SAPIENT CORP - 10-Q Quarterly Report

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No

As of November 11, 2002, there were 122,078,000 shares of Common Stock, $.01 par value, outstanding.

Certain statements contained in this Quarterly Report on Form 10-Q constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements included in this Quarterly Report, other than statements of historical facts, regarding our strategy, future operations, financial position, estimated revenues, projected costs, prospects, plans and objectives are forward-looking statements. When used in this Quarterly Report, the words “will,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “project” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We cannot guarantee future results, levels of activity, performance or achievements and you should not place undue reliance on our forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including the risks described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk Factors” and elsewhere in this Quarterly Report. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or strategic investments. In addition, any forward-looking statements represent our expectation only as of the day this Quarterly Report was first filed with the SEC and should not be relied on as representing our expectations as of any subsequent date. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change.

The accompanying notes are an integral part of these Consolidated Financial Statements.

The accompanying unaudited consolidated financial statements have been prepared by Sapient Corporation pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2001 included in the Company’s Annual Report on Form 10-K. The accompanying consolidated financial statements reflect all adjustments (consisting solely of normal, recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of results for the interim periods presented. The results of operations for the three and nine months ended September 30, 2002 are not necessarily indicative of the results to be expected for any future period or the full fiscal year.

The market for advanced technology consulting services expanded dramatically during 1999 and most of 2000, but declined significantly in 2001 and to date in 2002. As a result of this decrease in demand, the Company’s service revenues for the nine months ended September 30, 2002 decreased 50% from its service revenues for the nine months ended September 30, 2001, and the Company’s net loss increased from $160.3 million for the nine months ended September 30, 2001 to $204.5 million for the nine months ended September 30, 2002. Also, as a result of the losses incurred, the Company reduced its work force and office space in cities throughout the United States in March 2001, July 2001, February 2002 and June 2002. The Company also closed its Australia office in 2001 and is in the process of discontinuing its operations in Tokyo. This process is expected to be completed by December 31, 2002. The Company’s cash flows from operations for the nine months ended September 30, 2002 resulted in a use of cash of $53.1 million. The Company’s cash, cash equivalents and short-term investments at September 30, 2002 were $190.6 million. The Company believes that its existing cash, cash equivalents and short-term investments will be sufficient to meet its working capital, capital expenditure, restructuring and stock repurchase program requirements for at least the next 18 months.

Certain amounts in previously issued financial statements have been reclassified to conform to the current presentation.

Unless the context requires otherwise, references in this Quarterly Report to “Sapient,” “the Company,” “we,” “us” or “our” refer to Sapient Corporation and its consolidated subsidiaries.

The following information presents the Company’s computation of basic and diluted net loss per share for the periods presented in the consolidated statements of operations (in thousands, except per share data):

Options to purchase approximately 25.6 million and 23.5 million shares of common stock were outstanding during the three and nine months ended September 30, 2002, respectively, and options to purchase approximately 24.5 million and 22.0 million shares of common stock were outstanding during the three and nine months ended September 30, 2001, respectively, but were not included in the computation of diluted net loss per share because the Company recorded a net loss for all periods.

In November 2001, the Emerging Issues Task Force (EITF) issued Issue No. 01-14 regarding “Income Statement Characterization of Reimbursements Received for “Out-Of-Pocket” Expenses Incurred.” This pronouncement requires that reimbursements received for out-of-pocket expenses incurred should be characterized as revenue in the Company’s statement of operations. The Company incurs incidental expenses in the delivery of services to its clients that are commonly referred to as “out-of-pocket” expenses. These expenses include, but are not limited to, travel and related charges. Accordingly, the Company adjusted revenue for all periods reported to include the reimbursable expenses billed to clients. Previously, these expense reimbursements were classified as a reduction of project personnel costs. This change in classification had no effect on current or previously reported net loss or net loss per share.

Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income” (SFAS 130), establishes standards for reporting comprehensive income (loss). Comprehensive loss includes net loss as currently reported under generally accepted accounting principles, and also considers the effect of additional economic events that are not required to be recorded in determining net loss but rather are reported as a separate component of stockholders’ equity. The Company reports foreign currency translation gains and losses and unrealized gains and losses on investments as components of comprehensive loss. Comprehensive loss was $(10.6) million and $(94.0) million for the three months ended September 30, 2002 and 2001, respectively, and $(204.2) million and $(160.1) million for the nine months ended September 30, 2002 and 2001, respectively.

The Company has certain contingent liabilities that arise in the ordinary course of its business activities. The Company accrues contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. The Company is subject to various pending or threatened legal claims and administrative audits which have arisen in the ordinary course of its business. The Company settled certain of these items during the three months ended September 30, 2002, and accordingly, has a remaining accrual at September 30, 2002 of approximately $1.7 million related to those items that remain outstanding. The ultimate outcome of these items is uncertain and the potential loss, if any, may be significantly higher or lower than amounts previously accrued by the Company.

As a result of the decline in the demand for advanced technology consulting services that began in the second half of 2000, the Company implemented restructurings of its workforce and operations in March 2001, July 2001, February 2002 and June 2002. For the three months ended September 30, 2002, the Company recorded a $3.6 million restructuring credit for charges recorded in prior quarters. The credit is the result of savings in outplacement services and facility costs, net of restructuring charges for workforce reductions and facility charges in connection primarily with the closure of the Company’s Tokyo office, which is expected to be completed in December 2002. The restructuring charge for the Tokyo office closure is expected to result in the termination of approximately 33 employees in total, all of whom remained employed by the Company as of September 30, 2002, and whom the Company expects to terminate in the fourth quarter of 2002 and the first quarter of 2003 upon completion of project assignments and the closure of Tokyo operations. The total reduction of office space will be approximately 8,600 square feet, which is expected to be vacated in the fourth quarter of 2002.

In connection with the restructuring plan implemented in June 2002, the Company recorded restructuring and other related charges of $9.8 million, consisting of $3.1 million for workforce reductions, $6.2 million for consolidation of facilities and $0.5 million for the write-down of other depreciable assets during the three months ended June 30, 2002. The June 2002 restructuring is expected to result in the termination of approximately 106 employees in total, of whom 5 remained employed by the Company as of September 30, 2002, and whom the Company expects to terminate in the fourth quarter of 2002 upon completion of project assignments. 76% of the terminated employees are project personnel, 4% are selling and marketing personnel and 20% are general and administrative personnel. The June 2002 restructuring plan also included further consolidation of office space, which included the closing of the Company’s Houston and Denver offices. Estimated costs for the reduction in physical office space is composed of contractual rental commitments for office space being vacated and related costs, brokerage and related costs to sublet the office space, in addition to future depreciation of the related leasehold improvements, offset by estimated sub-lease income. The total reduction of office space was approximately 52,000 square feet, all of which was vacated as of September 30, 2002.

In connection with the restructuring plan announced in February 2002, the Company recorded restructuring and other related charges of $48.7 million, consisting of $12.9 million for workforce reductions, $35.0 million for consolidation of facilities and $0.8 million for the write-down of other depreciable assets during the three months ended March 31, 2002. The Company reduced its headcount by a total of approximately 415 project personnel. Significant actions were also taken to streamline internal operations, including reductions in physical space and the reduction of approximately 130 selling and marketing and general and administrative employees. In total, the February 2002 restructuring plan resulted in the termination of approximately 545 employees, none of whom remained employed by the Company as of September 30, 2002. 76% of the terminated employees were project personnel, 3% were selling and marketing personnel and 21% were general and administrative personnel. Estimated costs for the reduction in physical office space is composed of contractual rental commitments for office space being vacated and related costs, brokerage and related costs to sublet the office space, in addition to future depreciation of the related leasehold improvements, offset by estimated sub-lease income. The total reduction of office space was approximately 291,000 square feet, all of which was vacated as of September 30, 2002.

In connection with the restructuring plans announced in March 2001 and July 2001, the Company recorded restructuring and other related charges of $100.6 million during 2001. The restructuring plans resulted in the termination of approximately 1,251 employees. The restructuring plans also included closing the Sydney, Australia office and consolidating office space in other cities where the Company had multiple office locations. Estimated costs for the consolidation of facilities is composed of contractual rental commitments for office space vacated and related costs, brokerage and related costs to sublet the office space,

in addition to future depreciation of the related leasehold improvements, offset by estimated sub-lease income. The total reduction of office space resulting from these office closings and consolidations was approximately 639,000 square feet.

These restructuring charges and accruals require significant estimates and assumptions, including sub-lease income assumptions. The consolidation of facilities required the Company to make estimates, which included contractual rental commitments or lease buy-outs for office space being vacated and related costs, in addition to future depreciation of the related leasehold improvements, offset by estimated sub-lease income. The Company’s sub-lease assumptions include anticipated rates to be charged to a sub-tenant and the timing of the sub-lease arrangement. These estimates and assumptions are monitored on at least a quarterly basis for changes in circumstances. It is reasonably possible that such estimates could change in the future resulting in additional adjustments and the effect could be material.

Charges for restructuring and other related activities as of, and for, the nine months ended September 30, 2002 were as follows (in thousands):

During the three months ended June 30, 2002, the Company’s equity ownership percentage in Dream Incubator, Inc. (DI) was diluted from approximately 17% to approximately 15.7% as a result of a public offering of its common stock by DI. The Company’s equity ownership percentage in DI was previously diluted from approximately 19% to approximately 17% during the three months ended March 31, 2001. In both periods, the dilution was due to the sale by DI of shares to new investors which occurred at a higher share price than the Company previously paid. The Company recorded gains of $1.8 million and $1.4 million for the nine months ended September 30, 2002 and 2001, respectively, as a result of the change in equity interest.

For the three months ended September 30, 2002 and 2001, the Company recorded $246,000 and $131,000, respectively, in charges to write down certain investments to their current fair value, because the decline in the value of these investments was considered to be other than temporary. These charges were $271,000 and $4.8 million for the nine months ended September 30, 2002 and 2001, respectively.

The Company has deferred tax assets which have arisen primarily as a result of operating losses incurred in 2001 and the first nine months of 2002, as well as other temporary differences between book and tax accounting. Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Significant management judgment is required in determining the Company’s provision for income taxes, its deferred tax assets and liabilities and any valuation allowance recorded against the net deferred tax assets. As a

result of operating losses incurred in 2001 and uncertainty as to the extent and timing of profitability in future periods, the Company recorded a full valuation allowance of $16.2 million during the three months ended September 30, 2001. Due to continued operating losses in the remainder of 2001, the valuation allowance totaled $72.6 million for the year ended December 31, 2001. As a result of continued operating losses for the nine months ended September 30, 2002, the Company recorded additional valuation allowances of $3.9 million and $32.0 million for the three and nine months ended September 30, 2002, respectively, resulting in a full valuation allowance of approximately $104.6 million on its deferred tax assets as of September 30, 2002. The Company recorded a net income tax benefit of $18.8 million for the nine months ended September 30, 2002, of which $17.2 million relates to the enactment of “The Job Creation and Worker Assistance Act of 2002” enacted March 9, 2002, which allows the Company to carry back its tax net operating loss for U.S. federal purposes for an additional three years to 1996. The Company’s effective tax rate may vary from period to period based on changes in estimated taxable income or loss, changes to the valuation allowance, changes to federal, state or foreign tax laws, future expansion into areas with varying country, state, and local income tax rates, deductibility of certain costs and expenses by jurisdiction and as a result of acquisitions.

During the three months ended September 30, 2001, the Company recognized approximately $216,000 in net revenues from consulting services provided to Sapient S.p.A., the Company’s 50% owned joint venture, and $204,000 and $1.4 million during the nine months ended September 30, 2002 and 2001, respectively. In addition to recognizing revenue for services provided to Sapient S.p.A., the Company reduced its general and administrative expenses by approximately $117,000 for start-up and administrative services billed to the joint venture for the three months ended September 30, 2001 and $108,000 and $254,000 for the nine months ended September 30, 2002 and 2001, respectively. No amounts were recognized as revenue or reductions to general and administrative expenses for the three months ended September 30, 2002. The Company had receivables due from this entity of approximately $434,000 at December 31, 2001. The Company had no net receivables due from this entity at September 30, 2002.

During the three months ended September 30, 2002 and 2001, the Company incurred costs of zero and $10,000, respectively, for start-up and administrative services provided by DI to the Company’s Japanese subsidiary, Sapient KK, and $9,000 and $305,000 during the nine months ended September 30, 2002 and 2001, respectively. The Company had accrued expenses due to this entity of approximately $1,500 at December 31, 2001. The Company did not have an outstanding liability due to this entity at September 30, 2002.

On January 31, 2000, the Company entered into a strategic relationship with a client which included, among other things, the Company becoming a preferred supplier to that client and its affiliated entities. As part of the relationship, the co-CEOs and co-chairmen of the Board of Directors of the Company each issued a $10.0 million convertible note to the client. The notes were convertible into shares of the Company’s common stock owned by the co-CEOs and co-chairmen at a conversion rate equal to the closing price of the Company’s common stock on the date the convertible notes were executed. The client’s ability to convert the notes was subject to certain vesting restrictions, based upon the client’s payment of certain levels of consulting revenues to Sapient within prescribed timeframes. During the three months ended June 30, 2002, the co-CEOs and co-chairmen of the Board of Directors of the Company each repaid these notes in full. The client had not converted any portion of the notes into shares of the Company’s common stock prior to the repayment.

The Company is engaged in business activities which involve the provision of business and technology consulting services, primarily on a fixed-price basis. Through December 31, 2001, the Company operated in one operating segment. Effective January 1, 2002, the Company has discrete financial data by operating

segments available based on the Company’s new method of internal reporting, which disaggregates its operations on a business unit basis for its United States operations and on a geographic basis for its international operations. Operating segments are defined as components of the Company concerning which separate financial information is available that is evaluated regularly by the chief operating decision maker. Management uses this information to manage resources and evaluate performance. Data was not available for comparative periods prior to January 1, 2002.

The Company does not allocate certain selling and marketing and general and administrative expenses to its business unit segments in the United States, as these activities are managed separately from the business units. The Company did not allocate the costs associated with the February 2002 and June 2002 restructuring plans across its operating segments, given that the majority of the restructuring costs represent consolidation of facilities and other items that are not specific to individual operating segments. Asset information by operating segment is not reported to or reviewed by the chief operating decision maker and therefore the Company has not disclosed asset information for each operating segment. Included in “All Other” is the Company’s Japanese subsidiary. The Company is in the process of discontinuing operations in Tokyo. This process is expected to be completed by December 31, 2002, at which time the results of operations for Tokyo will be reported separately as discontinued operations.

The tables below present the service revenues and operating income (loss) attributable to these operating segments for the three and nine months ended September 30, 2002 (in thousands).


(1)	The business unit segment operating income (loss) reflects only the direct controllable expenses of each business unit segment. It does not represent the total operating results for each business unit segment in the U.S. as it does not contain an allocation of certain corporate and general and administrative expenses incurred in support of the business unit segments.

(2)	Represents consolidated loss before income taxes, net equity loss from investees and minority interest. Adjustments that are made to the total of the segments’ operating income (loss) in order to arrive at consolidated loss before income taxes include the following:


(3)	Includes corporate selling and marketing and general and administrative costs.

Data for the geographic regions in which the Company operates is presented below for the periods presented in the consolidated statements of operations and the consolidated balance sheets:

For the three and nine months ended September 30, 2002, Sapient Limited, the Company’s UK subsidiary, had revenues of $8.8 million and $26.6 million, respectively, or 59% and 62%, respectively, of total international revenues.

In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, “Business Combinations,” (SFAS 141) and SFAS No. 142, “Goodwill and Other Intangible Assets” (SFAS 142). SFAS 141 requires that all business combinations be accounted for under the purchase method only and that certain acquired intangible assets in a business combination be recognized as assets apart from goodwill. SFAS 142 requires that ratable amortization of goodwill be replaced with at least annual tests of the goodwill’s impairment and that intangible assets other than goodwill be amortized over their useful lives to their estimated value. Companies have six months from the date of adoption of SFAS 142 to complete a transitional goodwill impairment test, which is applied as of the beginning of the fiscal year in which the standard is first adopted. SFAS 141 is effective for all business combinations initiated after June 30, 2001 and for all business combinations accounted for by the purchase method for which the date of acquisition is after June 30, 2001. The provisions of SFAS 142 were adopted by the Company, as required, on January 1, 2002.

As a result of the provisions of SFAS 142, beginning January 1, 2002, the Company ceased amortization of goodwill, which was approximately $101.8 million at that time. The Company has performed an impairment review of its goodwill as of January 1, 2002, under the transitional provisions of SFAS 142. The Company identified its reporting units, allocated assets and liabilities to the reporting units and performed impairment tests on the goodwill associated with each of the reporting units by comparing the reporting units’ book value to their estimated fair value. Assets and liabilities, including goodwill, were allocated to reporting units based on factors such as specific identification, percentage of revenue and headcount. The fair value of the reporting units was estimated considering a market multiple of revenue approach. During the three months ended June 30, 2002, the Company completed the transitional impairment test of goodwill and concluded that no impairment of the goodwill had occurred as of January 1, 2002. By June 30, 2002, the Company’s stock price had declined significantly, at which point the Company’s stock price was trading below its book value. As a result, the Company performed an interim goodwill impairment test as of June 30, 2002. Based on the

analysis at June 30, 2002, the carrying amount of all reporting units exceeded their fair values and a goodwill impairment charge of $101.8 million was recognized in the statement of operations, which is reflected under the caption, “Impairment of goodwill and intangible assets,” for the nine months ended September 30, 2002. This charge represented 100% of the goodwill balance at January 1, 2002.

The following is a summary of net loss and net loss per share for the three and nine months ended September 30, 2002 and 2001, as adjusted to remove the amortization of goodwill (in thousands, except per share amounts):

The changes in allocated goodwill for the three and nine months ended September 30, 2002, are as follows:

In October 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). SFAS 144 supersedes FASB Statement No. 121 (SFAS 121), “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of.” SFAS 144 applies to all long-lived assets (including discontinued operations), except goodwill, and consequently amends Accounting Principles Board Opinion No. 30 (APB 30), “Reporting Results of Operations — Reporting the Effects of Disposal of a Segment of a Business.” SFAS 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001, and was adopted by the Company, as required, on January 1, 2002. In accordance with the provisions of SFAS 144, the Company determined that an interim impairment test of its long-lived assets was necessary and should be performed at June 30, 2002 due to the significant decline in the Company’s market value. Utilizing the lowest level of identifiable cash flows for each long-lived asset group, the Company determined that the expected undiscounted cash flows related to its long-lived asset groups would not recover the carrying value of the assets over their remaining useful lives. Accordingly, the Company compared the carrying amounts of its long-lived assets to their estimated fair values. Fair values were estimated using methods such as estimated replacement cost and relief from royalty. Based on the analysis at

June 30, 2002, the fair values of certain intangible assets were below their carrying values and an impairment charge of $5.6 million was recognized in the statement of operations, which is reflected under the caption, “Impairment of goodwill and intangible assets,” for the nine months ended September 30, 2002.

The following is a summary of intangible assets as of September 30, 2002 and December 31, 2001 (in thousands):

Amortization expense related to the intangible assets was $598,000 and $2.8 million for the three months ended September 30, 2002 and 2001, respectively, and $3.7 million and $6.5 million for the nine months ended September 30, 2002 and 2001, respectively. Estimated amortization expense related to intangible assets is $598,000 for the three months ended December 31, 2002 and $1.4 million for the year ended December 31, 2003. The current balance of amortizable intangible assets will be fully amortized in 2003.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS 146 requires that a liability for a cost that is associated with an exit or disposal activity be recognized when the liability is incurred. It nullifies the guidance of the EITF in EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” Under EITF 94-3, an entity recognized a liability for an exit cost on the date that the entity committed itself to an exit plan. In SFAS 146, an entity’s commitment to a plan does not, by itself, create a present obligation to other parties that meets the definition of a liability. SFAS 146 also establishes that fair value is the objective for the initial measurement of the liability. SFAS 146 will be effective for exit or disposal activities that are initiated after December 31, 2002.

On October 23, 2002, the Company granted 324,500 shares of restricted common stock to senior executive officers of the Company. These shares will vest ratably over a period of four years.

We are a leading business and technology consultancy that helps Global 2000 clients achieve measurable business results through the rapid application and support of advanced technology primarily on a fixed-price basis. We are focused on delivering business value to our clients by understanding the key business problems they face and by solving those problems. We create value for our clients through our combination of broad skills, fixed price approach, speed and reliability, and our culture. Our many years of experience with large-scale program management and fixed-price delivery enables us to successfully deliver our solutions in the form and within the timeframe we promise to our clients.

The market for advanced technology consulting services, including our services, has declined significantly since the second half of 2000. As a result of this decrease in demand, our service revenues for the nine months ended September 30, 2002 decreased 50% from our service revenues for the nine months ended September 30, 2001, and our net loss increased from $160.3 million for the nine months ended September 30, 2001 to $204.5 million for the nine months ended September 30, 2002. Also, as a result of the losses incurred, we reduced our work force and office space in cities throughout the United States in March 2001, July 2001, February 2002 and June 2002. We also closed our Australia office in 2001 and we are in the process of discontinuing our operations in Tokyo. This process is expected to be completed by December 31, 2002. Our cash flows from operations for the nine months ended September 30, 2002 resulted in a use of cash of $53.1 million. Our cash, cash equivalents and short-term investments at September 30, 2002 were $190.6 million. We believe that our existing cash, cash equivalents and short-term investments will be sufficient to meet our working capital, capital expenditure, restructuring and stock repurchase program requirements for at least the next 18 months.

We have, however, begun to see some stabilization in the demand for our services. Our service revenues for the three months ended September 30, 2002 increased 8% from the three months ended June 30, 2002. Our annualized service revenues per billable employee were $130,000 for the three months ended September 30, 2002, compared to $111,000 for the three months June 30, 2002, due mainly to an improvement in our utilization rate, from 52% for the three months ended June 30, 2002 to 60% for the three months ended September 30, 2002. Furthermore, we expect service revenues for the three months ended December 31, 2002 to be in the range of $40.0 to $43.0 million, based on our current revenue projections, and we expect to recognize a net loss for the three months ended December 31, 2002. Within our business units, we expect that demand for our services in our Financial Services business unit will decline for the three months ended December 31, 2002 compared to the three months ended September 30, 2002, but that demand for our services in our United Kingdom business unit will increase during this same period. We expect that demand in our other business units for the three months ended December 31, 2002 will not change materially from the levels of demand for the three months ended September 30, 2002.

Although we believe we are seeing signs of stabilization in our business, the economic outlook is still uncertain. We believe that technology spending by large companies will remain weak over the next several quarters. We cannot predict when the market for technology consulting services will significantly improve. When the market does improve, we cannot predict whether, and to what extent, the demand for our services will increase. Any decline in our service revenues will have a significant impact on our financial results, particularly because a significant portion of our operating costs (such as personnel, rent and depreciation) are fixed in advance of a particular quarter. As a result, despite cost savings realized from our restructuring plans, our costs for project personnel, sales and marketing and general and administrative could continue to increase as a percentage of revenues, thereby affecting our operating results. With respect to personnel, we experienced an increase in our turnover rate in the last fiscal quarter, with voluntary turnover for the three months ended September 30, 2002 substantially increasing on an annualized basis. We expect that voluntary turnover will decrease for the three months ended December 31, 2002.

Our Global Distributed Delivery (GDD) methodology continues to increase in importance both as a percentage of our projects and as a percentage of our services revenues. We created this proprietary methodology in 2000, which allows us to provide high-quality solutions within accelerated 24-hour delivery timescales, by utilizing India’s highly skilled technology specialists, lower costs and the time differences between India and the countries we serve. We also employ our GDD methodology to provide support and maintenance. For the three months ended September 30, 2002, projects with a GDD component accounted for 44% of our total services revenues, compared to 36% for the three months ended September 30, 2001.

Our future revenues and operating results may also fluctuate from quarter to quarter based on the number, size and scope of projects in which we are engaged, the contractual terms and degree of completion of such projects, any delays incurred in connection with a project, employee utilization rates, the adequacy of provisions for losses, the use of estimates of resources required to complete ongoing projects, general economic conditions and other factors. In addition, revenues from a large project or client may constitute a significant portion of our total revenues in a particular quarter.

Summary of Critical Accounting Policies; Significant Judgments and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements. The accompanying unaudited consolidated financial statements have been prepared by us pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2001 included in our Annual Report on Form 10-K. The preparation of these financial statements requires us to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. These items are regularly monitored and analyzed by management for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our estimates if past experience or other assumptions do not turn out to be substantially accurate.

A summary of those accounting policies that we believe are most critical to fully understanding and evaluating our financial results is set forth below.


	•	Revenue Recognition and Allowance for Doubtful Accounts. We recognize all of our revenue from the provision of professional services under written service contracts with our clients. We derive a significant portion of our revenue from fixed-price, fixed-timeframe contracts. Revenue generated from fixed-price contracts, with the exception of support and maintenance contracts, is recognized based on the ratio of labor hours incurred to estimated total labor hours. This method is used since reasonably dependable estimates of the revenues and costs applicable to various stages of a contract can be made, based on historical experience and milestones set in the contract. Revenue generated from fixed-price support and maintenance contracts is recognized ratably over the contract term. This method is used since the revenues are earned ratably throughout the course of the contract. Our failure to accurately estimate the resources required for a project, or our failure to complete our contractual obligations in a manner consistent with the project plan upon which our fixed-price, fixed-timeframe contract was based could have a material adverse effect on our business, financial condition and results of operations. We have been required to commit unanticipated additional resources to complete projects in the past, which has resulted in lower than anticipated profitability or losses on those contracts. We expect that we will experience similar situations in the future. In addition, we may fix the price for some projects at an early stage of the process, which could result in a fixed price that turns out to be too low and, therefore, would adversely affect our business, financial condition and results of operations.


	Our project delivery and business unit finance personnel continually review labor hours incurred and estimated total labor hours, resulting in revisions to the amount of recognized revenue for a contract.


	If we do not accurately estimate the resources required or the scope of work to be performed for a contract or we do not manage the project properly within the planned time period, then we may recognize a loss on the contract. Provisions for estimated losses on uncompleted contracts are made on a contract-by-contract basis and are recognized in the period in which such losses are determined.

	Revenue from time-and-materials contracts is recognized as services are provided. In some instances during 2001, we provided services to clients in exchange for equity instruments of the client. We measured the fair value of the equity instrument on the date the parties came to a mutual understanding of the terms of the arrangement and a commitment for performance by us to earn the equity instruments is reached, or when the equity is earned, whichever occurred earlier.

	We recognize revenue for services only in those situations where collection from the client is probable. Our normal payment terms are 30 days from invoice date. Earnings recognized in excess of the amounts invoiced to clients are classified as unbilled revenues. Amounts invoiced to clients in excess of revenue recognized are classified as deferred revenues. Our project delivery and business unit finance personnel continuously monitor timely payments from our clients and assess any collection issues. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our clients to make required payments. We base our estimates on our historical collection and write-off experience, current trends, credit policy, detailed analysis of specific client situations and percentage of our accounts receivable by aging category. While such credit losses have historically been within our expectations and the allowances we established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. If the financial condition of our clients were to deteriorate, resulting in an impairment of their ability to make payment, additional allowances may be required. Our failure to accurately estimate the losses for doubtful accounts and ensure that payments are received on a timely basis could have a material adverse effect on our business, financial condition and results of operations.

	In November 2001, the Emerging Issues Task Force (EITF) issued Issue No. 01-14 regarding “Income Statement Characterization of Reimbursements Received for “Out-Of-Pocket” Expenses Incurred.” This pronouncement requires that reimbursements received for out-of-pocket expenses incurred should be characterized as revenue in our statement of operations. We incur incidental expenses in the delivery of services to our clients that are commonly referred to as “out-of-pocket” expenses. These expenses include, but are not limited to, travel and related charges. Accordingly, we adjusted revenue for all periods reported to include the reimbursable expenses billed to clients. Previously, these expense reimbursements were classified as a reduction of project personnel costs. This change in classification had no effect on current or previously reported net loss or net loss per share.


	•	Accounting for Income Taxes. We record income taxes using the asset and liability 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. Our financial statements contain certain deferred tax assets which have arisen primarily as a result of operating losses incurred in 2001 and the first nine months of 2002, as well as other temporary differences between book and tax accounting. Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We evaluate 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. As a result of operating losses incurred in 2001, and in the first nine months of 2002, and uncertainty as to the extent and timing of profitability in future periods, we have continued to record a full valuation allowance, which was approximately $104.6 million as of September 30, 2002. The decision and amount of the valuation allowance required significant judgment. Had we not recorded this allowance, we would have reported materially different results. If the realization of deferred tax assets in the


		future is considered more likely than not, an adjustment to the deferred tax assets would increase net income or reduce net loss in the period such determination was made. The amount of the deferred tax asset considered realizable is based on significant estimates, and it is at least reasonably possible that changes in these estimates in the near term could materially affect our results of operations. Our effective tax rate may vary from period to period based on changes in estimated taxable income or loss, changes to the valuation allowance, changes to federal, state or foreign tax laws, future expansion into areas with varying country, state, and local income tax rates, deductibility of certain costs and expenses by jurisdiction and as a result of acquisitions.

	•	Valuation of Long-Lived Assets. In accordance with Financial Accounting Standards Board Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the carrying value of intangible assets and other long-lived assets is reviewed on a regular basis for the existence of facts or circumstances, both internally and externally, that may suggest impairment. Factors we consider important which could trigger an impairment review include:


	•	significant underperformance relative to historical or projected future operating results;

	•	significant negative industry or economic trends;

	•	significant decline in our stock price for a sustained period; and

	•	our market capitalization relative to net book value.


	If such circumstances exist, we evaluate the carrying value of long-lived assets to determine if impairment exists based upon estimated undiscounted future cash flows over the remaining useful life of the assets and comparing that value to the carrying value of the assets. If the carrying value of the asset is greater than the estimated future cash flows, the asset is written down to its estimated fair value. In determining expected future cash flows, assets are grouped at the lowest level for which cash flows are identifiable and independent of cash flows from other asset groups. We determined that an interim impairment test of long-lived assets was necessary and should be performed at June 30, 2002 due to the significant decline in our market value. We determined that the expected undiscounted cash flows related to our long-lived asset groups would not recover the carrying value of the assets over their remaining useful lives. Accordingly, we compared the carrying amounts of our long-lived assets to their estimated fair values. Fair values were estimated using methods such as estimated replacement cost and relief from royalty. Based on the analysis at June 30, 2002, the fair values of certain intangible assets were below their carrying values and an impairment charge of $5.6 million was recognized in the statement of operations, which is reflected under the caption “Impairment of goodwill and intangible assets” for the nine months ended September 30, 2002.

	In accordance with SFAS 142, “Goodwill and Other Intangible Assets,” beginning January 1, 2002, we ceased amortization of goodwill, which was approximately $101.8 million at that time. We identified our reporting units, allocated assets and liabilities to the reporting units and performed impairment tests on the goodwill associated with each of the reporting units by comparing the reporting units’ book value to their estimated fair value. Assets and liabilities, including goodwill, were allocated to reporting units based on factors such as specific identification, percentage of revenue and headcount. The fair value of the reporting units was estimated considering a market multiple of revenue approach. By June 30, 2002, our stock price had declined significantly, at which point our stock price was trading below our book value. As a result, we determined that an interim goodwill impairment test should be performed as of June 30, 2002. Based on the analysis at June 30, 2002, the carrying amount of all reporting units exceeded their fair values and a goodwill impairment charge of $101.8 million was recognized in the statement of operations, which is reflected under the caption “Impairment of goodwill and intangible assets” for the nine months ended September 30, 2002.

	The valuation of long-lived assets require significant estimates and assumptions, including cash flow estimates and estimated fair value of reporting units. Our cash flow estimates contain management’s best estimates, using appropriate and customary assumptions and projections at the time. If different


	estimates or adjustments were used, it is reasonably possible that our analysis would have generated materially different results.


	•	Restructuring and Other Related Charges. We established exit plans for each of the restructuring activities which took place in March 2001, July 2001, February 2002 and June 2002 and accounted for these plans in accordance with EITF Issue No. 94-3, “Liability Recognition for Certain Employee Benefits and Other Costs to Exit an Activity (including Certain Costs incurred in a Restructuring).” These exit plans required that we make estimates as to the nature, timing and amount of the exit costs that we specifically identified. We specifically identified all employees that were to be terminated and notified them on the date that the action was announced to the public. The consolidation of facilities required us to make estimates, which included contractual rental commitments or lease buy-outs for office space being vacated and related costs, in addition to future depreciation of the related leasehold improvements, offset by estimated sub-lease income. We review on a regular basis our sub-lease assumptions. These estimates include anticipated rates to be charged to a sub-tenant and the timing of the sub-lease arrangement. We changed our original estimates in 2001 due to changing real estate markets, which resulted in net additional restructuring charges. For the three months ended September 30, 2002, we recognized a restructuring credit, which primarily related to savings in outplacement services and facility costs. If the rental markets continue to change, our sub-lease assumptions and space requirements may not be accurate and it is possible that changes in these estimates could materially affect our financial condition and results of operations.


	We recorded a restructuring charge during the three months ended March 31, 2002 of approximately $48.7 million, which consisted of severance and related expenses from the reduction in our workforce, and other costs related to office space consolidations. This restructuring plan resulted in the termination of approximately 545 employees; 76% of the terminated employees were project personnel, 3% were selling and marketing personnel and 21% were general and administrative personnel. All of these employees have been terminated as of September 30, 2002.

	We also recorded a restructuring charge during the three months ended June 30, 2002 of approximately $9.8 million, which consisted of severance and related expenses from the reduction in our workforce, and other costs related to office space consolidations. This restructuring plan will result in the termination of approximately 106 employees; 76% of the terminated employees are project personnel, 4% are selling and marketing personnel and 20% are general and administrative personnel. 101 of these employees have been terminated as of September 30, 2002, and we expect to terminate the remaining 5 people in the fourth quarter of 2002.


	•	Contingent Liabilities. We have certain contingent liabilities that arise in the ordinary course of our business activities. We accrue contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. We are subject to various pending or threatened legal claims and administrative audits which have arisen in the ordinary course of our business. We settled certain of these items during the three months ended September 30, 2002, and accordingly, have a remaining accrual at September 30, 2002 of approximately $1.7 million related to those items that remain outstanding. The ultimate outcome of these items is uncertain and the potential loss, if any, may be significantly higher or lower than amounts previously accrued by us.

The following table sets forth the percentage of revenues of items included in our consolidated statements of operations:

Service revenues for the three months ended September 30, 2002 decreased 38% from service revenues for the three months ended September 30, 2001. For the nine months ended September 30, 2002, service revenues decreased 50% from the comparable period of the prior year. The decrease in service revenues was primarily due to a decline in the demand for advanced technology consulting services, including our services, in the United States. Our service revenues for the three months ended September 30, 2002 increased 8% sequentially from our service revenues for the three months ended June 30, 2002. We expect service revenues for the three months ended December 31, 2002 to be in the range of $40.0 to $43.0 million, based on our current revenue projections. The percentage of our revenue attributable to support and maintenance projects is also increasing, growing to 7% of our total services revenues for the three months ended September 30, 2002 from 3% for the three months ended September 30, 2001.

For the three months ended September 30, 2002, our five largest clients accounted for approximately 24% of our service revenues in the aggregate, compared to 25% of service revenues for the three months ended September 30, 2001. For the nine months ended September 30, 2002, our five largest clients accounted for approximately 21% of our service revenues in the aggregate, compared to 25% of service revenues for the nine months ended September 30, 2001. During the three months and nine months ended September 30, 2002 and 2001, no client accounted for more than 10% of revenues.

Project personnel costs, before reimbursable expenses, consist principally of salaries and employee benefits for personnel dedicated to client projects and direct expenses incurred to complete projects that were not reimbursed by the client and represent the most significant expense we incur in providing our services. Project personnel costs, before reimbursable expenses, remained the same as a percentage of revenues at 74% for the three months ended September 30, 2002 and 2001 and increased as a percentage of revenue to 81% for the nine months ended September 30, 2002, from 71% for the nine months ended September 30, 2001. This percentage increase was due to a decrease in billable utilization to 54% for the nine months ended September 30, 2002, from 56% for the nine months ended September 30, 2001, and our lower revenue base. For the three months ended September 30, 2002 and 2001, billable utilization was 60%. The absolute decrease in project personnel costs for the three and nine months ended September 30, 2002 was primarily due to a decrease in the number of project personnel from 1,807 at September 30, 2001 to 1,248 at September 30, 2002.

Selling and marketing costs consist principally of salaries, employee benefits and travel expenses of selling and marketing personnel, and promotional costs. Selling and marketing costs increased as a percentage of revenues to 15% for the three and nine months ended September 30, 2002, from 8% for the three and nine months ended September 30, 2001. This percentage increase was primarily due to the decline in our revenue base. The absolute decrease in selling and marketing costs for the nine months ended September 30, 2002 compared to the nine months ended September 30, 2001 was primarily due to a decrease in the number of selling and marketing personnel from 95 at September 30, 2001 to 74 at September 30, 2002.

General and administrative costs relate principally to salaries and employee benefits associated with our management, information technology, finance, recruiting, training and administrative groups, depreciation and occupancy expenses. General and administrative costs remained the same as a percentage of revenues at 42% for the three months ended September 30, 2002 and 2001 and increased as a percentage of revenues to 48% for the nine months ended September 30, 2002, from 39% for the nine months ended September 30, 2001. This percentage increase was due primarily to fixed personnel, rent and depreciation costs incurred in anticipation of expected revenue stabilization or growth, which did not materialize, and the decline in our revenue base. The absolute decrease in general and administrative costs for the three and nine months ended September 30, 2002 was primarily due to a decrease in the number of general and administrative personnel, occupancy costs, and depreciation costs related to our restructuring actions. General and administrative personnel decreased from 462 at September 30, 2001 to 288 at September 30, 2002. Our total headcount decreased from 2,364 at September 30, 2001 to 1,610 at September 30, 2002. Total occupancy at September 30, 2002 was approximately 388,000 square feet, compared to approximately 608,000 square feet at September 30, 2001.

As a result of the decline in the demand for advanced technology consulting services that began in the second half of 2000, we implemented restructurings of our workforce and operations in March 2001, July 2001, February 2002 and June 2002. For the three months ended September 30, 2002, we recorded a $3.6 million restructuring credit for charges recorded in prior quarters. The credit is the result of savings in outplacement services and facility costs, net of restructuring charges for workforce reductions and facility

charges in connection primarily with the closure of our Tokyo office expected to be completed in December 2002. The restructuring charge for the Tokyo office closure is expected to result in the termination of approximately 33 employees in total, all of whom remained employed by us as of September 30, 2002, and whom we expect to terminate in the fourth quarter of 2002 and the first quarter of 2003 upon completion of project assignments and closure of Tokyo operations. The total reduction of office space will be approximately 8,600 square feet, which is expected to be vacated in the fourth quarter of 2002.

In connection with the restructuring plan implemented in June 2002, we recorded restructuring and other related charges of $9.8 million, consisting of $3.1 million for workforce reductions, $6.2 million for consolidation of facilities and $0.5 million for the write-down of other depreciable assets during the three months ended June 30, 2002. The June 2002 restructuring is expected to result in the termination of approximately 106 employees in total, of whom 5 remained employed by us as of September 30, 2002, and whom we expect to terminate in the fourth quarter of 2002 upon completion of project assignments. 76% of the terminated employees are project personnel, 4% are selling and marketing personnel and 20% are general and administrative personnel. The June 2002 restructuring plan also included further consolidation of office space, which included the closing of our Houston and Denver offices. Estimated costs for the reduction in physical office space is composed of contractual rental commitments for office space being vacated and related costs, brokerage and related costs to sublet the office space, in addition to future depreciation of the related leasehold improvements, offset by estimated sub-lease income. The total reduction of office space will be approximately 52,000 square feet, all of which was vacated as of September 30, 2002. We estimate future cost savings of approximately $3.0 million per quarter upon full implementation of the plan, of which approximately 65% relates to project personnel costs, 3% relates to selling and marketing costs and 32% relates to general and administrative costs, including facilities and depreciation.

In connection with the restructuring plan announced in February 2002, we recorded restructuring and other related charges of $48.7 million, consisting of $12.9 million for workforce reductions, $35.0 million for consolidation of facilities and $0.8 million for the write-down of other depreciable assets during the three months ended March 31, 2002. We reduced our headcount by a total of approximately 415 project personnel. Significant actions were also taken to streamline internal operations, including reductions in physical space and the reduction of approximately 130 selling and marketing and general and administrative employees. In total, the February 2002 restructuring plan resulted in the termination of approximately 545 employees, none of whom remained employed by us as of September 30, 2002. 76% of the terminated employees were project personnel, 3% were selling and marketing personnel and 21% were general and administrative personnel. Estimated costs for the reduction in physical office space is composed of contractual rental commitments for office space being vacated and related costs, brokerage and related costs to sublet the office space, in addition to future depreciation of the related leasehold improvements, offset by estimated sub-lease income. The total reduction of office space was approximately 291,000 square feet, all of which was vacated as of September 30, 2002. We realized cost savings from the February 2002 restructuring actions of approximately $33.4 million for the nine months ended September 30, 2002, and we estimate future cost savings of approximately $14.7 million per quarter, of which approximately 62% relates to project personnel costs, 2% relates to selling and marketing costs and 36% relates to general and administrative costs, including facilities and depreciation.

In connection with the restructuring plans announced in March 2001 and July 2001, we recorded restructuring and other related charges of $100.6 million during 2001. The restructuring plans resulted in the termination of approximately 1,251 employees. The restructuring plans also included closing the Sydney, Australia office and consolidating office space in other cities where we had multiple office locations. Estimated costs for the consolidation of facilities is composed of contractual rental commitments for office space vacated and related costs, brokerage and related costs to sublet the office space, in addition to future depreciation of the related leasehold improvements, offset by estimated sub-lease income. The total reduction of office space resulting from these office closings and consolidations was approximately 639,000 square feet.

These restructuring charges and accruals require significant estimates and assumptions, including sub-lease income assumptions. These estimates and assumptions are monitored on at least a quarterly basis for changes in circumstances. It is reasonably possible that such estimates could change in the future resulting in additional adjustments and the effect could be material.

Charges for restructuring and other related activities as of, and for the nine months ended September 30, 2002 were as follows (in thousands):

For the three and nine months ended September 30, 2002, amortization of intangible assets consists primarily of amortization of marketing assets, customer lists and developed technology resulting from our acquisitions. The decrease in amortization of intangible assets for the three and nine months ended September 30, 2002 relative to the comparable periods from the prior year was primarily related to the cessation of amortization of goodwill as of January 1, 2002, in accordance with SFAS No. 142, “Goodwill and other Intangible Assets.” We recorded approximately $4.7 million and $14.2 million of amortization of goodwill for the three and nine months ended September 30, 2001, respectively. We performed an impairment review of our goodwill as of January 1, 2002, under the transitional provisions of SFAS 142. We identified our reporting units, allocated assets and liabilities to the reporting units and performed impairment tests on the net goodwill associated with each of the reporting units by comparing the reporting units’ book value to their estimated fair value. Assets and liabilities, including goodwill, were allocated to reporting units based on factors such as specific identification, percentage of revenue and headcount. The fair value of the reporting units was estimated considering a market multiple of revenue approach. During the three months ended June 30, 2002, we completed the transitional impairment test of goodwill as of January 1, 2002, concluding that no impairment of the goodwill had occurred at that date. Our stock price had declined significantly in the three months ended June 30, 2002, at which point our stock price was trading below our book value. As a result, we performed an interim goodwill impairment test as of June 30, 2002. Based on our analysis at June 30, 2002, the carrying amount of all reporting units exceeded their fair values and a goodwill impairment charge of $101.8 million was recognized in the statement of operations, which is reflected under the caption, “Impairment of goodwill and intangible assets,” for the nine months ended September 30, 2002. This charge represented 100% of the goodwill balance at January 1, 2002.

Also, in accordance with the provisions of SFAS 144, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of,” we determined that an interim impairment test of our long-lived intangible assets was necessary and should be performed at June 30, 2002 due to the significant decline in our market value. Utilizing the lowest level of identifiable cash flows for each long-lived asset group, we determined that the expected undiscounted cash flows related to our long-lived asset groups would not recover the carrying value of the assets over their remaining useful lives. Accordingly, we compared the carrying amounts of our long-lived assets to their estimated fair values. Fair values were estimated using methods such as estimated replacement cost and relief from royalty. Based on the analysis at June 30, 2002, the fair values of certain intangible assets were below their carrying values and an impairment charge of $5.6 million was recognized in the statement of operations, which is reflected under the caption, “Impairment of goodwill and intangible assets,” for the nine months ended September 30, 2002. Amortization expense related to the intangible assets was $598,000 and $2.8 million for the three months ended September 30, 2002 and 2001, respectively, and $3.7 million and $6.5 million for the nine months ended September 30, 2002 and 2001, respectively. Estimated amortization expense related to intangible assets is $598,000 for the three months ended December 31, 2002 and $1.4 million for the year ended December 31, 2003. The current balance of amortizable intangible assets will be fully amortized in 2003.

Stock-based compensation consists of expenses for deferred compensation associated with the Human Code, Inc. (Human Code) and The Launch Group Aktiengesellschaft (TLG) acquisitions. Stock-based compensation for the three and nine months ended September 30, 2002 includes a non-recurring catch-up adjustment of approximately $658,000 to correct the amortization period related to deferred compensation associated with the TLG acquisition, as described in the next paragraph. The decrease in stock-based compensation for the nine months ended September 30, 2002 relative to the comparable periods in 2001 was primarily due to the reduction of deferred compensation related to people no longer with the Company. In connection with the termination of Human Code employees to whom the deferred compensation relates, $4.2 million of deferred compensation was reversed through additional paid-in-capital during the second half of 2001 and the first quarter of 2002. In connection with the acquisition of Human Code, we assumed the outstanding options granted under the Human Code 1994 Stock Option/ Stock Issuance Plan. The options vest ratably over periods up to four years. We originally recorded deferred compensation of $11.2 million related to the intrinsic value of the unvested options, of which $259,000 has not been amortized as of September 30, 2002. The remaining deferred compensation will be charged to operations at the rate of approximately $75,000 for the next three quarters, and $34,000 in total thereafter, spread over approximately three quarters.

In connection with the TLG acquisition, in July 2001, we issued $10.0 million of restricted common stock to the former TLG employees continuing with the Company. We began to amortize the deferred compensation over a period of 4.75 years, commencing on the date of acquisition. The period should have been 4.0 years, which was corrected in the current quarter, as described in the preceding paragraph. We expect this charge to be approximately $625,000 per quarter for the next nine quarters, or $2.5 million annually.

On October 23, 2002, we granted 324,500 shares of restricted common stock to senior executive officers of the Company. These shares will rest ratably over a period of four years. The stock-based compensation charge will be approximately $17,000 for the three months ended December 31, 2002, and $25,000 per quarter thereafter, or $101,000 annually.

During the three months ended June 30, 2002, our equity ownership percentage in Dream Incubator, Inc. (DI) was diluted from approximately 17% to approximately 15.7%, as a result of a public offering of its common stock by DI. Our equity ownership percentage in DI was previously diluted from approximately 19% to approximately 17% during the three months ended March 31, 2001. In both periods, the dilution was due to the sale by DI of shares to new investors which occurred at a higher share price than we previously paid. We

recorded gains of $1.8 million and $1.4 million for the nine months ended September 30, 2002 and 2001, respectively, as a result of the change in equity interest.

For the three months ended September 30, 2002 and 2001, we recorded $246,000 and $131,000, respectively, in charges to write down certain investments to their current fair value, because the decline in the value of these investments was considered to be other than temporary. These charges were $271,000 and $4.8 million for the nine months ended September 30, 2002 and 2001, respectively.

Interest income was derived primarily from investments of the proceeds from our public stock offerings, which were invested primarily in U.S. government securities, tax-exempt, short-term municipal bonds and commercial paper. The decrease in interest income for the three and nine months ended September 30, 2002 over the comparable periods in 2001 was due to the decrease in the average cash and investment balances and lower interest rates, offset in part by transferring investment balances to higher interest bearing taxable securities.

We have deferred tax assets which have arisen primarily as a result of operating losses incurred in 2001 and the first nine months of 2002, as well as other temporary differences between book and tax accounting. Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against the net deferred tax assets. As a result of operating losses incurred in 2001 and uncertainty as to the extent and timing of profitability in future periods, we recorded a full valuation allowance of $16.2 million during the three months ended September 30, 2001. Due to continued operating losses in the remainder of 2001, the valuation allowance totaled $72.6 million for the year ended December 31, 2001. As a result of continued operating losses for the nine months ended September 30, 2002, we recorded additional valuation allowances of $3.9 million and $32.0 million for the three and nine months ended September 30, 2002, respectively, resulting in a full valuation allowance of approximately $104.6 million on our deferred tax assets as of September 30, 2002. We recorded a net income tax benefit of $18.8 million for the nine months ended September 30, 2002, of which $17.2 million relates to the enactment of “The Job Creation and Worker Assistance Act of 2002” enacted March 9, 2002, which allows us to carry back our tax net operating loss for U.S. federal purposes for an additional three years to 1996. Our effective tax rate may vary from period to period based on changes in estimated taxable income or loss, changes to the valuation allowance, changes to federal, state or foreign tax laws, future expansion into areas with varying country, state, and local income tax rates, deductibility of certain costs and expenses by jurisdiction and as a result of acquisitions.

Net equity income (loss) from investees for the three months ended September 30, 2002 and 2001 was approximately $162,000 and $(113,000), respectively. This consisted of net income from Sapient S.p.A. of approximately $57,000 and from DI of approximately $105,000 for the three months ended September 30, 2002 and net losses from Sapient S.p.A. of approximately $(64,000) and from DI of approximately $(49,000) for the three months ended September 30, 2001. Net equity loss from investees for the nine months ended September 30, 2002 and 2001 was approximately $(373,000) and $(464,000), respectively. This consisted of net losses from Sapient S.p.A. of approximately $(506,000) and net income from DI of approximately $133,000 for the nine months ended September 30, 2002 and net losses from Sapient S.p.A. of approximately $(240,000) and from DI of approximately $(224,000) for the nine months ended September 30, 2001. Our share of Sapient S.p.A.’s losses for the nine months ended September 30, 2002 included a restructuring charge recorded by Sapient S.p.A. of approximately $401,000.

Minority interest income for the three and nine months ended September 30, 2002 was approximately $163,000 and $342,000, respectively. Minority interest income for the three and nine months ended September 30, 2001 was approximately $189,000 and $274,000, respectively, related to DI’s 12% interest in our Japanese subsidiary’s losses.

We provide business and technology consulting services, primarily on a fixed-price basis. Through December 31, 2001, we operated in one operating segment. Effective January 1, 2002, we have discrete financial data by operating segments available based on our new method of internal reporting, which disaggregates operations on a business unit basis for our United States operations and on a geographic basis for our international operations. Operating segments are defined as components of the Company concerning which separate financial information is available that is evaluated regularly by the chief operating decision maker. Management uses this information to manage resources and evaluate performance. Data was not available for comparative periods prior to January 1, 2002.

We do not allocate certain selling and marketing and general and administrative expenses to our business unit segments in the United States, as these activities are managed separately from the business units. We did not allocate the costs associated with the February 2002 and June 2002 restructuring plans across our operating segments, given that the majority of the restructuring costs represent consolidation of facilities and other items that are not specific to individual operating segments. Asset information by operating segment is not reported to or reviewed by the chief operating decision maker and therefore we have not disclosed asset information for each operating segment. Included in “All Other” is our Japanese subsidiary. We are in the process of discontinuing operations in Tokyo. This process will be completed by December 31, 2002, at which time the results of operations for Tokyo will be reported separately as discontinued operations.

The tables below present the service revenues and operating income (loss) attributable to these operating segments for the three and nine months ended September 30, 2002 (in thousands).


(1)	The business unit segment operating income (loss) reflects only the direct controllable expenses of each business unit segment. It does not represent the total operating results for each business unit segment in the U.S. as it does not contain an allocation of certain corporate and general and administrative expenses incurred in support of the business unit segments.


(2)	Represents consolidated loss before income taxes, net equity loss from investees and minority interest. Adjustments that are made to the total of the segments’ operating income (loss) in order to arrive at consolidated loss before income taxes include the following:


(3)	Includes corporate selling and marketing and general and administrative costs.

We have primarily funded our operations from cash flow generated from operations and the proceeds from our public stock offerings. We invest predominantly in instruments that are highly liquid, investment grade securities. At September 30, 2002, we had approximately $190.6 million in cash, cash equivalents and short-term investments, compared to $244.5 million at December 31, 2001.

In March 2002, we canceled our bank revolving line of credit, which provided for borrowings of up to $5.0 million. At the time of cancellation and at all times throughout 2001 and 2002, we had no borrowings outstanding. We had letters of credit outstanding under the line of credit of approximately $2.3 million at the time of cancellation. We have deposited approximately $5.3 million with the bank as collateral for these and other letters of credit and have classified this cash as restricted on the accompanying consolidated balance sheet at September 30, 2002. The following summarizes our contractual obligations of non-cancelable operating leases, excluding restructured properties, for the remainder of 2002 and for each of the years ending December 31:

Cash used in operating activities was $53.1 million for the nine months ended September 30, 2002. This resulted primarily from a net loss of $204.5 million, increases in restricted cash of $5.3 million, decreases in deferred revenues on contracts of $4.4 million, increases in prepaid expenses and other current assets of $3.7 million and decreases in accrued compensation of $1.2 million, offset by net non-cash charges of $123.1 million, which includes $107.4 million of impairment charges, non-cash restructuring charges of $5.8 million, increases in accrued restructuring charges of $17.2 million, decreases in income tax receivable, net of $11.8 million, increases in accrued expenses of $2.6 million and decreases in accounts receivable of $6.9 million. Overall, the change was primarily due to the market decline for advanced technology services, which resulted in a net loss. Cash provided by operations was $11.6 million for the three months ended September 30, 2002. This was primarily the result of a $30.0 million tax refund received during the quarter. Also, our days sales outstanding (DSO) for accounts receivable decreased from 79 days for the three months ended June 30, 2002 to 72 days for the three months ended September 30, 2002.

Cash provided by investing activities was $12.8 million for the nine months ended September 30, 2002. This was due primarily to maturities of short-term investments (net of purchases) of $18.1 million offset by capital expenditures of $5.4 million primarily for expansion of our foreign locations.

Cash used in financing activities was $1.8 million for the nine months ended September 30, 2002, as a result of repurchases of our common stock of $5.2 million under our previous stock repurchase program, offset by cash provided from the sale of common stock through our employee stock purchase plan and the exercise of stock options of $3.4 million. Our previous stock repurchase program was effective for one year, commencing on September 20, 2001. Under this program, we repurchased $5.6 million of our common stock.

On October 24, 2002, we announced a new stock repurchase program of up to $20.0 million over the next year. This program became effective immediately. Purchases under our stock repurchase program may be made from time-to-time, in the open market, through block trades or otherwise.

The total cash outlay for the restructuring and other related activities implemented in June 2002 and additional charges in the three months ended September 30, 2002 is expected to be approximately $7.7 million. The remaining $1.3 million of restructuring and other related costs consists of non-cash charges primarily for asset write-offs and leasehold improvements for facilities being vacated. As of September 30, 2002, $2.8 million of cash had been used for restructuring and other related costs. $1.4 million cash outlay is expected during the remainder of 2002, $1.8 million is expected in 2003, $895,000 is expected in 2004, $360,000 is expected in 2005 and $117,000 is expected in 2006 and the remaining cash outlay of approximately $356,000, primarily related to real estate rental obligations, is expected to occur over the next five years.

The total cash outlay for the restructuring and other related activities announced in February 2002 is expected to be approximately $42.5 million. The remaining $4.9 million of restructuring and other related costs consists of non-cash charges primarily for asset write-offs and leasehold improvements for facilities being vacated. As of September 30, 2002, $16.8 million of cash had been used for restructuring and other related costs. An additional $2.0 million cash outlay is expected during the remainder of 2002, $10.9 million is expected in 2003, $3.2 million is expected in 2004, $2.1 million is expected in 2005, $1.7 million is expected in 2006 and the remaining cash outlay of approximately $5.8 million, primarily related to real estate rental obligations, is expected to occur over the next eight years.

The total cash outlay for the restructuring and other related activities announced in March 2001 and July 2001 is expected to be approximately $79.2 million. The remaining $20.0 million of restructuring and other related costs consists of non-cash charges primarily for asset write-offs and leasehold improvements for facilities being vacated. As of September 30, 2002, $46.1 million of cash had been used for restructuring and other related costs, of which $12.3 million was used during the nine months ended September 30, 2002, of which approximately $188,000 was expended for lease termination payments. An additional $3.2 million cash outlay is expected during the remainder of 2002, $11.0 million is expected in 2003, $5.7 million is expected in 2004, $4.3 million is expected in 2005 and $3.0 million is expected in 2006 and the remaining cash outlay of approximately $5.9 million, primarily related to real estate rental obligations, is expected to occur over the next five years.

We believe that our existing cash, cash equivalents and short-term investments will be sufficient to meet our working capital, capital expenditure, restructuring requirements and stock repurchase program requirements for at least the next 18 months.

SFAS 146 also establishes that fair value is the objective for the initial measurement of the liability. SFAS 146 will be effective for exit or disposal activities that are initiated after December 31, 2002.

The following important factors, among others, could cause our actual business and financial results to differ materially from those contained in forward-looking statements made in this Quarterly Report or presented elsewhere by management from time to time.

Our market and the demand for business and technology consulting services have changed rapidly

The market for our consulting services and the technologies used in our solutions have changed rapidly over the last three years, and we expect this rate of change to continue. The market for advanced technology consulting services expanded dramatically during 1999 and most of 2000, but declined significantly in 2001 and to date in 2002. These market changes have required us to shift the focus of our services, from design and implementation of Internet solutions to other strategic technology initiatives, and have also adversely affected our financial results. If we cannot successfully adapt to these changes in our marketplace, our business, financial condition and results of operations will suffer.

Our future success will depend, in part, on our ability to develop service offerings that keep pace with rapid and continuing changes in technology, evolving industry needs and changing client preferences. Our future success will also depend on our ability to develop and implement ideas that successfully apply existing and new technologies to deliver measurable business results to our clients. We may not be successful in addressing these developments on a timely basis or in selling our services in the marketplace.

Our clients may continue to cancel or delay spending on technology initiatives because of the current economic climate

Since the second half of 2000, many companies have experienced financial difficulties or uncertainty, and canceled or delayed spending on technology initiatives as a result. This trend has worsened for some clients following the September 11, 2001 terrorist attacks in the United States and the accounting scandals involving Enron, Worldcom and other companies. Furthermore, the severe financial difficulties which many start-up Internet companies have experienced has further reduced the perceived urgency by larger companies to begin or continue technology initiatives. If large companies continue to cancel or delay their business and technology consulting initiatives because of the current economic climate, or for other reasons, our business, financial condition and results of operations will continue to be materially adversely affected.

Our market is highly competitive and we may not be able to continue to compete effectively

The business and technology consulting market in which we operate includes a large number of companies and is highly competitive. Our primary competitors are large accounting and consulting firms and systems consulting and implementation firms. We compete to a lesser extent with specialized e-business consulting firms, offshore outsourcing companies, strategy consulting firms, other packaged technology vendors and internal information systems groups. Of these groups, we are seeing, in particular, increased competition from the offshore outsourcing companies. We compete frequently for client engagements against companies with far higher revenues and larger numbers of consultants than we have. Recent consolidations of large consulting companies within our market have further increased the size and resources of some of these competitors. These competitors are often able to offer more scale, which in some instances has enabled them to significantly discount their services in exchange for revenues in other areas or at later dates. Additionally, in an effort to maintain market share, many of our smaller competitors are heavily discounting their services to unprofitable levels. If we cannot keep pace with the intense competition in our marketplace, our business, financial condition and results of operations will suffer.

Our growing international operations and global distributed delivery model subject us to increased risk

We currently have offices in the United Kingdom, Germany, India, Japan and Canada and we have a joint venture in Italy. Our international operations are growing as a percentage of our total revenues, and our global distributed delivery model is a key component of our ability to successfully deliver our services. International operations are subject to inherent risks, including:


	•	economic recessions in foreign countries;

	•	fluctuations in currency exchange rates;

	•	political instability or changes in regulatory requirements;

	•	costs and management of staffing multi-national operations;

	•	difficulties or delays in obtaining required immigration approvals for international assignments;

	•	U.S. imposed restrictions on the import and export of technologies; and

	•	reduced protection for intellectual property in some countries.

In particular, our global distributed delivery model depends heavily on our office in New Delhi, India. Any escalation in the political or military instability in India, Pakistan or the surrounding countries could hinder our ability to successfully utilize global distributed delivery, and could result in material adverse effects to our business, financial condition and results of operations. Furthermore, the delivery of our services from remote locations causes us to rely on data, phone, power and other networks which are not as reliable as those in other countries where we operate. Any failures of these systems could affect the success of our global distributed delivery 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 timeframe and budget for each project.

Businesses may decrease or delay their use of advanced technologies as a means for conducting commerce

Our future success depends heavily on the increased acceptance and use of advanced technologies as a means for conducting commerce and streamlining operations. We focus our services on the development and implementation of advanced technology strategies and solutions. If use of these advanced technologies does not continue to grow, or grows more slowly than expected, our revenue could be less than we anticipate and our business, financial condition and results of operations could be materially adversely affected. Consumers and businesses may delay adoption of advanced technologies for a number of reasons, including:


	•	inability to implement and sustain profitable business models using advanced technologies;

	•	inadequate network infrastructure or bandwidth;

	•	delays in the development or adoption of new technical standards and protocols required to handle increased levels of usage;

	•	adoption of new laws and regulations applicable to new technologies and electronic commerce by federal, state or international governments that hinder the growth of new technologies;

	•	delays in the development of security and authentication technology necessary to effect secure transmission of confidential information; and

	•	failure of companies to meet their customers’ expectations in delivering goods and services using advanced technologies.

We have significant fixed operating costs, which may be difficult to adjust in response to unanticipated fluctuations in revenues

A high percentage of our operating expenses, particularly personnel, rent and depreciation, are fixed in advance of any particular quarter. As a result, an unanticipated decrease in the number or average size of, or

an unanticipated delay in the scheduling for, our projects may cause significant variations in operating results in any particular quarter and could have a material adverse effect on operations for that quarter.

An unanticipated termination or decrease in size or scope of a major project, a client’s decision not to proceed with a project we anticipated or the completion during a quarter of several major client projects could require us to maintain underutilized employees and could have a material adverse effect on our business, financial condition and results of operations. Our revenues and earnings may also fluctuate from quarter to quarter because of such factors as:


	•	the contractual terms and timing of completion of projects;

	•	any delays incurred in connection with projects;

	•	the adequacy of provisions for losses and bad debts;

	•	the accuracy of our estimates of resources required to complete ongoing projects;

	•	loss of key highly-skilled personnel necessary to complete projects; and

	•	general economic conditions.

We may lose money if we do not accurately estimate the costs of fixed-price engagements

Most of our projects are based on fixed-price, fixed-timeframe contracts, rather than contracts in which payment to us is determined on a time and materials basis. Our failure to accurately estimate the resources required for a project, or our failure to complete our contractual obligations in a manner consistent with the project plan upon which our fixed-price, fixed-timeframe 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 have been required to commit unanticipated additional resources to complete projects in the past, which has resulted in losses on those contracts. We will likely experience similar situations in the future. In addition, we may fix the price for some projects at an early stage of the process, which could result in a fixed price that turns out to be too low and, therefore, would adversely affect our business, financial condition and results of operations.

Some of our contracts can be canceled by the client with limited advance notice and without significant penalty. Termination by any client of a contract for our services could result in a loss of expected revenues and additional expenses for staff which were allocated to that client’s project. We could be required to maintain underutilized employees who were assigned to the terminated contract. The unexpected cancellation or significant reduction in the scope of any of our large projects could have a material adverse effect on our business, financial condition and results of operations.

We may be liable to our clients for damages caused by our services or by our failure to remedy system failures

Many of our projects involve technology applications or systems that are critical to the operations of our clients’ businesses and handle very large volumes of transactions. If we fail to perform our services correctly, we may be unable to deliver applications or systems to our clients with the promised functionality or within the promised timeframe, or to satisfy the required service levels for support and maintenance. While we have taken precautionary actions to create redundancy and back-up systems, any such failures by us could result in claims by our clients for substantial damages against us. Although we attempt to limit the amount and type of our contractual liability for defects in the applications or systems we provide, we cannot be assured that these limitations will be enforceable in all cases. Even if such limitations are found to be enforceable, our liability to our clients for these types of claims could be material in amount and affect our business, financial condition and results of operations.

We have derived, and believe that we will continue to derive, a significant portion of our revenues from a limited number of clients for which we perform large projects. For the three and nine months ended September 30, 2002, our five largest clients accounted for approximately 24% and 21% of our revenues in the aggregate, respectively, with two clients and one client each accounting for more than 5% of our revenues for the three and nine months ended September 30, 2002, respectively. In addition, revenues from a large client may constitute a significant portion of our total revenues in any particular quarter. As a result, we are dependent upon winning new projects from new or existing clients to replace completed projects. The loss of any principal client for any reason or the inability to replace existing projects, including as a result of the acquisition of that client by another entity, our failure to meet that client’s expectations, or that client’s decision to reduce spending on technology-related projects, could have a material adverse effect on our business, financial condition and results of operations.

If we do not attract and retain qualified professional staff, we may not be able to adequately perform 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. Although many specialized e-business and other business and technology companies have reduced their work forces or slowed their hiring efforts, and although we reduced our work force in March 2001, July 2001, February 2002 and June 2002, intense competition still exists for certain employees who have specialized skills or significant experience in business and technology consulting. We may not be successful in attracting a sufficient number of these highly skilled employees in the future. Furthermore, the industry turnover rates for these types of employees is high, and we may not be successful in retaining, training and motivating the employees we are able to attract. Any inability to attract, retain, train and motivate employees could impair our ability to adequately manage and complete existing projects and to bid for or accept new 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. Almost all of our employees participate in one or more of our stock option plans as a component of long-term incentive compensation, and many of the stock options held by current employees have exercise prices that significantly exceed the recent trading range of our common stock. A future prolonged decline or low stock price could result in reduced incentives for employees and in increased turnover.

Our common stock may not remain in compliance with Nasdaq National Market listing requirements

Our common stock is listed on the Nasdaq National Market (the “NNM”), which requires that listed stocks maintain a minimum per share closing bid price of $1. Between July 2002 and October 2002, the closing bid price of our stock dropped below $1 for certain periods of time. The closing bid price of our stock has been above $1 since October 7, 2002. If our closing bid price drops below $1 per share in the future for 30 consecutive trading days, Nasdaq may notify us of the resulting deficiency. If this happens, we must return to compliance within a 90-day grace period, or (after the 90 days) request a NASDAQ hearing to present our compliance plan. The hearing generally will occur within 45 days after a request, followed by a hearing decision two to four weeks later. Unless we develop a satisfactory plan for returning to compliance, Nasdaq could eventually delist our stock from the NNM. This would impact the liquidity of shares of our common stock.

Our stock price is volatile and may result in substantial losses for investors

The trading price of our common stock has been subject to wide fluctuations. Our trading price could continue to be subject to wide fluctuations in response to:


	•	quarterly variations in operating results and achievement of key business metrics by us or our competitors;

	•	changes in operating results estimates by securities analysts;


	•	any differences between our reported results and securities analysts’ published or unpublished expectations;

	•	announcements of new contracts or service offerings made by us or our competitors;

	•	announcements of acquisitions or joint ventures made by us or our competitors; and

	•	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 attention and resources.

Our success depends, in part, upon our proprietary methodology and other intellectual property rights. We rely upon a combination of trade secrets, nondisclosure and other contractual arrangements, and copyright and trademark laws to protect our proprietary rights. We enter into confidentiality agreements with our employees, consultants and clients, and limit access to and distribution of our proprietary information. We cannot be certain that the steps we take in this regard will be adequate to deter misappropriation of our proprietary information or that we will be able to detect unauthorized use and take appropriate steps to enforce our intellectual property rights. In addition, although we believe that our services and products do not infringe on the intellectual property rights of others, infringement claims may be asserted against us in the future, and, if asserted, these claims may be successful. A successful claim against us could materially adversely affect our business, financial condition and results of operations.

Our co-Chairmen and co-CEOs have significant voting power and may effectively control the outcome of any stockholder vote

Jerry A. Greenberg and J. Stuart Moore, our co-Chairmen of the Board of Directors and co-Chief Executive Officers, together own approximately 34.0% of our common stock. As a result, they have the ability to substantially influence, and may effectively control the outcome of corporate actions requiring stockholder approval, including the election of directors. This concentration of ownership may also have the effect of delaying or preventing a change in control of Sapient, even if such a change in control would benefit other investors.

Our success will depend in large part upon the continued services of a number of key employees, including Messrs. Greenberg and Moore. Our employment arrangements with Messrs. Greenberg and Moore and with our other key personnel provide that employment is terminable at will by either party. The loss of the services of any of our key personnel could have a material adverse effect on our business, financial condition and results of operations. In addition, if our key employees resign from Sapient to join a competitor or to form a competing company, the loss of such personnel and any resulting loss of existing or potential clients to any such competitor could have a material adverse effect on our business, financial condition and results of operations. Although we require our employees to sign agreements prohibiting them from joining a competitor, forming a competing company or soliciting our clients or employees for certain periods of time, we cannot be certain that these agreements will be effective in preventing our key employees from engaging in such actions or that courts or other adjudicative entities will substantially enforce these agreements. Furthermore, for those employees whom we involuntarily terminated in connection with our restructurings in March 2001, July 2001, February 2002 and June 2002, we have waived the non-competition clause of their agreements in exchange for releases of claims. We granted these waivers only in connection with the restructuring actions, and our general practice is not to waive the non-competition obligations of other departing employees.

Our corporate governance provisions may deter a financially attractive takeover attempt

Provisions of our charter and by-laws may discourage, delay or prevent a merger or acquisition that stockholders may consider favorable, including a transaction in which stockholders would receive a premium for their shares. These provisions include the following:


	•	our Board of Directors is staggered into three classes and the members may be removed only for cause upon the affirmative vote of holders of at least two-thirds of the shares entitled to vote;

	•	our Board of Directors has the authority, without further action by the stockholders, to fix the rights and preferences of and issue shares of preferred stock;

	•	any action that may be taken by stockholders must be taken at an annual or special meeting and may not be taken by written consent;

	•	stockholders must comply with advance notice requirements before raising a matter at a meeting of stockholders or nominating a director for election; and

	•	a Chairman of the Board or a Chief Executive Officer are the only persons who may call a special meeting of stockholders.

Provisions of Delaware law may also discourage, delay or prevent someone from acquiring us or merging with us.

Membership on our Board of Directors is evenly split between independent and affiliated directors

Three of the six directors on our Board of Directors are independent directors. The remaining three directors are affiliated with the Company as officers or former officers. A Nasdaq proposal currently before the SEC would require that a majority of board members be independent. The Company intends to comply with this requirement if adopted.

We do not believe that we have any material market risk exposure with respect to derivative or other financial instruments. At September 30, 2002, our exposure to market risk relates primarily to changes in interest rates on our investment portfolio. Our short-term investments consist primarily of fixed income securities. We invest only with high credit quality issuers and we do not use derivative financial instruments in our investment portfolio. We do not believe that a significant increase or decrease in interest rates would have a material adverse impact on the fair value of our investment portfolio.

We maintain disclosure controls and procedures, which we have designed to ensure that material information related to the Company, including our consolidated subsidiaries, is properly identified and evaluated on a regular basis and disclosed in accordance with all applicable laws and regulations. In response to recent legislation and proposed regulations, we reviewed our disclosure controls and procedures and internal controls. We also established a disclosure committee which consists of certain members of our senior management. After the formation of our disclosure committee and within 90 days prior to the filing of this Quarterly Report, the disclosure committee carried out an evaluation, under the supervision and with the participation of our Co-Chief Executive Officers, Mr. Greenberg and Mr. Moore, and Chief Financial Officer, Ms. Johnson, of the effectiveness of the Company’s disclosure controls and procedures and internal controls. Based on that evaluation, Mr. Greenberg, Mr. Moore and Ms. Johnson concluded that the Company’s disclosure controls and procedures and internal controls are effective in causing material information to be collected, communicated and analyzed on a timely basis and in ensuring that such information is disclosed in accordance with all applicable laws and regulations.

There were no significant changes in the Company’s internal controls, or in other factors that could significantly affect these internal controls, after the date of our most recent evaluation.

Pursuant to the requirements 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.


	1.	I have reviewed this Quarterly Report on Form 10-Q of Sapient Corporation;

	2.	Based on my knowledge, this Quarterly Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Quarterly Report;

	3.	Based on my knowledge, the financial statements, and other financial information included in this Quarterly Report, fairly present in all material respects the financial condition, results of operations and cash flows of Sapient Corporation as of, and for, the periods presented in this Quarterly Report;

	4.	Sapient Corporation’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for Sapient Corporation and we have:


	a)	designed such disclosure controls and procedures to ensure that material information relating to Sapient Corporation, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Quarterly Report is being prepared;

	b)	evaluated the effectiveness of Sapient Corporation’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this Quarterly Report (the “Evaluation Date”); and

	c)	presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;


	5.	Sapient Corporation’s other certifying officers and I have disclosed, based on our most recent evaluation, to Sapient Corporation’s auditors and the Audit Committee of Sapient Corporation’s Board of Directors:


	a)	all significant deficiencies in the design or operation of internal controls which could adversely affect Sapient Corporation’s ability to record, process, summarize and report financial data and have identified for Sapient Corporation’s auditors any material weaknesses in internal controls; and

	b)	any fraud, whether or not material, that involves management or other employees who have a significant role in Sapient Corporation’s internal controls; and


	6.	Sapient Corporation’s other certifying officers and I have indicated in this Quarterly Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.


	1.	I have reviewed this Quarterly Report on Form 10-Q of Sapient Corporation;

	2.	Based on my knowledge, this Quarterly Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Quarterly Report;

	3.	Based on my knowledge, the financial statements, and other financial information included in this Quarterly Report, fairly present in all material respects the financial condition, results of operations and cash flows of Sapient Corporation as of, and for, the periods presented in this Quarterly Report;

	4.	Sapient Corporation’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for Sapient Corporation and we have:


	a)	designed such disclosure controls and procedures to ensure that material information relating to Sapient Corporation, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Quarterly Report is being prepared;

	b)	evaluated the effectiveness of Sapient Corporation’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this Quarterly Report (the “Evaluation Date”); and

	c)	presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;


	5.	Sapient Corporation’s other certifying officers and I have disclosed, based on our most recent evaluation, to Sapient Corporation’s auditors and the Audit Committee of Sapient Corporation’s Board of Directors:


	a)	all significant deficiencies in the design or operation of internal controls which could adversely affect Sapient Corporation’s ability to record, process, summarize and report financial data and have identified for Sapient Corporation’s auditors any material weaknesses in internal controls; and

	b)	any fraud, whether or not material, that involves management or other employees who have a significant role in Sapient Corporation’s internal controls; and


	6.	Sapient Corporation’s other certifying officers and I have indicated in this Quarterly Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.


	1.	I have reviewed this Quarterly Report on Form 10-Q of Sapient Corporation;

	2.	Based on my knowledge, this Quarterly Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Quarterly Report;

	3.	Based on my knowledge, the financial statements, and other financial information included in this Quarterly Report, fairly present in all material respects the financial condition, results of operations and cash flows of Sapient Corporation as of, and for, the periods presented in this Quarterly Report;

	4.	Sapient Corporation’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for Sapient Corporation and we have:


	a)	designed such disclosure controls and procedures to ensure that material information relating to Sapient Corporation, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Quarterly Report is being prepared;

	b)	evaluated the effectiveness of Sapient Corporation’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this Quarterly Report (the “Evaluation Date”); and

	c)	presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;


	5.	Sapient Corporation’s other certifying officers and I have disclosed, based on our most recent evaluation, to Sapient Corporation’s auditors and the Audit Committee of Sapient Corporation’s Board of Directors:


	a)	all significant deficiencies in the design or operation of internal controls which could adversely affect Sapient Corporation’s ability to record, process, summarize and report financial data and have identified for Sapient Corporation’s auditors any material weaknesses in internal controls; and

	b)	any fraud, whether or not material, that involves management or other employees who have a significant role in Sapient Corporation’s internal controls; and


	6.	Sapient Corporation’s other certifying officers and I have indicated in this Quarterly Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Each of the undersigned hereby certifies that the Quarterly Report on Form 10-Q of the Company for the period ended September 30, 2002 fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and that the information contained in such report fairly presents, in all material respects, the financial condition of the Company at the end of such period and the results of operations of the Company for such period.


Delaware		04-3130648
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

One Memorial Drive, Cambridge, MA (Address of principal executive offices)		02142 (Zip Code)


CONSOLIDATED BALANCE SHEETS
CONSOLIDATED STATEMENTS OF OPERATIONS
CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4. Controls and Procedures
PART II
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002


		Page
		Number

PART I.	FINANCIAL INFORMATION
Item 1	Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001		2
	Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2002 and 2001		3
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2002 and 2001		4
	Notes to Consolidated Financial Statements		5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		33
Item 4.	Controls and Procedures		33
PART II.	OTHER INFORMATION
Item 6.	Exhibits and Reports on Form 8-K		34
SIGNATURES			35
CERTIFICATIONS			36


			September 30,			December 31,
			2002			2001


			(In thousands,
			except share amounts)
			(Unaudited)
ASSETS
Current assets:
	Cash and cash equivalents		$	68,759		$	109,744
	Short-term investments			116,484			134,793
	Restricted cash			5,312			—
	Accounts receivable, less allowance for doubtful accounts of $2,480 and $3,220, respectively			29,051			37,036
	Unbilled revenues on contracts			11,439			11,289
	Income tax receivable			1,246			13,562
	Prepaid expenses and other current assets			9,307			5,656

		Total current assets		241,598			312,080
Property and equipment, net				32,351			41,466
Intangible assets, net				1,984			11,349
Goodwill				—			101,795
Other assets				9,108			8,180

		Total assets	$	285,041		$	474,870

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Accounts payable		$	4,998		$	5,668
	Accrued expenses			15,764			13,194
	Accrued restructuring costs, current portion			29,978			17,829
	Accrued compensation			6,026			7,199
	Accrued income taxes payable			411			907
	Deferred revenues on contracts			3,981			9,465

		Total current liabilities		61,158			54,262
	Accrued restructuring costs, net of current portion			42,544			35,511
	Other long term liabilities			3,844			3,883

		Total liabilities		107,546			93,656

	Minority interest in consolidated subsidiary			102			444

Stockholders’ equity:
	Preferred stock, par value $.01 per share, 5,000,000 authorized and none issued and outstanding at September 30, 2002 and December 31, 2001			—			—
	Common stock, par value $.01 per share, voting, 200,000,000 shares authorized, 127,399,022 and 126,424,050 shares issued and outstanding at September 30, 2002 and December 31, 2001, respectively			1,220			1,262
	Additional paid-in capital			471,590			468,447
	Treasury stock, 5,321,022 and 110,000 shares at September 30, 2002 and December 31, 2001, respectively			(5,630	)		(421	)
	Deferred compensation			(5,467	)		(8,443	)
	Accumulated other comprehensive loss			(1,186	)		(1,478	)
	Accumulated deficit			(283,134	)		(78,597	)

		Total stockholders’ equity		177,393			380,770

		Total liabilities and stockholders’ equity	$	285,041		$	474,870



			Three Months Ended						Nine Months Ended
			September 30,						September 30,

			2002			2001			2002			2001


			(In thousands, except per share amounts)
			(Unaudited)
Revenues:
Service revenues			$	43,600		$	69,980		$	134,103		$	266,407
Reimbursable expenses				1,893			4,471			6,621			16,333

		Total gross revenues		45,493			74,451			140,724			282,740

Operating expenses:
	Project personnel costs, before reimbursable expenses (exclusive of stock-based compensation of $1,288 and $2,469 for the three and nine months ended September 30, 2002, respectively, and $762 and $2,809 for the three and nine months ended September 30, 2001, respectively)			32,180			51,510			108,188			189,497
	Reimbursable expenses			1,893			4,471			6,621			16,333

		Total project personnel costs		34,073			55,981			114,809			205,830
	Selling and marketing costs (exclusive of stock-based compensation of $59 and $177 for the three and nine months ended September 30, 2002, respectively, and $61 and $199 for the three and nine months ended September 30, 2001, respectively)			6,535			5,948			20,439			21,841
	General and administrative costs (exclusive of stock-based compensation of $11 and $51 for the three and nine months ended September 30, 2002, respectively, and $116 and $741 for the three and nine months ended September 30, 2001, respectively)			18,255			29,352			64,962			103,611
	Restructuring and other related charges (credits)			(3,607	)		42,608			54,906			93,420
	Impairment of goodwill and intangible assets			—			—			107,430			—
	Amortization of intangible assets			598			7,504			3,730			20,690
	Stock-based compensation			1,358			939			2,697			3,749

		Total operating expenses		57,212			142,332			368,973			449,141

Loss from operations				(11,719	)		(67,881	)		(228,249	)		(166,401	)
Gain on equity investment change in interest				—			—			1,755			1,407
Other expense				(246	)		(131	)		(242	)		(4,827	)
Interest income				977			2,315			3,397			8,011

Loss before income taxes, net equity income (loss) from investees and minority interest				(10,988	)		(65,697	)		(223,339	)		(161,810	)
Income tax provision (benefit)				174			29,030			(18,833	)		(1,726	)

Loss before net equity income (loss) from investees and minority interest				(11,162	)		(94,727	)		(204,506	)		(160,084	)
Net equity income (loss) from investees				162			(113	)		(373	)		(464	)
Minority interest in consolidated subsidiary				163			189			342			274

		Net loss	$	(10,837	)	$	(94,651	)	$	(204,537	)	$	(160,274	)

Basic net loss per share			$	(0.09	)	$	(0.76	)	$	(1.62	)	$	(1.30	)

Diluted net loss per share			$	(0.09	)	$	(0.76	)	$	(1.62	)	$	(1.30	)

Weighted average common shares				124,614			125,346			125,960			123,541
Weighted average dilutive common share equivalents				—			—			—			—

Weighted average common shares and dilutive common share equivalents				124,614			125,346			125,960			123,541

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þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2002


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .



												Utilized
	Balance		Additional		Additional		Additional		Adjust-									Balance
	12/31/01		Charge-Q1		Charge-Q2		Charge-Q3		ments			Non-Cash			Cash			9/30/02

Workforce	$	1,635	$	12,967	$	3,100	$	697	$	(706	)	$	—		$	(16,553	)	$	1,140
Facilities		51,705		34,981		6,153		820		(4,418	)		(2,495	)		(15,364	)		71,382
Depreciable assets		—		787		525		—		—			(1,312	)		—			—

	$	53,340	$	48,735	$	9,778	$	1,517	$	(5,124	)	$	(3,807	)	$	(31,917	)	$	72,522

Current accrued restructuring costs																			29,978

Non-current accrued restructuring costs																		$	42,544


Three Months Ended	Financial			Public			Automotive/			Consumer/			United						All			Reconciling			Consolidated
September 30, 2002:	Services			Services			Industrial			Transportation			Kingdom			Germany			Other			Items			Totals

Service revenues	$	7,718		$	6,549		$	3,691		$	3,464		$	8,790		$	2,796		$	10,592		$	—		$	43,600
Operating income (loss)	$	27	(1)	$	(30	)(1)	$	1,033	(1)	$	190	(1)	$	(1,301	)	$	(821	)	$	1,429	(1)	$	(11,515	)(2)	$	(10,988	)(2)


	Three Months			Nine Months
	Ended			Ended
	September 30, 2002			September 30, 2002

Impairment of goodwill and intangible assets	$	—		$	107,430
Restructuring and other related charges (credits)		(3,607	)		54,906
Amortization of intangible assets		598			3,730
Stock-based compensation		1,358			2,697
Other expense (income)		246			(1,513	)
Interest income		(977	)		(3,397	)
Unallocated expenses		13,897	(3)		54,443	(3)

	$	11,515		$	218,296



			September 30, 2002

			Gross Carrying		Accumulated			Impairment			Net Book
			Amount		Amortization			Charge			Value

Amortizable intangible assets
	Marketing assets and customer lists		$	4,100	$	(2,431	)	$	(1,519	)	$	150
	Employment agreements			1,000		(694	)		—			306
	Developed technology			16,160		(10,516	)		(4,116	)		1,528

		Total	$	21,260	$	(13,641	)	$	(5,635	)	$	1,984



			December 31, 2001

			Gross Carrying		Accumulated			Net Book
			Amount		Amortization			Value

Amortizable intangible assets
	Marketing assets and customer lists		$	4,100	$	(2,109	)	$	1,991
	Employment agreements			1,000		(444	)		556
	Developed technology			16,160		(7,358	)		8,802

		Total	$	21,260	$	(9,911	)	$	11,349


	(In thousands)

2002	$	2,565
2003		10,028
2004		7,364
2005		4,003
2006		3,844
Thereafter		12,429



Signature	Title	Date


/s/ JERRY A. GREENBERG Jerry A. Greenberg	Co-Chief Executive Officer Co-Chairman of the Board	November 14, 2002

/s/ SUSAN D. JOHNSON Susan D. Johnson	Chief Financial Officer	November 14, 2002

/s/ BRADLEY T. MILLER Bradley T. Miller	Chief Accounting Officer	November 14, 2002