now, what they buy from us is, they buy the strategy, they buy their creative, they buy the advertising, right. The fact that media rates have comedown, which drives a reduction in what you are seeing around online advertising spend, doesn’t mean there’s actually less advertising being done; it just means there’s advertising being done in a less effective rate for those you provide advertising media and not advertising properties.

So for us, we’re seeing more attention put on in this environment, because a couple of things are happening. One is obviously clients trying to focus on getting people into their stores online, immediately to reduce inventories and to bolster their own revenue and client base. You are also seeing clients doing much bigger step back on their business model and saying, “We’ve gotten away with having a piece of our business online.”

In this type of pressure, we really need to know how to figure out on how to make a more significant transition, where online is more instrumental and more integrated to our business model. Therefore you are seeing quite a bit of focus and investment in digital commerce and digital commerce in combination with digital marketing, where we’ve got to figure out how to track more customers. We have to figure out how to shift our own customers from stores to actually online or more complementary that way, as well as further investment in our channel.

So, we’re actually seeing kind of a pressure on costs. The pressure on downward revenue for our clients creating an increased focus in those areas, but then that’s balanced by the fact that what you read and that spend is down, because obviously you’ve got pressure on Ad rates. So, I don’t know if that helps to kind of articulate the shift, but we think the shift is actually occurring more meaningfully now.

Rod Bourgeois – Sanford C. Bernstein

Very well explained, thanks for doing that. Thanks guys.

Joe Tibbetts

Thanks Rod.

Operator

Our next question comes from the line of Jason Kupferberg of UBS; please proceed.

Jason Kupferberg - UBS

Thanks. I wanted to ask a question on the cash flows to make sure I got the parts right here. I know you guys talked a little bit about what drove the higher DSO; obviously the unbilled spiked up there a bit and I know the cash flow was quite a bit lower than you guys had expected, but I wasn’t clear on how much of this is pure timing, can we get a snap back in Q2 and the DSOs comeback to that 60 to 65 range. I mean is that a one quarter event or is that a multi quarter event and maybe as part of that, can you give us some kind of range of your cash flow expectations for Q2 and/or the full year ’09?

Joe Tibbetts

Sure. Some of it’s clearly just timing around some contractual billing. We have large contracts. Some of them start to apply certain case of billing; the work is done at another phase and sometimes that matches, sometimes it doesn’t. We’ve talked to you about that in other quarters when it’s occurred. So, some of it is that. So that should flip-flop in Q2 and come back and sort of go back to normal if you will.

The other is the idea that in Q1 we have a little more T&M going than we had in Q4, because it’s really the holiday effect if you will. So, some of that day-to-day work just gets sent out in Q4. We got more of it in Q1 and the way we build that tends to stretch out the DSO a little bit more than say fixed price contracts that just have a straight billing schedule. So, that should also put a snap back to normal in Q2 relative to any other quarter.

We need to make sure that we keep our focus on DSO; a little bit of slippage there not a lot, nothing to get excited about, but we want to make sure that we snap back to the 60, 65 range that we’ve been at. So, we don’t see any reason why that can happen.

Jason Kupferberg - UBS

So, what would you expect for cash flow for Q2?

Joe Tibbetts

I haven’t guided specific cash flow, but it would certainly be positive and I don’t see a reason it wouldn’t be in the same kind of magnitude that we’ve been seeing throughout ‘08. If you look at that as kind of a model for cash flow, there’s nothing to suggest that we should depart from that kind of a low.

Jason Kupferberg - UBS

Okay and then just on the margin side of things, if I’m not mistaken, I think in last years 2Q the non-GAAP Op margin was around 10.4%. So, the guidance for this year’s second quarter I guess would imply a year-over-year decline, but you were able to drive year-over-year operating margin improvement here in Q1. So, can you just talk about what might make Q2 a little different in that regard, because you are expecting a pretty similar revenue based obviously in Q2 and you’ve obviously taken out some cost via headcount as well.

Joe Tibbetts

So, you got the pieces Jason. I mean that’s really the two forces at work there. One is, a certain amount of fixed cost in our structure or semi fixed cost in our structure, that as we lower the revenue from here to a year ago, are going to hurt us percentage wise and then working four up there is the effective net cost improvements that we’ve made throughout last year and that continuing on in this quarter. So, right now we’re looking at about 0.5% or 1.4% less in our guidance, but those are the pieces going back and forth, there’s no other magic to it.

Jason Kupferberg - UBS

Okay, I guess just a follow-up though; your Q1 revenue was obviously down year-over-year, as well you had margin improvement. So, what’s changing in Q2 that sort of reverses that dynamics?

Joe Tibbetts

Well, I mean if you try to compare our Q1 to Q2 then the biggest item is the seasonal payroll effect which springs back on us. So we go from the 7.9 to adding in the seasonal payroll health. We also have some additional rent costs that we unfortunately have to sign up for as two major leases renewed or are renewing with effect in Q2, in both Miami and London. So a couple of big facilities of ours, both happen to hit that quarter so that’s going to have a negative impact, relative spend to Q1 and then also that’s part of your answer to the comparison with a year ago.

Jason Kupferberg - UBS

Okay, thanks.

Operator

Our next question comes from the line of Ashwin Shirvaikar of Citi. Please proceed.

Ashwin Shirvaikar - Citi

Hey guys, it looks like a pretty good performance, given the environment here. I have a question about the guidance; in terms of revenues, obviously flat or higher, but is there an upward bound you would put based on what you know here and you’re up two, up five and are you ruling out based on what you see; are you ruling out the possibility of down sequential?

Joe Tibbetts

I didn’t understand the last part. What do you mean by losing out on the potential for downside? You mean because of your inability to scale up?

Ashwin Shirvaikar - Citi

I said ruling out, sorry, not losing out, the potential for say minus one or minus two. I mean, are you seeing enough visibility in your base that you can say, you won’t have a minus one, minus two or things. Is the environment still fluid enough that you could have a much wider range of outcomes?

Joe Tibbetts

So, I think as we look at the potential for Q2, what we are seeing at this point is based on the same set of data that we always use to do our guidance and it runs weak-to-weak, day-to-day. In terms of the pipeline, the detailed built up sense of what’s out there for us and what’s likely to hit, what’s going to happen in the quarter. So, same sort of visibility; I don’t think that’s changed.

I think we have the overlay of what’s going on in the economy, much like we had in the last quarter and the last couple quarters in term of a certain amount of uncertainty that despite all that math that we do, can add a certain amount of standard deviation to what the actual outcome is.

So I think from that standpoint, that’s where we get the number, you asked “How high it could go effectively?” and I think we’re not saying how high it could go, there is certainly upside from that number, but where people in business, if we start running too hot, we’ve got obviously support additional revenue demand with hiring; hiring takes time and we’ve been very prudent about trying to keep our cost structure where it is and to appropriately adjust it for this decrease in revenue that we’ve already experienced.

To the extent that that may hurt us with hindsight, wishing we hadn’t let everybody go or something, we don’t know that yet, but we think that that was the right prudent decision to make as we went along in terms of making sure that we didn’t get out a whack, should things have gone even worse. That makes sense?

Ashwin Shirvaikar - Citi

That does make sense. Let me ask it a little bit different; I mean are you a net hirer over the next call it six months and then there was one question I had, if I heard it right, it’s sort of related; did you say recurring revenue, the percentage was down modestly. I know its small from 42% to 40%, but it’s not what I would expect in the current environment, given it’s the discretionary part of your work that should suffer and not to the recurring piece?

Joe Tibbetts

Yes, so two questions, the net higher question? On that, I think if you look at what we’re guiding for next quarter is flat revenue. So that suggests that we’ll keep our people count appropriate to that. To say beyond that is something we’re not saying. I mean we’re basically saying we’re not guiding past that. What Alan has said is, we have the potential for growth that would include the potential for being a net higher, but we’re not ready to signal that more definitely than that.

Alan Herrick

Okay, and one of the way that we think we can get there Ashwin is, we think we got revenue utilization right now, obviously by the number, so obviously we think that gets quite a bit of the job done if we can capitalize on that opportunity.

Joe Tibbetts

Second part of the question was the reduction; getting to the smaller amount of recurring revenue by 2%. I don’t know that that’s all that significant Ashwin. I think it is sort of consistent as we talked about some of the new revenue coming in is tentative, it’s not as long term committing, but it’s some of that happening on the short run just right now, that I think is probably affecting that number, but I think our relationships and when we look at our clients and what’s happening there, that’s a pretty consistent relationship. So, we don’t read that as something to be concerned about at this point.

Alan Herrick

Yes, I think you can simply see that. As I talked about in Q1, when you look at the top 13, obviously a bunch in that recurring revenue number; there’s a high correlation. We said “Hey, obviously there was some pricing pressure, but we said also clients were scoping down” so right.

So, I think that alone affected recurring revenue, right. At the same time we said, “Hey, we see a lot of new opportunities going in to Q2” and coming towards the back half of Q1 with new clients and new work as well, but as you win new clients and new work they rarely go right into recurring revenue.

It usually takes you some time to actually build a client relationship into recurring revenue. So, I think that’s probably more a function. Just as you know, everybody cut some budgets as we mentioned on the last call.

Ashwin Shirvaikar - Citi

Got it. Thank you.

Alan Herrick

Thanks Ashwin.

Operator

Our next question comes from the line of Julio Quinteros of Goldman Sachs; please proceed.

Julio Quinteros - Goldman Sachs

Hey guys, how are you? A couple of quick things, I guess maybe if you can just decompose the revenues a little bit. I guess if I think about the models, traditionally if we think about volume growth, we think about sort of effort mix, utilization and pricing, is there anyway to get a sense on how those pieces are kind of flowing through the model to sort of ascertain, like underneath the surface if you’re getting hurt by pricing or say utilization, are you still seeing positive volume growth. Just to sort of maybe decompose the pressure on the revenue a little bit more if there is anyway to maybe walk through that at all?

Joe Tibbetts

We probably don’t look at it quite that way, but you’re trying to get really a pricing utilization volume. There was one more question?

Julio Quinteros - Goldman Sachs

Yes, exactly or effort mix, yes. Just to sort of understand where the sources would be in terms of how it’s translating to kind of the reported revenue or even the constant currency revenue growth. So, in other words if you’re book-to-bill backup is that 2.5% year-over-year growth rate? What would be kind of the drivers that we would need to be thinking about?

Joe Tibbetts

Yes, I think if you look and if you start with pricing as we talked about, we had been seeing some pricing pressure. So, that’s definitely affected us on the revenue line, but not material, those are very considered conversations because of where we sit in the value chain. So I think all clients have had pricing pressure on, but we think we’re largely through that right now, so you’ve probably already seen those effects in our numbers.

So partly that; then when you look at utilization obviously, a little bit better here in Q1, but if you look at our historical levels, we think we can do a lot better on a utilization level, which gives us obviously improved profit room from here, and I don’t think I really have a work, don’t really look at volume on that. Yes, so the third part is tougher for me to answer.

Julio Quinteros - Goldman Sachs

Okay and then I guess just thinking more, just longer term or I don’t even know if longer term is really right, but just assuming things over the next couple of quarter don’t improve enough to sort of offset the revenue declines. At least if you sort of run the flat revenue kind of for the rest of the year, you’re still going to be showing revenue declines for ’09.

At what point do you guys need to go back and contemplate different efforts to try and reduce the cost structure and what areas would you guys still have left to be able to do that and just assuming that their revenue growth doesn’t materializes this year and then there are areas to cut costs from here? What areas would those be?

Alan Herrick

Yes, I think first of all, even at these levels we think we can run well for the rest of the year and let’s get through Q2 and get a little more view of the environment obviously, because the environment has been pretty volatile.

Let’s get through Q2 and when we get that we’ll probably give you a little better view, but I think just on a basis of what we think about on flat revenue, we think we can run pretty well on that and obviously we think there is a lot of improvement for us on the utilization side, longer terms as well as the G&A side.

If you look at the G&A side, the improvement’s going to come through further implementing processes and technology that we think we’ve got in front of us to further improve that.

So I guess the short answer is, we don’t think we are in a position where we really have to go back and look at our G&A structure in the flat environment. We think we’ve got it built or continue to improve as we grow.

Julio Quinteros - Goldman Sachs

Okay, great. I think that’s it. Thank you, guys.

Alan Herrick

Alright thanks Julio.

Operator

Our next question comes from the line of Matt Mccormack of Brigantine Advisors; please proceed.

Matt Mccormack - Brigantine Advisors

Yes, hi good evening. In terms of the trading growth for profits, is there down the road, I mean is that across the business or are you willing to I guess pass on new deals across the business, like interactive marketing; are you going to make sure that you’re fully invested there. How are you looking at the different pieces?

Joe Tibbetts

Yes, great question. I think obviously our strategy is clear. We think obviously both those opportunities are huge for us and you’re seeing absolute seismic shift on the digital market side as far as the industry in general and obviously we’ve got to be strategically smart and I’ve said even on the last call, we continue to make investments, we continue to hire to make sure we’re in the right position long term. So, we’re not going to do anything other than continue to press our position forward in areas that we think we’ve got just great advantage.

Now however, we think about broadly on the other side, we’re coming out of it incredibly. Volatile six to 12 months around the economy and we want to be just really physically fit and disciplined about that and make sure that we are triply sure that our footing is sure, before I really open up the capacity flood gates and really start the hiring engine at the levels that you are using to seeing us, right.

So we’re trying to stay strategically smart, we’re trying to push our position, but we’re also again and that’s what I said, we would really like to do growth through utilization; more than not, really make sure the footing is sound here and we get towards Q3 and hopefully it will come back and we’ll see the environment the same as it is here today and that to put us in a very positive position. So, we’re trying to balance pressing that position forward of being very kind of thoughtful about our cost base right now.

Matthew McCormack - Brigantine Advisors

Right and then I guess with the flat sequential guidance, just on a year-over-year basis, what are the puts and takes I guess in terms of interactive market TRM and then the other business consulting in terms of what is expected to be flat to up versus what’s seeing the most pressure?

Joe Tibbetts

Yes, well I think if you look at the pipeline for the year, in kind of order of grading amongst some shades of gray, interactive in digital marketing clearly has had the strongest pipeline expansion. Our trading in risk business has gained significant momentum and is tucking up pretty close to that now.

If you look at our consulting overall, we are seeing opportunity to expansion, but certainly not at the same level that we’re seeing in digital market for TRM. We are seeing some longer term things happen, longer term opportunities to start to come into our pipe as we talk about in government and health, but not the same six to nine month momentum that we’re talking about right in front of us on the digital marketing and the trading in risk side, as well as some of the types of example that I highlighted.

Matthew McCormack - Brigantine Advisors

Right and then since there is a new line item I guess in the P&L data acquisitions; I guess could you talk about what your strategy is there. You’ve already done one recently in TRM, could we expect something in that area, something in interactive marketing or what you were talking about, even maybe the government or the healthcare space?

Alan Herrick

Yes, what I can tell you is that obviously we’ve always been very thoughtful of that acquisition. It’s about really strategic augmentation, where we can deliver fundamentally more value for our client, that’s how we think about it, that’s how we look at it. I really personally enjoy the new accounting rules, but I think it’s not in our best interest to telegraph anything we’re doing to our competitors on this basis. We just look forward to telling you more if in fact something happens, but just can’t give you anymore on that right now Matt.

Matthew McCormack - Brigantine Advisors

Okay thank you

Operator

Our next question comes from Ed Caso of Wachovia Securities; please proceed.

Chris Whitman - Wachovia Securities

Hi, good evening this is Chris Whitman for Ed Caso. I was just hoping you could talk a little bit more; maybe a little more commentary on the TRM and Energy Services business and maybe how that has changed since the last call?

Alan Herrick

Well, I think less it’s changed, but more we’ve seen what we talked about on the last call start to happen, right. I think you’re seeing a major cyclical change in financial services and energy because we put so much in commodities as related to that and you’re seeing changes with both obviously fed mandates, ferk mandates on the energy side.

So I think a lot of what we talked about is, you’ve got a new administration, you’ve got a global financial crisis; you are about to see significant regulation and compliance issue driven into these companies, but at the same time they’re struggling for earnings and they’ve got to do massive cost management and increase in efficiency.

So I think kind of what’s different from Q1 to now is that’s starting to happen. So we want assignments in compliance and regulatory reporting as I mentioned. We are working with major intermediaries in the London Clearing House and that’s a derivative trading Corp to implement new mandates by the fed to look at transparency and efficiency around derivatives in OTC products.

So, I think what’s happening is what we talked about, kind of we saw building and we set kind of the regulation to drive some of that, well now it’s actually happening and I think that’s the biggest difference that I would say quarter-over-quarter.

Chris Whitman – Wachovia Securities

Okay, thank you and I guess building on that, it’s been around nine months since the DCG acquisition, is that meeting your expectations?

Alan Herrick

Yes, absolutely and actually two of the examples I gave in the London Clearing House and the DTCC are both wins in conjunction with the people and the talent that joined us from the Derivatives Consulting Group.

Chris Whitman - Wachovia Securities

Great. Thank you.

Operator

Our next question comes from the line of David Grossman of Thomas Weisel. Please proceed.

David Grossman - Thomas Weisel

Thanks and good afternoon. Just quickly; I mean I’m just going back in time and maybe this is a David perspective, but I thought I recall at one time that the margin lift throughout the calendar year from just seasonal factors like the payroll accrual or the payroll tax accrual generally ranged from 200 to 300 basis points from 1Q to 4Q, is that still a reasonable way to look at the business given this kind of year you’re in right now?

Joe Tibbetts

Yes, it is Dave, that’s about the right magnitude, but you said lift from Q4 to Q1, it’s actually the other way, right?

David Grossman - Thomas Weisel

Right, I’m sorry, that’s what I meant. So with that going forward for us, would we add on top of that the benefit that you should get from the restructuring that was announced mid-quarter or did you get pretty much a full quarter of benefit in the March quarter?

Joe Tibbetts

We got about a half a quarter benefit on that. It was just about mid-quarter or a little later that we ended up completing that action and then we’re looking at about 2% effect as we go into Q2.

David Grossman - Thomas Weisel

Okay. So I should take, I think what was it at; an $18 million annualized benefit, am I remembering that right?

Joe Tibbetts

It turned out to be $16 million, because we ended up actually meeting more of those people than we thought. Some of these areas we identified as appropriate to make a change, I actually turned around and we ended up utilizing those people. So, the total number ended up about 400 and I think we were talking about 500, so the $18 million actually dropped to about $16 million in terms of annual savings.

David Grossman - Thomas Weisel

Okay, so just doing a simple math then; if I have, call it 215 basis point left Q1 to Q4, and then it looks like another 150 I will get from a full quarter benefit from the restructuring action, you could be looking at about a 400 basis point left from March to December just from those two items alone; am I thinking about that right?

Joe Tibbetts

Yes, if we isolate those items in that order of magnitude 3% to 4%, sure.

David Grossman - Thomas Weisel

Okay. Is there any other headwinds that are going to mitigate that assuming that your revenues stay relatively flat?

Joe Tibbetts

I mentioned the facilities cost, the facility is obviously wet that the increase is substantially due to the two changes in the facilities to Miami and London and then a lot of other things coming and going, but those would be the things that would mostly go out from there.

David Grossman - Thomas Weisel

How much of a headwind is the incremental kind of rent expense if you will in the second quarter versus the first?

Alan Herrick

I guess a little granular for guidance if you will David. I think when we put it all in a blender and look at what we think, the end result is that’s when we come up with the 9% plus.

David Grossman - Thomas Weisel

Got it and then I guess secondly; I’m not sure I head your numbers right, I actually got on the call a little bit late, but was North America down 10% at constant currency and down 18% in constant currency sequentially?

Joe Tibbetts

Yes.

David Grossman - Thomas Weisel

What is it about the U.S. given that, it seems that Europe is behind North America and I know your European operations are not large, but is it just a matter of dealing with smaller numbers or is there something different going on in your business, that would lead to North America significantly underperforming Europe, which seems in contrast kind of trend we’re seeing in another companies?

Alan Herrick

Yes, as you said the business is a different size obviously, I think also the benefit in Europe is we’ve actually got a very strong client base. So, meaning that it’s a little more concentrated; sort of clients that are doing well in Europe and I think that’s also obviously helped us, we’re doing well with them, but I think if you kind of look broadly at the markets from here forward, I expect those to become more similar.

David Grossman - Thomas Weisel

Okay. Is there any comparison issues in the base that would suggest the comparisons or the growth rate North America should normalize or is there nothing in particular in there that’s driving that?

Joe Tibbetts

Well, I don’t think so at the revenue line David.

David Grossman - Thomas Weisel

Okay and then just finally Joe, I guess on the tax rate. If I’m remembering we’re at 18 to 22 and now if I heard you right, you are 25 to 30, did I hit that right first in terms of where the tax rate should go for the balance of the year?

Joe Tibbetts

Yes.

David Grossman - Thomas Weisel

Okay and that’s just a function of geographic mix?

Joe Tibbetts

It is, yes; that’s exactly what it is.

David Grossman - Thomas Weisel

Okay. Great, thank you.

Joe Tibbetts

Alright, thank you.

Operator

Our last question is from the line of Mark Marostica of Piper Jaffray, please proceed.

Mark Zutowich - Piper Jaffray

Hi it’s actually Mark Zutowich for Marostica. Just had three quick questions; regarding budgets, I’m just trying to get a better sense of sort of where they are tracking. I think last quarter you mentioned you saw them looking I think closer to 10%, down 10% and at the time I think you felt comfortable with growth in Q2. So I’m just curious; does your guidance imply that we’re seeing budgets now down greater than 10%?

Alan Herrick

What I said is that I think between 5% and 10%, that’s closer to 10% and 5% if I remember correctly and I also said that the issue that we talked about in Q1 was the decisions being made.

We saw an opportunity to be in a position to grow, but we had to get decisions being made right and we have seen improvements for that, in that process obviously, which has given you the guidance, but we think we can grow here in Q2 we’re going to be as flat to up and we think that keeps that opportunity in play for us, but I think no different, other than clients are now underway, than when I talked about in Q1.

Mark Zutowich - Piper Jaffray

Okay and then on interactive side, was that up sequentially?

Alan Herrick

We don’t release that. Interactive is still about half of our business and I think largely no real share shift in Q1.

Mark Marostica - Piper Jaffray

Okay. How about Q2; does your guys reflect that begin up sequentially in Q2?

Alan Herrick

Well, I think what I said earlier was that if you look at the rest of year, we’re definitely seeing a momentum across all our pipes, but obviously TRM and interactive are out front and interactive is out in front of TRM. So as far as the opportunity set, we are seeing some more momentum there.

Mark Marostica - Piper Jaffray

Okay and then just one follow-up question on India delivery headcount, it looks like it’s been coming down pretty consistently over the last four or five quarters as a percent of total delivery. I’m just curious, is that delivered strategy or is that just coincidental?

Alan Herrick

I think what we talked about, I think over the calls is that, that will ebb and flow some quarter-to-quarter and it will move a bit, because obviously we’ve done over the last couple of years a significant amount of hiring in digital marketing and digital commerce as we see more and more opportunities there and some of that hiring is done in India and some of that hiring is in North America and Europe, but it will move to balance back a little bit as digital marketing has taken some share over the last couple of years. So, I think it’s partly that effect; is what you’re seeing.

Mark Marostica - Piper Jaffray

Okay. Very good, thanks.

Alan Herrick

Alright, thank you.

Mark Marostica - Piper Jaffray

Thank you.

Alan Herrick

Alright, we’ll thank you for joining. We’re happy with our performance here given the environment that we’re performing in. As I talked about, at the top we also I think we’ve got some exciting opportunities in front of us, but obviously the environment remains choppy, so we’ve got to get focused and execute and hope for decision-making continue as we’ve seen a progress here in the last few weeks and look forward to catching up with you all on the next call. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a great day.

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Source: Sapient Corporation Q1 2009 Earnings Call Transcript
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