Foolish Forecast: Scandal Saps Sapient's Strength

Business software and services provider Sapient (Nasdaq: SAPE  ) will report preliminary third-quarter 2006 financial results on Wednesday, Jan. 10, because the company still has not completed its stock-option backdating review.

What analysts say:

• Buy, sell, or waffle? The 12 analysts covering Sapient are all equally unsure of what to think about the future, with four rating it a buy, four rating it a hold, and four saying sell.
• Revenues. Revenues for the third quarter -- the period ending Sept. 30 -- are expected to come in at $102.7 million, a 25.6% increase over the year-ago period.
• Earnings. Profits are forecast to come in at $0.05 per share, down a penny from a year ago, but estimates range from a low of $0.03 to a high of $0.09 per share.

What management says:
In August, the company began a voluntary review of its stock-option grants program, which has received heightened scrutiny in the wake of the backdating scandal that has been sweeping across corporate America. The audit committee that investigated the program announced in November that it had looked at all of the more than 67 million shares of options that had been issued by Sapient, and while it didn't disclose exactly how many were involved or what the cost was, it found that there was a broad scheme of participation by upper management. The CEO, the CFO, and the company's general counsel all actively participated in backdating stock options, according to the committee. Both the CEO and the CFO resigned a month before the committee released its report (and agreed to consulting contracts with the company) while the general counsel left the company a few years ago.

Several current members of the board of directors also received a single grant of 4,000 options each back in 1999, which were backdated and which they signed off on, but the committee said they did not direct that the options be backdated. Notice that it didn't say they were unaware of the backdating. As is the case with all of these scandals, the SEC has launched its own investigation.

What management does:
Beyond the backdating mess, Sapient has other problems, not least of which are uneven levels of revenues and declining profits and margins as costs have increased significantly. The last time it reported earnings, which was nearly a year ago last March, management noted that even though its service revenues in the U.S. had increased substantially from the prior year, this was offset by foreign markets. Also, costs from employee turnover -- more than 21% in that quarter -- ate up whatever profits it had made.

Margin %	06/05	09/05	12/05	03/06	06/06*
Gross	41.7	39.8	38.9	37.8	35.2
Op.	9.9	9.0	8.4	6.6	4.6
Net	8.4	7.4	7.7	5.4	6.6

*Derived from press release; quarterly report was never filed.
Data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
Considering the seriousness of the scandal and the fact that senior management actively participated in it and was forced out as a result, you may wonder how analysts can recommend the company as a buy. Performance has not indicated that it has found a way to provide smooth growth, and turnover at the software and services provider -- beyond that in the executive suite -- continues to keep costs high.

But since Sapient's stock sits some 33% off its 52-week high, and since it is a company in turmoil, it just might make itself a prime candidate for a takeover. I would imagine another firm might not want to touch it until after its scandal has been resolved, to avoid tarring itself with any liability. But with a semi-successful business operation in place, a cheap stock price, and a clean set of financials, it might look tempting to a larger competitor.

Competitors:

• Accenture (NYSE: ACN  )
• BearingPoint (NYSE: BE  )
• Cognizant Technology Solutions (Nasdaq: CTSH  )
• Computer Sciences (NYSE: CSC  )
• Electronic Data Systems (NYSE: EDS  )
• MPS Group (NYSE: MPS  )

Sapient's earned just a two-star rating in Motley Fool CAPS, our new investor intelligence community. You can add your voice to the stock-rating service by joining today. It's free!

Fool contributor Rich Duprey does not own any of the stocks mentioned in this article. You can see his holdings here. Accenture is an Inside Value pick. The Motley Fool has a disclosure policy.