Item 1. Business
General
Sapient Corporation (“Sapient” or the “Company”) is a global services company that helps clients identify and act upon opportunities to improve their business performance by capitalizing on changes, disruptions, or opportunities that exist in their business or industry.
We provide a combination of strategy, marketing, and technology services that we uniquely connect to enable our clients to gain a competitive advantage and succeed in a rapidly changing, hyper-connected, and increasingly global business environment. We achieve this success for our clients by delivering a unique combination of integrated marketing and business services that leverage a deep understanding of technology and a rich history of understanding the role technology plays in creating competitive advantage for companies in the digital age of business.
We provide services, as described below, which enable our clients to succeed in an increasingly connected, customer-centric environment. Capitalizing on market disruptions and technology-driven changes requires more than an understanding of and facility with technology. It demands the agility to act - to strategically create, integrate, and mobilize capability in service of what is ahead. To make an impact in this state of frenetic change, business will need deep insights into, and the ability to act on, changing consumer attitudes and shifting regulatory environments. We do this through three main business units: SapientNitro, Sapient Global Markets, and Sapient Government Services. Unless the context otherwise requires, references in this Annual Report on Form 10-K to “Sapient,” the “Company,” “we,” “us” or “our” refer to Sapient Corporation and its wholly owned subsidiaries.
SapientNitro is a new breed of agency redefining storytelling for an “always-on” world. In a market dramatically altered by the changing behavior of the connected consumer, we help clients tell their stories through seamless experiences across brand communications, digital and experimental engagement, and omni-channel commerce. We call this approach “StoryscapingSM”, where storytelling meets the power and scale of systems thinking, to create immersive worlds that enable clients to more meaningfully engage their always-on consumers wherever they are in the brand experience - whether attraction, engagement, or transaction. By using the storyscaping approach, brands can move beyond making ads and into creating worlds where their story becomes part of the consumer’s story. Our connected teams of strategists, creatives, and technologists, collaborating across disciplines, perspectives and continents, take a holistic approach to conceiving and driving a brand’s organizing idea across the full spectrum of physical and digital touch points, resulting in deeper, more meaningful relationships between brands and their customers.
Sapient Global Markets provides business and technology services and solutions to capital and commodity market participants, intermediaries and regulators. We leverage our deep industry insight and broad integrated capabilities to enable transformation for our clients and industry. Delivered on a global scale, our offerings help our clients to grow and enhance their organizations, create robust and transparent infrastructures, manage operating costs, and foster innovation.
Sapient Government Services provides consulting, technology, and marketing services to U.S. federal government agencies, nonprofit organizations and non-governmental organizations (“NGOs”). Focused on driving long-term change and transforming the citizen experience despite growing pressures on open data and shrinking budgets, we use a proven methodology to help our clients become more accessible, transparent, and effective. With a track record of delivering tailored mission-critical solutions, we serve as a trusted advisor to U.S. government agencies and globally recognized nonprofit organizations and NGOs.
Founded in 1990 and incorporated in Delaware in 1991, Sapient maintains a strong global presence with offices in 37 cities and approximately 11,900 employees in the Americas, Europe and the Asia-Pacific region, including India. Our headquarters and executive offices are located at 131 Dartmouth Street, Boston, Massachusetts 02116, and our telephone number is (617) 621-0200. Our stock trades on the NASDAQ Global Select Market under the symbol “SAPE.” Our Internet address is http://www.sapient.com. Material contained on our website is not incorporated by reference into this Annual Report on Form 10-K.
Our clients consist of leading Global 2000 and other companies within the following industries in which we have extensive expertise (our “industry sectors”): financial services, retail, technology & communications, consumer packaged goods, travel & leisure, automotive, energy services, and government, health & education. We also provide services to federal government clients within the U.S. and to provincial and other governmental entities in Canada and Europe.
Integral to our service capabilities is our Global Distributed Delivery (“GDD”) model, which enables us to perform services on a continuous basis, through client teams located in the Americas, Europe and the Asia-Pacific region, including India. 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 India offices in the cities of Gurgaon, Bangalore, and Noida) and development and client teams in the Americas, Europe, the Asia-Pacific region and India. To work effectively in this globally distributed environment, we have developed extensive expertise and processes in coordinating assignment management and implementation efforts among the various development teams that we deploy to enable continuous assignment services. Through our GDD model, we believe that we deliver greater value to our clients at a competitive cost and in an accelerated time frame. In addition to solution design and implementation, many of our long-term engagements and outsourcing relationships leverage our longstanding GDD execution model. Across all of our business units, we use our proprietary Fusion workshops to help our clients validate their proposed approach, gather requirements, and design effective solution road maps.
We derive Long-Term and Retainer Revenues from many of our client relationships. Long-Term and Retainer Revenues are revenues from contracts with durations of at least twelve months, or contracts in which our clients have chosen us as an exclusive provider, for marketing retainer-based services, capacity, applications management and other services. In 2013, Long-Term and Retainer Revenues represented 51% of our global services revenues, compared to 52% in 2012 and 48% in 2011. Further, in 2013 our five largest individual clients accounted for approximately 18% of our revenues in the aggregate, compared to 21% in 2012 and 19% in 2011. No individual client accounted for more than 10% of our revenues in 2013, 2012 or 2011.
We provide our services under time-and-materials, fixed-price, and retainer contracts. We price our work based on established rates that vary according to our professionals’ experience levels, roles and geographic locations.
Under our time-and-materials arrangements, we charge for our actual time and expenses incurred on an engagement. These arrangements may include an estimated fee range or a cap on our total fees. Under the latter circumstances, we may assume the risk that we have correctly estimated the time frame and level of effort required to complete any deliverables within the allotted fee cap.
In fixed-price contracts, we charge a fixed amount based on our anticipated total level of effort required for an assignment. For these arrangements, we similarly assume the risk of estimating correctly the scope of work and required resources for the applicable assignment. While we undertake rigorous assignment management throughout an engagement to ensure we deliver the assignment on time and on budget, we may recognize losses or lower profitability on fixed-price contracts if we do not successfully manage these risks. These risks are magnified for large assignments and multi-staged assignments in which we perform our scope and labor estimates, and fix the total assignment price from inception through implementation, at an early stage of an engagement.
Under our retainer contracts, we charge our clients a fixed fee in exchange for providing a defined team of consultants for a defined number of hours, to perform marketing, creative and other services at our clients’ direction. These arrangements are designed to afford our clients flexibility to engage us for myriad services as and when needed and, therefore, do not typically include defined scope or deliverables. Additionally, as our fees and level of effort are fixed in advance, should our clients choose not to use all level of effort allotted to them under the contract, we nonetheless charge and are entitled to receive our full fixed fee. Conversely, while we are contractually obligated to provide a specified number of hours of retainer service under each retainer contract, our clients may demand hours in excess of the contractually allotted amount. Under those circumstances, our retainer contracts typically include provisions that enable our clients to purchase additional hours of service on a time-and-materials basis.
Segment Information
We have three reportable segments: SapientNitro, Sapient Global Markets and Sapient Government Services. Further information about these reportable segments, including a presentation of financial information, is located in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 18, Segment Reporting, in the Notes to Consolidated Financial Statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. The principal risks and uncertainties facing our business, operations and financial condition are discussed in Part I, Item 1A, Risk Factors in this Annual Report on Form 10-K.
Our SapientNitro and Sapient Global Markets reportable segments include globally-based professionals, and our Sapient Government Services segment includes professionals based in the United States. Within each reportable segment, we focus our sales and delivery efforts on clients within our industry sectors. We have developed an extensive understanding of our clients’ markets that enables us to skillfully address the market dynamics and business opportunities that our clients face. This understanding also enables us to identify and focus on critical areas to help our clients grow, perform, and innovate.
Information regarding financial data by geographic area is set forth in Note 18, Segment Reporting, in the Notes to Consolidated Financial Statements in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
Acquisitions
In the past few years, we have acquired several businesses to enhance and/or complement our service offerings.
On February 5, 2014, we acquired 100% of the outstanding securities of OnPoint Consulting, Inc. (“OnPoint”), a technology consulting firm providing enterprise systems and infrastructure services to federal government customers based in Arlington, Virginia. We acquired OnPoint to expand our portfolio of government clients and contracts for application development, cyber-security services and IT infrastructure services. The acquisition added approximately 150 people and was allocated to our Sapient Government Services reportable segment.
On December 30, 2013, we acquired 100% of the outstanding equity of “la comunidad” CORPORATION and La Comunidad S.A., (together, “La Comunidad”). La Comunidad is an independent multicultural creative agency based in Miami, Florida and Buenos Aires, Argentina. We acquired La Comunidad to leverage the growing importance of multicultural marketing in expanding our combination of brand and creative service offerings to our clients. The acquisition added approximately 90 people and was allocated to our SapientNitro reportable segment.
On January 16, 2013, we acquired 81% of the outstanding securities of iThink Comunicação e Publicidade Ltda (“iThink”), an independent digital agency based in Sao Paulo, Brazil. We acquired iThink to expand our
combination of brand, digital and commerce service offerings to our global clients in Latin America. We subsequently increased our ownership to 84%. The acquisition added approximately 65 people and was allocated to our SapientNitro reportable segment.
On December 27, 2012, we acquired 100% of the membership interests of (m)Phasize, LLC (“(m)Phasize”), a marketing analytics company located in Westport, Connecticut. We acquired (m)Phasize to strengthen our analytics services and marketing mix modeling capabilities. The acquisition added approximately 16 people and was allocated to our SapientNitro reportable segment.
On November 1, 2012, we acquired 100% of the outstanding shares of Second Story Inc. (“Second Story”), an interactive studio located in Portland, Oregon. We acquired Second Story to strengthen our ability to craft immersive experiences that seamlessly blend physical and digital environments, from web and mobile to in-store and in-venue. The acquisition added approximately 35 people and was allocated to our SapientNitro reportable segment.
On September 6, 2011, we acquired 100% of the outstanding shares of D&D Holdings Ltd. (“DAD”), a London-based advertising agency operating in the United Kingdom and continental Europe. We acquired DAD to strengthen our capabilities in marketing campaign production and direct response measurement. The acquisition added approximately 200 people and was allocated to our SapientNitro reportable segment.
On July 13, 2011, we acquired 100% of the outstanding shares of CLANMO GmbH (“Clanmo”), a full-service mobile interactive agency based in Cologne, Germany, which focuses on mobile strategy, communications, design, and technological implementation. We acquired Clanmo to strengthen our mobile interactive capabilities in the European market. The acquisition added approximately 50 people and was allocated to our SapientNitro reportable segment.
Our Services
SapientNitro
SapientNitro services include integrated marketing and creative services, web and interactive development, traditional advertising, media planning and buying, strategic planning and marketing analytics, multi-channel commerce strategy and solutions including a significant focus on mobile, and content and asset management strategies and solutions. These connected capabilities are applied to solve our clients’ most challenging business problems. We integrate creative marketing concepts with technology tools and platforms to build rich experiences across brand, digital and commerce, designed to acquire new customers and increase demand, create profitable customer relationships and build brand awareness and loyalty.
Integrated Marketing and Creative Services
We conceive, design, develop and deliver seamlessly integrated, highly measurable multi-channel marketing and commerce experiences to engage our clients’ consumers and drive sales. Our marketing and creative services consist of:
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visual concept, design and implementation via multiple media;
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brand building and direct response programs, audience segmentation and profiling strategies;
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customer loyalty strategies;
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customer relationship strategy and implementation;
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customer lead generation and management; and
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integrated advertising campaigns.
Additionally, we offer our clients technology platforms that accelerate and advance key components of the marketing landscape, including the following:
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Sapient EngagedNowSM is a robust cloud-based platform offering that gives marketers the ability to better engage their consumers across a range of digitally enhanced channels, allowing brands to create immersive, multi-channel customer experiences without having to design, develop and support the infrastructure needed to enable these experiences. EngagedNow is a platform suite that can be used broadly across a range of industries. The suite also includes unique offerings and modular capabilities to support the specific needs of industry verticals, including sports & entertainment (Sapient EngagedFanSM) and travel (Sapient EngagedTravelerSM). EngagedNow is an end-to-end platform that connects brands with digitally enabled consumers across an integrated set of channels - from web and mobile to tablets and digital signage.
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Sapient EngagedNowSM Express is a highly productized version of EngagedNow. EngagedNow Express is built to support the rapid creation and operation of marketing microsites and campaign sites in the cloud. EngagedNow Express is tightly integrated to the Adobe Cloud Marketing Suite and is deployed on Amazon Web Services. It has a range of pre-built site responsive design templates and component libraries. This allows our clients to use true enterprise-class tools in highly cost-effective ways at scale and with high repeatability. EngagedNow Express is part of an overall managed service offering that currently hosts several live sites and will be a core part of our service offerings to our marketing services clients in 2014.
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BridgeTrack® is a proprietary advertising campaign tracking and measurement software application that enables clients to measure the effectiveness of an online campaign in real-time and, in turn, optimize results at the earliest possible phase of their campaigns by re-allocating marketing dollars across those marketing channels that are generating the best return on investment. BridgeTrack® generates real-time reporting and optimization of advertising campaigns across multiple media channels, including advertising via email, website displays/banner ads and internet natural search advertising. Through BridgeTrack®, our clients see how consumers react to their online marketing campaigns - whether, for example, consumers ultimately decide to buy the client’s offerings, even if the consumers make a purchase at a later date.
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IonosTM is a platform that provides content and advertising monetization capabilities for digital publishers and site owners. It works alongside content and commerce platforms across all digital channels - web, mobile, digital in-store - to help publishers and ad buyers identify and deliver monetized content and traditional advertising inventory with a unique patent-pending mechanism for allocating inventory using facet-based ad buying and prioritization. Ionos has been in production since 2010 and today is part of both our EngagedFan and EngagedTraveler multi-channel digital platforms. In 2013, Ionos was used in a range of mobile and in-venue retail applications for our clients. Ionos integrates directly with BridgeTrack® as well as several third-party advertising networks to ensure that publishers get the most from their digital properties.
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Ionos™ In-Venue Digital Platform provides a multi-tier, cloud-based architecture for managing complex digital signage and digital wayfinding networks. The In-Venue components are an extension of the core Ionos platform and feature sophisticated faceted and geo-located content delivery integrated to a range of content management systems. Ionos In-Venue was architected to deliver sophisticated user experiences at scale with integrated monitoring and alerting as well as real-time connection to broader client enterprise systems. Ionos In-Venue Digital is currently in use in U.S. travel and hospitality clients today and we expect it to see broad deployment in 2014 in travel, retail, and hospitality venues.
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Relay provides a unified development and operational toolset that helps our clients deliver consistent, superior experiences to mobile web and mobile application users across device operating systems. Our clients use Relay to reduce development, testing, and operations costs across a broad range of mobile platforms which are used by millions of users every day.
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Seamless is a mobile phone and tablet platform used across device operating systems to deliver in-store shopping and assisted sales experiences. Seamless integrates with in-store point of sale or e-commerce infrastructures to extend the in-store aisle or to allow customers to directly transact without having to wait in line at the point of sale.
Web and Interactive Development
We conceive, develop and implement world class, award-winning websites and applications for our clients. Our services include user interface design and development, site design and development, custom application development, user research and testing, content management and technology development and implementation, and quality assurance testing. As digital channels expand beyond the Web, we have applied our strategy, design, and development services to new digital platforms, such as mobile phones, tablet devices, interactive kiosks, touch-screen displays, and digital signage.
Traditional Advertising
We integrate our interactive marketing services with award-winning off-line media capabilities. Our services include brand strategy, copywriting, advertising creative and production for print, radio, and television campaigns. By combining the best of traditional advertising with an expansive mix of interactive and emerging technology expertise, our traditional advertising not only creates and engineers highly relevant experiences, it helps accelerate business growth and fuels brand advocacy by eliminating the operational silos that often block business success.
Media Planning and Buying
We help our clients design and implement media and customer channel planning and buying strategies and purchase and arrange for placement of our clients’ advertisements in the media. Our media planning and buying services include media strategy development, website search engine marketing, email marketing, online advertising, viral and social media marketing, emerging channels marketing (e.g., online video, mobile technologies, and social networking), gaming (placing advertisements in online games and creating “advergames”), real-time reporting and optimizing of the success of campaigns, and integration of our clients’ media spending strategy with their other marketing initiatives.
Strategic Planning and Marketing Analytics
We provide our clients with a broad array of strategic planning services that are intended to maximize return on marketing initiative investments. We combine our deep business and technology expertise to analyze how products, brands and consumers interact and the role that current and emerging technologies play in this relationship. Additionally, we apply expertise in marketing analytics to collect, analyze and report on online consumer behavior and insights, and assist our clients in developing successful online marketing strategies and campaigns. Our array of strategic planning and marketing analytics services includes brand strategy development, marketing mix modeling, consumer and market research (primary and secondary), advertising message content and medium strategy development, internet and blogosphere analytics (researching and analyzing what social networking websites and blogs say about our clients), and coordination and management of mixed media (e.g., online and print media).
Commerce and Content Technologies
We apply our substantial knowledge and expertise in connecting companies and customers to help our clients achieve their business goals. In today’s digitally disrupted marketplace, clients are looking for new approaches to managing in an always-on world. This impacts our work across marketing and commerce, which are becoming deeply integrated and increasingly omni-channel. Specifically, our multi-channel commerce work includes marketing asset management platforms, selection and implementation of advertising campaign management systems, application integration and research, and implementation of emerging technologies.
We devise content, collaboration, commerce and technology strategies that improve our clients’ competitive position and performance, as well as the value they realize from their technology portfolio. We apply our substantial expertise in diverse technologies and our understanding of each client’s business issues to design solutions that align with, and create a roadmap for, the achievement of the client’s business objectives. Our areas of content, collaboration, commerce and technology strategy expertise are geared toward helping clients succeed in today’s environment. The issues we help our clients address include:
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business process consulting - as digital disrupts core business processes;
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overall digital strategy;
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technology governance and enterprise architecture services; and
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program management.
Sapient Global Markets
Through highly specialized expertise, Sapient Global Markets delivers services and solutions that address the key drivers important to leaders in today’s capital and commodity markets, including: responding to a complex and changing regulatory environment; achieving operational efficiencies; creating a dynamic user experience; and managing enterprise risk. We leverage deep industry insight and expertise to deliver a wide range of integrated capabilities, which include business consulting, technology services and solutions.
Industry Insight and Expertise
We work with the key participants within the Global Markets ecosystem, including banks, investment management firms, custodians and brokers, intermediaries, energy and commodity companies and government and regulators, to identify their key challenges and develop solutions to address them. We also partner with the industry itself to shape market initiatives that address global issues, such as the need for increased market transparency and standards. To focus on key client requirements, we have created and continue to invest in practice areas that allow us to infuse deep knowledge and real-world experience into all of our engagements. These include:
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buy-side investment process;
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commodities trading and risk management;
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derivatives platforms;
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clearing and collateral;
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data management;
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operational risk;
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pipeline and shipping;
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portfolio accounting;
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trade documentation;
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regulatory reporting; and
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valuation and risk analytics.
Highly Integrated Breadth of Capabilities
We continuously invest in attracting, training and retaining the highest quality professionals. Our exceptionally knowledgeable teams offer fully integrated services and solutions that provide capabilities across the full engagement lifecycle from concept and delivery to ongoing management. Our offerings include:
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Business Consulting: With a focus on addressing business issues, we offer consulting services through which we develop and deliver executable strategies for enabling change.
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Technical Services: Our services help create efficiencies across the trading and risk management lifecycle in a wide range of projects from model definition and design to implementation and ongoing operations. Our cross-domain capabilities ensure comprehensive support and coverage from start to finish.
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Solutions: We deliver innovative software solutions and managed service offerings to help our clients leverage technology and new sourcing models to optimize their businesses.
Sapient Global Markets operates in key centers relevant to the global capital and commodity markets, including Boston, Chicago, Houston, New York, Calgary, Toronto, Amsterdam, Dusseldorf, Geneva, London, Munich, Zurich and Singapore, as well as in large technology development and operations outsourcing centers in Bangalore, Delhi, and Noida, India. Our services and solutions are delivered and executed around the world through our GDD model. Through the GDD model, we are able to leverage the right resources and expertise for any project regardless of physical location and scale to meet changing requirements.
Sapient Government Services
Leveraging over 20 years’ experience and a global understanding across industry perspectives, Sapient Government Services delivers transformational solutions for public sector organizations with complex challenges. We leverage our commercial best practices in digital strategies, mobile solutions and constituent outreach. Our robust suite of high-value capabilities includes: program management; solution delivery; strategy; and communications and outreach. We help our public sector clients to optimize through aligning technology, programs, and service platforms.
Program Management
We ensure that our clients’ programs are successfully managed from concept to completion. We perform strategic planning, enterprise architecture development, program management, and IT governance services for large-scale, multi-vendor initiatives to ensure that solutions are delivered on-time and on-budget.
Solution Delivery
We design, develop, and deliver innovative digital and mobile solutions for our public sector clients. With a focus on the user experience, we rapidly prototype new solutions and integrate critical business processes and information for our clients. Through agile systems engineering, we rationalize IT infrastructures to reduce cost and complexity while retiring or streamlining existing systems, and incorporating the best commercial products.
Strategy
We provide knowledge management, mission-needs analysis and requirements services to enable streamlined business processes for enhanced productivity and effectiveness. We employ our expertise to transform strategic intent into actionable plans and help our clients unlock the power of big government data.
Communications and Outreach
Our solutions position our public sector clients to better connect with key stakeholders and constituents to accomplish their missions faster and more effectively. Through thorough analytics, we develop digital communications strategies that enable the government and public sector to be accessible by providing information to citizens anywhere and anytime; ultimately improving the citizen’s experience and streamlining it with their public-sector expectations.
Alliances
We focus on building the right results for our clients’ businesses. To support this focus, we work closely with alliance partners to develop industry-leading solutions that we can deliver to meet our clients’ needs. We
have established global partnerships with industry leaders, including Adobe, IBM, Microsoft, Google, Oracle, Hybris, Demandware, HP, Sitecore, SDL Tridion and Jive Software. We have a skilled knowledge base in these companies’ products to help our clients solve their business challenges through technology. Further, we have formed, and continue to form, “Centers of Excellence,” comprising dedicated, globally distributed teams with deep application knowledge and a proven track record of implementing solutions based on our strategic partner technologies. Through our expert knowledge and commitment to collaboration, we help our clients identify and implement faster the right solutions at lower overall costs.
Our alliances with leading technology and services companies help us rapidly deliver high-performance business and technology solutions. We frequently recommend the use of pre-engineered components from our alliance partners to deliver the rapid business value our clients need. Our alliance relationships, and the solutions that we derive from these relationships, are structured in a manner to help ensure that we deliver to our clients solutions that will be sustainable and provide long-term value.
We also collaborate with our partners to selectively target specific markets and opportunities to offer quality repeatable solutions, frameworks and components that speed deployment and time-to-value for our clients. Additionally, our alliance partners provide us advance information and access to their product road maps to ensure that our technology solutions are more cost-effective to build and maintain over the long-term.
We continue to actively build relationships and strategic alliances with technology and other services companies, including packaged technology vendors. These relationships focus on a wide range of joint activities, including working on client engagements, evaluating and recommending the other party’s technology and other solutions to clients, and training and transferring knowledge regarding the other party’s solutions. We believe that these relationships and strategic alliances enable us to provide better delivery and value to our existing clients and attract new clients through referrals.
Additionally, we have a dedicated global industry analyst relations team that maintains ongoing relationships with leading industry analysts such as Gartner, Forrester, Aite and TABB Group. These relationships are integral to our business and help ensure that a core set of focused analysts maintains a good understanding of our offerings and positioning to help us drive innovative and creative solutions to the marketplace. These research analysts also manage related market research and advisory sessions that help identify market and technology trends for our clients and our internal business teams.
The Sapient Approach
Our unique consultative methodology, the “Sapient Approach,” helps ensure predictable business results that are delivered on-time and on-budget while meaningfully meeting the needs of our clients’ end customers. We employ a collaborative, agile/lean-based delivery approach, in which we develop and release in an iterative manner usable components of a deliverable, thus enabling our clients to review, validate and commence use of work product throughout the life cycle of a project, rather than await the end of the project to realize its full benefits. Our overall approach has been time tested over a number of years and has successfully produced meaningful results for our clients. Our SapientNitro business unit utilizes a slightly modified Sapient Approach, the “Idea Engineering Approach,” which uniquely leverages our multi-disciplinary teams and blends our skills at idea creation and strategy with the technology needed to bring them to life for today’s always-on consumer.
The Sapient Approach provides clients significant value and return on investment in the shortest possible time period, and also minimizes assignment risk because discrete pieces of work are tested and accepted throughout the assignment. At the same time it gives our clients speed to market advantages which are increasingly important given the rate and speed of change in the market today.
In contrast to traditional consulting services methods that require heavy up-front investment in time and effort to define all possible requirements, our agile/lean-based methodology uses actual development to evaluate and improve the design as the assignment progresses. This means that unnecessary steps or features are identified and eliminated early in the design and implementation process, materially reducing overall assignment cost.
The Sapient Approach also enables us to commit to delivering our marketing services and other work within the price and schedule that we have promised to our clients, and to create solutions that bring together marketing, business, user, creative and technology requirements to solve our clients’ problems. We design these solutions to deliver tangible business value to clients, including increased revenues, reduced costs and more effective use of assets.
Additionally, the Idea Engineering Approach integrates a creative methodology to design and create user experiences that are useful, usable and compelling. Our creative approach is highly iterative, and integrates input from a wide range of perspectives and disciplines. This approach is highly scalable, and evolves based upon whether the creative output is intended to be a marketing campaign, a social media initiative, a website customer experience, a mobile application, or a retail experience. Through our creative approach we develop a deep understanding of the target user’s needs, and synchronize the design of the user experience with agile delivery of the supporting technology to minimize risk and rework.
The Sapient Approach also enables flexibility in selecting the process standardization and continuous improvement models that work best for each client. Our teams regularly incorporate Six Sigma, Capability Maturity Model Integration® (CMMI), International Standards Organization (ISO) and Information Technology Infrastructure Library (ITIL) processes to ensure that appropriate rigor, discipline and accountability are built into each project. By employing these industry-leading techniques, our teams establish an enduring environment of process improvement that enables organizational capabilities essential to sustaining competitive business advantage.
Strategic Context, People and Culture
We have established and continuously promote a strong corporate culture based on our “strategic context” - purpose, core company values, vision, goals and client value proposition - which is critical to our success.
Our unwavering attention to our strategic context has enabled us to adapt and thrive in the fast-changing markets we serve, as we strive to build a great company that has a long-lasting impact on the world. Our passion for client success - evidenced by our ability to foster collaboration, drive innovation and solve challenging problems - is the subject of case studies on leadership and organizational behavior used by MBA students at both Harvard and Yale business schools.
To foster and encourage the realization of our strategic context, we reward teamwork, and evaluate performance and promote people based on their adoption of and adherence to our strategic context. In addition, we conduct an intensive orientation program to introduce new hires to our culture and values, and conduct internal communications and training initiatives that define and promote our culture and values.
As of December 31, 2013, we had approximately 11,900 full-time employees, consisting of 10,600 delivery personnel, 1,100 general and administrative personnel and 200 sales and marketing personnel. None of our employees is subject to a collective bargaining agreement. We believe that we have good relationships with our employees.
Selling and Marketing
Our corporate marketing team strives to build greater brand awareness and drive client acquisition, retention and loyalty in all global markets in which we operate. We conduct marketing activities at the company, industry and service levels across SapientNitro, Sapient Global Markets and Sapient Government Services.
Our dedicated team drives globally-integrated initiatives including, but not limited to, developing and implementing an overall global marketing and brand strategy for Sapient and its three business units; executing thought leadership campaigns; hosting focused multi-client events; cultivating media and industry analyst relations; conducting market research and analysis; sponsoring and participating in targeted industry conferences,
award shows, and events; creating marketing assets and materials to assist client-development teams with lead generation; and publishing our website, our blogs, and content on many corporate social media channels.
We organize our sales professionals primarily along our operating segments. We believe that the industry and geographic focus of our sales professionals enhances their knowledge and expertise within their applicable segments and generates additional client engagements.
Competition
The markets for the services we provide are highly competitive. We compete principally with large systems consulting and implementation firms, traditional and digital advertising and marketing agencies, offshore consulting and outsourcing companies, and clients’ internal IT departments. To a lesser extent, we compete with boutique consulting firms that maintain specialized skills and/or are geographically focused. With respect to Sapient Government Services, we both compete and partner with large systems integrators, major consulting firms with dedicated government business units, and government contractors.
We believe that the principal competitive factors in our markets include: ability to solve business problems; ability to provide creative concepts and solutions; expertise and talent with advanced technologies; global scale; expertise in delivering complex assignments through teams located in globally distributed geographies; availability of resources; quality and speed of delivery; price of solutions; industry knowledge; technology-enabled marketing expertise; understanding of user experience; and sophisticated assignment and program management capability.
We also believe that we compete favorably when considering these factors and that our ability to deliver business innovation and outstanding value to our clients on time and on budget, our GDD model, our integrated marketing services capabilities and our successful track record in working with our clients distinguish us from our competitors.
Intellectual Property Rights
We rely upon a combination of trade secrets, nondisclosure and other contractual arrangements, and patent, copyright and trademark laws to protect our proprietary consulting methodology, custom-developed software and other rights. We enter into confidentiality agreements with our employees, subcontractors, vendors, professionals, and clients, and limit access to, and distribution of, our proprietary information.
Our services involve the development of business, technology and marketing solutions for specific client engagements. Ownership of these solutions is the subject of negotiation and is frequently assigned to the client, although we often retain ownership of certain development tools and may be granted a license to use the solutions for certain purposes. Certain of our clients have prohibited us from marketing for specified periods of time or to specified third parties the solutions we develop for them, and we anticipate that certain of our clients will demand similar or other restrictions in the future.
Where to Find More Information
We make our public filings with the SEC, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all exhibits and amendments to these reports, available free of charge at our website, http://www.sapient.com, as soon as reasonably practicable after we file such materials with the SEC. We also make available on our website reports filed by our executive officers, directors and holders of more than 10% of our common stock, on Forms 3, 4 and 5 regarding their ownership of our securities. These materials are available in the “Investors” portion of our website, under the link “Financial Information - SEC Filings,” and on the SEC’s website, http://www.sec.gov. You may also read or copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
Item 1A.
Item 1A. Risk Factors
You should carefully consider the following risk factors, which could materially impact our business and which could cause our actual business, financial condition or future results to differ materially from those contained in forward-looking statements made in this Annual Report on Form 10-K or presented elsewhere by management from time to time. The risks described below are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and operating results.
Changes to earnings resulting from past acquisitions may adversely affect our operating results.
Under ASC Topic 805, “Business Combinations”, we allocate the total purchase price to an acquired company’s net tangible assets, intangible assets and in-process research and development based on their values as of the date of the acquisition (including certain assets and liabilities that are recorded at fair value) and record the excess of the purchase price over those values as goodwill. Management’s estimates of fair value are based upon assumptions believed to be reasonable but which are inherently uncertain. After we complete an acquisition, the following factors, among others, could result in material charges that would adversely affect our operating results and may adversely affect our cash flows:
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Impairment of goodwill or intangible assets;
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A reduction in the useful lives of intangible assets acquired;
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Identification of assumed contingent liabilities after we finalize the purchase price allocation period;
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Charges to our operating results to eliminate certain pre-merger activities that duplicate those of the acquired company or to reduce our cost structure; or
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Charges to our operating results resulting from revised estimates to restructure an acquired company’s operations after we finalize the purchase price allocation period.
Routine charges to our operating results associated with acquisitions include amortization of intangible assets, in-process research and development as well as other acquisition related charges, and restructuring. Charges to our operating results in any given period could differ substantially from other periods based on the timing and size of our future acquisitions and the extent of integration activities.
We may incur additional costs associated with combining the operations of our acquired companies, which may be substantial. Additional costs may include costs of employee redeployment, relocation and retention, including salary increases or bonuses, and severance payments, reorganization or closure of facilities, taxes, and termination of contracts that provide redundant or conflicting services. These costs would be accounted for as expenses and would decrease our net income and earnings per share for the periods in which those adjustments are made.
Our business, financial condition and results of operations may be materially impacted by economic conditions and related fluctuations in client demand for marketing, business, technology and other consulting services.
The market for our consulting services and the technologies used in our solutions historically has tended to fluctuate with economic cycles - particularly those cycles in the United States and Europe, 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 marketing, technology and other business initiatives. Our efforts to down-size, when necessary, in a manner intended to mirror downturned economic conditions could be delayed and costly and could also result in us having inadequate people resources as economic conditions improve. A downturn could result in reduced demand for our services, assignment cancellations or delays, lower revenues and operating margins resulting from price reduction pressures for our services, and payment and collection issues with our clients. Any of these events could materially and adversely impact our business, financial condition and results of operations.
Our markets are highly competitive and we may not be able to continue to compete effectively.
The markets for the services we provide are highly competitive. We compete principally with large systems consulting and implementation firms, traditional and digital advertising and marketing agencies, offshore consulting and outsourcing companies, and clients’ internal information systems departments. To a lesser extent, other competitors include boutique consulting firms that maintain specialized skills and/or are geographically focused. Regarding our Sapient Government Services business unit, we both compete and partner with large systems integrators, major consulting firms with dedicated government business units, and government 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. 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 have offices throughout the world. Our international operations account for 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;
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tightened credit markets in particular geographies;
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limitations on our ability to repatriate cash from our foreign subsidiaries;
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reduced protection for intellectual property in some countries;
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changes and complexities in tax laws; and
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complexities and costs associated with adapting our GDD model to ensure compliance with current and evolving regulations, client demands, and employee considerations.
In particular, our GDD model depends heavily on our offices in Gurgaon, Bangalore and Noida, India. 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 our GDD model 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 in India as those in other countries where we operate. Any failures of these systems, or any failure of our systems generally, 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 assignment.
In addition, in many parts of the world, including countries in which we operate and/or seek to expand, practices in the local business community might not conform to international business standards and could
violate anticorruption laws, or regulations, including the U.S. Foreign Corrupt Practices Act and the UK Bribery Act 2010, to which we are subject. Our employees, subcontractors, agents, alliance or joint venture partners and other third parties with which we may associate, could take actions that violate policies or procedures designed to promote legal and regulatory compliance or applicable anticorruption laws or regulations. Violations of these laws or regulations by us, our employees or any of these third parties could subject us to criminal or civil enforcement actions (whether or not we participated in or knew about the actions leading to the violations), including fines or penalties, disgorgement of profits and suspension or disqualification from work, including U.S. federal contracting, any of which could materially adversely affect our business, including our results of operations and our reputation.
Also, changes to government structure or policies in countries in which we operate could negatively impact our operations if such changes were to limit or cease any benefits that may currently be available to us. For example, although the Indian government has historically offered generous tax incentives to induce foreign companies to base operations in India, changes in tax laws have been introduced in recent years and may be introduced in the future that may partially offset those benefits. Specifically, in recent years, the income tax incentives applicable to three of our Software Technology Parks units in India expired. In 2009, we established a new India unit in a Special Economic Zone (“SEZ”), which is eligible for a five year, 100% tax holiday. Immediately following the expiration of the 100% tax holiday, the SEZ unit is entitled to a five-year, 50% tax holiday. In 2011, we established three new India business units in SEZs, which are eligible for similar tax benefits. The expiration of incentives may adversely affect our cost of operations and increase the risk of delivering our services on budget for client assignments. Expiration of tax benefits provided to us by having operations based in India could have a material adverse effect on our business, financial condition and results of operations. In addition, it has become increasingly difficult to obtain necessary visas for certain international personnel, particularly technical personnel, working in our domestic offices, and to receive necessary immigration approvals for our domestic employees working abroad on international assignments. If these challenges continue or increase, it may limit our ability to engage the most desirable personnel for particular assignments, increase the time necessary to receive approvals to do so or prevent us from obtaining such approvals, and increase our costs, all of which could materially adversely affect our business, financial condition, and results of operations.
Our business, financial condition and results of operations may be materially impacted by military actions, global terrorism, natural disasters and political unrest.
Military actions in Iraq, Afghanistan and elsewhere, global terrorism, natural disasters and political unrest in the Middle East and other countries are among the factors that may adversely impact regional and global economic conditions and, concomitantly, our client’s ability, capacity and need to invest in our services. In addition to the potential impact of any of these events on the business of our clients, these events could pose a threat to our global operations and people. Specifically, our people and operations in India could be impacted if continued civil unrest, terrorism and conflicts with bordering countries in India were to increase significantly. Additionally, hurricanes or other unanticipated catastrophes, both in the U.S. and globally, could disrupt our operations and negatively impact our business as well as disrupt our clients’ businesses, which may result in a further adverse impact on our business. As a result, significant disruptions caused by such events could materially and adversely affect our business, financial condition and results of operations.
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 labor intensive, and our success depends upon our ability to attract, retain, train and motivate highly skilled employees. The improvement in demand for marketing and business and technology consulting services has further increased the need for employees with specialized skills or significant experience in marketing, business and technology consulting, particularly at senior levels. We have been expanding our operations, 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 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 assignments 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.
The success of our business depends in large part on our ability to develop solutions and service offerings that keep pace with the changes in the markets in which we provide our services.
The professional services markets in which we operate are characterized by rapid technological change, evolving industry standards, changing customer preferences and new product and service introductions. Our future success will depend on our ability to develop solutions and service offerings that keep pace with changes in the markets in which we provide services. We cannot be sure that we will be successful in developing new services addressing evolving technologies in a timely or cost-effective manner or, if these services are developed, that we will be successful in offering and deploying them in the marketplace. In addition, we cannot be sure that products, services or technologies developed by others will not render our services non-competitive or obsolete. Our failure to address the demands of the rapidly evolving technological environment could have a material adverse effect on our business, results of operations and financial condition. Our ability to remain competitive will also depend on our ability to design and implement, in a timely and cost-effective manner, solutions for clients that both leverage their legacy systems and appropriately utilize newer technologies. Our ability to implement solutions for our clients incorporating new developments and improvements in technology which translate into productivity improvements for our clients and to develop service offerings that meet current and prospective clients’ needs are critical to our success.
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 service revenues were $461.1 million for 2013. Doing business in these foreign currencies exposes us to foreign currency risks in numerous areas, including revenues and receivables, purchases, payroll and investments on both a transactional level and a financial statement translation basis. As of December 31, 2013, 50% of our assets and 40% of our liabilities were subject to foreign currency exchange fluctuations. We also have a significant amount of foreign currency operating income and net asset exposures. Certain foreign currency exposures, to some extent, are naturally offset within a foreign country, 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 incur a portion of our assignment costs in Indian rupees and earn revenue from our clients in other currencies. We will continue to experience foreign currency gains and losses in certain instances where it is not possible or cost effective to hedge foreign currencies. There is no guarantee that any currency hedging activity we may undertake will be effective or that our financial condition will not be negatively impacted because our hedging activities are themselves subject to risk. These include risks related to counterparty performance under hedging contracts, risks related to currency exchange rate fluctuations of the Indian rupee or other currencies versus the U.S. dollar, and risks related to the regulatory environment under which we conduct our hedging activities. Costs for our delivery of services, including labor, could increase as a result of the decrease in value of the U.S. dollar against the Indian rupee or other currencies, affecting our reported results.
Our cash positions include 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. Any fluctuations in foreign currency exchange rates, or changes in local tax laws, 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 salary expense, rent, depreciation expense and amortization of purchased 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 assignments 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 assignment, a client’s decision not to proceed with an assignment we anticipated or the completion during a quarter of several major client assignments 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 assignments, including achievement of certain business results;
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any delays incurred in connection with assignments;
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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 assignments;
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loss of key highly-skilled personnel necessary to complete assignments; and
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general economic conditions.
Changes in our effective tax rate or tax liability may have an adverse effect on our results of operations.
Our effective tax rate could be adversely impacted by several factors, some of which are outside our control, including:
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changes in relative amounts of income before taxes in the various jurisdictions in which we operate that have differing statutory tax rates;
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our ability to accurately value certain assets, including intellectual property;
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changes in tax laws and the interpretation of those tax laws;
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changes to our assessments about the realizability of our deferred tax assets which are based on estimates of our future results, the prudence and feasibility of possible tax planning strategies and our internal structure, and the economic environment in which we do business;
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the cross-border mobility of our employees;
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the outcome of future tax audits and examinations; and
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changes in generally accepted accounting principles that affect the accounting for taxes.
In the ordinary course of our business, many transactions occur for which the ultimate tax determination is uncertain. Significant judgment is required in determining our worldwide provision for income taxes. The final determination could be materially different from our historical tax provisions and accruals.
Taxing authorities could challenge our historical and future tax positions related to the allocation of income among our subsidiaries.
We enter into intercompany transactions with affiliated companies located in various tax jurisdictions around the world. Transfer prices for these transactions could be challenged by the various tax authorities resulting in additional tax liabilities, interest, and/or penalties, and the possibility of double taxation. If any of these tax authorities are successful in challenging our tax positions, our income tax expense may be adversely affected.
We may not be able to recognize revenue in the period in which our services are performed, which may contribute to fluctuations in our revenue and margins.
We provide our services under time-and-materials, fixed-price, and retainer contracts. All revenue is recognized pursuant to generally accepted accounting principles. These principles require us to recognize revenue once evidence of an arrangement has been obtained, services are delivered, fees are fixed or determinable and collectability is reasonably assured. If we perform our services prior to the period in which we are able to recognize the associated revenue, our revenue and margins may fluctuate from quarter to quarter.
Our profits may decrease and/or we may incur significant unanticipated costs if we do not accurately estimate the costs of fixed-price engagements.
A portion of our service revenues is derived from 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 an assignment, or our failure to complete our contractual obligations in a manner consistent with the assignment 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 assignments that magnify this risk. We have been required to commit unanticipated additional resources to complete assignments in the past, which has occasionally resulted in losses on those contracts. We will likely experience similar situations in the future. In addition, we may fix the price for some assignments at an early stage of the assignment engagement, which could result in a fixed price that is too low. Therefore, any changes from our original estimates 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 as well as control our costs.
Our profitability derives from and is impacted by three primary factors: (i) the prices for our services; (ii) our professionals’ 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.
We are dependent on, and may be adversely impacted by, the performance of third parties on certain complex engagements.
Certain complex engagements may require that we partner with specialized software or systems vendors or other partners to perform 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 engagements 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 engagement. Furthermore, our relationships with our clients and our reputation generally may suffer harm as a result of these third parties’ unsatisfactory performance.
Our clients could unexpectedly terminate their contracts for our services.
Most 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 assignment. 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 assignments, or client termination of one or more recurring revenue contracts could have a material adverse effect on our business, financial condition and results of operations.
We may be liable to our clients for substantial damages caused by our unauthorized disclosures of confidential information, breaches of data security, failure to remedy system failures or other material contract breaches.
We frequently receive or have access to confidential information from our clients, including confidential client data that we use to develop or support solutions. If any person, including one of our employees, misappropriates client confidential information, or if client confidential information is inappropriately disclosed due to a breach of our computer systems, including an attack by computer programmers or hackers who may develop or deploy viruses, worms, or other malicious software programs, system failures or otherwise, we may have substantial liabilities to our clients or their customers. Further, any such compromise to our computer systems could disrupt our operations, as well as our clients’ operations.
Further, many of our assignments 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. Any such failures by us could result in claims for substantial damages by our clients against us.
We may be liable for breaches of confidentiality or data security, defects in the applications or systems we deliver or other material contract breaches that we may commit during the performance of our services (collectively, “Contract Breaches”). In certain circumstances, we agree to unlimited liability for Contract Breaches. Additionally, we cannot be assured that any insurance coverage will be applicable and enforceable in all cases, or sufficient to cover substantial liabilities that we may incur. Further, we cannot be assured that contractual limitations on liability will be applicable and enforceable in all cases. Accordingly, even if our insurance coverage or contractual limitations on liability are found to be applicable and enforceable, our liability to our clients for Contract Breaches could be material in amount and could materially and adversely affect our business, financial condition and results of operations. Moreover, 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, 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, and 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 IP 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, contractors, vendors 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 IP 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 at various times in the past. 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.
Certain of our directors have significant voting power and may effectively control the outcome of any stockholder vote.
Jerry A. Greenberg, current Co-Chairman of the Board of Directors and former Chief Executive Officer of the Company, and J. Stuart Moore, former Co-Chairman of the Board of Directors and Co-Chief Executive Officer and current member of our Board of Directors, hold, in the aggregate, approximately 12% of the outstanding shares of our common stock as of March 14, 2014. As a result, they have the ability to substantially influence and, in some cases, 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. Affiliates of Messrs. Greenberg and Moore own substantial holdings not represented by this percentage over which Messrs. Greenberg and Moore disclaim beneficial ownership.
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 or employees to any such competitor could have a material adverse effect on our business, financial condition and results of operations. We cannot be certain that any agreements we require our employees to enter into will be effective in preventing them 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.
The anticipated benefits from any acquisitions that we have undertaken in the past or 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 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 the acquisition.
The failure to successfully and timely implement certain financial system changes to improve operating efficiency and enhance our reporting controls could harm our business.
We have implemented and continue to install several upgrades and enhancements to our financial systems. We expect these initiatives to enable us to achieve greater operating and financial reporting efficiencies and also enhance our existing control environment through increased levels of automation of certain processes. 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 obligations under the Sarbanes-Oxley Act of 2002, significant deficiencies or a material weakness, and/or the inability to report our financial results in a timely and accurate manner.
The restatement of our consolidated financial statements and possible related events, should they occur, may negatively impact our stock price, and may consume time and resources.
As discussed in Note 21, Restatement, in the Notes to Consolidated Financial Statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K, we have restated in this Form 10-K our consolidated financial statements for certain prior periods to correct certain errors in those financial statements. The previously disclosed errors related to our unrecorded corporate income and employment tax liabilities in connection with the movement of employees globally.
As with all corporate controls, we cannot be certain that the measures we have taken, and are taking, to remedy the errors since they were discovered will ensure that no errors occur in the future. Further, the restatement may negatively impact our stock price.
Although we have now completed the restatement, we cannot guarantee that we will not receive regulatory inquiries or be subject to litigation regarding our restated financial statements or matters relating thereto. Were any such future regulatory inquiries or litigation to occur, regardless of the outcome, such actions would likely consume internal resources and result in additional legal and consulting costs.
We cannot assure investors that we will be able to fully or timely address the material weakness in our internal controls that led to the restatement, or that remediation efforts will prevent future material weakness.
As a result of our review of issues related to the restatement described herein, management has identified deficiencies in our control environment that constitute a material weakness and, consequently, has concluded that our internal control over financial reporting was not effective at December 31, 2013. In addition, management has concluded, based primarily on the identification of the material weakness that our disclosure controls and procedures and our internal control over financial reporting were not effective as of December 31, 2013 as a result of the material weakness in internal controls related to accounting for certain tax liabilities resulting from the movement of our employees globally. See Item 9A, Controls and Procedures, in Part II of this Annual Report
on Form 10-K. If we are unable to successfully remediate this material weakness and to do so in a timely manner, investors may lose confidence in our reported financial information, which could lead to a decline in our stock price, limit our ability to access the capital markets in the future, and require us to incur additional costs to improve our internal control systems and procedures.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Our headquarters and principal administrative, finance, and marketing operations are located in approximately 80,000 square feet of leased office space in Boston, Massachusetts. We also lease offices in other parts of the United States and in Canada, Europe, India, Asia, Australia and South America. We believe our properties are suitable for the conduct of our business, adequate for our present needs and adequate for our foreseeable future needs. We do not own any material real property. Substantially all of our office space is leased under long-term leases with varying expiration dates. For further information regarding our lease obligations, see Note 12, Commitments and Contingencies: Lease Commitments, in the Notes to Consolidated Financial Statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
Item 3.
Item 3. Legal Proceedings
We are subject to certain legal proceedings and claims incidental to the operations of our business. We are also subject to certain other legal proceedings and claims that have arisen in the course of business that have not been fully adjudicated. We currently do not anticipate that these matters, if resolved against us, will have a material adverse impact on our financial results or financial condition.
For further information regarding our legal proceedings and claims, see Note 12, Commitments and Contingencies: Legal Claims, in the Notes to Consolidated Financial Statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
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 and Holders
Our common stock is traded on the NASDAQ Global Select Market under the ticker symbol “SAPE.” The following table sets forth, for the periods indicated, the high and low intraday sales prices of our common stock as reported on NASDAQ.
On March 14, 2014, the last reported sale price of our common stock was $16.58 per share. As of the close of business on March 14, 2014, there were approximately 281 holders of record of our common stock. Because many of the common shares are registered in “nominee” or “street” names, we believe that the total number of beneficial owners is considerably higher.
Stock Performance
The following graph compares the cumulative five-year total stockholder return on our common stock from December 31, 2008 through December 31, 2013, with the cumulative five-year total return, during the equivalent period, on (i) the NASDAQ Composite Index and (ii) the Dow Jones US Technology Index. The comparison assumes the investment of $100 on December 31, 2008 in our common stock and in each of the comparison indices and, in each case, assumes reinvestment of all dividends.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Sapient Corporation, the NASDAQ Composite Index,
and the Dow Jones US Technology Index
*$100 invested on 12/31/08 in stock or index, including reinvestment of dividends.
Fiscal year ending December 31.
Copyright© 2014 Dow Jones & Co. All rights reserved.
Dividends
We have not paid dividends in the prior two fiscal years. We may declare or pay special cash dividends on our common stock in the future. The payment of future dividends is within the discretion of our Board of Directors and will depend upon various factors, including our results of operations, financial condition, cash requirements and business projections.
Issuer Purchases of Equity Securities
From time to time, we repurchase shares of our common stock in the open market pursuant to programs approved by our Board of Directors. We may repurchase our common stock for a variety of reasons, such as acquiring shares to offset dilution related to equity-based incentives granted to employees, including stock options and RSUs, and optimizing our capital structure.
On May 9, 2012, our Board of Directors authorized a stock repurchase program of up to $100 million of the Company’s common stock for a period of two years. The following table includes information with respect to repurchases we made of our common stock pursuant to our stock repurchase program during the three month period ended December 31, 2013:
Sales of Unregistered Securities
On December 30, 2013, 84,166 shares of unregistered common stock were issued in connection with the acquisition of La Comunidad. The issuance of such shares was made pursuant to Section 4(2) of the Securities Act. On October 1, 2013, 33,816 shares of unregistered common stock were issued in connection with the acquisition of Second Story. The issuance of such shares was made pursuant to Section 4(2) of the Securities Act. On November 1, 2012, 235,490 shares of unregistered common stock were issued in connection with the acquisition of Second Story. The issuance of such shares were made pursuant to Rule 506 of Regulation D under the Securities Act.
Securities Authorized for Issuance under Equity Compensation Plans
For information required by Regulation S-K Item 201(d), see Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, under Part III of this Annual Report on Form 10-K.
Item 6.
Item 6. Selected Financial Data
SELECTED CONSOLIDATED FINANCIAL DATA
We have restated the selected financial data presented in this report as of and for each of the years ended December 31, 2012, 2011, 2010, and 2009. This Part II, Item 6, Selected Financial Data of this Annual Report on Form 10-K includes the following:
•
The restated selected financial data for the annual periods described above;
•
The selected financial data for the year ended December 31, 2013;
•
Schedules presenting the details of the nature and impact of the restatement adjustments. For information regarding our restatement, see Note 21, Restatement, in the Notes to Consolidated Financial Statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. The adjustments related to the years prior to 2009 are reflected in the beginning retained earnings for 2009. The cumulative impact of these adjusting entries decreased retained earnings by $7.2 million, net of tax, at the beginning of 2009.
The following selected consolidated financial data should be read in conjunction with Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. The balance sheet data at December 31, 2013 and 2012 and the statement of operations data for each of the three years ended December 31, 2013, 2012 and 2011 are derived from the audited consolidated financial statements for such years, included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
The account balances labeled “As Reported” in the years ended December 31, 2012, 2011, 2010, and 2009 represent the previously reported audited balances in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.
(1) Certain financial statement amounts included in the years ended December 31, 2012, 2011, 2010 and 2009 have been restated to correct certain prior period errors, primarily relating to unrecorded corporate income and employment tax liabilities resulting from the movement of employees globally. The restatement adjustments are described in detail in Note 21, Restatement, in the Notes to Consolidated Financial Statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
(2) On August 4, 2011, we declared a special dividend equivalent payment of $0.35 per RSU for all outstanding RSU awards as of August 15, 2011, to be paid in shares when the awards vest. If an RSU does not vest, the dividend is forfeited. On February 18, 2010, we declared a special dividend equivalent payment of $0.35 per RSU for all outstanding RSU awards as of March 1, 2010, to be paid in shares when the awards vest. If an RSU does not vest, the dividend is forfeited.
Cumulative Restatement Adjustments to Previously Reported Beginning Retained Earnings and Net Income Attributable to Sapient Corporation
The following tables present the impact of the restatement adjustments on previously reported retained earnings for the years ended 2012, 2011, 2010, and 2009. These restatements are described in detail in Note 21, Restatement, in the Notes to Consolidated Financial Statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
Impact of Restatement Adjustments on the Year Ended December 31, 2012 Consolidated Statement of Operations
The following table presents the impact of the restatement adjustments on our Consolidated Statement of Operations for the year ended December 31, 2012:
Impact of Restatement Adjustments on the Year Ended December 31, 2011 Consolidated Statement of Operations
The following table presents the impact of the restatement adjustments on our Consolidated Statement of Operations for the year ended December 31, 2011:
Impact of Restatement Adjustments on the Year Ended December 31, 2010 Consolidated Statement of Operations
The following table presents the impact of the restatement adjustments on our Consolidated Statement of Operations for the year ended December 31, 2010:
Impact of Restatement Adjustments on the Year Ended December 31, 2009 Consolidated Statement of Operations
The following table presents the impact of the restatement adjustments on our Consolidated Statement of Operations for the year ended December 31, 2009:
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Restatement of Previously Issued Financial Statements
As discussed further in Note 21, Restatement, in the Notes to Consolidated Financial Statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K, we have restated our consolidated financial statements for the years ended December 31, 2012 and 2011 and our unaudited quarterly financial information for each of the quarters in the year ended December 31, 2012 and for the first three quarters in the year ended December 31, 2013 (collectively, the “Restated Periods”).
For information regarding our controls and procedures, see Part II, Item 9A, Controls and Procedures, of this Annual Report on Form 10-K.
Overview
The Company
We help clients identify and act upon opportunities to improve their business performance by capitalizing on changes, disruptions, or opportunities that exist in their business or industry. We market our services through three primary business units - SapientNitro, Sapient Global Markets, and Sapient Government Services - positioned at the intersection of marketing, business and technology. SapientNitro is a new breed of agency which helps clients tell their stories through seamless experiences across brand communications, digital engagement, and omni-channel commerce. SapientNitro offers services including integrated marketing and creative services, web and interactive development, traditional advertising, media planning and buying, strategic planning and marketing analytics, multi-channel commerce strategy and solutions including a significant focus on mobile, and content and asset management strategies and solutions. Sapient Global Markets provides business and technology services including integrated advisory, program management, analytics, technology and operations services to leaders in banking, investment management, energy and commodity industries, as well as to governments. A core focus area within Sapient Global Markets is trading and risk management, to which we bring more than 15 years of experience and a globally integrated service in derivatives processing. Sapient Government Services provides consulting, technology, and marketing services to U.S. governmental agencies, nonprofit organizations (“NPOs”), and non-governmental organizations (“NGOs”). Focused on driving long-term change and transforming the citizen experience, we use technology, marketing services and communications to help our clients become more accessible, transparent, and effective.
Founded in 1990 and incorporated in Delaware in 1991, we maintain a strong global presence with offices around the world. We utilize our proprietary Global Distributed Delivery (“GDD”) model in support of our SapientNitro and Sapient Global Markets segments. Our GDD model enables us to perform services on a continuous basis through global client teams and provide high-quality, cost-effective solutions under accelerated assignment 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 have established and continuously promote a strong corporate culture based on our “strategic context” - purpose, core company values, vision, goals and client value proposition - which is critical to our success. Our value proposition includes helping clients tell their stories through seamless experiences across brand communications, digital engagement, and omni-channel commerce. Our value proposition also includes offering integrated marketing and creative services, web and interactive development, traditional advertising, media planning and buying, strategic planning and marketing analytics, multi-channel commerce strategy and solutions including a significant focus on mobile, and content and asset management strategies and solutions. In addition, our value proposition refers to our organizational strategy of helping clients identify and act upon opportunities to improve their business performance by capitalizing on changes, disruptions, or opportunities that exist in their business or industry.
Summary of Results of Operations
The following table presents a summary of our results of operations for the years ended December 31, 2013 and 2012 (in thousands, except percentages):
The increase in service revenues for the year ended December 31, 2013 was due primarily to higher demand for our services from new and existing customers and, to a lesser extent, revenues generated from acquisitions completed during the quarters ended December 31, 2012 and March 31, 2013. The increase in income from operations was due to the increase in service revenues and decreases in project personnel expenses as a percentage of service revenue. Net income attributable to Sapient Corporation increased due to the foregoing as well as a lower tax effective rate.
The following table presents a summary of our results of operations for the years ended December 31, 2012 and 2011 (in thousands, except percentages):
The increase in service revenues for the year ended December 31, 2012 was primarily due to higher demand for our services from new and existing customers and, to a lesser extent, the revenues generated from acquisitions completed during the third quarter of 2011. Income from operations was essentially unchanged, as increased service revenues were largely offset by similar increases in operating expenses. Net income decreased due to lower interest and other income (net), and a higher provision for income taxes in 2012 as compared to 2011.
Please see our Results of Operations section for additional discussion and analysis of these items.
Non-GAAP Financial Measures
In our quarterly earnings press releases and conference calls, we discuss two key measures that are not calculated according to generally accepted accounting principles (“GAAP”). The first non-GAAP measure is operating income, as reported on our consolidated statements of operations, excluding certain expenses and benefits, which we refer to as “non-GAAP income from operations”. The second measure calculates non-GAAP income from operations as a percentage of reported services revenues, which we refer to as “non-GAAP operating margin”. Management believes that these non-GAAP measures help illustrate underlying trends in our business. We use these measures to establish budgets and operational goals (communicated internally and externally), manage our business and evaluate our performance. We exclude certain expenses and benefits from non-GAAP income from operations that we believe are not reflective of the underlying business trends and are not useful measures in determining our operational performance and overall business strategy. Because our reported non-GAAP financial measures are not calculated according to GAAP, these measures may not
necessarily be comparable to GAAP or similarly described non-GAAP measures reported by other companies within our industry. Consequently, our non-GAAP financial measures should not be evaluated in isolation or supplant comparable GAAP measures, but, rather, should be considered together with our consolidated financial statements, which are prepared in accordance with GAAP and included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. The following table reconciles income from operations as reported on our consolidated statements of operations to non-GAAP income from operations, and GAAP operating margin to non-GAAP operating margin, for 2013, 2012 and 2011 (in thousands, except percentages):
Non-GAAP income from operations increased in 2013 compared to 2012, and in 2012 compared to 2011 primarily due to the increases in reported GAAP income from operations and increases in non-GAAP items, specifically stock-based compensation expense. During 2011, we received insurance recovery proceeds of $3.5 million as reimbursement for expenses incurred in 2006 and 2007 relating to a review of stock option grant practices and the related restatement. When the expenses were originally incurred, they were excluded from our non-GAAP income from operations. Similarly, these benefits have been excluded from non-GAAP income from operations in 2011.
Please see the Results of Operations section for a more detailed discussion and analysis of restructuring and other related charges, amortization of purchased intangible assets, and acquisition costs and other related charges.
When important to management’s analysis, operating results are compared in “constant currency terms”, a non-GAAP financial measure that excludes the effect of foreign currency exchange rate fluctuations. The effect of exchange rate fluctuations is excluded by translating the current period’s local currency service revenues and expenses into U.S. dollars at the average exchange rates of the prior period of comparison. For a discussion of our exposure to exchange rates, see Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, of this Annual Report on Form 10-K.
Results of Operations
The following table presents the components of net income attributable to stockholders of Sapient Corporation included in our consolidated statements of operations as percentages of service revenues:
Years Ended December 31, 2013 and 2012
Service Revenues
Our service revenues for 2013 and 2012 were as follows (in thousands, except percentages):
The increase in service revenues for the year ended December 31, 2013 was due primarily to higher demand for our services from new and existing customers and, to a lesser extent, revenues generated from acquisitions completed during the quarters ended December 31, 2012 and March 31, 2013. Compared geographically to 2012, 2013 service revenues in the United States increased 16%, while international service revenues increased 7%. In constant currency terms, service revenues increased 13% in 2013 as compared to 2012.
The following table presents our service revenues by industry sector for 2013 and 2012 (in thousands, except percentages):
See Service Revenues by Reportable Segment below for discussion of service revenues by reportable segment and industry sector.
Utilization, which represents the percentage of our delivery personnel’s time spent on billable client work, was 72% for 2013, a one-point decrease from our 2012 utilization of 73%. Our 2013 average delivery personnel peoplecount increased 12% compared to 2012, which was in line with service revenue growth. Contractor and consultant usage, measured by expense, increased 11% compared to 2012 as our need for contractors and consultants in specialized areas for certain client contracts increased.
Our five largest clients, in the aggregate, accounted for 18% of our service revenues in 2013, compared to 21% in 2012. No individual client accounted for more than 10% of our service revenues for 2013 and 2012. Long-Term and Retainer Revenues represented 51% and 52% of our total service revenues for 2013 and 2012, respectively. Long-Term and Retainer Revenues are revenues from contracts with durations of at least twelve months, and from applications management and long-term support assignments, which are cancelable.
Project Personnel Expenses
Project personnel expenses consist primarily of compensation and employee benefits for personnel dedicated to client assignments, contractors and consultants and other direct expenses incurred to complete assignments that were not reimbursed by the client. These expenses represent the most significant costs we incur in providing our services. The following table presents project personnel expenses for 2013 and 2012 (in thousands, except percentages):
The increase in project personnel expenses in 2013 was a direct result of our service revenue growth as we increased delivery personnel peoplecount, use of contractors and consultants and certain other direct expenses in order to fulfill the increase in demand for our services. Compensation expenses increased $60.5 million, primarily due to the 12% increase in delivery personnel peoplecount. Contractor and consultant expense increased $9.5 million, as our need for contractors and consultants in specialized areas for certain client contracts increased. Travel expenses, which can fluctuate based on specific client project needs, increased $6.3 million. Other project personnel expenses increased, in the aggregate, by $7.5 million.
Selling and Marketing Expenses
Selling and marketing expenses consist primarily of compensation, employee benefits and travel expenses of selling and marketing personnel, and promotional expenses. The following table presents selling and marketing expenses for 2013 and 2012 (in thousands, except percentages):
The increase in selling and marketing expenses was due to increases of $2.6 million in compensation expenses relating to an increase in selling and marketing peoplecount, $1.3 million in travel expenses, and $1.2 million in trade show expenses. Other selling and marketing expenses increased, in the aggregate, by $0.8 million.
General and Administrative Expenses
General and administrative expenses consist primarily of compensation and employee benefits associated with our management, legal, finance, information technology, hiring, training and administrative groups, and depreciation and occupancy expenses. The following table presents general and administrative expenses for 2013 and 2012 (in thousands, except percentages):
The increase in general and administrative expenses was primarily due to the following factors:
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compensation expenses increased $7.6 million primarily due to an increase in stock-based compensation, increases in salary expense, and bonus expense;
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depreciation expense increased $3.3 million, primarily due to the impact of leasehold improvement assets purchased in recent years in connection with our expansions of office space in several locations;
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facilities expenses increased $2.1 million, primarily due to office space expansions in several locations during 2012 and 2013;
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accounting and tax fees increased $1.9 million due to increased tax and accounting services by outside consultants;
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the net impact of our hedging gains and losses resulted in an increase of general and administrative expenses of $1.7 million, as net losses of $1.7 million were recorded in 2013, compared to net losses of less than $0.1 million in 2012;
•
the net impact of foreign currency gains and losses resulted in an increase in general and administrative expenses of $1.4 million, as net losses of $1.0 million were recorded in 2013, compared to net gains of $0.4 million in 2012;
•
contracting and consultant expense increased $1.5 million, as our need for contractors and consultants in specialized areas for certain internal projects increased; and
•
Other general and administrative expenses increased, in the aggregate, $4.0 million.
Restructuring and Other Related Charges
Restructuring and other related charges were $2.0 million and $0.4 million in 2013 and 2012, respectively. The net charges recorded in 2013 included $2.1 million of cash and other termination benefits for 82 employees whose positions were made redundant. These actions were taken in order to improve efficiency based on our revenue mix, skills mix, and leverage mode. Also included were benefits of $0.1 million related to changes in the estimated costs to be incurred in connection with a previously restructured office lease. The net charges recorded in 2012 included a restructuring charge of $0.5 million which included cash and other termination benefits for 15 Australian employees whose positions were made redundant, net of $0.1 million of benefits relating to changes in estimated future costs to be incurred in connection with two previously restructured office leases. This action was taken in response to customer attrition as well as a continuing re-positioning of the Company’s SapientNitro business in Australia from traditional advertising capabilities to digitally-led capabilities.
Amortization of Purchased Intangible Assets
During 2013 and 2012, purchased intangible assets consisted of non-compete and non-solicitation agreements, customer lists, intellectual property, and tradenames acquired in business combinations. Amortization expense related to intangible assets increased from $11.1 million in 2012 to $12.8 million in 2013, primarily due to the additional amortization expense related to the new intangible assets acquired in connection with the three acquisitions which occurred during the fourth quarter of 2012 and the first quarter of 2013.
Acquisition Costs and Other Related (Benefits) Charges
Acquisition costs and other related (benefits) charges include expenses associated with third-party professional services we utilize related to the evaluation of potential targets and the execution of successful acquisitions. Although we may incur costs to evaluate targets, the related potential transaction(s) may never be consummated. Acquisition costs and other related (benefits) charges also include changes in the fair value of contingent consideration liabilities recorded as the result of acquisitions. These liabilities must be measured at fair value on the acquisition date, and until these liabilities are settled, they must be remeasured to fair value each reporting period, with the changes included in earnings. Acquisition costs and other related (benefits) charges was a benefit of $0.2 million and a charge of $4.4 million for 2013 and 2012, respectively. The decrease of $4.6 million was due to a $0.3 million decrease in third-party costs related to the evaluation of potential targets and the completion of acquisition and a $4.3 million decrease in remeasurements of the fair value of contingent consideration liabilities.
We recorded contingent consideration liabilities as the result of our acquisitions of La Comunidad and iThink during 2013, (m)Phasize, LLC during 2012, and D&D Holdings Limited (“DAD”) during 2011, and we expect to record quarterly remeasurements of the fair value of these liabilities until they are settled at various points in time through 2017. Acquisition costs and other related (benefits) charges recorded in 2013 and 2012 included benefits and expenses of $1.9 million and $2.4 million, respectively, relating to the remeasurement of the fair value of these contingent consideration liabilities. We may also continue to incur additional acquisition costs and other related (benefits) charges in future periods resulting from the evaluation of potential acquisition targets.
Impairment of Intangible Asset
During the quarters ended September 30, June 30, and March 31, 2013, we performed impairment reviews of the customer list intangible asset obtained in the acquisition of Nitro Group Limited (“Nitro”), acquired in 2009. The impairment reviews were triggered by certain legacy Nitro customers having notified us of their intentions to cease or reduce purchases of our services. In the first step of the June 30, 2013 impairment review, the undiscounted net cash flows expected to be generated by the asset were compared to the carrying value of the asset. The undiscounted net cash flows expected to be generated by the asset were greater than the carrying value of the asset, and as a result no impairment was recorded during the three months ended June 30, 2013. In the first step of the September 30 and March 31, 2013 impairment reviews, the carrying value of the asset exceeded the undiscounted net cash flows expected to be generated by the asset, indicating that the carrying value was not
recoverable. In the second step, the impairment amount of $0.6 million and $1.5 million recorded in the three months ended September 30 and March 31, 2013, respectively, was determined as the amount by which the asset’s carrying amount exceeded its fair value, which was estimated using a discounted cash flow approach. During the three months ended December 31, 2013, there were no triggering events that compelled the Company to perform an impairment review.
In estimating the undiscounted future net cash flows expected to be generated by this intangible asset, management considered the following factors: actual customer attrition rates since the acquisition date; expected future attrition rates; estimated undiscounted net cash flows generated by the intangible asset since the acquisition date; estimated undiscounted net cash flows expected to be generated by the intangible asset over its remaining expected useful life; and the expected remaining useful life of the intangible asset. In the course of these impairment reviews, we considered multiple future scenarios and the expected likelihood of those scenarios occurring, based on the information which was known to management at the times the reviews were performed. These impairment reviews involved the use of significant judgment by management, and different judgments could yield different results. The net book value of the Nitro customer list intangible asset was $0.4 million and $3.5 million as of December 31, 2013 and December 31, 2012, respectively.
Interest Income, Net
Interest income is derived from investments in U.S. government securities, bank time deposits, and money market funds. Interest expense consists primarily of imputed interest on rent payments for leased properties of which we are considered the owner for accounting purposes. The following table presents interest income, net for 2013 and 2012 (in thousands, except percentages):
Interest income, net increased in 2013 as compared to 2012 due to higher interest income relating to higher average balances of our interest-bearing foreign currency holdings of cash, cash equivalents and marketable securities partially offset by an increase in interest expense due to two “build-to-suit” office properties in India that we occupy, and the weakening of the Indian rupee against the U.S. dollar.
Provision for Income Taxes
The provision for income taxes was $47.7 million and $41.8 million for 2013 and 2012, respectively. Income tax is related to foreign, federal and state tax obligations. The increase in our provision for income taxes was primarily due to the increase in profit before tax, and changes in the mix of jurisdictional profits.
Deferred tax assets are to be reduced by a valuation allowance if, based on the weight of available positive and negative evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of December 31, 2013, a valuation allowance is maintained against deferred tax assets associated primarily with certain state net operating loss carryforwards.
We had gross unrecognized tax benefits, including interest and penalties, of $30.8 million and $28.1 million as of December 31, 2013 and 2012, respectively. The amounts of unrecognized tax benefits that, if recognized, would result in a reduction of our effective tax rate were $29.7 million and $25.6 million as of December 31, 2013 and 2012, respectively. We recognize accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes. As of December 31, 2013 and 2012, accrued interest and penalties were $4.2 million and $5.3 million, respectively.
We conduct business globally and, as a result, one or more of our subsidiaries files income tax returns in U.S. federal and state jurisdictions and various foreign jurisdictions. In the normal course of business, we are subject to examination by taxing authorities throughout the world, including major jurisdictions such as Canada, Germany, India, Switzerland, the United Kingdom and the United States. Our U.S. federal tax filings are open for examination for tax years 2010 through the present. The statutes of limitations in our other tax jurisdictions remain open for various periods between 2006 and the present. However, carryforward attributes from prior years may still be adjusted upon examination by tax authorities if they are used in an open period.
Although we believe our tax estimates are appropriate, the final determination of tax audits could result in favorable or unfavorable changes in our estimates. We anticipate the settlement of tax audits and the expiration of relevant statutes of limitations in the next twelve months could result in a decrease in our unrecognized tax benefits of an amount between $2.0 million and $3.5 million.
Our effective tax rate may vary from period to period based on changes in estimated taxable income or loss by 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. For 2013, our effective tax rate varied from the statutory tax rate primarily due to state income taxes, the tax rate differential attributable to income earned by our foreign subsidiaries and the related mix of jurisdictional profits, and changes in uncertain tax positions.
Results by Reportable Segment
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated on a regular basis by the Chief Operating Decision Maker (“CODM”) in deciding how to allocate resources to an individual segment and in assessing performance. The Company’s CODM is its Chief Executive Officer.
We identify such segments based upon target client markets because each operating segment helps clients identify and act upon opportunities to improve their business performance, but strategically serves different markets. We considered qualitative factors, including the economic characteristics of each operating segment to determine if any qualified for aggregation. More specifically, we evaluated the economic characteristics, the nature of products and services, the methods used to provide services, the types of customers, and the nature of the corresponding regulatory environment of our operating segments. As a result, we have identified the following reportable segments: SapientNitro, Sapient Global Markets, and Sapient Government Services.
The CODM evaluates performance based upon each segment’s operating income, which is defined as income before allocations of certain marketing and general and administrative expenses, including costs associated with its restructuring events (as described in Note 10, Restructuring and Other Related Charges, in the Notes to Consolidated Financial Statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K). These charges are excluded from evaluation of performance because these activities and costs generally impact areas that support the segments and, therefore, are managed separately. Management does not allocate amortization of purchased intangible assets, acquisition costs, stock-based compensation expense, or interest and other income to the segments for the review of results by the CODM. Asset information by segment is not reported to or reviewed by the CODM, and therefore, we have not disclosed asset information for the segments. The accounting policies of the segments are the same as those described in Note 2, Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
The following tables present the service revenues and operating income attributable to our reportable segments for the periods presented (in thousands):
(1) Segment operating income 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. Segment operating income reflects restructuring charges allocated to the SapientNitro and Sapient Global Markets reportable segments consisting of $1.3 million and $0.5 million for the year ended December 31, 2013.
(2) Adjustments that are made to reconcile total reportable segments operating income to consolidated income before income taxes include the following (in thousands):
Service Revenues by Reportable Segment
The Company does not internally measure or report revenues by individual service offering as providing such information is impracticable and, therefore, the Company has not disclosed the revenues from external customers for each service offering described in Note 2(m), Summary of Significant Accounting Policies, Revenue Recognition, in the Notes to Consolidated Financial Statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
The following table presents SapientNitro service revenues by industry sector for 2013 and 2012 (in thousands except percentages):
SapientNitro service revenues increased 10% driven by an increase in new clients partially offset by a decrease in revenues from existing clients. The increase was primarily driven by both an increase in the Consumer, Travel and Automotive industry sector and strong demand for our services in the Financial Services sector. In particular, the Consumer, Travel and Automotive industry sector has experienced increasing acceptance of our value proposition, as companies in this sector shift more of their marketing efforts to digital platforms. In 2013, the Consumer, Travel and Automotive sector increased 7% based on an increase in new client demand, partially offset by a decrease in revenue from existing clients in 2012. The Financial Services sector service revenue experienced equally strong demand from both new and existing clients, which drove the 24% increase in this sector in 2013. The Government, Health & Education sector experienced strong growth as service revenues increased from new clients, which was partially offset by a decrease in revenues from existing clients in 2013. Technology & Communications increased as new client revenues increased in 2013, which was partially offset by a decrease in revenues from existing clients. SapientNitro experienced a slowdown in existing Energy Services clients’ demand that drove the 35% decrease. Overall, in constant currency terms, SapientNitro service revenues increased 11% from 2012 to 2013.
The following table presents Sapient Global Markets service revenues by industry sector for 2013 and 2012 (in thousands except percentages):
Sapient Global Markets grew strongly 18% from 2012 to 2013. This increase was driven primarily within the Energy and Financial Services sectors with existing clients increasing their demand for Sapient Global Market services. The Energy Sector grew 41% driven by an increase in new and existing customers. The Financial Services sector grew 10% due to an increase in revenues from both new and existing clients. The Government, Health and Education sector growth was driven entirely by the expansion of work from our existing clients. In constant currency terms, Sapient Global Markets service revenues increased 18% from 2012 to 2013.
Service revenues for the Sapient Government Services segment (which are derived entirely from the Government, Health & Education industry sector) increased by $6.6 million, or 13%, in 2013 compared to 2012, due to increased demand for our services from new governmental and non governmental clients in this segment, and partially due to an expansion within the existing client base.
Operating Income by Reportable Segment
SapientNitro’s operating income increased $34.5 million in 2013. As a percentage of related service revenues, SapientNitro’s operating income increased to 32% in 2013 as compared to 31% in 2012. The increase is primarily due to our management of direct expenses as direct expenses increased 8% compared to an increase of 10% in service revenues.
Sapient Global Markets’ operating income increased $21.7 million in 2013. As a percentage of related service revenues, Sapient Global Markets’ operating income increased to 31% in 2013 as compared to 30% in 2012. The increase is primarily due to our management of direct expenses as direct expenses increased 15% compared to an increase of 18% in service revenues.
Sapient Government Services’ operating income increased $2.7 million in 2013. As a percentage of related service revenues, Sapient Government Services’ operating income increased to 29% in 2013 as compared to 28% in 2012. The increase is primarily due to our management of direct expenses as direct expenses increased 11% compared to an increase of 13% in service revenues.
Years Ended December 31, 2012 and 2011
Service Revenues
Our service revenues for 2012 and 2011 were as follows (in thousands, except percentages):
The increase in service revenues for the year ended December 31, 2012 was primarily due to higher demand for our services from new and existing customers and, to a lesser extent, the revenues generated from acquisitions completed during the third quarter of 2011.
The following table presents our service revenues by industry sector for 2012 and 2011 (in thousands, except percentages):
See Service Revenues by Reportable Segment below for discussion of service revenues by reportable segment and industry sector.
Utilization was 73% for 2012, a two-point increase from our 2011 utilization of 71%. Our 2012 average delivery personnel peoplecount increased 8% compared to 2011, which was in line with service revenue growth. Contractor and consultant usage, measured by expense, increased 1% compared to 2011 as our need for contractors and consultants in specialized areas for certain client contracts increased.
Our five largest clients, in the aggregate, accounted for 21% of our service revenues in 2012, compared to 19% in 2011. No individual client accounted for more than 10% of our service revenues for 2012 and 2011. Long-Term and Retainer Revenues represented 52% and 48% of our total service revenues for 2012 and 2011, respectively.
Project Personnel Expenses
The following table presents project personnel expenses for 2012 and 2011 (in thousands, except percentages):
The increase in project personnel expenses in 2012 was a direct result of our service revenue growth as we increased delivery personnel peoplecount, use of contractors and consultants and certain other direct expenses in order to fulfill the increase in demand for our services. Compensation expenses increased $67.6 million, primarily due to the 7% increase in delivery personnel peoplecount and the impact of annual compensation rate increases and promotions. Contractor and consultant expense increased $0.4 million, as our need for contractors and consultants in specialized areas for certain client contracts increased. Travel expenses, which can fluctuate based on specific client project needs, decreased $1.8 million. Other project personnel expenses increased, in the aggregate, by $8.8 million.
Selling and Marketing Expenses
The following table presents selling and marketing expenses for 2012 and 2011 (in thousands, except percentages):
The increase in selling and marketing expenses was due to increases of $2.3 million in travel expenses, $1.7 million in compensation expenses relating to an increase in selling and marketing peoplecount, $0.7 million in trade show expenses, and $0.6 million in consultant costs relating to selling and marketing initiatives. Other selling and marketing expenses increased, in the aggregate, by $0.3 million.
General and Administrative Expenses
The following table presents general and administrative expenses for 2012 and 2011 (in thousands, except percentages):
The increase in general and administrative expenses was primarily due to the following factors:
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compensation expenses increased $6.8 million due to a 10% increase in average general and administrative peoplecount and the impact of annual compensation rate increases and promotions;
•
facilities expenses increased $4.5 million, primarily due to office space expansions in several locations;
•
depreciation expense increased $2.6 million, primarily due to the impact of leasehold improvement assets purchased in recent years in connection with our expansions of office space in several locations;
•
health insurance costs increased $1.7 million due to increases in company-wide peoplecount and insurance rate increases;
•
the net impact of foreign currency gains and losses resulted in an increase in general and administrative expenses of $1.2 million, as net gains of $0.4 million were recorded in 2012, compared to net gains of $1.6 million in 2011;
•
2011 included a benefit of $3.5 million relating to insurance recovery proceeds received as reimbursement for expenses incurred during a review of stock option grant practices and the related restatement in 2006 and 2007, while 2012 included no similar benefits;
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These increases were partially offset by the net impact of hedging gains and losses, which resulted in a decrease in general and administrative expenses of $1.2 million, as net losses totaling less than $0.1 million were recorded in 2012 compared to net losses of $1.2 million in 2011; and
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Other general and administrative expenses increased, in the aggregate, $0.8 million.
Restructuring and Other Related Charges
Restructuring and other related charges were $0.4 million and $6.5 million in 2012 and 2011, respectively. The net charges recorded in 2012 included $0.5 million of cash and other termination benefits for 15 employees in Australia whose positions were made redundant, net of $0.1 million of benefits relating to changes in estimated future costs to be incurred in connection with two previously restructured office leases. The net charges recorded in 2011 consisted of the following:
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$5.7 million related to cash and other termination benefits for two former Nitro executives whose positions were made redundant, as well as the re-positioning of a portion of our SapientNitro business in Australia from traditional advertising capabilities to digitally-led capabilities; this charge consisted of $1.1 million of cash severance and other associated termination benefits, and a $4.6 million non-cash charge related to the acceleration of unrecognized compensation expense for stock-based awards;
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$0.9 million related to the consolidation of our New York City operations into one office space;
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$0.3 million related to future payments owed to us under a sub-lease of a previously restructured office space which are no longer expected to be collected; and
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net benefits of $0.4 million related to changes in the estimated operating expenses to be incurred and sub-lease income to be received in connection with previously restructured leases.
Amortization of Purchased Intangible Assets
During 2012 and 2011, purchased intangible assets consisted of non-compete and non-solicitation agreements, customer lists, intellectual property, and tradenames acquired in business combinations. Amortization expense related to intangible assets increased from $6.8 million in 2011 to $11.1 million in 2012, primarily due to the full-year impact of the two acquisitions we completed during the third quarter of 2011, and, to a lesser extent, the impact of the two acquisitions we completed during the fourth quarter of 2012.
Acquisition Costs and Other Related Charges
Acquisition costs and other related charges include expenses associated with third-party professional services we utilize related to the evaluation of potential targets and the execution of successful acquisitions. Although we may incur costs to evaluate targets, the related potential transaction(s) may never be consummated. Acquisition costs and other related charges also include changes in the fair value of contingent consideration liabilities recorded as the result of acquisitions. These liabilities must be measured at fair value on the acquisition date, and until these liabilities are settled, they must be remeasured to fair value each reporting period, with the changes included in earnings. Acquisition costs and other related charges were $4.4 million and $1.9 million for 2012 and 2011, respectively. The increase of $2.5 million was due to a $1.8 million increase in remeasurements of the fair value of contingent consideration liabilities, and a $0.7 million increase in third-party costs related to the evaluation of potential targets and the completion of acquisitions.
We recorded contingent consideration liabilities as the result of our acquisitions of (m)Phasize, LLC during 2012 and D&D Holdings Limited (“DAD”) during 2011, and we expect to record quarterly remeasurements of the fair value of these liabilities until they are settled at various points in time through 2014. Acquisition costs and other related charges recorded in 2012 and 2011 included expenses of $2.4 million and $0.6 million, respectively, relating to the remeasurement of the fair value of these contingent consideration liabilities.
Interest Income, net
The following table presents interest income, net for 2012 and 2011 (in thousands, except percentages):
Interest income, net decreased in 2012 as compared to 2011 primarily due to lower interest income relating to lower average balances of our interest-bearing foreign currency holdings of cash, cash equivalents and marketable securities, and due to interest expense relating to the two “build-to-suit” properties in India which we occupied during 2012.
Provision for Income Taxes
The provision for income taxes was $41.8 million and $36.8 million for 2012 and 2011, respectively. Income tax is related to foreign, federal and state tax obligations. The increase in our provision for income taxes was primarily due to changes in the mix of jurisdictional profits, provisions for uncertain tax positions, and the decrease in the deferred tax liability from unremitted foreign earnings in 2011.
Deferred tax assets are to be reduced by a valuation allowance if, based on the weight of available positive and negative evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of December 31, 2012, a valuation allowance was maintained against deferred tax assets associated with certain state net operating loss carryforwards. We also maintained a valuation allowance against our deferred tax assets in Switzerland, but believed that deferred tax assets in various other foreign jurisdictions are more likely than not to be realized and, therefore, no valuation allowance has been recorded against these assets.
We had gross unrecognized tax benefits, including interest and penalties, of approximately $28.1 million and $21.0 million as of December 31, 2012 and 2011, respectively. The amounts of unrecognized tax benefits that, if recognized, would result in a reduction of our effective tax rate were $25.6 million and $19.0 million as of December 31, 2012 and 2011, respectively. We recognize accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes. As of December 31, 2012 and 2011, accrued interest and penalties were $5.3 million and $4.4 million, respectively.
We conduct business globally and, as a result, one or more of our subsidiaries files income tax returns in U.S. federal and state jurisdictions and various foreign jurisdictions. In the normal course of business, we are subject to examination by taxing authorities throughout the world, including major jurisdictions such as Canada, Germany, India, Switzerland, the United Kingdom and the United States. As of December 31, 2012, our U.S. federal tax filings were open for examination for tax years 2009 through the present. The statutes of limitations in our other tax jurisdictions remain open for various periods between 2005 and the present. However, carryforward attributes from prior years may still be adjusted upon examination by tax authorities if they are used in an open period.
Although we believe our tax estimates are appropriate, the final determination of tax audits could result in favorable or unfavorable changes in our estimates. As of December 31, 2012, we anticipated the settlement of tax audits and the expiration of relevant statutes of limitations in the next twelve months could result in a decrease in our unrecognized tax benefits of an amount between $1.5 million and $2.5 million.
Our effective tax rate may vary from period to period based on changes in estimated taxable income or loss by 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. For 2012, our effective tax rate varied from the statutory tax rate primarily due to state income taxes, the tax rate differential attributable to income earned by our foreign subsidiaries and the related mix of jurisdictional profits, and changes in uncertain tax positions.
Results by Reportable Segment
The following tables present the service revenues and operating income attributable to our reportable segments for the periods presented (in thousands):
(1) Segment operating income 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 reconcile total reportable segments operating income to consolidated income before income taxes include the following (in thousands):
(a) Reflects stock option restatement-related benefits.
Service Revenues by Reportable Segment
The following table presents SapientNitro service revenues by industry sector for 2012 and 2011 (in thousands except percentages):
SapientNitro service revenues grew 13% primarily due to increase in demand from both new and existing client base. The increase was particularly driven by the Consumer, Travel and Automotive industry sector as we have experienced increasing acceptance of our value proposition, with companies in this sector shifting more of their marketing efforts to digital platforms. Within the Consumer, Travel and Automotive industry sector, service revenue increased from both new and existing clients. The 8% increase in Technology & Communications sector revenues was primarily due to an increase in new clients partially offset by a decrease in revenues from existing clients. The decrease within the Financial Services sector resulted from contract price compressions from some of our largest clients in this sector and a decrease in the volume of services provided to existing clients. This decrease was partially offset by an increase in new clients. The increase in Government, Health & Education industry sector was due to an increase in new and existing clients. The Energy Services sector increased 62%, primarily due to an increased demand from new and existing clients. In constant currency terms, SapientNitro service revenues increased 13% from 2011 to 2012.
The following table presents Sapient Global Markets service revenues by industry sector for 2012 and 2011 (in thousands except percentages):
The 5% increase in service revenues was primarily driven by higher demand from clients in the Financial Services sector while the increase within Energy Services was partially offset by the decrease in Government, Health, and Education sector. The Financial Services sector experienced an increase in revenue from new clients, partially offset by a decrease in revenue from existing clients. Within the Energy Services sector service revenues from both new clients and existing clients increased. In constant currency terms, Sapient Global Markets service revenues increased 6% from 2011 to 2012.
Service revenues for the Sapient Government Services segment (which are derived entirely from the Government, Health & Education industry sector) decreased by $1.4 million, or 3%, in 2012 compared to 2011, due to a decrease in demand for our services from existing clients in this segment, in large part due to budgetary pressures experienced by U.S. government agencies. This decrease was partially offset by an increase in new, primarily non-governmental, clients.
Operating Income by Reportable Segment
SapientNitro’s operating income increased $18.9 million in 2012. As a percentage of related service revenues, SapientNitro’s operating income decreased to 31% in 2012 as compared to 32% in 2011. The decrease in operating income as a percentage of service revenues was primarily due to higher compensation expenses as a percentage of related service revenues.
Sapient Global Markets’ operating income increased $4.0 million in 2012. As a percentage of related service revenues, Sapient Global Markets’ operating income was 30% in both 2012 and 2011. An increase in compensation expenses as a percentage of related service revenues was offset by a decrease in contractor and consultant expenses as a percentage of related service revenues.
Sapient Government Services’ operating income increased $0.3 million in 2012. As a percentage of related service revenues, Sapient Government Services’ operating income increased to 28% in 2012 as compared to 26% in 2011. This increase was primarily due to lower contractor and consultant expenses as a percentage of related service revenues.
Liquidity and Capital Resources
Years Ended December 31, 2013 and 2012
We invest our excess cash predominantly in money market funds, time deposits with maturities of 91 days or less, mutual funds and other cash equivalents.
As of December 31, 2013 and 2012, we had $2.1 million and $6.1 million, respectively, held with various banks as collateral for letters of credit and performance bonds, and as escrow funds related to acquisitions, and those amounts are classified as “Restricted cash” on our consolidated balance sheets. We also had $5.8 million recorded as restricted cash as of December 31, 2012 relating to our acquisitions of DAD and (m)Phasize.
As of December 31, 2013, our total cash, cash equivalents, restricted cash, and marketable securities balance included $141.0 million held by our U.S. entities and $204.6 million held by our foreign subsidiaries. If we need to access these overseas funds for our operations in the U.S., we would be required to accrue and pay U.S. taxes to repatriate these funds. However, our intent is to reinvest the unremitted earnings of our foreign subsidiaries indefinitely, except for $33.5 million of unremitted earnings which as of December 31, 2013 were not reinvested indefinitely, and for which a deferred income tax liability has been recorded. Determination of the potential deferred tax liability on other unremitted earnings is not practicable because such liability, if any, would depend on circumstances existing if and when such remittance occurs. Our current plans do not demonstrate a need to repatriate any overseas funds to fund our U.S. operations.
In July 2012, we entered into a revolving credit facility under which we may request advances for general working capital purposes, in U.S. dollars, British pounds sterling and euros, not to exceed an equivalent of $20.0 million U.S. dollars in the aggregate. As of March 18, 2014, we had not drawn any advances under this facility. We believe that our existing cash, credit facility and other short-term investments will be sufficient to meet our working capital and capital expenditure requirements, investing activities, repurchases of common stock, and the expected cash outlays for our previously recorded restructuring activities, for at least the next 12 months.
At December 31, 2013 we had the following contractual obligations:
(1) Purchase obligations represent minimum commitments due to third parties, including subcontractor agreements, telecommunications contracts, IT maintenance contracts in support of internal use of 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 canceled without payment penalties, have been excluded. Amounts presented also exclude accounts payable and accrued expenses at December 31, 2013.
(2) We are not able to determine a reasonably reliable estimate of the timing of potential future payments relating to uncertain tax positions.
Operating Activities
Cash provided by operating activities during 2013 totaled $155.3 million, primarily due to $77.5 million in net income and the addition of $55.8 million in non-cash items, and an increase of $22.0 million in cash related to changes in operating assets and liabilities. Cash provided by operating activities during 2012 totaled $110.8 million, primarily due to $58.8 million in net income and the addition of $59.3 million in non-cash items, partially offset by a decrease of $7.3 million in cash relating to changes in operating assets and liabilities.
Days sales outstanding (“DSO”) is calculated based on the most recent three months of total gross revenues and period end balances of accounts receivable, unbilled revenues and deferred revenues. Our DSO was 63 days as of December 31, 2013 and 2012. DSO is affected by changes in accounts receivable and unbilled revenues, which are related to the trend in service revenues, the timing of achieving certain project milestones and the timing of project billings. We expect our unbilled revenues to be short-term in nature, with a majority being billed within 90 days.
Investing Activities
Cash used in investing activities during 2013 totaled $49.0 million. This was primarily due to the use of $36.6 million for capital expenditures and internally developed software, and the use of $14.4 million (net of cash acquired) for the acquisitions of iThink Comunicação e Publicidade Ltda (“iThink”) and “la comunidad” CORPORATION and La Comunidad S.A. (together, “La Comunidad”). Cash used in investing activities during 2012 totaled $58.7 million, primarily due to the use of $37.8 million for capital expenditures and internally developed software, and the use of $18.3 million (net of cash acquired) for the acquisitions of Second Story, Inc. and (m)Phasize, LLC. Our use of cash for acquisitions can fluctuate from year to year based on acquisition opportunities available to us at any given time, as well as the proportions of acquisition consideration which are in the forms of cash or equity. The magnitude of capital expenditures in a given year is often impacted by our activities in leasing new office spaces or expanding existing spaces, which typically require expenditures for leasehold improvements, as well as replacement cycles for computer software and hardware.
Financing Activities
Cash provided by financing activities during 2013 totaled $5.6 million, primarily due to proceeds from stock option plan of $3.6 million and tax benefit from stock plans of $2.5 million, partially offset by the use of $0.6 million for repurchases of our common stock. Cash used in financing activities during 2012 totaled $33.2 million, primarily due the use of $44.6 million for repurchases of our common stock, partially offset by $10.1 million of tax benefits from stock plans.
We use foreign currency option contracts to partially mitigate the effects of exchange rate fluctuations on revenues and operating expenses denominated in certain foreign currencies. Please see Part II, Item 7A, Quantitative and Qualitative Disclosures about Market Risk, of this Annual Report on Form 10-K for a discussion of our use of such derivative financial instruments.
Years Ended December 31, 2012 and 2011
We invest our excess cash predominantly in money market funds, time deposits with maturities of 91 days or less, mutual funds and other cash equivalents.
As of December 31, 2012 and 2011, we had $11.9 million and $4.2 million, respectively, held with various banks as collateral for letters of credit and performance bonds, and as escrow funds related to acquisitions, and those amounts are classified as “Restricted cash” on our consolidated balance sheets.
As of December 31, 2012, our total cash, cash equivalents, restricted cash, and marketable securities balance included $80.1 million held by our U.S. entities and $173.4 million held by our foreign subsidiaries. If we need to access these overseas funds for our operations in the U.S., we would be required to accrue and pay U.S. taxes to repatriate these funds. However, our intent is to reinvest the unremitted earnings of our foreign subsidiaries indefinitely, except for $37.9 million of unremitted earnings which as of December 31, 2012 were not reinvested indefinitely, and for which a deferred income tax liability has been recorded. Determination of the potential deferred tax liability on other unremitted earnings is not practicable because such liability, if any, would depend on circumstances existing if and when such remittance occurs. Our current plans do not demonstrate a need to repatriate any overseas funds to fund our U.S. operations.
In July 2012, we entered into a revolving credit facility under which we may request advances for general working capital purposes, in U.S. dollars, British pounds sterling and euros, not to exceed an equivalent of $20 million U.S. dollars in the aggregate. As of December 31, 2012, we had not drawn any advances under this facility.
At December 31, 2012 we had the following contractual obligations:
(1) Purchase obligations represent minimum commitments due to third parties, including subcontractor agreements, telecommunications contracts, IT maintenance contracts in support of internal use of 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 canceled without payment penalties, have been excluded. Amounts presented also exclude accounts payable and accrued expenses at December 31, 2012.
(2) We are not able to determine a reasonably reliable estimate of the timing of potential future payments relating to uncertain tax positions.
Operating Activities
Cash provided by operating activities during 2012 totaled $110.8 million, primarily due to $58.8 million in net income and the addition of $59.3 million in non-cash items, partially offset by a decrease of $7.3 million in cash relating to changes in operating assets and liabilities. Cash provided by operating activities during 2011 totaled $131.9 million, primarily due to $66.8 million in net income and the addition of $61.0 million in non-cash items, partially offset by a decrease of $1.6 million in cash relating to changes in operating assets and liabilities.
Days sales outstanding (“DSO”) is calculated based on the most recent three months of total gross revenues and period end balances of accounts receivable, unbilled revenues and deferred revenues. Our DSO was 63 days as of December 31, 2012 compared to 64 days as of December 31, 2011. DSO is affected by changes in accounts receivable and unbilled revenues, which are related to the trend in service revenues, the timing of achieving certain project milestones and the timing of project billings.
Investing Activities
Cash used in investing activities during 2012 totaled $58.7 million. This was primarily due to the use of $37.8 million for capital expenditures and internally developed software, and the use of $18.3 million (net of cash acquired) for the acquisitions of Second Story, Inc. and (m)Phasize, LLC. Cash used in investing activities during 2011 totaled $81.0 million, primarily due to the use of $44.6 million (net of cash acquired) for the acquisitions of DAD and Clanmo GmbH, and the use of $35.5 million for capital expenditures and internally developed software. Our use of cash for acquisitions can fluctuate from year to year based on the acquisition opportunities available to us at any given time, as well as the proportions of acquisition consideration which are in the forms of cash or equity. The magnitude of capital expenditures in a given year is often impacted by our activities in leasing new office spaces or expanding existing spaces, which typically require expenditures for leasehold improvements, as well as replacement cycles for computer software and hardware.
Financing Activities
Cash used in financing activities during 2012 totaled $33.2 million, primarily due to the use of $44.6 million for repurchases of our common stock, partially offset by $10.1 million of tax benefits from stock plans. Cash used in financing activities during 2011 totaled $42.6 million, primarily due to a $48.9 million special dividend payment to holders of common stock, net repayments of $10.4 million under a revolving credit facility in India (which expired December 31, 2011), and the repayment of $3.8 million of debt assumed in the acquisition of DAD. These outflows were partially offset by the receipt of $10.2 million in cash proceeds from stock option exercises, and $4.4 million of tax benefits from stock plans.
We use foreign currency option contracts to partially mitigate the effects of exchange rate fluctuations on revenues and operating expenses denominated in certain foreign currencies. Please see Part II, Item 7A, Quantitative and Qualitative Disclosures about Market Risk, of this Annual Report on Form 10-K for a discussion of our use of such derivative financial instruments.
Contingencies
We are subject to certain legal proceedings and claims incidental to the operation of our business. We are also subject to certain other legal proceedings and claims that have arisen in the ordinary course of business and that have not been fully adjudicated. We currently do not anticipate that these matters, if resolved against us, will have a material adverse impact on our financial results or financial condition.
We accrue for loss contingencies when losses become probable and are reasonably estimable. If the reasonable estimate of the loss is a range and no amount within the range is a better estimate, the minimum amount of the range is recorded as a liability. As of December 31, 2013, we have recorded an accrual of $1.2 million for loss contingencies, which represents the minimum amount of probable range between $1.2 million and $7.8 million, related to all probable losses where a reasonable range could be made. This range includes a potential liability associated with non-income tax matters in certain of our foreign jurisdictions.
We do not accrue for contingent losses that, in our judgment, are considered to be reasonably possible, but not probable. Although we intend to defend these matters vigorously, the ultimate outcome of these matters is uncertain. However, we do not expect the potential losses, if any, to have a material adverse impact on our operating results or financial condition.
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 GAAP. In connection with the preparation of our consolidated financial statements, we are required to make estimates and assumptions about future events, and apply judgments that affect the reported amounts of assets, liabilities, revenues, expenses and the related disclosures at the date of the financial statements. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management believes to be relevant at the time our consolidated financial statements are prepared. On a regular basis, we review the accounting policies, assumptions, estimates and judgments to ensure that our financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.
Our significant accounting policies are discussed in Note 2, Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. We believe that the following accounting policies are the most critical to aid in fully understanding and evaluating our reported financial results, and they require our most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. We have reviewed these critical accounting estimates and related disclosures with the Audit Committee of our Board of Directors.
Revenue Recognition
We recognize revenues 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, delivery has occurred or services have been provided to the client, the fee is fixed or determinable and collectability is reasonably assured. In instances where the client, at its sole discretion, has the right to reject the services prior to final acceptance, revenue is deferred until such acceptance occurs.
We evaluate our contracts for multiple deliverables, and when appropriate, separate the contracts into separate units of accounting for revenue recognition. Typically, the elements bundled together in our multiple element arrangements are: development and implementation of web, interactive, and commerce and content technologies, as well as follow-up support services, including operations, maintenance, and hosting of those technologies. We allocate revenue to the deliverables in a multiple-element arrangement based upon their relative selling prices. We determine relative selling prices for each deliverable based on a selling price hierarchy. The selling price for a deliverable is based on vendor-specific objective evidence (“VSOE”), if available. If VSOE is not available, third party evidence (“TPE”) is used, and if neither VSOE nor TPE is available, the selling price for a deliverable is based on our best estimate of selling price. In some instances, multiple contracts with a single client are combined for purposes of assessing revenue recognition.
We recognize revenues from our fixed-price technology implementation contracts and certain time-and-materials technology implementation consulting contracts using the percentage-of-completion method. We use the percentage-of-completion method because the services provided in these technology implementation contracts are similar to services in contracts that are required to use the percentage-of-completion method under GAAP, such as services provided by engineers and architects, for example. Revenues generated from fixed-price and time-and-materials non-technology implementation contracts, except for support and maintenance contracts, are recognized based upon a proportional performance model. Our percentage-of-completion method and our proportional performance method of accounting calculate revenue based on the percentage of labor incurred to
estimated total labor. This method is used because reasonably dependable estimates of labor applicable to various stages of an arrangement can be made, based on historical experience and milestones set in the contract. Our assignment 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. Revenue from time-and-materials contracts is recognized as services are provided. In situations where time-and-materials contracts require deliverables and provide for a ceiling on fees that can be charged, the arrangement is recognized as time-and-materials are incurred unless calculated fees are estimated to exceed the ceiling and additional funding is not probable, in which case revenue recognition is based on the proportional performance method. Revenues generated from support and maintenance contracts are recognized ratably over the arrangement’s term. 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 assignment 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 assignments 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 assignments at an early stage of the process, which could result in a fixed price that is too low and, therefore, a corrected estimation could adversely affect our business, financial condition and results of operations.
Revenues related to our digital marketing media sales are recorded as the net amount of our 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 consolidated financial statements, because of various pass-through expenses such as production and media costs. We are required to 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 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 when 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.
Our marketing services, including access to our technology platforms, 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 revenues are recognized as the monthly services are provided.
Revenues from offline printing and production services are recognized at the time title of the related items transfers to our clients, provided that 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 assignment 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 does not recognize revenue until collectability is reasonable assured, in addition to all other revenue recognition criteria have been met. We establish billing terms at the time assignment 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 assignment delivery and business unit finance personnel continually monitor the timeliness of payments from our clients and assess any collection issues.
Accounting for Income Taxes
We record 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 carryforwards. 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 carryforwards 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. We are required to establish a valuation allowance based on whether realization of deferred tax assets is considered to be more likely than not. Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against our net deferred tax assets. We evaluate 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 certain earnings of foreign operations indefinitely and, accordingly, we do not provide for income taxes that could result from the remittance of such earnings. When we can no longer assert indefinite reinvestment of foreign earnings, we must provide for income taxes on these amounts.
Accounting for income taxes requires a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if, based on the technical merits, it is more likely than not that the position will be sustained upon audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement. We reevaluate these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit and new audit activity. Any changes in these factors could result in the recognition of a tax benefit or an additional charge to the tax provision.
We record accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes.
Valuation of Long-Lived Assets and Goodwill
Long-lived assets other than goodwill, which is separately tested for impairment, are evaluated for impairment whenever events or changes in circumstances indicate 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 the 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. We assess the useful lives and possible impairment of long-lived assets when an event occurs that may trigger such a review. Determining whether a triggering event has occurred includes significant judgment by management. Factors we consider important which could trigger an impairment review include, but are not limited to:
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significant underperformance relative to historical or projected future operating results;
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significant changes in the manner of 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.
We assess goodwill annually (during the fourth quarter), or more frequently when events and circumstances, such as the ones mentioned above, occur indicating that the recorded goodwill may be impaired. In assessing goodwill for impairment, an entity has the option to assess qualitative factors to determine whether events or circumstances indicate that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount. If this is the case, then performing the quantitative two-step goodwill impairment test is unnecessary. An entity can choose not to perform a qualitative assessment for any or all of its reporting units, and proceed directly to the use of the two-step impairment test. In assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we assess relevant events and circumstances that may impact the fair value and the carrying amount of a reporting unit. The identification of relevant events and circumstances and how these may impact a reporting unit’s fair value or carrying amount involve significant judgments by management. These judgments include the consideration of macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, events which are specific to Sapient, and trends in the market price of our common stock. Each factor is assessed to determine whether it impacts the impairment test positively or negatively, and the magnitude of any such impact.
The quantitative two-step goodwill impairment test requires us to identify our reporting units and to determine estimates of the fair values of those reporting units as of the date we test for impairment. Assets and liabilities, including goodwill, are allocated to reporting units based on factors such as specific identification and percentage of revenue. To conduct a quantitative two-step goodwill impairment test, the fair value of the reporting unit is first compared to its carrying value. If the reporting unit’s carrying value exceeds its fair value, we perform the second step and record an impairment loss to the extent that the carrying value of goodwill exceeds its implied fair value. The Company utilizes a combined weighted average of a market based approach (utilizing fair value multiples of comparable publicly traded companies) and an income based approach (utilizing discounted projected after tax cash flows) to determine the fair value of its reporting units.
These types of analyses contain uncertainties because they require management to make assumptions and to apply judgment to estimate industry economic factors and the profitability of future business strategies. It is our policy to conduct impairment testing based on our current business strategy in light of present industry and economic conditions, as well as our future expectations.
Contingent Liabilities
We have certain contingent liabilities that arise in the ordinary course of our business activities. We accrue for loss contingencies when losses become probable and are reasonably estimable. If the reasonable estimate of the loss is a range and no amount within the range is a better estimate, the minimum amount of the range is recorded as a liability. We do not accrue for contingent losses that, in our judgment, are considered to be reasonably possible, but not probable; however, we disclose the range of such reasonably possible losses.
Accounting for Acquisitions
We account for acquisitions using the acquisition method. The acquisition method requires us to recognize and measure the fair value of identifiable assets acquired, liabilities assumed and any non-controlling interest in the acquired entity. 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. Our financial position and results of operations may be materially impacted by the initial selection of, or changes in, assumptions and estimates used in accounting for prior or future acquisitions.
Accounting for Stock-Based Compensation
We issue various types of stock-based awards to employees, directors and certain key persons (including consultants and advisors) under stockholder-approved plans. For such awards, we measure compensation cost at
fair value on the grant date and recognize this cost as stock-based compensation expense over the requisite service period. We make estimates and assumptions which impact the amounts of expense recognized in our consolidated statement of operations, including estimated forfeiture rates. Also, for awards which include performance conditions, we make estimates as to the probability that the underlying performance conditions will be met. Changes to these estimates and assumptions may have a significant impact on the value and timing of stock-based compensation expense recognized, which could have a material impact on our consolidated financial statements.
New Accounting Pronouncements
For information regarding our new accounting pronouncements, see Note 2(s), Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements included in Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
Our cash equivalents and our portfolio of marketable securities are subject to market risk due to changes in interest rates. The market values of fixed rate securities may be adversely impacted due to a rise in market interest rates, while floating rate securities may yield less income than expected if market interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates, and we may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in interest rates. If the interest rate had fluctuated by 10%, the increase or decrease in value of our marketable securities would not have been material as of December 31, 2013 and our interest income would not have changed by a material amount for the year ended December 31, 2013.
The estimated fair value of our marketable securities portfolio was $5.9 million as of December 31, 2013, which consisted entirely of mutual funds.
The estimated fair value of our marketable securities portfolio was $7.5 million as of December 31, 2012, which included $6.3 million of mutual funds and $1.2 million of Auction Rate Securities (“ARS”).
Exchange Rate Sensitivity
We face exposure to adverse movements in foreign currency exchange rates because significant portions of our revenues, expenses, assets, and liabilities are denominated in currencies other than the U.S. dollar, primarily the British pound sterling, the euro, the Indian rupee and the Canadian dollar. These exposures may change over time as business practices evolve.
Foreign Currency Transaction Exposure
Foreign currency transaction exposure is derived primarily from intercompany transactions of a short-term nature and transactions with clients or vendors in currencies other than the functional currency of the legal entity in which the transaction is recorded. Assets and liabilities arising from such transactions are translated into the legal entity’s functional currency at each reporting period using period-end exchange rates and any resulting gain or loss as a result of currency fluctuations is recorded in “General and administrative expenses” in our consolidated statements of operations. Foreign currency transaction net losses of $1.0 million and gains of $0.4 million were recorded for the years ended December 31, 2013 and 2012, respectively.
We mitigate foreign currency transaction exposure by settling these types of transactions in a timely manner where practical, thereby limiting the amount of time that the resulting non-functional currency asset or liability remains outstanding and subject to exchange rate fluctuations.
Foreign Currency Translation Exposure
Foreign currency translation exposure is derived from the translation of the financial statements of our subsidiaries for which the functional currency is not the U.S. dollar into U.S. dollars for consolidated reporting purposes. These subsidiaries’ balance sheets are translated into U.S. dollars using period-end exchange rates and their income statements are translated into U.S. dollars using individual transactional exchange rates or average monthly exchange rates. Any difference between the period-end exchange rates and the transactional or average monthly rates is recorded in “Accumulated other comprehensive loss” in our consolidated balance sheets.
For 2013, approximately 26% of our revenues and approximately 44% of our operating expenses were generated by subsidiaries for which the functional currency is not the U.S. dollar and thus subject to foreign currency translation exposure, as compared to 21% and 47%, respectively, for 2012. In addition, 50% of our assets and 40% of our liabilities were subject to foreign currency translation exposure as of December 31, 2013, as compared to 49% of our assets and 41% of our liabilities as of December 31, 2012. We also have assets and liabilities in certain entities that are denominated in currencies other than the entity’s functional currency and are subject to foreign currency transaction exposure, as described above.
Approximately 15% of our operating expenses for 2013 were incurred by foreign subsidiaries whose functional currency is the Indian rupee. Because we have minimal associated revenues in Indian rupees, any significant movement in the exchange rate between the U.S. dollar and the Indian rupee has a significant impact on our operating expenses and operating profit. Approximately 10% and 2% of our service revenues for 2013 were generated by foreign subsidiaries whose functional currencies are the British pound sterling, and the euro, respectively. Any significant movements in the exchange rates between the U.S. dollar and the British pound sterling and the U.S. dollar and the euro, have a significant impact on our service revenues and operating income. We manage these exposures through a risk management program which is designed to mitigate our exposure to operating expenses incurred by foreign subsidiaries whose functional currency is the Indian rupee and operating margins in foreign subsidiaries whose functional currencies are the British pound sterling and the euro. This program includes the use of derivative financial instruments which are not designated as accounting hedges. As of December 31, 2013, we had option contracts outstanding in the notional amount of approximately $34.2 million ($24.3 million for our Indian rupee contracts, $8.2 million for our British pound sterling contracts, and $1.7 million for our euro contracts). Because these instruments are average rate option collars that are settled on a net basis with the counterparty banks, we have not recorded the gross underlying notional amounts in our consolidated balance sheets as of December 31, 2013. The following table presents net realized and unrealized gains or losses on our option contracts for 2013, 2012 and 2011 (in thousands):
We also performed a sensitivity analysis of the possible losses that could be incurred on these contracts as a result of unfavorable movements in the respective foreign currency exchange rates. The following table presents the maximum losses on these unsettled positions that would result from changes of 10%, 15% and 20% in the underlying average exchange rates of the respective foreign currencies (in thousands):
Open option positions as of December 31, 2013 expire in January, February and March of 2014 and, therefore, any realized losses in respect to these positions after December 31, 2013 would be recognized in the three months ending March 31, 2014.
For additional discussion of the risks we face and the recorded gains and losses as a result of foreign currency fluctuations, see Part I, Item 1A, Risk Factors, and Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this Annual Report on Form 10-K.
Item 8.
Item 8. Financial Statements and Supplementary Data
SAPIENT CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
of Sapient Corporation
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, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013 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 index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company did not maintain, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) because a material weakness in internal control over financial reporting related to the accounting for certain tax liabilities resulting from the global movement of employees existed as of that date. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weakness referred to above is described in the Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. We considered this material weakness in determining the nature, timing, and extent of audit tests applied in our audit of the 2013 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. The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in management’s report referred to above. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included 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. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
As discussed in Note 21 to the consolidated financial statements, the Company has restated its 2012 and 2011 financial statements to correct an error.
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.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
March 18, 2014
SAPIENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
The accompanying notes are an integral part of these Consolidated Financial Statements.
SAPIENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
The accompanying notes are an integral part of these Consolidated Financial Statements.
SAPIENT CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(1) Reclassification for realized loss on available-for-sale investments is presented in “Other income, net”
The accompanying notes are an integral part of these Consolidated Financial Statements.
SAPIENT CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(In thousands)
The accompanying notes are an integral part of these Consolidated Financial Statements.
SAPIENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
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 company that helps clients identify and act upon opportunities to improve their business performance by capitalizing on changes, disruptions, or opportunities that exist in their business or industry. The Company markets its services through three primary business units - SapientNitro, Sapient Global Markets and Sapient Government Services - positioned at the intersection of marketing, business and technology. SapientNitro is a new breed of agency which helps clients tell their stories through seamless experiences across brand communications, digital engagement, and omni-channel commerce. Sapient Global Markets provides business and technology services to capital and commodity market participants, intermediaries and regulators. Sapient Government Services provides consulting, technology, and marketing services to a wide array of U.S. governmental agencies, non-profit organizations and non-governmental organizations. Headquartered in Boston, Massachusetts, Sapient maintains a global presence with offices across the Americas, Europe, South America, and the Asia-Pacific region, including India.
(2) 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 controlled subsidiaries. All intercompany transactions have been eliminated in consolidation.
The results of operations of acquired companies have been included in the Company’s consolidated financial statements as of the respective acquisition dates, as described further in Note 3, Business Acquisitions.
Restatement of Prior Period Financial Statements
The Company has restated herein its audited consolidated financial statements as of and for the two years ended December 31, 2012 and its unaudited consolidated financial statements for each of the interim periods in the year ended December 31, 2012 and for the first three quarters in the year ended December 31, 2013.
For further information regarding the Company’s restatement, see Note 21, Restatement.
(b) Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions about future events, and apply judgments that affect the reported amounts of assets, liabilities, revenues, expenses and the related disclosures at the date of the financial statements. Significant estimates relied upon in preparing these financial statements include, but are not limited to, estimated costs to complete long-term contracts, accounting for acquisitions, estimated fair values of reporting units used to evaluate goodwill for impairment, stock-based compensation expenses, contingent liabilities and recoverability of the Company’s net deferred tax assets and related valuation allowances. The Company bases its assumptions, estimates and judgments on historical experience, current trends and other factors that management of the Company believes to be relevant at the time its consolidated financial statements are prepared. On a regular basis, management of the Company reviews the accounting policies, assumptions, estimates and judgments to ensure that the Company’s financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from the Company’s assumptions and estimates, and such differences could be material.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(c) Foreign Currency Translation and Transactions
Foreign currency translation exposure is derived from the translation of the financial statements of the Company’s subsidiaries for which the functional currency is not the U.S. dollar into U.S. dollars for consolidated reporting purposes. Assets and liabilities of these subsidiaries are translated into U.S. dollars at period-end exchange rates, and income statement items are translated using individual transactional exchange rates or average monthly exchange rates. The functional currency for the majority of the Company’s foreign subsidiaries is considered to be the local currency and, accordingly, translation adjustments for those subsidiaries are recorded as a separate component of stockholders’ equity in the caption “Accumulated other comprehensive loss”.
Cash flows of subsidiaries for which the functional currency is not the U.S. dollar are translated to U.S. dollars using 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.
Foreign currency transaction exposure is derived primarily from intercompany transactions of a short-term nature and transactions with clients or vendors in currencies other than the functional currency of the legal entity in which the transaction is recorded. Assets and liabilities arising from such transactions are translated into the legal entity’s functional currency at each reporting period using period-end exchange rates, and any resulting gain or loss as a result of currency fluctuations is recorded in “General and administrative expenses” in the Company’s consolidated statements of operations. Net (losses) gains from foreign currency transactions were $(1.0) million, $0.4 million and $1.6 million during 2013, 2012 and 2011, respectively.
(d) Cash and Cash Equivalents and Restricted Cash
The Company considers all highly liquid investments with a remaining maturity of three months or less from the date of purchase to be cash equivalents. At December 31, 2013, cash equivalents consisted of money market instruments and bank time deposits. The Company had short-term and long-term restricted cash totaling $2.1 million and $11.9 million at December 31, 2013 and 2012, respectively.
(e) Marketable Securities, Investments and Other Financial Assets
The Company classifies its marketable securities as “available-for-sale” or “trading” securities.
Available-for-sale securities are classified as short term investments and long-term investments on the consolidated balance sheets and are carried at fair value. Unrealized gains and losses on available-for-sale securities that are considered temporary are recorded, net of taxes, in the “Accumulated other comprehensive loss” caption of the Company’s consolidated balance sheets. Unrealized losses, excluding losses related to the credit rating of the security (credit losses), on available-for-sale securities that are considered other-than-temporary but relate to securities that the Company (i) does not intend to sell and (ii) will not be required to sell below cost are also recorded, net of taxes, in “Accumulated other comprehensive loss”. The Company does not intend to sell its available-for-sale securities before they mature. Further, the Company does not believe it will be required to sell such securities below cost. Therefore, the only other-than-temporary losses the Company records in “Other income, net” in its consolidated statements of operations are related to credit losses. The Company’s available-for-sale securities as of December 31, 2012 consist of Auction Rate Securities (“ARS”), which are collateralized by municipal debt and student loans, and mutual funds that are listed on a foreign exchange. As of December 31, 2013, the Company’s available-for-sale securities consisted of mutual funds that are listed on a foreign exchange.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Trading securities are carried on the balance sheet at fair value with unrealized gains and losses recorded in the “Other income, net” caption of the consolidated statements of operations. As of December 31, 2013 and 2012, the Company did not hold any trading securities.
The Company uses a framework for measuring fair value under GAAP and enhanced disclosures about fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The Company’s financial assets and liabilities reflected in the consolidated financial statements at carrying value include marketable securities and other financial instruments which approximate fair value. Fair value for marketable securities is determined using a market approach based on quoted market prices at period end in active markets.
The fair value hierarchy is based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value. Those levels are:
•
Level 1 - Quoted prices in active markets for identical assets or liabilities.
•
Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
•
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets and liabilities.
The Company classifies its marketable securities, investments and other financial assets and liabilities as either Level 1, 2 or 3 assets or liabilities according to the above hierarchy.
(f) Financial Instruments and Concentration of Credit Risk
Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents, restricted cash, marketable securities, accounts receivable and unbilled revenues.
The Company performs credit evaluations of its clients and generally does not require collateral on accounts receivable. The Company maintains allowances for credit losses and such losses have been within management’s expectations. During 2013, 2012 and 2011, no individual client accounted for greater than 10% of service revenues. No individual client’s accounts receivable balance exceeded 10% of total accounts receivable as of December 31, 2013 or 2012.
The carrying amounts of cash and cash equivalents, restricted cash, marketable securities, accounts receivable, unbilled revenues, accounts payable, accrued expenses, accrued compensation, income taxes payable, deferred revenues and other long-term liabilities at both December 31, 2013 and 2012 approximate their fair market values due to the nature of the items.
(g) Derivative Financial Instruments
The Company uses derivative financial instruments in the management of its foreign currency exposures. The Company does not hold or issue derivative financial instruments for speculative purposes.
The Company manages its foreign currency exposures through a risk management program which is designed to mitigate its exposure to operating expenses incurred by foreign subsidiaries whose functional
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
currency is the Indian rupee and operating margins in foreign subsidiaries whose functional currencies are the British pound sterling and the euro. This program includes the use of derivative financial instruments, consisting of foreign currency option contracts, which are not designated as accounting hedges. The Company uses these instruments to mitigate its exposure to movements of the Indian rupee, British pound sterling, and euro, relative to the U.S. dollar. The Company records all derivative instruments on its consolidated balance sheets at fair value. Changes in a derivative’s fair value through the settlement date are recognized in current period earnings unless specific hedge criteria are met.
Currently, the Company enters into 30-day average rate instruments covering rolling periods of up to four months, with the following notional amounts as of December 31, 2013:
•
1.5 billion Indian rupees (approximately $24.3 million)
•
5.0 million British pounds sterling (approximately $8.2 million)
•
1.3 million euros (approximately $1.7 million)
Because these instruments are average rate option collars that are settled on a net basis with the counterparty banks, the Company has not recorded the gross underlying notional amounts in its consolidated balance sheets as of December 31, 2013 or 2012. Open option positions as of December 31, 2013 will settle in the three month period ending March 31, 2014. None of the Company’s derivative financial instruments qualified for hedge accounting.
The following table presents the fair values of the derivative assets and liabilities recorded on the Company’s consolidated balance sheets as of December 31, 2013 and 2012 (in thousands):
Realized and unrealized gains and losses on the Company’s foreign exchange option contracts are included in “General and administrative expenses” in its consolidated statements of operations. The following table presents the effect of realized and unrealized gains and losses, net, of the Company’s foreign exchange option contracts on its results of operations for the years ended December 31, 2013, 2012 and 2011 (in thousands):
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(h) 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 3 to 30 years. Leasehold improvements are amortized over the lesser of the estimated useful lives of the assets or the remaining lease term. Buildings are depreciated over estimated useful lives of up to 30 years. When an item is sold or retired, the cost and related accumulated depreciation are relieved, and the resulting gain or loss, if any, is recognized in the consolidated statements of operations.
Occasionally, the Company is involved with the construction of leased office spaces. For leases in which the Company is involved with the construction of the building (generally on land owned by the landlord), the Company accounts for the lease during the construction period under the provisions of FASB Accounting Standards Codification (“ASC”) Subtopic 840-40 (“ASC 840-40”), Leases - Sale-Leaseback Transactions (formerly Emerging Issues Task Force No. 97-10, The Effect of Lessee Involvement in Asset Construction). If the Company concludes that it has substantively all the risks of ownership during construction of the leased property and therefore is deemed the owner of the leased property for accounting purposes during the construction period, it is required to record an asset and a related financing obligation on its consolidated balance sheet for the amount of total project costs related to construction-in-progress and the pre-existing building. Upon completion of construction, the Company considers the requirement under ASC 840-40 for sale-leaseback treatment. If the arrangement does not qualify for sale-leaseback treatment, the Company continues to amortize the financing obligation and depreciate the building over the lease term. At the end of the lease term, including exercise of any renewal options, the net remaining financing obligation over the net carrying value of the fixed asset is recognized as a non-cash gain on sale of the property. The Company does not record rent expense for the properties which are considered to be owned for accounting purposes. Rather, rental payments under the lease are recorded as a reduction of the financing obligation and interest expense.
The Company records final closure costs (also referred to as “asset retirement obligations”) when a contractual requirement exists to permanently retire capitalized improvements to a leased asset. Asset retirement obligations are calculated by estimating the total obligation in current dollars, adjusted for local inflation, and discounted at the Company’s credit-adjusted risk-free interest rate. A corresponding asset retirement cost is also recorded when the initial liability is incurred, which is depreciated over its estimated useful life. The aggregate fair value of the Company’s asset retirement obligations are $2.5 million as of December 31, 2013, which are classified within “Other long-term liabilities” in the Company’s consolidated balance sheets. The fair value of the Company’s aggregate asset retirement costs are $1.3 million as of December 31, 2013, which are classified within “Property and equipment, net,” in the Company’s consolidated balance sheets.
(i) Costs Incurred to Develop Computer Software for Internal Use
The Company capitalizes costs incurred during the application development stage, which include costs of designing 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 generally expensed as incurred. Capitalized development costs are amortized over the estimated life of the software, typically three years, using the straight-line method, beginning with the date that an asset is ready for its intended use. The capitalization and ongoing assessment of development costs requires considerable judgment by management, including, but not limited to, technological feasibility and estimated economic life. Capitalized software is included in “Property and equipment, net” on the consolidated balance sheets.
The Company capitalized costs of $4.3 million, $2.1 million, and $2.8 million in 2013, 2012 and 2011, respectively, which primarily related to the development of internal financial and human resources systems, a
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
project planning application and other upgrades. Of such total capitalized costs, $3.4 million, $1.2 million, and $1.9 million related to costs associated with software developed for internal use that was placed into service for 2013, 2012 and 2011, respectively. The remaining $0.9 million, $0.9 million, and $0.9 million related to costs associated with the development of software for internal use that was not yet placed into service as of December 31, 2013, 2012 and 2011, respectively. The capitalized costs placed in service during 2013, 2012 and 2011 are being amortized over three years. Amortization expenses for costs incurred to develop computer software for internal use totaled $2.7 million, $2.3 million and $2.6 million during 2013, 2012 and 2011, respectively, and are included in “General and administrative expenses” on the consolidated statements of operations and “Depreciation expense” on the consolidated statements of cash flows.
(j) Costs Incurred to Sell, Lease, or Otherwise Market Computer Software
GAAP specifies that internal costs incurred in researching and developing a computer software product to sell, lease or otherwise market, 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 clients. 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. Unamortized capitalized software costs included in “Property and equipment, net” on the consolidated balance sheets as of December 31, 2013 and 2012 were approximately $1.4 million and $0.8 million, respectively. Amortization expense totaled $0.5 million, $0.6 million and $0.6 million for the years ended December 31, 2013, 2012 and 2011, respectively, and is included in “Project personnel expenses” on the consolidated statements of operations. The Company capitalized costs of $1.1 million, $0.6 million and $0.4 million during the years ended December 31, 2013, 2012 and 2011, respectively. These capitalized costs are amortized over the expected useful life of the related product.
(k) Purchased Intangible Assets and Goodwill
In September 2011, the FASB issued Accounting Standards Update No. 2011-08 (“ASU 2011-08”), Testing Goodwill for Impairment, which amends ASC Topic 350, Intangibles-Goodwill and Other, with regard to performing annual and interim goodwill impairment tests. ASU 2011-08 provides entities with an option to perform a qualitative assessment to determine whether further impairment testing is necessary. An entity can perform the qualitative assessment on some, all or none of its reporting units. Under ASU 2011-08, an entity has the option to first assess qualitative factors to determine whether performing the quantitative two-step impairment test is necessary. If an entity believes, as a result of its qualitative assessment, that it is more likely than not that the fair value of a reporting unit is less than its carrying value, the quantitative impairment test will be required. Otherwise, no further testing will be required. The qualitative indicators also replace those previously used to determine whether an interim goodwill impairment test is required, and also are used when assessing whether to perform step two of the goodwill impairment test for reporting units with zero or negative carrying amounts.
The Company performs its annual goodwill impairment test during the fourth quarter, or more frequently when events and circumstances, such as the ones mentioned above for intangible assets, occur indicating that the recorded goodwill may be impaired. In assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the Company assesses relevant events and circumstances that may impact the fair value and the carrying amount of a reporting unit. The identification of relevant events and circumstances and how these may impact a reporting unit’s fair value or carrying amount involve significant judgments by management. These judgments include the consideration of macroeconomic conditions, industry and market considerations, cost factors, overall financial performance events which are
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
specific to the Company, and trends in the market price of the Company’s common stock. Each factor is assessed to determine whether it impacts the impairment test positively or negatively, and the magnitude of any such impact.
The quantitative two-step goodwill impairment test requires the Company to identify its reporting units and to determine estimates of the fair values of those reporting units as of the impairment testing date. Assets and liabilities, including goodwill, are allocated to reporting units based on factors such as specific identification and percentage of revenue. In the first step of a quantitative two-step goodwill impairment test, the fair value of the reporting unit is first compared to its carrying value. If the reporting unit’s carrying value exceeds its fair value, the Company performs the second step and records an impairment loss to the extent that the carrying value of goodwill exceeds its implied fair value. The Company utilizes a combined weighted average of a market based approach (utilizing fair value multiples of comparable publicly traded companies) and an income based approach (utilizing discounted projected after tax cash flows) to determine the fair value of its reporting units. Determining the fair values of reporting units and goodwill includes significant judgment by management, and different judgments could yield different results.
The Company performed its annual assessment of goodwill during the fourth quarter of 2013, using the quantitative approach described above.
Based on the results of the annual goodwill impairment test in 2013, the fair value of each of the Company’s reporting units exceeded their respective carrying value, and therefore the Company concluded that no impairment charges were required in 2013. However, one of the Company’s reporting units exceeded its carrying value by a smaller margin than the other reporting units. The 2013 fair value assessment determined that the fair value of such reporting unit exceed its carrying value by approximately 18% in 2013. A significant negative change in any of the factors mentioned above could negatively affect the financial performance of any of the reporting units and negatively impact the goodwill impairment test.
(l) Valuation of Long-Lived Assets
Long-lived assets primarily consist of property and equipment and intangible assets with finite lives. Long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate 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 future undiscounted 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.
The Company assesses the useful lives and possible impairment of existing recognized intangible assets whenever events or changes in circumstances occur that indicate that it is more likely than not that an impairment has occurred. The Company tests intangible assets with definite lives for impairment by comparing the carrying amount to the sum of the net undiscounted cash flows expected to be generated by the asset whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If the carrying amount of the asset exceeds its net undiscounted cash flows, then an impairment loss is recognized for the amount by which the carrying amount exceeds its fair value. The Company uses a discounted cash flow approach or other methods, if appropriate, to assess fair value. Factors considered important which could trigger a review include:
•
significant underperformance relative to historical or projected future operating results;
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significant changes in the manner of 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 involves significant judgment by the Company. 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, tradenames and order backlog. Finite-lived purchased intangible assets are amortized over their expected period of benefit, which generally ranges from one to eight years.
(m) Revenue Recognition and Allowance for Doubtful Accounts
The Company recognizes revenues 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, delivery has occurred, or services have been provided to the client, the fee is fixed or determinable and collectability is reasonably assured. In instances where the client, at its sole discretion, has the right to reject the services prior to final acceptance, revenue is deferred until such acceptance occurs.
The Company evaluates its contracts for multiple deliverables, and when appropriate, separates the contracts into separate units of accounting for revenue recognition. Typically, the elements bundled together in our multiple element arrangements are: development and implementation of web, interactive, and commerce and content technologies, as well as follow-up support services, including operations, maintenance, and hosting of those technologies. The Company allocates revenue to the deliverables in a multiple-element arrangement based upon their relative selling prices. The Company determines relative selling prices for each deliverable based on a selling price hierarchy. The selling price for a deliverable is based on vendor-specific objective evidence (“VSOE”), if available. If VSOE is not available, third party evidence (“TPE”) is used, and if neither VSOE nor TPE is available, the selling price for a deliverable is based on our best estimate of selling price. In some instances, multiple contracts with a single client are combined for purposes of assessing revenue recognition. The revenues earned from these multiple element arrangements were not material to the Company’s consolidated revenues for any of the years ended December 31, 2013, 2012, or 2011.
The Company recognizes revenues from its fixed-price technology implementation contracts and certain time-and-materials technology implementation consulting contracts using the percentage-of-completion method. The Company uses the percentage-of-completion method because the services provided in these contracts are similar to those in contracts that are required to use the percentage-of-completion method under GAAP, such as services provided by engineers and architects. Revenues generated from fixed-price and time-and-materials non-technology implementation contracts, except for support and maintenance contracts, are recognized based upon a proportional performance model. The Company’s percentage-of-completion method and its proportional performance method 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 labor applicable to various stages of an arrangement can be made, based on historical experience and milestones set in the contract. The Company’s 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. Revenue from time-and-materials contracts is recognized as services are provided. In situations where time-and-materials contracts require deliverables and provide for a ceiling on fees that can be charged, the arrangement is recognized
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as time-and-materials are incurred unless calculated fees are estimated to exceed the ceiling and additional funding is not probable, in which case revenue recognition is based on the proportional performance method. Revenues generated from fixed-price support and maintenance contracts are typically recognized ratably over the arrangement’s term.
Revenues related to digital marketing media sales are recorded as the net amount of our 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. The Company is required to assess 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 when management believes the key indicators of the business suggest that the Company generally acts as an agent on behalf of its clients in its primary lines of business.
Marketing services, including access to the Company’s technology platforms, are provided in exchange for monthly retainer fees and license fees, and revenues are recognized as the monthly services are provided. These services are provided in exchange for monthly retainer fees and license fees and revenues are recognized as the monthly services are provided.
Revenues from offline printing and production services are recognized at the time title of the related items transfers to the client, provided that 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 assignment 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 does not recognize revenue until collectability is reasonably assured and all other revenue recognition criteria have been met. The Company establishes billing terms at the time assignment 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 assignment delivery and business unit finance personnel continually monitor the timeliness of payments from clients and assess any collection issues. The Company maintains allowances for doubtful accounts for losses resulting from the inability of clients to make required payments. The Company uses the specific identification method and bases its estimates on historical collection and write-off experience, current trends, credit policy, and detailed analysis of specific client situations. 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 payments, 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.
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(n) Stock-Based Compensation
The Company recognizes the fair value of stock-based awards as stock-based compensation expense, net of a forfeiture rate, on a straight-line basis over the requisite service period of the award when the only condition to vesting is continued employment. If vesting is subject to a market or performance condition, vesting is based on the derived service period. The Company estimates its forfeiture rate based on its historical experience and any known factors that may influence future forfeitures. The fair value per share of Restricted Stock Unit (“RSU”) awards is equal to the quoted market price of the Company’s common stock on the date of grant. Restricted stock that is contingent on employment and/or has performance conditions is valued based on the fair market value on the date of issuance. RSU awards with market-based vesting criteria are valued using a lattice model. The Company uses the Black-Scholes valuation model for estimating the fair value of stock options granted.
The Company granted RSUs in 2013, 2012 and 2011. The Company has not granted stock options, regularly, since 2006. The Company is required to estimate the expected forfeiture rate and recognize expense only for those awards expected to vest. If actual forfeiture experience is materially different from the estimate, the stock-based compensation expense could be significantly different from the amount the Company has recorded in the current period. The Company’s 2013, 2012 and 2011 annual reviews of its forfeiture estimates did not yield any material adjustments.
(o) 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 expense recorded by the Company were immaterial for all periods presented.
(p) 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 carryforwards. 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 carryforwards 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. The Company is required to establish a valuation allowance based on whether realization of deferred tax assets is considered to be more likely than not. 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. The Company reinvests certain earnings of foreign operations indefinitely and, accordingly, does not provide for income taxes that could result from the remittance of such earnings. When the Company can no longer assert indefinite reinvestment of foreign earnings, it must provide for income taxes on those amounts.
Accounting for income taxes requires a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if, based on the technical merits, it is more likely than not that the position will be sustained upon audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement. The Company reevaluates these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit and new audit activity. Any changes in
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these factors could result in the recognition of a tax benefit or an additional charge to the tax provision. The Company records accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes.
(q) Net Income per Share
The Company presents basic net income per share and diluted net income per share. Basic net 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 net income per share reflects the per share effect of dilutive common share equivalents.
(r) Comprehensive Income
Comprehensive income includes net income and also considers the effect of other changes to stockholders’ equity that are not included in the determination of net income, but rather are reported as a separate component of stockholders’ equity. The Company reports unrealized gains and losses on investments (those which are considered temporary), net of taxes, and foreign currency translation adjustments as components of comprehensive income.
(s) New Accounting Pronouncements
In July 2013, the FASB issued Accounting Standards Update (“ASU”) No. 2013-11 (“ASU 2013-11”), Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This amendment requires entities to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward or a similar tax loss or a tax credit carryforward, unless certain conditions exist. This guidance is effective prospectively for annual reporting periods (and the interim periods within) beginning after December 15, 2013. Early adoption and retrospective application are permitted. The Company expects to adopt ASU 2013-11 effective January 1, 2014 and does not expect this adoption to have a material impact on its financial condition, results of operations or cash flows.
In March 2013, the FASB issued ASU No. 2013-05 (“ASU 2013-05”), Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity. This amendment requires a parent company to release any related cumulative translation adjustment into net income only if a sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. This guidance is effective prospectively for annual reporting periods (and the interim periods within) beginning after December 15, 2013. Early adoption and retrospective application are permitted. The Company expects to adopt ASU 2013-05 effective January 1, 2014 and does not expect this adoption to have a material impact on its financial condition, results of operations or cash flows.
In February 2013, the FASB issued ASU No. 2013-02 (“ASU 2013-02”), Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. ASU 2013-02 requires companies to provide information about the amounts reclassified out of accumulated other comprehensive income by component. Companies are also required to disclose these reclassifications by each respective line item on the statements of operations. ASU 2013-02 is effective prospectively for annual reporting periods beginning after December 15, 2012, and interim periods within those annual periods. The Company adopted ASU 2013-02 on January 1, 2013 and this adoption did not have a material impact on the Company’s financial results or disclosures. During the year ended December 31, 2013, the Company reclassified certain
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amounts relating to unrealized losses on marketable securities out of accumulated other comprehensive income, and the related disclosures have been presented in the consolidated statements of comprehensive income.
In December 2011, the FASB issued ASU 2011-11 (“ASU 2011-11”), Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. This amendment requires disclosing and reconciling gross and net amounts for financial instruments that are offset in the balance sheet, and amounts for financial instruments that are subject to master netting arrangements and other similar clearing and repurchase arrangements. In January 2013, the FASB issued Accounting Standards Update 2013-1 (“ASU 2013-1”), Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, which clarifies the scope of the offsetting disclosures of ASU 2011-11. ASU 2011-11 and ASU 2013-1 are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. The Company adopted ASU 2011-11 and ASU 2013-01 on January 1, 2013, which did not have a material impact on the Company’s disclosures.
(3) Business Acquisitions
2013 Acquisitions
“la comunidad” CORPORATION and La Comunidad S.A.
On December 30, 2013, the Company acquired 100% of the outstanding equity of “la comunidad” CORPORATION and La Comunidad S.A. (together, “La Comunidad”), an independent multicultural creative agency based in Miami, Florida and Buenos Aires, Argentina. The Company acquired La Comunidad to leverage the growing importance of multicultural marketing in expanding Sapient’s combination of brand and creative service offerings to its clients. The acquisition added approximately 89 people and was allocated to the SapientNitro reportable segment.
The acquisition date fair value, net of cash acquired, was $21.0 million for the purchase of 100% of La Comunidad’s common stock. This total consisted of $9.7 million in cash (net of cash acquired), stock-based awards with an estimated fair value of $2.0 million and contingent consideration with estimated fair value of $9.3 million. Of the stock-based awards, $1.5 million was not issued at the time of acquisition (determined fair value of $0.9 million), of which $1.0 million shall serve as security for any claims made by the Company, and $0.5 million is related to final working capital adjustments. Of the cash amount, $0.3 million remains a liability of the Company and will settle with the final working capital adjustments.
Assets acquired and liabilities assumed were recorded at their estimated fair values as of the acquisition date. The fair values of identifiable intangible assets were based on valuations using the income approach and estimates provided by management. The excess of the purchase price over the tangible assets, identifiable intangible assets and assumed liabilities was recorded as goodwill. The preliminary fair value of goodwill, intangible assets and net assets were approximately $13.9 million, $6.1 million, and $1.1 million, respectively. These amounts are subject to subsequent adjustment as the Company obtains additional information during the measurement period and finalizes its fair value estimates primarily with respect to certain components of working capital and deferred income taxes.
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The Company believes the amount of goodwill is attributable to the workforce of the acquired business (which is not eligible for separate recognition as an identifiable intangible asset) and the expected synergistic benefits of being able to leverage La Comunidad’s expertise with the Company’s existing services to provide integrated marketing services to the customer bases of both the Company and La Comunidad. All of the goodwill was allocated to the Company’s SapientNitro reportable segment. The following table presents the estimated fair values (in thousands) and useful lives of intangible assets acquired:
The useful lives of these intangible assets were based upon the patterns in which the economic benefits related to such assets are expected to be realized, and the intangible assets will be amortized on a basis reflecting those economic patterns. The “la comunidad” CORPORATION’s acquired goodwill and intangible assets will be deductible for tax purposes.
The former owners of La Comunidad are also eligible to receive additional consideration of up to $24.0 million, which is contingent on the fulfillment of certain financial and other performance conditions during the years ending December 31, 2014 through December 31, 2017. If such conditions are achieved, the consideration is payable under certain circumstances in cash or a combination of cash and common stock. Using a discounted cash flow method, the Company recorded an estimated liability of $9.3 million as of the acquisition date and as of December 31, 2013. The Company will continue to assess the probability that the conditions will be fulfilled, and any subsequent changes in the estimated fair value of the liability will be reflected in earnings until the liability is fully settled.
Consolidated service revenues and net income for 2013 attributable to La Comunidad since the acquisition date were not material. Pro forma results of operations have not been included, as the acquisition of La Comunidad was not material to the Company’s results of operations for any periods presented.
iThink Comunicação e Publicidade Ltda.
On January 16, 2013, the Company acquired 81% of the outstanding securities of iThink Comunicação e Publicidade Ltda. (“iThink”), an independent digital agency based in Sao Paulo, Brazil. The Company acquired iThink to expand Sapient’s combination of brand, digital and commerce service offerings to global clients in Latin America.
The acquisition date fair value, net of cash acquired, was $6.8 million for the purchase of 81% of iThink’s outstanding securities, including the fair value amount of $1.2 million of noncontrolling interest. This total consisted of $4.9 million of cash paid (net of cash acquired and working capital adjustments), deferred contingent consideration with an estimated fair value of $0.7 million, and noncontrolling interest with an estimated fair value of $1.2 million. Of the cash amount paid, $2.0 million was placed into escrow, of which $1.5 million serves as security for any claims made by the Company under the terms of an escrow agreement between the Company and the former owners of iThink. The remaining amounts were related to other adjustments, including net working capital adjustments, and were released from escrow during the three months ended June 30, 2013.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Assets acquired and liabilities assumed were recorded at their estimated fair values as of the acquisition date. The fair values of identifiable intangible assets were based on valuations using the income approach and estimates provided by management. The excess of the purchase price over the tangible assets, identifiable intangible assets and net assets was recorded as goodwill. The fair value of goodwill, intangible assets and net assets was $6.3 million, $1.4 million, and $(0.4) million, respectively.
The Company believes the amount of goodwill is attributable to the workforce of the acquired business (which is not eligible for separate recognition as an identifiable intangible asset) and the expected synergistic benefits of being able to leverage iThink’s expertise with the Company’s existing services to provide integrated marketing services to the customer bases of both the Company and iThink in Latin America. All of the goodwill was allocated to the Company’s SapientNitro reportable segment. The following table presents the estimated fair values (in thousands) and useful lives of intangible assets acquired:
The useful lives of these intangible assets were based upon the patterns and periods in which the economic benefits related to such assets are expected to be realized, and the intangible assets will be amortized on a basis reflecting those economic patterns. The acquired goodwill and intangible assets will not be deductible for tax purposes.
The former owners of iThink are eligible to receive additional cash consideration of up to $11.7 million, which is contingent on the fulfillment of certain financial conditions during the three years ending December 31, 2015. Using a discounted cash flow method, the Company recorded an estimated contingent consideration liability of $0.7 million as of the acquisition date, and less than $0.1 million as of December 31, 2013. The Company will continue to assess the probability that the conditions will be fulfilled, and until the liability is fully settled, any subsequent changes in the estimated fair value of the liability will be reflected in “Acquisition costs and other related charges” in the Company’s consolidated statements of operations. The contingent consideration liability is denominated in a foreign currency and, therefore, its value as reported in U.S. dollars on the Company’s consolidated balance sheet may also change from period to period due to currency exchange rate fluctuations. During the year ended December 31, 2013, the Company recorded a benefit of $0.7 million, relating to the remeasurement of the fair value of the contingent liability. This amount is included in “Acquisition costs and other related (benefits) charges” in the Company’s consolidated statements of operations.
The Company has the right (but not the obligation) to purchase the remaining noncontrolling interest in iThink at certain times and under certain circumstances (the “Call Option”) as defined by the terms of the purchase agreement. With respect to any of the remaining equity interests in iThink for which the Company does not exercise its purchase option, the owners of the noncontrolling interest in iThink have the right (but not the obligation) (the “Put Option”) to sell their equity interests to the Company. The Call Option and Put Option may only be exercised for a period of 30 days following specific circumstances. The Call Option and Put Option are embedded features of the noncontrolling interest and are not freestanding financial instruments. Due to the presence of the Put Option, the noncontrolling interest in iThink is classified as temporary equity, between liabilities and permanent equity, in the Company’s consolidated balance sheets. The noncontrolling interest was initially recorded at fair value and is subsequently adjusted at each reporting period for comprehensive income (loss) of the subsidiary attributed to the noncontrolling interest, dividends paid to the noncontrolling interest, and changes in the controlling entity’s
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ownership interest. During the three months ended December 31, 2013, the Company made additional capital contributions and exercised its Call Option on certain a portion of the remaining noncontrolling interests, which increased Company’s ownership from 81% to 84% of the outstanding securities of iThink.
Service revenues and net losses for iThink during the year ended December 31, 2013 were $3.9 million and $1.1 million, respectively. Proforma results of operations have not been included as the acquisition of iThink was not material to the Company’s operations for any periods presented.
Prior Year Acquisitions
(m)Phasize, LLC
On December 27, 2012, the Company acquired 100% of the membership interests of (m)Phasize, LLC (“(m)Phasize”), a marketing analytics company located in Westport, Connecticut. The Company acquired (m)Phasize to strengthen its analytics services and marketing mix modeling capabilities.
The acquisition date fair value, net of cash acquired, was $18.5 million for the purchase of 100% of (m)Phasize’s membership interests. This total consisted of $12.1 million in cash, inclusive of net working capital adjustments, stock-based awards with an estimated fair value of $0.3 million, and deferred contingent consideration with an estimated fair value of $6.1 million. Of the cash amount, $2.5 million was placed into escrow; $1.2 million shall serve as security for any claims made by the Company under the terms of an escrow agreement between the Company and the former owners of (m)Phasize; $1.0 million was contingent upon meeting certain revenue targets and was released to the former owners of (m)Phasize during the three months ended March 31, 2013; and $0.3 million related to final working capital adjustments and was released to the former owners of (m)Phasize in July 2013.
Assets acquired and liabilities assumed were recorded at their estimated fair values as of the acquisition date. The fair values of identifiable intangible assets were based on valuations using the income approach and estimates provided by management. The excess of the purchase price over the tangible assets, identifiable intangible assets and assumed liabilities was recorded as goodwill. The fair value of goodwill, intangible assets and net assets were $11.8 million, $5.9 million, and $0.8 million, respectively.
The former members of (m)Phasize are also eligible to receive additional consideration of up to $12.8 million, which is contingent on the fulfillment of certain financial conditions during the years ending December 31, 2013 and 2014. If such conditions are achieved, the consideration is payable under certain circumstances in cash or a combination of cash and common stock. Using a discounted cash flow method, the Company recorded an estimated liability of $6.1 million as of the acquisition date and $7.4 million as of December 31, 2013. The Company will continue to assess the probability that the conditions will be fulfilled, and any subsequent changes in the estimated fair value of the liability will be reflected in earnings until the liability is fully settled. During the year ended December 31, 2013, the Company recorded an expense of $1.0 million relating to the remeasurement of the fair value of the contingent liability. This amount is included in “Acquisition costs and other related (benefits) charges” in the Company’s consolidated statements of operations.
Second Story Inc.
On November 1, 2012, the Company acquired Second Story Inc. (“Second Story”), an interactive studio operating in the United States. The Company acquired Second Story to strengthen the Company’s ability to craft physical and digital experiences from web and mobile to in-store and in-venue.
The acquisition date fair value, net of cash acquired, was $9.9 million for the purchase of 100% of Second Story’s outstanding shares. This total consisted of $6.0 million in cash, restricted stock with an estimated fair
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value of $2.1 million, and deferred stock consideration with an estimated fair value of $1.8 million. Of the cash amount, $0.9 million was placed into escrow; $0.5 million served as security for any claims made by the Company under the terms of an escrow agreement between the Company and the former owners of Second Story, and $0.4 million was related to final working capital adjustments. These escrow amounts were released to the former owners of Second Story during the three-months ended March 31, 2013. As of December 31, 2013, the fair value of the deferred stock consideration was $1.5 million.
Assets acquired and liabilities assumed were recorded at their estimated fair values as of the acquisition date. The fair values of identifiable intangible assets were based on valuations using the income approach and estimates provided by management. The excess of the purchase price over the tangible assets, identifiable intangible assets and assumed liabilities was recorded as goodwill. The fair value of goodwill, intangible assets and net assets were $6.5 million, $2.4 million, and $1.0 million, respectively.
D&D Holdings Limited
On September 6, 2011, the Company acquired D&D Holdings Ltd. (“DAD”), a London-based advertising agency operating in the United Kingdom and continental Europe. The Company acquired DAD in order to strengthen its capabilities in marketing campaign production and direct response measurement.
The acquisition date fair value, net of cash acquired, was $45.2 million for the purchase of 100% of DAD’s outstanding shares. The $45.2 million consisted of $29.5 million in cash and deferred contingent consideration with an estimated fair value of $15.7 million. Of the cash amount, $9.8 million was placed into escrow, to serve as security for any claims made by the Company under the terms of an escrow agreement between the Company and the former owners of DAD. The escrow amount may also be utilized for the potential settlement of a portion of the deferred contingent consideration.
Assets acquired and liabilities assumed were recorded at their estimated fair values as of the acquisition date. The fair values of identifiable intangible assets were based on valuations using the income approach and estimates provided by management. The excess of the purchase price over the tangible assets, identifiable intangible assets and assumed liabilities was recorded as goodwill. The fair value of goodwill, intangible assets and net assets were $24.0 million, $25.2 million, and $(4.0) million, respectively.
The former shareholders of DAD are also eligible to receive additional consideration of up to $21.9 million, which is contingent on the fulfillment of certain financial conditions within the period from July 1, 2011 to June 30, 2014. If such conditions are achieved, the consideration is payable under certain circumstances in cash, common stock or a combination of both. Using a discounted cash flow method, the Company recorded an estimated liability of $15.7 million as of the acquisition date, $13.7 million as of December 31, 2012, and $6.8 million as of December 31, 2013. During the three months ended March 31, 2012, one of the financial conditions was achieved and as a result, $4.7 million of the escrow was released to the former shareholders of DAD during the three months ended June 30, 2012. At December 31, 2012, another of the financial conditions was achieved and as a result, $4.8 million of the escrow was released to the former shareholders of DAD during the three months ending March 31, 2013. The Company will continue to assess the probability that the remaining conditions will be fulfilled, and any subsequent changes in the estimated fair value of the liability will be reflected in earnings until the liability is fully settled. During the years ended December 31, 2013 and 2012, the Company recorded a benefit of $2.1 million and expense of $2.4 million respectively, relating to remeasurement of the fair value of the contingent liability, which are included in “Acquisition costs and other related (benefits) charges” in the Company’s consolidated statements of operations. This liability is denominated in a foreign currency and therefore, its value as reported in U.S. dollars on the Company’s consolidated balance sheets may also change from period to period due to currency exchange rate fluctuations.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The unaudited pro forma information presented in the following table summarizes the Company’s consolidated results of operations for the periods presented, as if the acquisition of DAD had occurred on January 1, 2011 (in thousands, except per share amounts). The pro forma financial information is presented for comparative purposes only and is not necessarily indicative of the results of operations that actually would have been achieved if the acquisition had taken place at the beginning of 2011, nor is it intended to be a projection of future results.
CLANMO GmbH
On July 13, 2011, the Company acquired CLANMO GmbH (“Clanmo”), a full-service mobile interactive agency based in Cologne, Germany. Clanmo focuses on strategy, communications, design, and technological implementation. The Company acquired Clanmo in order to strengthen its mobile interactive capabilities in the European market.
The acquisition date fair value, net of cash acquired, was $5.4 million for the purchase of 100% of Clanmo’s outstanding shares, and was paid entirely in cash. The consideration paid was allocated to the assets acquired and liabilities assumed based on their estimated fair values as of the acquisition date. The fair values of identifiable intangible assets were based on valuations using the income approach and estimates provided by management. The excess of the purchase price over the tangible assets, identifiable intangible assets and assumed liabilities was recorded as goodwill. The fair value of goodwill, intangible assets and net assets, net of cash acquired, were $3.2 million, $2.3 million, and $(0.1) million, respectively.
(4) Supplemental Cash Flow Information
Net total income taxes paid in 2013, 2012 and 2011 were $34.3 million, $27.3 million, and $15.3 million, respectively.
Non-cash investing transactions in 2013 included the issuance of common stock with a fair value of $1.1 million for the acquisition of La Comunidad, which the Company acquired in December 2013 and the issuance of common stock with a fair value of $0.5 million for the deferred stock consideration associated with the acquisition of Second Story.
Non-cash investing transactions in 2012 included the issuance of common stock with a fair value of $2.1 million as part of the consideration for the acquisition of Second Story.
Non-cash investing transactions in 2011 included the issuance of common stock in the amount of $4.9 million as contingent consideration for the acquisition of Derivatives Consulting Group Limited (“DCG”), which the Company acquired in 2008. Non-cash investing transactions in 2011 also included $12.6 million relating to construction in progress assets, which were recorded on the consolidated balance sheet in “Property and equipment, net” as of December 31, 2011 with related financing obligations recorded in “Other long-term liabilities.” See Note 7, Property and Equipment, for additional details regarding these assets.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As of December 31, 2013, 2012 and 2011, respectively, the Company had recorded purchases of property and equipment in the amounts of $2.3 million, $5.1 million and $3.4 million for which cash payments had not yet been made as of the respective year-end dates.
(5) Marketable Securities and Fair Value Disclosures
Marketable Securities
See Note 2(e), Marketable Securities, Investments and Other Financial Assets, for a discussion of the Company’s accounting policy related to its marketable securities investments and other financial assets and the methods and assumptions used to determine their fair values.
At December 31, 2013 and 2012, all of the Company’s marketable securities were classified as available-for-sale and their estimated fair values were $5.9 million and $7.5 million, respectively.
The following tables present details of the Company’s marketable securities as of December 31, 2013 and 2012 (in thousands):
During the quarter ended June 30, 2013, one of the Company’s auction rate securities (“ARS”) holdings was redeemed by the issuer at its amortized cost of $1.0 million, resulting in no realized gain or loss. Also during the quarter ended June 30, 2013, the Company accepted an offer to sell an ARS holding with an amortized cost of $0.4 million, resulting in a realized loss of $28,000. This realized loss is included in “Other income, net” in the Company’s consolidated statements of operations. As a result of these transactions, the Company no longer held any ARS as of June 30 and December 31, 2013.
As of December 31, 2012, all of the Company’s available-for-sale ARS had been in an unrealized loss position for more than twelve months. Using a discounted cash flow analysis, the Company determined that the fair value of its ARS classified as available-for-sale securities was $198,000 less than their amortized cost as of December 31, 2012. The gross unrealized losses on ARS of $198,000 as of December 31, 2012 are included, net of taxes, in “Accumulated other comprehensive loss” on the Company’s consolidated balance sheets.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
There were no other-than-temporary impairment losses recorded during the years ended December 31, 2013 and 2012. Any other-than-temporary impairment losses on marketable securities would be recorded in “Other income, net” in the Company’s consolidated statements of operations.
Fair Value Disclosures
The Company accounts for certain assets and liabilities at fair value. The following tables present the Company’s fair value hierarchy for its assets and liabilities which are measured at fair value on a recurring basis as of December 31, 2013 and 2012 (in thousands):
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company had no transfers of assets or liabilities between Level 1 and Level 2 or Level 3 of the fair value measurement hierarchy during 2013.
Level 1 assets consist of money market fund deposits and mutual funds that are traded in active markets with sufficient volume and frequency of transactions. The fair values of these assets were determined from quoted prices in active markets for identical assets.
Level 2 assets consist of bank time deposits and foreign exchange option contracts, and Level 2 liabilities consist of foreign exchange option contracts. The fair values of these assets and liabilities were determined from inputs that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 assets include ARS investments structured with short-term interest rate reset dates of generally less than 90 days but with contractual maturities that can be well in excess of 10 years. At the end of each reset period, which occurs every 7 to 35 days, investors can continue to hold the investments at par or sell the securities at auction provided there are willing buyers to make the auction successful. The Company’s ARS investments are collateralized by student loans and municipal debt and have experienced failed auctions. The ARS investments were sold during the quarter ended June 30, 2013. Level 3 assets and liabilities also include the following financial assets and liabilities, assumed as a result of acquisitions: (i) indemnification assets; (ii) contingent consideration; and (iii) other long-term liabilities.
The fair value of an acquired indemnification asset is affected most significantly by changes in the fair value of the subject of the indemnification and changes in the expected probabilities of collecting the asset amounts.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The fair value of an acquisition-related contingent consideration liability is affected most significantly by changes in the estimated probabilities of the contingencies being achieved. The fair value of other acquisition liabilities is affected most significantly by the specific discount rate used to adjust the outcomes to their present values.
The following table presents a summary of changes in fair value of the Company’s Level 3 assets and liabilities measured on a recurring basis for 2013 and 2012 (in thousands):
The Company’s non-financial assets, which include goodwill and long-lived assets held and used, are not required to be measured at fair value on a recurring basis. However, if certain triggering events occur, or if an annual impairment test is required, the Company would evaluate the non-financial assets for impairment. If an impairment was to occur, the asset or liability would be recorded at the estimated fair value. During the year ended December 31, 2013, the Company recorded an impairment of its Nitro customer list intangible asset in the amount of $2.1 million. For additional details, see Note 9, Purchased Intangible Assets.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(6) Restricted Cash
The Company has deposited $2.1 million and $6.1 million with various banks as collateral for letters of credit and performance bonds and has classified these amounts as “Restricted cash” on its consolidated balance sheets at December 31, 2013 and 2012, respectively. The Company also had $5.8 million recorded as restricted cash as of December 31, 2012 relating to its acquisitions of DAD and (m)Phasize. Portions are classified as current or non-current assets based on the expiration of the contractual requirements.
(7) Property and Equipment
The cost and accumulated depreciation of property and equipment at December 31, 2013 and 2012 were as follows (dollars in thousands):
Depreciation expense of property and equipment was $27.1 million, $23.5 million, and $19.4 million during 2013, 2012 and 2011, respectively. During 2013, the Company disposed of $3.5 million of gross property and equipment with a net book value of $1.2 million and received no cash proceeds. During 2012, the Company disposed of $12.0 million of gross property and equipment with a net book value of $0.8 million and received $0.4 million cash proceeds. During 2011, the Company disposed of $2.0 million of gross property and equipment with a net book value of $0.1 million and received no cash proceeds.
During the year ended December 31, 2010, the Company entered into two separate lease agreements whereby it leased space in two buildings which were constructed by third parties. Under ASC Subtopic 840-40 (“ASC 840-40”), Leases - Sale-Leaseback Transactions, because the Company was involved with certain structural aspects of construction, the Company was considered the owner for accounting purposes during the construction periods. Accordingly, the Company recorded assets on its consolidated balance sheets for the costs paid by the landlords to construct the facilities, along with corresponding financing liabilities for amounts equal to the landlord-paid construction costs.
During the three months ended June 30, 2012, construction on both of these buildings was completed, and the Company commenced its occupancy of the buildings. Upon the completion of construction, the Company performed sale-leaseback analyses pursuant to ASC 840-40 to determine if it could remove the assets and liabilities from its consolidated balance sheet. For both buildings, the required criteria which are specified in ASC 840-40 to qualify for sale-leaseback accounting and de-recognition of the property assets and related financing liabilities were not met. Therefore, the property assets and related financing obligations remained on the Company’s consolidated balance sheets.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As of December 31, 2012, the balance of the property assets and the related financing obligations (recorded in “Other long-term liabilities” on the Company’s consolidated balance sheets) were $23.0 million and $13.6 million, respectively.
During the first and third quarters of 2013, the Company exercised options to lease additional space in its leased buildings. Because the Company was involved with certain structural aspects of construction, the Company was considered the owner of the additional spaces for accounting purposes during the construction periods. As of December 31, 2013, the balances of the property assets and the related financing obligations were $23.0 million and $15.0 million, respectively.
The property assets recorded during the construction periods, which represent the Company’s shares of the estimated construction costs incurred by the building owners, are being depreciated over periods of 30 years, in accordance with the Company’s policy for depreciating owned building assets. The costs incurred by the Company to build out the leased office spaces are being depreciated over periods of 10 years, in accordance with the Company’s policy for depreciating leasehold improvement assets. The 10-year periods for both buildings are based on the initial contractual lease terms of five years and the expectation that the Company will exercise contractual options to extend the leases on both buildings for five additional years.
The Company bifurcates its lease payments for both buildings into a portion allocated to the buildings, and a portion allocated to the parcels of land on which the buildings have been built. The portions of the lease payments allocated to land are treated for accounting purposes as operating lease payments, and therefore are recorded as rent expense, which is included in “General and administrative expense” in the consolidated statements of operations. The portions of the lease payments allocated to the buildings are bifurcated into a portion allocated to interest expense, and a portion allocated to reducing the financing obligation. At the end of the expected lease terms of 10 years for both buildings, the Company expects to de-recognize the remaining balances of the property assets and the related financing obligations, with no resulting gain or loss expected to be recorded at that time.
(8) Goodwill
The following tables present the changes in goodwill allocated to the Company’s reportable segments during 2013 and 2012 (in thousands):
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(9) Purchased Intangible Assets
The following table summarizes purchased intangible assets as of December 31, 2013 and 2012 (in thousands):
Amortization expense related to the purchased intangible assets was $12.8 million, $11.1 million, and $6.8 million during 2013, 2012 and 2011, respectively. The estimated future amortization expense of purchased intangible assets as of December 31, 2013, is as follows (in thousands):
During the quarters ended September 30, June 30, and March 31, 2013, the Company performed impairment reviews of the customer list intangible asset obtained in its acquisition of Nitro in 2009. The impairment reviews were triggered by certain legacy Nitro customers having notified the Company of their intentions to cease or reduce purchases of the Company’s services. In the first step of the June 30, 2013 impairment review, the undiscounted net cash flows expected to be generated by the asset were compared to the carrying value of the asset. The undiscounted net cash flows expected to be generated by the asset were greater than the carrying value of the asset, and as a result no impairment was recorded during the three months ended June 30, 2013. In the first step of the September 30 and March 31, 2013 impairment reviews, the carrying value of the asset exceeded the undiscounted net cash flows expected to be generated by the asset, indicating that the carrying value was not recoverable. In the second step, the impairment amounts of $0.6 million and $1.5 million recorded in the three months ended September 30 and March 31, 2013, respectively, was determined as the amount by which the asset’s carrying amount exceeded its fair value, which was estimated using a discounted cash flow approach.
In estimating the undiscounted future net cash flows expected to be generated by this intangible asset, management considered the following factors: actual customer attrition rates since the acquisition date; expected future attrition rates; estimated undiscounted net cash flows generated by the intangible asset since the acquisition date; estimated undiscounted net cash flows expected to be generated by the intangible asset over its remaining expected useful life; and the expected remaining useful life of the intangible asset. In the course of
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
these impairment reviews, the Company considered multiple future scenarios and the expected likelihood of those scenarios occurring, based on the information which was known to management at the times the reviews were performed. These impairment reviews involved the use of significant judgment by management, and different judgments could yield different results. The net book value of the Nitro customer list intangible asset was $0.4 million and $3.5 million as of December 31, 2013 and December 31, 2012, respectively.
(10) Restructuring and Other Related Charges
Short-term and long-term restructuring and other related liabilities are recorded in “Accrued expenses” and “Other long-term liabilities,” respectively, in our consolidated balance sheets.
2013 - Restructuring Event
During the year ended December 31, 2013, the Company recorded a restructuring charge of $2.0 million primarily related to cash severance and other termination benefits for 82 employees whose positions were made redundant. This action was taken primarily in order to improve efficiency based on our revenue mix, skills mix, and leverage model. Of the total charges, $1.3 million and $0.5 million were allocated to the Company’s SapientNitro and Sapient Global Markets reportable segments, respectively.
2012 - Restructuring Event
During the fourth quarter of 2012, the Company recorded a restructuring charge of $0.5 million which included cash and other termination benefits for 15 Australian employees whose positions were made redundant. This action was taken in response to customer attrition as well as a continuing re-positioning of the Company’s SapientNitro business in Australia from traditional advertising capabilities to digitally-led capabilities.
2011 - Restructuring Events
During the third quarter of 2011, the Company consolidated its New York City operations into one office space. As such, the Company exited one leased office space and recorded a restructuring charge of $0.9 million, consisting of contractual rental commitments and related costs, offset by sub-lease income. The term of the restructured lease ends in January 2016.
During the first quarter of 2011, the Company recorded a restructuring charge of $5.7 million related to cash and other termination benefits for two former Nitro executives whose positions were made redundant, as well as the re-positioning of a portion of its SapientNitro business in Australia from traditional advertising capabilities to digitally-led capabilities. This charge consisted of $1.1 million of cash severance, and a $4.6 million non-cash charge related to the acceleration of unrecognized compensation expense for stock-based awards.
For the year ended December 31, 2013, the Company recorded net restructuring benefits associated with the 2011 restructuring events totaling $0.1 million, relating to changes in the estimated facility costs to be incurred.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table presents activity during 2013, 2012 and 2011 related to all restructuring events (in thousands):
The total remaining accrued restructuring balance of $0.5 million as of December 31, 2013 is expected to be paid in full by March 31, 2016.
(11) Income Taxes
The provision for income taxes consists of the following (in thousands):
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table presents a reconciliation of the effective tax rate to the statutory federal tax rate:
The sources of income before the provision for income taxes for the years ended December 31, 2013, 2012 and 2011 are as follows (in thousands):
The Company continuously evaluates its operational and legal entity structure on a worldwide basis in order to assess its effectiveness in the context of the Company’s Global Distributed Delivery model. Future changes in the Company’s structure depend on the results and the effectiveness of these assessments.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
At December 31, 2013 and 2012, 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 (in thousands):
Deferred tax assets are to be reduced by a valuation allowance if, based on the weight of available positive and negative evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of December 31, 2013 and 2012, the Company determined that it was more likely than not that a portion of its deferred tax assets related to state net operating losses would not be realized, and therefore recorded valuation allowances against these deferred tax assets of $0.1 million and $0.4 million, respectively. As of December 31, 2013, the Company determined that a deferred tax asset related to certain losses on investments would not be realized and recorded a valuation allowance of $0.1 million on this asset. The Company also maintained a valuation allowance against certain foreign deferred tax assets in the amount of $1.5 million at December 31, 2012. These deferred tax assets were written off against the valuation allowance in 2013. The Company continues to believe that deferred tax assets in its other foreign subsidiaries are more likely than not to be realized and, therefore, no valuation allowance has been recorded against these assets.
The following table presents changes in the valuation allowance (in thousands):
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company had net operating loss carryforwards of $2.1 million and $2.4 million for U.S. federal tax purposes, and $1.4 million and $61.7 million related to foreign jurisdictions, at December 31, 2013 and 2012, respectively. During 2013, the Company determined that $56.0 million of the foreign net operating losses could not be utilized, and the related deferred tax asset was written off against the valuation allowance. If not utilized, the federal net operating loss carryforwards will expire at various times through 2029, but the foreign net operating loss carryforwards can be carried forward indefinitely.
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, 2013 and 2012, $33.6 million and $37.9 million of unremitted earnings were not reinvested indefinitely and the Company recorded a related long-term deferred tax liability of $5.7 million and $6.2 million, respectively. At December 31, 2013 and 2012, earnings of foreign operations that could result in incremental taxes, if remitted, for which no deferred tax liability is recorded, amounted to $157.6 million and $143.8 million, respectively. Determination of the potential deferred tax liability on these unremitted earnings is not practicable because such liability, if any, is dependent on circumstances existing if and when such remittance occurs.
Accounting for income taxes requires a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if, based on the technical merits, it is more likely than not that the position will be sustained upon audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement. The Company reevaluates these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit and new audit activity. Any changes in these factors could result in the recognition of a tax benefit or an additional charge to the tax provision. The Company had gross unrecognized tax benefits including interest and penalties of $30.8 million and $28.1 million at December 31, 2013 and 2012, respectively. The amounts of unrecognized tax benefits that, if recognized, would result in a reduction of the Company’s effective tax rate are $29.7 million and $25.6 million at December 31, 2013 and 2012, respectively.
The Company recognizes accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes. As of December 31, 2013 and 2012, accrued interest and penalties were $4.2 million and $5.3 million, respectively.
A tabular roll forward of the Company’s gross unrecognized tax benefits, excluding interest and penalties, is presented below (in thousands):
The Company conducts business globally and, as a result, its subsidiaries file income tax returns in U.S. federal and state jurisdictions and various foreign jurisdictions. In the normal course of business the Company may be subject to examination by taxing authorities throughout the world, including such major jurisdictions as Canada, Germany, India, Switzerland, the United Kingdom and the United States. The Company
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
is currently under examination in the United States for the fiscal years ended December 31, 2010, 2011, and 2012 and in India for the fiscal years ended March 31, 2008, 2009, and 2010. The statutes of limitations in the Company’s other tax jurisdictions remain open for various periods between 2006 and the present. However, carryforward attributes from prior years may still be adjusted upon examination by tax authorities if they are used in an open period.
Although the Company believes its tax estimates are appropriate, the final determination of tax audits could result in favorable or unfavorable changes in its estimates. The Company anticipates the settlement of tax audits and proceedings, as well as the expiration of relevant statutes of limitations in the next twelve months could result in a decrease in its unrecognized tax benefits of an amount between $2.0 million and $3.5 million.
The Company enjoys the benefits of income tax holidays in certain jurisdictions in which it operates. In 2009, the Company established a new India unit in a Special Economic Zone (“SEZ”) which is entitled to a five year, 100% tax holiday. Immediately following the expiration of the 100% tax holiday, the SEZ unit is entitled to a five year, 50% tax holiday. In 2011, the Company established three new India business units in SEZs, which are eligible for similar tax benefits. These benefits resulted in decreases in the Company’s income tax provision of $2.0 million, $1.9 million, and $2.8 million for 2013, 2012 and 2011, respectively. Excluding these benefits, diluted earnings per share would have been $0.53, $0.40, and $0.45 for 2013, 2012 and 2011, respectively.
On September 13, 2013, the U.S. Department of the Treasury and Internal Revenue Service released final tangible property regulations that provide guidance on the tax treatment regarding the deduction and capitalization of expenditures related to tangible property. While early adoption is available, the effective date to implement these regulations is for tax years beginning on or after January 1, 2014. The Company is currently assessing these rules and the impact to its financial statements, if any, but believes adoption of these regulations will not have a material impact on our consolidated results of operations, cash flows or financial position.
(12) Commitments and Contingencies
Lease Commitments
The Company maintains its executive offices in Boston, Massachusetts and operating offices in several locations throughout the United States and abroad. Future minimum rental commitments under non-cancelable operating and build-to-suit leases with initial or remaining terms in excess of one year at December 31, 2013 were as follows (in thousands):
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Rent expense for the years ended December 31, 2013, 2012 and 2011 was $25.9 million, $24.1 million, and $23.4 million, respectively. The Company’s capital lease obligations as of December 31, 2013 were not material.
Guarantees and Indemnification Obligations
As permitted under Delaware law, the Company’s Second 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 party for certain losses suffered or incurred. With respect to the Company’s professional services agreements, these indemnification provisions typically apply to any third party claim asserted against its client for infringement of intellectual property rights, but may also include third party 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 third party 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 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, 2013 and 2012.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Legal Claims
The Company is subject to certain legal proceedings and claims incidental to the operations of its business. The Company is also subject to certain other legal proceedings and claims that have arisen in the ordinary course of business and that have not been fully adjudicated. The Company currently does not anticipate that these matters, if resolved against the Company, will have a material adverse impact on its financial results or financial condition.
The Company accrues loss contingencies when losses become probable and are reasonably estimable. If the reasonable estimate of the loss is a range and no amount within the range is a better estimate, the minimum amount of the range is recorded as a liability. As of December 31, 2013, the Company has recorded an accrual of $1.2 million for loss contingencies, which represents the minimum amount of probable range between $1.2 million and $7.8 million, related to all probable losses where a reasonable range could be made. This range includes a potential liability associated with non-income tax matters in certain of the Company’s foreign jurisdictions.
The Company does not accrue for contingent losses that, in the judgment of the Company, are considered to be reasonably possible, but not probable. Although the Company intends to defend these matters vigorously, the ultimate outcome of these matters is uncertain. However, the Company does not expect the potential losses, if any, to have a material adverse impact on its operating results or financial condition.
(13) Credit Facilities
In July 2012, Sapient International GmbH, a Switzerland subsidiary of the Company (the “Borrower”), entered into an uncommitted, multi-currency revolving credit facility (the “Facility”) with a bank. The Facility permits the Borrower to request advances for general working capital purposes, in U.S. dollars, British pounds sterling and euros, not to exceed an equivalent of $20 million U.S. dollars in the aggregate. For each advance, the Borrower requests a term of one, two, three or six months, or such other period to which the Borrower and the bank may agree. Each advance is due for repayment on the last day of the agreed-upon term, or upon demand by the bank or termination of the Facility. Each advance bears interest at an annualized rate equal to the London Interbank Offered Rate (“LIBOR”) benchmark rate in effect on the advance date and applicable to the relevant term, plus 2.25%. Interest is payable every three months, or at the end of the relevant advance term, if such term is less than three months. The Facility does not have a contractual term, but the bank may terminate the Facility at any time. The Facility does not include any financial covenants. Any obligations incurred by the Borrower under the Facility are guaranteed at all times by Sapient Corporation. As of March 18, 2014, the Borrower had not drawn any advances under the Facility.
(14) Stock Plans
Project personnel expenses, selling and marketing expenses, and general and administrative expenses appearing in the consolidated statements of operations for 2013, 2012, and 2011 include the following stock-based compensation amounts (in thousands):
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Stock-based compensation costs capitalized relating to individuals working on internally developed software were immaterial during all periods presented. The Company values restricted stock units (“RSUs”) contingent upon achieving performance conditions and RSUs contingent on employment based on the fair market value on the date of grant, which is equal to the quoted closing market price of the Company’s common stock on the date of grant.
For only those awards that are expected to vest, the Company recognizes stock-based compensation expense, net of an estimated forfeiture rate, on a straight-line basis over the requisite service period of the award when the only condition to vesting is continued employment. If vesting is subject to a market or performance condition, vesting is based on the derived service period. The Company estimates its forfeiture rate based on its historical experience.
During the third quarter of 2011, the Company granted a special dividend equivalent payment of $0.35 per RSU for each RSU award outstanding as of August 15, 2011, to be paid in shares when the underlying award vests. If the underlying RSU award does not vest, the dividend equivalent is forfeited.
During the second quarter of 2011, the Company granted an aggregate of 294,000 RSUs with service and performance conditions to six members of its leadership team. Up to 294,000 units will vest on April 1, 2014 if the performance conditions are met for the years ended December 31, 2013, 2012, and 2011 (98,000 units for each year). Any units which become eligible for vesting as a result of fulfillment of the performance conditions will vest only if the recipient remains continuously employed with the Company through the award vesting period. The performance conditions for the years ended December 31, 2013, 2012, and 2011 were partially achieved and as a result, the recipients became eligible to vest in a total of 83,997, 69,848, and 87,268 units, respectively, provided they fulfill the service condition.
During the second quarter of 2010, the Company granted RSUs with service and performance conditions to its Chief Executive Officer (“CEO”). The performance conditions for the three year period ended December 31, 2012 were partially achieved and as a result, the recipient became eligible to vest in a total of 34,306 units (of a maximum of 100,000) on the service vesting date (March 1, 2013). The CEO also vested in an additional 50,000 units (of a maximum of 50,000) on March 1, 2013 based on the achievement of strategic objectives, with achievement having been determined by the Company’s Board of Directors.
Expense for these performance-based awards is estimated and adjusted on a quarterly basis, based on assessments of the probability that the performance conditions will be met.
(a) 1996 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 certain other equity-related awards such as restricted common stock and restricted stock units, to employees and Directors of, and consultants and advisors to, the Company. A total of 19,200,000 shares of common stock were available for issuance 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 4-year period and expire 10 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 was made under the 1996 Plan after February 13, 2006 and the 1996 Plan expired on December 31, 2008. As of December 31, 2013, there were 365,886 options to purchase shares of common stock outstanding under the 1996 Plan.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(b) 1998 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, and consultants and advisors, to the Company. A total of 18,000,000 shares of common stock were available for issuance under the 1998 Plan. 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. As of June 8, 2011, 3,075,979 shares of common stock were available for grant under the 1998 Plan. Subsequent to the approval of the 2011 Incentive Plan on June 8, 2011, the available shares were transferred to the 2011 Incentive Plan. The 1998 Plan has since expired, and no further awards will be issued under the 1998 Plan. Refer to subsection (d) below for discussion of the 2011 Incentive Plan.
(c) 2001 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, and advisors and consultants to, the Company. A total of 12,000,000 shares of common stock were available for issuance under the 2001 Plan. 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. Stock options granted under the 2001 Plan are nontransferable, generally become exercisable over a 4 year period and expire 10 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). As of December 31, 2013 there were no shares available for grant under the 2001 Plan. No award was made under the 2001 Plan after March 14, 2011, the date the 2001 Plan expired. As of December 31, 2013, there were 96,290 options to purchase shares of common stock outstanding under the 2001 Plan.
(d) 2011 Incentive Plan
On June 8, 2011, the Company’s stockholders approved the Sapient Corporation 2011 Incentive Plan (the “2011 Plan”). The 2011 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, Directors and certain key persons (including consultants and advisors) of the Company. A total of 13,679,147 shares may be issued under the 2011 Plan, consisting of 10,000,000 new shares of common stock, 3,075,979 shares of common stock that were available for issuance under the 1998 Plan immediately prior to the time that the 2011 Plan was adopted, and 603,168 shares that were outstanding under the 1998 Plan but then were canceled due to forfeiture between July 1, 2011 and December 31, 2012. The 2011 Plan is administered by the Compensation Committee of the Board of Directors, which selects the persons to whom restricted common stock 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. As of December 31, 2013, 7,579,236 shares were available for grant under the 2011 Plan.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table presents activity relating to stock options under all of the Company’s stock option plans during the year ended December 31, 2013 (in thousands, except prices):
The aggregate intrinsic value of stock options exercised in 2013, 2012, and 2011 was $6.5 million, $3.6 million, and $8.1 million, respectively, determined as of the date of exercise. At December 31, 2013, the weighted average remaining contractual term for stock options outstanding, vested and exercisable was less than one year.
As of December 31, 2013, there was no remaining unrecognized compensation expense related to non-vested stock options.
The following table presents activity relating to RSUs during the year ended December 31, 2013 (in thousands, except prices):
The weighted average grant date fair value of RSUs granted in 2013, 2012, and 2011 was $12.30, $12.04, and $11.85, respectively. The aggregate intrinsic value of RSUs vested in 2013, 2012, and 2011 was $29.1 million, $24.7 million, and $28.4 million, respectively. The aggregate intrinsic value of non-vested RSUs, net of forfeitures, as of December 31, 2013 was $118.5 million. As of December 31, 2013, there remained $53.9 million of unrecognized compensation expense, net of estimated forfeitures, related to non-vested RSUs and restricted stock that is contingent on employment, which is expected to be recognized as expense over a weighted average period of approximately 2.3 years.
(15) Retirement Plans
The Company established a 401(k) retirement savings plan for U.S. 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 $1.7 million in 2013, $1.7 million in 2012, and $1.6 million in 2011.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(16) Stockholders’ Equity
(a) Preferred Stock
The Company’s Second Amended and Restated Certificate of Incorporation authorizes the Board of Directors 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. To date, the Company has not issued any shares of preferred stock.
(b) Restricted Common Stock
On November 1, 2012, the Company issued 235,490 shares of restricted common stock to certain Second Story senior executives as part of the acquisition of Second Story. The Company valued these shares based on the 90-day trailing average closing price of the Company’s common stock on the acquisition date, less a reduction in fair value to reflect the impact of the selling restrictions. The restrictions will lapse at various dates through October 1, 2016.
On December 30, 2013, the Company issued 84,166 shares of common stock from treasury shares to the former owners of La Comunidad as part of the acquisition. The Company valued these shares based on the closing price of the Company common stock on the issuance date less a reduction in fair value to reflect the impact of the selling restrictions. The restrictions will lapse at various dates through December 31, 2017.
(c) Treasury Stock
The Company uses the cost method to account for its treasury stock transactions. Shares of treasury stock are issued in connection with the Company’s stock option plans, restricted stock plans, employee stock purchase plan, and acquisitions using the average cost basis method. On May 9, 2012, the Board of Directors authorized a stock repurchase program of up to $100 million of the Company’s common stock over the next two years. Under the program, management of the Company is authorized to repurchase shares through Rule 10b5-1 plans, open market purchases, privately negotiated transactions, block purchases or otherwise in accordance with applicable federal securities laws, including Rule 10b-18 of the Securities Exchange Act of 1934, as amended. Depending on market conditions and other factors, the repurchases may be commenced or suspended at any time or from time to time, without prior notice. During the year ended December 31, 2013, the Company settled repurchases of 38,257 shares of its common stock at an average price of $14.94 per share for an aggregate purchase price of $0.6 million, including transaction costs. During the year ended December 31, 2012, the Company settled repurchases of 4,230,039 shares of its common stock at an average price of $10.54 per share for an aggregate purchase price of $44.6 million, including transaction costs. As of December 31, 2013, $54.8 million remained available for repurchase under this program. During 2011, the Company did not repurchase any shares of its common stock.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(d) Net Income Per Share
The following table presents the computation of basic and diluted net income per share for the periods presented (in thousands, except per share amounts):
Weighted average dilutive common share equivalents include the dilutive impact of deferred stock consideration and restricted stock associated with the acquisitions of La Comunidad, (m)Phasize, Second Story, and DAD. These shares are reflected in weighted average dilutive common share equivalents as they were contingent shares during the relevant periods presented.
(e) Accumulated Other Comprehensive Loss
The following table presents the components of accumulated other comprehensive loss (in thousands):
(17) Noncontrolling Interest Subject to Put Provisions
The Company has potential obligations to purchase the noncontrolling interests held by third parties in connection with its acquisition of iThink. See Note 3, Business Acquisitions. These obligations are in the form of put provisions that are exercisable at the third-party owners’ discretion, within the specified period, as outlined in the iThink purchase and sale agreement. If these put provisions are exercised by the third parties within the specified period, the Company will be required to purchase all of the third-party owners’ noncontrolling interests at a determined put price as outlined in the iThink purchase and sale agreement, which is based on a specified factor multiplied by the average quarterly EBITDA achieved in the 12 quarters subsequent to the acquisition date. The put provisions are not exercisable until after the fiscal year ending December 31, 2015.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The acquisition date fair value of the noncontrolling interest was derived by extrapolating the fair value of the noncontrolling interest ownership based on the consideration transferred for the controlling interest in connection with the acquisition of the majority interest of iThink, net of a discount factor, to take into account the noncontrolling interest’s lack of marketability.
As of December 31, 2013, the Company’s potential obligations under these put options were approximately $0.8 million, of which none were exercisable.
The following table presents a roll forward of the noncontrolling interest subject to put provisions from the date of acquisition of iThink (January 16, 2013) through December 31, 2013 (in thousands):
During the three months ended December 31, 2013, the Company made additional capital contributions and exercised its Call Option on certain remaining noncontrolling interests which increased the Company’s ownership from 81% to 84% of the outstanding securities of iThink.
(18) Segment Reporting
Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated on a regular basis by the Chief Operating Decision Maker (“CODM”) in deciding how to allocate resources to an individual segment and in assessing performance. The Company’s CODM is its Chief Executive Officer.
The Company identifies such segments based upon target client markets because each operating segment helps clients identify and act upon opportunities to improve their business performance, but strategically serves different markets. The Company considered qualitative factors, including the economic characteristics of each operating segment to determine if any qualified for aggregation. More specifically, the Company evaluated the economic characteristics, the nature of products and services, the methods used to provide services, the types of customers, and the nature of the corresponding regulatory environment of its operating segments. As a result, the Company has identified the following reportable segments: SapientNitro, Sapient Global Markets, and Sapient Government Services.
The CODM evaluates performance based upon each segment’s operating income, which is defined as income before allocations of certain marketing and general and administrative expenses, including costs associated with its restructuring events (as described in Note 10, Restructuring and Other Related Charges). These charges are excluded from evaluation of performance because these activities and costs generally impact areas that support the segments and, therefore, are managed separately. Management does not allocate amortization of purchased intangible assets, acquisition costs, stock-based compensation expense, or interest and other income to the segments for the review of results by the CODM. Asset information by segment is not reported to or reviewed by the CODM, and therefore, the Company has not disclosed asset information for the segments. The accounting policies of the segments are the same as those described in Note 2, Summary of Significant Accounting Policies.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following tables present the service revenues and income from operations attributable to the Company’s reportable segments for the periods presented (in thousands):
(1) Segment operating income 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. Segment operating income reflects restructuring charges allocated to the SapientNitro and Sapient Global Markets reportable segments consisting of $1.3 million and $0.5 million, respectively, for the year ended December 31, 2013.
(2) Adjustments that are made to reconcile total reportable segments operating income to consolidated income before income taxes include the following (in thousands):
(a) Reflects stock option restatement-related benefits.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Geographic Data
The Company does not internally measure or report revenues by individual service offering as providing such information is impracticable and, therefore, the Company has not disclosed the revenues from external customers for each service offering described in Note 2(m), Summary of Significant Accounting Policies - Revenue Recognition.
The following tables present data for the geographic regions in which the Company operates (in thousands):
(1) Allocation of service revenues to individual countries is based on the location of the Sapient legal entity that contracts with the customer.
(2) Allocation of long-lived tangible assets to individual countries is based on the location of the Sapient legal entity that has title to the assets.
(3) Reflects net book value of the Company’s property and equipment.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(19) Prepaid Expenses and Other Current Assets, Accrued Expenses and Other Long-Term Liabilities
The following table presents the components of selected balance sheet items as of December 31, 2013 and 2012 (in thousands):
(20) Interest and Other Income, Net
The following table presents the components of interest and other income, net, for the years ended December 31, 2013, 2012 and 2011 (in thousands):
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(21) Restatement
The Company has restated its consolidated financial statements for the years ended December 31, 2012 and 2011 and its unaudited quarterly financial information for each of the quarters in the year ended December 31, 2012 and for the first three quarters in the year ended December 31, 2013, to correct primarily the manner in which the Company recorded certain tax liabilities resulting from the movement of our employees globally.
As disclosed previously in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2013, the Company identified certain prior period errors which affected the interim and annual periods in the years ended December 31, 2006 through 2012. The prior period errors primarily relate to the Company’s unrecorded corporate income and employment tax liabilities resulting from cross-border mobility of employees into various countries in prior periods. More specifically, the Company concluded that during those prior periods several of its subsidiaries had created previously unrecognized permanent establishments in foreign tax jurisdictions as a result of employees working in those foreign countries, which triggered corporate income tax liabilities for those subsidiaries and individual-tax liabilities for some of those employees. The net expense recorded in the interim and annual periods in the years ended December 31, 2006 through December 31, 2012 amounted to $14.2 million.
During the quarter ended December 31, 2013, the Company identified certain prior period errors which affected the interim and annual periods in the years ended December 31, 2010 through 2012 and the first three quarters in the year ended December 31, 2013. The prior period errors primarily relate to the Company’s unrecorded employment-related tax liabilities associated with the movement of employees globally. More specifically, the Company did not properly report the appropriate amount of income, and did not withhold and remit the appropriate amount of employment related tax resulting from taxable benefits provided to certain employees on foreign long-term assignments for those periods. The net expense recorded in the interim and annual periods in the years ended December 31, 2010 through December 31, 2012 amounted to $13.1 million. The net expense recorded in the interim periods ended March 31, June 30, and September 30, 2013 amounted to $2.3 million.
The Company also has corrected certain other immaterial prior period errors in the Company’s consolidated financial statements into the periods in which they originated.
In evaluating whether the Company’s previously issued consolidated financial statements were materially misstated, the Company considered the guidance in ASC Topic 250, Accounting Changes and Error Corrections, ASC Topic 250-10-S99-1, Assessing Materiality, and ASC Topic 250-10-S99-2, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. The Company concluded that these errors were in the aggregate material to the prior reporting periods, and therefore, restatement of previously filed financial statements was necessary.
The adjustments related to the years prior to 2011 are reflected in the beginning retained earnings for 2011. The cumulative impact of these adjusting entries decreased retained earnings by $11.8 million, net of tax, at the beginning of 2011.
The account balances labeled “As Reported” in the following tables for the years ended December 31, 2012 and 2011 represent the previously reported audited balances in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The effects of these prior period errors on the consolidated financial statements are as follows (in thousands, except per share amounts):
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following tables present consolidated unaudited quarterly financial data for the first three quarters in the year ended December 31, 2013:
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following tables present consolidated unaudited quarterly financial data in the interim periods in the year ended December 31, 2012:
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following tables present consolidated unaudited balance sheets as of December 31, 2011, 2010, and 2009:
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(22) Subsequent Events
On February 5, 2014, the Company acquired 100% of the outstanding equity of OnPoint Consulting, Inc. (“OnPoint”), a technology consulting firm providing enterprise systems and infrastructure services to Federal government customers based in Arlington, Virginia. The Company acquired OnPoint to expand its portfolio of government clients and contracts for application development cyber-security services and IT infrastructure services. This transaction will be accounted for as a business combination using the acquisition method. The Company made an initial cash payment of $12.5 million upon closing. Due to the timing of this acquisition, certain disclosures, including the preliminary allocation of the purchase price, have been omitted from this Annual Report on Form 10-K because the initial accounting for the business combination was incomplete as of the filing date.
(23) Quarterly Financial Results (Unaudited)
As discussed further in Note 21, Restatement, the Company has restated its consolidated financial statements for the years ended December 31, 2012 and 2011 and its unaudited quarterly financial information for each of the quarters in the year ended December 31, 2012 and for the first three quarters in the year ended December 31, 2013 (collectively, the “Restated Periods”).
The quarterly financial results presented in the tables below reflect the impacts of the restatement adjustments of all restated periods. The quarterly operating results are not necessarily indicative of future results of operations.
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following tables present quarterly financial data for the year ended December 31, 2013:
SAPIENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following tables present quarterly financial data for the year ended December 31, 2012:
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
Management has conducted an evaluation, under the supervision of, and with the participation of, the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of December 31, 2013. Based on that evaluation, the CEO and CFO concluded that our disclosure controls and procedures as of December 31, 2013 were not effective as a result of a material weakness in internal control over financial reporting related to the accounting for certain tax liabilities resulting from the movement of our employees globally. Disclosure controls and procedures are designed to ensure that information required to be disclosed in company reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in company reports filed under the Exchange Act is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer as appropriate, to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external purposes in accordance with GAAP and includes those policies and procedures that:
•
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets of the Company;
•
provide reasonable assurance that the transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
•
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.
Under the supervision of, and with the participation of, management, including the CEO and CFO, an evaluation was performed, as of December 31, 2013, of the effectiveness of the Company’s internal control over financial reporting. The evaluation was based on the criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. We did not maintain effective controls over certain tax liabilities in connection with the movement of our employees globally resulting from (i) previously unrecognized permanent establishments in foreign tax jurisdictions, and (ii) not properly reporting, withholding, and remitting the appropriate amount of employment related tax from certain
taxable benefits provided to some employees on foreign long-term assignments. Specifically, the Company’s controls were not properly designed to (i) monitor the extent of travel performed by international workers for purposes of identifying permanent establishment; (ii) monitor the activities conducted by international workers during their travel; and (iii) identify the complete population of international workers that could trigger permanent establishment in foreign countries. In addition, the Company’s controls were not properly designed to (i) capture some taxable benefits provided to certain employees on foreign long-term assignments; (ii) ensure reporting of the additional benefits as taxable benefits to these employees; and (iii) monitor changes in the Company’s international long-term assignment policies.
The aggregated impact of these control deficiencies resulted in the restatement of the Company’s consolidated financial statements for the years ended December 31, 2006 through December 31, 2012, and each of the quarters ended on March 31, June 30, and September 30, 2013. Additionally, these control deficiencies could result in misstatements of the aforementioned accounts and disclosures that would result in a material misstatement of the consolidated financial statements that would not be prevented or detected. Accordingly, our management has determined that the aggregation of these control deficiencies constitute a material weakness. Because of this material weakness, management concluded that the Company did not maintain effective internal control over financial reporting as of December 31, 2013, based on criteria in Internal Control-Integrated Framework (1992) issued by the COSO.
PricewaterhouseCoopers LLP, the Company’s independent registered public accounting firm, has audited the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013, which is set forth in Item 8.
Remediation of the Material Weakness
The Company has implemented a number of remediation steps to address the material weakness discussed above and to improve its internal controls. With respect to the control deficiency associated with the Company’s previously unrecognized permanent establishments in certain foreign jurisdictions in prior periods, the Company has (i) reorganized the reporting structure of the Company’s global people movement department under one leadership head; (ii) created a cross-functional team, which includes individuals from the global people movement, legal, tax, delivery, staffing, and finance departments, in order to identify ways to improve the tracking of international workers, assess the impact of regulatory changes in foreign jurisdictions, assess and identify ways to mitigate exposures in new legal jurisdictions, and understand current and future travel patterns of international workers to assess any potential additional exposures; (iii) implemented a new control to review on a regular basis projects staffed with international workers; (iv) enhanced the functionality of our systems to generate reports containing the cumulative number of hours worked by international workers, which are regularly reviewed by cross-functional teams to evaluate permanent establishment exposures; (v) designed a new tool to communicate tax-related mobility considerations to the staffing department, which will help support the Company’s compliance process. The following are planned to be implemented: (i) update the Company’s global people movement policies; (ii) continue to refine system generated reports used for better tracking of international workers; (iii) retain experienced external advisors for technical assistance; and (iv) implement the new tool to communicate tax-related mobility considerations to the staffing department.
With respect to the control deficiency associated with the Company not properly reporting, withholding and remitting the appropriate amount of employment related tax, the Company has (i) engaged and retained experienced external advisors to help advise the Company on technical requirements in each impacted jurisdiction; (ii) authorized the hiring of a leadership role to focus on enhancing our internal controls in the global people movement process relative to designing and implementing a combination of preventive and detective controls regarding the proper tracking and reporting of taxable employee benefits. The following are planned to be implemented: (i) implement policy, process and system changes to streamline efforts to gather and report all taxable benefits provided to international workers on long-term assignments; (ii) return international workers to their home countries as deemed appropriate; (iii) update travel policies to limit the total number of long-term travelers and associated costs.
The Company expects that the measures described above should remediate the material weakness identified and strengthen our internal control over financial reporting. Management is committed to improving the Company’s internal control processes. As the Company continues to evaluate and improve its internal control over global people movement, additional measures to address the material weakness or modifications to certain of the remediation procedures described above may be identified. The Company expects to complete the required remedial actions during 2014. We do not believe the costs of these remediation efforts will be material to the financial statements of the company, either individually or in aggregate.
Changes in Internal Control Over Financial Reporting
There were changes and improvements to our internal control over financial reporting as described above under “Remediation of the Material Weakness” that occurred during the three month period ended December 31, 2013. These changes have materially affected the Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this Item is set forth in our Proxy Statement for the 2014 Annual Meeting of Stockholders to be filed with the SEC within 120 days of December 31, 2013, and is incorporated into this Annual Report on Form 10-K by reference.
Item 11.
Item 11. Executive Compensation
The information required by this Item is set forth in our Proxy Statement for the 2014 Annual Meeting of Stockholders to be filed with the SEC within 120 days of December 31, 2013, and is incorporated into this Annual Report on Form 10-K by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item is set forth in our Proxy Statement for the 2014 Annual Meeting of Stockholders to be filed with the SEC within 120 days of December 31, 2013, and is incorporated into this Annual Report on Form 10-K by reference.
Securities Authorized for Issuance under Equity Compensation Plans
The following table summarizes, as of December 31, 2013, the number of securities issued under our equity compensation plans and the number of awards available for future issuance under these plans.
(1) 7,579,236 of the shares listed in column (c) may be issued in the form of stock-based and other incentive awards, pursuant to the terms of our 2011 Incentive Plan, as amended. No shares of restricted stock are currently available for issuance under our other equity compensation plans.
(2) Column (c) includes 1,773,600 shares that are available for issuance under our 2005 Employee Stock Purchase Plan as of December 31, 2013, should the Company decide to conduct additional offerings under the 2005 Employee Stock Purchase Plan.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item is set forth in our Proxy Statement for the 2014 Annual Meeting of Stockholders to be filed with the SEC within 120 days of December 31, 2013, and is incorporated into this Annual Report on Form 10-K by reference.
Item 14.
Item 14. Principal Accounting Fees and Services
The information required by this Item is set forth in our Proxy Statement for the 2014 Annual Meeting of Stockholders to be filed with the SEC within 120 days of December 31, 2013, and is incorporated into this Annual Report on Form 10-K by reference.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
15(a)(1) Financial Statements
The Consolidated Financial Statements filed as part of this Annual Report on Form 10-K are listed and indexed on page 61. 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 is included on page 141 of this Annual Report on Form 10-K.
15(a)(3) Exhibits
The exhibits filed as part of this Annual Report on Form 10-K are listed in the Exhibit Index on page 142 of this Annual Report on Form 10-K. 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 15(a)(3) 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
Co-Chairman of the Board of Directors, President and Chief Executive Officer
Dated: March 18, 2014
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.
SAPIENT CORPORATION
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
Years Ended December 31, 2013, 2012 and 2011
EXHIBIT INDEX
* Exhibits filed herewith.
 Management contract or compensatory plan or arrangement.
(1) Incorporated herein by reference to the Company’s Form 8-K filed August 7, 2008 (File No. 000-28074).
(2) Incorporated herein by reference to the Company’s Form 10-Q for the period ended September 30, 2004 (File No. 000-28074).
(3) Incorporated herein by reference to the Company’s Form 8-K filed October 29, 2012 (File No. 000-28074).
(4) Incorporated herein by reference to the Company’s Registration Statement on Form S-1 (File No. 333-12671).
(5) Incorporated herein by reference to the Company’s Form 10-K for the fiscal year ended December 31, 1998 (File No. 000-28074).
(6) Incorporated herein by reference to the Company’s Form 10-Q for the period ended September 30, 2007 (File No. 000-28074).
(7) Incorporated herein by reference to the Company’s Proxy Statement for the 2001 Annual Meeting of Stockholders (File No. 000-28074).
(8) Incorporated herein by reference to the Company’s Form 10-K for the fiscal year ended December 31, 2012 (File No. 000-28074).
(9) Incorporated herein by reference to the Company’s Form 10-Q for the period ended June 30, 2007 (File No. 000-28074).
(10) Incorporated herein by reference to the Company’s Form 10-K for the fiscal year ended December 31, 2006 (File No. 000-28074).
(11) Incorporated herein by reference to the Company’s Form 10-Q for the period ended June 30, 2009 (File No. 000-28074).
(12) Incorporated herein by reference to the Company’s Form 10-Q for the period ended March 31, 2010 (File No. 000-28074).
(13) Incorporated herein by reference to the Company’s Form 10-Q for the period ended June 30, 2010 (File No. 000-28074).
(14) Incorporated herein by reference to the Company’s Form 8-K filed September 2, 2010 (File No. 000-28074).
(15) Incorporated herein by reference to the Company’s Form 10-K for the fiscal year ended December 31, 2011 (File No. 000-28074).
(16) Incorporated herein by reference to the Company’s Proxy Statement for the 2011 Annual Meeting of Stockholders (File No. 000-28074).
(17) Incorporated herein by reference to the Company’s Form 10-Q for the period ended September 30, 2012 (File No. 000-28074).