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Perot Systems Corporation (NYSE:PER)

Q3 FY08 Earnings Call

November 4, 2008, 10:15 AM ET

Executives

John Lyon - IR

Peter Altabef - President and CEO

John Harper - CFO

Analysts

Rod Bourgeois - Stanford Bernstein

Joseph Vafi - Jefferies & Co.

George Price - Stifel Nicolaus

Operator

Good morning. Thank you very much for standing by and welcome to the Perot Systems Third Quarter 2008 Earnings Conference Call.

At this time, all participants are in a listen-only mode; and later, we will conduct a question-and-answer session with instructions to be given at that time.

During the course of today's call, Perot Systems will be making forward-looking statements that contain risks and uncertainties. These statements are only predictions and actual results may vary materially. Perot Systems disclaims any obligations, any intention or obligation to update any forward-looking statements as a result of new information or otherwise.

Please refer to the Perot Systems Form 10-K for the fiscal year ending December 31, 2007 for a listing of risk factors that could cause actual events or results to vary from those contained in the forward-looking statements.

Now I would like to turn the call over to John Lyon. Please go ahead, sir.

John Lyon - Investor Relations

Good morning. Welcome to our third quarter earnings conference call.

During our call today, Peter Altabef, our CEO will review the performance of our major units and John Harper, our Chief Financial Officer will provide a review of our financial performance and forecast.

Before we get started, let me remind you that in addition to our press release, we have placed a downloadable financial summary for your convenience in analyzing our financial results at perotsystems.com. In addition, we will refer to two non-GAAP financial measures today.

The first is free cash flow, which is the measure we use to assess the net cash production of our operations including long term and short term capital, and it's calculated as operating cash flow less capital expenditures. The second is organic revenue growth, a measure of our pre-acquisition revenue growth. It is calculated by taking total revenue, growth less the revenue contribution from acquisitions completed in the past 12 months and then comparing it to the third quarter 2007 revenue. The information necessary to calculate these measures are available on our earnings press release.

Again, I want to thank you for joining us. I'll turn the call over to Peter.

Peter Altabef - President and Chief Executive Officer

Thank you John. Good morning and thank you for joining us today.

In the third quarter, we continued to build upon the steady financial progress we have been demonstrating. Revenue grew by 9% year-to-year to $711 million. Earnings per share grew by 25% year-to-year to $0.25. And free cash flow was $47 million bringing the trailing 12 month total to $174 million.

We have a sound business model that is designed for a variety of economic conditions. We produce 70% of our revenue from health care and federal government services. Two markets that have been less cyclical in the past and where we see attractive long term growth trends.

Our solutions help clients to improve the efficiency of their operations and optimize their cost structure. While these are fundamental benefits of outsourcing, we tend to see an increasing focus on these initiatives in a challenging economic environment.

We have $246 million of cash and debt of $185 million, which provides a sound financial footing. With our financial resources and the level of free cash flow we are producing, we have significant financial flexibility. And we are a backlog-driven business with 66% of our revenues coming from base level contracts and 84% of revenue generated by accounts that include an element of our long term backlog.

While we are well positioned with a very solid business model, to the extent that our clients experience financial pressure in their businesses, they may adjust discretionary investment levels even though we have been in a very healthy return-oriented project market. There have been significant economic headlines since we last spoke with you in the third quarter. And macroeconomic events are certainly in the news.

These macro economic events however did not have a significant impact on our third quarter financial performance. Our financial results were on target with our expectations and guidance. Cash flow continue to progress as invoice collections were solid and our cash balance continue to increase and project related investment was inline with our expectations this quarter with the pace of projects remaining at stable levels.

Looking at the fourth quarter the normal seasonal effect of fewer billable days is expected to have a greater impact on earnings than project bill productions. So far project reductions have been isolated. The clients are formulating their plans to response to economic weakness, which could result in some project pressure although the extent in timing is uncertain.

At the same time, through global modular services including the rapid deployment of resources, we can provide our clients with flexible and scalable solutions that lower costs without lengthy set up and transition periods. We expect these offering to open new growth opportunities for us in this environment.

While our financial results progress in the quarter with no significant impacts from macro events, we believe the magnitude of the macro issues and resulting uncertainty contributed to delays in new contract signings. When there's significant turmoil affecting the business environment, decision making typically slows.

New contract signings for the third quarter totaled $184 million, which was lower than we expected entering the quarter. We have seen some delays in decision making and revision to scope. But we are hopeful that the delays are temporary, and our pipeline will begin yielding greater new contract signings as we move into 2009.

With respects to our sales pipeline, we have a good level of activity. We continue to see clients evaluating new system investments although cost reductions are operating efficiencies are the focus of many pursuits. In particular, globalization of service delivery is a growing priority both with new clients and existing clients. We are continuing to see increased interest from clients and prospects that we're once hesitant to consider this form of delivery.

In addition to new client opportunities, 2008 will be an excellent year of contract extensions. We have extended two of our five largest client relationships. Harvard Pilgrim in the first quarter and Catholic Healthcare West in October. We are very pleased that we continue to earn our client's trust, which is resulting a new opportunities to serve them.

Turning to review of our unit performance and growth prospects, revenue grew by 9% year-to-year in the third quarter. Our two lines of business, Industry Solutions and Government Services grew by 7% and 14% year-to-year. For healthcare, sales activity has broadened over the course of the year and recent research points to the industry increasing into adoption of outsourcing. We are making good progress this year, but results are coming slowly.

As we look at the healthcare industry, we see several factors. First, the level of business trends within healthcare in general. Second, the changing landscape of patient care and reimbursement. Third, the impact of foreign markets on financial investment returns; and finally, a level of uncertainty as to the effects of regulatory changes on the industry. These have created an environment, where there is healthy activity, but careful deliberate movement.

In the third quarter, new business wins ranged from health system IT outsourcing to existent client add on business and to outsourcing services in support of the stage program to bring health insurance to more of its citizens. Subsequent to the end of the quarter, we also extended our contracts with of our larger clients, Catholic Healthcare West.

Under our new seven year contract, we will bring a greater level of savings to the client, gaining greater flexibility to leverage resources in return. There will also be a change to the third party contract management services we provide, which consist predominantly a pass through expenses. This functioning is transitioning back to the client, which will have an impact on our revenue, but an insignificant effect on profit.

In terms of our healthcare quarterly performance, revenue grew by 2% year-to-year. We still have year-to-year pressure related to the end of our Triad contract last year, six points of pressure in the quarter. Beyond this, we have growth in all of the major areas of healthcare.

Large hospitals after adjusting for the impact of Triad grew by 5% year-to-year. We are continuing to see project growth in the segments. Developing areas of the provider market including small to mid-sized hospitals, solutions related to the revenue cycle and physician practices, the federal government and the international community grew by 20% year-to-year. The new sales pipeline for these developing areas is very active.

Within the international marketplace, clinical transformation and implementation of electronic health records are important priorities in several countries. Solutions to reduce the payment cycle and maximize collection of insured amounts are gaining increasing interest as bad debt within the industry gross.

The non-provider areas of healthcare, consisting primarily of the payer market grew by 2% year-to-year. We are currently seeing this market embrace globalization as a way to generate significant efficiencies. This has led to an increase of sales activity this year. With the leading software platform for this market and our extensive global delivery capabilities, we are very well prepared to serve payers looking to generate efficiencies while improving quality.

Across the healthcare industry, cost saving initiatives are on the rise, whether through projects that produce efficiencies, globalization of functions or leveraging resources through outsourcing, we see a trend toward cost optimization. This should translate into new opportunities for new clients as well as building upon existing relationships. For government services, revenue growth comes primarily from webbing contracts within the civilian area and existing contract extension and project wins in the homeland and national security areas.

From a sales perspective, near term activity for government services relates primarily to smaller new projects and existing programs Re-Compete. Based on where larger opportunities are in our sales pipeline and moving from a prime to subcontracts position on a recent Re-Compete. We expect to start 2009 with limited year-to-year revenue growth in government services, but with opportunities to build upon that base. From a profit perspective, we expect to start the year with good year-to-year growth based upon the contract efficiencies we are delivering.

Finally, as we've discussed on the last call, in the third quarter, we realigned our organizational structure to combine consulting and application solutions with industry solutions. This realignment unified teams in our commercial business, where we had overlapping end markets.

The growth for our commercial unit continued to be very solid this quarter with 17% growth year-to-year, 13% prior to the full point contribution from acquisitions completed over the past year. In terms of our commercial sales activity, we have a good pipeline including small-to-mid sized opportunities. Overall, we continue to move our business in the right direction. We will continue to monitor the environment and manage our business in a disciplined way.

We thank you for joining us. And I'll now ask John Harper to detail our financial performance and forecast.

John Harper - Chief Financial Officer

Thank you Peter. Good morning everyone. I want to thank you for joining us today.

In the third quarter, we continued to build upon our first half 2008 results. Revenue, operating margin, and earnings per share all grew sequentially this quarter. DSOs and free cash flows were solid at 62 days and $47 million. In addition, to continued favorable financial results. We continued to solidify our revenue base, extending key contracts that expand our backlog and provide greater long term visibility.

I will begin my review today by detailing the factors behind our year-to-year growth. After that, I will review our fourth quarter forecast and our financial position. Before I begin, I will refer you to the financial tables in our earnings release, where we have placed historical segment information that restates past periods or the organizational realignment that occurred this quarter. We have gone from three segments to two segments, industry solutions and government services to reflect how we are running our business.

Revenue for the third quarter was $711 million. This represents an increase of 9% year-to-year on a reported basis, 8% on an organic basis. This growth came from four sources: First, new contracts signed over the past year with an industry solution's added $23 million of revenue. With the move in the markets to smaller contracts, the profitability stage for new sales is reached faster. The result that these new contracts signing were beneficial not only to year-to-year revenue comparisons, but also year-to-year earnings comparisons.

Second, the ramp of new contracts and government services helped this segment to report a $21 million revenue increase year-to-year. In this case, we are working with larger more complex engagements, which are expected to reach a sustainable profit level during 2009.

Third, acquisitions completed over the past year added $7 million. Fourth, existing contracts within industry solutions added $6 million of revenue growth. This represents the net growth number. We realize $26 million of year-to-year revenue of growth from projects, new business and additional volumes. Conversely, $20 million of this growth was offset by the end of our Trial contract last year, which produced a minimum level of profit. Therefore, this account growth not only produced higher revenue, it depends also primary factor that enables us to produce higher earnings and profit margins.

Third quarter earnings were $0.25, which represents a $0.05 or 25% increase year-to-year. Our operating margins increased from 6.4% in the third quarter of last year to 6.8% for the third quarter of this year. Account profit improvements and new sales produced the majority of our earnings growth year-to-year.

Partially offsetting these were two factors. First, rebuilding our bonus tool resulted in additional compensation expense. Please note that we achieved our run rate for incentive compensation in first quarter of 2008. So, there was not a significant incremental sequential pressure associated with this year-to-year increase. Second and as expected, we have early stage acquisitions that are currently dilutive to earnings. When factoring intangible amortization expense and the cost of invested capital, it's very difficult for acquisitions to be neutral or accretive to earnings in the early months.

Turning to our forecast for the fourth quarter, there will be two factors that cause an optical change in our financials, but the economic change will be insignificant. First as Peter discussed, the low margin, third party contract management function. We have managed for CHW will be transitioned back to the client.

This average $20 million of revenue for quarter through nine months of 2008 although the revenue was not linear across these experience. The reduction going to the fourth quarter will be only $16 million, because the new contract did not take effect until beginning of November. Going to the first quarter, there will another reduction of approximately $8 million.

Second, one of our government Re-Competes, we moved from a prime contractor role to a sub contractor role, because we are no longer a prime contractor with low margin subcontract work, revenue will decrease by $5 million per quarter. But the effect on profits will be insignificant. Combined, these two items account for $21 million of lower revenue in the fourth quarter, which has the effect of lowering the $711 million of revenue for the third quarter to $690 million for the fourth quarter.

Keep in mind, this revenue did not provide much profit. So with the slightly beneficial to profit margins, our revenue range of $680 million to $695 million includes this impact and normal fourth quarter seasonality, which could create up to $4 million of sequential revenue pressure. For earnings per share, seasonality has the potential to pressure pre-tax earnings up to $4 million equal to approximately $0.02 per share. As a result, we expect earnings for the fourth quarter to range from $0.23 to $0.25.

Going to the first quarter, we see four potential things. First, the normal fourth quarter seasonal effect will reverse. Second, we expect one penny per share of earnings pressure in the first quarter related to globalization of certain functions. This represents operational setup expense that cannot be deferred. We expect this pressure to begin reversing as we go to the second half of 2009.

Third, we need to see how the project environment progresses. Four, we are hopeful that some of the hesitation in long-term contract sales environment will ease, which could provide us with new sales revenue and profits as we move into 2009. We should gain a greater level of clarity over the next 90 days as to how the business environment will progress.

From what we see today, our sale pipeline is active and positioned to produce favorable results. The pricing and competitive environment remains stable. We have seen isolated instances, where our prospective client push for economics that were not attractive. But overall, the market environment remains reasonable. The key here is to see some of the caution created by macro events subside.

In our consulting areas, we have seen a few clients pullback on projects early on the fourth quarter, while others are evaluating the cost structure given the current economic environment. At the same time, we are bidding on new work, it is designed to generate tangible near term benefits for clients.

On our long-term accounts, projects grew sequentially in the third quarter and met the expectations we had entering the quarter. With respect to the potential effects of the economy, there are more questions than answers. We're closely monitoring our business and we'll continue to make sound economic decisions.

Looking at our balance sheet, cash increased to $246 million as of September 30, an increase of $50 million for the quarter, $47 million of this increase came from free cash flow. Days sales were outstanding were 62 days. Capital expenditures were $11 million for the quarter or 1.6% of revenue. This was below our target of 3%. Although 2009 might be slightly higher than 3%, given potential facility and datacenter expansion, this is just a matter of timing.

Debt was a $185 million as of September 30. As we look at full year free cash flow, solid financial performance this year combined with generally low capital requirement should allow us to report free cash flow that equates to net income. Overall, the year has progressed well.

We've grown earnings, revenue, and profit margins, secured important revenue long term, strengthened our financial position with an outstanding year of cash generation. There are certainly questions about the state of the economy and how it may affect business. But we have a very solid business model, a strong financial position and we will to proactively address any challenges that come our way.

I want to thank you for joining us we will now answer your questions.

Question And Answer

Operator

This concludes the formal portion of the conference call. A question-and-answer session will now be conducted [Operator Instructions]. The first question will come from Rod Bourgeois with Stanford Bernstein.

Rod Bourgeois - Stanford Bernstein

Hey, guys.

Peter Altabef - President and Chief Executive Officer

Hi, Rod. How are you?

Rod Bourgeois - Stanford Bernstein

Doing fine. I want to ask about the seasonality in Q4. And I am not trying to be acute with this question. But, is the normal negative seasonality you expect in Q4 this year, consistent with the normal negative seasonality that you've seen in Q4s of the past. I guess, it seems that the $0.02 of pressure that you are planning to see this year. From my recollection it's a little greater than what you've seen in the past. But that maybe because you have left new stuff ramping up right now to offset the pressure that you are going to see in Q4, given the client and decision that exists out there. So, can you clarify the negative seasonality situation that you have this year versus in the past couple of years at this point in time?

John Harper - Chief Financial Officer

Rod, I think... this is John. I think you hit it spot on. Typically, we see this level of seasonality. So this is very consistent with fourth quarters of past. But in many cases, we have had other things that came on and helped offset that. I think as we look forward to this fourth quarter, given the market environment and the level of uncertainty out there, we're being a little more cautious about being able to offset that impact. But all of that's factored into our guidance for the fourth quarter.

Rod Bourgeois - Stanford Bernstein

All right. So, in other words, if the deal flow were consistent with the normal year, you had apparently a pretty stacked pipeline heading into Q3. Some of those deals were apparently pushed out. I had those deals coming to fruition, would your Q4 outlook be a little better than what it is right now?

John Harper - Chief Financial Officer

I think so. I think that's a fair statement. And also the... in past years, the level of project work and impact that as well and we are being relatively cautious about the project environment given what's going on in the economy.

Peter Altabef - President and Chief Executive Officer

Right. On that note, on the project work, have you already seen issues in the project work to be concerned about or are you guiding under the assumption that you may end up seeing issues that have yet to occur?

Peter Altabef - President and Chief Executive Officer

That's a great question, Rod and that is probably as we're sitting here looking at short term guidance. It's probably the most difficult question that we as a management team have to answer internally as well as to you. So that, so, let me be as clinical as I can on it. When you look at the third quarter results, you actually don't see any significant effect on, let's say, the macroeconomic level. So the project work we had in the third quarter was about what we would have expected to see in the third quarter and I think the results speak for themselves.

The revenue number is strong; the earning number is very strong at the top end of guidance. So, we are hard pressed to say that we saw any appreciable amount in the third quarter. So that gets you to the fourth quarter and we are only a month into the fourth quarter. And there are always going to be and certainly we have seen some isolated instances of clients picking up the phone and saying, hey, we're going to have to... because of a certain item affecting our business, we're going to have to pull back on this project or that project. And we have had some of those isolated instances. The question is this is a substantial business and do isolated instances make a pattern or are they isolated instances? And it's too early in the quarter to tell you frankly. So I think that's where you are. We're seeing us being cautious. But I think it's not fair to say that we have a programmatic retreat from project work. It is fair to say we have some isolated instances of that.

Rod Bourgeois - Stanford Bernstein

All right. I think that's prudent to assume that things might happen that you haven't seen yet. But I wanted to then ask about some margin outlook. You've got a couple of contracts with CHW and a government client, where you're essentially eliminating some low or no margin revenues. And so I guess I'm wondering whether your margins for the full year can actually come in at the high end of the expectation range, rather than at the lower end or the middle part of it because of the margin benefit that you're going to get as these low margin revenue roll offline.

Peter Altabef - President and Chief Executive Officer

Rod, thank you. That certainly helps. And I think looking at the full year, I think we will be certainly and comfortably within that guidance range. I think a lot of it really depends on what you see in the discretionary environment in the fourth quarter and the impact of profit as we've just discussed. So, I think we feel very comfortable that we are going to be able to achieve that range. But where we come out in that range I think, it's still too early to tell. But we're very, very pleased with the margin story. And I think internally, we're very proud. If you step back over the last five quarters and look what we've done with margins, we've increased margin 1 point, 1 point. So, as a team we were very, very proud of that and very pleased with the margin progression we've seen. Again, growing margin year-over-year and sequentially. So, we're pleased with the progress.

Rod Bourgeois - Stanford Bernstein

All right. It's nice to see the 174 million of pre-cash flow in the last year. I think that's your trailing 12 months number. I guess, the question at this point is how sustainable is that free cash flow, I guess specifically I am wondering whether you're prone to see push back form clients in ways that will hurt your working capital. And what's your thought on that. But I know your CapEx and you're just probably going to go up some, but is there also a working capital wildcard here as well?

Peter Altabef - President and Chief Executive Officer

Well, that's a good question and I think a keen observation, especially as you look at year end. We're being a little bit cautious around collections, given that we have seen in the past that year end people manage quarter ends for that matter, people managing cash pretty tightly. And so, that could have some impact and you could see some push back there. And anytime you're in a tight environment. People are obviously going to manage their cash very closely. I think the other factor that you've seen is as you noted is that next year we do expect CapEx to tick up a little bit, and that tends to be timing. If you go back to 2007, we were slightly above 3%. This year, we are going to be below 3%, and I think next year we'll probably be above 3%. So that will have a little pressure as well.

Operator

The next question will come from Joseph Vafi with Jefferies & Co.

Joseph Vafi - Jefferies & Co.

Hi, guys. Good morning. Good results here.

Peter Altabef - President and Chief Executive Officer

Thank you, Joe.

Joseph Vafi - Jefferies & Co.

Maybe we could talk a little bit on the Government side. Some of the pure play companies that have reported so far this quarter have shown some, actually some nice budget flush coming out of the government here at end of the government's fiscal year. They're more DoD focused, I think, than you are. But it might be interesting to get your commentary on the overall funding environment coming out of the Government right now. And how that market looks in terms of the pipeline and actually the bookings numbers in the quarter in the government?

Peter Altabef - President and Chief Executive Officer

Thanks Joe. That's a very good question and one that we are focused on. As you know, government work is now 24% of our revenue. And that's a market that we think will be very successful for a long time. You saw the growth for us, I think was about 14% for the quarter year-on-year. And interestingly, the composition of our government wok is as you pointed out, a little stronger on the civilian side than it is on the Department of Defense. So civilian makes up about 45% of our revenues, whereas the balance is both in defense and homeland security and in national security. The civilian part of that business is one that we think in particular has a very strong growth prospects going into next year.

Obviously, depending on the results of today's elections, you can guess as to whether there will be more of a focus on Department of Defense issues or civilian issues. We feel very strongly about our positioning in civilian, where that part of our business is weighted towards not only Veterans Affairs, although the Veterans Affairs numbers are actually in healthcare from a reporting standpoint. But from a government approach, we have a strong, strong focus on Veterans Affairs as well as health and human services. We expect under any administration for more focus in that area. And also on the Department of Education, where we have a very strong focus.

So, we feel very good about those areas going into next year. In terms of freeing up of moneys at the end of the quarter, we saw some of it. We didn't see a huge amount of it. And the one item that you saw in our press release, where we went from a prime to a sub with something you'll be familiar with. That was an older contract of ours, where because of the agency preferences and how the contract, the renewal was led, we moved into a sub position. So, that happens as your business matures as you know. So, I would say we feel very good about our government team going forward. But at this point, we haven't seen the flood gates open in terms of new moneys coming in.

Joseph Vafi - Jefferies & Co.

Okay. That's helpful, and then maybe one follow up again on the margin side. Obviously, some less pass through is going to help to the margin profile. And I know I think John, you talked about some of the smaller healthcare deals, helping margin, because it's a quicker ramp. Is that, everything else aside, the economic conditions and less pass through, is that something we should expect to continue into '09 on the margin side maybe given continued growth in these smaller deals?

Peter Altabef - President and Chief Executive Officer

Well, thanks for the question. We absolutely aspire in our focused on improving margins. But with the economic uncertainty, it's really hard to predict as you noted. Ultimately, it will depend under discretionary environment that we're in. But what you are seeing with short term projects and things like that. And not only that, but early deal economics for some of these new deals that we have signed. So, one of the focuses we are seeing in the market is people wanting to save money, make sense in the market like this, people wanting to save money. A lot of times that can put a little bit of pressure on the early deal economics. So, I think those are the two factors. Are we committed to continuing to improve margins? Absolutely and it's an absolute focus of ours. And again, we're just very, very pleased with the progress we have made. But a lot of it's going to depend on the environment.

Joseph Vafi - Jefferies & Co.

All right, thank you very much.

Peter Altabef - President and Chief Executive Officer

Thank you Joe.

Operator

The next question will come from George Price with Stifel Nicolaus.

George Price - Stifel Nicolaus

Hi guys, good morning.

Peter Altabef - President and Chief Executive Officer

Hi Joe... George.

George Price - Stifel Nicolaus

Couple of questions, first just on the two contracts; Catholic bringing in third party management functions back in house, is that some sort of cost reduction effort or what's the driver there?

Peter Altabef - President and Chief Executive Officer

Well, I mean from a business standpoint, obviously there is some cost reduction in the sense that there was some incremental profit that we made for that service although as you saw from John's remarks. That was a very, very small amount. There were substantial changes to our contract with Catholic Healthcare West to give them, as I've said in my remarks, more flexibility, also to allow us to have more flexibility in terms of how we manage and support that account. So that was really quite a lot of things going on.

At the end of the day, that has been a contract we've had for many years. And whenever you have a contract for that number of years, you always say, gee, how do we think this will work better going forward? And so, there were really a lot of things, moving parts at the end of the day. At the end of the day, it's one of our top five accounts and we just signed a seven year renewal. So we feel very good about the relationship and where we're going. And I'll defer to John for the rest.

John Harper - Chief Financial Officer

Yes, George, just to add a little more color to that, when we first took that function over, it was much, much smaller than it is today. And we really early on in that process added a lot of value to what they were doing and really helped them get that function organized and working very well. It's at a point today, where it works very well. And our ability to add value and to continue to add value to that function has substantially decreased. So in a renegotiation, it was one of those natural functions that went back to them, and I think why it was a win-win is that it actually losing that revenue, that had very little profit with it. As we've noted, actually it helped slightly margins.

George Price - Stifel Nicolaus

Just to clarify peers, where both of your response. So beyond this part of the contract, it is the run rate on

Catholic coming down; is that some of the flexibility that you referred to?

Peter Altabef - President and Chief Executive Officer

There is going to be some decrease in the, if you will, the base level of the run rate although there is also an opportunity as we restructured it for the project work that we do for that to actually increase. So as I said, it's given them more flexibility, which is something that I think many of our clients and many IT clients around the globe were asking for in this environment. At the same time, we are very excited about the ability to continue to grow the revenue on that account. This is a good thing for us and a good thing for Catholic Healthcare West.

George Price - Stifel Nicolaus

Okay. Second question on the federal contract; is that that was moved... you were moved from a prime to a sub. Was that a legacy QSS small business contract?

Peter Altabef - President and Chief Executive Officer

It was, George.

George Price - Stifel Nicolaus

Okay. And then, I guess if I look at the $25 million... well, it's actually $21 million, those two contracts and then, you said $4 million from seasonal impacts. But even if we make it $25 million, if I take that out of the... or add that back to the guidance and kind of look at it versus what we in the street were expecting and even relative to third quarter, it looks kind of flattish, which in terms of revenue in your typical seasonal trend in fourth quarter. Is that entirely explained by your caution kind of around the project, the discretionary environment is there anything else going on there?

Peter Altabef - President and Chief Executive Officer

No, I think that's right. I mean let's step back and walk through the pieces. You've got $711 million base from the third quarter, take out the $21 million for low margin and the $4 million for the seasonal revenue. That gets you to about $685 million. We have a range of $680 million to $695 million. So there is some... still some upside there in the range to grow revenue. I think it's fair to say that given the economic uncertainty that creates some pressure. I think the second thing is that you saw some of those bigger deals push out and that creates a little caution in that range as well.

George Price - Stifel Nicolaus

Okay. And then last thing if I could, just on the healthcare side. I know you noted some good growth in the emerging areas and even a little bit of growth in the larger hospitals, but given the environment we are hearing about from our healthcare analysts volumes down, tighter on credit and tighter on cash outlays. Are you not seeing any sort of pullback in terms of their willingness to invest either slower uptake or deferring some projects, but their willingness to invest in IT projects that are discretionary or outsourcing?

Peter Altabef - President and Chief Executive Officer

Well, George I think that's a very good question. Again I think it's early days for us on that question. As I said in my remarks on the project side in the large hospital world, we did not see a pullback in the third quarter numbers. And in fact we even saw an increase. So rationally you would think that would happen. We have not yet seen it at least not seen it as of the third quarter. There is a very concerted focus, I think I've said it three times in my remark about the cost initiatives and healthcare.

And the good news is we have a very healthy cost focused set of offerings in healthcare. So, our revenue cycle work both at the physician level as well as at the hospital level. We expect to begin now to see good growth coming out of that team. Because those are our projects that can start in relatively short order. And we are seeing more and more interest both at the physician and at the hospital level in that kind or work.

In addition, as I talk about globalization, we are seeing more of an appetite in some of those healthcare organizations to permit us to have more globalized model again around cost savings initiatives. So, we actually see a very healthy amount of activity in healthcare right now. It is not your traditional huge big TCV deals, but a very healthy level of activity. And we actually expect the level of activity in healthcare to begin to increase.

George Price - Stifel Nicolaus

Great. Thank you for taking the time.

Operator

The next question is a follow-up question from Joseph Vafi with Jefferies & Company.

Joseph Vafi - Jefferies & Co.

Hi, guys. Just one clarification I guess, John, you were saying that in addition to the $16 million, there will be an extra $8 million of Canada's lower margin revenue decrease starting in Q1. So, we're at a $24 million, is that the right way to look at $24 million on Catholic Healthcare West for a quarter on '09. Is that the way to look at it?

John Harper - Chief Financial Officer

Yes. So, $16 million drops off from 3Q to 4Q and 8 million drops off from 4Q to the first quarter. Now, it's averaged about $20 million a quarter, but that's just the way it works out on average. But that is the numbers for fourth quarter and first quarter.

Joseph Vafi - Jefferies & Co.

And then it stays at that run rate from there forward then?

John Harper - Chief Financial Officer

That's correct.

Joseph Vafi - Jefferies & Co.

Okay, and then just maybe just one final question here on some of your offshore business. I guess we have seen some early signs of little of counter cyclicality moving into the decision making among clients on trying to lower cost and things like that in the tougher environment. Is... are you seeing that in the offshore piece? I mean I know you mentioned a little bit of that generally in projects that are cost savings driven. Is that coming from offshore? Is that maybe coming from other traditional healthcare areas and any color there would be useful. Thanks.

Peter Altabef - President and Chief Executive Officer

Joe, thanks I think it's coming from both. I think the reference that some of you have made about macro shock in terms of decision making is accurate. So, I think even for smaller level of projects you're seeing some people delayed in pulling triggers, on deals that in a normal environment, we would say hey, from a return on investment standpoint. Or even from a return on not actually financial investment, but just the time and effort it takes to put some of these together. It looks like something that you would ordinarily do quickly or actually being dragged out.

So, I think you have some of that. I think you have to some extent, fewer new logo opportunities than traditionally you have for exactly the same reason. Clients are simply not willing to take the time and effort to bring on new vendors. So, while we have new logos being signed, we also have a consulting effort within existing clients to expand our work for clients, both in terms of more of what we are doing and in terms of a broader breadth of what we are doing.

One of things I mentioned in my remarks was kind of a global modular services approach, which is actually a multi-faceted approach, as being able to save clients money very quickly with projects that are less than full outsourcing. But that hit both the applications world and the infrastructure world in particular around our REMO [ph] activities that can be put into place very, very quickly. We've modularized that work so that work can be done in short order and not through a large scale outsourcing that takes long decision making. So we have adjusted, if you will, our approach to the market to be able to accommodate smaller deals and shorter deals, deals that don't require as much taking over of control or functions at the client level, but that get client level saving in a quicker mode. So all of that is going on. I think it's going to take a little while for those projects to take hold because of the decision making process. But we think we've got the right offerings for this marketplace.

Joseph Vafi - Jefferies & Co.

Okay. And then maybe just one final one on for those larger deals and going back a couple of quarters, we kind of heard that the large deals, especially in healthcare were slowing down and then there was a little bit of movement in the pipeline and maybe it sounds now like that pipeline is kind of getting pushed out again. Is that economic driven, do you think at this point or is there a change going on again in the industry?

John Harper - Chief Financial Officer

I think that that is more decision making, if you will, delays than anything else. Because those deals have... from an economic standpoint, we think are very advantageous for the clients, and we think from the strategic standpoint are advantageous as well; and they're still in the pipeline. So we think that those things will eventually come to fruition, but the decision making has clearly business stretched up.

Peter Altabef - President and Chief Executive Officer

And I think just to add to that when you're doing a larger outsourcing contract, it really requires a lot of client focus and a lot of their time and attention and in this market, it creates a lot of distraction. And I think that just adds to that environment.

Joseph Vafi - Jefferies & Co.

That's helpful. Thanks guys.

John Harper - Chief Financial Officer

Thank you, Joe.

Operator

Your next question is a follow up question from George Price with Stifel Nicolaus.

George Price - Stifel Nicolaus

Thanks very much for letting me get back on and for letting us ask follow-ups. I appreciate it. On the acquisition revenue, $7 million was a little lighter than I think I was expecting based on the two acquisitions that you have an anniversary you had based on the prior run rates. I know, one is in Europe it is... can you just talk about what's going on with those two businesses?

John Harper - Chief Financial Officer

Yes, I think the businesses are going well. Integration is proceeding well. And we are really using their capabilities and that's going to combine ultimately for better growth. We feel like, you do have a situation, where you've got weakening exchange rates that's lowering reported revenue. And anytime you have, you're in the early phases of integration.

It's difficult given all the responsibilities of integrating those businesses to keep at the levels that you're at. But I think that's only a matter of timing. I think given the environment, given what we've seen, we're still very pleased that we've done that... done those acquisitions, and they're hanging in there. And I think we'll be great value adds to our team.

Peter Altabef - President and Chief Executive Officer

Yeah I mean our approach as expand revenue outside the United States, George, is to allow us the time to really...if you will integrates these teams. We are one operating team, we are not a holding company. And so to some extent while I would have liked to see faster growth in the Irish and in the German acquisitions. The Irish acquisition has a good emphasis on financial services business and the German acquisition has a good emphasis on the auto business. And in this environment, both of those are going to be a little challenge. I will say the flip side is it really has allowed us to spend a lot of time thoroughly integrating those teams. And I think over the long-term, that will pay dividends in the way they work within Perot Systems, and I think those markets will rebound nicely. So as John said, I remain very supportive of those acquisitions. We are focused on EMEA in terms of up in a measured, very kind of prudent way expanding our footprint there. And those acquisitions are part of that.

George Price - Stifel Nicolaus

Okay. And just on the margin target, 50 to 100 bips; is that still a target range that you think is achievable next year? Is it too early to say given the environment? Where do you stand there?

John Harper - Chief Financial Officer

Well, as I noted earlier, we absolutely aspire to continue to improve profit margins. But in this time of economic uncertainty makes it very difficult to predict. Ultimately, it's going to depend on what the discretionary environment looks like. And as I noted, what our early deal economics for our new business that we signed looked like. So again big focus here. This team is make no mistake, this team is absolutely focused on improving margins. If you look at our track record on the last five quarters, 1 point 1 points of improved margin. It has been a focus it will continue to be a focus, but it's very difficult to predict.

George Price - Stifel Nicolaus

Okay. And last just clarification on the internal growth; was that... I think you said 7.5% or 8%?

John Harper - Chief Financial Officer

Organic, correct.

George Price - Stifel Nicolaus

Is that kind of basically fully performing JJWild to be acquired at late third quarter '07? Did you...

John Harper - Chief Financial Officer

I would have to look at that, but I think that fully includes the impact of JJWild.

George Price - Stifel Nicolaus

Okay, all right.

John Harper - Chief Financial Officer

That's something I can look up and then clarify and get back with you.

George Price - Stifel Nicolaus

Okay, okay, many thanks guys.

Peter Altabef - President and Chief Executive Officer

Thank you, George.

Operator

This ends the Q&A portion of the call. Peter Altabef will now make his closing remarks.

Peter Altabef - President and Chief Executive Officer

I want to thank everyone for joining the call today. And again remind everyone that we have a two page downloadable on our Investor Relations site that I think you'll find helpful and continues to provide guidance and insights into the business; and look forward to speaking with you next quarter. Thanks very much.

Operator

Ladies and gentlemen, thank you for participating in today's Perot Systems third quarter 2008 earnings conference call. You may now disconnect. .

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Source: Perot Systems Corp. Q3 2008 Earnings Call Transcript
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