Item 1.
Business
General
Sapient Corporation (“Sapient” or the “Company”) is a global services firm that innovates in marketing, technology and business operations. Our multidisciplinary teams of expert thinkers and designers provide business and information technology strategy, business applications, experience marketing and global outsourcing services that help our clients succeed. Headquartered in Cambridge, Massachusetts, Sapient maintains a strong global presence with offices across the United States and in Canada, Germany, the Netherlands, India and the United Kingdom. Unless the context otherwise requires, references in this Annual Report to “Sapient,” “we,” “us” or “our” refer to Sapient Corporation and its subsidiaries.
Our Global Distributed Delivery (“GDD”) model enables us to perform services on a continuous basis, through client teams located in North America, Europe and India. This model accelerates the speed with which we deliver projects and significantly enhances the returns on our clients’ business investments. Our GDD model involves a single, coordinated effort between development teams in a remote location (typically highly skilled business, technology, and creative specialists in our New Delhi and Bangalore, India offices) and development and client teams in North America or Europe. To work effectively in this globally distributed environment, we have built extensive expertise and processes in managing business specifications and project management issues between the various development teams that are necessary to enable continuous project work. Through our GDD model, we believe that we deliver greater value to our clients at a competitive cost and in a more rapid timeframe. In addition to solution design and implementation, most of our long-term engagement and outsourcing relationships engage GDD.
We deliver our services globally through multiple business units. Our North America-based business units consist of North America Commercial, Experience Marketing and Government Services. We deliver services in the United Kingdom, Germany, and the Netherlands through our Europe business unit. Each business unit includes consultants based locally as well as consultants based in our India offices. Within each business unit, we focus our sales and delivery efforts on certain industry specializations. Through our global industry focus, we have developed an extensive understanding of our clients’ markets and can effectively address the market dynamics and business opportunities that our clients face. This understanding further enables us to identify and focus on critical areas to help our clients grow, perform, and innovate. Further information about our international operations and our operating segments is located in Item 7 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 20 in the Notes to Consolidated Financial Statements included in this Annual Report. For a presentation of the financial information about the geographic areas in which we conduct our business, please see Item 7 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 20 to our consolidated audited financial statements. The principal risks and uncertainties facing our business, operations and financial condition are discussed in Part 1, Item 1A
Item 1A.
Risk Factors
Risk Factors
The following important factors, among others, could cause our actual business and financial results to differ materially from those contained in forward-looking statements made in this Annual Report or presented elsewhere by management from time to time.
Our business, financial condition and results of operations may be materially impacted by economic conditions and related fluctuations in customer demand for business, technology and other consulting services.
The market for our consulting services and the technologies used in our solutions historically have tended to fluctuate with economic cycles - particularly those cycles in the United States and the United Kingdom, where we earn the majority of our revenues. During economic cycles in which many companies are experiencing financial difficulties or uncertainty, clients and potential clients may cancel or delay spending on technology and other business initiatives. Military actions in Iraq and elsewhere, global terrorism, natural disasters and political unrest are among the factors that may adversely impact regional and global economic conditions and, concomitantly, client investments in our services. Although economic conditions in our industry have been improving in recent years, a sudden or gradual downturn in these conditions may cause large companies to cancel or delay consulting initiatives for which they have engaged us. Further, if the rate of cancellations or delays significantly increases, our business, financial condition and results of operations could be materially and adversely impacted.
Our market is highly competitive and we may not be able to continue to compete effectively.
The markets for the services we provide are highly competitive. We believe that we compete principally with large systems consulting and implementation firms, offshore outsourcing companies, and clients’ internal information systems departments. Other competitors include interactive and traditional advertising agencies, and, to a lesser extent, boutique consulting firms that maintain specialized skills and/or are geography based. In our Government Services practice, we both compete and partner with large defense contractors. Some of our competitors have significantly greater financial, technical and marketing resources, and generate greater revenues and have greater name recognition, than we do. Often, these competitors offer a larger and more diversified suite of products and services than we offer. These competitors may win client engagements by significantly discounting their services in exchange for a client’s promise to purchase other goods and services from the competitor, either concurrently or in the future. If we cannot keep pace with the intense competition in our marketplace, our business, financial condition and results of operations will suffer.
Our international operations and Global Distributed Delivery (“GDD”) model subject us to increased risk.
We currently have international offices in the United Kingdom, Germany, the Netherlands, India and Canada. Our international operations are a significant percentage of our total revenues, and our GDD model is a key component of our ability to deliver our services successfully. Our international operations are subject to inherent risks, including:
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economic recessions in foreign countries;
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fluctuations in currency exchange rates or impositions of restrictive currency controls;
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political instability, war or military conflict;
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changes in regulatory requirements;
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complexities and costs in effectively managing multi-national operations and associated internal controls and procedures;
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significant changes in immigration policies or difficulties in obtaining required immigration approvals for international assignments;
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restrictions imposed on the import and export of technologies in countries where we operate; and
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reduced protection for intellectual property in some countries.
In particular, our GDD model depends heavily on our offices in New Delhi and Bangalore, India, where approximately 64% of our worldwide employees are located. Any escalation in the political or military instability in India or Pakistan or the surrounding countries, or a business interruption resulting from a natural disaster, such as an earthquake, could hinder our ability to use GDD successfully and could result in material adverse effects to our business, financial condition and results of operations. Furthermore, the delivery of our services from remote locations causes us to rely on data, phone, power and other networks which are not as reliable as those in other countries where we operate. Any failures of these systems could affect the success of our GDD model. Remote delivery of our services also increases the complexity and risk of delivering our services, which could affect our ability to satisfy our clients’ expectations or perform our services within the estimated time frame and budget for each project.
If we do not attract and retain qualified professional staff, we may be unable to perform adequately our client engagements and could be limited in accepting new client engagements.
Our business is people intensive, and our success depends upon our ability to attract, retain, train and motivate highly skilled employees. The improvement in demand for business and technology consulting services has further increased the need for employees with specialized skills or significant experience in business, marketing and technology consulting, particularly at senior levels. We have been expanding our operations in all locations, and these expansion efforts will be highly dependent on attracting a sufficient number of highly skilled people. We may not be successful in attracting enough employees to achieve our desired expansion or staffing plans. Furthermore, the industry turnover rates for these types of employees are high, and we may not be successful in retaining, training and motivating the employees we attract. Any inability to attract, retain, train and motivate employees could impair our ability to manage adequately and complete existing projects and to bid for or accept new client engagements. Such inability may also force us to increase our hiring of expensive independent contractors, which may increase our costs and reduce our profitability on client engagements. We must also devote substantial managerial and financial resources to monitoring and managing our workforce and other resources. Our future success will depend on our ability to manage the levels and related costs of our workforce and other resources effectively.
We earn revenues, incur costs and maintain cash balances in multiple currencies, and currency fluctuations affect our financial results.
We have significant international operations, and we frequently earn our revenues and incur our costs in various foreign currencies. Our international segment revenues were $136.8 million for the year ended December 31, 2006. Doing business in these foreign currencies exposes us to foreign currency risks in numerous areas, including revenues and receivables, purchases, payroll and investments. We also have a significant amount of foreign currency net asset exposures. Certain foreign currency exposures, to some extent, are naturally offset within an international business unit, because revenues and costs are denominated in the same foreign currency, and certain cash balances are held in U.S. dollar denominated accounts. However, due to the increasing size and importance of our international operations, fluctuations in foreign currency exchange rates could materially impact our financial results. Our GDD model also subjects us to increased currency risk, because we frequently incur a significant portion of our project costs in Indian rupees and earn revenue from our clients in other currencies. Currently, we do not hold any derivative contracts that hedge our foreign currency risk, but we may adopt such strategies in the future.
Our cash position includes amounts denominated in foreign currencies. We manage our worldwide cash requirements considering available funds from our subsidiaries and the cost effectiveness with which these funds can be accessed. The repatriation of cash balances from certain of our subsidiaries outside the United States could
have adverse tax consequences and be limited by foreign currency exchange controls. However, those balances are generally available without legal restrictions to fund ordinary business operations. We have transferred, and will continue to transfer, cash from those subsidiaries to the parent company, and to other international subsidiaries, when it is cost effective to do so. However, any fluctuations in foreign currency exchange rates could materially impact the availability and size of these funds for repatriation or transfer.
We have significant fixed operating costs, which may be difficult to adjust in response to unanticipated fluctuations in revenues.
A high percentage of our operating expenses, particularly personnel, rent, depreciation and amortization of intangible assets, are fixed in advance of any particular quarter. As a result, an unanticipated decrease in the number or average size of, or an unanticipated delay in the scheduling for, our projects may cause significant variations in operating results in any particular quarter and could have a material adverse effect on operations for that quarter.
An unanticipated termination or decrease in size or scope of a major project, a client’s decision not to proceed with a project we anticipated or the completion during a quarter of several major client projects could require us to maintain underutilized employees and could have a material adverse effect on our business, financial condition and results of operations. Our revenues and earnings may also fluctuate from quarter to quarter because of such factors as:
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the contractual terms and timing of completion of projects, including achievement of certain business results;
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any delays incurred in connection with projects;
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the adequacy of provisions for losses and bad debts;
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the accuracy of our estimates of resources required to complete ongoing projects;
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loss of key highly skilled personnel necessary to complete projects; and
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general economic conditions.
We may lose money if we do not accurately estimate the costs of fixed-price engagements.
Many of our projects are based on fixed-price contracts, rather than contracts in which payment to us is determined on a time and materials basis. Our failure to estimate accurately the resources and schedule required for a project, or our failure to complete our contractual obligations in a manner consistent with the project plan upon which our fixed-price contract was based, could adversely affect our overall profitability and could have a material adverse effect on our business, financial condition and results of operations. We are consistently entering into contracts for large projects that magnify this risk. We have been required to commit unanticipated additional resources to complete projects in the past, which has resulted in losses on those contracts. We will likely experience similar situations in the future. In addition, we may fix the price for some projects at an early stage of the project engagement, which could result in a fixed-price that is too low. Therefore, this incorrect estimation could adversely affect our business, financial condition and results of operations.
Our profitability will be adversely impacted if we are unable to maintain our pricing and utilization rates and control our costs.
Our profitability derives from and is impacted by three factors, primarily: (i) the prices for our services; (ii) our consultants’ utilization or billable time, and (iii) our costs. To achieve our desired level of profitability our utilization must remain at an appropriate rate, and we must contain our costs. Should we reduce our prices in the future as a result of pricing pressures, or should we be unable to achieve our target utilization rates and costs, our profitability could be adversely impacted and the price of our securities could decline materially.
We partner with third parties on certain complex engagements in which our performance depends upon, and may be adversely impacted by, the performance of such third parties.
Certain complex projects may require that we partner with specialized software or systems vendors or other partners to perform our services. Often in these circumstances, we are liable to our clients for the performance of these third parties. Should the third parties fail to perform timely or satisfactorily, our clients may elect to terminate the projects or withhold payment until the services have been completed successfully. Additionally, the timing of our revenue recognition may be affected or we may realize lower profits if we incur additional costs due to delays or because we must assign additional personnel to complete the project. Furthermore, our relationships with our clients and our reputation generally may suffer harm as a result of our partners’ unsatisfactory performance.
Our clients could unexpectedly terminate their contracts for our services.
Some of our contracts can be canceled by the client with limited advance notice and without significant penalty. A client’s termination of a contract for our services could result in a loss of expected revenues and additional expenses for staff that were allocated to that client’s project. We could be required to maintain underutilized employees who were assigned to the terminated contract. The unexpected cancellation or significant reduction in the scope of any of our large projects, or client termination of one or more recurring revenue contracts (see definition of “recurring revenues” in Item 1, above), could have a material adverse effect on our business, financial condition and results of operations.
We may be liable to our clients for damages caused by unauthorized disclosures of confidential information or by our failure to remedy system failures.
We frequently receive confidential information from our clients, including confidential customer data that we use to develop solutions. If any person, including a Company employee, misappropriates client confidential information, or if client confidential information is inappropriately disclosed due to a breach of our computer systems, system failures or otherwise, we may have substantial liabilities to our clients or client customers.
Further, many of our projects involve technology applications or systems that are critical to the operations of our clients’ businesses and handle very large volumes of transactions. If we fail to perform our services correctly, we may be unable to deliver applications or systems to our clients with the promised functionality or within the promised time frame, or to satisfy the required service levels for support and maintenance. While we have taken precautionary actions to create redundancy and back-up systems, any such failures by us could result in claims by our clients for substantial damages against us.
Although we attempt to limit the amount and type of our contractual liability for breaches of confidentiality and defects in the applications or systems we provide and carry insurance coverage which mitigates these liabilities in certain instances, we cannot be assured that these limitations and insurance coverages will be applicable and enforceable in all cases. Even if these limitations and insurance coverages are found to be applicable and enforceable, our liability to our clients for these types of claims could be material in amount and affect our business, financial condition and results of operations. Additionally, such claims may harm our reputation and cause us to lose clients.
Our services may infringe the intellectual property rights of third parties, and create liability for us as well as harm our reputation and client relationships.
The services that we offer to clients may infringe the intellectual property (“IP”) rights of third parties and result in legal claims against our clients and Sapient. These claims may damage our reputation, adversely impact our client relationships and create liability for us. Moreover, although we generally agree in our client contracts to indemnify the clients for expenses or liabilities they incur as a result of third party IP infringement claims associated with our services, the resolution of these claims, irrespective of whether a court determines that our services infringed another party’s IP rights, may be time-consuming, disruptive to our business and extraordinarily costly. Finally, in connection with an IP infringement dispute, we may be required to cease using or developing certain IP that we offer to our clients. These circumstances could adversely impact our ability to generate revenue as well as require us to incur significant expense to develop alternative or modified services for our clients.
We may be unable to protect our proprietary methodology
Our success depends, in part, upon our proprietary methodology and other intellectual property rights. We rely upon a combination of trade secrets, nondisclosure and other contractual arrangements, and copyright and trademark laws to protect our proprietary rights. We enter into confidentiality agreements with our employees, subcontractors, vendors, consultants and clients, and limit access to and distribution of our proprietary information. We cannot be certain that the steps we take in this regard will be adequate to deter misappropriation of our proprietary information or that we will be able to detect unauthorized use and take appropriate steps to enforce our intellectual property rights.
Our stock price is volatile and may result in substantial losses for investors.
The trading price of our common stock has been subject to wide fluctuations. Our trading price could continue to be subject to wide fluctuations in response to:
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quarterly variations in operating results and achievement of key business metrics by us or our competitors;
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changes in operating results estimates by securities analysts;
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any differences between our reported results and securities analysts’ published or unpublished expectations;
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announcements of new contracts or service offerings made by us or our competitors;
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announcements of acquisitions or joint ventures made by us or our competitors; and
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general economic or stock market conditions.
In the past, securities class action litigation has often been instituted against companies following periods of volatility in the market price of their securities. The commencement of this type of litigation against us could result in substantial costs and a diversion of management’s attention and resources.
Our former Chairmen and Chief Executive Officers have significant voting power and may effectively control the outcome of any stockholder vote.
Jerry A. Greenberg, our former Co-Chairman of the Board and Chief Executive Officer of the Company and J. Stuart Moore, our former Co-Chairman of the Board and Co-Chief Executive Officer and current member of our Board of Directors, own, in the aggregate, approximately 34% of our outstanding common stock. As a result, they have the ability to substantially influence and may effectively control the outcome of corporate actions requiring stockholder approval, including the election of directors. This concentration of ownership may also have the effect of delaying or preventing a change in control of Sapient, even if such a change in control would benefit other investors.
We are dependent on our key employees.
Our success depends in large part upon the continued services of a number of key employees. Our employment arrangements with key personnel provide that employment is terminable at will by either party. The loss of the services of any of our key personnel could have a material adverse effect on our business, financial condition and results of operations. In addition, if our key employees resign from Sapient to join a competitor or to form a competing company, the loss of such personnel and any resulting loss of existing or potential clients to any such competitor could have a material adverse effect on our business, financial condition and results of operations. Although we require our employees to sign agreements prohibiting them from joining a competitor, forming a competing company or soliciting our clients or employees for certain periods of time, we cannot be certain that these agreements will be effective in preventing our key employees from engaging in these actions or that courts or other adjudicative entities will substantially enforce these agreements.
We may be unable to achieve anticipated benefits from acquisitions and joint ventures.
The anticipated benefits from any acquisitions or joint ventures that we may undertake might not be achieved. For example, if we acquire a company, we cannot be certain that clients of the acquired business will continue to conduct business with us, or that employees of the acquired business will continue their employment or integrate
successfully into our operations and culture. The identification, consummation and integration of acquisitions and joint ventures require substantial attention from management. The diversion of management’s attention, as well as any difficulties encountered in the integration process, could have an adverse impact on our business, financial condition and results of operations. Further, we may incur significant expenses in completing any such acquisitions, and we may assume significant liabilities, some of which may be unknown at the time of such acquisition. We note, in particular, our ongoing efforts to integrate and assimilate our Experience Marketing reporting segment, following our acquisition of PGI in early 2006. Failure to complete this initiative in a timely and efficient manner may adversely impact our business, financial condition and results of operations.
If we do not effectively improve our operational and financial processes and systems, our ability to achieve efficiencies and cost savings may be delayed and our results of operations may be adversely impacted.
To streamline our general and administrative infrastructure and costs as a percentage of revenue and ensure that the Company can appropriately scale as our business expands, since early 2006 we have been redesigning many operational processes and transitioning certain internal, non-billable roles to our India office. The activities principally relate to finance, human resources and certain IT functions. If we do not timely, efficiently and effectively upgrade or replace systems, redesign processes and implement the preceding role transitions and necessary training as our business requires, we may be unable to support our growth effectively or realize cost savings as quickly as expected or maintain effective internal controls over financial reporting. Additionally, the quality of our services may decline pending the successful completion of these initiatives. Consequently, our results of operations may be adversely impacted. In fact, as indicated below in this Item 1A and in Item 9A, challenges that we have encountered relating to the transition of several finance functions to our offices in India have contributed in significant part to management’s conclusion that a material weakness exists in the Company’s internal control over financial reporting as of December 31, 2006.
The failure to successfully and timely implement certain financial system changes to improve operating efficiency and enhance our reporting controls could harm our business.
In parallel with the foregoing operational process redesign and role transition activities, we have implemented and continue to install several upgrades and enhancements to our financial systems. Failure to successfully execute these initiatives in a timely, effective and efficient manner could result in the disruption of our operations, the inability to comply with our Sarbanes-Oxley obligations and the inability to report our financial results in a timely and accurate manner.
Management’s determination that a material weakness exists in our internal controls over financial reporting could have a material adverse impact on the Company.
We are required to maintain internal control over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with generally accepted accounting principles. In Item 9A of this Annual Report, management reports that a material weakness exists in the Company’s internal control over financial reporting as a result of a significant disruption to our financial accounting organization, processes and workload during 2006 that was attributable to the (i) transition of key accounting and administrative functions and processes to India during 2006; (ii) changes in the finance organization and resultant significant turnover in the Company’s finance and accounting staff, including three Chief Financial Officers during 2006; and (iii) investigation and restatement of the Company’s financial statements relating to historical stock option granting practices, which have required significant financial research, analysis and incremental recordkeeping. Due to this material weakness, management has concluded that as of the end of the period covered by this Annual Report, the Company’s disclosure controls and procedures were not effective. Consequently, and pending the Company’s remediation of the matters that have caused the control deficiencies underlying the material weakness, our business and results of operations could be harmed, we may be unable to report properly or timely the results of our operations, and investors may lose faith in the reliability of our financial statements. Accordingly, the price of our securities may be adversely and materially impacted.
We face risks related to the restatement of our financial statements and the ongoing SEC investigation regarding our historical stock-based compensation practices.
On November 30, 2006, the Securities and Exchange Commission (“SEC”) notified us that it had commenced a formal inquiry into our historical stock-based compensation practices. Subsequently, on March 8, 2007, we received a subpoena from the SEC requesting several documents relating to this matter. We are cooperating fully with the SEC and will continue to do so as the inquiry moves forward. At this point, we are unable to predict what, if any, consequences the SEC investigation may have on us. However, the investigation could result in considerable legal expenses, divert management’s attention from other business concerns and harm our business. If the SEC were to commence legal action, we could be required to pay significant penalties and/or fines and could become subject to an administrative order and/or a cease and desist order. The filing of our restated financial statements to correct the discovered accounting errors will not resolve the SEC investigation. Further, the resolution of the SEC investigation could require the filing of additional restatements of our prior financial statements, and/or our restated financial statements, or require that we take other actions not presently contemplated.
Our corporate governance provisions may deter a financially attractive takeover attempt.
Provisions of our charter and by-laws may discourage, delay or prevent a merger or acquisition that stockholders may consider favorable, including a transaction in which stockholders would receive a premium for their shares. These provisions include the following:
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our Board of Directors has the authority, without further action by the stockholders, to fix the rights and preferences of and issue shares of preferred stock;
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any action that may be taken by stockholders must be taken at an annual or special meeting and may not be taken by written consent;
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stockholders must comply with advance notice requirements before raising a matter at a meeting of stockholders or nominating a director for election; and
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the Chairman of the Board or the Chief Executive Officer are the only persons who may call a special meeting of stockholders.
Provisions of Delaware law may also discourage, delay or prevent someone from acquiring us or merging with us.
Item 1B.
Item 1B.
Unresolved Staff Comments
None.
Item 2.
Item 2.
Properties
Our headquarters and principal administrative, finance, selling and marketing operations are located in approximately 28,000 square feet of leased office space in Cambridge, Massachusetts. We also lease offices in the Washington D.C. metropolitan area, New York City, Chicago, Atlanta, Los Angeles metropolitan area, San Diego, Miami, Detroit, Denver, Kansas City metropolitan area, London, Düsseldorf, Munich, New Delhi, Bangalore and Toronto. We do not own any material real property. Substantially all of our office space is leased under long-term leases with varying expiration dates. We believe that our facilities are adequate to meet our needs in the near future.
Item 3.
Item 3.
Legal Proceedings
Regulatory Proceedings
On November 30, 2006, the SEC notified us that it had commenced a formal inquiry into our historical stock-based compensation practices. Subsequently, on March 8, 2007, we received a subpoena from the SEC requesting documents relating to this matter and responded by providing documents. We have been cooperating with the SEC as it continues its investigation. We are cooperating fully with the SEC and will continue to do so as the inquiry moves forward. At this point, we are unable to predict what, if any, consequences the SEC investigation may have on us. However, the investigation could result in considerable legal expenses, divert management’s attention from
other business concerns and harm our business. If the SEC were to commence legal action, we could be required to pay significant penalties and/or fines and could become subject to an administrative order and/or a cease and desist order. The filing of our restated financial statements to correct the discovered accounting errors will not resolve the SEC investigation.
Private Litigation
We are subject to certain legal proceedings and claims, as discussed below. We are also subject to certain other legal proceedings and claims that have arisen in the course of business and that have not been fully adjudicated. In the opinion of management, we do not have a potential liability related to any current legal proceedings and claims that would individually or in the aggregate have a material adverse effect on our financial condition, liquidity or results of operations. However, the results of legal proceedings cannot be predicted with certainty. Should we fail to prevail in any of these legal matters or should several of these legal matters be resolved against us in the same reporting period, the operating results of a particular reporting period could be materially adversely affected.
On August 17, 2006 a derivative action, captioned as Alex Fedoroff, Derivatively on Behalf of Nominal Defendant Sapient Corporation v. Jerry A. Greenberg, J. Stuart Moore, Susan D. Johnson, et al., was filed in the Superior Court for Middlesex County, Massachusetts, against Sapient as a nominal defendant and sixteen of Sapient’s current and former directors and officers. On August 31, 2006, a nearly identical complaint, captioned as Jerry Hamilton, Derivatively on Behalf of Nominal Defendant Sapient Corporation v. Jerry A. Greenberg, J. Stuart Moore, Susan D. Johnson, et al., was filed in the same court by a different Company shareholder. Both plaintiffs claim breaches of fiduciary duty by all defendants for allegedly backdating stock options between 1997 and 2002. The Plaintiffs also claim that some of the defendants were unjustly enriched by receipt of purportedly backdated stock options, and seek unspecified damages, disgorgement of “backdated” stock options and any proceeds received from the exercise and sale of any “backdated” options, costs and attorneys’ fees. Neither of the plaintiffs made a pre-suit demand on Sapient’s Board of Directors, as required by Delaware law (Sapient’s state of incorporation) prior to filing their respective actions.
On October 13, 2006, the Superior Court for Middlesex County, Massachusetts, entered an order consolidating the foregoing derivative actions under the caption In re Sapient Corporation Derivative Litigation. On February 20, 2007, the consolidated complaint was transferred into the Business Litigation Session of the Suffolk Superior Court, Massachusetts under docket number 07-0629 BLS1. On April 25, 2007, the defendants filed a motion to dismiss, which was heard by the Court on May 23, 2007. The Company is awaiting notice on the results of this hearing.
On October 27, 2006 and October 31, 2006, three additional shareholder derivative actions were filed in the United States District Court for the District of Massachusetts; Mike Lane, Derivatively on Behalf of Sapient Corporation v. J. Stuart Moore, Jerry A. Greenberg, Sheeroy D. Desai, et al. and Sapient Corporation; Marc Doyle, Derivatively on Behalf of Sapient Corporation v. J. Stuart Moore, Jerry A. Greenberg, Sheeroy D. Desai, et al. and Sapient Corporation; and Laurence Halaska, Derivatively on Behalf of Sapient Corporation v. Jerry A. Greenberg, J. Stuart Moore, Scott J. Krenz, et al. and Sapient Corporation. The federal derivative actions are substantially similar to the state derivative actions, except that federal derivative actions assert violations of Sarbanes-Oxley and violations of Sections 10(b), 14(a) and 20(a) of the Securities Exchange Act.
None of the foregoing derivative actions asserts a claim against the Company for specific monetary damages.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Price of Common Stock
Our common stock is quoted on the Nasdaq Global Market under the symbol “SAPE.” The following table sets forth, for the periods indicated, the high and low intraday sale prices for our common stock.
On June 7, 2007, the last reported sale price of our common stock was $7.50 per share. As of June 7, 2007, there were approximately 449 holders of record of our common stock and approximately 12,531 beneficial holders of our common stock.
We have never paid or declared any cash dividends on our common stock and do not anticipate paying cash dividends in the foreseeable future.
Issuer Purchases of Equity Securities
On November 16, 2004, Sapient’s Board of Directors authorized up to $25.0 million in funds for use in the Company’s common stock repurchase program. On February 10, 2006 the Board of Directors authorized an additional $25.0 million in funds for use in such programs. Sapient has announced that it will repurchase shares on the open market or in private transactions from time to time depending on market conditions. Each authorization shall continue for a period of two years from its inception or until it is discontinued by the Board of Directors. Under the Company’s buyback program no shares were repurchased in 2004 and approximately 3.0 million shares were repurchased in 2005 at an average price of $5.84 per share for an aggregate purchase price of $17.6 million. The Company repurchased approximately 3.4 million shares of its common stock at an average price of $5.27 per share for an aggregate purchase price of approximately $18.1 million during 2006. No repurchase were made during the three months ended December 31, 2006.
Item 6.
Item 6.
Selected Financial Data
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and the notes thereto and management’s discussion and analysis of financial condition and results of operations included elsewhere in this Annual Report. The balance sheet data at December 31, 2006 and the statement of operations data for the year ended December 31, 2006 have been derived from the audited consolidated financial statements included elsewhere in this Annual Report. The balance sheet data at December 31, 2005 and the statement of operations data for the two years ended December 31, 2005 and 2004 have been restated to reflect the impact of the stock-based compensation adjustments and other immaterial adjustments and have been derived from the restated audited financial statements included in this Annual Report. The balance sheet data at December 31, 2004, 2003 and 2002 and the statement of operations data for each of the two years ended December 31, 2003 and 2002 have been restated to reflect the impact of the stock-based compensation adjustments and other immaterial adjustments from amounts reported in prior periods.
(1)
As a result of having identified incorrect measurement dates and other errors in accounting for stock option grants, management concluded that the Company’s previously issued financial statements should be restated. Results for 2005 and prior have been restated to reflect non-cash compensation expense for stock options with incorrect measurement dates, other immaterial adjustments that were not previously recorded and related tax effects for all items.
(2)
We ceased operations of our Japanese subsidiary in December 2002 and we sold our HWT unit in May 2006. As a result, operating results of these subsidiaries for all prior periods presented have been reclassified into the caption “Income (loss) from discontinued operations.”
(3)
We have never declared or paid any cash dividends.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Restatement of Prior Period Financial Statements
Background of the Restatement
As announced on August 8, 2006, the Audit Committee of Sapient’s Board of Directors (“Audit Committee”) initiated a voluntary, independent investigation into the Company’s historical stock-based compensation practices after a management review discovered irregularities in certain past stock option grants for the periods 1996 through 2001. One committee member who had been on the Compensation Committee during this period recused himself from participation.
On November 20, 2006, the Audit Committee announced that the results of the internal investigation indicated a lack of controls and documentation, principally prior to 2004, around the Company’s stock-based compensation granting process, as well as irregularities relating to pricing of certain grants of options to purchase the Company’s common stock (“options” or “stock options”) awarded principally during the period from 1996 through 2001 (the “Identified Period”). With the exception of the 60-day and 7-day pricing, which occurred primarily in 1996 and 1997, the Audit Committee did not find any evidence of a systematic effort to intentionally backdate stock option grants on a large scale. The Audit Committee’s report included the following key findings:
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The investigation found no misconduct by any of the individuals who were serving on the Company’s management team as of the conclusion of the Audit Committee’s internal investigation.
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The investigation found that the Company’s former CEO, Jerry Greenberg, former CFO, Susan Cooke and former General Counsel, Deborah Gray, participated, to varying degrees, in issuing these grants. All three participated in the authorization of the 60-day pricing practice and in certain instances of targeted pricing. Additionally, the investigation found that the former CFO and former General Counsel participated in the authorization of re-pricing and “look-back” pricing of grants in connection with certain of the Company’s acquisitions in 1998 and 1999. The investigation was inconclusive on whether the former CEO and former General Counsel fully understood the accounting and disclosure ramifications of these practices. The Audit Committee found evidence that the former CFO knew that certain practices had accounting and disclosure implications but failed to take steps to ensure that the accounting for those practices was proper. The former CEO, who received no stock options in the 15 years since his co-founding Sapient, resigned from the Company in October 2006. The former CFO also resigned then. The former General Counsel, Deborah Gray, left the Company in January 2002. Stuart Moore, a member of the Board of Directors, who co-founded Sapient and was co-CEO until June 2006, never received stock options and did not participate in issuing these grants.
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Some members of current management received options that, in some cases, had prices corresponding to a date earlier than the measurement date for accounting purposes. None of the members of current management were in a position at the time to approve their own option grants.
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Certain outside members of the Board of Directors received options that had prices corresponding to a date other than the measurement date for accounting purposes. In some instances Board members receiving these grants had executed written consents approving the grants, although none of the members of the Board of Directors directed the pricing of options they received or the pricing of any other options.
The Audit Committee and Management concluded that the actual “measurement date,” as that term is defined in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), was different from the measurement date recorded by the Company for a number of grants of options to purchase the Company’s common stock (“options” or “stock options”) which were awarded to both “Section 16” officers and directors and other employees. As a result of having identified these incorrect measurement dates and other errors
described below in accounting for stock option grants, management concluded that the Company’s previously issued financial statements should be restated. The issues identified by the investigation fall into the following main categories:
(a) Lack of certain documentation for Company-wide grants. With respect to certain of the grants that were typically made on an annual or semi-annual basis to all eligible rank-and-file employees in the Company (“Company-wide grants”), there is a lack of certain supporting documentation.
(b) Grants without proper authorization. These grants which were primarily to new hires or in connection with promotions were made: (i) by individuals who may not have been explicitly delegated the authority to make grants under the relevant plans (e.g., grants were authorized by one of the Company’s two co-CEOs, during a period when approval from both co-CEOs was required under the terms of the plans); (ii) in amounts beyond the ranges authorized by the Compensation Committee; or (iii) without Compensation Committee approval, when such approval was required (e.g., a grant to an individual who had been designated as a Section 16 officer).
(c) 7-day, 15-day or 60-day pricing for grants. Certain grants were priced at the lowest quoted market price in the 7 days, 15 days or 60 days following the date of grant. It appears that this practice occurred primarily in 1996 and 1997.
(d) Targeted pricing. Certain grants were made to an individual or small group of individuals in which the measurement date recorded by the Company preceded the appropriate measurement date as determined under APB No. 25, and in which it appears that the earlier measurement date was chosen in part because pricing was favorable on that date.
(e) Grants issued in connection with business acquisitions. For grants issued to employees who joined the Company in connection with two acquisitions which occurred in 1999, it was determined that both acquisitions granted options priced utilizing a 30-day “look-back” where the Company priced the options at the lowest stock price in the 30-day period after the acquisition. The Company determined that options granted in connection with one acquisition in 1998 were repriced.
(f) Promotion grants. In certain instances, the Company priced grants as of the date the promotion was authorized, rather than the date that the terms of the stock option grant (including the number of shares to be granted) were finalized. In some instances, this practice resulted in more favorable prices and in some instances it did not result in more favorable pricing.
(g) Grants authorized by written consent. These grants, primarily to senior personnel within the Company, and in one instance in 1999 to outside Directors on the Board, were authorized by written consents bearing a date which was used to establish the exercise price, and which was significantly earlier than the date the written consents were fully executed.
(h) Administrative errors. These grants comprise several instances where stock-based compensation grants were mispriced due to what appears to be administrative or clerical errors, such as failing to correctly input a date from a grant list.
Upon the conclusion of the internal investigation, the Company completed an assessment of the appropriate measurement dates and the related accounting for the matters described above.
The Company is restating the financial statements and related disclosures described above in accordance with accounting principles generally accepted in the United States to record the following:
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Non-cash stock-based compensation expense for the difference between the option price and the quoted market price on the measurement date;
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Other immaterial adjustments that were not previously recorded; and
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Related tax effects for all items.
Summary of the Restatement Adjustments
The restatement principally reflects additional stock-based compensation expense and related tax effects pertaining to the Company’s historical stock-based compensation practices under APB No. 25, the Company’s accounting method for periods prior to January 1, 2006.
The following is a summary of the pre-tax compensation expense associated with the Adjusted Options to be recognized in each period from 1996 to 2005 (in thousands):
Related Tax Adjustments
The Company reviewed the tax effects associated with the Adjusted Options. Many of the Adjusted Options were originally intended to be Incentive Stock Options (“ISOs”), under U.S. income tax regulations. However, by definition, ISOs may not be granted with an exercise price less than the fair market value of the underlying stock on the date of grant. Due to the impact of the measurement date changes on the qualified status of affected ISOs, they may no longer qualify as ISOs under the regulations. Therefore, the affected ISOs were accounted for as if these options were non-qualified stock options for income tax accounting purposes. The Company recorded a liability for the unpaid income and employment taxes plus potential penalties and interest based upon the change in status of the affected options. The Company recorded a liability for the taxes, penalties and interest due based upon the change in status of the options in the amount of $17.8 million for the periods 1996 through 2006. The Company recorded reversals of this accrual in the amount of $16.5 million through 2006 due to the expiration of the payroll tax statute of limitations for years 2002 and prior. These adjustments resulted in a net charge to expense of $1.3 million over the
period 1997 to 2006. The net expense (benefit) recorded by the Company for these liabilities for the period indicated is as follow (in thousands):
Because the Company has a full valuation allowance against its deferred tax assets in the U.S., the income tax benefit of stock-based compensation adjustments described above were not material to any of the periods presented in this Form 10-K.
The following table sets forth the net impact of the Company’s restatement and the related tax effects as a result of historical stock option practices, as well as other immaterial adjustments unrelated to historical stock option practices that were previously unrecorded. The Company recorded other immaterial adjustments that were not previously recorded in the financial statements which consisted primarily of corrections to restructuring related lease obligations, adjustments to the period in which leasehold improvement write-offs were recorded in connection with restructured facilities and other miscellaneous adjustments. The pre-tax impact of all adjustments are set forth below:
Restatement Adjustments
The following table is a summary of all restatement amounts included in the cumulative adjustment to opening Accumulated Deficit as of January 1, 2004:
Overview
Sapient Corporation (“Sapient” or the “Company”) is a global services firm that innovates in marketing, technology and business operations. Our multidisciplinary teams of expert thinkers and designers provide business and information technology strategy, business applications, experience marketing and global outsourcing services that help our clients succeed. Headquartered in Cambridge, Massachusetts, Sapient maintains a strong global presence with offices across the United States, Canada, Germany, the Netherlands, India and the United Kingdom.
This MD&A as it relates to 2005 and 2004 has been updated for the restatements described above.
Our service revenues were $405.6 million for 2006, a 29% increase from service revenues of $313.6 million for 2005, and a 63% increase from service revenues of $248.2 million for 2004. The growth in service revenues year-over-year was derived from the continued demand for our services from new and existing clients coupled with revenue in the amount of $28.9 million related to our January 2006 acquisition of PGI. Service revenues in 2006 also include 12 months of revenue related to our 2005 acquisition of BIS compared to seven months of revenue in 2005. Our Recurring Revenues were 33% of our services revenues in 2006 compared to 35% in 2005. Recurring Revenues are revenue commitments of a year or more in which the client has committed spending levels to Sapient or chosen Sapient as an exclusive provider of certain services. During 2007, certain of these Recurring Revenue agreements will end, while others may be signed.
During 2006, we increased the number of our project personnel to effectively staff our client engagements and achieve the desired staffing mix of experience level and role. Currently, we are retaining subcontractors in certain cases to fill specific project needs. If we are not successful in maintaining effective staffing levels, our ability to achieve our service revenue and profitability objectives will be adversely affected. Our ability to effectively staff our engagements and achieve the desired staffing mix depends heavily on our ability to keep turnover at appropriate levels. Our voluntary turnover for 2006 increased to 22% compared to 18% for 2005. We also continue to modify and upgrade critical internal systems that we require to manage client projects and our business generally. Our operations and business results will be adversely impacted if we do not successfully and efficiently implement these system changes, as necessary, from time to time.
During 2006, we continued to utilize our India-based effort on our GDD projects thereby increasing our billable days, or level of effort, incurred by our India people as a percentage of total Company billable days for 2006 of 55% compared to 2005 of 53%. Our GDD methodology continues to be important to our clients’ success. This proprietary methodology allows us to provide high-quality, cost effective solutions under accelerated project schedules. By engaging India’s highly skilled technology specialists, we can provide services at lower total costs as well as offer a continuous delivery capability resulting from time differences between India and the countries we serve. We also employ our GDD methodology to provide application management services.
Our full year net income was $3.1 million in 2006 compared to $26.4 million in 2005. Our operating margin for 2006 was (1%) compared to 7% in 2005. The year-over-year decline in our operating margin is primarily due to additional costs of $8.1 million in 2006 related to our stock-based compensation review and restatement as well as an incremental $3.8 million in stock-based compensation related to a full year of restricted stock unit stock-based compensation in addition the implementation of SFAS No. 123R which resulted in $6.1 million stock-based compensation previously not recorded in the income statement. For 2006, our utilization rate increased to 75%, compared to 74% for 2005. Included in our full year net income for 2005 is a one time benefit of $4.3 million, related to the release of the valuation allowance related to deferred tax assets in Germany, while 2006 includes the one time net gain of $4.8 million on the sale of our investment in HWT a majority-owned, fully consolidated subsidiary.
We have observed the current market trend where pricing is based on market competitiveness and beginning in 2005, we have implemented a new going-to-market strategy which requires us to focus on decreasing general and administrative (“G&A”) costs as a percentage of revenue. During 2006 we continued progress on our strategic initiative of reengineering our G&A functions. In conjunction with streamlining G&A processes, we have transferred a number of support activities to India. These activities principally relate to finance, human resources, and some of our internal IT functions. As such, we recorded a $300,000 restructuring charge during 2005 and a charge of $1.9 million during 2006.
On June 1, 2005, we purchased Business Information Solutions, LLC (“BIS”), a privately-held provider of SAP-related professional services, specializing in business intelligence solutions. We added forty-eight full-time BIS people. This acquisition allowed us to expand our services in business intelligence and in newer modules of SAP, specifically Business Information Warehouse, Strategic Enterprise Management, data analytics, NetWeaver, other “SAP New Dimension” products and energy specific solutions. In addition, the acquisition has allowed us to offer a much broader variety of value-added ERP integration, upgrade, and maintenance services related to the globally dominant SAP products and its Netweaver platform.
On January 3, 2006, we acquired Planning Group International, Inc. (“PGI”). Through this acquisition we enhanced our strengths in advertising, digital and direct marketing, brand development, data mining, customer acquisition and loyalty, paid search, and media planning and buying strategies and services. Additionally, we now can provide our clients a clear understanding of the effectiveness of their media spend using BridgeTrack®, a proprietary online marketing and analysis platform. We believe that our combination with PGI expanded our opportunities to help our clients exploit the possibilities created by the rapid evolution of media, advertising, and technology and derive measurable value from their marketing investments.
On May 2, 2006, we sold 100% of our investment in HWT, for which we received net cash proceeds of approximately $5.4 million. Net assets sold included cash of approximately $274,000. During Q1 2007, the Company received additional cash proceeds of approximately $530,000 related to holdback and escrow in accordance with the terms of the agreement. In addition, the Company could receive up to $4.0 million in earn-out payments over 2007 and 2008, which will be recorded when and if earned.
Although the growth in our business has been positive, the economic outlook, as always, is subject to change. Any decline in our service revenues will have a significant impact on our financial results, particularly because a significant portion of our operating costs (such as personnel, rent, depreciation and amortization of intangible assets) are fixed in advance of a particular quarter. In addition, our future operating segment and overall Company revenues and operating results may fluctuate from quarter to quarter based on the number, size and scope of projects in which we are engaged, the contractual terms and degree of completion of such projects, any delays incurred in connection with a project, employee utilization rates, the adequacy of provisions for losses, the use of estimates of resources required to complete ongoing projects, general economic conditions and other factors.
Summary of Critical Accounting Policies; Significant Judgments and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. These items are regularly monitored and analyzed by management for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ substantially from our estimates.
A summary of those accounting policies, significant judgments and estimates that we believe are most critical to fully understanding and evaluating our financial results is set forth below. This summary should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this Annual Report.
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Revenue Recognition. We recognize revenue from the provision of professional services, digital marketing services and offline printing and production services arrangements with our clients when persuasive evidence of an arrangement exists, services or product have been provided to the customer, the fee is fixed or determinable and collectibility is reasonably assured. In instances where the customer, at its discretion, has the right to reject the services or product prior to final acceptance, revenue is deferred until such acceptance occurs.
We recognize revenues from our fixed-price technology implementation consulting contracts using the percentage-of-completion method pursuant to Statement of Position 81-1, Accounting for Performance of Construction Type and Certain Production Type Contracts. Revenues generated from fixed-price non-technology implementation contracts, except for support and maintenance contracts, are recognized based upon a proportional performance model in accordance with Staff Accounting Bulletin (“SAB”) No. 101, Revenue Recognition in Financial Statements, (“SAB No. 101”) as amended by SAB No. 104, Revenue Recognition (“SAB No. 104”). Our percentage-of-completion method and our proportional performance method of accounting calculates revenue based on the percentage of labor incurred to estimated total labor. This method is used because reasonably dependable estimates of the revenues and labor applicable to various stages of an arrangement can be made, based on historical experience and milestones set in the contract. Revenue from time-and-material contracts is recognized as services are provided. Revenue generated from staff augmentation and support contracts are recognized ratably over the arrangement’s term.
Our project delivery and business unit finance personnel continually review labor incurred and estimated total labor, which may result in revisions to the amount of recognized revenue under an arrangement. Certain arrangements provide for revenue to be generated based upon the achievement of certain performance standards. Revenue related to the achievement of performance standards was immaterial for any of the periods presented in our consolidated financial statements.
Revenues from arrangements with multiple elements are allocated based on the fair value of the elements in accordance with the Emerging Issues Task Force (“EITF”) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, (“EITF No. 00-21”). For these arrangements, we evaluate all deliverables in the arrangement to determine whether they represent separate units of accounting. Fair value is determined based on reliable evidence of the fair value of each deliverable. Revenues are recognized in accordance with our accounting policies for the separate elements when the services have value on a stand-alone basis, fair value of the separate elements exists and, in arrangements that include a general right of refund relative to the delivered element, performance of the undelivered element is considered probable and substantially under our control. This evaluation is performed at the inception of the arrangement and as each item in the arrangement is delivered. The evaluation involves significant judgments regarding the nature of the services and deliverables being provided, whether these services and deliverables can reasonably be divided into the separate units of accounting and the fair value of the separate elements determined.
Revenues related to our digital marketing media sales are recorded as the net amount of our gross billings less pass-through expenses charged to a client. In most cases, the amount that is billed to clients significantly exceeds the amount of revenue that is earned and reflected in our financial statements, because of various pass-through expenses such as production and media costs. In compliance with EITF Issue No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, (“EITF No. 99-19”) we assess whether the
agency or the third-party supplier is the primary obligor. We evaluate the terms of our client agreements as part of this assessment. In addition, we give appropriate consideration to other key indicators such as latitude in establishing price, discretion in supplier selection and credit risk to the vendor. Because we broadly operate as an advertising agency based on our primary lines of business and given the industry practice to generally record revenue on a net versus gross basis, we believe that there must be strong evidence in place to overcome the presumption of net revenue accounting. Accordingly, we record revenue net of pass-through charges as we believe the key indicators of the business suggest we generally act as an agent on behalf of our clients in our primary lines of business. In those businesses where the key indicators suggest we act as a principal, we record the gross amount billed to the client as revenue.
Our marketing services help our clients optimize their cross platform marketing effectively to track behavior and improve conversion rates through data-driven analysis. These services are provided in exchange for monthly retainer fees and license fees and are recognized as the monthly services are provided.
Revenue from offline printing and production services are recognized at the time title of the related items transfers to our customers given all other revenue recognition criteria have been met.
If we do not accurately estimate the resources required or the scope of work to be performed for an arrangement or we do not manage the project properly within the planned time period, then we may recognize a loss on the arrangement. Provisions for estimated losses on uncompleted arrangements are made on an arrangement-by-arrangement basis and are recognized in the period in which such losses are identified. We have committed unanticipated additional resources to complete projects in the past, which has resulted in lower than anticipated profitability or losses on those arrangements. We expect that we will experience similar situations in the future. In addition, we may fix the price for some projects at an early stage of the process, which could result in a fixed-price that is too low and, therefore, a correct estimation could adversely affect our business, financial condition and results of operations.
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Allowance for Doubtful Accounts. We recognize revenue for services when collection from the client is reasonably assured, and our fees are fixed or determinable. We establish billing terms at the time project deliverables and milestones are agreed. Our normal payment terms are thirty days from invoice date. Revenues recognized in excess of the amounts invoiced to clients are classified as unbilled revenues. Amounts invoiced to clients in excess of revenue recognized are classified as deferred revenues. Our project delivery and business unit finance personnel continually monitor timely payments from our clients and assess any collection issues. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our clients to make required payments. We base our estimates on our historical collection and write-off experience, current trends, credit policy, detailed analysis of specific client situations and percentage of our accounts receivable by aging category. While such credit losses have historically been within our expectations and the allowances we established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. If the financial condition of our clients were to deteriorate, resulting in an impairment of their ability to make payment, additional allowances may be required. Our failure to accurately estimate the losses for doubtful accounts and ensure that payments are received on a timely basis could have a material adverse effect on our business, financial condition and results of operations.
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Stock-Based Compensation Expense. Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123R, using the modified prospective transition method, and therefore have not restated prior periods’ results for the implementation of SFAS No. 123R. Under this method we recognize compensation expense for all share-based payments granted after January 1, 2006 and the portion of awards granted prior to January 1, 2006 but not yet vested as of January 1, 2006, in accordance with SFAS No. 123R. Under the fair value recognition provisions of SFAS No. 123R, we recognize stock-based compensation net of an estimated forfeiture rate and only recognize compensation cost for those shares expected to vest on a straight-line basis over the requisite service period of the award. Prior to SFAS No. 123R’s adoption, we accounted for share-based payments under APB No. 25 and accordingly, generally recognized compensation expense only when we granted options with a discounted exercise price.
Based on historical experience the Company has assumed an annualized forfeiture rate of 7% for awards granted to its senior executives and directors, and a 20% forfeiture rate for its remaining employees. The Company will record additional expense if the actual forfeitures are lower than estimated and will record a recovery of prior expense if the actual forfeitures are higher than estimated. The actual expense recognized over the vesting period will only be for those shares that vest. The cumulative effect of the accounting change to reflect forfeiture assumption for stock-based compensation recorded in prior periods resulted in income of $154,000 and was recognized in the statement of operations for the three-month period ending March 31, 2006.
Determining the appropriate fair value model and calculating the fair value of share-based payment awards requires the input of highly subjective assumptions, including the expected life of the share-based payment awards and stock price volatility. Management determined that using historical volatility of its own stock is an indicator of expected volatility. Therefore, expected volatility for 2006 option grants was based on the daily closing prices of our common stock during the 6.25-year period ended December 31, 2005. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if circumstances change and we use different assumptions, our stock-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the stock-based compensation expense could be significantly different from what we have recorded in the current period. See Note 3 to the Consolidated Condensed Financial Statements for a further discussion on stock-based compensation.
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Accounting for Income Taxes. Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We evaluate all available evidence, such as recent and expected future operating results by tax jurisdiction, current and enacted tax legislation and other temporary differences between book and tax accounting, to determine whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. As a result of operating losses incurred in 2001, 2002 and 2003, and uncertainty as to the extent and timing of profitability in future periods, we have recorded a valuation allowance of approximately $119.0 million as of December 31, 2006 relating to the deferred tax assets in the United States. Having assessed the ability to realize the deferred tax assets in certain foreign jurisdictions, we believe that future taxable income will be sufficient to realize the deferred tax benefit of the deferred tax assets in Canada, the United Kingdom, and Germany. The establishment and amount of the valuation allowance requires significant estimates and judgment and can materially affect our results of operations. If the realization of deferred tax assets in the future is considered more likely than not, an adjustment to the deferred tax assets would increase net income in the period such determination was made. Our effective tax rate may vary from period to period based on changes in estimated taxable income or loss in each jurisdiction, changes to the valuation allowance, changes to federal, state or foreign tax laws, future expansion into areas with varying country, state, and local income tax rates, deductibility of certain costs and expenses by jurisdiction and as a result of acquisitions.
In July 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), which clarifies the accounting for uncertainty in income tax recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company has evaluated FIN 48 and determined that there is no material impact of adopting this interpretation.
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Valuation of Long-Lived Assets and Intangible Assets. In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, (“SFAS No. 144”) long-lived assets are reviewed for impairment on a regular basis for the existence of facts and circumstances that may suggest that the carrying amount of an asset, or group of assets, may not be recoverable. Recoverability of long-lived assets or groups of assets is assessed based on a comparison of the carrying amount to the estimated undiscounted future cash flows. If estimated future undiscounted net cash flows are less than the carrying amount, the asset is considered impaired and expense is recorded at an amount required to reduce the carrying amount to fair value. Determining the fair value of long-lived assets includes significant judgment by management, and different judgments could yield different results.
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Valuation of Goodwill. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, (“SFAS No. 142”) requires, among other things, the discontinuance of goodwill amortization. The standard also includes provisions for the assessment of the useful lives of existing recognized intangible assets and the identification of reporting units for purposes of assessing potential future impairments of goodwill. Factors we consider important which could trigger an impairment review include:
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significant underperformance relative to historical or projected future operating results;
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significant changes in the manner of or use of the acquired assets or the strategy for our overall business;
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identification of other impaired assets within a reporting unit;
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disposition of a significant portion of an operating segment;
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significant negative industry or economic trends;
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significant decline in our stock price for a sustained period; and
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a decline in our market capitalization relative to net book value.
Determining whether a triggering event has occurred includes significant judgment from management.
The goodwill impairment test prescribed by SFAS No. 142 requires us to identify reporting units and to determine estimates of the fair value of our reporting units as of the date we test for impairment. The Company’s reporting units are consistent with the reportable segments identified in Note 20 of our consolidated financial statements. Assets and liabilities, including goodwill were allocated to reporting units based on factors such as specific identification and percentage of revenue. To conduct a goodwill impairment test, the fair value of the reporting unit is compared to its carrying value. If the reporting unit’s carrying value exceeds its fair value, we record an impairment loss to the extent that the carrying value of goodwill exceeds its implied fair value. Management estimates the fair value of its’ reporting units using discounted cash flow valuation models. Those models require estimates of future revenue, profits, capital expenditures and working capital for each unit. We estimate these amounts by evaluating historical trends, current budgets and operating plans. We performed the annual assessment during the fourth quarter of 2006 and determined that goodwill was not impaired. We complete goodwill impairment analyses at least annually, or more frequently when events and circumstances occur indicating that the recorded goodwill may be impaired. Determining fair value of reporting units and goodwill includes significant judgment by management and different judgments could yield different results.
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Costs Incurred to Develop Computer Software for Internal Use. We account for costs incurred to develop computer software for internal use in accordance with SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use (“SOP 98-1”). As required by SOP 98-1, the Company capitalizes the costs incurred during the application development stage, which include costs to design the software configuration and interfaces, coding, installation and testing. Costs incurred for internal use computer software during the preliminary project stage and through post-implementation stages of internal use computer software are expensed as incurred. The capitalization and ongoing assessment of recoverability of development cost requires considerable judgment by management with respect to certain external factors, including, but not limited to, technological and economic feasibility, and estimated economic life.
Capitalized software is included in property and equipment and is depreciated over its estimated life, which is typically three years.
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Restructuring and Other Related Charges. We established exit plans for each of the restructuring activities which took place in 2001 and 2002 and accounted for these plans in accordance with EITF Issue No. 94-3, Liability Recognition for Certain Employee Benefits and Other Costs to Exit an Activity (including Certain Costs incurred in a Restructuring) (“EITF No. 94-3”). These exit plans required that we make estimates as to the nature, timing and amount of the exit costs that we specifically identified. The consolidation of facilities required us to make estimates, which included contractual rental commitments or lease buy-outs for office space vacated and related costs, offset by estimated sub-lease income. We review on a regular basis our sub-lease assumptions and lease buy-out assumptions. These estimates include lease buy-out costs, anticipated sublease rates, other terms and conditions in sub-lease contracts, and the timing of these sub-lease arrangements. If the rental markets continue to change, our lease buy-out, sub-lease and space requirement assumptions may not be accurate and it is possible that changes in these estimates could materially affect our financial condition and results of operations. Our sublease reserve is sensitive to the level of sublease rent anticipated and the timing of sublease commencement. If the estimated sublease dates were to be delayed by six months, based on our current estimates, we would potentially have to recognize an additional $900,000 in our statement of operations for restructuring and other related charges. A 10% reduction in our sublease rate would have resulted in an additional $800,000 of charges as of the end of 2006. If any future adjustments are required to the restructuring initiatives recorded under the provisions of EITF No. 94-3, such adjustments will be measured in accordance with EITF No. 94-3. SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, (“SFAS No. 146”) was effective for exit or disposal activities that are initiated after December 31, 2002. SFAS No. 146 requires that a liability that is associated with an exit or disposal activity be recognized when the liability is incurred. SFAS No. 146 supersedes the guidance in EITF No. 94-3. SFAS No. 146 includes a rebuttable presumption that if an entity has a history of providing similar termination benefits to employees, the benefit arrangement is presumed to be an ongoing benefit arrangement that should be accounted for under SFAS No. 112, Employers’ Accounting for Postemployment Benefits (SFAS No. 112”). SFAS No. 112 prescribes the accounting for the estimated cost of benefits, including severance benefits, provided by an employer to former or inactive employees after employment but before retirement. A liability is recognized when the severance amounts relate to prior services rendered, the payment of the amount is probable and the amount can be reasonably estimated. Since the second quarter of 2003, we have accounted for severance-related restructuring charges in accordance with SFAS No. 112 because we have a history of paying similar severance benefits since 2001.
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Contingent Liabilities. We have certain contingent liabilities that arise in the ordinary course of our business activities. We accrue contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. We are subject to various legal claims totaling approximately $3.2 million and various administrative audits, each of which have arisen in the ordinary course of our business. We have an accrual at December 31, 2006 of approximately $800,000 related to certain of these items. We intend to defend these matters vigorously, although the ultimate outcome of these items is uncertain and the potential loss, if any, may be significantly higher or lower than the amounts we have previously accrued. Further, as noted in Item 3, the pending derivative actions do not assert a claim against the Company for specific monetary damages and, accordingly, the amounts described herein are exclusive of any potential future monetary damages that the company may incur as a result of the derivative actions. We record expense for legal services at the time such services are provided.
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Accounting for Acquisitions. Our accounting for acquisitions involves significant judgments and estimates primarily, but not limited to: the fair value of certain forms of consideration, the fair value of acquired intangible assets, which involve projections of future revenues and cash flows, the fair value of other acquired assets and assumed liabilities, including potential contingencies, and the useful lives and, as applicable, the reporting unit, of the assets. The impact of prior or future acquisitions on our financial position or results of operations may be materially impacted by the change in or initial selection of assumptions and estimates. Additionally, under SFAS No. 142, we determine the fair value of the reporting unit, for purposes of the first step in our annual goodwill impairment test based on a discounted future cash
flows approach. If prior or future acquisitions are not accretive to our results of operations as expected, or the fair value of a reporting unit declines dramatically, we may be required to complete the second step which requires significant judgments and estimates and which may result in material impairment charges in the period in which they are determined.
Off-Balance Sheet Arrangements
We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating parts of our business that are not consolidated into our financial statements. Although the Company holds no ownership interest in the voting shares of Sapient S.p.A., the management team of Sapient S.p.A. is the exclusive licensee of Sapient’s intellectual property in Italy, and we are entitled to a royalty equal to 2% of the annual revenue of Sapient S.p.A. beginning July 2, 2005. We previously had an option to purchase 100% of the ownership of Sapient S.p.A., from 2007 through 2010; however this option terminated during 2006. We do not have any other arrangements or relationships with entities that are not consolidated into our financial statements that are reasonably likely to materially affect our financial condition, results of operations, liquidity, capital expenditures or capital resources.
Discontinued Operations
On May 2, 2006, the Company sold 100% of its investment in HWT, the Company’s majority-owned, fully consolidated subsidiary, for which we received net cash proceeds of approximately $5.4 million. Net assets sold included cash of approximately $274,000. The Company has recorded a receivable for $1.2 million related to the holdback and escrow payments, which is recorded in prepaid expenses and other current assets on the Company’s consolidated balance sheet at December 31, 2006, and has recorded a payable of $213,000 in other current liabilities, representing the portion of the escrow and holdback that is due to minority shareholders. During 2007, the Company received additional cash proceeds of approximately $530,000 related to holdback and escrow in accordance with the terms of the agreement. In addition, the Company could receive up to $4.0 million in earn-out payments over 2007 and 2008, which will be recorded when and if earned. The Company has reflected HWT’s historical results as discontinued operations in the consolidated financial statements for all periods. The sale of HWT resulted in a net gain on disposal (after tax) of $4.8 million. Gross revenues for HWT were $1.3 million, $6.0 million and $5.7 million for the years ended December 31, 2006, 2005 and 2004, respectively. Income (loss) of the discontinued operation was approximately ($433,000), $961,000 and $665,000 for the year-ended December 31, 2006, 2005 and 2004, respectively. The gross revenue and net income (loss) figures noted above for HWT for the year ended December 31, 2006 only include amounts recorded through April 30, 2006, as HWT was disposed of on May 2, 2006. Our financial statements and all financial information included in this report for 2006 and prior periods reflect the results of operations for HWT as a single line item listed as “Income (loss) from discontinued operations.”
Equity Investments
As of December 31, 2006, we have no equity investments.
Related Party Transactions
In October of 2006, in connection with his resignation, Jerry A. Greenberg and Sapient Corporation (the “Company”) entered into a consulting agreement pursuant to which Mr. Greenberg may provide consulting services to the Company in respect of long-term strategic planning, ongoing client relations and general business development. The consulting agreement is effective as of October 16, 2006, has an initial term of one year and may be terminated by either party upon written notice. The amount earned under this arrangement as of December 31, 2006 was $70,148 of which $57,923 was paid and $12,225 was payable as of December 31, 2006.
Results of Operations
The following table sets forth the percentage of service revenues of items included in our consolidated statements of operations:
Years Ended December 31, 2006 and 2005
Service Revenues
Our service revenues for 2006 and 2005 were as follows:
The year-over-year increase in our service revenues is primarily due to the continued strong growth in our North America Commercial business segment. The year-over-year increase attributable to our North American Commercial business segments was $59.7 million. In addition, North America Commercial includes a full twelve months of revenue related to its 2005 acquisition of BIS, whereas only seven months are included in 2005, as BIS was acquired on June 1, 2005. The revenue increase in our European business units of $12.0 million was offset by a decrease in our Government Services revenue of $8.6 million. Total additional revenue as a result of our PGI acquisition was approximately $28.9 million. The effects of foreign currency exchange rates accounted for 1 percentage point of the increase in service revenues in 2006 as compared to 2005. Our recurring revenues decreased to 33% of our service revenues in 2006 from 35% in 2005. Recurring revenues are revenue commitments of a year or more in which the client has committed spending levels to us or chosen us as an exclusive provider of certain services.
In 2006, our five largest clients accounted for approximately 25% of our revenues in the aggregate; one client accounted for 10% of such revenues and no other client accounted for more than 5% of such revenues. In 2005, our five largest clients accounted for approximately 26% of our revenues in the aggregate; one client accounted for more than 10% of such revenues.
Project Personnel Expenses
Project personnel expenses consist principally of salaries and employee benefits for personnel dedicated to client projects, independent contractors and direct expenses incurred to complete projects that were not reimbursed by the client. These expenses represent the most significant costs we incur in providing our services.
The increase in project personnel expenses was due to the increase in the number of delivery people worldwide in 2006 compared to 2005, coupled with an increase of $4.8 million in stock-based compensation expense which was primarily a result of the adoption of SFAS No. 123R on January 1, 2006 and a full year of expense related to restricted stock units. Additionally, we experienced increased usage of third-party consultants and travel expenses during 2006 as compared to 2005. We ended 2006 with 4,223 delivery people, of which 2,697 were India-based, compared to 2,495 delivery people, of which 1,354 were India-based, at the end of 2005.
Gross profit (service revenues less project personnel expenses) as a percentage of service revenues for 2006 was 33% compared to 40% in 2005. The decrease was due to the increased usage of third-party consultants, increased travel expenses, and to a lesser extent, the acquisition of PGI during 2006, which has higher project personnel expenses as a percentage of service revenues.
Selling and Marketing Expenses
Selling and marketing expenses consist principally of salaries, employee benefits and travel expenses of selling and marketing personnel, and promotional expenses.
The year-over-year increase in selling and marketing expenses in absolute dollars is due to the inclusion of salaries and benefits of certain delivery personnel who focused on sales pursuits during the first quarter of 2006, an increase of approximately $2.7 million of stock-based compensation which was primarily a result of the adoption of SFAS No. 123R and a full year of compensation expense related to restricted stock units, and an increase in bonus expense and commissions. The number of selling and marketing personnel increased to 68 people at the end of 2006 compared to 57 people at the end of 2005.
General and Administrative Expenses
General and administrative expenses relate principally to salaries and employee benefits associated with our management, legal, finance, information technology, hiring, training and administrative groups, and depreciation and occupancy expenses.
General and administrative expenses increased in absolute dollars for 2006 compared to 2005. The increase was due to the increased salaries and employee benefits associated with increased headcount to support our worldwide growth in revenues and billable headcount, $8.1 million in stock-based compensation review and restatement expenses, and an increase of approximately $2.8 million of stock-based compensation which was primarily a result of the adoption of SFAS No. 123R and a full year of compensation expense related to restricted stock units. Additionally, depreciation expense increased by $3.6 million, primarily as a result of our expansion in India. The number of general and administrative personnel increased to 661 at the end of 2006, of which 439 were India based, compared to 465 at the end of 2005, 233 of which were India based. The additions in 2006, were primarily in finance, hiring and administrative groups.
Our general and administrative expenses include a foreign currency translation gain of approximately $244,000 in 2006, compared to a foreign currency translation loss of approximately $1.3 million in 2005. These gains and losses were related to intercompany foreign currency translations that were of a short-term nature.
Restructuring and Other Related Charges
During 2006, we recorded restructuring and other related charges of approximately $1.9 million, of which $572,000 related to the 2006 restructure event, $430,000 related to the 2005 restructure event and $910,000 related to the 2001, 2002 and 2003 restructure events.
2006 - Restructure Event
During the first quarter of 2006, we initiated a restructuring plan in the United Kingdom to better position ourselves to capitalize on market opportunities. As a result, 28 employees were terminated and we recorded $572,000 in restructuring and other related charges for severance and termination benefits in the first half of 2006 in accordance with SFAS Statement No. 112, Employers’ Accounting for Postemployment Benefits. These charges were recorded in the United Kingdom segment in our Results by Operating Segment. We paid the entire liability during 2006.
2005 - Restructure Event
During the fourth quarter of 2005, we initiated a restructuring plan to streamline general and administrative (“G&A”) activities. This initiative included the transfer of certain finance, human resources, and internal IT functions to India. As of December 31, 2006, this initiative resulted in the reduction of 21 employees and charges of approximately $430,000 during 2006 and $300,000 during 2005 to restructuring and other related charges for severance, termination benefits and stay-bonuses in accordance with SFAS No. 112, and SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. These charges were not recorded to a segment because it impacted an area of the business that supports all business units, but is included in ‘Reconciling items’ in the Results by Operating Segment. The severance accrual is included in the consolidated balance sheet in “Accrued restructuring costs, current portion”. We paid approximately $505,000 through the end of 2006 and paid the remainder during the first two quarters of 2007.
2001, 2002 and 2003 - Restructure Events
As a result of the decline in the demand for advanced technology consulting services that began in 2000, we restructured our workforce and operations in 2001, 2002 and 2003. The restructuring consisted of ceasing operations and consolidating or closing excess offices. Estimated costs for the consolidation of facilities included contractual rental commitments or lease buy-outs for office space vacated and related costs, offset by estimated sublease income.
During 2006, we recorded restructuring and other related charges of approximately $910,000, of which, $465,000 related to an increase in operating expense assumptions associated with the our previously restructured facilities. The remaining $445,000 was primarily due to a decrease in estimated sublease income resulting from changes in market leasing conditions on previously restructured facilities. During 2005, we recorded restructuring charges of approximately $6.1 million, primarily due to a decrease in estimated sublease income resulting from changes in market leasing conditions on previously restructured facilities. We have not finalized sublease agreements for all leases and are currently involved in negotiations to sublease the vacant spaces.
The total remaining accrued restructuring costs for all events are $15.6 million at December 31, 2006, of which the cash portion is $15.5 million. The net cash outlay over the next 12-month period is expected to be $3.9 million and the remainder will be paid through 2011.
These restructuring charges and accruals require significant estimates and assumptions, including sub-lease income assumptions. The consolidation of facilities required us to make estimates, which included contractual rental commitments or lease buy-outs for office space vacated and related costs, offset by estimated sub-lease income. Our sub-lease assumptions include anticipated rates to be charged to a sub-tenant and the timing of the sub-lease arrangement. These estimates and assumptions are monitored on a quarterly basis for changes in circumstances. It is reasonably possible that such estimates could change in the future, resulting in additional adjustments and these adjustments could be material.
Amortization of Intangible Assets
During 2006, amortization of intangible assets consisted primarily of: non-compete and non-solicitation agreements, customer list and backlog related to the 2006 PGI acquisition, SAP license agreement and customer list relating to the 2005 BIS acquisition, and customer contracts and developed technology resulting from prior acquisitions. During 2005, amortization of intangible assets consisted primarily of amortization of customer contracts and developed technology resulting from prior acquisitions and investments in consolidated subsidiaries. Amortization expense related to intangible assets was $3.6 million for 2006 and $1.1 million for 2005. Amortization expense related to intangible assets is expected to be approximately $2.0 million, $1.9 million, $1.8 million, $788,000, and $363,000 for the years ending December 31, 2007, 2008, 2009, 2010 and 2011, respectively.
Interest and Other Income
Interest and other income is derived primarily from investments in U.S. government securities, corporate debt securities, commercial paper, time deposits, money market funds and insurance proceeds.
Interest and other income for 2006 included approximately $1.9 million of insurance proceeds. Included in these amounts are business interruption proceeds of approximately $394,000 in the first quarter of 2006 and $283,000 in the second quarter of 2006. These amounts were received in connection with a fire that occurred in our Gurgaon, India office during the first quarter of 2005. The fire did not have a material effect on our business or in our ability to serve our clients. The remainder of the insurance proceeds were related to an employee matter that was settled during 2006. Interest income increased slightly from 2005 to 2006.
Provision (Benefit) for Income Taxes
We have deferred tax assets that have arisen primarily as a result of net operating losses incurred in 2001, 2002 and 2003, as well as other temporary differences between book and tax accounting. Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against the net deferred tax assets. As a result of net operating losses incurred from 2001 through 2003, and uncertainty as to the extent, and timing of profitability in future periods; in the United States, we have continued to record a valuation allowance against our deferred tax assets of $119.0 million, at December 31, 2006 and $117.2 million at December 31, 2005. For the years ended December 31, 2006 and 2005, we recorded an income tax provision (benefit) of approximately $4.4 million and ($612,000) respectively. Our income tax provision is primarily related to foreign, federal alternative minimum tax and state tax obligations. As of December 31, 2006, and reflected in the tax provision, is a deferred tax liability of approximately $1.0 million that has been recorded as a result of the goodwill acquired in connection with the BIS and PGI acquisition. See Note 4.
Our effective tax rate may vary from period to period based on changes in estimated taxable income or loss, changes to the valuation allowance, changes to federal, state or foreign tax laws, future expansion into areas with varying country, state, and local income tax rates, deductibility of certain costs and expenses by jurisdiction and as a result of acquisitions.
Results by Operating Segment
The Company has discrete financial data by operating segments available based on its method of internal reporting, which disaggregates its operations. Operating segments are defined as components of the Company for which separate financial information is available to manage resources and evaluate performance. Beginning with the first quarter of 2006, the Company combined its Canada international business unit and two of its United States business units, and identified one additional business unit in the United States. Specifically, the Company combined its Financial Services, Automotive, Consumer and Energy, Technology, Education, Communications and Health Care business unit and its Canada business unit into one business unit, which is now named North America Commercial. In addition, Experience Marketing became a standalone business unit. Our three business units in North America are now: (i) North America Commercial (“NAC”), (ii) Government Services and (iii) Experience Marketing.
Prior to the first quarter of 2006 the Company did allocate certain selling, marketing and general and administrative expenses, managed within the unit to its business units in the United Kingdom, Germany and Canada, but the Company had not allocated these expenses to the business units in the United States. Beginning in the first quarter of 2006, the Company does not allocate certain marketing and general and administrative expenses to its NAC, United Kingdom, Germany and Experience Marketing business unit segments because these activities are managed separately from the business units. The Company allocates certain marketing and general and administrative expenses to its Government Services business unit as these activities are managed within the business unit. Quarterly results for operating segments for 2005 have been restated to reflect these changes. The Company did not allocate the costs associated with its restructure events before 2006 across all operating segments for internal measurement purposes, given that the substantial majority of the restructuring costs were related to the initiative to reengineer general and administrative activities and the consolidation of facilities. We did allocate the workforce reduction costs associated with the United Kingdom’s 2006 restructuring plan due to the specific identification of the terminated employees to their respective business unit. Asset information by operating
segment is not reported to or reviewed by the chief operating decision makers and, therefore, the Company has not disclosed asset information for each operating segment.
The tables below present the service revenues and operating income attributable to these operating segments for the periods presented.
(1)
Acquired January 3, 2006, see Note 4, “Acquisitions.”
(1)
Reflects only the direct controllable expenses of each business unit segment. It does not represent the total operating results for each business unit segment as it does not contain an allocation of certain corporate and general and administrative expenses incurred in support of the business unit segments.
(2)
Adjustments that are made to the total of the segments’ operating income in order to arrive at consolidated income from continuing operations before income taxes, discontinued operations and cumulative effect of accounting change include the following:
(3)
Includes corporate portion of both selling and marketing and general and administrative expenses.
Service Revenues by Operating Segments
Consolidated service revenues for 2006, compared to 2005, increased 29% in both U.S. dollars and in local currency terms. With the exception of the Experience Marketing segment, which was created in 2006, all of the reportable operating segments recorded increased service revenues during this period except for Government Services. The increase in our North America Commercial, United Kingdom, and Germany business units for 2006 compared to 2005, was primarily due to continued demand from new and existing clients coupled with the acquisition of BIS in the North America Commercial business unit. The Experience Marketing segment became a standalone segment in 2006. Our Government Services business unit service revenue decreased for 2006 compared to 2005, due to a general slowing in the signing of new business.
Operating Income by Operating Segments
All of our reportable segments had profitable operating results for 2006. Operating income for our North America Commercial and United Kingdom operating segments increased slightly during 2006, compared to 2005, primarily due to sustained revenue growth from new and existing clients. Our Government Services and Germany operating segments did not have improved operating results for 2006 compared to 2005. Lower operating results in Government Services and Germany are primarily due to a decrease in average utilization rates resulting from lower than expected service revenues.
Years Ended December 31, 2005 and 2004
Service Revenues
Our service revenues for 2005 and 2004 were as follows:
The year-over-year increase in our service revenues is primarily due to the continued strong growth in our North America Commercial (“NAC”) business segments. The year-over-year increase attributable to our North America Commercial business segments was $59.7 million. Continued demand from new and existing clients, the renegotiation of our contract with Sprint to include a 5-year term in our NAC business unit during the fourth quarter of 2004, and two large long-term engagements signed during 2005 in our NAC business unit, coupled with the acquisition of BIS helped drive continued service revenue growth in our NAC business segments. Revenue related to our non-U.S business units increased only slightly year-over-year primarily attributable to slowed revenue growth related to service agreements associated with our United Kingdom business unit and a decrease in revenue related to our Germany business unit primarily due to a decrease in revenue related to our energy service clients. Total additional revenue as a result of our BIS acquisition was approximately $13.0 million. The effects of foreign currency exchange rates accounted for 1 percentage point of the increase in service revenues in 2005 as compared to 2004. Our recurring revenues increased to 35% of our service revenues in 2005 from 26% in 2004. Recurring revenues are revenue commitments of a year or more in which the client has committed spending levels to us or chosen us as an exclusive provider of certain services.
In 2005, our five largest clients accounted for approximately 26% of our revenues in the aggregate; one client accounted for more than 10% of such revenues and no other client accounted for more than 5% of such revenues. In 2004, our five largest clients accounted for approximately 24% of our revenues in the aggregate; no client accounted for more than 10% of such revenues and two clients accounted for more than 5% of such revenues.
Project Personnel Expenses
The increase in project personnel expenses was due to the increase in the number of delivery people worldwide in 2005 compared to 2004, coupled with an increase in the 2005 bonus expense compared to 2004. We ended 2005 with 2,495 delivery people, of which 1,354 were India based compared to 1,898 delivery people, of which 1,050 were India based, at the end of 2004.
Gross profit (service revenues less project personnel expenses) as a percentage of revenues before reimbursements for 2005 were 40% compared to 46% in 2004. The decrease in the gross profit was primarily due to a decrease in our utilization rate to 74% for 2005, compared to 76% for 2004. The decrease in our 2005 utilization rate compared to 2004 is primarily due to the increase in the number of delivery people in 2005 compared to 2004 in anticipation of 2006 revenue growth.
Selling and Marketing Expenses
Selling and marketing expenses decreased in absolute dollars for 2005 compared to 2004, primarily due to a decrease in compensation expenses as a result of the re-assignment of some of our higher paid sales people to delivery due to internal growth initiatives. In addition, commission expense decreased as a result of the slowing of new business signing related to our non-U.S. business units. This decrease was offset by an increase in travel expenses as we continue to focus on recurring revenue engagements, which leverage our existing client relationships. The decrease as a percentage of service revenues is primarily due to our higher revenue base during 2005 compared to 2004. The number of selling and marketing personnel increased to 57 people at the end of 2005 compared to 45 people at the end of 2004.
General and Administrative Expenses
General and administrative expenses increased in absolute dollars for 2005 compared to 2004. The increase was primarily due to increased salaries and employee benefits associated with increased headcount to support our worldwide growth in revenues and billable head count. The number of general and administrative personnel increased to 465 at the end of 2005, compared to 371 at the end of 2004, primarily in finance, hiring and administrative groups.
Our general and administrative expenses include a foreign currency translation loss of approximately $1.3 million in 2005, compared to a foreign currency translation loss of approximately $54,000 in 2004. These losses were primarily related to intercompany foreign currency translations that were of a short-term nature.
Restructuring and Other Related Charges
2005 - Restructure Event
During the fourth quarter of 2005, we initiated a restructuring plan to streamline general and administrative (“G&A”) activities. This initiative included the transfer of a number of finance, human resources, and internal IT functions to India. As of December 31, 2005, this initiative resulted in the reduction of 21 employees and charges of approximately $300,000 during 2005 to restructuring and other related charges, related to severance, termination benefits and stay-bonuses in accordance with SFAS No. 112, and SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. The charge was not recorded to a segment because it impacted an area of the business that supports all business units, but is included in ’Reconciling items’ in the Results by Operating Segment. The severance accrual is included in the consolidated balance sheet in “Accrued restructuring costs, current portion”.
2001, 2002 and 2003 - Restructure Events
As a result of the decline in the demand for advanced technology consulting services that began in 2000, the Company restructured its workforce and operations in 2001, 2002 and 2003. The restructuring consisted of ceasing operations and consolidating or closing excess offices. Estimated costs for the consolidation of facilities included contractual rental commitments or lease buy-outs for office space vacated and related costs, offset by estimated sublease income.
During 2005 and 2004, we recorded restructuring charges of approximately $6.1 million and $1.5 million, respectively, primarily due to a decrease in estimated sublease income resulting from changes in market leasing conditions on previously restructured facilities. We have not finalized sublease agreements for all leases and is currently involved in negotiations to sublease the vacant spaces. No employees were terminated in connection with these restructuring charges.
The total remaining accrued restructuring costs for all events were $21.6 million at December 31, 2005, of which the cash portion is $21.3 million.
Amortization of Intangible Assets
During 2005, amortization of intangible assets consisted primarily of: SAP license agreement and customer list relating to the 2005 BIS acquisition, and customer contracts and developed technology resulting from prior acquisitions. During 2004, amortization of intangible assets consisted primarily of amortization of customer contracts and developed technology resulting from prior acquisitions and investments in consolidated subsidiaries. Amortization expense related to intangible assets was $1.1 million for 2005 and $515,000 for 2004.
Interest and Other Income
Interest and other income is derived primarily from investments in U.S. government securities, corporate debt securities, commercial paper, time deposits, money market funds and insurance proceeds.
Interest income increased due to higher prevailing interest rates and higher cash balances in 2005 compared to 2004.
Provision (Benefit) for Income Taxes
We have deferred tax assets that have arisen primarily as a result of net operating losses incurred in 2001, 2002 and 2003, as well as other temporary differences between book and tax accounting. Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against the net deferred tax assets. As a result of net operating losses incurred from 2001 through 2003, and uncertainty as to the extent, and timing of profitability in future periods, at December 31, 2005 we have continued to record a valuation allowance against our deferred tax assets in the United States of $117.2 million. In 2005, the Company concluded that Germany’s deferred taxes would be realized in the foreseeable future and as such released the full valuation allowance resulting in an income statement benefit of $4.3 million at the end of December 31, 2005. For the years ended December 31, 2005 and 2004, we recorded an income tax provision (benefit) of approximately $612,000 and $2.4 million, respectively. Excluding the benefit from the reversal of the $4.3 million and $635,000 foreign valuation allowances in 2005 and 2004, respectively, our income tax provision is primarily related to foreign, federal alternative minimum tax and state tax obligations. As of December 31, 2005, and reflected in the tax provision, is a deferred tax liability of approximately $188,000 that has been recorded as a result of the goodwill acquired in connection with the BIS acquisition. See Note 4 of the Consolidated Financial Statements.
Our effective tax rate may vary from period to period based on changes in estimated taxable income or loss, changes to the valuation allowance, changes to federal, state or foreign tax laws, future expansion into areas with varying country, state, and local income tax rates, deductibility of certain costs and expenses by jurisdiction and as a result of acquisitions.
Results by Operating Segment
The Company has discrete financial data by operating segments available based on its method of internal reporting, which disaggregates its operations. Operating segments are defined as components of the Company for which separate financial information is available to manage resources and evaluate performance. Beginning with the first quarter of 2006, the Company combined its Canada international business unit and two of its United States business units, and identified one additional business unit in the United States. Specifically, the Company combined its Financial Services, Automotive, Consumer and Energy, Technology, Education, Communications and Health
Care business unit and its Canada business unit into one business unit, which is now named North America Commercial. In addition, Experience Marketing became a standalone business unit. Our three business units in North America are now: (i) North America Commercial (“NAC”), (ii) Government Services and (iii) Experience Marketing.
We do not allocate certain selling, marketing and general and administrative expenses to our business unit segments in the United States because these activities are managed separately from the business units. Asset information by operating segment is not reported to or reviewed by the chief operating decision makers and, therefore, we have not disclosed asset information for each operating segment.
The tables below present the service revenues and operating income attributable to our operating segments for the periods presented.
(1)
Reflects only the direct controllable expenses of each business unit segment. It does not represent the total operating results for each business unit, as it does not contain an allocation of certain corporate and general and administrative expenses incurred in support of the business unit segments.
(2)
Adjustments that are made to the total of the segments’ operating income in order to arrive at consolidated income from continuing operations before income taxes, discontinued operations and cumulative effect of accounting change include the following:
(3)
Includes corporate portion of both selling and marketing and general and administrative expenses.
Service Revenues by Operating Segments
Consolidated service revenues for 2005, compared to 2004, increased 26% in U.S. dollars and 25% in local currency terms. Three out of four reportable operating segments recorded increased service revenues during this period. The increase in our North America Commercial business unit for 2005 compared to 2004, was primarily due to continued demand from clients in the financial and energy industries and two large long-term engagements signed during 2005, coupled with the acquisition of BIS and continued demand from new and existing clients in the technology and communications industries. In addition, we renegotiated our agreement with Sprint into a longer term, multi-year, contract. The increase in our Government Services business unit service revenues for 2005 compared to 2004, was due to increased demand from our government clients. Our United Kingdom business unit service revenue increased slightly for 2005 compared to 2004, primarily due to growth in demand in the financial services and telecommunications industries offset by a year-over-year decline in revenue related to a service agreement in the United Kingdom. Our Germany business units’ service revenue decreased for 2005 compared to 2004, due to a general slowing in the signing of new business.
Operating Income by Operating Segments
All of our reportable segments had profitable operating results for 2005. Operating income for our U.S. operating segments increased significantly during 2005, compared to 2004, primarily due to sustained revenue growth from new and existing clients. Our United Kingdom and Germany operating segments did not have improved operating results for 2005 compared to 2004. Lower operating results in the United Kingdom and Germany are primarily due to a decrease in average utilization rates resulting from lower than expected service revenues.
Liquidity and Capital Resources
During 2006 and 2005 we funded our operations from cash flows generated from operations. We invest our excess cash predominantly in instruments that are highly liquid, investment grade securities. At December 31, 2006, we had approximately $128.8 million in cash, cash equivalents, restricted cash and marketable investments, compared to $157.8 million at December 31, 2005. This decrease was primarily due to cash paid of $27.7 million in connection with acquisitions and cash paid of $18.1 million throughout the year to repurchase common stock offset by cash flow from operation of $18.2 million.
We have deposited approximately $1.9 million with various banks as collateral for letters of credit and performance bonds, and have classified this cash as restricted on our consolidated balance sheet at December 31, 2006.
At December 31, 2006, we had the following contractual obligations:
(1)
Cash outlays for restructuring and other related activities include minimum future lease and related payments for excess facilities, net of estimated sublease income of $9.9 million under existing arrangements, excluding expected sublease arrangements of approximately $7.9 million.
(2)
Purchase obligations represent minimum commitments due to third parties, including subcontractor agreements, telecommunication contracts, IT maintenance contracts in support of internal use software and hardware and other marketing and consulting contracts. Contracts for which our commitment is variable based on
volumes, with no fixed minimum quantities, and contracts that can be cancelled without payment penalties, have been excluded. Amounts presented also exclude accounts payable and accrued expenses at December 31, 2006.
Cash provided by operating activities was $18.2 million for 2006, primarily attributable to net income of $3.1 million, adjusted for an increase in accrued compensation of $5.9 million and accrued expenses of $20.1 million and net non-cash charges of $28.4 million, including $13.6 million of depreciation and amortization, $12.4 million of stock-based compensation, and $1.8 million in provision for bad debt allowance, off-set by increases in our accounts receivable of $7.0 million and our unbilled revenues of $16.1 million and decrease in our accrued restructuring cost of $5.7 million. Days sales outstanding (“DSO”) is calculated based on actual total revenue for the three months ended December 31, 2006 and 2005 and accounts receivable, net, adjusted for unbilled revenues on contracts and deferred revenues on contract balances as of December 31, 2006 and 2005. Our DSO for accounts receivable, net decreased from 71 days for 2005 to 70 days for 2006.
Cash used in investing activities was $1.9 million for 2006. This was due primarily to the net cash paid for the PGI acquisition of approximately $25.9 million and $1.0 million paid to the former owners of BIS, capital expenditures of $14.3 million, offset by $35.1 million of net purchase and sale of marketable securities. Our capital expenditures for 2006 included approximately $2.5 million, primarily related to our human resource management system.
Cash used in financing activities was $12.7 million in 2006, as $18.1 million of stock repurchases was offset by $5.5 million of cash proceeds provided from the sale of common stock through our employee stock purchase plan and the exercise of stock options.
On January 3, 2006, the Company purchased Planning Group International, Inc (“PGI”), a privately held company, which specializes in online, offline and multi-channel marketing strategies and programs. Consideration for the acquisition totaled $35.6 million, including transaction costs of $600,000. The consideration consisted of approximately $29.2 million in cash paid at closing, the issuance of 1,306,908 shares of common stock valued at $5.9 million, and additional payments made to PGI shareholders of $1.6 million during January 2006. The $5.9 million of common stock consideration related to the issuance of 1,306,908 shares of common stock.
We believe that our existing cash, cash equivalents, restricted cash and marketable investments will be sufficient to meet our working capital and capital expenditure requirements and expected cash outlay for our previously recorded restructuring activities for at least the next 12 months.
New Accounting Pronouncements
In July 2006, the FASB issued FIN No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), which clarifies the accounting for uncertainty in income tax recognized in an enterprise’s financial statements in accordance with SFAS No. 109. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The adoption of FIN 48 did not have a material impact on the Company’s financial position or results of operations.
In September 2006, the SEC issued SAB No. 108, Considering the Effect of Prior Year Misstatements when Qualifying Misstatements in Current Year Financial Statements (“SAB No. 108”). SAB No. 108 provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB No. 108 is effective for companies with fiscal years ending after November 15, 2006 and was adopted in the year ending December 31, 2006. The adoption of SAB No. 108 did not have a material impact on our financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within
those fiscal years. The Company has not yet determined the effect, if any, that the application of SFAS No. 157 will have on its consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115 (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value at specified election dates. If the fair value option is elected, a business entity shall report unrealized gains and losses on elected items in earnings at each subsequent reporting date. Upon initial adoption of this Statement an entity is permitted to elect the fair value option for available-for-sale and held-to-maturity securities previously accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. The effect of reclassifying those securities into the trading category should be included in a cumulative-effect adjustment of retained earnings and not in current-period earnings and should be separately disclosed. SFAS No. 159 is effective as of the beginning of the first fiscal year that begins after November 15, 2007. The Company has not yet determined the effect, if any, that the application of SFAS No. 159 will have on its consolidated financial statements.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
We do not believe that we have any material market risk exposure with respect to derivative or other financial instruments. At December 31, 2006, our exposure to market risk relates primarily to changes in interest rates on our investment portfolio. Our marketable investments consist primarily of fixed income securities. We invest only with high credit quality issuers and we do not currently use derivative financial instruments in our investment portfolio. We do not believe that a significant increase or decrease in interest rates would have a material adverse impact on the fair value of our investment portfolio.
The net consideration in connection with our BIS acquisition in June 2005 included the issuance of 409,357 shares of common stock, of which 313,943 shares carry an embedded put and call option feature. The put feature could require us to purchase up to 224,469 of the issued shares for an aggregate price of approximately $480,000 as of December 31, 2006. During 2006, the put feature related to 89,474 shares expired. As the potential redemption is outside of our control, the potential future cash obligation associated with the put option has been classified outside of permanent equity in the accompanying consolidated balance sheets. The put option expires on June 1, 2008. As of December 31, 2006, 224,469 shares are subject to the put option feature. See Note 4 of the Consolidated Financial Statements.
Exchange Rate Sensitivity
We face exposure to adverse movements in foreign currency exchange rates, because a significant portion of our revenues, expenses, assets, and liabilities are denominated in currencies other than the U.S. dollar, primarily the British pound, the Euro, the Indian rupee and the Canadian dollar. These exposures may change over time as business practices evolve. Currently, we do not hold any derivative contracts that hedge our foreign currency risk, but we may adopt such strategies in the future.
For a discussion of the risks we face as a result of foreign currency fluctuations, please see “Risk Factors” in Part I, Item 1A and - “Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7.”
Item 8.
Item 8.
Financial Statements and Supplementary Data
SAPIENT CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
of Sapient Corporation:
We have completed integrated audits of Sapient Corporation’s consolidated financial statements and of its internal control over financial reporting as of December 31, 2006, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements and financial statement schedule
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Sapient Corporation and its subsidiaries at December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 2 to the consolidated financial statements, the Company has restated its 2005 and 2004 consolidated financial statements.
As discussed in Note 3 to the consolidated financial statements, the Company changed the manner in which it accounts for share-based compensation in 2006.
Internal control over financial reporting
Also, we have audited management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that Sapient Corporation did not maintain effective internal control over financial reporting as of December 31, 2006, because of the effect of not maintaining an effective control environment, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in management’s assessment. The Company did not maintain an effective control environment as they did not maintain a sufficient complement of personnel with an appropriate level of accounting knowledge, experience and training in the application of accounting principles generally accepted in the United States commensurate with their financial reporting requirements. This control deficiency could result in a misstatement of the Company’s financial statement accounts and disclosures that would result in a material misstatement to the annual or interim financial statements that would not be prevented or detected. This control deficiency could also impede the Company’s ability to complete their financial reporting process and prepare financial statements on a timely basis. Accordingly, the Company has concluded that this control deficiency constitutes a material weakness. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2006 consolidated financial statements, and our opinion regarding the effectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements.
In our opinion, management’s assessment that Sapient Corporation did not maintain effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control - Integrated Framework issued by the COSO. Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Sapient Corporation has not maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the COSO.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
June 12, 2007
SAPIENT CORPORATION
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these Consolidated Financial Statements.
SAPIENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these Consolidated Financial Statements.
SAPIENT CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
The accompanying notes are an integral part of these Consolidated Financial Statements.
SAPIENT CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY - (Continued)
The accompanying notes are an integral part of these Consolidated Financial Statements.
SAPIENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these Consolidated Financial Statements.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1)
Nature of Business
Sapient Corporation (“Sapient” or the “Company”) is a global services firm that innovates in marketing, technology and business operations. Our multidisciplinary teams of expert thinkers and designers provide business and information technology strategy, business applications, experience marketing and global outsourcing services that help our clients succeed. Headquartered in Cambridge, Massachusetts, Sapient maintains a global presence with offices across the United States and Canada, and in Germany, the Netherlands, India and the United Kingdom.
(2)
Restatement of Consolidated Financial Statements
In this Form 10-K, Sapient Corporation (“Sapient” or the “Company”) restates its Consolidated Balance Sheet as of December 31, 2005, and the related Consolidated Statements of Operations, Cash Flows, and Changes in Stockholders’ Equity for the years ended December 31, 2005 and December 31, 2004.
Background of the Restatement
As announced on August 8, 2006, the Audit Committee of Sapient’s Board of Directors (“Audit Committee”) initiated a voluntary, independent investigation into the Company’s historical stock-based compensation practices after a management review discovered irregularities in certain past stock option grants for the periods 1996 through 2001. One committee member who had been on the Compensation Committee during this period recused himself from participation.
On November 20, 2006, the Audit Committee announced that the results of the internal investigation indicated a lack of controls and documentation, principally prior to 2004, around the Company’s stock-based compensation granting process, as well as irregularities relating to pricing of certain stock option grants awarded principally during the period from 1996 through 2001 (the “Identified Period”). With the exception of the 60-day and 7-day pricing, which occurred primarily in 1996 and 1997, the Audit Committee did not find any evidence of a systematic effort to intentionally backdate stock option grants on a large scale. The Audit Committee’s report included the following key findings:
•
The investigation found no misconduct by any of the individuals who were serving on the Company’s management team as of the conclusion of the Audit Committee’s internal investigation.
•
The investigation found that the Company’s former CEO, Jerry Greenberg, former CFO, Susan Cooke and former General Counsel, Deborah Gray, participated, to varying degrees, in issuing these grants. All three participated in the authorization of the 60-day pricing practice and in certain instances of targeted pricing. Additionally, the investigation found that the former CFO and former General Counsel participated in the authorization of re-pricing and “look-back” pricing of grants in connection with certain of the Company’s acquisitions in 1998 and 1999. The investigation was inconclusive on whether the former CEO and former General Counsel fully understood the accounting and disclosure ramifications of these practices. The Audit Committee found evidence that the former CFO knew that certain practices had accounting and disclosure implications but failed to take steps to ensure that the accounting for those practices was proper. The former CEO, who received no stock options in the 15 years since his co-founding Sapient, resigned from the Company in October 2006. The former CFO also resigned then. The former General Counsel, Deborah Gray, left the Company in January 2002. Stuart Moore, a member of the Board of Directors who co-founded Sapient and was co-CEO until June 2006, never received stock options and did not participate in issuing these grants.
•
Some members of current management received options that, in some cases, had prices corresponding to dates earlier than the measurement date for accounting purposes. None of the members of current management were in a position at the time to approve their own option grants.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
•
Certain outside members of the Board of Directors received options that had prices corresponding to a date other than the measurement date for accounting purposes. In some instances Board members receiving these grants had executed written consents approving the grants, although none of the members of the Board of Directors directed the pricing of options they received or the pricing of any other options.
The Audit Committee and management concluded that the actual “measurement date,” as that term is defined in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), was different from the measurement date recorded by the Company for a number of grants of options to purchase the Company’s common stock (“options” or “stock options”) which were awarded to both “Section 16” officers and directors and other employees. As a result of having identified these incorrect measurement dates and other errors described below in accounting for stock option grants, management concluded that the Company’s previously issued financial statements should be restated. The issues identified by the investigation fall into the following main categories:
(a) Lack of certain documentation for Company-wide grants. With respect to the grants that were typically made on an annual or semi-annual basis to all eligible rank-and-file employees in the Company, there is a lack of certain supporting documentation.
(b) Grants without proper authorization. These grants which were primarily to new hires or in connection with promotions were made: (i) by individuals who may not have been explicitly delegated the authority to make grants under the relevant plans (e.g., grants were authorized by one of the Company’s two co-CEOs during a period when approval from both co-CEOs was required under the terms of the plans); (ii) in amounts beyond the ranges authorized by the Compensation Committee; or (iii) without Compensation Committee approval, when such approval was required (e.g., a grant to an individual who had been designated as a Section 16 officer).
(c) 7-day, 15-day or 60-day pricing. These discrepancies are defined as grants that were priced at the lowest quoted market price in the 7 days, 15 days or 60 days following the date of grant. It appears that this practice occurred primarily in 1996 and 1997.
(d) Targeted pricing. These discrepancies are defined as grants to an individual or small group of individuals in which the measurement date recorded by the Company preceded the appropriate measurement date as determined under APB No. 25, and in which it appears that the earlier measurement date was chosen in part because pricing was favorable on that date.
(e) Grants issued in connection with business acquisitions. For grants issued to employees who joined the Company in connection with two acquisitions which occurred in 1999, it was determined that both acquisitions were determined to have granted options priced utilizing a 30-day “look-back” where the Company priced the options at the lowest closing stock price in the 30-day period after the acquisition. The Company determined that options granted in connection with one acquisition in 1998 were repriced.
(f) Promotion grants. In certain instances the Company priced grants as of the date the promotion was authorized, rather than the date that the terms of the stock option grant (including the number of shares to be granted) were finalized. In some instances, this practice resulted in more favorable prices and in some instances it did not result in more favorable pricing.
(g) Grants authorized by written consent. These grants, primarily to senior personnel within the Company, and in one instance in 1999 to outside Directors on the Board, were authorized by written consents bearing a date which was used to establish the exercise price, and which was significantly earlier than the date the written consents were fully executed.
(h) Administrative errors. These grants comprise several instances where stock option grants were mispriced due to what appears to be administrative or clerical errors, such as failing to correctly input a date from a grant list.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Upon the conclusion of the internal investigation, the Company completed an assessment of the appropriate measurement dates and related accounting for the matters described above.
The Company is restating the financial statements and related disclosures described above in accordance with accounting principles generally accepted in the United States to record the following:
•
Non-cash compensation expense for the difference between the option price and the quoted market price on the measurement date;
•
Other immaterial adjustments that were not previously recorded; and
•
Related tax effects for all items.
Summary of the Restatement Adjustments
The restatement in this Form 10-K principally reflects additional stock-based compensation expense and related tax effects pertaining to the Company’s historical stock-based compensation practices under APB No. 25, the Company’s accounting method for the periods prior to January 1, 2006.
The following is a summary of the pre-tax compensation expense associated with the Adjusted Options to be recognized in each period from 1996 to 2005 (in thousands):
Related Tax Adjustments.
The Company reviewed the tax effect associated with the Adjusted Options. Certain of the Adjusted Options were originally intended to be Incentive Stock Options (“ISOs”), under U.S. tax regulations. However, by definition, ISOs may not be granted with an exercise price less than the fair market value of the underlying stock on the date of grant. Due to the impact of the measurement date changes on the qualified status of affected ISOs, they may no longer qualify as ISOs under the regulations. Therefore, the affected ISOs were accounted for as if these options were non-qualified stock options for income tax accounting purposes. The Company recorded a liability for the unpaid income and employment taxes plus potential penalties and interest based upon the change in status of the affected options. The Company recorded a liability for the taxes, penalties and interest due based upon the change in status of the options in the amount of $17.8 million for the periods from 1996 through 2006. The Company recorded reversals of this accrual in the amount of $16.5 million through 2006 due to the expiration of the tax statute of limitations for years 2002 and prior. These adjustments resulted in a net charge to expense of
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
$1.3 million over the period 1997 to 2006. The net charge (benefit) recorded by the Company for these liabilities for the period indicated is as follow (in thousands):
Because the Company has a full valuation allowance against its deferred tax assets in the U.S., the income tax benefit of stock-based compensation adjustments described above were not material to any periods.
The following table sets forth, on a year-by-year basis, the impact of the Company’s restatement and the related tax effects as a result of historical stock option practices, as well as other immaterial adjustments unrelated to historical stock option practices that were previously unrecorded. The Company recorded other immaterial adjustments that were not previously recorded in the financial statements which consisted primarily of corrections to restructuring related lease obligations, adjustments to the period in which leasehold improvement write-offs were recorded in connection with restructured facilities and other miscellaneous adjustments. The pre-tax impact of all adjustments are set forth below:
Restatement Adjustments
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table is a summary of all restatement amounts included in the cumulative adjustment to opening Accumulated Deficit as of January 1, 2004:
The following table illustrates the effect of the restatement adjustments on the Company’s pro forma earnings and pro forma earnings per share if the Company had recorded compensation costs based on the revised grant dates, under the fair value accounting method defined by SFAS No. 123 for 2005 and 2004 (in thousands, except per share amounts).
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following tables present the effect of the restatement adjustments by financial statement line item for the Consolidated Statements of Operations, Balance Sheet, and Statements of Cash Flows.
CONSOLIDATED STATEMENTS OF OPERATIONS
(1)
The As Reported amounts reflect the reclassification of HWT results to discontinued operations. See Note 14.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
CONSOLIDATED BALANCE SHEET
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
CONSOLIDATED STATEMENTS OF CASH FLOWS
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(3)
Summary of Significant Accounting Policies
(a)
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the Company and its wholly-owned and majority-owned, controlled subsidiaries. All intercompany transactions have been eliminated in consolidation.
On May 2, 2006, the Company sold 100% of its investment in HWT, Inc. (“HWT”), the Company’s majority-owned, fully consolidated subsidiary. The historical results of HWT have been presented as discontinued operations for all periods presented. On January 3, 2006, the Company purchased 100% of the outstanding shares of Planning Group International, Inc. (“PGI”). The acquisition of PGI was accounted for under the purchase method of accounting and, accordingly, the results of operations have been included in the Company’s consolidated financial statements as of the acquisition date. On June 1, 2005, the Company purchased Business Information Solutions, LLC (“BIS”). The acquisition of BIS was accounted for under the purchase method of accounting and, accordingly, the results of operations have been included in the consolidated financial statements since the date of acquisition.
(b)
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant estimates relied upon in preparing these financial statements include estimated costs to complete long-term contracts, allowances for doubtful accounts, estimated fair value of investments, including whether any decline in such fair value is other-than-temporary, estimated fair values of long-lived assets and reporting units used to record impairment charges related to intangible assets and goodwill, stock-based compensation expenses, restructuring and other related charges, contingent liabilities and recoverability of the Company’s net deferred tax assets and related valuation allowances. Although the Company regularly assesses these estimates, actual results could differ materially from these estimates. Changes in estimates are recorded in the period in which they become known. The Company bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances. Actual results may differ significantly from the Company’s estimates.
(c)
Foreign Currency Translation and Transactions
For non-U.S. subsidiaries, which operate in a local currency environment, assets and liabilities are translated at period-end exchange rates, and income statement items are translated at the average exchange rates for the period. The local currency for all foreign subsidiaries is considered to be the functional currency and, accordingly, translation adjustments are reported as a separate component of stockholders’ equity under the caption “accumulated other comprehensive income.”
Cash flows of non-U.S. subsidiaries, whose functional currency is the local currency, are translated to U.S. dollars using weighted average exchange rates for the period. The Company reports the effect of exchange rate changes on cash balances held in foreign currencies as a separate item in the consolidated statements of cash flows during the period.
Gains (losses) from foreign currency transactions of approximately $244,000, ($1.3) million and ($54,000) are included in general and administrative expenses in the consolidated statement of operations for 2006, 2005 and 2004, respectively.
(d)
Cash and Cash Equivalents
The Company considers highly liquid investments with maturities of three months or less, from the date of purchase, cash equivalents.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(e)
Marketable Securities
The Company classifies its marketable securities as available-for-sale, and carries them at fair market value. The difference between amortized cost and fair market value, net of tax effect, is recorded as a separate component of stockholders’ equity. The cost of securities available-for-sale is adjusted for amortization of premiums and discounts to maturity. Accretion and amortization of discounts and premiums for all securities are included in interest income. Realized gains and losses from sales of available-for-sale securities were not material for any period presented. The Company considers available evidence, including the duration and extent to which declines in fair value compares to cost in determining whether the unrealized loss is “other-than-temporary.” If the decline is considered other than temporary, the unrealized loss is removed from other comprehensive income (loss) and recorded as other expense in the consolidated statement of operations. For each period presented, the Company did not record any charges to write down investments.
(f)
Financial Instruments and Concentration of Credit Risk
Financial instruments which potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents, restricted cash, marketable securities and accounts receivable.
The Company performs credit evaluations of its customers and generally does not require collateral on accounts receivable. The Company maintains allowances for potential credit losses and such losses have been within management’s expectations. During both 2006 and 2005 one customer, Sprint accounted for greater than 10% of service revenues. No client accounted for more than 10% of services revenue during 2004. No customer’s accounts receivable balance exceeded 10% of total accounts receivable as of December 31, 2006 or 2005.
The fair market values of cash and cash equivalents, restricted cash, marketable securities, accounts receivable, accounts payable, accrued expenses and income taxes payable at both December 31, 2006 and 2005 approximate their carrying amounts.
(g)
Property and Equipment
Property and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related assets, which primarily range from three to five years. Leasehold improvements are amortized over the lesser of the estimated useful lives of the assets or the remaining lease term. When an item is sold or retired, the cost and related accumulated depreciation is relieved, and the resulting gain or loss, if any, is recognized in the consolidated statement of operations.
(h)
Costs Incurred to Develop Computer Software for Internal Use
The Company accounts for costs incurred to develop computer software for internal use in accordance with AICPA Statement of Position (“SOP”) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use (“SOP 98-1”). As required by SOP 98-1, the Company capitalizes costs incurred during the application development stage, which include costs to design the software configuration and interfaces, coding, installation and testing. Costs incurred during the preliminary project stage along with post-implementation stages of internal use computer software are expensed as incurred. Capitalized development costs are typically amortized over the estimated life of the software, up to three years. The capitalization and ongoing assessment of recoverability of development cost requires considerable judgment by management with respect to certain external factors, including, but not limited to, technological and economic feasibility, and estimated economic life. Capitalized software is included in property and equipment.
During 2006, the Company capitalized costs of $3.3 million, primarily related to the human resource management system, of which $2.5 million relates to costs associated with software developed for internal use
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
as the computer software was placed into service during 2006. The remaining $819,000 relates to costs associated with the development of software for internal use not placed into service as of December 31, 2006. During 2005, the Company capitalized costs of $2.8 million, primarily related to internal financial systems and human resource management related systems and upgrades, of which $1.4 million relates to costs associated with software developed for internal use as the computer software was placed into service during 2005. The remaining $1.4 million relates to costs associated with the development of software for internal use placed into service during 2006. During 2004, the Company capitalized computer software costs of $247,000 associated with an internal financial system upgrade. The capitalized costs placed in service during 2006 and 2005 are being amortized over three years. Amortization expense totaled $616,000 and $200,000 during 2006 and 2005, respectively. There was no amortization expense in 2004, as the computer software had not been placed in service as of December 31, 2004.
(i)
Costs Incurred to Sell, Lease, or Otherwise Market Computer Software.
The Company accounts for research and development costs in accordance with SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed (“SFAS No. 86”). SFAS No. 86 specifies that costs incurred internally in researching and developing a computer software product should be charged to expense until technological feasibility has been established for the product. Once technological feasibility is established, all software costs should be capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established. The Company has determined that technological feasibility for its software products is reached after all high-risk development issues have been resolved through coding and testing. This is generally shortly before the products are released. Unamortized capitalized software costs as of December 31, 2006 was approximately $846,000. Amortization expense totaled approximately $395,000 during 2006. There were no amounts capitalized for under SFAS 86, prior to the acquisition of PGI (See Note 4).
(j)
Goodwill and Purchased Intangible Assets
Goodwill is the amount by which the cost of acquired net assets in a business acquisition exceeded the fair value of net identifiable assets on the date of purchase. Following the adoption of SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”) goodwill is no longer amortized, but instead assessed for impairment on at least an annual basis at year-end or whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. Factors we consider important which could trigger an impairment review include:
•
significant underperformance relative to historical or projected future operating results;
•
significant changes in the manner of or use of the acquired assets or the strategy for our overall business;
•
identification of other impaired assets within an reporting unit;
•
disposition of a significant portion of an operating segment;
•
significant negative industry or economic trends;
•
significant decline in our stock price for a sustained period; and
•
a decline in our market capitalization relative to net book value.
The Company’s reporting units are consistent with the reportable segments identified in Note 20, “Segment Reporting.” Assets and liabilities, including goodwill, were allocated to reporting units based on factors such as specific identification and percentage of revenue. To conduct a goodwill impairment test, the fair value of the reporting unit is compared to its carrying value. If the reporting unit’s carrying value exceeds its fair value, an
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
impairment loss is recorded to the extent that the carrying value of goodwill exceeds its implied fair value. Management estimates the fair value of its’ reporting units using discounted cash flow valuation models.
Other identifiable intangible assets include purchased intangible assets with finite lives, which primarily consist of marketing assets and customer lists, customer contracts, non-compete agreements, developed technology, purchased license agreements and order backlog. Finite-lived purchased intangible assets are amortized over their expected period of benefit, which generally ranges from one to five years.
(k)
Valuation of Long-lived Assets
Long-lived assets primarily include property and equipment and intangible assets with finite lives (purchased software, capitalized software, and purchased intangible assets). Long-lived assets are reviewed for impairment on a regular basis for the existence of facts and circumstances that may suggest that the carrying amount of an asset or group of assets may not be recoverable. Recoverability of long-lived assets or groups of assets is assessed based on a comparison of the carrying amount to the estimated undiscounted future cash flows. If estimated future undiscounted net cash flows are less than the carrying amount, the asset is considered impaired and expense is recorded at an amount required to reduce the carrying amount to fair value. Determining the fair value of long-lived assets includes significant judgment by management, and different judgments could yield different results.
(l)
Revenue Recognition and Allowance for Doubtful Accounts
The Company recognizes revenue from the provision of professional services, digital marketing services and offline printing and production services arrangements with its clients when persuasive evidence of an arrangement exists, services have been provided to the customer, the fee is fixed or determinable and collectibility is reasonably assured. In instances where the customer, at its discretion, has the right to reject the services prior to final acceptance, revenue is deferred until such acceptance occurs.
The Company recognizes revenues from its fixed-price technology implementation consulting contracts using the percentage-of-completion method pursuant to SOP 81-1, Accounting for Performance of Construction Type and Certain Production Type Contracts. Revenues generated from fixed-price non-technology implementation contracts, except for support and maintenance contracts, are recognized based upon a proportional performance model in accordance with Staff Accounting Bulletin (“SAB”) No. 101, Revenue Recognition in Financial Statements, as amended by SAB No. 104, Revenue Recognition. The Company’s percentage-of-completion method and proportional performance methods of accounting calculate revenue based on the percentage of labor incurred to estimated total labor. This method is used because reasonably dependable estimates of the revenues and costs applicable to various stages of an arrangement can be made, based on historical experience and milestones set in the contract. Revenue from time-and-material contracts is recognized as services are provided. Revenue generated from staff augmentation and support arrangements are recognized ratably over the arrangement’s term.
The Company’s project delivery and business unit finance personnel continually review labor incurred and estimated total labor, which may result in revisions to the amount of recognized revenue under an arrangement. Certain arrangements provide for revenue to be generated based upon the achievement of certain performance standards. Revenue related to the achievement of performance standards was immaterial for the fiscal years ended 2006, 2005 and 2004.
Revenues from arrangements with multiple elements are allocated based on the fair value of the elements in accordance with EITF Issue No. 00-21 (“EITF No. 00-21”), Revenue Arrangements with Multiple Deliverables. For these arrangements, all deliverables in the arrangement are evaluated to determine whether they represent separate units of accounting. Fair value is determined based on reliable evidence of the fair value of each deliverable. Revenues are recognized in accordance with the Company’s accounting policies for the separate elements when the services have value on a stand-alone basis, fair value of the separate elements exists and, in arrangements that include a general right of refund relative to the delivered element, performance of the undelivered element is
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
considered probable and substantially under the Company’s control. This evaluation is performed at the inception of the arrangement and as each item in the arrangement is delivered. The evaluation involves significant judgments regarding the nature of the services and deliverables being provided, whether these services and deliverables can reasonably be divided into the separate units of accounting and the fair value of the separate elements determined.
Revenues related to digital marketing media sales are recorded as the net amount of our gross billings less pass-through expenses charged to a client. In most cases, the amount that is billed to clients significantly exceeds the amount of revenue that is earned and reflected in the Company’s financial statements, because of various pass-through expenses such as production and media costs. In compliance with EITF Issue No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, (“EITF No. 99-19”) the Company assesses whether the agency or the third-party supplier is the primary obligor. The terms of client agreements are evaluated as part of this assessment. In addition, the Company gives appropriate consideration to other key indicators such as latitude in establishing price, discretion in supplier selection and credit risk to the vendor. Because Sapient broadly operates as an advertising agency based on its primary lines of business and given the industry practice to generally record revenue on a net versus gross basis, the Company believes that there must be strong evidence in place to overcome the presumption of net revenue accounting. Accordingly, revenue is recorded net of pass-through charges as management believes the key indicators of the business suggest that the Company generally act as an agent on behalf of its clients in its primary lines of business. In those businesses where the key indicators suggest Sapient acts as a principal, the Company records the gross amount billed to the client as revenue.
Marketing services that are provided in exchange for monthly retainer fees and license fees and are recognized as the monthly services are provided. Revenue from offline printing and production services are recognized at the time title of the related items transfers to the customer given all other revenue recognition criteria have been met.
If the resources required or the scope of work to be performed for an arrangement cannot be accurately estimated, or if the project is not managed properly within the planned time period, then a loss, or lower profitability on the arrangement may be recorded. Provisions for estimated losses on uncompleted arrangements are made on an arrangement-by-arrangement basis and are recognized in the period in which such losses are identified. The Company has committed unanticipated additional resources to complete projects in the past, which has resulted in lower than anticipated profitability or losses on those arrangements. Management expects that it will experience similar situations in the future. In addition, the Company may fix the price for some projects at an early stage of the process, which could result in a fixed-price that is too low and, therefore, a correct estimation could adversely affect the Company’s business, financial condition and results of operations.
The Company recognizes revenue for services when collection from the client is reasonably assured, and the fees are fixed or determinable. The Company establishes billing terms at the time project deliverables and milestones are agreed. Normal payment terms are thirty days from invoice date. Revenues recognized in excess of the amounts invoiced to clients are classified as unbilled revenues. Amounts invoiced to clients in excess of revenue recognized are classified as deferred revenues. The Company’s project delivery and business unit finance personnel continually monitor timely payments from clients and assess any collection issues. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of clients to make required payments. These estimates are based on historical collection and write-off experience, current trends, credit policy, detailed analysis of specific client situations and percentage of accounts receivable by aging category. While such credit losses have historically been within management’s expectations and the allowances established, the Company cannot guarantee that it will continue to experience the same credit loss rates that it has in the past. If the financial condition of the Company’s clients were to deteriorate, resulting in an impairment of their ability to make payment, additional allowances may be required. Failure to accurately estimate the losses for doubtful accounts and ensure that payments are received on a timely basis could have a material adverse effect on the Company’s business, financial condition and results of operations.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(m)
Stock-Based Compensation
At December 31, 2005, the Company had multiple stock-based compensation plans, which are described more fully in Note 16. Effective January 1, 2006, Sapient adopted the fair value recognition provisions of SFAS No. 123R, using the modified prospective application transition method and therefore has not restated prior periods’ results for the application of SFAS No. 123R. Under this transition method, stock-based compensation expense for fiscal 2006 included compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”). Stock-based compensation expense for all share-based payment awards granted after December 31, 2005 is based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R.
Prior to January 1, 2006, Sapient provided pro forma disclosure amounts in accordance with SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure (“SFAS No. 148”), as if the fair value method defined by SFAS No. 123, had been applied to its stock-based compensation.
The Company’s unearned stock-based compensation balance of $11.9 million as of January 1, 2006, which was accounted for under APB 25, was reclassified against additional paid-in-capital upon the adoption of SFAS No. 123R. The unearned stock-based compensation balance was from the issuance of awards in the form of restricted shares (“Restricted Stock”), awards in the form of units of stock purchase rights (“Restricted Units”), (collectively referred to as “Restricted Awards) and discounted stock option grants, which have been accounted for based on the intrinsic value on the date of grant. The unrecognized expense of restricted awards and employee stock option awards not yet vested at December 31, 2005 will be recognized as expense in operations in the periods after that date, based on their fair value which was determined under the original provisions of SFAS No. 123, as restated.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SFAS No. 123R requires the presentation of pro forma information for the comparative period prior to the adoption as if the Company had accounted for all its employee stock options under the fair value method of the original SFAS No. 123 The impact of applying SFAS No. 123 proforma compensation costs are not likely to be representative of the effects reported in net income in accordance with SFAS No. 123R. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation to the prior-year:
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Project personnel expenses, selling and marketing expenses and general and administrative expenses appearing in the consolidated statements of operations are shown inclusive of the following stock-based compensation expense amounts:
(n)
Advertising Costs
The Company charges the costs of advertising to expense as incurred, and includes these costs in selling and marketing expenses in the consolidated statements of operations. The amounts of advertising expenses recorded by the Company were immaterial for all periods presented.
(o)
Income Taxes
The Company records income taxes under the asset and liability method. Under this method, deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective income tax bases, and operating loss and tax credit carry forwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences, operating losses, or tax credit carry forwards are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Significant management judgment is required in determining the Company’s provision for income taxes, its deferred tax assets and liabilities and any valuation allowance recorded against its net deferred tax assets. The Company evaluates the weight of all available evidence to determine whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. We reinvest unremitted earnings of certain foreign operations indefinitely and, accordingly, we do not provide for income taxes that could result from the remittance of such earnings.
(p)
Restructuring and Other Related Charges
The Company established exit plans for each of the restructuring activities which took place in 2001 and 2002 and accounted for these plans in accordance with EITF Issue No. 94-3, Liability Recognition for Certain Employee Benefits and Other Costs to Exit an Activity (including Certain Costs incurred in a Restructuring) (“EITF No. 94-3”). These exit plans required that the Company make estimates as to the nature, timing and amount of the exit costs that we specifically identified. The consolidation of facilities required the Company to make estimates, which include contractual rental commitments or lease buy-outs for office space vacated and related costs, offset by estimated sub-lease income. The Company reviews, on a regular basis, their sub-lease assumptions and lease buy-out assumptions. These estimates include lease buy-out costs, anticipated sublease rates, other terms and conditions in sub-lease contracts, and the timing of these sub-lease arrangements. If the rental markets continue to change, the Company’s lease buy-out, sub-lease and space requirement assumptions may not be accurate and it is possible that changes in these estimates could materially affect the Company’s financial condition and results of operations. If any future adjustments are required to the restructuring initiatives recorded under the provisions of EITF No. 94-3, such adjustments will be measured in accordance with EITF No. 94-3. SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, (“SFAS No. 146”) was effective for exit or disposal activities that are
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
initiated after December 31, 2002. SFAS No. 146 requires that a liability that is associated with an exit or disposal activity be recognized when the liability is incurred. SFAS No. 146 supersedes the guidance in EITF No. 94-3. SFAS No. 146 includes a rebuttable presumption that if an entity has a history of providing similar termination benefits to employees, the benefit arrangement is presumed to be an ongoing benefit arrangement that should be accounted for under SFAS No. 112, Employers’ Accounting for Postemployment Benefits (SFAS No. 112”). SFAS No. 112 prescribes the accounting for the estimated cost of benefits, including severance benefits, provided by an employer to former or inactive employees after employment but before retirement. A liability is recognized when the severance amounts relate to prior services rendered, the payment of the amount is probable and the amount can be reasonably estimated. Since the second quarter of 2003, the Company has accounted for severance-related restructuring charges in accordance with SFAS No. 112 because of the history of paying similar severance benefits since 2001.
(q)
Income Per Share
Under SFAS No. 128, Earnings Per Share, the Company presents basic net income per share and diluted net income per share. Basic income per share is based on the weighted average number of shares outstanding during the period, less restricted stock which is considered contingently issuable. Diluted income per share reflects the per share effect of dilutive common stock equivalents.
(r)
Comprehensive Income
SFAS No. 130, Reporting Comprehensive Income (“SFAS No. 130”) establishes standards for reporting comprehensive income and its components in the body of the financial statements. Comprehensive income includes net income as currently reported under generally accepted accounting principles and also considers the effect of other changes to stockholders’ equity unrelated to stock activity that are not required to be recorded in determining net income, but are rather reported as a separate component of stockholders’ equity. The Company reports foreign currency translation gains and losses and unrealized gains and losses on investments which are considered temporary as components of comprehensive income.
(s)
New Accounting Pronouncements
In July 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), which clarifies the accounting for uncertainty in income tax recognized in an enterprise’s financial statements in accordance with SFAS No. 109. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The adoption of FIN 48 did not have a material impact on the Company’s financial position or results of operations.
In September 2006, the SEC issued SAB No. 108, Considering the Effect of Prior Year Misstatements when Qualifying Misstatements in Current Year Financial Statements (“SAB No. 108”). SAB No. 108 provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB No. 108 is effective for companies with fiscal years ending after November 15, 2006 and was adopted in the year ending December 31, 2006. The adoption of SAB No. 108 did not have a material impact on the Company’s financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company has not yet determined the effect, if any, that the application of SFAS No. 157 will have on its consolidated financial statements.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115 (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value at specified election dates. If the fair value option is elected, a business entity shall report unrealized gains and losses on elected items in earnings at each subsequent reporting date. Upon initial adoption of this Statement an entity is permitted to elect the fair value option for available-for-sale and held-to-maturity securities previously accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. The effect of reclassifying those securities into the trading category should be included in a cumulative-effect adjustment of retained earnings and not in current-period earnings and should be separately disclosed. SFAS No. 159 is effective as of the beginning of the first fiscal year that begins after November 15, 2007. The Company has not yet determined the effect, if any, that the application of SFAS No. 159 will have on its consolidated financial statements.
(4)
Acquisitions
Planning Group International, Inc.
On January 3, 2006, the Company purchased 100% of the outstanding shares of Planning Group International, Inc (“PGI”) which specializes in online, offline and multi-channel marketing strategies and programs. As part of the acquisition, the Company was able to significantly expand its presence regarding marketing services to include advertising, brand development, direct marketing, data mining, paid search, and media planning and buying. As a result of the acquisition, the Company formed a new business unit called Experience Marketing. The acquisition added approximately 160 employees, all of whom became part of the Company’s Experience Marketing operating segment.
Consideration for the acquisition totaled $35.6 million, including transaction costs of $570,000. The consideration consisted of approximately $29.2 million in cash paid at closing and the issuance of 1,306,908 shares of common stock valued at $5.9 million. The acquisition has been treated as a taxable transaction, therefore the intangible assets, including goodwill, are deductible for tax purposes.
The $5.9 million of common stock consideration related to the issuance of 1,306,908 shares of common stock was measured based on the average market price of the Company’s common shares ($5.83 per share), adjusted for the resale restriction placed on these common shares. The stock issued as partial consideration for the acquisition contains restrictions as to tradability which lapse with the passage of time at rates of 50%, 25% and 25% on the first, second and third anniversaries, respectively, of the acquisition date. The present value of these restrictions was estimated at approximately $1.8 million.
The Company has recorded the acquisition using the purchase method of accounting and, accordingly, the results of operations of the acquired business have been included in the financial statements of the Company since the date of acquisition.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The final purchase price allocation is as follows (in thousands):
The following table lists the identifiable intangible assets acquired and the respective weighted-average useful life over which the assets will be amortized. The customer relationships are being amortized on a revenue-based accelerated model and the non-compete and order backlog agreements are amortized on a straight-line basis.
The amount assigned to identifiable intangible assets acquired was based on their respective fair values determined using the income approach as of the acquisition date. The income approach is based upon the economic principle of anticipation in that the value of the property is the present value of the expected income that can be generated through the ownership of that property. The excess of the purchase price over the tangible and identifiable intangible assets was recorded as goodwill and amounted to $26.2 million. In accordance with SFAS No. 142, the goodwill is not being amortized and will be tested for impairment as required at least annually.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following unaudited, pro forma information for the year ended December 31, 2005 assumes the PGI acquisition occurred as of the beginning of that year:
The pro forma information is presented for information purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.
Business Information Solutions, LLC
On June 1, 2005, the Company purchased Business Information Solutions, LLC (“BIS”), a privately-held provider of SAP-related professional services, specializing in business intelligence solutions, by acquiring approximately $2.1 million of the net tangible assets of BIS for total current consideration of approximately $17.2 million. BIS’ results of operations have been included in the consolidated financial statements since the date of acquisition (June 1, 2005). The acquisition added forty-eight BIS people, all of whom became part of the Company. As a result of the acquisition, the Company (1) expanded its services in business intelligence and in newer modules of SAP, specifically business warehouse, the SEM module, data analytics and energy specific solutions and (2) offers a much broader variety of value-added ERP integration, upgrade, and maintenance services related to SAP products.
The aggregate consideration of approximately $17.2 million consisted of $13.0 million in cash, net common stock valued at approximately $3.3 million (value of $3.5 million, less the net value of $190,000 relating to the put and call option features described below), additional consideration of approximately $500,000 paid in equal annual installments over a three-year period in cash or common stock, and acquisition costs of $400,000.
The net $3.3 million of common stock consideration resulted in the issuance of 409,357 shares of common stock based on a market price of $8.55 per share. Of the 409,357 shares issued, 313,943 shares carry an embedded put and call option feature as defined below.
Put option: if the Company’s average common stock per share price during the ten business days ending on each of the first, second and third anniversary of the Closing Date (June 1, 2005) is less than 25% ($2.1375 per share) of the Buyer Share Price, certain holders of the shares issued as consideration can require the Company to repurchase the shares at $2.1375 per share.
Call option: the Company has the right to purchase the common stock from certain holders of the shares issued as consideration at a price of 175% ($14.9625 per share) of the Buyer Share Price (the “Call Option Price”) if the holder proposes to sell his shares at a price greater than $14.9625 per share during the first three years subsequent to the Closing Date. Additionally, during the period beginning as of the third anniversary and ending on the tenth anniversary of the Closing Date, if the per share closing price of a share of Company common stock exceeds the Call Option Price, and if certain other conditions occur (for example, a holder of the shares issued as
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
consideration is terminated “for cause” prior to the third anniversary of the Closing Date), the Company has the right to purchase the common stock from certain holders of shares issued as consideration at the Call Option Price.
The put and call option features, using the Black-Scholes Option Pricing Model, have been valued at approximately $33,000 and ($223,000), respectively. The $3.5 million of common stock was reduced by $190,000, the net value of the put and call options, resulting in net $3.3 million of common stock consideration issued in connection with the acquisition. The Company issued common stock shares using treasury stock shares, which carried an average cost of $1.50 per share.
The put feature could require the Company to purchase up to 224,469 of the issued shares for an aggregate price of approximately $480,000 as of December 31, 2006. As the potential redemption is outside the control of the Company, the potential future cash obligation associated with the put option has been classified outside of permanent equity in the accompanying consolidated balance sheets. The put option expires on June 1, 2008. As of December 31, 2005, 313,943 shares were subject to the put option feature.
The additional cash consideration of $600,000, having a net present value of approximately $500,000, will be paid annually in equal installments over a three-year period within ten days of the first, second and third anniversary dates of the Closing Date. The Company can elect to pay the additional consideration in cash or shares of common stock. Approximately $175,000 of this obligation is classified as current and is included in accrued expenses in the accompanying consolidated balance sheets. The non-current portion of approximately $324,000 is classified as other long-term liabilities in the accompanying consolidated balance sheets.
The Company has agreed to pay additional consideration in future periods, based upon the attainment by the acquired entity of defined operating objectives. In accordance with SFAS No. 141, Business Combinations (“SFAS No. 141”), the Company does not accrue contingent consideration obligations prior to the attainment of the objectives. At December 31, 2006, the maximum potential future consideration pursuant to such arrangements, to be resolved over the following three years, is approximately $3.9 million. The Company, at its sole discretion, can elect to pay the additional consideration in cash or by issuing common stock shares. Any such payments will result in increases in goodwill at time of payment.
The following table summarizes the estimated fair values of the assets acquired at the date of acquisition:
Of the $3.4 million of acquired intangible assets, $2.3 million was assigned to the customer list, having an estimated useful life of 5 years. The income approach was used to value the customer list. The income approach is based upon the economic principle of anticipation in that the value of any property is the present value of the expected income that can be generated through the ownership of that property.
The remaining $1.1 million was attributable to the SAP Services Partner Agreement (“SAP License Agreement”), having a weighted-average useful life of approximately 3 years. The purpose of the SAP License Agreement is to formalize the business relationship between the Company and SAP America, Inc. (“SAP America”), working together with the SAP Services Partner Program. Similar to the customer list, the income approach was also used to value the SAP License Agreement.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The acquisition has been treated as a taxable transaction, therefore the intangible assets, including goodwill, are deductible for tax purposes.
The following table reflects unaudited proforma results of operations of the Company assuming that the BIS acquisition had occurred on January 1, 2004:
In the second quarter of 2006, the Company paid an additional $183,000 in purchase price consideration related to its acquisition of BIS consummated in June of 2005. The additional consideration is the first of three annual installments. In addition, the Company recorded a current liability and additional goodwill of approximately $991,000 in the second quarter of 2006 related to contingent earn-out consideration associated with the BIS acquisition, which was paid in the third quarter of 2006. Lastly, approximately 28.5% of the redeemable common stock, or 89,474 shares, issued as part of the total purchase consideration for BIS expired during the second quarter of 2006 and as a result the Company has reclassified approximately $191,000 of redeemable common stock to additional paid-in capital during the second quarter of 2006.
In May of 2007, the Company amended the terms of its earn-out arrangement with the former owners of BIS. Due to the Company’s integration of BIS with our existing segments, we agreed to amend the earn-out in order to facilitate the calculation of the amount based on what discrete SAP related revenue information is readily available. The amendment provides for year two and year three payments of $700,000 in each period. These payments are due on June 1, 2007 and 2008 with additional potential for performance based payouts of $233,000 per year to be made based on performance against set revenue goals. The amendment approximates what management believes the BIS shareholders would have earned under the original amount if the information to calculate those amounts were readily available. The guaranteed payments will be recorded as an increase to goodwill by $1.4 million as of the execution of the amendment in May of 2007. Additional payments, if any, earned as a result of the performance based payments will result in increases to goodwill at the time of payment. On June 1, 2007, the Company made a cash payment of $700,000 to the former owners of BIS, decreasing the remaining maximum potential future consideration to $1.2 million.
(5)
Supplemental Cash Flow Information
Net total income taxes paid (refunds) in 2006, 2005 and 2004 were approximately $3.8 million, $3.2 million and $752,000, respectively.
Non-cash transactions in 2006 consisted of the issuance of common stock in the amount of $5.9 million as partial consideration for the acquisition of PGI in January 2006. Non-cash transactions in 2005 related primarily to the acquisition of BIS in June 2005 when 409,357 shares of common stock were issued.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(6)
Marketable Securities
At December 31, 2006 and 2005, all of the Company’s marketable securities were classified as available-for-sale. Marketable securities are carried on the balance sheet at their fair market value.
The following tables summarize the Company’s marketable securities:
The following table shows the gross unrealized losses and fair value of the Company’s marketable securities with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2006.
All contractual maturities of marketable securities at December 31, 2006 were less than one year. Actual maturities may differ from contractual maturities because some borrowers have the right to call or prepay obligations. Gross realized gains and losses on the sale of securities are calculated using the specific identification method, and were not material to the Company’s consolidated results of operations for 2006, 2005 or 2004.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(7)
Restricted Cash
The Company has deposited approximately $1.9 million and $1.5 million with various banks as collateral for letters of credit and performance bonds and has classified this cash as restricted on the accompanying consolidated balance sheet at December 31, 2006 and 2005, respectively, and is reflected in current or non-current assets based on the expiration of the requirement with the various banks.
(8)
Property and Equipment
The cost and accumulated depreciation of property and equipment at December 31, 2006 and 2005 are as follows:
Depreciation expense was approximately $10.0 million, $6.4 million and $6.0 million during 2006, 2005 and 2004, respectively. During 2006, the Company disposed of approximately $1.4 million of gross property and equipment with a net book value of $0.1 million excluding $1.2 million of gross property and equipment sold in connection with the HWT divestiture. During 2005, the Company wrote-off $10.7 million of fully depreciated property and equipment and disposed of approximately $500,000 of property and equipment which was no longer in use.
(9)
Goodwill
The following tables present the changes in goodwill allocated to our reportable segments during 2006 and 2005:
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(10)
Purchased Intangible and Long-lived Assets
The following is a summary of intangible assets as of December 31, 2006 and 2005:
During 2006, the Company wrote off $2.1 million of fully-amortized intangible assets associated with its HWT business unit, which was sold during the second quarter of 2006.
Amortization expense related to the purchased intangible assets was $3.6 million, $1.1 million and $515,000 for 2006, 2005 and 2004, respectively.
The estimated future amortization expense of purchased intangible assets as of December 31, 2006, is as follows:
(11)
Investments and Minority Interest
Although the Company holds no ownership interest in the voting shares of Sapient S.p.A., the management team of Sapient S.p.A. is the exclusive licensee of Sapient’s intellectual property in Italy and the Company is entitled to a royalty equal to 2% of the annual revenue of Sapient S.p.A. beginning July 2, 2005. The Company
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
previously had an option to purchase 100% of the ownership of Sapient S.p.A. from 2007 to 2010; however, this option was terminated during 2006. There were no royalties recorded in the three years ended December 31, 2006.
(12)
Restructuring and Other Related Charges
During 2006, the Company recorded restructuring and other related charges of approximately $1.9 million, of which $572,000 related to the 2006 restructure event, $430,000 related to the 2005 restructure event and $910,000 related to the 2001, 2002 and 2003 restructure events.
2006 - Restructure Event
During the first quarter of 2006, the Company initiated a restructuring plan in the United Kingdom to better position itself to capitalize on market opportunities. As a result, 28 employees were terminated and the Company recorded $572,000 in restructuring and other related charges in the first and second quarter of 2006 for severance and termination benefits in accordance with SFAS Statement No. 112, Employers’ Accounting for Postemployment Benefits. These charges were recorded in the United Kingdom segment in the Company’s Results by Operating Segment. The Company paid approximately $572,000 during 2006 and does not expect to make any further payments related to this restructuring event.
2005 - Restructure Event
During the fourth quarter of 2005, the Company initiated a restructuring plan to streamline general and administrative (“G&A”) activities. This initiative included the transfer of certain finance, human resources, and internal IT functions to India. As of December 31, 2006, this initiative resulted in the reduction of 21 employees and charges of approximately $430,000 and $300,000 during 2006 and 2005, respectively, to restructuring and other related charges, for severance, termination benefits and stay-bonuses in accordance with SFAS No. 112, and SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. These charges were not recorded to a segment because it impacted an area of the business that supports all business units, but is included in ’Reconciling items’ in the Results by Operating Segment. The severance accrual is included in the consolidated balance sheet in “Accrued restructuring costs, current portion”. The Company paid approximately $505,000 through the end of 2006 and paid the remainder during the first quarter of 2007.
2001, 2002 and 2003 - Restructure Events
As a result of the decline in the demand for advanced technology consulting services that began in 2000, and the resulting decline in the Company’s service revenues in 2001 and 2002, the Company restructured its workforce
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
and operations in 2001, 2002 and 2003. The restructuring consisted of ceasing operations and consolidating or closing excess offices. Estimated costs for the consolidation of facilities included contractual rental commitments or lease buy-outs for office space vacated and related costs, offset by estimated sublease income.
During 2006, the Company recorded restructuring and other related charges of approximately $910,000, of which, $465,000 related to an increase in operating expense assumptions associated with the Company’s previously restructured facilities. The remaining $445,000 was primarily due to a decrease in estimated sublease income resulting from changes in market leasing conditions on previously restructured facilities. During 2005 and 2004, the Company recorded restructuring charges of approximately $6.1 million and $1.5 million, respectively, primarily due to a decrease in estimated sublease income resulting from changes in market leasing conditions on previously restructured facilities. The Company has not finalized sublease agreements for all leases and is currently involved in negotiations to sublease the vacant spaces. No employees were terminated in connection with these restructuring charges.
The total remaining accrued restructuring costs for all events are $15.6 million at December 31, 2006, of which the cash portion is $15.5 million. The net cash outlay over the next 12-month period is expected to be $3.9 million and the remainder will be paid through 2011.
These restructuring charges and accruals require significant estimates and assumptions, including sub-lease income assumptions. The consolidation of facilities required the Company to make estimates, which included contractual rental commitments or lease buy-outs for office space vacated and related costs, offset by estimated sub-lease income. The Company’s sub-lease assumptions include anticipated rates to be charged to a sub-tenant and the timing of the sub-lease arrangement. These estimates and assumptions are monitored on a quarterly basis for changes in circumstances. It is reasonably possible that such estimates could change in the future, resulting in additional adjustments and these adjustments could be material.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(13)
Income Taxes
The provision (benefit) for income taxes consists of the following:
Income tax expense for 2006, 2005 and 2004 differed from the amounts computed by applying the U.S. statutory income tax rate to pre-tax income as a result of the following:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
At December 31, 2006 and 2005, deferred income tax assets and liabilities resulted from differences in the recognition of income and expense for tax and financial reporting purposes. The sources and tax effects of these temporary differences are presented below:
At December 31, 2006 and 2005, the net deferred tax assets and liabilities included in the consolidated balance sheet are as follows:
The Company has operating loss carry-forwards of approximately $204.0 million and $201.0 million for U.S. federal purposes, $245.0 million and $233.0 million related to state jurisdictions, and $7.0 million and
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
$11.0 million related to foreign jurisdictions at December 31, 2006 and 2005, respectively. If not utilized, the federal and state net operating loss carry-forwards will begin to expire at various times beginning in 2021 and 2007, respectively. The Company’s federal and Massachusetts research and development tax credit carry-forwards for income tax purposes are approximately $4.8 million at December 31, 2006 and 2005. If not utilized, the federal tax credit carry-forwards will begin to expire in 2017. In assessing the realizability of deferred income tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. As a result of operating losses incurred in 2001, 2002 and 2003 and uncertainty as to the extent and timing of profitability in future periods, the Company had valuation allowances of approximately $119.0 million and $117.2 million at December 31, 2006 and 2005, respectively, relating to the United States. The Company continues to believe that deferred tax assets in Germany, Canada and the United Kingdom are more likely than not to be realized and, therefore, no valuation allowance has been recorded against these assets. The assessment of the valuation allowance requires significant judgment and can materially affect net income. If the realization of deferred tax assets in the future becomes more likely than not, an adjustment to the deferred tax assets would increase net income in the period such determination is made.
The Company has a deferred tax asset pertaining to net operating loss carry-forwards resulting from the exercise of employee stock options of approximately $5.6 million at December 31, 2006. When recognized, the tax benefit of these loss carry-forwards will be accounted for as a credit to additional paid-in capital.
The Company reinvests unremitted earnings of certain foreign operations indefinitely and, accordingly, does not provide for income taxes that could result from the remittance of such earnings. At December 31, 2006 and 2005, earnings of such operations that could result in incremental taxes, if remitted, amounted to $34.5 million and $23.0 million, respectively.
(14)
Discontinued Operations
On May 2, 2006, the Company sold 100% of its investment in HWT, Inc. (“HWT”), the Company’s majority-owned, fully consolidated subsidiary, for which it received net cash proceeds of approximately $5.4 million. Net assets sold included cash of approximately $274,000. The Company has received additional cash proceeds of approximately $530,000 during 2007 related to holdback and escrow in accordance with the terms of the agreement. The Company has recorded a receivable for $1.2 million related to the holdback and escrow payments, which is recorded in prepaid expenses and other current assets on the Company’s consolidated balance sheet at December 31, 2006, and has recorded a payable of $213,000 in other current liabilities, representing the portion of the escrow and holdback that is due to minority shareholders. In addition, the Company could receive up to $4.0 million in earn-out payments over 2007 and 2008, which will be recorded when and if earned. The Company has reflected HWT’s historical results as discontinued operations in the consolidated financial statements for all periods. The sale of HWT resulted in a net gain on disposal (after tax) of $4.8 million. Gross revenues for HWT were $1.3 million, $6.0 million, and 5.7 million for the year-ended December 31, 2006, 2005 and 2004, respectively. Income (loss) of the discontinued operation was approximately ($433,000), $961,000, and $665,000 in 2006, 2005 and 2004, respectively. The gross revenue and income (loss) figures noted above for HWT for 2006 only include amounts recorded through April 30, 2006, as HWT was disposed of on May 2, 2006. Our financial statements and all financial information included in this report for 2006 and prior periods reflect the results of operations for HWT as a single line item listed as “Loss from discontinued operations.”
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(15)
Commitments and Contingencies
Lease Commitments
The Company maintains its executive offices in Cambridge, Massachusetts and operating offices in several locations throughout the United States and abroad. Future minimum rental commitments under non-cancelable operating leases with initial or remaining terms in excess of one year at December 31, 2006, net of sublease income of $9.9 million under signed sublease agreements and $7.9 estimated for expected future sublease arrangements, were as follows:
Rent expense for the years ended December 31, 2006, 2005 and 2004 was approximately $9.4 million, $8.9 million and $8.3 million, respectively.
Guarantees and Indemnification Obligations
As permitted under Delaware law, the Company’s Amended and Restated Certificate of Incorporation provides that the Company will indemnify its officers and Directors for certain claims asserted against them in connection with their service as an officer or Director of the Company. The maximum potential amount of future payments that the Company could be required to make under these indemnification provisions is unlimited. However, the Company has purchased certain Directors’ and Officers’ insurance policies that reduce its monetary exposure and that may enable it to recover a portion of any future amounts paid. As a result of the Company’s insurance coverage, the Company believes the estimated fair value of these indemnification arrangements is minimal.
The Company frequently has agreed to indemnification provisions in professional services agreements with its clients and in its real estate leases in the ordinary course of its business. Pursuant to these provisions, the Company indemnifies the indemnified party for certain losses suffered or incurred by the indemnified party. With respect to the Company’s professional services agreements, these indemnification provisions typically apply to any claim asserted against its client for infringement of intellectual property rights, but may also include claims asserted against its client relating to personal injury or property damage, violations of law or certain breaches of the Company’s contractual obligations. With respect to lease agreements, these indemnification provisions typically apply to claims asserted against the landlord relating to personal injury and property damage caused by the Company, violations of law or to certain breaches of the Company’s contractual obligations. In each case, the term of these indemnification provisions generally survives the termination of the agreement, although the provision has the most relevance during the contract term and for a short period of time thereafter. The maximum potential amount of future payments that the Company could be required to make under these indemnification provisions is unlimited, although in many cases the Company’s liability for indemnification is limited to a specific dollar amount in the applicable contract. The Company also has purchased insurance policies covering professional errors and omissions, property damage and general liability that reduce its monetary exposure for indemnification and enable it to recover a portion of any future amounts paid. The Company has never paid any material amounts to defend
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
lawsuits or settle claims related to these indemnification provisions. Accordingly, the Company believes the estimated fair value of these indemnification arrangements is minimal.
The Company frequently warrants that the technology solutions it develops for its clients will operate in accordance with the project specifications without defects for a specified warranty period, subject to certain limitations that the Company believes are standard in the industry. In the event that defects are discovered during the warranty period, and none of the limitations apply, the Company is obligated to remedy the defects until the solution that the Company provided operates within the project specifications. The Company is not typically obligated by contract to provide its clients with any refunds of the fees they have paid, although a small number of its contracts provide for the payment of liquidated damages upon default. The Company has purchased insurance policies covering professional errors and omissions, property damage and general liability that reduce its monetary exposure for warranty-related claims and enable it to recover a portion of any future amounts paid. The Company typically provides in its contracts for testing and client acceptance procedures that are designed to mitigate the likelihood of warranty-related claims, although there can be no assurance that such procedures will be effective for each project. The Company has never paid any material amounts with respect to the warranties for its solutions, although the Company sometimes commits unanticipated levels of effort to projects to remedy defects covered by its warranties. Deferred revenues on contracts related to warranties were immaterial as of December 31, 2006 and 2005.
Legal Claims
The Company is subject to certain legal proceedings and claims, as discussed below. The Company is also subject to certain other legal proceedings and claims that have arisen in the course of business and that have not been fully adjudicated. In the opinion of management, the Company does not have a potential liability related to any current legal proceedings and claims that would individually or in the aggregate have a material adverse effect on its financial condition, liquidity or results of operations. However, the results of legal proceedings cannot be predicted with certainty. Should the Company fail to prevail in any of these legal matters or should several of these legal matters be resolved against the Company in the same reporting period, the operating results of a particular reporting period could be materially adversely affected.
The Company accrues contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. The Company is subject to various legal claims totaling approximately $3.2 million and various administrative audits, each of which have arisen in the ordinary course of our business. The Company has an accrual at December 31, 2006 of approximately $800,000 related to certain of these items. The Company intends to defend these matters vigorously, although the ultimate outcome of these items is uncertain and the potential loss, if any, may be significantly higher or lower than the amounts that the Company has previously accrued. The pending derivative actions do not assert a claim against the Company for specific monetary damages and, accordingly, the amounts described herein are exclusive of any potential future monetary damages that the company may incur as a result of the derivative actions.
On August 17, 2006 a derivative action, captioned as Alex Fedoroff, Derivatively on Behalf of Nominal Defendant Sapient Corporation v. Jerry A. Greenberg, J. Stuart Moore, Susan D. Johnson, et al., was filed in the Superior Court for Middlesex County, Massachusetts, against Sapient as a nominal defendant and sixteen of Sapient’s current and former directors and officers. On August 31, 2006, a nearly identical complaint, captioned as Jerry Hamilton, Derivatively on Behalf of Nominal Defendant Sapient Corporation v. Jerry A. Greenberg, J. Stuart Moore, Susan D. Johnson, et al., was filed in the same court by a different Company shareholder. Both plaintiffs claim breaches of fiduciary duty by all defendants for allegedly backdating stock options between 1997 and 2002. The Plaintiffs also claim that some of the defendants were unjustly enriched by receipt of purportedly backdated stock options, and seek unspecified damages, disgorgement of “backdated” stock options and any proceeds received from the exercise and sale of any “backdated” options, costs and attorneys’ fees. Neither of the plaintiffs
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
made a pre-suit demand on Sapient’s Board of Directors, as required by Delaware law (Sapient’s state of incorporation) prior to filing their respective actions.
On October 13, 2006, the Superior Court for Middlesex County, Massachusetts, entered an order consolidating the foregoing derivative actions under the caption In re Sapient Corporation Derivative Litigation. On February 20, 2007, the consolidated complaint was transferred into the Business Litigation Session of the Suffolk Superior Court, Massachusetts under docket number 07-0629 BLS1. On April 25, 2007, the defendants filed a motion to dismiss, which was heard by the Court on May 23, 2007. The Company is awaiting notice on the results of this hearing.
On October 27, 2006 and October 31, 2006, three additional shareholder derivative actions were filed in the United States District Court for the District of Massachusetts; Mike Lane, Derivatively on Behalf of Sapient Corporation v. J. Stuart Moore, Jerry A. Greenberg, Sheeroy D. Desai, et al. and Sapient Corporation; Marc Doyle, Derivatively on Behalf of Sapient Corporation v. J. Stuart Moore, Jerry A. Greenberg, Sheeroy D. Desai, et al. and Sapient Corporation; and Laurence Halaska, Derivatively on Behalf of Sapient Corporation v. Jerry A. Greenberg, J. Stuart Moore, Scott J. Krenz, et al. and Sapient Corporation. The federal derivative actions are substantially similar to the state derivative actions, except that federal derivative actions assert violations of Sarbanes-Oxley and violations of Sections 10(b), 14(a) and 20(a) of the Securities Exchange Act. None of the foregoing derivative actions asserts a claim against the Company for specific monetary damages.
On November 30, 2006, the Securities and Exchange Commission (“SEC”) notified us that it had commenced a formal inquiry into our historical stock-based compensation practices. Subsequently, on March 8, 2007, we received a subpoena from the SEC requesting documents relating to this matter, and responded by producing documents. We are cooperating fully with the SEC and will continue to do so as the inquiry moves forward. At this point, we are unable to predict what, if any, consequences the SEC investigation may have on us. However, the investigation could result in considerable legal expenses, divert management’s attention from other business concerns and harm our business. If the SEC were to commence legal action, we could be required to pay significant penalties and/or fines and could become subject to an administrative order and/or a cease and desist order. The filing of our restated financial statements to correct the discovered accounting errors will not resolve the SEC investigation.
Other Contingencies
On June 1, 2005, the Company issued 313,943 shares of common stock in the BIS acquisition that carry an embedded put option feature which expire over a three year period. As of December 31, 2006, the maximum amount that the Company would be required to pay in cash is approximately $480,000 for the 224,469 shares of common stock subject to this put feature.
In connection with the independent investigation into the Company’s historical stock-based compensation practices, the Company reviewed the payroll withholding tax effect associated with certain stock options. Certain stock options were originally intended to be Incentive Stock Options (“ISOs”), under U.S. tax regulations. However, by definition, ISOs may not be granted with an exercise price less than the fair market value of the underlying stock on the date of grant. Due to the impact of the measurement date changes on the qualified status of affected ISOs, they may no longer qualify as ISOs under the regulations. Therefore, the affected ISOs were accounted for as if these options were non-qualified stock options for payroll tax accounting purposes. The Company recorded a liability for the unpaid income and employment taxes plus potential penalties and interest based upon the change in status of the affected options. The Company recorded a liability for the taxes, penalties and interest due based upon the change in status of the options in the amount of $17.8 million. The Company recorded reversals of this accrual in the amount of $16.5 million between 2003 and 2006 due to the expiration of the tax statute of limitations. These adjustments resulted in a net charge to income of $1.3 million over the period 1996 to 2006, which represent management’s best estimate of the Company’s liability.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company has recorded approximately $530,000 of estimated interest and penalties associated with remittances of withholding taxes in certain of its jurisdictions related to stock-based awards.
(16)
Stock Plans
Under the provisions of SFAS No. 123R, the Company recorded $12.4 million of stock-based compensation expense in the accompanying consolidated statement of operations for the year ended December 31, 2006. Under the provisions of APB No. 25, the Company recorded $2.1 million and $3.2 million of stock-based compensation for the years ended December 31, 2005 and 2004, respectively. Stock-based compensation expense capitalized in conjunction with costs capitalizable related to internally developed software was immaterial. The Company values restricted stock awards based on the fair market value on the date of grant. Restricted Stock Unit awards with market-based vesting criteria were valued using a lattice model. The Company uses the Black-Scholes valuation model for estimating the fair value of the stock option awards with the following weighted-average assumptions:
Dividend yield is 0% because the Company has never paid dividends and has no current intent to do so. Expected volatility is based on the Company’s historical volatility over a period commensurate with the expected term of the award. Average risk-free interest rate is based on the historical U.S. Treasury risk-free rate over a period commensurate with the expected term of the award. Expected term is based on an analysis of the Company’s historical forfeitures and cancellations.
The Company recognizes these compensation costs net of a forfeiture rate and recognizes the compensation costs for only those shares expected to vest on a straight-line basis over the requisite service period of the award, which is generally the vesting term. The Company estimated the forfeiture rate for 2006 based on its historical experience. Upon the adoption of SFAS No. 123R, the Company calculated the estimated forfeitures for previously recorded stock-based compensation expense. As a result of this calculation, the Company recorded a cumulative effect of the accounting change, resulting in income of $154,000, which was recognized in the statement of operations in the first quarter of fiscal year 2006.
Based on historical experience the Company has assumed an annualized forfeiture rate of 7% for awards granted to its senior executives and directors, and a 20% forfeiture rate for its remaining employees. The Company will record additional expense if the actual forfeitures are lower than estimated and will record a recovery of prior expense if the actual forfeitures are higher than estimated. The actual expense recognized over the vesting period will only be for those shares that vest.
The fair value per share of the Restricted Awards with time-based vesting is equal to the quoted market price of the Company’s common stock on the date of grant.
The intrinsic value of the vested Restricted Stock Units as of December 31, 2006 was $21.8 million. The purchase price for vested Restricted Stock Units is $0.00 per share. The weighted average contractual term of the Restricted Stock Units, calculated based on the service-based term of each instrument, is 2.3 years.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(a)
Equity Stock Incentive Plan
The Company’s 1996 Equity Stock Incentive Plan (the 1996 Plan) authorizes the Company to grant options to purchase common stock, and other certain other equity-related awards such as restricted common stock and restricted stock units, to employees and directors of, and consultants to, the Company. A total of 19,200,000 shares of common stock may be issued under the 1996 Plan. The 1996 Plan is administered by the Compensation Committee of the Board of Directors, which selects the persons to whom stock options and other awards are granted and determines the number of shares, the exercise or purchase prices, the vesting terms and the expiration dates of options granted. Non-qualified stock options may be granted at exercise prices which are above, equal to or below the grant date fair market value of the common stock. The exercise price of options qualifying as Incentive Stock Options may not be less than the fair market value of the common stock on the grant date. Stock options granted under the 1996 Plan are nontransferable, generally become exercisable over a four-year period and expire ten years after the date of grant (subject to earlier termination in the event of the termination of the optionee’s employment or other relationship with the Company). No award may be made under the plan after February 13, 2006.
(b)
1996 Director Stock Option Plan
Options granted pursuant to the Directors Plan vest in four equal annual installments commencing on the first anniversary of the date of grant and generally expire ten years after the date of grant. As of December 31, 2006 and 2005, options to purchase 96,300 shares, of common stock were outstanding under the Director Plan.
(c)
Stock Incentive Plan
The Company’s 1998 Stock Incentive Plan (the 1998 Plan) authorizes the Company to grant options to purchase common stock, to make awards of restricted common stock, and to issue certain other equity-related awards to employees and directors of the Company. The total number of shares of common stock which may be issued under the 1998 Plan is 18,000,000 shares. The 1998 Plan is administered by the Compensation Committee of the Board of Directors, which selects the persons to whom stock options and other awards are granted and determines the number of shares, the exercise or purchase prices, the vesting terms and the expiration date. Non-qualified stock options may be granted at exercise prices which are above, equal to or below the grant date fair market value of the common stock. The exercise price of options qualifying as Incentive Stock Options may not be less than the fair market value of the common stock on the grant date.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(d)
Human Code 1994 Stock Option/Stock Issuance Plan
Prior to the acquisition of Human Code, options to purchase approximately 2,864,000 shares of Human Code common stock were outstanding at exercise prices between $0.10 and $3.25 per share. As a result of the acquisition, the Company assumed these outstanding Human Code stock options and converted them into options to purchase approximately 471,000 shares of the Company’s common stock at exercise prices between $1.00 and $32.64 per share. The options vest ratably over periods up to four years. The Company recorded deferred compensation of $11.2 million related to the intrinsic value of the unvested options, all of which has been amortized as of December 31, 2004. Stock-based compensation expense relating to these options was approximately $16,000 and $105,000 for 2004 and 2003, respectively. Deferred compensation was fully amortized in the first quarter of 2004. In connection with the termination of certain Human Code employees to whom the deferred compensation related, $63,000 was reversed through additional paid-in-capital during 2003. No further grants may be made pursuant to the Human Code Plan. Previously outstanding options under the Human Code Plan remain outstanding, and are exercisable for shares of the Company’s common stock.
(e)
Stock Option Plan
The Company’s 2001 Stock Option Plan (the 2001 Plan) authorizes the Company to grant options to purchase common stock to employees and directors of the Company. The total number of shares of common stock which may be issued under the 2001 Plan is 12,000,000 shares. The 2001 Plan is administered by the Board of Directors, or a subcommittee thereof, which selects the persons to whom stock options are granted and determines the number of shares, the exercise prices, the vesting terms and the expiration date. Under the terms of the 2001 Plan, no stock options, including non-qualified options, may be granted at exercise prices which are below the grant date fair market value of the common stock. In connection with the Company’s internal investigation into its historical stock-based compensation practices, management determined that certain stock option grants under the 2001 Plan were made at exercise prices below fair market value (“FMV”). Although the 2001 Plan requires that all stock option awards be made at FMV, management has determined that these below-FMV awards are valid because the Company historically has honored the awards upon exercise and the Company has the ability and intent to continue honoring the awards in the future. Stock options granted under the 2001 Plan are nontransferable, generally become exercisable over a four-year period and expire ten years after the date of grant (subject to earlier termination in the event of the termination of the optionee’s employment or other relationship with the Company).
(f)
Employee Stock Purchase Plan
The Company’s 2002 Employee Stock Purchase Plan (the 2002 Purchase Plan) authorizes the issuance of up to 2,700,000 shares of common stock to participating employees through a series of periodic offerings. The precise length of each offering, and the maximum number of shares available for purchase in each offering, are established by the Company’s Board of Directors in advance of the applicable offering commencement date. The first offering under the 2002 Purchase Plan ran from July 1, 2002 until February 28, 2003, and the maximum number of shares available was 720,000 shares. The second, third and fourth offerings under the 2002 Purchase Plan ran for six months each, and the maximum number of shares available in each offering was 540,000 shares (plus any unpurchased shares from previous offerings). The fifth offering under the 2002 Purchase Plan ran for four months, and the maximum number of shares available in the offering was 360,000 shares (plus any unpurchased shares from previous offerings). The sixth offering ran from January 1, 2005 until May 31, 2005, and the maximum number of shares available was 685,237, which represent the unpurchased shares from previous offerings. No new shares were available for the sixth offering. An employee becomes eligible to participate in the Purchase Plan when he or she is regularly employed by the Company for at least 20 hours a week and for more than five months in a calendar year on
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
the first day of the applicable offering. The price at which employees can purchase common stock in an offering is 85 percent of the closing price of the common stock on the Nasdaq Global Market on the day the offering commences or on the day the offering terminates, whichever is lower.
(g)
Employee Stock Purchase Plan
The Company’s 2005 Employee Stock Purchase Plan (the 2005 Purchase Plan) authorizes the issuance of up to 2,074,000 shares of common stock, plus 276,248 number of shares of common stock unpurchased under the Company’s 2002 Purchase Plan after the May 31, 2005 purchase, to participating employees through a series of periodic offerings. The precise length of each offering, and the maximum number of shares available for purchase in each offering, are established by the Company’s Board of Directors in advance of the applicable offering commencement date, no plan period may have a duration exceeding twelve months. The first offering under the 2005 Purchase Plan ran from June 1, 2005 until November 30, 2005, and the maximum number of shares available was 400,000 shares. The second offering began on December 1, 2005 and extended through May 31, 2006, and the maximum number of shares available was 400,000, which represented the unpurchased shares from previous offerings. On June 1, 2006, 283,926 shares were issued under the 2005 Purchase Plan related to the second offering at a price of $4.55 per share. No new shares were available for the second offering. An employee becomes eligible to participate in the Purchase Plan when he or she is regularly employed by the Company of a Designated Subsidiary for at least 20 hours a week and for more than five months in a calendar year on the first day of the applicable offering and an employee has not become ineligible to so participate. The price at which employees can purchase common stock in an offering is 85 percent of the closing price of the common stock on the Nasdaq Global Market on the day the offering terminates. As a result of the Company’s internal investigation into historic stock option practices, activity under this plan was suspended during Q3 and Q4 2006.
A summary of the status of the Company’s stock option plans for 2006, 2005 and 2004 is presented below (in thousands, except weighted average prices):
The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model. The following are the weighted average assumptions for grants in 2005 and 2004: dividend yield of zero
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
percent for each year; expected volatility ranging from 49 percent to 99 percent for 2005 and from 101 to 108 percent for 2004; risk free interest rates ranging from 3.88 to 4.26 percent for 2005 and 3.25 to 4.00 percent for 2004; and expected lives of 3.92 to 4.56 years for 2005, and 4.56 years for 2004.
As of December 31, 2006, there remained approximately $8.7 million of compensation costs related to non-vested stock options to be recognized as expense over a weighted average period of 1.4 years. The following table summarizes information about stock options outstanding at December 31, 2006:
The table below summarizes activity relating to Restricted Units for 2006 and 2005 (in thousands, except weighted average prices):
As of December 31, 2006, there remained $18.8 million of compensation costs related to non-vested restricted units to be recognized as expense over a weighted average period of approximately 2.3 years.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The table below summarizes activity relating to Restricted Awards for 2006, 2005, and 2004 (in thousands, except for per share values):
(1)
The aggregate intrinsic value in this table was calculated based on the positive difference between the closing market value of the Company’s common stock on December 31, 2006, 2005 and 2004 ($5.49, $5.69 and $7.91, respectively) and the exercise price of the underlying Stock Options, Restricted Units, or Restricted Stock.
(17)
Retirement Plans
The Company established a 401(k) retirement savings plan for employees in June 1994. Under the provisions of the plan, the Company matches 25 percent of an employee’s contribution, up to a maximum of $1,250 per employee per year. Total Company contributions were approximately $800,000 in 2006, $700,000 in 2005 and $500,000 in 2004.
(18)
Stockholders’ Equity
(a)
Redeemable Common Stock
On June 1, 2005, the Company issued 313,943 shares of redeemable common stock which carry an embedded put option feature. If the Company’s average common stock per share price during the ten business days ending on each of the first, second and third anniversary of June 1, 2005, the closing date of the BIS acquisition, is less than 25% ($2.1375 per share) of the Buyer Share Price, certain holders of the shares issued as consideration can require the Company to repurchase the shares at $2.1375 per share. In June 2006, 89,474 of the redeemable shares were reclassified into stockholders’ equity when the put option lapsed. As of December 31, 2006, the maximum amount that the Company would be required to pay in cash is approximately $480,000. As the potential redemption is outside the control of the Company, the potential future cash obligation associated with the put option has been classified outside of permanent equity to a temporary equity account in the accompanying consolidated balance sheet.
(b)
Preferred Stock
The Company’s Certificate of Incorporation gives the Board the authority to issue up to 5,000,000 shares, $0.01 par value, of preferred stock with terms to be established by the Board at the time of issuance. The Company has not issued shares of preferred stock to date.
(c)
Restricted Common Stock
On October 23, 2002, the Company granted 324,500 shares of restricted common stock to senior executive officers of the Company. These shares vest ratably over a period of four years from the grant date. The Company
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
measured the intrinsic value of the shares based on the market value of the shares on the date of the grant. Six of these senior executive officers have since left the Company and 90,000 shares were forfeited as a result. The stock-based compensation charge for 2006, 2005 and 2004 was approximately $0.2 million, $0.3 million and $0.6 million, respectively. All of these awards became fully vested in October 2006.
(d)
Restricted Stock Units
During the third quarter of 2005, the Company began granting restricted stock unit awards (“RSUs”) instead of the Company’s annual grant of stock options. During 2006 the Company granted approximately 3.1 million RSUs that will allow employees the right to acquire shares of the Company’s common stock. The RSUs were valued at their fair market value on date of grant and vest 25% annually over four years. During 2006, the Company granted 400,000 Restricted Stock Unit awards with market-based vesting criteria. These awards have a four year life and were valued using a lattice model. These awards had a weighted average grant date fair value of $4.03. The stock-based compensation charge related to RSU grants for 2006 and 2005 was $5.0 million and $1.8 million, respectively.
(e)
Unrestricted Common Stock
On August 8, 2004, the Company issued 3,000 shares of unrestricted common stock under its 1996 Equity Stock Incentive Plan to a former member of its Board of Directors and a member of its new advisory board. The shares were 100% vested upon issuance and the Company recorded stock based compensation in the amount of approximately $20,000, which was the fair market value of the shares of common stock on the issuance date.
(f)
Treasury Stock
The Company uses the cost method to account for its treasury stock transactions. Treasury stock shares are issued in connection with the Company’s stock option plans, restricted stock plans and its employee stock purchase plan using the average cost basis method.
On November 16, 2004, Sapient’s Board of Directors authorized up to $25.0 million in funds for use in the Company’s common stock repurchase program. On February 10, 2006 the Board of Directors authorized an additional $25.0 million in funds for use in such programs. Sapient has announced that it will repurchase shares on the open market or in private transactions from time to time depending on market conditions. Each authorization shall continue for a period of two years from its inception or until it is discontinued by the Board of Directors. Under the Company’s buyback program no shares were repurchased in 2004 and approximately 3.0 million shares were repurchased in 2005 at an average price of $5.84 per share for an aggregate purchase price of $17.6 million. The Company repurchased approximately 3.4 million shares of its common stock at an average price of $5.27 per share for an aggregate purchase price of approximately $18.1 million during 2006.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(g)
Income Per Share
The following information presents the Company’s computation of basic and diluted income per share from continuing operations and basic and diluted net income per share for the periods presented in the consolidated statements of operations:
Excluded from the above 2006, 2005 and 2004 computation of weighted average common shares and dilutive common share equivalents for diluted net income per share were options to purchase approximately 13.4 million, 8.7 million, and 10.4 million shares, respectively, of common stock because their inclusion would have an anti-dilutive effect on diluted net income per share.
(19)
Related Party Transactions
In October of 2006, in connection with his resignation, Jerry A. Greenberg and Sapient Corporation (the “Company”) entered into a consulting agreement pursuant to which Mr. Greenberg may provide consulting services to the Company in respect of long-term strategic planning, ongoing client relations and general business development. The consulting agreement is effective as of October 16, 2006, has an initial term of one year and may be terminated by either party upon written notice. The amount earned under this arrangement as of December 31, 2006 was $70,148, of which $57,923 was paid and $12,225 was payable as of December 31, 2006. The amount earned under this arrangement during the first quarter of 2007 was $78,563, of which $63,375 was paid and $15,188 was payable as of March 31, 2007.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(20)
Segment Reporting
The Company has discrete financial data by operating segments available based on its method of internal reporting, which disaggregates its operations. Operating segments are defined as components of the Company concerning which separate financial information is available to manage resources and evaluate performance. Beginning with the first quarter of 2006, the Company combined its Canada international business unit and two of its United States business units, and identified one additional business unit in the United States. Specifically, the Company combined its Financial Services, Automotive, Consumer and Energy, Technology, Education, Communications and Health Care business unit and its Canada business unit into one business unit, which is now named North America Commercial. In addition, Experience Marketing became a standalone business unit. Our three business units in North America are now: (i) North America Commercial (“NAC”), (ii) Government Services and (iii) Experience Marketing. The Company has reported its results by operating segments accordingly, and quarterly results for operating segments for 2005 have been restated to reflect these changes.
Prior to the first quarter of 2006 the Company did allocate certain selling, marketing and general and administrative expenses to its business units in the United Kingdom, Germany and Canada as these activities had been managed within the business unit, but the Company had not allocated these expenses to the business units in the United States. Beginning in the first quarter of 2006 the Company does not allocate certain marketing and general and administrative expenses to its NAC, United Kingdom, Germany and Experience Marketing business unit segments because these activities are managed separately from the business units. The Company does allocate certain marketing and general and administrative expenses to its Government Services business unit as these activities are managed within the business unit. Quarterly results for operating segments for 2005 have been restated to reflect these changes. The Company did not allocate the costs associated with its restructure events across all operating segments for internal measurement purposes, given that the substantial majority of the restructuring costs were related to the initiative to reengineer general and administrative activities and the consolidation of facilities. We did allocate the workforce reduction costs associated with the United Kingdom’s 2006 restructure plan due to the specific identification of the terminated employees to their respective business unit. Asset information by operating segment is not reported to or reviewed by the chief operating decision makers and, therefore, the Company has not disclosed asset information for each operating segment.
The tables below present the service revenues and operating (loss) income attributable to these operating segments for the periods presented.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(1)
Reflects only the direct controllable expenses of each business unit segment. It does not represent the total operating results for each business unit segment as it does not contain an allocation of certain corporate and general and administrative expenses incurred in support of the business unit segments.
(2)
Adjustments that are made to the total of the segments’ operating income (loss) in order to arrive at consolidated income (loss) from continuing operations before income taxes include the following:
(3)
Includes corporate portion of both selling and marketing and general and administrative expenses.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Geographic Data
Data for the geographic regions in which the Company operates is presented below for the periods presented in the consolidated statements of operations and the consolidated balance sheets:
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(21)
Quarterly Financial Results (Unaudited)
The following tables set forth certain unaudited quarterly results of operations of the Company for 2006 and 2005. The quarterly operating results are not necessarily indicative of future results of operations. The three months ended March 31, 2006 and each of the quarterly periods in 2005 have been restated to reflect additional stock based compensation, other adjustments previously unrecorded and related tax effects for all items. See Note 2 for a description of the Restatement.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
Years Ended December 31, 2006, 2005 and 2004
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A.
Controls and Procedures
Background
During 2006 there were numerous changes to our accounting personnel. This has led to an insufficient complement of personnel with an appropriate level of accounting knowledge, experience and training in the application of accounting principles generally accepted in the United States commensurate with our financial reporting requirements. The turnover in accounting personnel described above is a result of the significant disruption to the financial accounting organization, processes and workload incurred during 2006 as follows:
•
the transition of key accounting and administrative functions and processes to India during 2006;
•
the changes in the finance organization and resultant significant turnover in the Company’s finance and accounting staff, including three different Chief Financial Officers during 2006; and
•
the investigation and restatement of the Company’s financial statements relating to historical stock option practices, requiring significant financial research, analysis and incremental recordkeeping.
Evaluation of Disclosure Controls and Procedures
Under the supervision of and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness, as of December 31, 2006, of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”). Our evaluation has identified a Material Weakness in our internal control over financial reporting as noted below in Management’s Report on Internal Control over Financial Reporting. Based on the evaluation of this Material Weakness, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of December 31, 2006 to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control Over Financial Reporting
We are responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision of and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial
reporting based on the criteria in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based upon that evaluation, management identified the following material weakness as of December 31, 2006 in the Company’s internal control over financial reporting. A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement to the annual or interim financial statements will not be prevented or detected.
Control Environment. We did not maintain an effective control environment as we did not maintain a sufficient complement of personnel with an appropriate level of accounting knowledge, experience and training in the application of accounting principles generally accepted in the United States commensurate with our financial reporting requirements. This control deficiency could result in a misstatement of our financial statement accounts and disclosures that could result in a material misstatement to the annual or interim financial statements that would not be prevented or detected. This control deficiency could also impede our ability to complete our financial reporting process and prepare financial statements on a timely basis. Accordingly, management has concluded that this control deficiency constitutes a material weakness.
As a result of the material weakness in internal control over financial reporting described above, management concluded that our internal control over financial reporting was not effective as of December 31, 2006 based on the criteria established in Internal Control - Integrated Framework issued by the COSO.
Our assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.
Plan for Remediation of the Material Weakness in Internal Control Over Financial Reporting
During the second half of 2006, we began adding members to our accounting and finance staff and implementing additional review procedures in our financial statement close processes to address these issues. While the impact of these enhancements to the internal control over financial reporting were positive, management’s assessment of our internal control over financial reporting for 2006 indicated that additional resources, training, and experience were necessary for certain of these controls to operate effectively.
Management’s actions to further address these issues in 2007 include:
•
assigning the new Chief Administrative Officer direct responsibility for resolving the issues with the core transaction team in India;
•
adding a significant number of resources to help stabilize the accounting and finance team in India and providing additional training to ensure the processes and controls there are being followed; and
•
hiring and training of additional key personnel in corporate accounting, purchasing, financial planning and analysis, Sarbanes-Oxley compliance and other open roles.
Changes in Internal Control Over Financial Reporting
No changes in our internal control over financial reporting occurred during the fiscal quarter ended December 31, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART III
Item 10.
Item 10.
Directors and Executive Officers of the Company
Directors and Director Nominees
Our current directors, and one director nominee (James M. Benson), are listed below, with their principal occupation and business experience for at least the last five years, the names of other publicly held companies of which they serve as a director, and their age and length of service as a member of our Board of Directors, as applicable.
Director
Principal Occupation, Other Business Experience
Name
Age
Since
and Directorships During Past Five Years
James M. Benson
N/A
Mr. Benson, a director nominee, is a candidate for election to our Board of Directors by our stockholders at our 2007 Annual Meeting. Mr. Benson currently is the Chief Executive Officer of Clark Benson LLC, a position he has held since January 2006, and a principal of its parent company, Clark Wamberg, LLC, a position he has held since the company’s formation in February 2007. Mr. Benson served as a director of Clark, Inc., the former parent company of Clark Benson, from January 2006 until March 12, 2007.
Prior to joining Clark Benson, Mr. Benson served as President and Chief Executive Officer of John Hancock Life Insurance Company, a division of Manulife Financial, from 2002 to 2006. From 1997 to 2002, Mr. Benson served as President of MetLife’s Individual Business enterprise, as well as Chairman, President, and Chief Executive Officer of two separate MetLife affiliates: New England Financial, and GenAmerica Financial Corporation.
Hermann Buerger
Mr. Buerger has served as a member of Sapient Corporation’s Board of Directors and Audit Committee chair since June 2006. Mr. Buerger was employed by Commerzbank AG from 1972 through 2004, holding a variety of senior executive positions, focusing on commercial lending for multinational businesses. Mr. Buerger retired from Commerzbank AG as Chief Executive Officer and regional board member for the Americas. Mr. Buerger currently is a director and chairman of the audit committee of EMS Technologies.
Dennis H. Chookaszian
Mr. Chookaszian has been a director since January 2003. Since his retirement from employment in February 2001, Mr. Chookaszian has served as an independent advisor and board member for various non-profit and for-profit organizations. From November 1999 to February 2001, Mr. Chookaszian was Chairman and Chief Executive Officer of mPower, Inc., a financial advisory firm. From February 1999 to November 2001, Mr. Chookaszian was also Chairman of the Executive Committee of CNA Financial Corporation, a global insurance and financial services holding company. From October 1992 to February 1999, Mr. Chookaszian was Chairman and Chief Executive Officer of CNA Insurance Companies, a global insurance company. Mr. Chookaszian is also a director of Career Education Corporation, a for-profit educational provider, InsWeb Corporation, an online insurance portal, and Chicago Mercantile Exchange, Inc., a financial services company.
Executive Officers of the Company
Below are the name, age and principal occupations for the last five years of each executive officer of Sapient, as of June 12, 2007. All such persons have been elected to serve until their successors are elected and qualified or until their earlier resignation or removal.
Preston B. Bradford, Chief Operations and Administrative Officer
Mr. Bradford joined Sapient in September 1994. Mr. Bradford was appointed as Senior Vice President in April 2000 and Executive Vice President in February 2004. Prior to joining Sapient, Mr. Bradford held various positions with Sprint Corporation, a telecommunications company, from July 1980 to August 1994.
Alan J. Herrick, President and Chief Executive Officer
Mr. Herrick joined Sapient in March 1995. Mr. Herrick was appointed as Vice President in December 1996, Executive Vice President in June 2002 and President and Chief Executive Officer in October 2006.
Christian Oversohl, Vice President and Managing Director, Europe
Mr. Oversohl joined Sapient in April 2000, following Sapient’s merger with the company he founded, The Launch Group. Mr. Oversohl serves as Vice President and Managing Director of Sapient European Operations. Prior to joining Sapient, Mr. Oversohl was a manager at A.T. Kearney and also worked with Dicke & Wicharz Management Consulting, BMW, Henkel-Kosmetik, and Dresdner Bank.
Jane E. Owens, Senior Vice President and General Counsel
Ms. Owens joined Sapient in September 2000 as Senior Vice President, General Counsel and Secretary. Prior to joining Sapient, Ms. Owens served as Senior Vice President, General Counsel and Secretary of The Dial Corporation, a consumer products company, from May 1997 to September 2000.
Stephen P. Sarno, Vice President, Corporate Controller and Chief Accounting Officer
Mr. Sarno joined Sapient in October 2005 as Vice President, Corporate Controller and Chief Accounting Officer. Prior to joining Sapient, Mr. Sarno served as a Director of Finance with BearingPoint from 2004 to 2005. Mr. Sarno was formerly a Senior Manager with PricewaterhouseCoopers LLP.
Joseph S. Tibbetts, Jr., Senior Vice President and Chief Financial Officer
Mr. Tibbetts joined Sapient in October 2006 as Senior Vice President and Chief Financial Officer. Prior to joining Sapient, Mr. Tibbetts was most recently the chief financial officer of Novell, Inc. and has also held a variety of senior financial management positions at Charles River Ventures, Lightbridge, Inc., and SeaChange International, Inc. Mr. Tibbetts was formerly a partner with Price Waterhouse LLP.
Alan M. Wexler, Senior Vice President
and Managing Director, North America
Mr. Wexler joined Sapient in April 1998 and serves as Senior Vice President and Managing Director of Sapient’s North American Operations. Since joining Sapient in 1998, Mr. Wexler has held a number of key management positions, including Vice President and Managing Director of Sapient’s Technology and Communications Group. He launched Sapient’s Global Wireless Group, and led Sapient’s Media, Entertainment, and Communication Group in New York. Prior to joining Sapient, Mr. Wexler founded and operated a management and technology-consulting firm.
Compliance with Section 16(a) of the Exchange Act
Our directors, executive officers and persons holding more than 10% of our common stock, are required under Section 16(a) of the Securities Exchange Act of 1934, as amended, to file initial reports of ownership and reports of changes in ownership of our common stock and other equity securities with the SEC, and to provide us with a copy of any such filings. Based on a review of the copies of such reports provided to us, and written representations that no other reports were required, we believe that our directors, officers and other persons holding more than 10% of our common stock complied with all Section 16(a) filing requirements during 2006, except as set forth below.
Administrative oversights caused late filings of the following required forms: (i) an Initial Statement of Beneficial Ownership of Securities (Form 3) for each of Christian Oversohl and Alan M. Wexler related to their October 19, 2006 designation as executive officers of the Company, (ii) a Statement of Changes in Beneficial Ownership (Form 4) for each of Sheeroy D. Desai, Alan J. Herrick, Jane E. Owens and Gary S. McKissock, relating to the amendment of outstanding options held by the reporting persons associated with Section 409A of the Internal Revenue Code of 1986; and (iii) Forms 4 for each of Preston B. Bradford, Sheeroy D. Desai, Alan J. Herrick and Jane E. Owens associated with the Company withholding certain shares to satisfy income tax obligations of the reporting persons associated with the release of vested restricted stock until awards to such persons.
Code of Ethics and Conduct
On November 9, 2006, our Board of Directors approved the amended Sapient Corporation Code of Ethics and Conduct, a copy of which is included as an exhibit to this Annual Report. Our Code of Ethics and Conduct covers all employees, directors and independent contractors of the Company, including our Chief Executive Officer and our Chief Financial Officer. A current copy of our Code of Ethics and Conduct can be found on our web site, http://www.sapient.com. Any future amendments to the Code of Ethics and Conduct, and any waivers thereto involving our executive officers will also be posted on our web site. A printed copy of these documents will be made available upon request.
Audit Committee
We maintain a separately-designated Audit Committee of our Board of Directors. The current members of the Audit Committee are Messrs. Buerger, Cunningham, and Parker, each of whom is an independent director within the meaning of the applicable NASDAQ listing rules, SEC rules and applicable securities laws and regulations. Mr. Buerger serves as the Chairperson of the Audit Committee.
Our Board of Directors has determined that Mr. Buerger is an “audit committee financial expert” within the meaning of the rules and regulations of the SEC and applicable NASDAQ listing standards.
Item 11.
Item 11.
Executive Compensation
Compensation Discussion and Analysis
Compensation Objectives and Strategy
The primary purpose of Sapient’s executive compensation programs (“Executive Programs”) is to establish a meaningful reward system within an appropriate cost structure that aligns executive compensation with the interests of our shareholders. The objectives and strategy concerning our Executive Programs are as follows.
•
We administer a clear, understandable reward program that enables Sapient to attract and retain top management talent critical to improving our performance and building long-term shareholder value.
•
We aim to structure executive compensation that, subject to our executives’ and Company performance, will result in:
•
total compensation that emphasizes components tied to - and dependent upon - achievement of Company and individual performance.
•
base pay being targeted at amounts not above market median (“Median”), consistent with our emphasis on “variable” compensation (i.e., bonus pay and equity awards) over “fixed” compensation (i.e., base salary);
•
base pay plus cash bonus eligibility (“Total Cash”) targeted “at Median” for Total Cash; and
•
Total Cash, combined with equity incentive compensation, targeted to exceed the Median for total executive compensation.
•
We have designed our Executive Programs to promote a performance-based culture that rewards our executives based on both overall Company performance and individual performance. We weigh individual performance and contributions significantly in determining base salary, bonus pay and equity-based awards for our executives.
•
To encourage individual performance and achievement, we place a significant portion of our executives’ compensation at risk in the form of variable pay (defined as the annual cash bonus and equity-based awards).
•
We administer short-term (e.g., annual cash bonus) and long-term (e.g., equity-based compensation) incentives in a manner intended to promote Sapient’s short-term operational objectives, such as business unit performance, and long-term strategic goals.
Role of the Compensation Committee
The Compensation Committee (the “Committee”) of our Board of Directors approves and oversees the framework for our Executive Programs, including the elements and amounts of compensation for our executive officers. The Committee consists of three non-employee directors of Sapient, each of whom is an independent director under the Nasdaq listing requirements. The Committee’s decisions and decision-making processes concerning executive compensation are informed by consultation with Sapient’s Chief Executive Officer (the “CEO”), who provides input regarding those officers’ job performance, as well as by general market information regarding compensation trends that becomes available to the Company through its normal recruiting efforts and industry awareness or through benchmarking information provided by an outside compensation firm retained by the Company (the “Management Adviser”). Additionally, the Committee’s decisions and decision-making processes concerning executive compensation for our Chief Financial Officer (the “CFO”) have been informed by ExEquity, LLP, an independent compensation adviser retained by the Committee (the “Third-Party Adviser”). The Third-Party Adviser, as noted below, also has been advising the Committee concerning a proposed compensation package for our CEO, which we expect to finalize in the near future. The Committee’s Charter, which the full Sapient Board of Directors has approved, describes the Committee’s functions in greater detail, and is available via our website at http://www.sapient.com.
Our CEO and Vice President - People Success (who oversees the Company’s human resources functions) typically attend Committee meetings in which the Committee reviews the performance of the Company and individual executives (other than themselves) and approves executive compensation. The Committee weighs the CEO’s recommendations regarding pay issues applicable to other executives and members of senior management who compose our company-wide leadership team. Other members of management and certain other Board members may also participate in the executive compensation review and approval process on an as-requested basis. However, the Committee retains ultimate decision-making authority over the compensation decisions for these individuals, and the Committee members only (and no members of management) may approve executive compensation.
Sapient’s Board of Directors appointed our current CEO, Alan J. Herrick, to the CEO role in October 2006. Since his appointment, Mr. Herrick’s base pay and equity compensation have remained unchanged. However, with respect to Mr. Herrick’s 2006 cash bonus, the Committee determined, in consultation with the Third-Party Adviser, that Mr. Herrick’s payout should be prorated, with the bonus portion applicable to the 2006 period before Mr. Herrick became CEO being calculated on an unchanged basis, and the portion applicable to the remainder of 2006 when Mr. Herrick served as CEO being established at $70,000, to reflect Mr. Herrick’s assumption of increased responsibilities.
The Committee and Mr. Herrick are currently negotiating a proposed compensation package for Mr. Herrick for 2007. This proposed package is anticipated to be retroactive to January 1, 2007, in certain respects. In connection with these negotiations, the Committee has retained the Third-Party Adviser to provide it with benchmarking data and recommendations concerning the components and size of the proposed package. Additionally, the Committee has conducted special “executive sessions” to evaluate the package, which we expect to finalize in the near future.
Prior to Mr. Herrick’s appointment as CEO in October 2006, Jerry A. Greenberg and J. Stuart Moore, the Company’s co-founders, shared the CEO role (however, Mr. Greenberg served as sole CEO from July 31, 2006 until October 16, 2006). Each co-CEO’s compensation package consisted solely of a base salary of $50,000 for all years in which he served as co-CEO. The co-CEOs did not receive annual cash bonus awards or long-term incentive grants during their tenure as co-CEOs. Accordingly, Committee review of their compensation packages neither occurred nor was necessary.
Compensation and Benefits Structure
This section describes each aspect of our compensation and benefits structure:
•
Pay Level - determination of the appropriate levels of pay
•
Pay Mix - determination of each element of compensation, its purpose and design, and its relationship to the Executive Programs
•
Pay-for-Performance - determination of the performance measures and goals used in the Executive Programs
Pay Level
The Committee determines executive pay levels based on several factors, including an individual’s experience and role, responsibilities and performance at Sapient, and comparative pay levels for peers within Sapient and in similar job functions in the marketplace.
To the extent it deems advisable, the Committee uses appropriate tools and resources to review the aggregate value delivered to each executive by each pay element (i.e., base salary, bonus and equity-based awards). To evaluate and develop the actual and proposed compensation packages for the CFO and CEO, respectively, the Committee retained the Third-Party Adviser, who made recommendations informed by benchmarking of compensation for CEOs and CFOs in several comparable peer group companies.
For other executive officers, the Committee’s decisions and decision-making processes concerning executive compensation are informed by consultation with the CEO, who provides input regarding those officers’ job performance, as well as by general market information regarding compensation trends that becomes available to the Company through its normal recruiting efforts and industry awareness or through benchmarking information provided to the Company by the Management Adviser.
Consistent with our stated compensation philosophy to tie total compensation closely to - and make it heavily dependent upon - achievement of Company and individual performance, we emphasize “variable” compensation (i.e., bonus and equity-based awards) over “fixed” compensation (i.e., base salary). Accordingly, relative to an assessment of competitive market practices, the Committee aims to establish executive base salaries targeted not above Median, with Total Cash executive compensation targeted at Median, and total executive compensation (inclusive of equity-based incentive compensation) targeted above Median. However, pay levels and opportunities for specific individuals and/or job functions may vary from these targets, based on market demand for particular talent and other factors. As a result of our emphasis on performance-based pay, actual total compensation in a given year may vary well above or well below our targeted compensation relative to Median levels, based primarily on the Company’s attainment of its operating goals and individual performance achievement.
Pay Mix
The Committee believes strongly in the importance of assessing each pay element in relation to the other pay elements that the Executive Programs comprise. To determine optimal pay mix, the Committee reviews a variety of information provided by the Company regarding our executives, including historic equity grants, salary progression, target and actual bonus levels by year, experience levels and job responsibilities, as well as general market information.
Sapient’s Executive Programs consist of the following pay elements:
•
Base Salary - fixed pay amount determined based upon an individual’s experience and role, responsibilities and performance at Sapient, and comparative pay levels for peers within Sapient and in similar job functions in the marketplace.
•
Annual Incentive Bonus - an annual incentive pay plan that is designed to reward Company and individual performance and attainment of annual business goals, with target award opportunities generally expressed as a percentage of an executive’s base salary.
•
Long-term Incentives - stock-based awards that generally vest over several years and are intended to tie the interests of our executives to those of our shareholders, and reward the executives for achievement of our long-term business goals and Strategic Context (which comprises our purpose, core values, vision, goals and “client value proposition”). These awards also are intended to promote retention among our executives, who are our key Company leaders.
•
Benefits - additional programs offered to provide appropriate health care coverage and other benefits to our employees and their families. The Company maintains a 401(k) program for all eligible employees, but does not offer any special “tax advantaged” programs for its executives. The Committee believes our benefit plans assist Sapient in its mission to attract and retain high quality employees.
Base Salaries
As noted above, our compensation philosophy emphasizes the aspects of compensation that are performance-dependent. Accordingly, the Committee targets executive base salaries not above Median, and places greater emphasis on variable compensation in the form of bonus and equity-based awards. However, pay levels and opportunities for specific individuals and/or job functions may vary from these targets, based on market demand for particular talent and other factors.
Adjustments to executives’ base pay levels are determined annually based upon numerous factors, including individual performance, job responsibilities, impact on the development and achievement of our strategic initiatives, the then-current state of the labor market, compensation data available from general industry resources and our ability to attract and retain critical executives.
Annual Incentive Program
Our annual incentive plans are designed to reward individual performance and our achievement of our short-term operating objectives. Our executives are eligible to receive annual bonuses under our Global Performance Bonus Plan, paid in cash or equity. Consistent with our pay level strategy, we set annual incentive levels for our executives at an amount intended to generate target Total Cash compensation that is at Median. Annual incentives for our executives range from 30% to 100% of the executives’ base salaries. In 2006, our executives received annual incentive pay based on several factors, including Company and business unit operating profit, progress against our Strategic Context and an overall individual performance score. In the aggregate, and as a result of our 2006 performance, actual awards paid to our executives for 2006 were significantly less than the aggregate bonus targets that the Committee established for 2006.
To date, payments under our annual incentive plans have not qualified as “performance-based” compensation under Section 162(m) of the Internal Revenue Code (“Section 162(m)”). The Committee is currently in the process of qualifying certain future compensation for purposes of Section 162(m), but may continue to make payments that do not comply with this statute to the extent it deems necessary and/or advisable.
Messrs. Herrick and Tibbetts, who assumed the CEO and CFO roles, respectively, in October 2006, were guaranteed prorated 2006 cash bonus payouts for the period of time they served in these roles. The Committee reviewed the market appropriateness of these guaranteed payouts with the Third-Party Adviser prior to approving them.
Long-Term Incentive Program
The Committee uses long-term incentives to balance the short-term focus of our annual incentive program by tying rewards to executive performance over multi-year periods. Under three of our long-term incentive plans, approved by our shareholders at Sapient’s 1996, 1998, and 2001 Annual Meetings, the Committee may grant a variety of long-term incentive vehicles to our executives, including stock options, stock appreciation rights, restricted stock units (“RSUs”) and performance shares or units, settled in cash or stock. In 2006, the Committee approved RSUs only for equity-based awards to our executives and other employees, and this practice continues to date. However, consistent with its authority under our long-term incentive plans, the Committee may opt to grant other types of equity-based awards in the future.
The Committee believes that long-term incentives, together with annual incentives, provide significant incentives to our executives that promote high performance year-over-year and long-term retention.
In 2006, we granted time-based RSU awards to our executives that vest according to the following schedule: 33% at 18 months, and 67% at the third anniversary, following the grant date (the “Standard Vesting Schedule”). Any unvested portion of an executive’s RSU award is forfeited if the executive’s employment terminates prior to the vest date. The Committee may grant RSU (or other equity) awards based on a vesting schedule different from the Standard Vesting Schedule. Unless otherwise noted, RSU awards granted to our executive officers vest according to the Standard Vesting Schedule.
In November 2006, our Chief Financial Officer, Joseph S. Tibbetts, Jr., received both a time-based RSU award subject to the Standard Vesting Schedule, and a performance-based award of 400,000 RSUs. The performance-based RSUs vest in increments of 100,000 units when/if the average 30-day closing price of our stock equals or exceeds each of the following targets: $5.00; $10.00; $15.00; and $20.00. Any performance-based units that have not vested as of the fourth anniversary of the RSU grant date will be forfeited.
Our current executive long-term incentive granting framework involves developing RSU grant ranges for our leadership group and, within those ranges, allocating awards to our executives based on their performance during the prior year, cash compensation, amount of equity needed to achieve Median targeting, and historical equity holdings. The Committee believes this method not only ensures that each executive receives appropriate awards, but also that the awards are equitable as compared to the executive’s colleagues on our management team.
While the Company believes that both retention and long-term performance are important objectives for the long-term incentive program, the Company also believes that the “at risk” component of the long-term incentive program should be higher for our executives in more senior roles. Therefore, the ratio of RSUs to cash varies by level of participant, with our more senior executives receiving a higher percentage of their total long-term award value in the form of RSUs. In 2006, for the named executive officers (other than Messrs. Greenberg and Moore, who did not receive RSUs while serving as co-CEOs), 100% of their 2006 long-term incentive awards were granted in the form of RSUs.
While the Committee has not historically used formal benchmarking data to establish long-term incentive levels, it has relied on general market information to deliver long-term incentive awards that it perceives to be within Median ranges. Within general grant guidelines that the Committee authorizes, individual awards may be adjusted up or down to reflect the executive’s performance and his or her potential to contribute to the success of our initiatives to create shareholder value and other individualized considerations.
As part of our long-term incentive program, we typically grant equity awards to our executives once per year, on a pre-determined grant date that occurs shortly after the Committee approves the executive equity grants. The Committee reviews and approves the annual equity award for each executive at a scheduled meeting, usually held in July. Our internal human resources department, in conjunction with E*TRADE Financial, which provides us certain stock plan administration services, administers all executive and other employee equity awards.
Other Benefits and Perquisites
As employees of the Company, our executives are eligible to participate in all Company-sponsored benefits programs on the same basis as other full-time employees. These include the Company’s health and welfare benefits (e.g., medical/dental plans, disability plans, life insurance) and 401(k) Plan (or its equivalent for management team members located outside of the United States). Additionally, while our executives from time to time receive certain immaterial personal benefits from the Company, in 2006 the value of these perquisites for each executive did not exceed $10,000. We do not offer any supplemental executive health and welfare or retirement programs, or provide any other supplemental benefits or perquisites, to our executives.
Employment Contracts
The Company maintains employment agreements with Messrs. Tibbetts, Wexler and Oversohl, and currently is in the process of negotiating an employment contract with Mr. Herrick. These agreements contain severance arrangements and other benefits to the executives. Further, Mr. Tibbetts’ employment agreement contains provisions that provide him certain financial benefits in the case of a change in control of Sapient. Employment contracts and change in control provisions for the foregoing officers (except Mr. Herrick, whose agreement is not yet complete) are described on pages 119-121 of this annual report. Finally, all of our executives have agreed to covenants that protect Sapient against the executives joining a competitor, and/or soliciting Sapient clients and employees.
Pay-for-Performance
As noted, we use multiple vehicles to create a strong link between pay and performance:
•
The annual cash bonus program rewards participants for the achievement of short-term, operational goals (either through generating revenue or helping to create efficiencies in programs that help reduce costs) as well as contributions to our Strategic Context. As mentioned above, we use the annual bonus plan as a means to focus the organization on the achievement of annual performance goals.
•
RSUs reward participants for long-term commitment to Sapient. We believe our use of RSUs is appropriate, particularly given our general philosophy of aiming to link compensation to actual performance and to de-emphasize “fixed” compensation, accordingly, by positioning executive base salaries not above Median. As noted, our RSU grants generally vest over 3 years and are intended to promote senior management continuity, which is necessary to facilitate the achievement of our long-term objectives.
The Committee maintains discretion to make adjustments (upward or downward) to an executive’s incentive compensation if Company and/or individual goals are not achieved.
Compensation Actions
The Committee reviews and approves salary levels for our executive officers typically on an annual basis, in July. For 2006, our named executive officers salaries increased over their 2005 salaries by an average of 8.23%. Additionally, as illustrated in our Summary Compensation Table on page 114, base salaries for our five most highly paid executives in 2006 represented between 8% and 52% of total compensation for these individuals, excluding benefits.
For 2006, we paid total annual incentives of $688,957 to our named executive officers. In the aggregate, these actual amounts represent 58% of the executives’ target annual incentive for 2006, based on Company and individual performance relative to Company/individual goals for 2006.
In 2006, we granted an aggregate of 979,500 RSU awards to our named executive officers.
Impact of Tax and Accounting on Compensation Decisions
When determining amounts of equity grants to executives and employees under our long-term incentive program, the Committee examines the accounting cost associated with the grants. Under Statement of Financial Accounting Standard No. 123(R) (revised 2004), grants of stock options, restricted stock, RSUs and other share-
based payments result in an accounting charge for the Company. The accounting charge is equal to the fair value of the instruments being issued. For RSUs, the cost is equal to the fair value of the stock on the grant date times the number of stock units granted. For stock options (if granted with time-based vesting), the cost is equal to the fair value of the option on the grant date using a Black-Scholes option pricing model times the number of options granted. RSUs granted with market-based vesting are valued using a lattice model. With respect to both RSUs and stock options, this expense is amortized over the requisite service or vesting period.
Further, as noted, the Committee is currently in the process of qualifying certain future executive compensation for purposes of Section 162(m). In this regard, we are seeking shareholder approval at our 2007 Annual Meeting of Stockholders of an amendment to our 1998 Stock Incentive Plan that will enable cash and equity awards granted thereunder to qualify for the tax benefits available under Section 162(m).
Finally, we currently are reviewing our executives’ employment agreements to determine the tax impact/implications of severance arrangements for which the executives are eligible under the agreements.
Summary of Compensation
The following table summarizes compensation for the fiscal year ended December 31, 2006 with respect to our Chief Executive Officer, Chief Financial Officer, and our three other most highly compensated executive officers who earned more than $100,000 in fiscal year 2006. We refer to these officers in this Annual Report as the “Named Executive Officers.”
SUMMARY COMPENSATION TABLE
(1)
Amounts reflect the compensation cost of restricted stock held by the Named Executive Officer for 2006, calculated in accordance with SFAS No. 123(R) expensed over the vesting period of the restricted stock, but do not include any assumed forfeitures.
(2)
Amounts reflect the compensation cost of stock options held by the Named Executive Officers for 2006, calculated in accordance with SFAS No. 123(R) and using the Black-Scholes valuation model utilizing the
Company’s assumptions expensed over the vesting period of the stock options, but do not include any assumed forfeitures. No stock options were granted to executives in 2006.
(3)
Reflects bonus payouts made in 2007 relating to performance in 2006.
(4)
This column only includes the value of the Company’s 401(k) contributions for each executive in 2006. The Named Executive Officers from time to time received certain immaterial personal benefits from the Company in 2006, however, the value of these perquisites for each executive did not exceed $10,000.
(5)
Amounts reflect equity-based awards granted to Mr. Herrick, and payments according to Mr. Herrick’s base salary, unadjusted by his appointment as Chief Executive Officer in October 2006. However, with respect to Mr. Herrick’s 2006 cash bonus, the portion for the period prior to October 2006 is calculated on an unchanged basis, and the portion applicable to the remainder of 2006 when Mr. Herrick served as CEO is set at $70,000 to reflect Mr. Herrick’s increased responsibilities.
(6)
The Company awarded Mr. Tibbetts 625,000 restricted stock units (“RSUs”) on November 1, 2006, of which 400,000 RSUs are performance-based RSUs that vest contingent on the Company’s stock price performance, and 225,000 RSUs are subject to time-based vesting.
(7)
On January 29, 2007, Mr. Desai announced his resignation as Chief Operating Officer of Sapient Corporation, effective March 31, 2007.
(8)
As Dr. Oversohl is compensated in Euros, his base salary was converted using an average of the 2006 Euro to American Dollar exchange rate of $1.25603.
(9)
Resigned from Sapient Corporation on October 16, 2006.
(10)
Resigned from Sapient Corporation on June 1, 2006.
(11)
Resigned from Sapient Corporation on August 10, 2006.
(12)
Resigned from Sapient Corporation on October 16, 2006.
Grants of Plan-Based Awards
GRANTS OF PLAN - BASED AWARDS
(1)
This column shows the SFAS No. 123(R) date of the grant. The restricted stock grants for the Named Executive Officers other than Mr. Tibbetts and Ms. Cooke were approved by the Compensation Committee effective on July 17, 2006 and October 2, 2006, at a grant price of $5.00 and $5.18, respectively, which was the closing price of Sapient stock on the grant date. On October 16, 2006, the Company’s Board of Directors approved a new hire restricted stock award for Mr. Tibbetts, which was granted on November 1, 2006 at a grant price of $5.45, the closing price of Sapient stock on the grant date. The award consists of 225,000 RSUs subject to time-
based vesting, and 400,000 RSUs subject to performance-based vesting. The start of the relevant performance period for this grant begins on November 1, 2006 and extends until November 1, 2010.
(2)
For all current executives, the target reflects 30-100% of base salary.
(3)
These prices represent Sapient’s closing stock price on the RSU grant date.
(4)
Other than as described in footnote (5) below, the Full Fair Value is determined by multiplying the number of RSUs granted in 2006 by the grant price (the closing price on the date of grant).
(5)
Mr. Tibbetts was awarded an initial grant of 475,000 RSUs on November 1, 2006, of which 400,000 RSUs vest contingent on Sapient’s stock price performance. The value of these 400,000 performance-vesting RSUs is calculated using a lattice model. The remaining 75,000 RSUs are subject to time-based vesting and the value reflects the number of shares times the grant price. Additionally, Mr. Tibbetts will receive 75,000 RSUs, also subject to time-based vesting, on each of the first and second anniversary of the date of grant of the initial grant, respectively, each with terms identical to those of the initial grant.
(6)
As of Ms. Cooke’s October 16, 2006 resignation date, no portion of the award had vested and the award was canceled.
Outstanding Equity Awards at Fiscal Year-End
The following table provides information regarding all outstanding equity awards held by each of the Named Executive Officers as of December 31, 2006.
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
*
Options were amended, as filed with the SEC, to avoid the adverse tax consequences of Section 409A of the Internal Revenue Code of 1986, as amended, by increasing the exercise price of the affected portion of the option award to the fair market value on the date of grant.
(1)
Assumes a stock price of $5.49 as of December 29, 2006 to calculate the in-the-money value of unvested equity.
(2)
Stock options become fully exercisable on July 1, 2007.
(3)
Stock options become exercisable in equal installments on each of June 1, 2007 and June 1, 2008.
(4)
Stock options become exercisable in equal installments on each of December 17, 2007 and December 17, 2008.
(5)
Restricted stock vests in equal installments on each of July 1, 2007, July 1, 2008, and July 1, 2009.
(6)
74,250 shares of restricted stock vest on January 17, 2008, and 150,750 shares of restricted stock vest on July 17, 2009.
(7)
Of the 225,000 RSUs subject to time-based vesting and valued at $1,235,250 in this table, 75,000 RSUs are awarded to Mr. Tibbetts on each of the first and second anniversary of the date of grant of the Initial Grant, November 1, 2006, provided Mr. Tibbetts is still employed by the Company. The 300,000 RSUs listed on this table and valued at $1,647,000 are the unvested portion of an RSU grant that vests in the following amounts if and when the average 30-day closing price of the Company’s common stock as listed on the Nasdaq Global Market equals or exceeds the following per share prices, provided Mr. Tibbetts is still employed by the Company on each such vesting date: 100,000 shares at $5.00 per share (the “First Vest Event”); 100,000 shares at $10.00 per share; 100,000 shares at $15.00 per share; and 100,000 shares at $20.00 per share. The value of the unvested shares was calculated using a lattice model. As of December 31, 2006, 100,000 shares had vested per the achievement of the First Vest Event.
(8)
Stock options become fully exercisable on July 1, 2007.
(9)
Stock options become exercisable in equal installments on each of June 1, 2007 and June 1, 2008.
(10)
Stock options become exercisable in equal installments on each of December 17, 2007 and December 17, 2008.
(11)
Restricted stock vests in equal installments on each of July 1, 2007, July 1, 2008 and July 1, 2009.
(12)
9,900 shares of restricted stock vest on January 17, 2008 and 20,100 shares of restricted stock vest on July 17, 2009.
(13)
6,600 shares of restricted stock vest on April 2, 2008 and 13,400 shares of restricted stock vest on October 2, 2009.
(14)
Due to Mr. Desai’s resignation from the Company on March 31, 2007, the unvested shares underlying this stock option have terminated.
(15)
Due to Mr. Desai’s resignation from the Company on March 31, 2007, the unvested shares underlying this stock option have terminated.
(16)
Due to Mr. Desai’s resignation from the Company on March 31, 2007, the unvested shares underlying this restricted stock award have terminated.
(17)
Due to Mr. Desai’s resignation from the Company on March 31, 2007, the unvested shares underlying this restricted stock award have terminated.
(18)
Stock options become exercisable in equal installments on each of July 1, 2007 and July 1, 2008.
(19)
Stock options become exercisable in equal installments on each of June 1, 2007 and June 1, 2008.
(20)
Restricted stock fully vests on July 1, 2007.
(21)
Restricted stock vests in equal installments on each of July 1, 2007, July 1, 2008, and July 1, 2009.
(22)
7,260 shares of restricted stock vest on April 2, 2008 and 14,740 shares of restricted stock vest on October 2, 2009.
(23)
Mr. Greenberg received no stock options, restricted stock or other equity-based awards during his tenure at the Company.
(24)
Mr. Moore received no stock options, restricted stock or other equity-based awards during his tenure at the Company.
(25)
All of Mr. Krenz’s outstanding equity awards terminated upon his August 10, 2006 resignation.
Option Exercises and Stock Vested
The following table provides information regarding the number of shares of common stock acquired and the value realized pursuant to the vesting of stock awards, during fiscal 2006 by each of the Named Executive Officers.
OPTION EXERCISES AND STOCK VESTED - 2006
(1)
Mr. Wexler’s stock options were exercised as follows:
Pension Benefits
We have no pension plans or long-term incentive plans.
Nonqualified Defined Contribution and Other Nonqualified Deferred Compensation Plans
We have no nonqualified defined contribution or deferred compensation plans.
Employment, Severance and Change of Control Agreements
Employment Agreements
The Company has entered into employment agreements with certain of its Named Executive Officers, as described below. Additionally, all of our executives have agreed to covenants that protect Sapient against the executives joining a competitor, and/or soliciting Sapient clients and employees.
Joseph S. Tibbetts, Jr. On October 16, 2006, the Company and Mr. Tibbetts entered into an agreement pursuant to which the parties agree that Mr. Tibbetts will serve as Senior Vice Present and Chief Financial Officer of Sapient. The agreement has no set term, and indicates that Mr. Tibbetts’ employment is on an “at-will” basis. Under the agreement, Mr. Tibbetts’ annual base salary is $350,000 and he is entitled to a prorated performance bonus with a target of $175,000 for 2006, and eligible for a performance bonus with a target of not less than $175,000 for 2007. Mr. Tibbetts was awarded 625,000 RSUs, of which 400,000 are subject to performance-based vesting, and 225,000 are subject to time-based vesting. The 400,000 performance-based RSUs, vest in four equal installments, if and when the average 30-day closing price of the Company’s common stock on the Nasdaq Global Market equals or exceeds $5.00, $10.00, $15.00, and $20.00, respectively, provided he is still employed by the Company at the time such vesting occurs. Of the 225,000 RSUs subject to time-based vesting, 75,000 are granted upon employment (the “Initial Grant”), with 24,750 vesting 18 months from the date of grant of the Initial Grant, November 1, 2006, and 50,250 vesting on the third anniversary of the Initial Grant. Additionally, 75,000 RSUs will commence vesting on each of the first and second anniversary of the Initial Grant, respectively, on vesting terms identical to the vesting terms of the Initial Grant.
If his employment is terminated by the Company without Cause or by Mr. Tibbetts for Good Reason, and other than pursuant to a Change-in-Control (as these terms are defined in the agreement), the Company is required to provide Mr. Tibbetts compensation equal to 150% of his base salary and target bonus amount, benefits continuation, and the acceleration of certain outstanding RSUs. In the event of a Change-in-Control, all outstanding RSUs held by Mr. Tibbetts shall become fully vested. Should Mr. Tibbetts be terminated within the two-year period following such Change-in-Control, he will be paid a lump-sum payment equal to 200% of his base salary and target bonus amount. See “Potential Payments on Termination or Change in Control” below.
Alan M. Wexler. On April 1, 2002, the Company entered into a letter agreement with Alan M. Wexler, pursuant to which Mr. Wexler is entitled to severance compensation in an amount equal to one year of base salary and bonus payments if he is terminated by the Company without cause.
Christian Oversohl. On January 8, 2005, Sapient GmbH, a Company subsidiary of which the Company is the sole shareholder, entered into an agreement with Dr. Oversohl, under which it is agreed that Dr. Oversohl, a Vice President of the Company, will serve as Managing Director of Sapient GmbH. The agreement terminates on June 30, 2007. Pursuant to the agreement, Mr. Oversohl is entitled to severance compensation in an amount equal to 10 months of base salary payments if he is terminated by the Company without cause.
The Company is currently in the process of finalizing the terms of an employment agreement to be entered into by and between the Company and Alan J. Herrick, our Chief Executive Officer. Details of the terms and conditions of Mr. Herrick’s employment agreement will be disclosed in a filing made on Form 8-K upon finalization and execution thereof.
Potential Payments upon Termination or Change-in-Control
As described under “Employment Agreements” above, the Company is required to make certain payments to Mr. Tibbetts upon his termination of employment. The following table shows what those payments would be, assuming a termination date of December 29, 2006. Amounts listed under the “Terminations following a Change in Control” column assume a December 29, 2006 Change-in-Control.
(1)
Represents all outstanding equity awards held by Mr. Tibbetts as of December 29, 2007.
(2)
Assumes that all bonus amounts provided under Sapient’s annual incentive bonus plan were earned in full in 2006, are based on actual performance, and are not treated as subject to the golden parachute excise tax upon a change in control. Earned amounts under Sapient’s annual incentive bonus plan are treated as paid for purposes of the severance estimates.
(3)
Represents the in-the-money value of all vested and outstanding long-term incentive awards, based on a stock price of $5.49 (the closing price of the Company’s common stock on the Nasdaq Global Market on December 29, 2006). As of December 29, 2006, one fourth of the 400,000 performance-based RSUs awarded to Mr. Tibbetts were fully vested pursuant to the grant’s performance vesting schedule and will be delivered to Mr. Tibbetts upon termination for any reason.
(4)
Represents the value of all accelerated equity, based on a stock price of $5.49.
(5)
Any unvested RSUs subject to performance-based vesting will continue to vest during the 90-day period following termination. Outstanding time-based RSUs will be subject to accelerated vesting such that the next scheduled vesting date will be deemed to have occurred on the date of termination. Mr. Tibbetts will be entitled to the value of 25,000 time-based RSUs as a result of accelerated vesting.
(6)
Reflects the value of all unvested time-based RSUs (225,000 shares) and all unvested performance-based RSUs (300,000 shares).
(7)
Reflects an estimated prorated target bonus amount for the period during which Mr. Tibbetts was employed in 2006, based on his October 31, 2006 employment start date.
(8)
As outlined in his employment agreement, Mr. Tibbetts is eligible for benefits continuation for the 18-month period following termination without Cause or for Good Reason. However, because Mr. Tibbetts will not be a participant in Sapient’s benefits programs until mid-2007, no value is reflected. If Mr. Tibbetts were eligible for
benefits contribution, benefits would be payable in either a single lump sum or in installments upon his reaching normal retirement age (as defined as age 591/2). Mr. Tibbetts is not currently of retirement age.
Director Compensation
The following table sets forth in summary form information concerning the compensation that we paid during the fiscal year ended December 31, 2006 to each of our non-employee directors.
(1)
Amount includes all payments made in 2006 for meeting attendance, and, where applicable, service as a lead director and/or a committee chair.
(2)
Amounts reflect the compensation cost of the restricted stock held by our non-employee directors for the year ended December 31, 2006, calculated in accordance with SFAS No. 123(R) expensed over the vesting period of the restricted stock, but do not include any assumed forfeitures.
On June 1, 2006, all non-employee directors, except Mr. Buerger, received a RSU grant with a fair market value of $40,000 that will “cliff” vest 100% on June 1, 2007. Mr. Buerger received an RSU grant with a fair market value of $68,250 that vests 25% per year for four years.
(3)
Amounts reflect the compensation cost of the stock options held by our non-employee directors for the year ended December 31, 2006, calculated in accordance with SFAS No. 123(R) and using the Black-Scholes valuation model utilizing the Company’s assumptions expensed over the vesting period of the stock options, but does not include any assumed forfeitures. No stock options were granted to our directors in 2006.
(4)
As of December 31, 2006, our non-employee directors have the following RSUs and stock options outstanding:
(5)
Reflects a one-time payment for service relating to the investigation of the Company’s historical stock-based compensation practices.
As of January 1, 2007, as consideration for their service on the Board, we pay each of our non-employee directors an annual retainer of $15,000 and the following additional retainers, as applicable:
All annual retainers are paid in four equal quarterly installments, provided that the Director continues to serve in such capacity. Additionally, we pay non-employee directors the following attendance fees:
If a director participates in either a Board or committee meeting by telephone, rather than in person, or if the committee meeting is held on the same day and at the same location as a Board meeting, the director receives one-half of the applicable meeting fees. Additionally, we reimburse each non-employee director for expenses incurred in connection with his meeting attendance. Except as outlined above, our directors receive no other cash compensation for serving as directors.
Pursuant to our 1998 Stock Incentive Plan, and under the revised Board compensation plan approved by our directors effective as of January 1, 2007, each of our non-employee directors is granted the following equity grants in connection with his service on the Board:
Board Membership Status
Equity Grants(1)
Vesting Schedule
Initial election to our Board of Directors:
RSU grant in the amount equal to the number of shares of Sapient common stock having an aggregate fair market value of $75,000 (but in no event exceeding 12,500 shares).
Vests in four equal annual installments (provided that the RSU holder is serving as a director on each vest date).
Re-election to our Board of Directors:
RSU grant in the amount equal to the number of shares of Sapient common stock having an aggregate fair market value of $40,000.
Vests in full on the first anniversary of the date of the grant (provided that the RSU holder is serving as a director on the vest date).
(1)
The fair market value of the equity grants is calculated based on the last reported sale price per share of our common stock on the date of grant, as listed on the Nasdaq Global Market.
Effective as of the date of our 2007 Annual Meeting of Stockholders, the Board has approved the following adjustments to compensation paid to non-employee directors under the Board compensation plan:
•
An increase to the Annual Board Member Retainer from $15,000 to $25,000;
•
An increase to the Annual Board Chair Retainer from $50,000 to $60,000;
•
Elimination of the Lead Independent Director Retainer; and
•
An increase to the Annual Compensation Committee Chair Retainer from $10,000 to $20,000.
All other cash compensation paid to our non-employee directors under the Board compensation plan is to remain unchanged. No adjustments were made to stock units granted under the Board compensation plan.
Change of Control Arrangements in Director Stock Options
Certain stock options that we have granted to our directors contain “change in control” provisions. Under the terms of the applicable stock option agreement for each of these grants, the vesting of shares under these stock
option grants will be accelerated by twelve months in the event of a change in control of the Company. The following table summarizes the director stock options containing such “change in control” provisions:
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth information as of June 4, 2007 regarding the beneficial ownership of shares of our common stock by: (i) each person, or group of affiliated persons, known by us to beneficially own more than five percent of our common stock, (ii) each director and nominee for director, (iii) each of our executive officers named in the Summary Compensation Table included earlier in this Annual Report, and (iv) all of our current executive officers and directors as a group. The table is based on information supplied by our officers, directors, 5% stockholders, and a review of Schedules 13G, if applicable, as filed with the SEC.
The number of shares beneficially owned includes any shares which may be acquired by exercising stock options that are either immediately exercisable or will become exercisable on or before August 3, 2007 (60 days from June 4, 2007) as well as any RSUs that have not yet vested but which will be vested as of that date. These shares are deemed to be outstanding and beneficially owned by the person holding those options for the purpose of computing the person’s percentage ownership, but they are not treated as outstanding for purposes of computing the percentage ownership of any other person. Applicable percentages are based on 123,679,495 shares of common stock outstanding as of June 4, 2007.
*
Less than 1%
(1)
To the best of our knowledge, each stockholder possesses sole voting and investment power with respect to the shares listed, except as otherwise noted, and subject to community property laws where applicable.
(2)
Includes (i) 4,209,618 shares held by two trusts of which Mr. Greenberg is a co-trustee and over which he shares voting or investment power, (ii) 18,262 shares held by a trust of which Mr. Greenberg’s wife is a co-trustee and in which his wife and children are beneficiaries, and over which his wife shares voting and investment power, and (iii) 3,573,893 shares held by three trusts, over which Mr. Greenberg does not have voting or investment power, but in which he is a beneficiary. Mr. Greenberg disclaims beneficial ownership of the shares held by the trusts except to the extent of his pecuniary interest therein.
(3)
Includes (i) 925,577 shares held by a trust of which Mr. Moore’s wife is a co-trustee and in which his wife and children are beneficiaries, and over which his wife shares voting and investment power, (ii) 160,000 shares held by Eaglis Aggressive Growth, LLC, a Massachusetts limited liability company of which Mr. Moore is the manager, and over which Mr. Moore has sole voting and investment control (iii) 1,074,910 shares held by a trust over which Mr. Moore does not have voting or investment power, but in which he is a beneficiary, and (iv) 6,148,442 shares held by a trust over which Mr. Moore does not have voting or investment power, but in which his children are beneficiaries. Mr. Moore disclaims beneficial ownership of the shares held by the trusts except to the extent of his pecuniary interest therein.
(4)
Mr. Sichko serves as trustee or co-trustee of certain trusts established by Messrs. Greenberg and Moore. The shares listed in the above table represent shares of common stock over which Mr. Sichko maintains sole voting or investment control (5,113,735 shares) and shares voting or investment control (11,432,970 shares) as trustee or co-trustee of these trusts. Mr. Sichko has disclaimed beneficial ownership of, and any pecuniary interest in, all shares of common stock held by these trusts.
(5)
Mr. George is a co-trustee of certain trusts established by Mr. Moore. The 8,134,270 shares listed in the above table represent shares of common stock over which Mr. George shares voting or investment control in his capacity as co-trustee. Mr. George does not maintain sole voting or investment control with respect to any of the shares of common stock held by these trusts, and has disclaimed beneficial ownership of, and any pecuniary interest in, all such shares.
(6)
Based on Schedule 13G filed with the SEC on February 14, 2007, Wellington Management Company, LLP, in its capacity as an investment adviser, reported that as of December 31, 2006, may be deemed to beneficially own 16,733,391 shares of common stock which are held of record by clients of Wellington Management. Of the 16,733,391 shares, Wellington Management shares the power to vote 12,476,891 shares and has shared power to dispose or to direct the disposition of 16,379,291 shares.
(7)
Mr. Chookaszian has notified the Company that he will not stand for re-election as a Director and will retire from the Board immediately prior to the Annual Meeting.
(8)
Mr. Desai, a former executive officer of the Company resigned effective March 31, 2007.
(9)
Mr. Krenz, former Chief Financial Officer of the Company, resigned on August 10, 2006.
(10)
Ms. Cooke served as Chief Financial Officer of the Company from August 10, 2006 until her resignation on October 16, 2006.
(11)
Mr. Greenberg co-founded Sapient in 1991 and served as Co-Chief Executive Officer and Co-Chairman of the Board together with J. Stuart Moore until July 31, 2006, from which date he continued to serve as the Company’s sole Chief Executive Officer until his resignation on October 16, 2006. Mr. Greenberg continues to serve as a consultant to the Company.
(12)
Mr. Moore, co-founder and former Co-Chief Executive Officer and Co-Chairman of the Board of the Company, resigned as Co-Chief Executive Officer on June 1, 2006. Mr. Moore continues to serve as a Director, although he stepped down as Chairman of the Board on October 16, 2006.
(13)
Includes 418,171 shares (and 656,515 shares subject to options exercisable within 60 days) held by three officers not required to be named in this table.
The following table summarizes, as of December 31, 2006, the number of options issued under our equity compensation plans and the number of awards available for future issuance under these plans.
(1)
8,847,235 of the shares listed in column (c) may be issued in the form of restricted stock or RSUs, pursuant to the terms of our 1998 Stock Incentive Plan. No shares of restricted stock are currently available for issuance under our other equity compensation plans.
(2)
Column (c) includes 1,772,080 shares that are available for issuance under our 2005 Employee Stock Purchase Plan as of June 1, 2006.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Greenberg Consulting Agreement
On October 19, 2006, Jerry A. Greenberg, the Company’s former Chief Executive Officer and current security holder covered by Item 403(a), entered into a consulting agreement with the Company to provide consulting services to the Company in respect of long-term strategic planning, ongoing client relations and general business development. The consulting agreement was effective as of October 16, 2006, has an initial term of one year and may be terminated by either party upon written notice. Per the terms of the consulting agreement, Mr. Greenberg receives $750 per hour for his services. As of March 31, 2007, Mr. Greenberg has received approximately $133,523 in payments from the Company. Mr. Greenberg’s consulting agreement was approved by the Company’s Board on October 16, 2006. Pursuant to the Company’s policy regarding related parties transactions, the Audit Committee has responsibility for the review and prior approval of all transactions between the Company and related parties or affiliates of the officers of the Corporation.
Benson Relationship to Company Consultant
Since November 2006, the Company has received compensation consulting services from Pearl Meyer & Partners, a compensation consultancy (“Pearl Meyer”). Fees paid to Pearl Meyer for services rendered in 2006 were approximately $69,000. Based on ongoing work and additional planned projects in 2007, we anticipate that aggregate fees paid to Pearl Meyer since the beginning of its engagement by the Company will be approximately $524,000.
In March 2007, the Company began discussions with James M. Benson regarding his potential service as a director of the Company. During these discussions, Mr. Benson disclosed that he is a principal of, and holder of a 17.5% ownership interest in, Clark Wamberg, LLC (“Clark Wamberg”) the parent of Pearl Meyer. Based on the aggregate fees to the Company anticipates paying to Pearl Meyer, the approximate dollar value of Mr. Benson’s interest in the transactions between the Company and Pearl Meyer is approximately $92,000.
Independence of our Board of Directors and its Committees
The listing rules established by the National Association of Securities Dealers (the “NASD”) require that a majority of the members of a listed company’s board of directors qualify as “independent” as affirmatively determined by the board, meaning that each independent director has no direct or indirect material relationship with a company other than as a director and/or a stockholder. Our Board of Directors consults with legal counsel to ensure that our Board’s determination with respect to the definition of “independent” is consistent with current NASD listing rules.
Our Board of Directors reviewed all relevant transactions or relationships between each director, or any of his family members, and Sapient, our senior management, and PricewaterhouseCoopers LLP (“PwC”), and has affirmatively determined that each of our directors, other than Alan J. Herrick (our Chief Executive Officer) and S. Stuart Moore, our former co-founder and co-chief executive officer, are independent directors under the applicable guidelines noted above. The Board specifically reviewed a related party transaction involving James M. Benson, a director nominee, and a Company consultancy, and has affirmatively determined that the relationship does not interfere with Mr. Benson’s independent judgment. See “Benson Relationship to Company Consultant,” above, for specific information with respect to this transaction.
Our Board of Directors has three committees: the Audit Committee, the Compensation Committee and the Governance and Nominating Committee. Each of these committees consists solely of Board members who meet the standards for independence required under current NASD listing rules, SEC rules, and applicable securities laws and regulations.
Pre-Approval Policy with Respect to Related Party Transactions
Pursuant to its Charter, our Audit Committee has responsibility for the review and approval of all transactions between the Company and any related parties or affiliates of the Company, its officers, and directors.
Item 14.
Item 14.
Principal Accountant Fees and Services
Aggregate fees for professional services rendered to the Company by PwC as of, and for, the years ended December 31, 2006 and 2005 were as follows:
(1)
Audit Fees. These fees include services performed by PwC in connection with the audit of our annual financial statements included in our annual filing on Form 10-K; the review of our interim financial statements as included in our quarterly reports on Form 10-Q; the audit of our internal controls over financial reporting; the attestation of management’s report on the effectiveness of internal controls over financial reporting; and services that are normally provided by PwC in connection with statutory and regulatory filings or engagements. In addition, the fees for audit services for the year ended December 31, 2006 include services performed in connection with the restatement of our prior period financial statements.
(2)
Audi-Related Fees. These fees are for services provided by PwC such as accounting consultations, plan audits, and any other audit and attestation services not required by applicable law.
(3)
Tax Fees. These fees include all services performed by PwC for non-audit related tax advice, planning and compliance services.
(4)
All Other Fees. Includes fees for licenses to web-based accounting and finance reference materials.
Pre-Approval Policies and Procedures
The Audit Committee is required to review and approve the proposed retention of independent auditors to perform any proposed permissible non-audit services, as outlined in its charter. The Audit Committee has specified certain types of prohibited “non-audit” services which the Company is not authorized to obtain from PwC, as well as types of audit-related and “non-audit” services that are permitted and approved. The Audit Committee has not established policies and procedures separate from its charter concerning the pre-approval of audit and “non-audit” related services. However, for those services that are permitted and approved, the Audit Committee requires the Company to obtain additional approval from the Audit Committee prior to initiating such service by PwC where the fees payable by Sapient are anticipated to exceed $100,000 in the aggregate. All PwC services provided in 2006 were pre-approved by the Audit Committee.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
15(a) (1) Financial Statements
The Consolidated Financial Statements filed as part of this report are listed and indexed on page 45. Schedules other than those listed in the index have been omitted because they are not applicable or the required information has been included elsewhere in this report.
15(a) (2) Consolidated Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts and Reserves are included in this report.
15(a) (3) Exhibits
The exhibits filed as part of this Annual Report on Form 10-K are listed in the Exhibit Index immediately preceding the exhibits. The Company has identified in the Exhibit Index each management contract and compensation plan filed as an exhibit to this Annual Report on Form 10-K in response to Item 14(c) of Form 10-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SAPIENT CORPORATION
By:
/s/ Alan J. Herrick
Alan J. Herrick
President and Chief Executive Officer
Dated: June 12, 2007
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the following capacities and on the dates indicated.
EXHIBIT INDEX
*
Exhibits filed herewith.

Management contract or compensatory plan or arrangement.
(1)
Incorporated herein by reference to the Company’s Form 10-Q for the fiscal quarter ended September 30, 2004 (File No. 000-28074).
(2)
Incorporated herein by reference to the Company’s Registration Statement on Form S-1 (File No. 333-1586).
(3)
Incorporated herein by reference to the Company’s Form 10-K for the fiscal year ended December 31, 1998 (File No. 000-28074).
(4)
Incorporated herein by reference to the Company’s Proxy Statement for the 2001 Annual Meeting of Stockholders (File No. 000-28074).