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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 SapientThird Quarter 2007 Earnings Call. My name is Amanda and I'll be your operatorfor today. At this time all participants are in a listen-only mode. We willconduct 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 KohlDirector, Investor Relations. Please proceed, Ma'am.

Mindy Kohl

Thanks very much, Amanda. Good evening everybody. I'd liketo take this time to remind you that some of the matters that we will discusson this call are considered to be forward-looking statements, as defined by theSEC. These forward-looking statements are subject to known and unknown risksand uncertainties that could cause our actual results to differ materially fromthose expressed or implied by such statements. We have described some of theseknown risks and uncertainties in today's press release and in our annual andquarterly SEC filings, which we strongly encourage you to read. Theforward-looking statements included in this call represent the Company's viewsas of November 8, 2007. Sapient disclaims any obligation to update thesestatements to reflect future events or circumstances.

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

Alan Herrick

Alright, thanks, Mindy and thank you everybody for joiningthe call today. I am going to start with press release highlights, give you anoverview of Q3, give you a people update, and then we'll do a little steppingback and give you a strategy, an overall update for Sapient. A brief update onJerry Greenberg, and then I'll hand it over to Joe to walk you through thefinancials, give you an update on our hedging strategy, as well as our G&Aimprovements, 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 releasehighlights. 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 constantcurrency.

Non-GAAP income from operations totaled $12.5 million, whichis 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% ofservice revenue in Q3 '06.

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

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

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

Growthand 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 forus 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 NorthAmerican performance as having very strong new sales activity, great win ratesand improvement in utilization which I’ll speak about later, and we continue tosee 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 nationalbusiness-to-business retailer. We are helping re-architect their e-Commerceplatform design to improve user experience, allow sales and marketing teamsmore integrated access to customer data, in order to continue to drive saleswhile maintaining a focus on cost. And this is just a simple and great exampleof how our creative skills, our business consulting skills, and our technology andprogram management skills come together to create a unique value propositionfor our client and great results.

As you may have also seen, we released a new version ofBridgeTrack, 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 worldlargest owned and operated self storage facilities, as purchase BridgeTracking context of a broaderrelationship with the patient. The other one GE money is using BridgeTrack togrow its online business in the Americas.They are leveraging BridgeTrack to improve their results with additionalmarketing campaigns. BridgeTrack also gives them a media snapshot of ongoingcampaign results. They can make changes and improvements during the earliestand most critical phases. And Sapient is also giving GE Money better leverageto use its multiple online channels, while simplifying its overall interactivemarketing delivery. So, North America Q4, we do expect our outlook for North America to be up in Q4.

Switching to Europe, 31% ofour revenues in Q3 or $43.7 million, our revenue is up 57% year-over-year and15% quarter-over-quarter. In constant currency, Europeis up 46%, year-over-year and 13% quarter-over-quarter. We are not allowed to say here other than just faroutstanding performance by our team in Europe.We are sitting in a good market and we’re sitting on the right path and we’rewinning, and year-over-year Europe has built very strong, with business, morethan doubled its portfolio with major clients, and let me give you a little bitof a feel for some of the new wins in Europe, on both the consulting side ofour business and interactive.

Let’s start with the UK Department of Health. The Departmentof 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 stilllots of (inaudible) across IT while lowering their overall IT cost andincreasing their efficiencies and effectiveness. So in Q3 we beganworking with a number of organizations, also affiliated with the Department of Health,including the prescription pricing division, healthcare commission. We alsostarted working with thenew health care regulatory body, Healthcare to help them define their ITstrategy.

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

We alsohave a nice win with Sky News, and are in a process of building whatwould be the UK'ssecond largest news site, one of Sky's most strategic initiatives, whichprovide 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 adcampaign for their new game World of Warcraft; a win with DeBeers, helping themwith online corporate communication strategy and execution, and finallySportingbet, we becametheir online agency of record, focusing on producing a step change in theircustomer experience. So, for Europe ouroutlook 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 acouple of wins for our government service scheme, one is we've extended workwith the Library of Congress, and this work is really to support their newvisitor experience and really looking at re-launching the public face of theinstitution with a new experience for visitors, both on-site and online at the Libraryof Congress.

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

Switching to people update; ending people count for Q3 was5,857, 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, theoverall utilization rate may not tell the story and effective utilization in Q3was very strong, with strong utilization from North America, but overallutilization was down due to increased number of trainees in India and youmay ask, did we see a profit improvement from utilization? In fact, we did. Wesaw gross margin improvement due to utilization and some of those improvementswere offset by seasonal wage increases which probably, as you do know, we dohistorically take in Q3.

I would also like to mention some recognition for us and ourpeople. Overall, we've been named as one of the 50 best places to work in UK, top 100 best places to work in Europe, top100 Best Employer in Canada,Toronto’s Top 15 players and then just veryrecently we just won best companies to work for in India. We moved up to number 4 onthe list, we were number 5 last year in Business Today, as foreign visits havepointed out that this is for all companies in India, not just consultingcompanies or agencies.

With that, let me try to move into the strategy update andgive you a little more of a top down view of where we are going from here. Andas I've said before, we have a highly differentiated value proposition, andstrategically we are in a great spot and we continue to believe that we are ina great spot in having both the interactive and consulting capabilities that wehave to offer to the market. And really the easy way to think about it is twocomplimentary businesses leveraging the same shared platform for globaldelivery 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 peoplefrom both the Interactive side and the Consulting side.

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

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

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

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

Our consulting business, if you think about it, is focused infour key industries; energy services, financial services, communication, healthcare and government. We really provide that package of services primarily tothese four industries. Now, I am just going to give you some quick highlights insome 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 gassegment as well as the utility segment. To give you a quick example, we are helpingutilities improve their customer service level through better scheduling andmanagement of their skilled forces, helping them to integrate their customerservice, work management, order dispatch and work completion processes to lowertheir cost of service while better or improving their customer service. And ofcourse, as you do know, our CRM business is a subset of our energy business, focusedon commodities, management and scheduling.

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

We also work withseveral clients to provide services in the area of custody, cash management andtransaction processing, through the financial services industry. And thesecases were primarily during planning, application, design, and development andmaintenance cost. Our depth in financial services goes beyondtraditional privately held and publicly traded firms, as for example, we have strong relationshipswith government and quasi-governmental agencies for work-on-engagements rangingfrom critical systems development to more traditional business analysis.And finally, as you are aware, our TRM practice, and its focus on coreimprovements in trading operations.

Moving on to our communications business, the majority ofour 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 andcustomer ticket management. We are also deploying all of our services to thecommunications industry.

And finally, healthcare and government, I'll just give oneexample there that’s indicative; the Department of Homeland Security; severalhighly visible engagements,surround efforts to modernize and transform the United States ImmigrationSystem. This workencompasses all aspects of Sapient consulting services, business consulting,program management, business development. Also to note our work with HomelandSecurity also does entail interactive services, as well. So to give you somecolor on the content and the structure of our services and how they lay outacross the primary industries they serve on our consulting a side.

And let me switch to our financial strategy. We made goodprogress financially year-over-year and I want to give you a recap of those non-GAAPnumbers 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 oursales and marketing investment by 88 basis points, resulting in a net operatingimprovement, or increase of 350 basis points. We also had a great improvementin our DSO, which improved to 62 days versus 83 days in Q3 '07. We alsogenerated cash flow from operations of $38.7 million.

Now, I wanted to give you an update on our roadmap of 13% to16% 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 primarilypricing and improving our effective utilization. G&A from here forwardexpecting another 150 to 220 basis points for the improvement. Sales cost 25 to50 basis points of improvement from here forward. Overall this remainsconsistent with our 13% to 16% guidance exiting 2008, and I think we've madebig progress across the board in doing what we said we would do, and now welook forward to continuing that through Q4 and the balance of '08.

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

So, the quick summary, top to bottom, this was a solidquarter for us. We are very pleased with all the hard work that the entire teamhas put in to making this happen. There has been great execution for us and asolid 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 $38.7million. Recurring revenues also moved up strongly to 40% of revenue Win ratescontinue to show that we have a tremendous value proposition; we arecompetitively very sharp in any situation.

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

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

Joe Tibbetts

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

On the revenue side, as Alan mentioned at the beginning ofthe call, consolidated service revenues for Q3 were $141.6 million. That’s anincrease of more than 32% for the same period a year ago, a 10% increase fromQ2. 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 strongcontinued perform in the financial services, technology, and communicationsectors. The industry breakdown is the financial services represented 29% ofour total revenue in the quarter. Technology and communications was 24%,consumer and travel was 19%, energy services was 12%, government health andeducation was more than 14%, and industrial was 2%.

Moving on to recurring revenue, which includes revenuecommitment to one year and more, and which the client has committed spendinglevels to or has chosen us an exclusive provider of certain services. This was40% in the quarter, which is up from 36% last year and 33% a year ago.

The percentage of service revenue coming from top fiveclients 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 lowerpercentage of our revenue in this quarter, revenues from them did increase onabsolute dollar basis or quarter-over-quarter basis. Q3 revenue was split about50-50 between fixed price contracts,T&M contract.

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

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

Total stock-based compensation expenses for Q3 were $5million versus $4.7 million in Q2. Just as a note, included in this amount isthe new Indian Corporate Fringe Benefit Tax on stock-based compensation. Youmight have heard about this from other companies. This quarter there wasapproximately $500,000 of that expense. Going forward, this tax is not expectedto be material to us at any given quarter. For example, for 2008, we estimatethat 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, ourguidance for stock-based comp for Q3 didn't include the fringe-benefit tax, inlight 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 youfor Q3.

Like most companies in the industry, we expect to pass thiscompensation tax back to the employees respectively. As you may know, US GAAPaccounting considers the pass-through to employees as an additional exerciseprice unfortunately and not as an offset to the expense. That accountingtreatment is currently under evaluation by accounting professionals. So we willstay tuned to see if that turns out differently and if there is also someamount of hope that the Indian government will actually change the law to makeit a withholding obligation for companies, as opposed to actually having thecompanies as the primary obligor for the tax.

Restructuring and other related expenses represented a smallgain this quarter of $35,000 and that compared to similar net gain last quarterof $57,000. Our non GAAP operating profit for Q3 was $12.5 million, 8.8% as wesaid, and represented another quarter of improved profitability. That comparesto $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% ofrevenue. That compared to $1.4 million or 1.1% of revenue last quarter and inQ3 2006 we actually reported a GAAP loss from operations of $2.6 million.

Turning to foreign currency gains and losses, as anticipatedon our last earnings call, we analyzed our currency exposures, which for us, isseveral currencies, but primarily the Indian Rupee -- well we have rupeedenominated expenses and some of the other currencies, in fact in all of theother currencies we have some natural hedging where we also have foreigncurrency revenue.

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

And then secondly in Q4 we began utilizing some thresholdhedging, the women’s translation risk to the rupee. We have monthly zero costcallers in place for 90 days forward, and then we may extend this program inthe future for longer periods as we go forward. While these steps obviously donot eliminate all currency risks, we believe that they will greatly reduce ourexposure 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 netforeign currency transaction loss of 115,000 that compares to a foreigncurrency transaction last quarter of 915,000. And our practice clearly -- apractice of more timely settlement of inter company and other foreign currencybase receivables and payables clearly reduced the negative impact from thecontinuing 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 youmay recall that Q2 compared to Q1 was a $1.1 million loss.

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

Income taxes. The income tax provision in Q3 was $3.7million. That’s an effective tax rate on income from continuing operations of46%. The lower effective rate for Q3 versus Q2 is the result of the change ofour 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 annualprofit, and as you know, our rate is pretty sensitive to these kinds ofchanges.

The quarter's provision also includes the charge for thisquarter for changes in the German and UK. tax rate, which will change in2008, but was recorded this quarter to re-value our differed tax assetsrelating to those countries. And then, we also caught up the effective tax ratefor 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 webooked this quarter, is now 38% for the year.

Income from continuing operations -- the Q3 non-GAAP incomefrom continuing operations was $10.3 million. That compares to $9.4 million inQ2 and $9 million in Q3 of last year. Non-GAAP dilutive earnings per share continuing operationswere at $0.08 per share in Q3 versus $0.07 in Q2 and $0.07 a year ago. The GAAPincome 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 operationswere $0.03 this quarter, $0.01 last quarter and $0.01 a year ago. Weightedaverage common shares for the third quarter were 124.875 shares on basic basisand on a diluted basis there were 128.314 shares.

Switching quickly over to the balance sheet; cash andmarketable securities increased significantly to just under $146 million at theend of Q3 from $109 million at the end of Q2. The company generated cash fromoperations of just under $39 million during the quarter, obviously a dramaticincrease from $5.8 million in Q2 and approximately $15 million a year ago. Andour strong focus on collections across the company really paid off thisquarter.

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

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 thesecond quarter of -- this past quarter or second quarter and 83 days a yearago. The majority of this improvement are attributable to operationalimprovement, which we implemented with respect of accounts receivable collections and also reflectssome favorable contract channel with respect to payment schedule and obviouslywe are very pleased to return DSO this quarter to well under our targeted levelof fewer than 70 days.

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

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

Several other data points we wanted to leave you with,expenses for outside services relating to the restatement are expected tocontinue at above the $500,000 level that relates to ongoing tax with legalwork, obviously we don't want to be accounted for the reinstatement. Stockbased compensation expenses are expected to be just over $5 million. They areapproximately $5.1 million in Q4 and this number includes the new India fringe-benefittax on stock compensation, as I mentioned it will not be going into -- notexpected to be material in Q4 or to be well under 100,000, probably more like50,000 included in that number.

The effective income tax-rate is expected to beapproximately 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 $3million to $5 million for Q4. Anticipating some questions about our tax expensepicture in 2008 and beyond, I am going to hit on that now. While we aregenerally not going to give guidance past Q4, I will say that we expect oureffective tax rate to be lower in 2008 then in 2007. As we generate income inthe USand have the opportunity to utilize our NOLs with provision.

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

In 2009, just to sort of go out, because of the anticipatedchanges in the Indian tax law, unless the Indian law changes to extend SPPIbenefit that we are currently enjoying, we will loose the partial tax holidaybenefits under that program in Q2 of 2009. So it gives us some perspective onthat benefit, in our case it’s running about $2.5 million of tax that we don'thave to pay on an annual basis.

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

So, as a result while it’s obviously a long way out andsubject to several key variables, I would say that we expect our 2009 effectivetax rate to stay in about the 25% to 30% range. So, lastly as per outstandingshares, 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 increaseoutstanding weighted average shares by about a net 2 million or so by the endof 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 veryhappy 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 opportunityset in front of us and a great opportunity to execute and continue to parallellygrow, but also improve our profit position in line with my guidance.

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

Question-and-AnswerSession

Operator

(Operator Instructions)

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

Andrew Steinerman -Bear Stearns

Hi, there. I just thought if you were reviewing theaccomplishment of G&A being below 20%, for the first time in the corporatehistory, 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 efficientbefore, and why we should believe that there is kind of more efficiencies tocome pass will, that'sbeen achieved already?

Joe Tibbetts

Well, Andrew…hi, it's Joe. Thanks for taking up thatquestion, because I think it's an important aspect to what will enable us toaccomplish and what we see going forward, So if you look at this quarter wejust have been through versus the same quarter a year ago, end up about 400basis points better in G&A. Let me take out the non-GAAP stuff, which isincluded 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 reallyable to knock out a bunch of spending in G&A, relative to our revenuegrowth. And if we sit back and look at where that came from, we clearly have anumber of things around the things we've said we would do, which is to saylooking at our processes and building more efficiencies into the things that wehave to do in order to -- that we do in our G&A world so, also processingpayables and receivables and payroll and expenses and all those sort oftransactions throughout. Looking at how we procure stuff, and the vendors thatwe are procuring from, and how we are going about doing that, and controllingour spending…

We've standardized a lot more of how we do things, and howwe do business with clients -- so that does makes it less complicated andeasier for all of those processes throughout. We've done things to our systems;we got away if wego with that, so we've done a number of things to our systems to helptransaction handling. We put more accountability into the system, and peoplehave 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, Ithink as Alan said, we are visible to another 200 to 250 basis points to groundin 2008 over the next four quarters. It's essentially more of the same, so itslots of -- doing all things I just rattled off. More of, we think in the ITarea there is more opportunity for productivity and systems improvements thatwill match up better -- match our systems better with the way we do businessand how we now operate. We think there is room for improvements in our staffingprocesses that we can do which will help and then further scale. So we do thinkwe can get to those kinds of numbers.

Andrew Steinerman -Bear Stearns

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

Joe Tibbetts

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

Andrew Steinerman -Bear Stearns

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

Joe Tibbetts

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

Andrew Steinerman -Bear Stearns

Yeah.

Alan Herrick

And did, again, in Q3. Having said that,Ttis is AlanHerrick. 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 haveeverybody be told to sit in their seat and act more efficiently and be able tocontribute more to the business. There certainly has been some amount ofinvoluntary and voluntary turnover as a result of the processes, but I -- thatisn’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 Grossmanwith 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 plusesand minuses on the gross margin sequentially. You mentioned that utilizationand a couple of other factors, and I was wondering if you could kind of breakthat 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. Ongross margin, try improvement and utilization due to better improvement in North America. So that contributed most of the grossmargin. On the plus side then probably a (thick) or so appraising now startedto 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 thatcomes on the minus side.

Joe Tibbetts

So on the rupee side, the numbers were transaction losses of115,000 andtranslation 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 Europewhen everybody on that side of the pond seems to be on vacation for half of thequarter?

Mindy Kohl

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

Rod Bourgeois –Bernstein

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

Joe Tibbetts

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

Rod Bourgeois -Bernstein

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

Joe Tibbetts

Absolutely.

Rod Bourgeois -Bernstein

Okay. And then, the other question here, and if you look atwhat’s happening on Wall Street right now, this is the obvious question thatwould be helpful to get your perspective on, are you seeing a slowdownparticularly in the U.S. financial services vertical, and then specifically ifyou can comment on whether you are seeing the absence of sort of normalyear-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 onthat front. When I say, 4Q-- Q4 - for us and what we look at, we do expect financial services to continueto grow quarter-over-quarter for us in Q4. So, it’s all positive when you lookat [archives] and the set of opportunities, it’s difficult in front of us asfar as the way that we measure and look at the business. The opportunities arethere 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 helpsour visibilities. Well, we sit in a very big spot in financial services, but weare very differentiated, we got a lot of focus on core improvements in thebusiness and a big part of that is focused on core training for improvementsand 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, weare seeing, capital moving to commodities right now, which bodes well for ourbusiness, because we've got a big history in energy and financial services andin 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, welike that part of the idea.

On the interactive side again, I think that based on anyparticular company, and ifyou're foster child or not, things could yin and yang on you, but dobelieve that clients will all continue to spend on acquisition of new customerson the interactive side, over the balance of whatever period that you arelooking at, because you are looking at revenue growth opportunities for clientson that side.

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

Joe Tibbetts

Which to my view, is.

Rod Bourgeois -Bernstein

Okay. And just to clarify that, if you look outside of thecommodity trading portion of your business in financial services, andparticularly when you look at the sort of normal consulting work you do, thetraditional consulting work you do for a capital market-related client, are youseeing any issues in that pipeline, any hesitation, any push-outs, any budgetcuts, 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 Quinteroswith Goldman Sachs. Please proceed.

Vincent Nguye -Goldman Sachs

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

Joe Tibbetts

Thanks for that question. I don't really think I see it asthe forecast for Q4; we really try to give you some sense of what we did forQ4. Deferred revenue balance is very much a function of specific accounts thatwe have and specific contracts we have and where we are with revenuerecognition of those contract, the timing of which depends on whether it’s afixed price contract or [inaudible] and just how we hit. So I don't really seeanything 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, anyprojection 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 sayingthat overtime we like to have our number continue to hit below 70, so thisquarter may not be sustainable at 62; there is, at least, one item in therethat helps a fair amountof not materially its still in the number of 70, but I think theguidance that we have given, I think, just keep number sort of under 70 that issuccessful place for us, and we'll make that better over time, hopefully. Butright now, that's what we are. As far cash flow from operations, I think we hadspectacular quarter, obviously, and it reflected a lot effort and a lot ofclean up in our books, and balances that we got through the door. I think goingforward in Q4 we are looking at probably in the order of magnitude of about $10million in cash flow from operations, the number could actually bit more higherthan 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 Kupferbergwith UBS. Please proceed.

Jason Kupferberg -UBS

Thanks and good afternoon guys. Sort of a big picturequestion, it seems like in this quarter a lot of stars aligned for Sapientutilization, G&A, the tax rate, the OpEx and lot of stuff really went yourway, to your credit, this quarter. My question is, what's your comfort levelthat all of these factors can continue representing areas of continuedimprovement for you, as opposed to, hey look, just a few things broke our waythis quarter, so we had some great result, but there is still some variabilityhere. Just want to get a sense of kind of the sustainability of these trendsthat you guys try and produce more consistent quarterly performance goingforward?

Alan Herrick

Well, we both have something to say about this Jason, but Ihate to characterize it that the stars aligned, because it makes to sound likea random event that we used to have influence over. We clearly have beenfocused a lot more on the good side of business post three statement and we've had an opportunityfor some of the efforts that we have been putting in place over -- even longerperiod than that just this so -- I think, you know, when you talk, I think Iaddressed pretty clearly where we got the G&A and where we think that'sgoing, so I think that’s sustainable. I think some of the margin improvementsreally reflect a lot of the -- I’ll leave that for Alan to address in moredetail. But I think it clearly reflects the focus on that area. The cash flowwas absolutely a really strong effort on the part of the whole business to takethat seriously and get us really in a great position there. You need to keepthat momentum going forward, and we intend to do that. So, I think the thingsdid work for us. Even the currency, we took very proactive steps around managingthe transaction part of it, the rupee lost another 2% on the spot rate in thequarter, and you know that didn’t hit us to hard, right. So, I think it clearlyreflects that we have been on top of those balances both restatement and getthose straight enough. So, I think its real stuff that we deserve but, we’renot just start to lining up.

Alan Herrick

Well, I agree, as well. I think that's well played. And Iguess the only thing I would add, in the follow-on to Joe’s comment about postrupee 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 structureas a percent of revenue, but additionally, one thing, I think if you go back acouple of quarters, we talked a lotabout -- we need to bring in increased predictability to our business, and partof that is to have a more reliable processes. That’s part of how you driveincreased predictability to business, and I think we have put in a lot of hardwork there, whether you are looking atthe gross margin side, or are you looking at the G&A side, I think youstart to see some of the early parts of returns now. And I think, we arepleased with that. We’ve got a lot more work to do, and we think we've got agood 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 justcomment a little bit looking ahead here, understanding that you are not seeingany slowdown at this point, but your general confidence level in kind offorward 12 months visibility just in qualitative terms, now, versus how youfelt at this time of the year over, let’s say, the last few years. Can youcharacterize any new answers or differences, and kind of how you are thinkingabout things and what the level of uncertainty out there is?

Alan Herrick

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

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

Jason Kupferberg -UBS

Okay, that’s fair enough. If I can just squeeze one last onein. 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 seeinghere? I guess Greenberg, can you guys make any comments in terms of stock salesyou've been seeing, I guess, since probably early summer, from Jerry andStuart;;;I just …we’ve… been getting lot of questions from investors in termsof a nature of the sales. Is there any intent in sight there, or anything Sapientcan do at a corporate level to try and mitigate some of the impact under theshares the hitting the open market on a regular basis?

Alan Herrick

Obviously, I'm not privy to their plan. All I can say fromeverything, we believe that we'll to continue to have large additions inSapient going forward. As to the nature of the sale, I think, again, notspecifically for them, but one of the things involved Gerry's consultingagreement, and Stuart'sadditions with. Before they were both subject to inside information, and as with inside informationis, it's kind of stronger partner you can plan for but when you are actuallygoing to get some right now, I think that was part of the challenge andin generally I think that's the reason people set up10b1 plans because theydon't know when they're going to be subject to insider information, I thinkthat, in general, that's why people use those vehicles, and I'm not going tocomment 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 AshwinShirvaikar, with Citigroup. Please proceed.

Ashwin Shirvaikar -Citigroup

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

Mindy Kohl

I think you may just have great choices there, Ashwin, but Ithink Q4, I think you can look that historically for us there is seasonality inQ4, which simply said as 50% of our business is time and material, and we havegot lot of people who go on vacation in Q4 which usually leads a to lessbillings especially in the last couple of weeks of December, which leads tosofter revenue in Q4. So, it's a seasonal affect. I think you will find thathistorically and that's obviously built into our Q4 guidance.

Ashwin Shirvaikar - Citigroup

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

Joe Tibbetts

Yeah, that's a good question. Discretionary versusnon-discretionary is fairly subjective because it's hard to understand what'snon-discretionary. Some people would argue and support what’snon-discretionary. Fair, but then I would argue with who…with an outsidecompany, or to some people? So, it's hard to judge that. So, a couple of thingswe look to is, one, we got great performance on our recurring revenue. So our relationships that areplus one year or lose it roughly 40% of our revenue. We think that's agreat addition -- in the diversification of our portfolio, or the stability ofour portfolio. And then on the Interactive side, obviously, talking about, wethink that's very measurable channel that probably when people are reallylooking at where to spend money. What matters is that's a great area, then, becauseyou can actually understand its return and its performance. And on theConsulting side, I think I tried to illustrate that by trying to give you someexamples of the type of work we do, but we really focus on lot of coreimprovement work and a lot of real revenue, new revenue, opportunity work whichwould really help in companies trying to find the next level of growth forthemselves, and I think those things, typically, you know, do better when youare 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 aset of things or eventualities ever happen, I feel like we got a reallygood stock, we got a good mix. We got some solid diversification bothdiscretionary 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. Andjust, again, we are very pleased, and thanks very much for joining the call.Tremendous top line growth, solid, solid progress on operating profit, cashflows. DSO down to 60, recurring revenue up to 40%, and again record win ratesagain in Q3 for us, which we think, yes we are competitively sharp and continueto be so I think that's a function of our value proposition, a function of howfast we set in the market, and look forward to continuing to come through onwhat we said we do from here. So again, thanks for joining. Now, we'll wrap ourcall for tonight.

Operator

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

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