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Sapient Corporation (NASDAQ:SAPE)

Q3 2009 Earnings Call Transcript

November 5, 2009 4:30 pm ET

Executives

Dean Ridlon – Director, IR

Alan Herrick – President & CEO

Joe Tibbetts – SVP & CFO

Analysts

Rod Bourgeois – Bernstein

David Grossman – Thomas Weisel

Julio Quinteros – Goldman Sachs

George Price – Stifel Nicolaus

Mark Zutowich – Piper Jaffray

Operator

Good day, ladies and gentlemen, welcome to the Q3 2009 Sapient earnings conference call. My name is Diana and I will be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call, Mr. Dean Ridlon. Please proceed.

Dean Ridlon

Thank you, Diana, 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 Investors 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 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 November 5th, 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 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

Great. Thanks, Dean and thanks, everybody, for joining the call. I’ll go over press release highlights, an overview of Q3, and then get into market outlook and guidance, and then Joe will walk you through the financials.

Let me start with press release highlights. Service revenues were $165.5 million, down 7% year-over-year, down 3% in constant currency. It was up 12% sequentially versus Q2 and up 10% in constant currency. Without Nitro, we were up 4% sequentially and 2% in constant currency.

Non-GAAP income from operations was $16.8 million, which is a 10.2% operating margin for Q3.

GAAP income from operations was $7.8 million, which includes $3.6 million of charges related to the acquisition of Nitro as well as an adjustment to a prior real estate restructuring.

Non-GAAP diluted income per share was $0.11, down from $0.18 in Q308. GAAP diluted income per share for the quarter was $0.04, down from $0.14 in Q308. And cash from operations was a positive $16.8 million in the quarter.

Overall, we are pleased with the strong operating performance in Q3. Also, very strong growth in our core business, which was at the top of our range, if you remember, $151 million to $154 million, so we got the top of our range, so we got the top of our range on the top line as it relates to the core business, and then very strong performance by Nitro at $11 million plus in their first quarter as a public company, which also contributed to our results. And then 10.2% non-GAAP operating margin we think is a solid result in this environment.

And then before I move to the environment and the market update le me just give you a quick overview of the business units. North America represented 56% of our service revenues in Q3 or $91.9 million. Revenues were down 15% year-over-year and up 1% sequentially. In constant currency, North America was down 14% year-over-year and up 1% sequentially. North America was slightly down if you are excluding the Nitro revenues.

Europe, including Nitro Europe and Asia represented 38% in Q2, or $63.5 million. Revenues were up 2% year-over-year and up 30% sequentially. In constant currency, Europe was up 13% year-over-year and 25% sequentially. Europe posted very strong growth in Q3 before you add the Nitro revenues.

Government Services was 6% of revenue, or %10.2 million in revenue. Revenues were up 41% year-over-year and 27% quarter over quarters. Team has done a really nice job growing the business in this environment.

Total ending people count for Q3 was 6,748 people, which included 282 people from the acquisition of Nitro, up from 6,009 people in Q2. Q3 annualized voluntary turnover was 14.2%, up from 11.9% in Q2 and utilization was 80%, down from 81% in Q2.

Let me highlight a couple of key wings. I am going to start with two at Mars. DOVE GALAXY, we were awarded the global creative work for DOVE GALAXY as their AOR. And TWIX U.S. Digital, we have expanded our relationship with TWIX to include digital marketing as well as the brand agency record relationship.

Also, you saw a press residential shortly after earnings around our win in Government with the FBI, a five-year contract with the FBI to support the implementation of INNOVARi, a strategic forensic management program for the FBI. The program has created an automated information management and evidence tracking system.

And then finally a win with Deutsche Telekom to really start work around conception and implementation a business intelligence suite [ph] for Deutsche Telekom and their IPTV product.

With that, let me move overall to the market and some of the conditions we saw in Q3 and expect in Q4 as what’s probably obvious is the demand environment was strong for us and as we got towards the end of Q3 that demand environment actually picked up. We think there is multiple contributors to the demand environment picking up. One was Nitro clearly contributed to that. The Nitro acquisition and the integration of both traditional and digital marketing skills on a base of strong core technology capacity in Sapient clearly resonated when we saw inbound demand for both Sapient Nitro as well as Sapient Interactive as clients look to take advantage of our unique value proposition and we did notice that about seven, eight weeks into the quarter.

We also continue to see clients consolidate agencies and when you are consolidating agencies to driver there has been to really efficiencies by less agencies doing more things or controlling more of your global platform whether that’s a global brand or that’s consolidating their digital players across the global platform. Different flavors of consolidation we are seeing, but in the consolidation, we have been a benefactor, and we are clearly positioned uniquely and in a way that no one else can claim or deliver on and that is definitely playing to our advantage.

We also see clients becoming very focused on product differentiation in this market and how do you really stand out in a multi-channel environment we’ve talked over previous quarters and on our investor day around the opportunity we see in the multi-channel environment, but also in a recessionary environment where consumer end spending is expected to stay down. Even if it grows slightly over the next year, it creates more focus on our clients really trying to differentiate their products to drive increased revenue.

The final thing I note on the marketing side that we are seeing is an increase for help around strategy and a different kind of strategy that we are seeing in the past and I referred to when we did the Nitro acquisition, a tipping point. And I think this is also an output of that tipping point where we are really seeing an integration of – what clients are looking for is an integration of marketing, technology, and business strategy, it’s all blurring now, right. When you really look at the multi-channel world, my business strategy, my marketing strategy, my brand strategy, how do I look at traditional and digital, how do I look at multi-channel commerce, support for those marketing efforts, in that experience I think one package of things? So a common question might be from a client right now that we have seen is can you really help us put together a multi-channel strategy that cuts across marketing and technology, and business, which again we think is right in a spot we want to be, and we just – we can't do enough of that kind of work to help our clients, so we hope that trend will continue as this marketplace evolves on the marketing side.

Mention a couple of high-level comments about TRM. TRM was also strong in the quarter and we see a lot of improvement in the pipe as we look into the Q4 and beyond and just a couple of specific areas that I would highlight, a historical strength for us has been in commodities that we’ve talked and we see both on the banking side and the utilities sector renewed focus in commodities. We also see focus on what we call enterprise style risk management and how you look at metrics and compliance in that environment to understand what to measure your efficiency and your compliance level especially in the obvious backdrop of increasing regulation.

And then the final one I would mention is really distressed debt and securitized assets. As those markets and secondary markets begin to develop our clients are really trying to look at underlying asset positions and understand how those derivate markets work and when you break all those pieces down it leads you right back to processes and technologies you need to have for valuation in order to look at those markets and be successful and execute.

I guess just stepping away from those two ideas, as a general backdrop across the business, I’d say that clients are still cautious, but their sentiment overall has improved. I think clients – and it’s not 100%, but I think if you aggregate it, clients are universally feeling that they are in an improved environment here. I am not saying that’s a great environment, but that’s a far improved environment, clearly from how clients felt in Q4 of last year. They are still cautious, they are still cost-cutting, but they are now really beginning to invest in ‘how do I get it, the next wave of revenue and expansion of the profit line for our clients and their businesses?’

Make a couple of comments of pricing. I mentioned last quarter that we started to signs of stabilization in pricing. And we did see improvement in pricing in the new wins that occurred in Q3. However, net pricing impact for Q3 was still down. And really the effect of that can be attributed to agreements that we signed in really late ’08 in Q4 as well as agreements we signed early in 2009 where, frankly, we were experiencing most of the pricing pressure that we saw through the year when you were at the height of uncertainty in the overall economy and obviously our clients were under a great duress [ph].

So, we do expect continued pricing improvement and we are expecting pricing improvement to turn net positive in 2010 as some of those agreements and statements of work actually finish and complete and then – and lead [ph] off into next year.

Let me now turn to guidance. Q4, we expect revenues to be in the range of $172 million to $175 million, and non-GAAP operating profit to be in the range of 10% to 11%. In Q4, I want to point out, we are also investing $1.6 million in strategic talent acquisition. This really associates with the successful demand we believe we can create in the Nitro – Sapient Interactive combination. And what’s really happening, what we are seeing is obviously Sapient a much larger platform than was Nitro and we’ve seen more cross-selling opportunities than we first envisioned. And because of that, we really want to take advantage of that. So we are going invest in some senior people that we are going to bring on board fairly rapidly that we’ve already started and plan to complete. In Q4, they can really build an infrastructure to start to really cross-sell and mine [ph] all the opportunities across both companies, but specifically in the Sapient client base. And the only reason I point this out because our history has been to linearly grow people with our revenue, so what we are doing here is getting a bid ahead of that, and we are making an investment in the range of $1.6 million to get a package of people in the right form and framework to get us set up for the future. I do expect that will be very productive to us as we get into 2010, obviously, but it’s a net expense in Q4.

And just a few comments about 2010 because I expect we’ll get a few questions there, but as you recall, as we go back for a minute and then build back up, in 2007 and 2008, we were really focused on hitting our target range for profitability and we were able to achieve that in the back half of 2008 before we hit the full blown effects of the recession. You also know we saw a terrible start to 2009, but we faired well once decisions were being made by our clients and they were progressing work forward. And we said that our intent was to manage our profit responsibility and responsibly in any environment and we have to this point. But as we sit here today, we see improved demand environment, and we hold a unique strategic position in the market with both the capability that we’ve built and the addition of Sapient Nitro. So for those of you that were able to see our investor day, you get a first hand look into how deep and competitively sharp our offerings are in both marketing and technology. As we look to 2010, you will hear us discuss reflation of our pricing as much as we did in 2008 as well as improvement and effective utilization to move towards our operating profit targets and we will provide you a road map for both revenue and profit on the February call.

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

Joe Tibbetts

Great, thanks, Alan. Good evening everyone. I will take you through the details of the third quarter results and share our outlook for Q4. Just as a remainder, the acquisition of Nitro happened to take place right on the first day of the quarter, so our Q3 results include a full quarter of Nitro’s results.

Consolidated service revenues for Q3 $165.5 million. That’s up 12% sequentially and down 7$ from Q3 of 2008. If you put that on a constant currency basis, revenues were up 10% from Q2 and were down 3% from Q3 of 2008. And then if you exclude Nitro service revenues for the third quarter, which were $11.6 million, organic sequential revenue growth was 4% and 2% in constant currency.

And looking at the revenue broken down by industry, consumer and travel moved up to 23% of total revenue in Q3. That’s up from 21% in Q2 and it is as a result of including Nitro’s revenues, which were very strong in this particular segment. Financial services generated 32% of total revenue, down 2% from 34% in Q2, again due to the impact of including Nitro in the total revenue denominator there. Technology and communications generated 16% of total revenue in Q3, down 1% from 17% in Q2, again Nitro. And government, health, and education was 14% of total revenue in Q3. That was consistent with Q2. Energy services was 14% of total revenue, up a point from 13% in Q2.

Recurring revenue, which includes revenue commitments of one year or more in which the client has committed spending levels to us and includes retainer based revenue and then the revenue where the client has chosen us as the exclusive provider of certain services, that was 43% in the quarter, and was consistent with Q2.

The percentage of service revenues coming from our top five clients in the third quarter was 21%, a decrease from 23% in Q2 and the top 10 clients were 35%, a decrease from 36% in the second quarter. And again both of those numbers were affected by including Nitro revenue in the base. 44% of Q3 revenue came from fixed price contracts and 56% from T&M contracts.

Turning to gross margin and operating margin, as usual, I am going to use the non-GAAP numbers as we feel they reflect a more accurate – a more accurate picture of the Company’s comparative performance. Overall, third quarter gross margin excluding non-GAAP was 32% consistent with Q2 and a decrease from 37% a year ago. Selling and marketing expenses were 4.7% of revenue with slight increase from 4.6% in Q2 and compared to 4.2% in Q3 of last year.

General and administrative expenses were 17.4% of revenues, a decrease from 18% in both Q2 and the same quarter a year ago. Total stock based compensation expense for Q3 was $3.8 million, a slight increase from $3.7 million last quarter and a decrease from $4.4 million a year ago. Restructuring and other related charges were $2.5 million in Q3. That compares to a small charge of $200,000 last quarter and $100,000 a year ago.

And that significant increase of $2.5 million in Q3 is the result of a change in estimated sub-lease income associated with some lease space that we restructured a number of years ago. So, we had two separate sub-tenants in our sub-leased space that defaulted in the quarter. So we had to readjust our estimates of future income from that space and had to take a $2.5 million charge in restructuring as a result.

Acquisition cost and other related charges, as you know, were expensed as incurred under the new accounting rules that became effective in January and so as we previously mentioned the expenses related to the Nitro acquisition was split between Q2 and Q3 as they were incurred and the amount in Q3 was, as predicted, around $1.1 million.

Q3 non-GAAP operating profit was $16.8 million, which was 10.2% of service revenues. And that compares to $14.2 million in Q2, which was 9.6% of service revenues and then last year Q3 profit of $26.1 million or 14.7% of service revenues.

GAAP operating profit was $7.8 million or 4.7% of revenue, down from $8.5 million or 5.7% of revenue in Q2 and compared to last year’s reported operating profit in Q3 of $20.7 million or 11.6% of service revenues.

Foreign currency had a sequential net positive impact on the quarter on the operating profit of approximately $1 million in three pieces as usual. The first piece is translation gain, we had about $200,000 translation gain compared sequentially to Q2. We had a net transaction gain of about $0.5 million that’s included in general and administrative expenses. And we had a net hedging gain of approximately $300,000 also included in G&A expense line.

Interest and other income netted about $700,000 for us in the quarter compared to $800,000 last quarter and $1.5 million a year ago. Turning to income taxes, the income tax provision for Q3 was $2.5 million. The effective tax rate for the quarter was 29.4%. The effective rate for the quarter reflected an adjustment upward due to the higher expected annual rate, including the year-to-date catch-up effects of that higher rate that we had to process through the quarter. And that was largely due to lower expected income allocated to the U.S. compared to the rest of the world. If you recall, we get a big benefit on the book side and the cash side of taxes in the U.S. so there was a little less U.S. tax and a little more non-U.S. tax, which drove that rate up.

Looking at net income and EPS, our Q3 non-GAAP net income was $14.7 million compared to $13.1 million last quarter and $23.4 million a year ago. Non-GAAP diluted earnings per share was $0.11 per share in Q3, $0.10 in Q2, $0.18 a year ago.

GAAP net income was $5.9 million in Q3. That compared to $7.6 million last quarter and $18.1 million a year ago. And GAAP diluted earnings per share was $0.04 per share in Q3, $0.06 a quarter ago, and $0.14 a year ago. And just to note, I mentioned that restructuring charge a few minutes ago. That by itself moved EPS by about $0.02 this quarter.

Weighted average common shares for the third quarter were 128.6 million shares on a basic basis and 135.3 million shares on a diluted basis.

Switching to the balance sheet, cash and marketable securities at quarter-end were $195.5 million. That’s an increase of $1 million in the quarter. Cash provided from operating activities was $16.8 million in Q3.

Accounts receivable net off allowances decreased to $93.4 million at the end of Q3 and was $94.6 million a quarter ago. Unbilled revenues at quarter-end were $49.1 million compared to $47.7 million at the end of Q2. Deferred revenues totaled $15.3 million in Q3 compared to $13 million in Q2. Days sales outstanding, DSO, was 66 days this quarter, which was an improvement from 75 days last quarter.

Our people count at the end of the Q3 was 6,748; I think Alan mentioned that number. 5,761 of those were in delivery and 3,590 were India based delivery people.

Just as an aside now, we filed our Q3 quarterly report on Form 10-Q earlier today.

Another – the event, of course, that occurred in the quarter of the acquisition of Nitro was recorded as of the acquisition date on July 1. We’ve talked about those numbers a few time and I am not going to go through all the details again, but some of the numbers were refined from the estimates we gave on our previous calls with the result of allocating more to purchase intangibles and to stock based compensation.

So, the future amortization expense related to these assets will be approximately $800,000 per quarter through 2010 and really beyond. But I just sort of – at least get addressing the next five quarters, it’s about $800,000 per quarter. And the stock based comp related to Nitro is about $600,000 per quarter now. So, those numbers you can use.

Looking to further financial outlook, as Alan mentioned, we expect the fourth quarter service revenues will be in the range of $172 million to $175 million, including Nitro. The Q4 non-GAAP operating margins is expected to be in the range of 10% to 11%. And just as a note that this level of 10% to 11% for Q4 our non-GAAP operating margins for the year would be expected then to fall about 10% for the whole year.

Stock-based compensation expense is expected to be about $4 million next quarter. The effective income tax rate for the fourth quarter and obviously then for the full year 2009 will be expected to be in the range of 24% to 27%.

And a note about the deferred tax asset valuation allowance relating to our U.S. net operating losses. That’s still in place. And while nothing is guaranteed, if we continue to meet our operating targets, I would expect that this – a decision on the reversal of the valuation allowance would be addressed at the end of this year.

And as a remainder, at the time the valuation allowance is reverses, if it is, we will report a one-time credit to income tax expense. And the normal tax rate for the fourth quarter would not be affected by that decision. But obviously that one-time item would flow through quarter.

Capital expenditures for Q4 are estimated to be in the range of $4 million to $5 million, as usual, related to office space and computer hardware and software. And finally, with respect to share count, we expect our weighted average basic share count to increase by approximately 200,000 shares in Q4 to about 129.3 million shares. That’s the basic. And then that would bring the weighted average basic shares for the whole year to the neighborhood of $128 million.

On a diluted share count basis, the share count for the quarter should be about 136 million and that would bring the whole year average to about 133 million.

And with that I’ll pass the call back to you Alan.

Alan Herrick

Alright, great thanks, Joe. So, overall, we are very satisfied with our growth in Q3 and have a strong outlook for Q4. I think we’ve shown we’ve got a very strong competitive position throughout this recession and we look forward to continuing our progress on all fronts, both revenue and profits, in 2010.

So, with that, operator, can we open it up to questions?

Question-and-Answer Session

Operator

(Operator instructions) And we have a question from the line Rod Bourgeois of Bernstein. Please proceed.

Rod Bourgeois – Bernstein

Yes, Rod Bourgeois here. Hey, one of the first things to enquire about the differential across the different regions. Your European growth was excellent on an organic basis, much better than in North America. Can you talk about what specifically drove that differential? I am assuming some specific client ramp-ups or a big factor there, but can you give a little more detail on that front?

Alan Herrick

Yes, sure, say we had an excellent, excellent growth I Europe. Team did an outstanding job and we saw and continue to see a strong pipeline in Europe. We also – say on last call do you see good, solid pipeline in North America and if you look at kind of the history over the last four quarters, clearly North America was hit much harder than Europe on a recession impact basis. But as we look into Q3, the deals were there to have and we didn’t get them all across the line or certainly didn’t get all them all across the line in time for Q3.

So, as we look forward to Q4, we see a very strong pipeline for North America and we do expect that when we are on the next call with you that – we will saying that North America is up for the quarter, but I think from a perspective of demand, Rod, we didn’t really see – you know, Europe was stronger on demand, but we saw good demand for North America. We just didn’t get it execute against the sales process as we had hoped.

Rod Bourgeois – Bernstein

Is that – does that indicate that there were some larger deals in the U.S. that slipped there weren’t enough small ones to really flow into the quarter?

Alan Herrick

Yes, I think that at a broad level just trying to wrestle some of those deals down on time was part of it, clearly.

Rod Bourgeois – Bernstein

Okay, and your –

Joe Tibbetts

And you had revenue recognition, Ron, in terms of – Rod, sorry, in terms of how that income flowed into the quarter.

Rod Bourgeois – Bernstein

And it looks like the upper end of you guidance range for Q4 sequential growth is around 6%. That’s a pretty hefty number in a quarter that sometimes has some seasonality due to fewer billable days and so on. How much of that pipeline is already very far progressed in discussions at this point in Q4? In other words, how much confidence do you have in being able to get to the upper end of that range versus the lower end of the range relative to what’s already happening in the pipeline?

Alan Herrick

Yes, I think obviously the guidance reflects that the pipeline looks very, very strong for us, right in that kind of sequential growth in Q4. I think as always right the opportunities is part A, part B is you’ve actually got to execute them, win them, and knock them down, right. So, I think the idea here for me at least is less the demand question, and more – we’ve got to just compete and it’s a very competitive market. We’ve got to win and get thinks ramped up, staffed, and moving. And I think frankly that’s more the difference in the high and the low end of the range than are the deals out there to execute.

Rod Bourgeois – Bernstein

But may be since some of the deals in the U.S. slipped out of Q3, if there is a chance some of those will book early in Q4 and that enables you to put out a – what is a by historical standards, a pretty hefty sequential guidance number, does it have to do with some of the North America deals that slipped into Q4?

Alan Herrick

I think you’ve got a little effect there. But I think even if you remove that effect just the demand looks very strong in North America in Q4.

Rod Bourgeois – Bernstein

Okay, that’s great. And then, on the tax rate, after the – this valuation and allowance is recognized, you recognize the one-time item, potentially in Q4. Where should we expect the sort of normal tax rate to go in 2010? Can you give us at least a range on that for 2010?

Joe Tibbetts

Yes, so let me first emphasize, obviously from a cash flow standpoint and a cash tax basis nothing is going to change. We have the NOL and we are going enjoy the benefits and then file the returns and the cash paid on those tax returns for years to come. As far as the book rate is concerned, which is your question, I think it goes to sort of the 36%, 37%, 38% range in terms of book tax rate, Rod. We are obviously still enjoying some benefit in India. And we enjoy some amount of differential in Europe versus very high rates in the U.S. And then – but again not for cash basis. And then we are looking at our global tax structure and obviously taking some steps to try and improve that as we I think mentioned before. So, over time, we believe that rate will come down, but the impact in 2010, at least conservatively is probably around 36% to 38%.

Rod Bourgeois – Bernstein

But can you tell us, I mean if you are able to pull these international tax structure levers, it would seem that you would be able get your structural tax rate, your book tax rate meaningfully below that 36% range. Can you give us an idea of how much room you have to bring that down with better tax structure?

Joe Tibbetts

Yes, I am not sure I want to conjecture about that, Rod, but, yes, it’s meaningful in terms of what we think we can accomplish over time as we move some business into the right jurisdictions with the right setup and substance behind it. So – I think we can move it meaningfully, but that’s probably all I want to say at this point rather than start pegging [ph] a number this early.

Rod Bourgeois – Bernstein

Okay great. Thanks guys very much.

Alan Herrick

Thanks, Rod.

Joe Tibbetts

Yes, thank you.

Operator

And we have a question from the line of David Grossman – Thomas Weisel. Please proceed.

David Grossman – Thomas Weisel

Thanks. You know you guys – it seems like you are experiencing better than expected revenue momentum in the second half of the year that you had anticipated and, Alan, you have mentioned the investments in people that you are making in the fourth quarter. But I guess I am wondering if you could help us better understand why you are not getting a little bit of better margin leverage in both, I guess the September quarterly you just printed as well as the December quarter. And how should we think about kind of those investments as we go into next year?

Alan Herrick

Yes, great question. And I think the way I think your question about Q3 and Q4 is typically we would be getting better leverage. I think the challenge, as I mentioned upfront is that in the climate of Q4 and Q1 as we talked about back then, there was definitely some pressure on pricing. And what you are seeing is in Q3 and we expect probably in Q4 there is still a continued downward effect on our aggregate pricing even though our new deal pricing is now improving again. I think which is an important point and I think that’s really when you look at Q3 and Q4 and you look frankly at Q3 and Q4 relative to Q3 and Q4 last year and you look at predominantly a gross margin what you are really witnessing there is some of the pricing pressure that hit us in Q4 and Q1 of ’08 and ’09, respectively. And I think that’s probably the biggest single reason as an answer to your question.

David Grossman – Thomas Weisel

So, as we get into next year, I mean is the duration of let’s say 4Q08, 1Q09 kind of a 12 month duration on these deals or how should we think of how that headwind rolls off in 2010?

Alan Herrick

Yes, a lot of it’s – that’s something that we are really trying to make sure that we understand very mathematically deals have different pricing dates, but obviously a lot of this occurred between, let’s say, September and the end of March or early April. And there is a little more (inaudible) off that. And then you’ve got a difference of the deals that are one year versus two years, versus three years, versus four years, right. So you got to get into that mix a little bit, but, as I stated, we are [ph] going to get – if we can continue to improve pricing as what we saw in Q3 on a new deal basis, and get that to flow through the rest of the portfolio, we do expect positive improvement in 2010. And I am going to get – I will get more specific on that, but I don’t want to get there until we get to the next call, once we’ve got a look at how 2010 opens for us. And then we’ll give you some more specific guidance on how quickly we are going to deal – to get that pricing reflated.

David Grossman – Thomas Weisel

Okay. And I know you guys are just in the process of putting together segment reporting, but is there any color you can give us in terms of the relative growth within the different pockets of your business as you’ve defined them?

Alan Herrick

Yes, I think that we are seeing as we look forward good across – if you take the three areas, right, there is more than this, but if you take the three major areas, which is the government business, and you obviously can see the results of at least with the U.S. government business. But the government business over here, whether it’s here or in the United Kingdom has been very strong, obviously, in its growth rate.

The TRM business, overall, and especially in Europe and now we think Q4 in the U.S. will be stronger. But that business is showing strong demand profile as we look forward and of course as we said all long the marketing business, marketing and digital marketing business overall also shows a strong profile. So we are seeing good balance across the three major areas that we focus on.

David Grossman – Thomas Weisel

Okay, thanks. And just one last question I guess, Joe, back just to the tax rate for a minute. So is it realistic to think that some of the structural things that you can do would impact the 2010 GAAP tax rate or do you think that given the things that have to be accomplished and your desire to utilize the NOLs in the U.S. that that’s something more a 2011, 2012 kind of benefit?

Joe Tibbetts

Yes, a good question, Dave. I think it does have some impact or should have some impact on 2010, I think it will weaken over time. It’s one of those things that you have to adjust your business over time and that’s what we will be doing. We expect to take some action early in 2010 that should have some impact. So, the numbers I gave are kind of expecting no impact and then if we were able to get some traction in that in 2010 then the rate would get better from there.

David Grossman – Thomas Weisel

Okay, great, thanks very much.

Alan Herrick

Thanks, David

Joe Tibbetts

Thanks, David.

Operator

And we have a question from the line of Julio Quinteros, Goldman Sachs. Please proceed.

Julio Quinteros – Goldman Sachs

Hi guys, just on – more on the demand side I guess, first of all, looking at the pace of budgeting cycles, and what your clients are sort of up to at this point in time, any sense that you can give us there? And then I guess, more importantly, as we into sort of March quarter of next year, do we see enough momentum on the budgeting process that we could actually see growth sequentially or do we get a little bit of pause as people sort of get their numbers together and then actually start spending? How are your guys – your clients, you guys are looking at, how are they looking about there, any sense that you can give us on that side?

Alan Herrick

Yes, I think obviously that’s something that we are watching very closely, I’ve mentioned on prior conversations. But we are looking for how does 2010 get out of the gate, right. So, you know our common sense belief is from outside of what we are hearing from clients that just you’ve got improved confidence overall, so you are not going to have this bunker effect we had last year where everybody really had to regroup their businesses and their strategies, which really caused great delay last year, and – but once people got standing [ph] we did great.

So I think now as we look towards 2010, we don’t see that dynamic. Now, if you look at budgets overall, what we are hearing is – it’s a 80:20 role, so that’s 20% that obviously have issues, but from 80% of clients we are hearing they are going to either be flat, maybe they would be a little bit up, right. And that will be fine us, right.

And I think to your point, what we got to really watch is how quick does Jan 1 turn to the budget process complete and spending and flowing and we are trying to really understand and get a sense of that for ourselves and I think clients are doing the same thing right now. So I guess at one end I expect anything like last year. Does that mean it gets off to a rapid start? It may not. It still may be a little slower start. But I think clients’ view point right now is from a budgetary perspective they are not going into slashes and cuts, but it’s probably more of the same, may be a bit up, may be some share shift as they move some [ph] priorities to the revenue side of the equation in how they spend their money.

And my strongest sense is there going to be a normal budget guidance. It’s going to be a normal speed for what they usually do as opposed to 2009.

Julio Quinteros – Goldman Sachs

Got it. And then just on the margin drivers, you talked about at least into the fourth quarter you talked about the investments that you are making to hire some folks ahead. What about on the utilization front and to address pricing (inaudible) forward? I guess I am just wondering if there is anything on utilization front or may be even on wages, are those incremental pressure points or how are we thinking about those as it relates to the overall margin picture.

Alan Herrick

Yes, so when you look at obviously on a wage front, we think that will obviously be something that we need to address as we got through 2010. Now I think when you have different markets and things happening right, I think Europe and the U.S. and Canada are one thing. I think clearly you have a much more robust job market in India right now. So obviously we have some very talented people. And we need to make sure we are making all the right competitive choices and the right choices for our people. So I think there is clearly thinks that we’ll think about and want to do in that – from a wage perspective when that time comes. As it relates to utilization, our utilization rate is high, but our effective utilization is not near where we want it. and the way Joe and I have talked about that is just really the execution of our fixed price business and some of the T&M business and some extra days and other things that are added to create the right results for clients and make sure that they are long-term clients, but at the same time it’s our belief that those things can be much more effectively managed over time. So I think as Joe talked about at investor day, we do expect there is still meaningful gain in effective utilization.

I also think that as we go to the new segment reporting, we’ll also give you guys a new view at utilization that will give you a much more accurate reflection of the headroom that we believe we do have in utilization.

Julio Quinteros – Goldman Sachs

Okay. And then lastly, if one business is ramping faster than the other, so if you can sort of think of Interactive versus the traditional Consulting business, does that impact your margin model at all or as we think about the fourth quarter margins, I mean we are assuming the Interactive is going to grow faster because that’s where more of the demand is. Is that more negative or more of a drag on your margins relative to the Consulting business or is it too difficult to split that out right now?

Alan Herrick

Well I’d say, on the top part of your thought, that TRM, Government, and Interactive as well as the traditional marketing side, now we look at that and we see a nice pattern across all of those as far as growth. I think the thing to your point that is affected is on the marketing side of the business, we – and as you folks that really making investor day; you’ve obviously seen we’ve been making investments all along, obviously in the marketing business. But, we definitely have more investment there right now. Obviously think the long term leadership opportunity is absolutely tremendous if you look at the secular ship. So, when you add in the package of people we are talking about, obviously that creates a margin impact in that particular short term or quarter.

Julio Quinteros – Goldman Sachs

Got it, great. Thanks guys, good luck.

Alan Herrick

Alright. Thanks a lot.

Operator

And we have a question from the line of George Price, Stifel Nicolaus. Please proceed.

George Price – Stifel Nicolaus

Hi, thanks very much for taking my questions. First think I wanted to just dig a little bit more into the margin in 4Q and we can talk about a GAAP or pro forma, it doesn’t matter, although you guys sort of know my stance on the – on GAAP versus pro forma. But, regardless, even if we look at on a pro forma basis, even if I look back to 4Q08, you exclude some of the one-time hedging gains there and kind of push up the stock comp to account for the adjustment you made in the quarter, the expected margin is down obviously several hundred basis points and you talked before about the flow through of the pricing impact on that year-over-year comparison. And I guess my question is, is there anything else going on there because it seems like an awful big disparity still even for that kind of flow-through? Maybe I just don’t appreciate how much impact it’s having, but is there anything else at work going on there?

Joe Tibbetts

Well I think it’s all of – George, it’s Joe. Good question. I think it’s all the pieces that you’ve heard us talk about. I mean, clearly, we’re making an investment in the quarter, so that’s kind of hit that line–

George Price – Stifel Nicolaus

Yes, that’s about what a 100 – it’s about 100 basis points, right?

Joe Tibbetts

Yes, a little bit more I think. Yes, about 100, in fact almost exactly, you are right. And then the pricing that Alan talked about, so I won't repeat all that. And then I think the effective utilization is a notion that we’ve tried to explain a few times over some quarters here that we have not been executing against fixed price contracts and in some cases giving away T&M time. Again, as Alan just put it, to make sure the clients are happy at the end of the day, but we do believe we can do a better job of managing delivery projects so that either the issue doesn’t come up or when the issue does come up, we are clear on whether it’s clients stuff that should be paid for or stuff that we should be in fact still giving away. So, I think all of that sort of is in a spot now, which isn’t as good as it could be, and gives us the opportunity to say that we think as we look forward, we talked about improving gross margin by 200 to 400 basis points and I think even from where we are today that looks more like 300 to 500 basis point. And I think that’s really the opportunity as we go forward. It’s not where we want it to be.

George Price – Stifel Nicolaus

Okay. And I didn’t really – or you didn’t really talk about it specifically, but I assume you guys are still comfortable with that 13% to 16% target range–?

Joe Tibbetts

Yes, and I think that’s – as we’ve said, we haven’t put a timeframe on that and that’s something that we expect to address on our next call, but that is – we’ve achieved that level not too long ago, as you know, before the economy changed. And we don’t see any reason why we shouldn’t just set that right back out as our target again. And when these factors – when we can start making an impact on the effective utilization around delivery, and then start to gain back some of the pricing, reflating it, as Alan puts its, and getting some of that, that we don’t see any reason why we can't get back to those levels of profitability.

George Price – Stifel Nicolaus

Okay. I know, I will throw this out there, I know you’ve talked about it, there have been a couple of questions on it, but is – do you think on an annual basis, do you think it’s in the realm of reasonable possibility that you can get to the low end of your range for the year next year?

Joe Tibbetts

Well, we think – as I said in my comments, I think we’re expecting at this point to hit 10% this year in a bad year, right. We were at 12.5% last year in a year that ended badly, I mean it actually for us worked out well. But I mean we also had some economy headwind there, anyway. And so the low end of the range is 13%. So I think – I don’t – I won't – I am not going to say that we are going to do that in 2010, but that’s – that is an achievable annual that I think we’ve already shown and I would hope we could get to that and go up from there.

George Price – Stifel Nicolaus

Okay.

Joe Tibbetts

Not necessarily in 2010, but just as a goal for the business.

George Price – Stifel Nicolaus

Okay. And I guess one last thing, may be specifically o the Interactive side there has been a lot of attention being focused on the Interactive side from the other – from the ad agencies and actually from a lot of other players out there. I was wondering maybe if you could comment a little bit on given all of that attention where you see the competitive environment from the interactive units of the ad agencies and maybe you feel – there are any implications for your business, either positive or negative, from some other players out there talking more about interactive marketing, for example, there have been some articles and some announcements from Google to focus in that area and it looks initially more like something that might be more of a partner opportunity, but just maybe bring us up to speed on how all that’s playing in the competitive environment. Thanks.

Alan Herrick

Yes, I think obviously we’ve had a great success in digital marketing, but I think but then the combination with Sapient and Nitro I think that was – we kid about internally the shot around the world that that really got some people’s attention that we are wholly different in what we can provide and I think what our clients are going through and saying is that – as I talk about little bit upfront, but they are really looking for a simple idea. We want to build a business and a brand strategy and we got to do all our digital and traditional marketing in an integrated way. So it’s not really that hard an idea on that basis. And I think that what we are seeing now is there is a lot – and this is one of the reasons I think a lot of the client companies are consolidating agencies is because they’ve got companies that can't really live up to that expectation right now that in a lot of the larger companies as you know have multiple P&Ls and don’t have integrated capability, don’t have integrated workflows, don’t even integrated compensation or incentives.

So, I think right now, we are unique; we are pure in our ability to connect us. We don’t have any of that atrophy in our system that we need to remove. And I think that really advantages us right now. So that’s gotten a lot of attention and Sapient Nitro has gotten enormous amount of attention in the press. But what’s more importantly is it’s getting that attention with CEOs and clients is just a better way to help people improve their businesses.

I think the other thing that people are starting to really get as we talked about at investor day, but people focus on the marketing shift, which obviously is large and you can see it, right. But at the same time, this idea of multi-channel commerce and this connection of deep, hardcore technology capacity in a partner plus integrated marketing capacity in what we can MC squared or multi-channel marketing to multi-channel commerce. I think people are just starting to really get that now and get how important that capacity is, and when you add in our secret weapon of having deep, core technology capacity on top of integrated marketing capacity and strategy, we are just really – we are hard to deal with on the competitive front right now. And I think you are seeing companies now pursue similar strategies and similar ideas, and I think you are seeing some press on that. So, in lot of smart companies, and lot of smart people, I am sure there will be some great things, but we love our position right now. And we will seek to press it.

George Price – Stifel Nicolaus

Okay, great, thank you.

Operator

And the next question will come from the line of Mark Marostica, Piper Jaffray. Please proceed.

Mark Zutowich – Piper Jaffray

Thank you. It’s Mark Zutowich for Marostica. It looks like Nitro in the quarter was up – or was 30%, 40% better than what you had expected at the start of the quarter. Just curious if this is a sustainable run rate for the next couple of quarters and separately I was curious what Nitro contributed to your European revenues in the quarter.

Joe Tibbetts

So, yes, I mean, Nitro, we predicted and gave guidance of $8 million to $9 million, we ended up doing $11.6 million and I think what that reflects is very smooth flows for them as their first foray into GAAP accounting and public company disciple. And I think we were – obviously our experience with acquisitions is that doesn’t always happen. So I think we were pleased with where they ended up. I wouldn’t predict that kind of overshot every quarter from them. But they are in a strong position. Alan talked about the kinds of opportunities we are seeing jointly as a company. We are making some investments to help address those and give them some feet on the street to be able to work the client opportunities and get us longer term in the right position with those clients. So I think we are optimistic about Nitro, but I just wouldn’t get you out of your skis [ph] in terms of exactly how to predict past the kind of experience we had in Q3.

Alan Herrick

Yes. And also just remember the idea here is integrated revenue, so like even when I mentioned a win with the extension of Twix, which Nitro had historically into the U.S. digital business, well that’s digital interactive marketing combined with traditional. So, you are going to see connected revenue, which is the whole idea. So, then as a separate revenue ideas is not something we are pushing as part of how we actually operate our business there.

Mark Zutowich – Piper Jaffray

Okay. And the contribution to Europe in the quarter?

Joe Tibbetts

I am trying to decide if we have that over right here. Well, I think we said – let’s see if we have it – hang on, we’ll get it here. We got it on–

Mark Zutowich – Piper Jaffray

Okay. While you are looking for them, I am going to ask you another question on the pricing front, can you just sort of talk about how the trend line looks since the beginning of the year? You mentioned that pricing was down in the quarter. Just curious how what compared to the prior couple of quarters and whether or not there was any link to here to the relative weakness that you saw in North America, i.e., did you pass on more deals that were slightly more competitive that you had seen in past – in the past couple of quarters?

Alan Herrick

Yes. So I don’t think there is a pricing link to North America. I think obviously the brunt of the pricing pressure was the end of last year, Q1, you saw it stumble a little bit into Q2, but I would say Q2 from a new pricing perspective, as opposed to the pricing – obviously most of our book is existing work. We have a little bit of new work in each quarter. But was probably more flattish. Where we really saw the improvement is Q3 in new pricing but yet still the aggregate book of revenue we had was down on that basis. But our sense of the environment overall right now is client – you are not seeing a rational competitive behavior anymore where definitely at the end of Q4 and the beginning of Q1 you were seeing some companies willing to do anything to obviously secure a deal. And again a 1% move in pricing is pretty much a direct hit on your margin, right. So it’s highly sensitive to pricing for us or any services company. So I think now what we are seeing is competitors are being rational, which helps us, right. And then clients are in an improved confidence situation. They are being rational, they want the right partner, they want the right price. But I think that’s clearly relented for us and that’s why we believe we can reflate from here forwards.

Joe Tibbetts

So the Nitro revenue split was about two-thirds, one-thirds, with two-thirds in Europe, but remember that Alan mentioned that we flumped [ph] there Asia revenue in with Europe, because that’s how we are managing it right now just overall. So it’s included in the Europe segment, about two-thirds of the $11.6 million.

Mark Zutowich – Piper Jaffray

Got it. And then for Q4 what should we expect for Nitro?

Joe Tibbetts

We were not going to – we are not going to talk about Nitro as a separate revenue number in the future. As Alan said, the business is rapidly integrating into the combination of multi-channel commerce and multi-channel–

Mark Zutowich – Piper Jaffray

Sure.

Joe Tibbetts

– marketing. And so we are – the business is operating together and we are just not going to talk about it as a separate number anymore.

Mark Zutowich – Piper Jaffray

Okay, fair enough. Just one final one. Any additional restructure or acquisition related charges we should be expecting in Q4?

Joe Tibbetts

No, there shouldn’t be any acquisition charges, no hangover on that. And then with respect to restructuring, we don’t – there is nothing to guide you to right now. That tends to be at this point adjustments to previous leases and things like that, which has been pretty noise level numbers and I don’t know any reason to suggest that they won't be that in Q4 as well.

Alan Herrick

Alright, great. Operator, we have to wrap there to stay on schedule. I know we didn’t quite get to everybody this time, but we will definitely get to everybody in the after hours, but again very satisfied with the quarter. I think we’ve got strong growth in front of us for Q4 and beyond, and obviously we look to advance our leadership position not just now, but into 2010. So, appreciate all of you joining. And we’ll talk to you next time.

Operator

And ladies and gentlemen, this concludes today’s conference. Thank you for your participation. You may now disconnect and have a good day.

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Source: Sapient Corporation Q3 2009 Earnings Call Transcript
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