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Sapient Corp. (NASDAQ:SAPE)

Q3 2007 Earnings Call

November 8, 2007 5:00 pm ET

Executives

Alan Herrick - President and CEO

Joe Tibbetts - SVP and CFO

Mindy Kohl - Director, IR

Analysts

Andrew Steinerman - Bear Stearns

Maurice Mary-Ann - Thomas Weisel Partners

Rod Bourgeois - Bernstein

Vincent Nguye - Goldman Sachs

Jason Kupferberg - UBS

Ashwin Shirvaikar - Citigroup

Operator

Good day, ladies and gentlemen, and welcome to the Sapient Third Quarter 2007 Earnings Call. My name is Amanda and I'll be your operator for today. At this time all participants are in a 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 Miss Mindy Kohl Director, Investor Relations. Please proceed, Ma'am.

Mindy Kohl

Thanks very much, Amanda. Good evening everybody. I'd like to take this time to remind you that some of the matters that we will discuss on this call are considered to be forward-looking statements, as defined by the SEC. These forward-looking statements are subject to known and unknown risks and uncertainties that could cause our actual results to differ materially 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 encourage you to read. The forward-looking statements included in this call represent the Company's views as of November 8, 2007. Sapient disclaims any obligation to update these statements to reflect future events or circumstances.

With that, I'd like to turn the call over right now to our President and CEO, Alan Herrick. Alan?

Alan Herrick

Alright, thanks, Mindy and thank you everybody for joining the call today. I am going to start with press release highlights, give you an overview of Q3, give you a people update, and then we'll do a little stepping back and give you a strategy, an overall update for Sapient. A brief update on Jerry Greenberg, and then I'll hand it over to Joe to walk you through the financials, give you an update on our hedging strategy, as well as our G&A improvements, and then I'll do a quick wrap up before we go into Q&A.

So let's jump in and start with the press release highlights. Service revenues were $141.6 million, up by more than 32% over Q3 '06, and 29% in constant currency, up 10% sequentially or 9% in constant currency.

Non-GAAP income from operations totaled $12.5 million, which is an 8.8% operating margin for Q3, more than a two fold increase from Q3 '06. This was an increase of more than $7 million, from $5.7 million or 5.3% of service revenue in Q3 '06.

GAAP income from operations was $6.6 million. This compared to a GAAP loss from operations of $2.6 million in Q3 '06. Non-GAAP diluted income per share from continuing operations was $0.08, up slightly from $0.07 in Q3 of '06. And GAAP diluted income per share from continuing operations in the quarter was $0.03, an increase from $0.01 per share in Q3 '06. So for the overview of the quarter, I mean, top to bottom, we are very pleased with where we are. We are very pleased with our results in the quarter, top to bottom, for a strong execution rate growth. We continue to see and benefit from a very distinctive value proposition in the market. In Q3, general run rate hit an all time high for the company across our 17 year history. We continue to be very strong in competitive situations.

And we really think our passion, our approach, and our very talented people create a great package of results which focus on high-end capabilities for our clients. Great top line, good strength is broad. It’s good strength across the broad for us if you look at where the topline growth came from, and we continue to have strong win rates for new clients -- in new client additions in Q3 as well as expanding our existing relationships.

On the profit side picture, we have also made solid progress on operating profit at 8.8% operating margin. This improved our G&A by 165 basis points to approximately 19% of revenue from approximately 21% of revenue. We also demonstrated strong progress on key operational metrics. Including DSO and utilization, recurrent revenue also up 40%, which is a nice overall improvement in our portfolio from 36% in Q2.

Growth and win rates continue to attest to our competitive position and our strategy, and top to bottom, we are very happy with how the health [keeper] come out for us and how we are positioned from here forward for the future.

So with that let me give you some detail on North America's performance in Q3, which represented 65% of our service revenues in Q3 or $92.2 million. Revenues are up 23% year-over-year, 9% quarter-over-quarter, and constant currency growth is at 22% year-over-year and 8% quarter-over-quarter. And I would characterize North American performance as having very strong new sales activity, great win rates and improvement in utilization which I’ll speak about later, and we continue to see strong demand in both Interactive and Consulting.

I will just highlight a couple of notable wins for North America. One is with the multi-billion national business-to-business retailer. We are helping re-architect their e-Commerce platform design to improve user experience, allow sales and marketing teams more integrated access to customer data, in order to continue to drive sales while maintaining a focus on cost. And this is just a simple and great example of how our creative skills, our business consulting skills, and our technology and program management skills come together to create a unique value proposition for our client and great results.

As you may have also seen, we released a new version of BridgeTrack, our BridgeTrack 5.0, our integrated marketing platform at ad:tech. Please refer to the press release to get a better overview of that product. We’ll just highlight a few quick wins in Q3 in North America for BridgeTrack. One is with public storage, the world largest owned and operated self storage facilities, as purchase BridgeTracking context of a broader relationship with the patient. The other one GE money is using BridgeTrack to grow its online business in the Americas. They are leveraging BridgeTrack to improve their results with additional marketing campaigns. BridgeTrack also gives them a media snapshot of ongoing campaign results. They can make changes and improvements during the earliest and most critical phases. And Sapient is also giving GE Money better leverage to use its multiple online channels, while simplifying its overall interactive marketing delivery. So, North America Q4, we do expect our outlook for North America to be up in Q4.

Switching to Europe, 31% of our revenues in Q3 or $43.7 million, our revenue is up 57% year-over-year and 15% quarter-over-quarter. In constant currency, Europe is up 46%, year-over-year and 13% quarter-over-quarter. We are not allowed to say here other than just far outstanding performance by our team in Europe. We are sitting in a good market and we’re sitting on the right path and we’re winning, and year-over-year Europe has built very strong, with business, more than doubled its portfolio with major clients, and let me give you a little bit of a feel for some of the new wins in Europe, on both the consulting side of our business and interactive.

Let’s start with the UK Department of Health. The Department of Health wanted a single partner that could really help them move their [IS] capabilities forward overall in organizations. So, really just think about the scope of the assignment is that there is still lots of (inaudible) across IT while lowering their overall IT cost and increasing their efficiencies and effectiveness. So in Q3 we began working with a number of organizations, also affiliated with the Department of Health, including the prescription pricing division, healthcare commission. We also started working with the new health care regulatory body, Healthcare to help them define their IT strategy.

We also started working with P&O [Ferry's] and being a large IT transformation program for them, as you probably do know they are a large freight and transport company. On the interactive side, a nice win of Vodafone, new long time work to develop their next generation customer experience, including their online sales channel. A nice win with Metro in delivering a new customer experience for Metro, who is the world’s largest newspaper by circulation, and we will be rolling out their new customer experience, their new global news platform and their local sites.

We also have a nice win with Sky News, and are in a process of building what would be the UK's second largest news site, one of Sky's most strategic initiatives, which provide us with a great opportunity with Sky and in the media space in general. We also had a nice win with Sony PlayStation, to really launch an online ad campaign for their new game World of Warcraft; a win with DeBeers, helping them with online corporate communication strategy and execution, and finally Sportingbet, we became their online agency of record, focusing on producing a step change in their customer experience. So, for Europe our outlook for Q4 continues to be up.

Government services represent 4% of revenue or $5.7 million. Revenues were up 40% year-over-year and 2% quarter-over-quarter. To highlight a couple of wins for our government service scheme, one is we've extended work with the Library of Congress, and this work is really to support their new visitor experience and really looking at re-launching the public face of the institution with a new experience for visitors, both on-site and online at the Library of Congress.

We were also awarded the AIMS or Advertising and Integrated Marketing Solution's contract through the GSA. Aims will allow Sapient to be a prime service provider of advertising and marketing and services to the federal government. This opened up a great opportunity for our government services team to provide Sapient interactive offerings across our current list of clients also to just penetrate new areas within the government as well.

Switching to people update; ending people count for Q3 was 5,857, up from 5,376 in Q2, so net ads of 481 people. Our turnover rate was 20%, level with Q2 of '07 and significantly down from Q3 of '06. Utilization was 74% compared with 77% in Q2. Effective utilization, as I said last time, the overall utilization rate may not tell the story and effective utilization in Q3 was very strong, with strong utilization from North America, but overall utilization was down due to increased number of trainees in India and you may ask, did we see a profit improvement from utilization? In fact, we did. We saw gross margin improvement due to utilization and some of those improvements were offset by seasonal wage increases which probably, as you do know, we do historically take in Q3.

I would also like to mention some recognition for us and our people. Overall, we've been named as one of the 50 best places to work in UK, top 100 best places to work in Europe, top 100 Best Employer in Canada, Toronto’s Top 15 players and then just very recently we just won best companies to work for in India. We moved up to number 4 on the list, we were number 5 last year in Business Today, as foreign visits have pointed out that this is for all companies in India, not just consulting companies or agencies.

With that, let me try to move into the strategy update and give you a little more of a top down view of where we are going from here. And as I've said before, we have a highly differentiated value proposition, and strategically we are in a great spot and we continue to believe that we are in a great spot in having both the interactive and consulting capabilities that we have to offer to the market. And really the easy way to think about it is two complimentary businesses leveraging the same shared platform for global delivery of our services and both those services can share skills and people. And, as I pointed out earlier, many of our assignments mix T-skills in people from both the Interactive side and the Consulting side.

Our value proposition has really allowed us to focus on high-end, high-value work for our clients and continues to drive record win rates at Sapient.

On the Interactive side, and many of you have asked me this question time and time again over the last couple of quarters, but we are now beginning to see an expansion of the opportunities in our sales funnel. So to be more clear, from here forward, as you look at our sales funnel, we are seeing increase in the amount of interactive opportunities in the funnel overall. And we really attribute that expansion in the funnel to two reasons, a good market with a strong opportunities and investments that we have been making and are continuing to make in the Interactive area.

And we have, also, on the Interactive side, received some great recognition externally on that side as well over the course of the year; #1 number one digital marketing agency in the UK by New Media Age. Sapient was also named the second largest digital agency in North America, and number two position in the 2007 New Media Service rankings for Germany, Germany’s Interactive agencies and most recently the Forrester Wave that named Sapient a leader of European Interactive agencies. And it is a great testament, great recognition and validation of our strategic progress overall with the business, and my final point on Interactive would be, our success in Interactive provides us with good diversification of our revenues, and allows us to tap into a huge and growing market for our clients and us.

Switching to the Consulting side of the business; we help our clients solve complex business in IT issues, as you all well know, and client’s engage with us in areas of business strategy, process design, redesign, technology implementation and systems integration. We bring great depth in industry knowledge and large scale IT know-how to those assignments.

Our consulting business, if you think about it, is focused in four key industries; energy services, financial services, communication, health care and government. We really provide that package of services primarily to these four industries. Now, I am just going to give you some quick highlights in some of the kinds of work and assignments we do in each of those four industries.

So our energy business is really focused on the oil and gas segment as well as the utility segment. To give you a quick example, we are helping utilities improve their customer service level through better scheduling and management of their skilled forces, helping them to integrate their customer service, work management, order dispatch and work completion processes to lower their cost of service while better or improving their customer service. And of course, as you do know, our CRM business is a subset of our energy business, focused on commodities, management and scheduling.

In our Financial Services business, I'll give you a few different categories here in ways to think about a decline in the portfolio that we have in financial services. We are working with several financial services companies, designing and developing TRM solutions to their business. So the solutions included data warehouses that drive the customer facing applications. These are applications that help and mange investor changes and asset allocations, sales force solutions and call center solutions.

We also work with several clients to provide services in the area of custody, cash management and transaction processing, through the financial services industry. And these cases were primarily during planning, application, design, and development and maintenance cost. Our depth in financial services goes beyond traditional privately held and publicly traded firms, as for example, we have strong relationships with government and quasi-governmental agencies for work-on-engagements ranging from critical systems development to more traditional business analysis. And finally, as you are aware, our TRM practice, and its focus on core improvements in trading operations.

Moving on to our communications business, the majority of our work there is really helping global mobile operators with strategy, technology, delivering and outsourcing in the areas of bundling, convergence, customer self-service and online sales, order management, provisioning and customer ticket management. We are also deploying all of our services to the communications industry.

And finally, healthcare and government, I'll just give one example there that’s indicative; the Department of Homeland Security; several highly visible engagements, surround efforts to modernize and transform the United States Immigration System. This work encompasses all aspects of Sapient consulting services, business consulting, program management, business development. Also to note our work with Homeland Security also does entail interactive services, as well. So to give you some color on the content and the structure of our services and how they lay out across the primary industries they serve on our consulting a side.

And let me switch to our financial strategy. We made good progress financially year-over-year and I want to give you a recap of those non-GAAP numbers and I will give you some forward thoughts on that.

So if you are comparing Q3 '07 to Q3 '06, revenue grew 32%. We reduced general and administrative expenses by 418 basis points, down to 19% from 23% approximately. Gross margin improved 20 basis points. We increased our sales and marketing investment by 88 basis points, resulting in a net operating improvement, or increase of 350 basis points. We also had a great improvement in our DSO, which improved to 62 days versus 83 days in Q3 '07. We also generated cash flow from operations of $38.7 million.

Now, I wanted to give you an update on our roadmap of 13% to 16% exiting 2008. So, how to think about our improvements to hit the 13% to 16% on a negative basis, but in '08 from here forward off of basis sort of 8.8% non-GAAP operating margin.

So, to go through each piece, let’s start with gross margins; 250 to 400 basis points from here of improvement on gross margin due primarily pricing and improving our effective utilization. G&A from here forward expecting another 150 to 220 basis points for the improvement. Sales cost 25 to 50 basis points of improvement from here forward. Overall this remains consistent with our 13% to 16% guidance exiting 2008, and I think we've made big progress across the board in doing what we said we would do, and now we look forward to continuing that through Q4 and the balance of '08.

I also said I'll give you a very brief update on Jerry Greenberg. Now I am happy to announce that we have extended our consulting agreement with Jerry in the areas of strategic planning and marketing position -- in market positioning. [Neil Dell] will work with me in these areas as needed and we'll file an 8-K shortly to provide you the details of that agreement.

So, the quick summary, top to bottom, this was a solid quarter for us. We are very pleased with all the hard work that the entire team has put in to making this happen. There has been great execution for us and a solid result. We had 32% year-over-year top line, 29% in constant currency, 8.8% operating margin, along with 350 basis point improvement year-over-year.

DSOs at 62 days generated cash flow from operations at $38.7 million. Recurring revenues also moved up strongly to 40% of revenue Win rates continue to show that we have a tremendous value proposition; we are competitively very sharp in any situation.

And finally, we are seeing Interactive gain some share as we look forward in our sales funnel in the rest of ’07 and ’08.

And with that, I will hand it over to Joe, to walk you through the financials.

Joe Tibbetts

Great. Thanks, Alan. Good evening, everyone. I’m going to talk about the details of the third quarter results, beginning with P&L, and then I’ll move on to the balance sheet, and then we will wrap up with some guidance for the fourth quarter.

On the revenue side, as Alan mentioned at the beginning of the call, consolidated service revenues for Q3 were $141.6 million. That’s an increase of more than 32% for the same period a year ago, a 10% increase from Q2. On a constant currency basis this was 29% year-over-year, 9% quarter-over-quarter. So this has been a great quarter for us.

Next, looking at the revenue by industry, we saw a strong continued perform in the financial services, technology, and communication sectors. The industry breakdown is the financial services represented 29% of our total revenue in the quarter. Technology and communications was 24%, consumer and travel was 19%, energy services was 12%, government health and education was more than 14%, and industrial was 2%.

Moving on to recurring revenue, which includes revenue commitment to one year and more, and which the client has committed spending levels to or has chosen us an exclusive provider of certain services. This was 40% in the quarter, which is up from 36% last year and 33% a year ago.

The percentage of service revenue coming from top five clients in the third quarter increased to 27% from 25% in Q2, and also from 25% a year ago. Revenue from our largest customer, Sprint Nextel, represented 9.7% of the quarter's revenue, and although Sprint represented a slightly lower percentage of our revenue in this quarter, revenues from them did increase on absolute dollar basis or quarter-over-quarter basis. Q3 revenue was split about 50-50 between fixed price contracts, T&M contract.

Turning to gross margin and operating margin, in comparing gross margins to the previous quarter, I'll be referring to the non-GAAP numbers that will give a more accurate actual reflection of the company compared with performance. So overall third quarter gross margin, excluding stock-based comp, was 34%, roughly flat with 34% in the past quarter. Selling and marketing expenses, excluding stock-based comp were approximately 6% of service revenue against a similar in Q2.

General and administrative expenses, excluding stock-based comp and expenses incurred in connection with the stock-based compensation review and reinstatement, were 19.2% of revenue in Q3, again an improvement compared to 20.8% in Q2. So throughout 2007 we've been focused on improving our systems and processes and watching our spending in order to increase our operating efficiency. We are very pleased to see yet another quarter of improvement in our G&A spending rate.

Total stock-based compensation expenses for Q3 were $5 million versus $4.7 million in Q2. Just as a note, included in this amount is the new Indian Corporate Fringe Benefit Tax on stock-based compensation. You might have heard about this from other companies. This quarter there was approximately $500,000 of that expense. Going forward, this tax is not expected to be material to us at any given quarter. For example, for 2008, we estimate that the fringe-benefit tax expense will be in the order of magnitude of $200,000 to $400,000 for the whole year. So just as a point of interest, our guidance for stock-based comp for Q3 didn't include the fringe-benefit tax, in light of the uncertainty at that time as to the accounting for this expense. However, we did [rerun] for the tax in our overall profit guidance we gave you for Q3.

Like most companies in the industry, we expect to pass this compensation tax back to the employees respectively. As you may know, US GAAP accounting considers the pass-through to employees as an additional exercise price unfortunately and not as an offset to the expense. That accounting treatment is currently under evaluation by accounting professionals. So we will stay tuned to see if that turns out differently and if there is also some amount of hope that the Indian government will actually change the law to make it a withholding obligation for companies, as opposed to actually having the companies as the primary obligor for the tax.

Restructuring and other related expenses represented a small gain this quarter of $35,000 and that compared to similar net gain last quarter of $57,000. Our non GAAP operating profit for Q3 was $12.5 million, 8.8% as we said, and represented another quarter of improved profitability. That compares to $9.9 million in Q2, which was 7.7% of that quarter's revenue and compared to $5.7 million, or 5.3% of revenue in Q3 last year.

GAAP operating profit is $6.6 million, or some 4.6% of revenue. That compared to $1.4 million or 1.1% of revenue last quarter and in Q3 2006 we actually reported a GAAP loss from operations of $2.6 million.

Turning to foreign currency gains and losses, as anticipated on our last earnings call, we analyzed our currency exposures, which for us, is several currencies, but primarily the Indian Rupee -- well we have rupee denominated expenses and some of the other currencies, in fact in all of the other currencies we have some natural hedging where we also have foreign currency revenue.

Specifically, if unhedged, a strengthening of 1% in the value of the rupee against the US dollar and other currencies will cost us about 20 basis points of profit through a combination of transactions and translation losses. We have now taken some steps to abrupt this risk and we have implemented a multi prompt approach to managing the exposure to currency losses. First, we put procedures in place during Q3 to expedite settlement of intercompany and other foreign currency denominated receivable and payables to manage the transaction loss for us.

And then secondly in Q4 we began utilizing some threshold hedging, the women’s translation risk to the rupee. We have monthly zero cost callers in place for 90 days forward, and then we may extend this program in the future for longer periods as we go forward. While these steps obviously do not eliminate all currency risks, we believe that they will greatly reduce our exposure to unfavorable rupee movement in excess of 2% on a rolling 90 days, making it more predictable and enabling us to build them into our guidance.

Included in G&A expense, and in this quarter is the net foreign currency transaction loss of 115,000 that compares to a foreign currency transaction last quarter of 915,000. And our practice clearly -- a practice of more timely settlement of inter company and other foreign currency base receivables and payables clearly reduced the negative impact from the continuing weakening of the US dollar versus the rupee in the quarter.

Translation losses were also way down in Q3, totaling $288,000 across all currencies sequentially on a constant basis for Q2. And you may recall that Q2 compared to Q1 was a $1.1 million loss.

Turning to interest and other income, moving on, this totaled $1.6mm in Q3, up from $1.2 million in the prior quarter and $1.2 million a year ago, and the quarter-over-quarter increase is due to the higher average cash balance and an improved average rate of return as well.

Income taxes. The income tax provision in Q3 was $3.7 million. That’s an effective tax rate on income from continuing operations of 46%. The lower effective rate for Q3 versus Q2 is the result of the change of our estimated tax rate for the year to 38% from 51% that it was last quarter. This is due to a revision in the level and country mix of forecasted annual profit, and as you know, our rate is pretty sensitive to these kinds of changes.

The quarter's provision also includes the charge for this quarter for changes in the German and UK. tax rate, which will change in 2008, but was recorded this quarter to re-value our differed tax assets relating to those countries. And then, we also caught up the effective tax rate for the year-to-date basis, and basically get it to 38% for the year-to-date. So, clearly our effective tax rate, independent of those discrete items that we booked this quarter, is now 38% for the year.

Income from continuing operations -- the Q3 non-GAAP income from continuing operations was $10.3 million. That compares to $9.4 million in Q2 and $9 million in Q3 of last year. Non-GAAP dilutive earnings per share continuing operations were at $0.08 per share in Q3 versus $0.07 in Q2 and $0.07 a year ago. The GAAP income from continuing operations is $4.4 million in Q3 compared to just under $900,000 last quarter, just over $700,000 in the third quarter of 2006.

GAAP diluted earnings per share from continuing operations were $0.03 this quarter, $0.01 last quarter and $0.01 a year ago. Weighted average common shares for the third quarter were 124.875 shares on basic basis and on a diluted basis there were 128.314 shares.

Switching quickly over to the balance sheet; cash and marketable securities increased significantly to just under $146 million at the end of Q3 from $109 million at the end of Q2. The company generated cash from operations of just under $39 million during the quarter, obviously a dramatic increase from $5.8 million in Q2 and approximately $15 million a year ago. And our strong focus on collections across the company really paid off this quarter.

Accounts receivable net of allowances decreased to $84.2 million at the end of Q3 from a $103.9 million in Q2, again attributable to our strength and focus on collections and reduction and [ageing], and other factors. Unbilled revenue this quarter was $37.3 million at the end of the quarter, compared to unbilled revenue at the end of last quarter of $35.6 million.

The current portion of deferred revenues was $18.7 million, compared to $20.2 million at the end of last quarter. DSO, as Alan said, decreased significantly to 62 days in Q3, much improved from 80 days in the second quarter of -- this past quarter or second quarter and 83 days a year ago. The majority of this improvement are attributable to operational improvement, which we implemented with respect of accounts receivable collections and also reflects some favorable contract channel with respect to payment schedule and obviously we are very pleased to return DSO this quarter to well under our targeted level of fewer than 70 days.

Our ending people count 5857 as Alan said, 4,993 of those are in delivery and 3,444 are India-base delivery. In August we announced that we had recommenced a repurchase of our stock, of our common stock under a stock repurchase program that was previously improved by the Board of Directors and during this quarter, we referred just over 6,800 shares for $3.8 million under this program.

Turning to guidance, for Q4, as noted in the press release, we expect that that fourth quarter service revenues will be in excess of $146 million bringing the expected total for 2007 to $537 million. We expect that our Q4 non-GAAP profit margin will be in the range of 9.5% to 10% reflecting another quarter of expected improvement in profitability.

Several other data points we wanted to leave you with, expenses for outside services relating to the restatement are expected to continue at above the $500,000 level that relates to ongoing tax with legal work, obviously we don't want to be accounted for the reinstatement. Stock based compensation expenses are expected to be just over $5 million. They are approximately $5.1 million in Q4 and this number includes the new India fringe-benefit tax on stock compensation, as I mentioned it will not be going into -- not expected to be material in Q4 or to be well under 100,000, probably more like 50,000 included in that number.

The effective income tax-rate is expected to be approximately 40% for the quarter. That's the 38% that I mentioned earlier, plus probably about 2% worth of discrete items that will flow through Q4.

Capital expenditures are expected to be somewhere between $3 million to $5 million for Q4. Anticipating some questions about our tax expense picture in 2008 and beyond, I am going to hit on that now. While we are generally not going to give guidance past Q4, I will say that we expect our effective tax rate to be lower in 2008 then in 2007. As we generate income in the US and have the opportunity to utilize our NOLs with provision.

While the overall effective rate is quite variable depending on our level of profitability and how that ends up in the US, 2008’s effective tax rate should be in the range of 25% to 30%.

In 2009, just to sort of go out, because of the anticipated changes in the Indian tax law, unless the Indian law changes to extend SPPI benefit that we are currently enjoying, we will loose the partial tax holiday benefits under that program in Q2 of 2009. So it gives us some perspective on that benefit, in our case it’s running about $2.5 million of tax that we don't have to pay on an annual basis.

So it’s not a huge number for us, but it’s significant, and we are expecting that as that goes away, a large part of our future expansion of business in India will be in the qualified special economic zones, the SEZs, which will afford us tax holiday benefits under that program. And I would expect with increasing SEZ benefits, together with increasing profitability in the US -- again, giving us those NOL benefit should offset some or all of the increase.

So, as a result while it’s obviously a long way out and subject to several key variables, I would say that we expect our 2009 effective tax rate to stay in about the 25% to 30% range. So, lastly as per outstanding shares, I know people would like to know, kind of where we are going with that, I would expect the share count likely to increase something like 200,000 shares, or a little bit less in Q4. And then in 2008, we'll probably increase outstanding weighted average shares by about a net 2 million or so by the end of the year.

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

Alan Herrick

All right, thanks, Joe. So just a quick wrap. We're very happy with the quarter. I think there was great progress obviously on profit, and an excellent position on top line growth, and we've talked about strategically, and we do like where we sit right now. We think we’ve got a great opportunity set in front of us and a great opportunity to execute and continue to parallelly grow, but also improve our profit position in line with my guidance.

So with that, let me turn it over to you operator to open for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from the line of Andrew Steinerman with Bear Stearns. Please proceed.

Andrew Steinerman - Bear Stearns

Hi, there. I just thought if you were reviewing the accomplishment of G&A being below 20%, for the first time in the corporate history, and I know it has been the goal of Sapient to see these efficiencies, but could you just review for us why G&A has never been this efficient before, and why we should believe that there is kind of more efficiencies to come pass will, that's been achieved already?

Joe Tibbetts

Well, Andrew…hi, it's Joe. Thanks for taking up that question, because I think it's an important aspect to what will enable us to accomplish and what we see going forward, So if you look at this quarter we just have been through versus the same quarter a year ago, end up about 400 basis points better in G&A. Let me take out the non-GAAP stuff, which is included all of these statements.

If you look at it on a nine-month-to-nine-month basis, coincidentally, it will also end up at about 400 basis points better. So, it's -- sort of…if you generally, well, look at the numbers -- we weren't really able to knock out a bunch of spending in G&A, relative to our revenue growth. And if we sit back and look at where that came from, we clearly have a number of things around the things we've said we would do, which is to say looking at our processes and building more efficiencies into the things that we have to do in order to -- that we do in our G&A world so, also processing payables and receivables and payroll and expenses and all those sort of transactions throughout. Looking at how we procure stuff, and the vendors that we are procuring from, and how we are going about doing that, and controlling our spending…

We've standardized a lot more of how we do things, and how we do business with clients -- so that does makes it less complicated and easier for all of those processes throughout. We've done things to our systems; we got away if we go with that, so we've done a number of things to our systems to help transaction handling. We put more accountability into the system, and people have a better sense of what they are supposed to do, and not supposed to, working with what the metrics are, all of that and, by the way, skill helps, too,

So, that's sort of how we got to 400. As we look forward, I think as Alan said, we are visible to another 200 to 250 basis points to ground in 2008 over the next four quarters. It's essentially more of the same, so its lots of -- doing all things I just rattled off. More of, we think in the IT area there is more opportunity for productivity and systems improvements that will match up better -- match our systems better with the way we do business and how we now operate. We think there is room for improvements in our staffing processes that we can do which will help and then further scale. So we do think we can get to those kinds of numbers.

Andrew Steinerman - Bear Stearns

Right. And when you talk about turnover, does that include G&A personal, and is that notable?

Joe Tibbetts

It does include G&A personal in that number, and is what, notable? Sorry...

Andrew Steinerman - Bear Stearns

Is it notable, in the sense that maybe part of the turnover came from G&A personal, that it was obvious that they've already been made redundant?

Joe Tibbetts

Right, and as we said, in the last, probably, couple of quarters, as well, our G&A -- our headcounts turnover has gone higher than the company average

Andrew Steinerman - Bear Stearns

Yeah.

Alan Herrick

And did, again, in Q3. Having said that,Ttis is Alan Herrick. I heard of people-count reduction exercise. I mean, that hasn't been, just go around and shoot everybody, it has really been an opportunity to -- with a growing business, they use what we know about the business to have everybody be told to sit in their seat and act more efficiently and be able to contribute more to the business. There certainly has been some amount of involuntary and voluntary turnover as a result of the processes, but I -- that isn’t really, it is in a game of trying to reduce cost that way.

Andrew Steinerman - Bear Stearns

Okay, thank you. That sounds very productive.

Alan Herrick

Thank you, Andrew.

Operator

Your next question comes from the line of David Grossman with Thomas Weisel Partners. Please proceed.

Maurice Mary-Ann - Thomas Weisel Partners

Hi, this is actually [Maurice Mary-Ann] for David Grossman. I was wondering if you could just give us a little bit more color on the pluses and minuses on the gross margin sequentially. You mentioned that utilization and a couple of other factors, and I was wondering if you could kind of break that out and also tell us what the rupee impact was in the quarter?

Alan Herrick

I'll take gross margin and, Joe, you take the rupee part. On gross margin, try improvement and utilization due to better improvement in North America. So that contributed most of the gross margin. On the plus side then probably a (thick) or so appraising now started to show off as we've talked about, and then on the negative side, obviously, our wage increases historically and again this year I'll take in Q3 so that comes on the minus side.

Joe Tibbetts

So on the rupee side, the numbers were transaction losses of 115,000 and translation losses compared to Q2 of 288,000,a total of just over 400,000 for the quarter.

Maurice Mary-Ann - Thomas Weisel Partners

Okay. Thank you.

Alan Herrick

Okay.

Operator

Your next question comes from line of Rod Bourgeois with Bernstein. Please proceed, sir.

Rod Bourgeois - Bernstein

Hey, guys, I am going to ask you about Europe. How did you do 15% sequential growth in Europe when everybody on that side of the pond seems to be on vacation for half of the quarter?

Mindy Kohl

Yeah, I think, well, Rod you just you follow on to their favorite destination. But seriously, I think if you go through the kinds of wins we have, we do have very broad strength and extending customer list in both Consulting and Interactive, but I think what is striking is the amount of interactive momentum in Europe right now, and I believe that, that is not vacationing right now. I believe there is lot of urgency around things that are happening in media and what's happening in advertising, whether it’s in United States or Europe and I think that, that plays well and contributed to live the momentum in Europe.

Rod Bourgeois – Bernstein

Okay. On that note, can you quantify the increase in the interactive pipeline? You mentioned that as a noteworthy positive in your outlook, and that your pipeline is shifting towards Interactive, can you at all quantify that shift of the magnitude, the pipeline increase, I mean, is this an incremental thing or is this a [tectonic] thing?

Joe Tibbetts

Well, I think we've already been saying over the last couple of quarters, when you guys asked that question, we've seen the Interactive business to be about 40%, and it continues in that range in Q3. And as we look ahead in the pipeline, not just for Q4, but if we look in our 12 quarter--12 month, or four-quarter pipeline, we also see an increase there. So we have been obviously watching this very closely over the last year or plus. And I think it has now become obvious to us that there is a meaningful share gain on the Interactive side. I don’t want to go any further on quantifying it, we actually have to prove that we can execute against that, make that happen, and turn that into actual revenue in Q4, but if we do see every opportunity to do that, I would just say, that it is now a change or distinction in our pipeline. It has now become obvious to us.

Rod Bourgeois - Bernstein

But it's not the Consulting pipeline floundering, it's the Interactive pipeline bourgeoning?

Joe Tibbetts

Absolutely.

Rod Bourgeois - Bernstein

Okay. And then, the other question here, and if you look at what’s happening on Wall Street right now, this is the obvious question that would be helpful to get your perspective on, are you seeing a slowdown particularly in the U.S. financial services vertical, and then specifically if you can comment on whether you are seeing the absence of sort of normal year-end flurry of spending that you sometimes see in some of these clients?

Alan Herrick

Yeah, and obviously, into this spot, we have to be very, very watchful not just now, but going forward based on new news everyday on that front. When I say, 4Q -- Q4 - for us and what we look at, we do expect financial services to continue to grow quarter-over-quarter for us in Q4. So, it’s all positive when you look at [archives] and the set of opportunities, it’s difficult in front of us as far as the way that we measure and look at the business. The opportunities are there across, and we do expect that to continue to be up again in Q4.

Now, I think part of the thing is going to help us and helps our visibilities. Well, we sit in a very big spot in financial services, but we are very differentiated, we got a lot of focus on core improvements in the business and a big part of that is focused on core training for improvements and then one another things that you probably heard me say over several calls, but a big part of that portfolio is commodities trading and, if anything, we are seeing, capital moving to commodities right now, which bodes well for our business, because we've got a big history in energy and financial services and in energy services. So, we have noted that movement over the last few months, and maybe a little longer, but it seems like it continues to increase. So, we like that part of the idea.

On the interactive side again, I think that based on any particular company, and if you're foster child or not, things could yin and yang on you, but do believe that clients will all continue to spend on acquisition of new customers on the interactive side, over the balance of whatever period that you are looking at, because you are looking at revenue growth opportunities for clients on that side.

So, I do believe that that's helpful just in the places that we sit in the market. Our competitive position, our win rate, and those sorts of things, so we do see growth in Q4 -- I have not seen anything to indicate differently -- but obviously, we've got to keep our eye all over this, because it's the news, e-news everyday, you know, our budgeting season right now. You know an early indication to that budgeting season, it depends again on what part of financial services you want to look at, but it looks like before you really take a look, and you are going to spend on the things that matter and make a difference.

Joe Tibbetts

Which to my view, is.

Rod Bourgeois - Bernstein

Okay. And just to clarify that, if you look outside of the commodity trading portion of your business in financial services, and particularly when you look at the sort of normal consulting work you do, the traditional consulting work you do for a capital market-related client, are you seeing any issues in that pipeline, any hesitation, any push-outs, any budget cuts, that are effecting you at all at this point?

Alan Herrick

No, not at this point.

Joe Tibbetts

Okay, great, thanks guys.

Alan Herrick

Thanks.

Operator

Your next question comes from the line of Julio Quinteros with Goldman Sachs. Please proceed.

Vincent Nguye - Goldman Sachs

Hi, this is [Vincent Nguye], for Julio. Just one quick question about the deferred revenue. The amount on the balance sheet looks like it decrease quarter-over-quarter, and just wondering if you can provide us some color regarding the trend of deferred revenue. Should we expect that balance to continue to trend down, and whether that had anything to do with the Q4 revenue guidance, and then, revenue momentum for the next couple of quarters?

Joe Tibbetts

Thanks for that question. I don't really think I see it as the forecast for Q4; we really try to give you some sense of what we did for Q4. Deferred revenue balance is very much a function of specific accounts that we have and specific contracts we have and where we are with revenue recognition of those contract, the timing of which depends on whether it’s a fixed price contract or [inaudible] and just how we hit. So I don't really see anything notable about that number going down at $1.5 million.

Vincent Nguye - Goldman Sachs

Got it, okay. And then probably on the cash flow side, any projection in terms of DSO transfer for next couple of quarters? And then, finally, what's your expectation in terms of cash flow coming out next quarter?

Joe Tibbetts

So, on the DSO I think we’ve been pretty consistent saying that overtime we like to have our number continue to hit below 70, so this quarter may not be sustainable at 62; there is, at least, one item in there that helps a fair amount of not materially its still in the number of 70, but I think the guidance that we have given, I think, just keep number sort of under 70 that is successful place for us, and we'll make that better over time, hopefully. But right now, that's what we are. As far cash flow from operations, I think we had spectacular quarter, obviously, and it reflected a lot effort and a lot of clean up in our books, and balances that we got through the door. I think going forward in Q4 we are looking at probably in the order of magnitude of about $10 million in cash flow from operations, the number could actually bit more higher than that but that'll be the order of [magnitude] in US.

Vincent Nguye - Goldman Sachs

Great thanks.

Operator

Your next question comes from the line of Jason Kupferberg with UBS. Please proceed.

Jason Kupferberg - UBS

Thanks and good afternoon guys. Sort of a big picture question, it seems like in this quarter a lot of stars aligned for Sapient utilization, G&A, the tax rate, the OpEx and lot of stuff really went your way, to your credit, this quarter. My question is, what's your comfort level that all of these factors can continue representing areas of continued improvement for you, as opposed to, hey look, just a few things broke our way this quarter, so we had some great result, but there is still some variability here. Just want to get a sense of kind of the sustainability of these trends that you guys try and produce more consistent quarterly performance going forward?

Alan Herrick

Well, we both have something to say about this Jason, but I hate to characterize it that the stars aligned, because it makes to sound like a random event that we used to have influence over. We clearly have been focused a lot more on the good side of business post three statement and we've had an opportunity for some of the efforts that we have been putting in place over -- even longer period than that just this so -- I think, you know, when you talk, I think I addressed pretty clearly where we got the G&A and where we think that's going, so I think that’s sustainable. I think some of the margin improvements really reflect a lot of the -- I’ll leave that for Alan to address in more detail. But I think it clearly reflects the focus on that area. The cash flow was absolutely a really strong effort on the part of the whole business to take that seriously and get us really in a great position there. You need to keep that momentum going forward, and we intend to do that. So, I think the things did work for us. Even the currency, we took very proactive steps around managing the transaction part of it, the rupee lost another 2% on the spot rate in the quarter, and you know that didn’t hit us to hard, right. So, I think it clearly reflects that we have been on top of those balances both restatement and get those straight enough. So, I think its real stuff that we deserve but, we’re not just start to lining up.

Alan Herrick

Well, I agree, as well. I think that's well played. And I guess the only thing I would add, in the follow-on to Joe’s comment about post rupee payment, is few parts of the process improvement that we've been making, one part is the obviously effectiveness and the decrease in its cost structure as a percent of revenue, but additionally, one thing, I think if you go back a couple of quarters, we talked a lot about -- we need to bring in increased predictability to our business, and part of that is to have a more reliable processes. That’s part of how you drive increased predictability to business, and I think we have put in a lot of hard work there, whether you are looking at the gross margin side, or are you looking at the G&A side, I think you start to see some of the early parts of returns now. And I think, we are pleased with that. We’ve got a lot more work to do, and we think we've got a good read and how to do that work, and keep going from there.

Jason Kupferberg - UBS

Okay. That's really encouraging. Alan, can you may be just comment a little bit looking ahead here, understanding that you are not seeing any slowdown at this point, but your general confidence level in kind of forward 12 months visibility just in qualitative terms, now, versus how you felt at this time of the year over, let’s say, the last few years. Can you characterize any new answers or differences, and kind of how you are thinking about things and what the level of uncertainty out there is?

Alan Herrick

I guess as a level of uncertainty, if you look actually at our funnel, very positive, where I compare with any other time probably sitting here in Q4, kind of what you are looking at. We feel very positive, if you look at the actual real firm opportunities in our front. Now, of course, you get a lot of uncertainty happening with companies and you got to wait to see how that all plays out in plays, so through and that's why you got to like a hot grade now. But I think that what makes that is we see this opportunities right now, that's all we can go on is what we seen, its in our mindset, but I think it does come back, our value proposition where our position.

If you believe clients are going to continue to spend on what that matters, and you look at our overall share in the market, share and financial services we are very differentiates in that business and I think you will be hard pressed upon anybody that can stand with us in the work that we do on core improvements, core trading, core improvements, the work we do on the interactive side. So we believe that when you do work that matters we are going to be on the top of that list going through that. So its hard to project; I know you guys are trying hard to project that as of today, in a lot of different ways, that could play out, and we have to take on that, but we feel like we are well-positioned to be on the short list going forward on any uncertainties or changes in kind of mix for the [FS] industry but if you are coming back to the fact that what we see right now the funnel does look very positive for us and we expect growth in Q4.

Jason Kupferberg - UBS

Okay, that’s fair enough. If I can just squeeze one last one in. As you mentioned, the expense in the consulting agreement with Jerry Greenberg, can you guys make any comments in terms of the stock sales you have been seeing here? I guess Greenberg, can you guys make any comments in terms of stock sales you've been seeing, I guess, since probably early summer, from Jerry and Stuart;;;I just …we’ve… been getting lot of questions from investors in terms of a nature of the sales. Is there any intent in sight there, or anything Sapient can do at a corporate level to try and mitigate some of the impact under the shares the hitting the open market on a regular basis?

Alan Herrick

Obviously, I'm not privy to their plan. All I can say from everything, we believe that we'll to continue to have large additions in Sapient going forward. As to the nature of the sale, I think, again, not specifically for them, but one of the things involved Gerry's consulting agreement, and Stuart's additions with. Before they were both subject to inside information, and as with inside information is, it's kind of stronger partner you can plan for but when you are actually going to get some right now, I think that was part of the challenge and in generally I think that's the reason people set up10b1 plans because they don't know when they're going to be subject to insider information, I think that, in general, that's why people use those vehicles, and I'm not going to comment specifically on them.

Jason Kupferberg - UBS

Okay, thanks.

Alan Herrick

Thanks.

Mindy Kohl

Okay, we're going to have time for one more question please. We are running over a little bit, so we'll have one more question.

Operator

And your last question does come from the line of Ashwin Shirvaikar, with Citigroup. Please proceed.

Ashwin Shirvaikar - Citigroup

All right, thank you. As good revenue performance in the quarter, but I’m little bit concerned about, on the one hand you have bullish comments about your pipeline, but then I look at the sequential revenue growth rate that you are projecting in Q4 and that's its fairly low. So could you parse out, what is leading to that expectation, is it just maybe some pull forward into because of strong Q3 or fewer billing days or macro economic factors is cautioned conservatism. What is it and if you could…

Mindy Kohl

I think you may just have great choices there, Ashwin, but I think Q4, I think you can look that historically for us there is seasonality in Q4, which simply said as 50% of our business is time and material, and we have got lot of people who go on vacation in Q4 which usually leads a to less billings especially in the last couple of weeks of December, which leads to softer revenue in Q4. So, it's a seasonal affect. I think you will find that historically and that's obviously built into our Q4 guidance.

Ashwin Shirvaikar - Citigroup

Okay. So it's not a factor, if you are looking at discretionary versus non-discretionary may be it’s sort of a reputation of a team, you probably heard on this call, but if you could talk about, as you look at Consulting versus Interactive, how do you think of the discretionary versus non-discretionary aspects of what you offer?

Joe Tibbetts

Yeah, that's a good question. Discretionary versus non-discretionary is fairly subjective because it's hard to understand what's non-discretionary. Some people would argue and support what’s non-discretionary. Fair, but then I would argue with who…with an outside company, or to some people? So, it's hard to judge that. So, a couple of things we look to is, one, we got great performance on our recurring revenue. So our relationships that are plus one year or lose it roughly 40% of our revenue. We think that's a great addition -- in the diversification of our portfolio, or the stability of our portfolio. And then on the Interactive side, obviously, talking about, we think that's very measurable channel that probably when people are really looking at where to spend money. What matters is that's a great area, then, because you can actually understand its return and its performance. And on the Consulting side, I think I tried to illustrate that by trying to give you some examples of the type of work we do, but we really focus on lot of core improvement work and a lot of real revenue, new revenue, opportunity work which would really help in companies trying to find the next level of growth for themselves, and I think those things, typically, you know, do better when you are looking at where you might cut or not cut expense. So that is a just a comment I have. I think we would stand if a set of things or eventualities ever happen, I feel like we got a really good stock, we got a good mix. We got some solid diversification both discretionary and non-discretionary, specifically the hard thing to comment on.

Ashwin Shirvaikar - Citigroup

Okay. Great. This is good call. Thanks.

Joe Tibbetts

Thanks, Ashwin, I appreciate it.

Mindy Kohl

Well, thank you, operator. With that we'll wrap it up. And just, again, we are very pleased, and thanks very much for joining the call. Tremendous top line growth, solid, solid progress on operating profit, cash flows. DSO down to 60, recurring revenue up to 40%, and again record win rates again in Q3 for us, which we think, yes we are competitively sharp and continue to be so I think that's a function of our value proposition, a function of how fast we set in the market, and look forward to continuing to come through on what we said we do from here. So again, thanks for joining. Now, we'll wrap our call for tonight.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. That concludes the presentation. You may now disconnect. Have a good day.

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Source: Sapient Q3 2007 Earnings Call Transcript
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