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Sapient Corporation (NASDAQ:SAPE)

Q4 2007 Earnings Call

February 28, 2008 5:00 pm ET

Executives

Gail Scibelli - Vice President of Corporate Communications

Alan Herrick - President and Chief Executive Officer

Joe Tibbetts - Senior Vice President and Chief Financial Officer

Analysts

Rod Bourgeois - Sanford C. Bernstein & Co.

Jason Kupferberg – UBS

Mark Marostica - Piper Jaffray

David Grossman - Thomas Weisel

Andrew Steinerman - Bear Stearns

Operator

Welcome to the Q4 2007 Sapient earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call Ms. Gail Scibelli, Vice President of Corporate Communications.

Gail Scibelli

I would like to take the time to remind you that some of the matters 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 those 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 on February 28, 2008. Sapient disclaims any obligation to update these statements to reflect future events or circumstances.

Thank you for joining today’s call. And now, I would like to turn the call over to our CEO, Alan Herrick.

Alan Herrick

Thanks everybody for joining our Q4 call. We’ve got a lot of information to go through today, so let me give you the quick agenda and cover of press release highlights, give you an overview of Q4 and 2000 performance annually, take you through BU performance quickly, a people update, make some comments about the market and ‘08 guidance.

I’m going to update you on our roadmap to 13% to 16% as exit rate for 2008 then I will hand it over to Joe to walk you through the financials and more details on our guidance for ‘08. So, with that let me start with press release highlights.

Service revenues $155 million, up by 36% year-over-year, 32% in constant currency and up 9.4% sequentially or 8% in constant currency. Non-GAAP income from operations $16.3 million, which is 10.5% operating margin for Q4 represents a 70% increase from $9.6 million in Q4 ‘06.

GAAP income from operations $10.4 million compared to GAAP income from operations of $500,000 in Q4 ‘06. Non-GAAP diluted income per share from continuing operations was $0.12, up significantly from $0.06 in Q4 ‘06. GAAP diluted income per share from continuing operations for the quarter was $0.07, increased from a loss of $0.01 per share in Q4 ‘06, operating cash flows of $31.7 million in Q4.

So, let me move quickly to the year and then I will make some comments on Q4 and the year in total. Our revenue growth for the year at 35% year-over-year 32% in constant currency as we finished at $546 million, we experienced the highest win rates in our history. Non-GAAP operating profit up 104% year-over-year. G&A as a percent of revenue on a non-GAAP basis down 400 basis points year-over-year. People growth up 26%. Turnover down to 18% from 23% in 2006. Significant improvement in our DSO as well as cash flow from operations $58.2 million, up from $18.2 million last year.

So, overall for the year and Q4, I am very pleased with where we are, very pleased with how we finished, strong quarter across-the-board for us obviously and strong progress year-over-year. Top line growth excellent, strong cash flow, solid margin expansion. We are on track where we wanted to be as we start 2008.

Before we keep going, I just want to take a moment to recognize and thank everyone at Sapient. This was obviously a tremendous team effort and our people have incredible passion for our company and I think you can see that in the progress that we demonstrated here today.

Sapient continues to benefit from a distinctive value proposition in the market. As I said, we saw tremendous win rates in 2007 and we sustained those in Q4. We also continued to be very sharp in competitive situations. Our value proposition, which is really based on very high levels of accountability, a unique blend of skills with interactive and consulting and a very passionate culture continue to differentiate us.

Great top line growth and we see good strength across the board and we are positioned in two large and growing markets in both interactive and consulting. And as I said on the last call, I said we thought we would see some expansion in interactive in Q4 and as you know, it had been running approximately 40% throughout the year.

And we did telegraph that we hoped to see some expansion in Q4 and we did in fact realize significant expansion in interactive, which gained meaningful share, and now sits north of 45% of revenue for Sapient. And let me break down the interactive number for you, to at least give you a better feel for what we classify as interactive. I am going to take you through five broad categories of services that help you understand how we get at that 45%.

So category one is Media Services, which includes paid search, paid media and standalone SEO engagements. The second category is Marketing Services, which really includes integrated marketing campaigns, marketing strategy and marketing analytics. The third category is BridgeTrack, which we talked about previously, but that really includes e-mail, ad serving, landing page subscription fees, database hosting fees.

Fourth category is experience designed for integrated digital channels where this might be really designing an experience either on the web, mobile kiosk or in some cases across all those channels, but really looking at multi-channel integration and how you design the right experience and the right brand experience for our clients.

So really inside that category we have strategy and creative services for design and implementation. We have also creative services that usually are part of larger programs of technology and strategy or can grow into where you actually have a larger belly on the work, if you will.

The fifth category is e-Commerce, which is really helping our clients transact online sales and service with their clients. So it is a high-level, five categories Media Services, Marketing Services, BridgeTrack, Experience Design for integrated digital channels, and the fifth category being e-Commerce.

Let me review overall the Q4 improvements and just give you the highlights on the improvement numbers Q4 versus Q3. Gross margin up 30 bps, impact of better pricing. Utilization down a bit in Q4 as expected in usually a seasonally softer quarter for utilization. G&A decrease 90 bps to 18.3%, which does set a new low for Sapient historically from 19.2% of revenues in Q3.

Sales and marketing also decreased 50 basis points, which is really due to us catching up with some of the investments. I think a quarter or two ago I said we were making investments on the interactive side of our business, which was in business development as well as investments in BridgeTrack and other parts of interactive.

Well, we have got some of those investments on board and now you’re beginning to see that work for us and obviously the tremendous revenue progress we have, as well as the reduction in sales and marketing as a percent of revenue.

Also, demonstrated strong progress on key operational metrics DSO, which went from 62 to 57 days, which is also a historical low for Sapient. Recurring revenue increased to 44%, up from 40% in Q3.

And in summary just an excellent quarter for us. We are in great position; we are on track and where we want to be at this point. And let me give you some quick highlights on the BUs and then we will get into market outlook. North America 63% of revenues in Q4 at $98 million. Revenues up 24% year-over-year, 7% quarter-over-quarter, constant currency 21% year-over-year, and 6% quarter-over-quarter.

I want to give you a couple of examples. I highlighted Europe more on the last call, I want to highlight some of the examples of the kind of work we are doing in North America so you get a good feel for the texture of the kind of problems and solutions we are involved in.

And start with some key wins on the interactive side, Scripps Network, which is the home of leading lifestyle brands including HGTV, Food Network, DIY Network, Fine Living and Great American Country. We are designing an innovative social media experience across all of Scripps Network of online properties, and we are redesigning their popular HGTV website.

We had also a win with AP, the Associated Press, which I’m sure as you know is the largest news organization in the world, serving thousands of newspapers, radio, TV and online customers. As their creative agency, we will enhance their ability to deliver digital news media and services quickly and easily to customers.

And the final one I’ve highlighted on the interactive side is Virgin Charter as their agency of record we’ve launched a new brand site for Virgin Charter that will go March 3. This site will provide a new way to book private jet charter flights.

Switch over to our Q4 key wins on the consulting side, our TRM practice major win with a super major integrated oil firm and to help them manage their trading activity by using our value at risk techniques. We have also been working with one of the world’s largest investment banks, to drive alignment around their business decisions and create a business process and IT strategy that will ultimately transform their commodity trading business. That was also a new win for us in Q4.

Switching to Europe, 33% of revenues in Q4 or $51 million. Revenue up 63% year-over-year, 16% sequential. In constant currency, Europe up 52% year-over-year and 13% quarter-over-quarter and just such an outstanding job done by the European team. What a tremendous year, we see great strength going forward in Europe and we’ve built a strong foundation of accounts and clients and feel like we’ve got a great base to keep going and building off of.

I would highlight just a couple of very quick wins in Europe. Scandic Hotels, largest hotels chain in the Nordic region is a new client of ours. We are creating a new online strategy that will enable Scandic to increase their online bookings by 30% in 2011. We also won an assignment working with De Beers Group to define their online corporate communication strategy and translate their website experience for engaging with stakeholders.

So with that, let me move to government services represented 4% of revenue or $6 million. Revenues up 96% year-over-year and 6% quarter-over-quarter, just highlight one important win for us there where we’ve engaged with the Department of Defense. Their defense digital information directorate, DBI as it’s referred to which is responsible for the intake, quality control and redistribution of thousands of stills and video imagery from U.S. Military operations worldwide. A nice win in Q4 to start work with them.

So with that, let me transition to talking about our people. Ending people count in Q4 was 6,217 people up from 5,857 people in Q3. Net adds of 360 people. Turnover improved significantly to 15.4% compared with 19.9% in Q3 ‘07 and 18.3% in Q4 ‘06. Utilization was 73% compared to 74% in Q3. Strong hiring, utilization was down as was effective utilization but as expected in Q4 due to seasonal impact. Pricing improvements also showed through which I’ll talk more about later.

Let me now move into our ‘08 outlook guidance. What we’re seeing generally in the market right now. So, overall the very top 2008 outlook is very positive for us. We do expect expansion across the board and let me give you a little color on at least what we’re seeing and hearing in our conversations with our clients.

Clearly, it’s been a slower budgeting season. I’d especially highlight slower budgeting in financial services but I’d also highlight now budgets are being put in place. This for us has resulted in a slower January, but then we saw good strength in February as clients started to get underway.

Spending plans on interactive for ‘08 appeared to be very strong from our conversations with clients and our experience so far this year. Channel shift maybe even accelerating into digital. And the shift of dollars coming from offline or from TV and print and radio we believe continued to pick up and obviously the CAGR and the growth rate on that space is significant. And we think that may even be increasing on us and we obviously saw that pick up in Q4.

Consulting and IT spend in areas where there is return or areas where there is revenue growth seem positive and budgets seem to be putting in place now and we are seeing that pickup. Offshoring as a general idea, we see that continuing, if you haven’t done it, you are doing it, if you’ve done it, you may be evolving to more of a capability bias in your offshoring with competitive rates rather than just a low cost idea.

In financial services specifically, we see growth in both our interactive business and our TRM business. I’ve already talked about interactive, as it relates to TRM. We see strong demand for the year, opportunities in commodities, derivatives in addition to growing opportunities that we now see around compliance and risk-management.

Both in our conversations with our clients and stakeholders as well as our fourth quarter pipeline, we see good strength and we have seen a meaningful acceleration in the last seven weeks of our fourth quarter forward pipe, which brings me to guidance for ‘08.

We are guiding revenue to 22% to 25% growth over ’07, non-GAAP operating profit to be 10% or higher. And we think we sit in a great spot in the market right now. We see strong demand for what we do and we need to just continue to execute our game plan on the top and bottom lines.

With that, let me move on to giving you a very short update on our road map to 13% to 16% not a lot of new here which is probably the good news, is we are on track for where we want to be starting off a basis of 10.5% non-GAAP operating margin for Q4.

On a gross margin basis, we see 150 to 370 basis points of expansion that we can gain over the course of ‘08 through effective utilization and continued pricing improvements. On the G&A side, we see 100 to 180 basis points of improvement through continuing use of better processes and better implementation of technology in ‘08.

So in summary, we are very pleased with the outcome in Q4 of cash flow, operating margin, revenue, tremendous expansion on the interactive side for us and we finish strong and right where we want to be as we enter 2008. Q4 was 36% year-over-year on the top line, 32% in constant currency, interactive expansion now north of 45% of revenue, 10.5% non-GAAP operating margin, DSO at 57 days, generated cash from operations of $31.7 million, recurring revenues increased to 44% of revenues.

And as I mentioned at the top, our win rates continue to show that we’re extraordinarily compelling in the market and we think we sit in a unique way in the markets and in two markets that we think have very good growth outlooks not just short-term but long-term. We are in a good position from here forward.

And with that, let me turn it over to Joe to walk you through the financials.

Joe Tibbetts

I am going to take you through a little more detail of the fourth quarter results. As usual, I’ll go on through the P&L and then a little bit on the balance sheet and then I will wrap up with a little more detail on the guidance for both first quarter and fiscal 2008.

So as Alan mentioned at the beginning of the call, consolidated revenue Q4 were $155 million, an increase of more than 36% from the same period a year ago and a 9.4% sequential increase in Q3. On a constant currency basis those numbers were 32% and 8%.

Next, looking at our revenue by industry, we saw a pretty consistent growth across all of our usual industries. Financial services stayed strong and represented 28% of total revenue, and while that’s down a percent from 29% in Q3, it still represented a healthy 7% sequential growth.

Technology and communications stayed consistent at 24% of revenue. Consumer and travel was 18%, down 1%. Energy services grew a percent to 13% of total revenue in the quarter and government, health and education was up a percent to 15% of total revenue. And automotive and industrial stayed at 2% consistently with Q3.

Moving on to recurring revenue, as Alan mentioned, that was 44% in the quarter up from 40% in the prior quarter and 32% last year. Just remind you that includes revenue commitments of one year or more on which the client has committed spending levels to us or has chosen us as an exclusive provider of certain services.

The percentage of service revenues coming from our top five clients in the fourth quarter was 25%, slightly down from 27% on the prior quarter, a little bit down from the 26% a year ago. Our largest client Sprint Nextel was 9.5% of Q4 revenue down only slightly from 9.7% last quarter and Sprint Nextel was 10.2% of revenue for the whole year 2007.

Q4 revenue split was about 50:50 between fixed price contracts and T&M contracts. In comparing Q4 gross margin to the previous quarter, I’m going to refer to all these numbers on a non-GAAP basis as I usually do which we feel are a more accurate reflection of the company’s comparative performance.

Overall fourth-quarter gross margins excluding stock based comp was 34% consistent with Q3 and down from 37% a year ago. Selling and marketing expenses excluding stock based comp were 5% of service revenues compared with 6% in the prior quarter.

And G&A expenses excluding both the stock based comp and then other expenses incurred in connection with the stock based compensation review and restatements that we did during ‘07 continued to improve in Q4 as Alan mentioned, down to 18.3% of revenue as compared to 19.2% in the prior quarter and 23.3% same quarter a year ago. So that was a full 5% improvement from a year ago.

Throughout 2007, we focused on spending levels and on improving our systems and processes in order to increase our operating efficiency and we are very pleased to see this pay off in yet another quarter of improvement in G&A spending.

Our total stock-based compensation expense for the quarter was $4.7 million versus $4.4 million in the prior quarter. Restructuring charges were minor at $236,000 in Q4, compared to a $35,000 benefit in Q3.

On the operating profit line, $16.3 million non-GAAP operating profit, that was 10.5% of revenue, representing another quarter of improved profitability on that line that compared to $12.5 million in Q3, which was 8.8% of revenue and it compared to $9.6 million a year ago, which was 8.4% of revenue.

GAAP operating profit $10.4 million, 6.7% of revenue. Last quarter it was $6.6 million or 4.6% of revenue, and last year it was just a small operating profit of $511,000 on a GAAP basis.

The foreign currency activity this quarter was largely neutral on a net basis for us. Transaction gains were largely offset by translation losses compared to Q3. So specifically foreign currency transactions netted to a gain of about $450,000 in the quarter, those are included in G&A expenses. And this compared to a foreign currency transaction loss of $115,000 in Q3.

And on the translation side, we had losses of $442,000 across all currency sequentially, compared to Q3. The effect of this currency loss, as you know, is distributed throughout the P&L based on the nature of the expense being translated. So we continue, as you know to utilize a 90-day hedging program to limit our exposure to the Indian rupee, which is where most of our exposure is on a translation basis.

Moving onto interest and other income on a net basis that totaled $1.8 million in Q4, compared to $1.6 million last quarter and $1.4 million a year ago.

The income tax provision for the quarter was about $3 million. The effective tax rate on income from continuing operations for the year was 37%, including some discrete items of about 8%. The effective rate this quarter was just under 25% due to the effects of some beneficial discrete items that happened in the quarter and the year-to-date true-up effect from the 38% rate that we were running through Q3.

Our Q4 non-GAAP income from continuing operations was $15 million compared to $10.3 million in Q3 and $8 million a year ago. Non-GAAP diluted earnings per share from continuing operations were $0.12 per share this quarter versus $0.08 last quarter and $0.06 a year ago. GAAP income from continuing operations was $9.2 million in Q4 compared to $4.4 million last quarter and a GAAP loss from operations a year ago of $1.1 million.

GAAP diluted earnings per share as a result from continuing operations were $0.07 a share in Q4, $0.03 a share last quarter and a loss of $0.01 a share a year ago. And the weighted average common shares in this quarter were 125 million shares on a basic basis and then on a diluted basis 128.7 million.

Looking to the balance sheet, cash and marketable securities including about $2 million of restricted cash increase to $178 million at the end of Q4, that’s up from $148 million at the end of the Q3. As Alan talked already about we had an outstanding quarter of cash flow generating cash from operations of $32 million on top of the $39 million in Q3. So we brought total cash flow from operations for the year to a total of $58.2 million.

Our investments at year-end included $41.6 million of auction rate securities, these are securities that are collateralized only by student loans and municipal debt and I just want to be clear that none of these securities were backed by residential or commercial mortgages or some subprime debt.

In the past two weeks, these kinds of securities have come under some liquidity pressure as periodic auctions meant to provide liquidity and to reset interest rates have failed, meaning that the selling interest exceeded the buying interest on these securities.

So as of yesterday, the company held approximately $28 million, that’s largely down from the $42 million at the end of the year, but still holding $28 million of such securities, only some of these have experienced these failed auctions to date, but additional failures are likely and that will prevent us from liquidating some or all these securities on a short-term basis.

So based on our ability to access and utilize our total cash and other investments, we believe we have the ability to hold these auction rate securities until they become liquid. And then any impairment of value that we’ll experience will be temporary and will not result in a charge to earnings. Obviously all that can change, but we feel pretty strongly at this point that’s the way that will turn out for us.

Accounts receivable net of allowances decreased to $82.4 million at the end of Q4 from $84.2 million at the end of Q3. Unbilled revenues is now at quarter end $33.4 million that’s down slightly from $37.3 million at the end of Q3.

And deferred revenues were $14.3 million in Q4 compared to $19.4 million in Q3. And I’ll remind you at the end of Q3 and actually at the end of Q2, it was some favorable billing terms that we had with a client that caused that number to jump up in those two quarters. So we’re sort of back to a pretty normal level of deferred revenue there.

DSO decreased further as Alan reported to 57 days, that’s a record I think for this company improved from a very strong 62 days at the end of last quarter, and that compares to 70 days a year ago. And again our strong focus on collections and the whole billing process having been improved contributed to the strong performance.

People count at the end of the year was 6,217 that are with 5,358 in delivery of which 3,718 are India-based delivery people. Last August we announced that we have recommenced repurchase of our common stock under a stock repurchase program which was previously approved by the Board of Directors and at that time we had approximately $14 million of authorized repurchases remaining in the program.

We continued to buy back shares in the fourth quarter and into this quarter, the first quarter. And we repurchased about 96,000 shares in the fourth quarter for about $618,000 that was at an average of about $6.43 per share and we purchased an additional 208,000 shares for about $1.3 million through yesterday and that is at about $6.32 average per share.

Approximately $8.6 million of authorized buyback remains in the program. We expect to file our annual report on Form 10-K tomorrow and just a note that our Sarbanes-Oxley compliance testing and controls assessment yielded successful results and included no reportable weakness that will be in that 10-K.

Turning to guidance, as noted in the press release we expect that the first quarter service revenues will be $155 million or higher, taking into consideration some good growth across the business, including financial services and that will be offset by a couple of million dollar revenue impact from the weakening of the UK pound and Canadian dollar since year-end.

We expect that our Q1 non-GAAP operating margin will be 7.5% or higher. This guidance takes into consideration the substantial first quarter seasonal effect that we always have from payroll taxes and vacation expense, as well as a small utilization impact of the slower start at the beginning of the quarter, which Alan talked about earlier.

We expect growth in our annual fiscal 2008 service revenues will be in the range of 20% to 25% and as Alan said we believe we are still on target to exit ‘08 with non-GAAP operating margin within our targeted range of 13% to 16% and giving us 10% or more in non-GAAP operating margin for the year.

A few other notes in terms of guidance and some other data points for you, just to note our guidance is largely foreign currency neutral for the year except that since we’re two months through the first quarter, we’ve taken into consideration currency expectations for this quarter and otherwise have assumed neutral currency as we go forward through the rest of the year.

Trailing expenses for outside services relating to the 2007 restatement are expected to continue something like $400,000 per quarter relating to ongoing tax and legal work. Stock based compensation expense is expected be approximately $4.4 to $4.8 million per quarter totaling something a little bit north of $18 million for the year and the effective income tax rate going forward is expected to be approximately 15% to 20% for the first quarter and for the full year 2008.

This reflects our current expectations for a higher level of profit in the U.S. than in 2007, allowing our book tax rate to benefit from our U.S. tax loss carry forwards. This is a blended rate, which reflects our favorable tax position in India, our transfer pricing arrangements for non-U.S. business and the favorable effect of our U.S. net operating loss carry forward.

Just as a little bit of a side note, the Indian government budget is actually due out tomorrow and we will find out if the STPI tax benefit will be extended past March 31, of 2009, where they are currently scheduled to expire. If that happens, our Gurgaon Delhi area office will expire, the benefits relating to that office will expire in any event on that same day coincidentally as it reaches its full 10-year term.

However if it was to be extended our Bangalore office would continue to enjoy STPI tax benefits for several years. In any event, as we previously discussed, we plan to avail ourselves of the tax benefits afforded by the Special Economic Zones, SEZ as we grow into future facilities in India.

Cash flow from operations for 2008, we expect to be positive obviously and somewhat in excess of $60 million. And note that our expectations for Q1 cash flow would be that we would have negative cash flow from operations as we normally do seasonally because that is the quarter in which we pay our annual bonus pay out.

Capital expenditures for the year are estimated at $30 million for 2008, that’s as usual primarily for office space and computer hardware and software both at the corporate level and then obviously for our individual people.

And as for outstanding shares, the quarterly weighted-average share count for 2008 should increase by approximately about 300,000 shares each quarter, and that’s a net of estimated option exercises, RSU vesting and share repurchase activity. And then as a result, the weighted-average shares for the whole year 2008 would be in the neighborhood of 126.3 million shares.

With that, I will pass the call back to Alan who will wrap us up here.

Alan Herrick

So we obviously ended the revenue growth, operating profit and cash flows very strong solid quarter, good year for us, as I said highly differentiated value proposition, we are setting in good spots in the market right now. We’re very excited looking forward to our continued progress in 2008.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Rod Bourgeois - Sanford C. Bernstein & Co.

Rod Bourgeois - Sanford C. Bernstein & Co.

So you’re growing 36% and I guess there is definitely some currency benefit in that. You mentioned that you’ve seen acceleration in your pipeline recently and it would seem that these data points would imply that your revenue growth guidance of 20% to 25% might be on the conservative side, when you look at those numbers in the accelerating pipeline. So am I missing something in trying to reconcile the pipeline comment your current growth rate with your guidance for next year?

Alan Herrick

Yes, I think, as we look at the year in balance, we’ve given you solid guidance for the year. We do see strong opportunities in our pipeline, and we have and my comments about acceleration as we started with a softer January than usual we have seen acceleration and pick up in our four-quarter pipe since January 1 as we look out.

But when you look at growth rate overall, the way we think about is, we are really trying to build a great business. We want quality, we want consistency and we’re building off a bigger base than we obviously had going into ‘07 given the great growth that we had in ‘06, given the great growth we had in ‘07.

So we think that 20% to 25% is a prudent choice. We want to keep quality high. We’ve got to execute in our sales cycle and make things happen, but we think that’s a good spot for us to be given what we are trying to be in the market.

Rod Bourgeois - Sanford C. Bernstein & Co.

Is there a quality or sort of internally imposed constraint on your growth at 25% where you’re saying? I don’t want to grow faster than 25% because I want to keep quality high and hire talent very carefully and so on and so on. Is 25% a constraint that you’re setting on yourself?

Alan Herrick

Yes, well the way we think about it it’s really based on, we think about the quality on the interactive side, the consulting side, we think about our geographic distribution that’s kind of come up with what we think makes sense for us and what we think we need to do in order to continue to move our brand and sit ourselves with the kinds of services that we need to provide for our clients.

So there is always in our thinking is what’s a smart growth rate for us? What makes some sense? Does the market have more to give? I think the market from what we’ve seen probably has more to give but we’ve got to make sure we make some sense out of what we need to do in order to support strategically what we are trying to accomplish.

Rod Bourgeois - Sanford C. Bernstein & Co.

So the market has more to give but you are going to evaluate it for the year as to whether you want to try to shoot for something more than 25%. Is that the way to think about it?

Alan Herrick

20 to 25, yes.

Rod Bourgeois - Sanford C. Bernstein & Co.

So the 13% to 16% operating margin guidance for Q4. I am wondering if you can characterize what annualized margin run rate is implied by that Q4 rate, given the seasonality in your business, that figure implies an annualized rate that’s below 13% to 16%. But can you give us a ballpark on what the annualized rate associated with that would be?

Alan Herrick

Our goal is very clearly we want to get our exit rate to 13% to 16%. We also said that we are probably not finished at that point but that is a good milestone for us, right? But yes, what we’re saying is the pattern would continue to be true that we would be a little softer and we’d be softer in Q1 due to the seasonal impact and higher in Q4 due to seasonal impact.

Joe Tibbetts

With an overall 10% or better for the year, is that what people are missing or is that a different question?

Rod Bourgeois - Sanford C. Bernstein & Co.

So as an example if you hit 15% operating margins in Q4, you’ll be on a certain annualized margin run rate after you get to that margin structure. Is that annualized if you are at 15% for Q4, does that imply an annualized rate of about 10% or does that imply an annualized rate of a little more than 10%?

Joe Tibbetts

Well, I think if you analogize this to we are coming out of Q4 of ‘07 at 10.5 right? So that’s comparable to 13% to 16% coming out of this year we’re in now and so the following year at this point looks to us to be like 10% for the whole year.

So I think there is a relationship there that we would hope to keep going on. We haven’t reset a new target and I want to be careful because we have got to look at, reexamine what we can then get from our future improvements in both gross margin and our spending which is largely G&A, but also selling and marketing.

So I think it does imply obviously that we would enter ‘09 better poised to perform better than we’re predicting at this point for ‘08. So it’s all part of the plan to continue on our quest for continued profitability.

Rod Bourgeois - Sanford C. Bernstein & Co.

And then on the tax rate, it is encouraging to see the tax rate you are guiding for the year, but as you move into ‘09, I’m assuming you will continue to have a low tax rate because you continue to benefit from the tax loss carry-forwards, but do you have a perspective on a reasonable tax rate as you move into ‘09?

Joe Tibbetts

Yes, I mean just so everybody understands the dynamics as we go into ‘09. If we continue to expand our profitability and more of that ends up in the U.S. dollar wise than it has then you are right, we will get a continued benefit and an increased benefit from the U.S. tax accounting.

And then assuming nothing happens tomorrow with the Indian budget, assuming the second, third and fourth quarter of ‘09 will jump up to a 34% rate in India from basically zero today, so those two kind of work against one another. And then at the same time we are going to be trying to get some benefit out of the SEZ aspects of our India business, so that will be another thing working for us.

So when I put that all in a blender and then come out with where do I think it is really going to come out, it’s a little bit tough because it is very dependent on profitability or so. But I would be thinking about a 25% kind of rate as we go out into 2009 sitting here early in ‘08.

Operator

And your next question comes from the line of Jason Kupferberg - UBS.

Jason Kupferberg - UBS

So the recurring revenues I know are at about 44%, I guess that implies that project based revenues should be about 56%. And in that context, can you give us a sense of how much of the ‘08 revenue target if we take let’s say the mid-point of the range is already either under contract or in backlog, I know backlog’s not a metric that you disclose. What I’m trying to get our here is true visibility in terms of what clients have committed to formally versus what they are talking about in terms of general plans?

Alan Herrick

Yes, and I’d start with the improvement in recurring revenues. So if you look at 44% of our business coming out from relationships that have more than one year in contract or exclusivity that gives us obviously some firmness in our view. But also we can obviously look out in the four quarters and based on our momentum and understanding what our business does, we do have good visibility of the kind of numbers we think we ought to be able to do for the year.

And obviously, we have been talking to clients very closely and following everything that is happening given the economy. I think we need to continue to watch that with great vigilance but in addition in those conversations we believe yes, people are slower getting off the dime. They have been very thoughtful, very pragmatic about their spending but they are continuing spending where it makes sense and how it makes sense.

And we think given what we offer to the market and our value proposition we think that lines up well and has allowed us to have the visibility we have right now to 2008.

Jason Kupferberg - UBS

And in terms of Sprint, they had kind of a tough quarter today and I think there may have been some general mention of potential cutbacks in the areas of contractors. I know you do a lot of work in the testing area there, any concerns or issues there in terms of your revenue run rate there going forward?

Alan Herrick

We have a very good relationship with Sprint. That continues but obviously they are under a lot of pressure around their own performance and improvement. So, we have been expecting Sprint to tail off some for us. You have seen that start to happen in Q4 and Q1.

In our planning, we believe that will continue. We believe that we will have solid and significant relationship with Sprint and it is very healthy but given what we’ve gone through, we do expect some tail off to that and that is part of what’s in our planning for the year as well.

Joe Tibbetts

Just to clarify, I think Alan meant Q3 and Q4 where we saw that tail-off, not Q4 and Q1.

Alan Herrick

Yes.

Jason Kupferberg - UBS

And just a last question, if we look out at the margin goals for both Q4 and for the full year ‘08, what would be the biggest risk factor behind achieving those goals? Is it more a top line risk in terms of leverage of the revenue growth? Is it G&A execution? Is it the pricing environment, just want to get a sense in terms of how you think about the potential risk factors there?

Alan Herrick

As we’ve talked about our win rates being so high, we think as we’ve mentioned before that that’s tied to our ability to continue to improve pricing. So, we feel positive about that and positive about our value proposition and being able to achieve some of the reflation of pricing that we’ve talked to you all about.

On the utilization front we’ve thought a lot about that but as we said going into Q3 of last year, we put some very different management processes in place around utilization that seem to be working. We’ve demonstrated a great progress with our G&A.

So in the way we look at it focused on our execution and being able to really drive our own execution both in the market and around our internal processes is where we’ve got to stay sharp and keep doing what we are doing is the way we really look at the risk given what we currently see from the outlook.

Operator

And your next question comes from the line of Mark Marostica - Piper Jaffray.

Mark Marostica - Piper Jaffray

I wanted to just get a little more color on your commentary around interactive which saw a jump up in terms of percentage of the overall revenue. And appreciate the color regarding the breakdown of interactive; can you give us a sense of where the up tick came from in terms of the various categories that you outlined, Alan?

Alan Herrick

I think broad strength because the categories are interrelated, right? So when I talk about marketing of services that tends to be a lot of campaign strategy and analytics, that often leads to design work that we might do for somebody in creating a new multi-channel experience.

So think about our marketing services when I look at it, as almost a little bit of the strategy top of the value chain, it’s BridgeTrack, which is more ad serving, analytics measurement into experience design which is more obviously the design and then the implementation all the way to commerce which is really the transaction orientation for our consumer.

So there is a certain shape in relationship of these things to each other but in general broad strength across those things because they tend to work together for us, and are often bought in an integrated package from us.

Mark Marostica - Piper Jaffray

And then as you look at your guidance, I’m curious as you exit next year or this year, where do you think that interactive mix will be?

Alan Herrick

Obviously a question that we get a lot but we think obviously on the consulting side and the interactive side two very larger markets both growing well. You have a channel shift dynamic that is obviously driving up the growth rate on the interactive side and we think that’s going to continue through ‘08 and beyond.

So I do believe that as we said in Q4 if we look at the balance of ‘08, we will see interactive take some more share of Sapient revenues. And I think that is fine but again you have to understand that these things interactive and consulting have become very blended for us. They’re both built on the same execution base of people that can move in between assignments, we have a lot fungibility.

So that kind of dynamic works fine for us, but I do think if you’re talking about just interactive revenue versus consulting, you will see some share points taken in ‘08 by interactive.

Mark Marostica - Piper Jaffray

And then regarding your India-based headcount, obviously you’ve seen an uptick in that head count as a percentage of your overall delivery capability I think at around 69% right now, about 64% a year ago. Where is that metric in your thinking by year-end of this year and can you give us a sense also on the hiring front in India, if it has gotten more difficult or if it is about the same in terms of difficulty for you?

Alan Herrick

I think on the hiring, starting with the last and working backwards. I think on the hiring front, we have done a great job there but I would say it’s a difficult market, it continues to be difficult and incredibly competitive. But I think we have executed well. I think as we mentioned a couple of calls ago being ranked the fourth best company of all companies in India helps a lot.

We got a very different culture, we offer a very different opportunity to people, we look different than the other companies that might be hiring down there and that really works for us, right? But strong execution and hiring matters. We have had that, we can’t take that for granted and we’ve got to stay on that.

But on your question around kind of share or mix in India I would say there is some ebb and flow there but strategically I don’t see a material change there. When you look at our business and what’s happening with consulting, interactive and how those move into India for us. I wouldn’t expect material movement on that number in ‘08, it could go one way or another a couple of points. But I wouldn’t expect any kind of strategic effect that we are trying to have on that mix at this point.

Mark Marostica - Piper Jaffray

With the slow start in January and with your experience thus far in February should we expect a significant decline in utilization in Q1? Or do you feel things are picking up here on the utilization front given what you are seeing with your customer base?

Alan Herrick

Yes. I think they clearly are, to my comments around February, I won’t go farther than February but I think we’re starting from a lower point than we have seen in January’s. But we do expect given what we have seen in February that overall for the quarter you’re going to be a tick or two down, but we don’t see anything substantial on that basis.

Operator

Your next question comes from the line of David Grossman - Thomas Weisel Partners.

David Grossman - Thomas Weisel

Alan, just going back to a question that was asked a little bit earlier. The pricing and the utilization you’re expecting a fairly large kind of margin expansion as a result of those two dynamics improving. Can you give us any thing that maybe would give us a little more insight into why you feel comfortable and where you see the pricing improvements coming from, is it mix or is it some other fundamental change in your business.

And then I guess secondly on the utilization side, obviously that’s bounced around and a lot of times that’s been mismatching of resources and geographies. And maybe if you could help us understand what you’ve done over the last six months that again gives you that confidence that that utilization rate, which has bounced around quite a bit over the last couple of years. Why you expect a much more steady state improvement in 2008?

Alan Herrick

I guess starting on the last as we’ve talked about, we’re managing our utilization differently and we’re managing on a geographic basis. As I said, the overall number isn’t as meaningful to us because it’s very important what’s India is doing versus the United States and Europe. So we put our management processes in place to manage that way, which I think is yielding a much better outcome.

As we talked about a couple of quarters ago utilization on an aggregate basis could go up but economically it might be actually negative for us. Much stronger processes around utilization and much stronger mindset and orientation around how much utilization matters for us is the answer to the second part of your question.

I guess on the first part of your question around pricing when we think about it, it’s partly a factor how we sit in the market. So we’re going to compete with the agencies on one side and we think we have a great value proposition and obviously we’re looking at our win rates been all time highs, that matters and we are competing on the consulting side and that matters.

We also compete once in a while with the Indian firms and that is tougher pricing. No doubt about it when we bump into them the good news on our basis is given the kind of work we’re doing we don’t bump into them a ton competitively. It’s more the large Western firms and the agencies. So when we look at the kind of value that we’re placing into the market and we look at our win rates being where they are, we think that gives us some room for improvement.

So then coming back to the utilization side, I also talk about effective utilization and you’ve got to also remember that half of our business roughly is fixed price. And as I said, I think a quarter or the last couple of quarters that we believe there is a lot of room for improvement in how we execute our fixed-price business, which also adds power to our effective utilization.

Being more on track with how we execute that and we think based on historical averages we’ve got some room we can improve that, we know how to do that. We’ve got a heritage that’s been great around fixed price. So we think as part of the utilization gain we’ll get some there as well over the course of ‘08.

David Grossman - Thomas Weisel

So if I just kind of retrace what you’ve just said, so on the pricing versus the agencies and the consulting firms you feel you’ve got some room, is that how I should interpret that?

Alan Herrick

Yes, if you look, pricing in this kind of business is very tough to benchmark but I believe that given our value proposition and our win rates, you look at where we are clearing I believe we’ve been able to prove to our self that we do have some room.

David Grossman - Thomas Weisel

And then on the utilization side, I understand your point on the fixed price. But just getting back to the utilization point just at large, I mean you reported I think 73% utilization this quarter. I know there is some seasonality in that number.

But what can you tell us about the trend in utilization in the U.S. and Europe that would suggest that you’ve kind of harnessed that issue and in fact those numbers are going up to get that economic benefit that you are talking about?

Alan Herrick

There is always seasonality in utilization, right? Q4 is always going to be a softer on design I’d say Q1, Q2 and Q3 get better and back to a little softer Q4, you have some vacation stuff. But and hard to net that out in quick conversation, but if you look across the balance of the year to the balance of the year in ‘07, we believe on an aggregate basis, utilization can run higher.

And the way in which we are managing utilization has much more precision, the way in which we are building mix at a detailed city level. There is just a lot more detail and precision in the way that we are building our company and the way that we are managing utilization and keeping those things in balance which has led to additional consistency in those numbers if you look at ‘07. So, we think we’ve got the right processes and techniques in place. We’ve just got to keep executing.

David Grossman - Thomas Weisel

Getting back to again another question that was asked slightly differently a little while ago about the visibility on the revenue guidance, if we assume that 40 some odd percent of your revenue is out a year and I know that some of that may expire during the course of the year. But how should we think about the degree of visibility that you have on your target of 20% to 25% growth next year?

Alan Herrick

I would not think about it any differently than we have in past years. I’d say we have similar visibility right now for 2008 to what we had in 2007. We’ve got the recurring base as we talked about also; we’ve got house accounts where we really look at size of relationship now. We have a good sense of what those relationships are going to do.

Then we look at what the new business component is and how many new clients you have to go out and sell and win and secure. And that whole mix on balance of the things that we need to do and the things we understand with those relationships and what we call house accounts on top of recurring revenue looks in a similar fashion for us. So from our perspective that gives us comfort in what we are looking at for the year.

Joe Tibbetts

I look at that question from my experience in two perspectives. One is how good is our internal discipline around really looking at our clients, understanding them and then collecting a lot of information from around the world to put an accurate prediction together.

And then secondly, what’s the visibility or what’s the susceptibility of the outside market for changing its mind if you will. And I think from that first metric there this company has really good visibility, really good metrics and really good measurement capability and ways of collecting pipeline information.

On the second factor, we look at the kind of work we’re doing and Alan said it five ways already but just in terms of the discretionary aspect of what we do, we think we are in a much stronger position than the average provider out there and we are in the right spot with our client to make a left turn a lot less likely. So think those two together give us some confidence that what we are looking at as a forecast feels good.

Operator

Your next question comes from the line of Andrew Steinerman - Bear Stearns.

Andrew Steinerman - Bear Stearns

Could you just give us some thought behind why your European business is growing pretty much over twice as fast than your North American business recognizing it’s a smaller business unit? Do you think that type of gap in growth rate will continue forward?

Alan Herrick

Yes, so if you look at Europe obviously I think that and we talked about this probably more a year ago, but Europe really changing some things strategy wise to sit themselves in the right markets around the industries that we serve. The value propositions, making sure we have a strong play in interactive, I think lended tremendous growth to Europe and obviously as we look forward we see positive growth in Europe as well for ‘08.

North America as you said, Andrew, is the larger business. You might expect a little slower on the larger business overall, but positive for both businesses and becoming more similar I guess in the kinds of things that matters to clients.

So we’ve had great strength in the start up of our TRM practice. If you go back a year and to what Europe has now in TRM, tremendous momentum on the interactive side. So I think you have also got Europe tapping some things that they hadn’t tapped before and finding that there has been just some great growth for us there in those markets.

Andrew Steinerman - Bear Stearns

And do you think there is a good stretch ahead also with this?

Alan Herrick

Yes, when you look at our funnels and pipeline overall obviously we would look at Europe and North America and we do in fact see positive things on both sides of the ocean.

Alan Herrick

I want to thank everybody for joining. And again, we are very pleased with where we are. I think we’ve demonstrated what we set out to do in 2007. And we are very excited about entering 2008. And we’ve got to just keep doing our job as a team and as a company, continue to win some great clients, do great work, and take advantage of our value proposition in the market.

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Source: Sapient Corporation Q4 2007 Earnings Call Transcript
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