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Perot Systems Corp. (NYSE:PER)

Q4 2008 Earnings Call

February 10, 2009 10:15 AM ET

Executives

John Lyon - Director of Investor Relations

Peter Altabef - President and Chief Executive Officer

John Harper - Chief Financial Officer

Analysts

Rod Bourgeois - Sanford Bernstein

Anurag Rana - Keybanc

George Price - Stifel Nicolaus & Co.

Joseph Vafi - Jefferies and Co.

Eric Boyer - Wachovia Capital Markets

Operator

Good morning. Thank you very much for standing by and welcome to the Perot Systems Fourth 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 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

Good morning. Welcome to our fourth quarter earnings conference call. During our call today, Peter Altabef, our CEO will review our 2008 business accomplishments and 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 results at perotsystems.com.

In addition, we will refer to two non-GAAP financial measures today. The first is free cash flow, which is a measure we use to assess the net cash production of our operations including long term and short term capital. It is 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 growth contributions from acquisitions completed in the past 12 months and comparing it to the fourth quarter revenue. The information necessary to calculate these measures is available in our earnings press release. Once again, I want to thank you for joining us. I'll turn the call over to Peter.

Peter Altabef

Thank you, John. And good morning and thank you for joining us today. 2008 was a very productive year for Perot Systems with important accomplishments and progress in all major facets of our business.

From a strategic perspective, we continue to strengthen our market position by expanding our solutions in target markets such Physician Solutions. Geographically, we expanded our healthcare operations to the Middle East and to China and strengthened our applications management offerings in Europe.

Operationally we strengthened the profitability of our existing contracts while providing our clients with outstanding customer service. During 2008, we extended two of our three largest client contracts; Harvard Pilgrim and Catholic Healthcare West. And we signed existing client contract renewals valued at $2 billion of total value during the year.

Financially, we grew revenue by 6% to 2.8 billion for 2008, despite of sales environment that slowed significantly during the second half of the year. We expanded our operating margin over the course of the year by increasing contract profit and tightly managing costs. On this base, the revenue growth and profit margin expansion, we grew our net income and earnings per share to the highest levels ever.

Free cash flow was 162 million for the year, increasing our cash balance to 234 million at year-end. The fourth quarter marked a financially strong ending to the year, with revenue of 683 million, earnings per share of $0.24 and an operating margin of 6.9%. Our revenue earnings and the level of project and consulting work were as expected. In addition, free cash flow increased to $62 million on very strong collections. From a sales perspective, the lengthening of the sales cycle that began in the third quarter continued in the fourth quarter.

Progress on later-stage sales opportunities continued to be slow in the quarter because of decision making delays and scope changes. Although, total bookings remained robust on an excellent pace of contract extensions.

As we move into 2009, we are seeing encouraging activity for early stage sales. Later stage sales prospects remain in our sales pipeline and are progressing. And since the beginning of 2009, we assigned new contracts valued at approximately 200 million with total bookings of 350 million; including an important extension in the government healthcare arena. While we will experience lower revenue in the first quarter, we believe that new contract signings and revenue are positioned to rebound as the year progresses.

I will now take a few minutes to provide a perspective on what is happening in our major market areas. I'll begin with the healthcare industry, where 2008 proved to be a challenging year for healthcare providers, although it was strategically important for Perot Systems. As 2008 progressed, a series of business issues in the healthcare industry emerged. Including financial pressures resulting from reimbursement short falls and bad debt increases, a higher cost of borrowing and lack of liquidity in the debt markets and reduced investment returns resulting from financial market pressure.

These issues caused healthcare industry business priorities and slowed decision making. Capital initiatives failed in priority as the year progressed, while initiatives to create efficiency and increased cash flow became higher priorities. As we entered 2008, the market for clinical system development and transformation was broadening domestically to include small and mid-sized hospitals, with promise for increased adoption in the international market. Up to that point, advanced clinical technology had been adopted mostly by large health systems and academic medical centers.

Broader adoption was expected to be a key factor to our growth in health care in 2008. However, as industry priorities changed during the year, so did the sources of our growth. Prospective client interest in IT and business process outsourcing and solutions surrounding cash flow enhancement are now more often leaving our domestic pipeline because of the cost savings and cash flow benefits.

Turning to the international market, we are experiencing rapidly growing interest and bid activity for electronic health record solutions. In the international community, clinical implementations are more likely to be government sponsored and these governments are continuing to invest. With respect to our fourth quarter health care revenue, we saw a shift from low margin pass through revenue to higher quality revenue. We experienced a 2% overall sequential decrease in revenue as a result of the previously discussed CHW contract change.

Outside of this change, healthcare revenue grew by 4% sequentially as a result of growth in hospital IT outsourcing particularly in the small to mid size hospital market as incentives that reduced cost are priority. Solutions surrounding cash optimization, both for hospitals and physician practices and payer organizations, where IT and business process outsourcing revenue is increasing. Our emphasis on the developing areas of healthcare which includes small to mid size hospitals, solutions related to the revenue cycle and physician practices, the federal government and the international community is serving us well.

These are the sources of most of our healthcare revenue growth. Revenue from these developing areas of demand grew by 25% in 2008, with 14 points of this growth coming from new clients and existent client expansion. The remainder came from having a full year of the JJWild acquisition; now our MEDITECH Solutions Group, and the late 2008 acquisition of Tellurian. Tellurian extends our reach in the physicians market to small practices, through a cost effective hosting of electronic health record and practice management software.

From a timing perspective, this acquisition positions us very well to serve the needs of physician groups as the Obama administration works to expand the use of healthcare IT. Smaller physician groups have historically been slow in adopting new technologies, such as e-prescribing and electronic health records.

A recent development is the economic stimulus package. While this legislation is still being finalized, it is expected to provide substantial investment in a number of key federal agencies and promote the expansion of health information technology and the implementation of electronic health records or EHRs.

We anticipate having opportunities to develop in both the public and private sector, through direct funding and our support of healthcare clients that receive federal grants and/or increased reimbursement rates. The expansion of healthcare IT is a critical step to modernizing the industry, reducing medical errors and increasing patient care and safety.

While the industry's financial challenges have caused clinical system adoption to slow, we believe that the added support of the stimulus build coupled with the Obama administration's commitment to provide funding to advance the implementation of healthcare IT will accelerate this long term industry direction.

With our leadership position in both the private and public healthcare IT markets, we are well positioned to help our clients respond to changes in the regulatory environment, including implementation of clinical systems and transformation of processes, modernization of systems to help clients meet expanding reporting requirements, delivery of IT cost savings to produce stronger cash flow and additional funding for the implementation of electronic health record systems.

Initially, there will be startup activities centering on the establishment of national standards for EHRs, EHR demonstration programs and implementation planning. Over time, we see increased needs for healthcare IT, including expanded reporting requirements and the increased adoption of EHRs among hospitals, physicians, payers and other healthcare providers. The ability to successfully move into new areas of healthcare comes from our record of accomplishment in the industry, our market leadership position and the quality of our solutions and client relationships.

During 2008, we were ranked number one in market share for healthcare professional services in North America by the Gartner Group. We were recognized by the Black Book of Outsourcing as the highest graded full service vendor by hospital and healthcare provider clients, as well as the highest rated information technology outsourcing vendor based on criteria's such as trust, reliability and client relationships.

We earned two prestigious class awards, including the number one ranking of professional services firms that provide clinical implementation services. We received the Outsourcing Centre and Forbes Magazine's Best Partnership Award, for our work with Harvard Pilgrim and we extended 16 major healthcare clients during the year. While we are encouraged by the prospects of healthcare IT in the proposed stimulus package, in the near term IT and Business Process Outsourcing are expected to continue to fuel domestic demand, while adoption of electronic health records will continue to drive international demand.

Based on the opportunities in our sales pipeline, we are well positioned to expand healthcare revenue as the year progresses. In our commercial area, fourth quarter revenue grew by 2% year-to-year with backlog revenue growing by 8% and non-backlog revenue decreasing by 2%.

During the year, we produced important outsourcing wins in the insurance and manufacturing industries. On the discretionary side of the business, we have recently experienced pressure in the consulting and engineering services areas, although we continue to have important bid activity in those areas. Insurance policy administration, is providing to be an increasingly important element in our commercial business mix. We continue to realize high rates of year-to-year growth in this developing market, 33% for the full year. With the need for this industry to increase efficiency and reduce costs, we continue to realize a heightened pace of sales opportunity.

For government services, we added a significant revenue from new sales and ramping contracts. With the largest component of this revenue growth coming from the Contractor Owned, Contractor Operated, EDUCATE contract and other Department of Education wins.

New business led us to 18% growth for the year in government. While larger contracts provided a healthy boost to revenues, a challenge with larger and more complex outsourcing contracts, is that they may cause initial profit pressure. For the first half of the year, our government pre-tax profit margin was 2.5% as a result of early stage contract profit pressure. As new contract transition services progressed, and we delivered contract profit improvement, this margin increased to 5.7% for the second half of the year. For the fourth quarter, revenue from government services grew by 11% year-to-year with a primary source of this growth being the Department of Education and the Department of Defense.

In terms of sales activity, the enhancements we made to our government sales teams have resulted in an increased pace of new business opportunities. From the fourth quarter to the first quarter, we will experience a small sequential reduction in government services revenue, related to lower subcontractor and equipment pastures. We then see the potential to build upon that base because of the growing pace of new business opportunities.

Looking back, 2008 was an important and productive year for our company. From a strategic, financial and operations perspective, we furthered our business even as the macro environment changed. While macro uncertainty may create challenges in 2009 we have a very resilient business with an experienced leadership team, excellent client relationships and a very solid financial position. The revenue weakness we are experiencing in the fourth quarter is balanced by our ability to manage our cost structure and sign new business; we are well positioned to do this.

I want to thank you for joining us and John Harper will now detail our financial performance and forecast.

John Harper

Thank you, Peter. Good morning everyone. Thank you for joining us today. I will begin with a brief summary of our fourth quarter financial results and our first quarter guidance. Earnings per share was $0.24 for the quarter. As we expected, seasonality pressured earnings on a sequential basis. As we move to the first quarter, we expect earnings to range from $0.23 to $0.25 per share.

Although there are a number of moving parts, we expect earnings per share to be essentially flat with the fourth quarter. Revenue was $683 million for the fourth quarter of 2008. This is a $28 million decrease from the third quarter and is consistent with the range we provided you.

As we discussed last quarter, the major sequential revenue change from the third quarter to the fourth quarter comes from major contract renewals that reduced mostly pass through oriented revenues and expenses. In addition to the $21 million of lower pass through revenue, there were two smaller changes. Normal seasonality and weakening of the Euro and pound against the dollar which caused $10 million of revenue pressure in the quarter.

While the economy and its potential impact on services was a focus for much of 2008, the impact the economy had on our business during the year turned out to be relatively small. It was mostly in the form of lengthening sales cycles, caused by the magnitude of macro economic events.

In the fourth quarter, project cancellations were isolated as we expected going into the quarter. The same appears true thus far in the first quarter. Outside of these isolated cancellations, fourth quarter project starts and increases outpaced the normal course of projects ending with healthcare projects leading the way.

In the first quarter and a result of delays and late stage sales pursuits, we do not expect major revenue contributions from new sales and project starts. However, we have the opportunity to add revenue as the year progresses. Revenue for the first quarter of 2009 is expected to range from $635 to $655 million. There are two factors causing lower first quarter revenue. First, a reduction of pass through expenses of approximately $20 million, part of this was anticipated because of recent contract extensions. This had minimal impact on earnings. Second, we have approximately $15 to $20 million of revenue pressure related to more projects ending, than projects and major sales starting.

Let me put our first quarter revenue projection into perspective. In a normal sales environment, this level of revenue ending would be offset with a good quarter of new major signings and a normal level of project starts. Our late state sales pipeline remained strong and there's interest in project services. If we can get back to relatively normal level of projects starts or new sales, then we are positioned for a greater level of revenue additions.

Free cash flow was $62 million for the quarter, increasing 2008 full year free cash flow to $162 million. While free cash flow was already on a strong trajectory for the year, a five day reduction organically to DSOs in the fourth quarter added approximately $35 million to full year free cash flow. The fourth quarter marked a strong financial ending to the year. While major factors limited the amount of revenue we added in 2008, consistent operational execution and discipline in the way we approached the market enabled us to grow earnings and profit margins at a healthy pace, replenish our incentive compensation and produce an outstanding year of free cash flow. These same factors will be important to our 2009 successes.

Turning to a detailed review of our fourth quarter financial results; for the fourth quarter, revenue was $683 million. On a reported basis, revenue decreased by 7% year-to-year. The decrease was caused by $74 million or 11 percentage points of revenue recognized in the fourth quarter of 2007, related to the end of the triad contract including $59 million of revenue associated with the early termination of the contract and $15 million of operating revenue.

Outside of this 11 percentage point change, the rest of our revenue increased by 4%, year-to-year. This remaining increase is spread between government services and industry solutions. Within industry solutions, we generated revenue growth from new major client revenue and small acquisitions. This was partially offset by currency movements that affected our existing account base. For government services, growth came from a series of new contracts and ramping contracts with the Department of Education and growth in the Department of Defense. For earnings per share, we reported $0.24 for the fourth quarter.

The year-to-year change has four main elements to it, the first two reducing earnings. First, there is a $0.14 reduction of earnings related to the fourth quarter 2007 events including $0.23 of profit recognized in the fourth quarter of 2007 related to the early termination of the Triad contract and $0.09 of expense related to cost reduction activities occurred in the same quarter.

Second, we had an increase to incentive compensation. In 2007, we had reduced levels of incentive compensation. Consistent with our plans, we replenished those levels in 2008. Third is the significant profit growth on existing accounts within industry solutions as a result of new business, higher volume and contract efficiencies. Fourth, new client sales within industry solutions.

With respect to operating margin, we reported 9.8% in the fourth quarter of 2007. This includes a net benefit of 3.3 percentage points from contract termination related profits partially offset by cost reduction activities. Outside of this non-recurring benefit, our operating margin in the fourth quarter of 2008 increased 40 basis points as compared to the fourth quarter of 2007. This increase came primarily from strong improvements in account profitability within industry solutions partially offset by increased incentive compensation.

In reviewing our liquidity and capital resources, our financial position continues to be strong. Cash and short term investments were $234 million and $36 million at year-end respectively. For the year, we produced net cash flow of $47 million. This cash flow came predominantly from $162 million of free cash flow, but was partially offset by acquisition consideration and earnout payments of $33 million, debt repayment of $34 million and stock repurchases of $44 million.

Accounts receivable was $443 million at year-end, a $34 million decrease for the year. Fourth quarter day sales outstanding were 58 days. We saw a five day sequential decrease in DSOs organically this quarter. Our operating team did an excellent job of collecting our receivables, particularly given the weakness in economy. We are proud of this performance and will do best to sustain it. However, it will be challenging given the current environment and the fact that our business tends to operate in the low to mid 60s for DSOs.

Debt ended the year at a $184 million, a decrease of $35 million for the year. We financed our 2008 acquisitions and share repurchases with -- share repurchases with cash, plus made repayments on our line of credit. Shares outstanding as of the end of 2008, were 121 million versus 124 million at the beginning of the year, a decrease of 2%. We continue to be active repurchaser's of our stock in 2008. We repurchased 1.7 million shares at an average price of $11.60 per share in the fourth quarter. Over the past three years, we have invested approximately $110 million in stock repurchases, buying 8.3 million shares during this time period.

To conclude, financially 2008 was an outstanding year for our company. We grew earnings per share to its highest level ever, achieved our target operating margin range for the year, expanded existing account profits, something that is essential to the IT services business model and delivered strong cash flow. The focus, discipline and execution that produced these results will continue to be key to our success in 2009. While the environment holds uncertainty for all of us, we are well prepared to capitalize on the opportunities and address the challenges that we are presented with. I want to thank you again for joining us and we will now answer to your questions.

Question-and-Answer Session

Operator

This concludes the formal of the conference call. A question and answer session will now be conducted. (Operator Instructions). The first question is from Rod Bourgeois with Sanford Bernstein.

Rod Bourgeois - Sanford Bernstein

Hey guys. I wanted to enquire about your current pipeline versus the pipeline that might become available if the stimulus package is approved. My sense is that your current sales pipeline is not being helped by the stimulus package at this point; that's a future thing. But can you decipher between your current pipeline and to what extend that's standing on its own versus the pipeline that might be created down the road, if the stimulus is approved. Are those two things pretty separate right now?

Peter Altabef

Rod, thanks for the question and thanks for letting me have an opportunity to elaborate on it. You are correct and they are actually completely separate. In the sense that my remarks around the pipeline and the pipeline itself do not include today the stimulus package work that might come down the road. So and that's why you heard in my remarks when I talked about the current state, domestically there is a big emphasis on IT outsourcing and business process outsourcing in healthcare around such things, such as revenue cycle work focusing on efficiencies and saving money and your base outsourcing kind of traditional economies.

We don't have currently a very-very active pipeline in the clinical implementation side. There's some of it, but not the level of -- that we would have expected let's say at this time, 2008. As that comes onboard with the stimulus, we anticipate that will be in addition to our existing pipeline. So I hope that helps.

The exception by the way around the clinical side is international, where there is a very strong demand for clinical services. We've actually taken a good number of our folks that have been doing clinical services here and repositioned them internationally, because they are in high demand there.

Rod Bourgeois - Sanford Bernstein

Okay. Great and then if you look at the current deals in your pipeline, can you guys characterize whether those deals are normal in terms of their margin profile or do a number of the deals in your current pipeline have front loaded investments that might bring a lower than normal margin profile?

John Harper

You know Rod, I wouldn't say that it's anything out of the usual. We're seeing the economics being pretty consistent with what we've experienced in the past. We've done a real good job in the past of getting the upfront cost funded and I'm not seeing a dramatic shift in that. But as looking forward to 2009, we're probably anticipating a little bit more of the upfront funding that we will have to bear but we do a very good job of trying to manage through that. So the economics are terribly different and the profile of the deal in terms of that upfront payment is not terribly different.

Rod Bourgeois - Sanford Bernstein

Okay so working capital could be somewhat strained over the next year because we're in a bad economy and clients are going to want a bit more upfront funding but you're working to really offset that?

John Harper

Yeah I think so. I anticipate 2009 there will be more transition funding than we had in 2008. And I think to your point, DSOs will most likely be pressured given the economy we did a great job of collection in the fourth quarter. We are very worried about the state of the economy and so we doubled our efforts around collection and it had really a blow out quarter in terms of collection.

I don't think that's sustainable as we look forward. So I think that could create some pressure, the transition could create some pressure and I think our facility CapEx may tick up a little bit in 2009 as well, was very low this year. So I think all of those will add a bit of pressure to cash flow as we look forward to 2009.

Rod Bourgeois - Sanford Bernstein

And then just to complete that question, is the margin profile of the work to be added by the stimulus likely to be normal margin profile work. I mean if its clinical transformation, does that mean we go through a period of very good demand but demand with deals that do you have a lot of front end loaded investments or is it too early to really know at this point. Thanks.

Peter Altabef

Well I think it is too early to know but there is no reason at least at this point I think, to think that it would be different than normal commercial terms for that work especially the work that flows through the private sector, as opposed to the work that might come directly to the government sector.

We already have a very healthy government business. So I would expect at this point that we'd expect normal returns for clinical application where both on -- what we would typically get from our government practice and then what we typically get from the private practice. But it's too early to tell.

Rod Bourgeois - Sanford Bernstein

Thanks guys.

Peter Altabef

Thank you.

Operator

Your next question is form Anurag Rana with Keybanc.

Anurag Rana - Keybanc

Hey good morning everyone. Could you please comment on the pipeline of large as well as small to mid-size hospitals at this point and what kind of services are these folks looking for and what projects are on hold right now?

Peter Altabef

Well you know Anurag, I think it's a continuation if you will, on the large hospital front. We do have some active large hospital deals, but the bulk of our IT outsourcing pipeline is now in the small and medium hospital arena. There are more of them. They are more than that we don't already serve, since we already serve a large percentage of the large hospital work anyway. So I think you'll continue to see around IT outsourcing more of an emphasis on the small and medium hospital organizations.

On the clinical transformation side, as we said; those are not built into our forecasts at this point but assuming that the stimulus bill is passed in a -- in close to way it is currently envisioned, I think that the clinical applications work will really be across the board. It'll be at the large hospitals, it'll be at the small, medium; it'll be in physician practices and there'll also be added demand even in the payer business.

So I think that, that's to come. But right now, you continue to see an emphasis for us in the small and medium hospitals, exception to that being the revenue cycle work where it's still across the board.

Anurag Rana - Keybanc

Great, and is that what gives you the confidence that the company is well positioned to increase their booking as the year goes on?

Peter Altabef

Well. We are seeing as I said in my remarks Anurag, there really are two different things. We have a number of late stage deals that are in progress. We signed some already this quarter which is why you see $200 million of TCV already this quarter. And we continue to have more late stage deals. That deal we signed this quarter by the way, one of the large deals we've already signed was the large hospital deal. So there still is business there.

But as you go forward, what we're seeing in the pipeline is not only a carry over of the existing deals that didn't close in the third or fourth quarter, but we are now seeing as I referenced, a healthy addition to the pipeline of new deals coming onboard. And that is very encouraging. So I would say to you this is not a case where we're simply hanging on to the older deals. We are seeing a nice group of new deals coming on line.

Anurag Rana - Keybanc

Great. And any comments on pricing of this point, please?

John Harper

I think the pricing environment has been relatively disciplined. There are some aggressive requests but that's no different in this market than any market. We have seen some pressure on the Indian based pricing, that pricing has been somewhat pressured. But other than that I would say it's been relatively disciplined and relatively consistent.

Anurag Rana - Keybanc

Great, thank you.

Peter Altabef

Thank you Anurag.

Operator

Your next comes from George Price from Stifel Nicolaus.

George Price - Stifel Nicolaus & Co.

Hi guys thanks very much, how are you doing?

Peter Altabef

Good, thank you George.

George Price - Stifel Nicolaus & Co.

Couple of things. First -- I was wondering the so the 200 million of work signed you mentioned there is couple of deals and I guess one is a large hospital. Can you I guess characterize may be what kind of work we're talking about?

Peter Altabef

Yeah, the majority of that 200 million to date is what I characterize as IT outsourcing work. The majority of it is in healthcare and it is I get, it is your standard healthcare, lets go in and revamp and create efficiencies from their existing organizations.

George Price - Stifel Nicolaus & Co.

Okay and what's your expectation I guess of how -- looking at the existing pipeline, non-stimulus; and I have kind of a follow up to the stimulus element to that. But looking at the existing pipeline, what's your best sense of how award flow is going to track as we move through 2009? I mean, do we expect second quarter to be better than first, third to be better than second? Are we going to see some of the normal seasonality, do you think or a little bit of disruption given the timing coming out of '08?

Peter Altabef

Obviously George, there's more uncertainty in the current environment than I think many of us have experienced. So it's difficult to have a crystal ball on this. I would say though when I look at the pipeline over the remainder of this quarter and next quarter and the third quarter, it's pretty balanced. So this is not a hockey stick type of environment. We see the ability to sign, good signings in each of the next three quarters. Now whether that actually happens or not, we'll have to cross our fingers and work as hard as we can to make it happen but its very balanced pipeline as we are looking at it today.

George Price - Stifel Nicolaus & Co.

And then, just kind to carrying that over to the stimulus, what kind of timing would, you expect on the clinical work post stimulus package. Again I know there is a lot of unknowns but, do you have any sense of how soon you think that that the debt funding could actually start to translate into booked opportunities and opportunities ramping up?

Peter Altabef

There are a lot of unknowns, when -- and obviously there is still a lot of work in conference that will have to be done between the House and the Senate versions of the legislation. When you work through the legislation obviously, we're spending a lot of time looking at that and understanding it. There are really two elements to healthcare IT funding right now that jump out. One is a jump start program which is currently about $3 billion, of which may be 400 million or so is earmarked for 2009 distribution.

And then there is about a 19.7, $20 billion kind of larger element there, which is tied -- the implementation of that is going to be through Medicare and Medicaid kind of reimbursements and credits, and even there where you'd expect that to take a little longer to be paid is about $250 million that's expected to be disbursed in 2009.

So about 300 -- excuse me about $650 million could see the light of day in 2009 from that effort. Now whether that happens or not, whether the legislation gets past; whether it gets past in this way, whether the money can actually get spent in a timely way like that, a lot of uncertainties, but there clearly does seem to be stimulus in the stimulus bill and that they definitely want to get the spending started quickly. And the good news is we are in a position to respond because we have the experience, we have the expertise on the clinical side and we can gear up very quickly.

George Price - Stifel Nicolaus & Co.

Let me throw one last then, any change in how the macroeconomic impacts particularly on the discretionary side of the business, both onsite and offshore I guess. Any -- could you talk maybe a little bit how that progressed through the end of the year and how -- what you've seen thus far in January and thank you?

John Harper

I think that the macro environment as I -- we said in our formal remarks, really were less about projects and more about projects ending or project cancellations, it was more about the lack of new starts and the lack of new sales. So as you move into the first quarter, you see our guidance has a lot of moving parts, and I talked about moving parts. You've got seasonality that we had in the fourth quarter that will reverse. That will be partially offset by the globalization expense that we talked about as well.

Then you've got this element of work ending that we talked about. That is where you're seeing the effects of the macroeconomic environment. You're seeing that work end because of the lack of new sales in the third and fourth quarter and the lack of project starts. So I think that's where we're really probably impacted the most. Fortunately for us, we've done some cost saving opportunities that has served to partially offset the financial impact of that work ending.

Finally we have some one time benefits as we look forward to the first quarter that roughly offset, we've got some expense for these cost actions and we have a potential tax benefit. So I think what we try to do is really work hard to mitigate the impact of the economy, and if I had to say one thing about it, it was -- it's not about the project, the work ending. That's kind of normal core stuff. It's not having the new sales and the new projects starts to essentially and effectively cover that.

George Price - Stifel Nicolaus & Co.

Just to clarify, is there a in terms of the EPS being flat quarter-over-quarter into the first quarter, which often times you take a little bit of a I think seasonally often times you takes a little bit of dip going in the beginning year. Is there a tax benefit that's partially going to contribute to that? Can you flush that out a little bit more?

John Harper

Well there is a potential tax benefit but its normal course kind of stuff. As you settle with taxing authorities, under the current accounting for tax, any discrete item where you for example, settle, resolve in a current taxing jurisdiction, flows through your way.

And so there is a potential tax benefit that would serve to offset part of this -- some of these cost actions that we're taking. But we're not talking large numbers. It's really, just kind of two potential one times that would offset.

Operator

Your next question comes from Joseph Vafi with Jefferies and Co.

Joseph Vafi - Jefferies and Co.

Hi guys, good morning, congratulations on the steady results in this environment. I think was it Peter or was it John you mentioned that the healthcare business was up 4% sequentially; I know, there might have been a little acquisition related revenue in there but was that -- or how much of that was indeed organic and is there really anything to be looking at in the Q4 growth there that stands out that we might be interested in?

Peter Altabef

Well, let me kind of walk you through the puts and takes of the growth. There is a little bit of Tellurian revenue in there, but it's small. Hospital outsourcing was up, our projects starts as we noted in healthcare were up. RCS and physicians were up and payer was up. So if you take out the impact of the CHW managed contracts going down which was roughly $17 million, that's how you get to the 4%. But there was a small amount of Tellurian revenue in the quarter.

Joseph Vafi - Jefferies and Co.

So, generally it was relatively broad based it sounded like more or less...?

Peter Altabef

That's right.

Joseph Vafi - Jefferies and Co.

Okay. And then...

Peter Altabef

And then -- I am sorry Joe and then when you looked into the first quarter, just underscore what John is saying, you're seeing good activity on the larger deal side, but you're not seeing the kind of project work that would ordinarily take over from project work, that is normally expiring which is part of the pressure you're seeing in that first quarter. That includes both healthcare and commercial, in terms of that project work and we are seeing pressure in the first quarter on project work.

Joseph Vafi - Jefferies and Co.

That make sense. I guess the follow up to that commentary Peter would be, we've seen decent bookings activity here so far early in the quarter. Last quarter Q4 wasn't that great kind of understandable, given the economic environment and so we're seeing maybe a little bit of project pressure in the P&L for Q1.

Is it too early to say or is it fair to say that we're kind of seeing a normalish type year emerge? Its just may be a quarter or two late at this point because the Q4 decision making was slow and its getting pushed or is it too early to say that you're seeing kind of better and normal flow to bookings activity here early in the year?

Peter Altabef

Joe, I think those are both very good questions. I do think you're seeing a very light signings in the last 6 months of last year, which will pressure revenue early this year. Because we really we don't have that revenue from signings last year which is why you are seeing a -- what I would consider a low revenue quarter for us but with the potential to continue to built on that revenue quarter-for-quarter throughout the rest of the year.

With respect to, do we think we're now at a state of normalcy, I'm not sure what normalcy is now going forward in this economy. I think we're going to continue to see some lurches (ph) back and forth with decision making as people get news on a weekly basis. But I will say that in terms of the deals we have in the pipeline now and in terms of deals that are coming into the pipeline, we're very encouraged by both of that. I'm just not sure I'm ready to declare anything normal yet.

Joseph Vafi - Jefferies and Co.

Okay that's fair and then just on the bookings so far this year, I know you reported Q1 and yet obviously you did talk about a large healthcare deal, is there any other color in the bookings pattern this quarter, stands out in terms of verticals or types of work that's kind of converting here at this point and as I guess some of it also was stuff that potentially you thought would've booked last quarter and it's just spilled over into this quarter?

Peter Altabef

Well, you saw that that our booking number is substantially higher than our TCV number that we reported through January, and we did have an addition to our large ITO on the private sector side in the TCV number, we had a large renewal in the government healthcare side of the defense on the booking side. Which we're very encouraged by as well. So we -- again on those larger deals we're beginning to see some throughput, we're not seeing in the first quarter a lot of new small projects startups and as I noted in my comments we've got some weakness on the commercial side in terms of supporting some of our clients, which are experiencing some significant layoffs and cut-backs and we're dealing with that as you would expect any partner to deal with it.

So we're working through challenges that every other company is doing, but we do expect that the first quarter will kind of be a triumph (ph) on revenue and that we'll build from there.

Joseph Vafi - Jefferies and Co.

Okay, that's helpful and then maybe just one final question on the government business. You kind of, in your commentary you talked a little bit about improving margins there, getting past some startup costs and better margin activity in the second half of '08. Sounds like there'll be a little bit pass through revenue moving forward but even ex (ph) the pass through revenue. Have those -- does that business still have margin expansion opportunities in '09? Thanks a lot.

John Harper

Well, as we noted, we're very pleased with the contract improvement that we were able to achieve in 2008, getting that margin back up to 6.1%. What you saw in 2008 were this large deal economics with our large department of education contract and what that means is that you have early pressure because you have true big deal economics, the likes of which we deal with routinely on the commercial side. But this was really our first foray on the government side.

What that means is as you execute and cut cost, you can achieve future profit expansion and we've been enjoying some of that expansion. We do have opportunities, if we continue to execute and continue to sell good profitable business to increase margin. But that's work we actually have to do.

Peter Altabef

On the revenue side of the government work Joe as I pointed out, we had a very strong revenue year last year. We were really absorbing some contracts for us with the department of education and some others that were on much larger scale than we're typically used to.

We had a challenging last six months in terms of sales in government, just like we had a challenging six months and in the non-government side, but for an entirely different reason. On the government side, we really were very-very focused on delivery and we did not think we had the right team in place around our plan moving forward either in sales or business developments.

So we made some major changes last year in our government team and we are extremely encouraged with where they're going now. But they don't have a huge number of new sales from last year that will help them in terms of revenue early this year. So similar story, we expect the revenue in government to build over the course of year, but it's going to be a little challenged certainly in the first quarter and may be in the second quarter as well. Again I have to say, we are very encouraged by what we're seeing in that government team in terms of pipeline

Operator

Your next question is from Eric Boyer with Wachovia.

Eric Boyer - Wachovia Capital Markets

Hi thanks. Yeah, I am sorry if I didn't catch this but did you give the assumption for the operating margin for Q1, and how we should thinking about operating margin moving it through the year?

John Harper

Well I think in terms of operating margin, I want to start out by saying we're just very-very pleased with the progress we've made in 2008. We ended the quarter at 6.9%, ended the year at 6.7%; both of which were in the range of what we laid out. And more importantly we remained committed to improving margins and I think we had the opportunity to improve margins in the first quarter. But we're not providing a formal guidance on margin given the level of uncertainty in the environment particularly around projects.

Eric Boyer - Wachovia Capital Markets

Okay. But if you just look at what you gave for revenue in your EPS target, would that assume a margin above 7% or is there something else in there that could hamper that?

John Harper

Well again, you've done the math. We think we have the opportunity to improve margins as we move into the first quarter.

Eric Boyer - Wachovia Capital Markets

Okay great. On the cost action side, have you guys done any workforce rightsizing or anything along those lines or are you expecting to?

Peter Altabef

In terms of workforce management on the cost side, we are -- if you go back to our business in December of '07 and you remember when the Triad contract was terminated, we actually took a very hard look at our business at that point and said, how do we really manage very-very carefully. And so, we actually did a headcount reduction starting in December of '07 through really June of '08 that resulted in about a reduction of about 800 people for our shop.

Now interestingly although I'd like to say we of course had an amazing foresight, we did not but the recession started in December of '07 as the same time we started to make those changes. So we've already really gone through if you will one stage of that. Where we are now and where we have been in the fourth quarter and continue to be in the first quarter of this year is very tactical around work force management. We are working very hard not to keep an extended bench and to really follow our clients and their needs. So that's really what we're doing. We are taking action, but we're doing it very tactically and really in a situation-by-situation basis.

Eric Boyer - Wachovia Capital Markets

Along lines of the stimulus bill, I just wondering do you think you could actually see a pause or decision pause for something -- your clinical work as the hospitals and the doctor practices try to figure out exactly what the stimulus would mean for them?

Peter Altabef

I think it would be fair to say it's already paused. And I think part of the reason for the pause in addition to the economic limitations, is exactly that. I mean people are looking I think to see where the puck is going in terms of the new regulations and the new reporting environment.

So, but again I think we're seeing the stimulus package moving forward pretty smartly in terms of speed and so, I don't think it will continue to be paused for an extended time. Now how long it takes once the bill has passed, assuming that it's passed to actually result in funds and result in a framework where people understand the future reporting and the future investing needs, it's really to too early to tell. Which is why again for 2009, while there are some possibilities that some of this funding can come through, in the remarks I gave you about our pipeline, we're really not including that in our pipeline right now. So if that happens in 2009, that's terrific, its upside. If it doesn't happen in 2010, we'll be ready for it then as well.

Eric Boyer - Wachovia Capital Markets

And then finally, do you have any large federal, I guess projects coming up for re-compete in '09?

John Harper

We have about 15% of our revenue that's due for re-compete in 2009, all small type stuff and we did have a big as we noted a big win in the federal -- a big win on the re-compete in the federal healthcare space in the first quarter. And we were -- good news is in the fourth quarter, we were actually 5 for 5 on re-competes. So we're doing a very good job on the re-compete front.

Operator

Your next question is a follow up question from Anurag Rana with Keybanc.

Anurag Rana - Keybanc

Hi, good morning guys I'm sorry to -- thanks for taking my question. But just to get an idea right now, what percentage of your total revenue comes from clinical transformations and what can we project this number to be year down the road or two years down the road? Thank you.

John Harper

Yeah, it's still a very small percentage, I would say roughly 6% and what percent it could be down the road, really is anybody's guess. I mean we certainly are of the opinion that the stimulus bill will have a positive impact on that business. As Peter noted in his remarks, we're finding, internationally the clinical work is very well accepted and we're seeing a lot of activity around that.

Operator

Your last question is from George Price of Stifel Nicolaus.

George Price - Stifel Nicolaus & Co.

Hi thanks again. I wanted to circle back around on a couple of things. I know Eric touched on the operating margin question. I guess John, I just wanted to go back to understand if there was -- what's in the $0.23 to $0.25 in terms of expectations around tax rate? Anything else below the line, just trying understand where -- what the moving parts might be and then I have a follow up.

John Harper

Well, in terms of margin again we think we have the opportunity to improve margins as we move into the first quarter. We're very committed. I think if you look our track record we grew 10 -- margined 10 BIPS sequentially and 40 BIPS year-over-year for the fourth quarter and that's with -- and I don't want to lose it, that's with a 150 BIPS of pressure from bonus. So we had to grow margin in the face of rebuilding that bonus proof. So I think we've demonstrated a commitment and a track record to doing that.

In terms of what's out there -- there is nothing -- I kind of walked through the moving parts of the EPS estimate for the first quarter. Happy to do that again but I don't I think the tax rate typically will range between 35 to 38% and I don't see anything that would change that per se.

Operator

Ladies and gentlemen this ends the Q&A portion of the call. Peter Altabef will now make his closing remarks.

Peter Altabef

Thank you. I'd like to thank everyone for joining us this quarter. As always we have a downloadable set of papers on our Investor Relations portion of our website and I encourage you to download those. John Lyon and John Harper and myself and our whole team of course getting (ph) ready to continue to have a dialogue with you and to answer questions. That said I look forward to speaking with each of you next quarter as well, and thank you for your time and thank you for spending the time to continue to learn about our business.

Operator

Ladies and gentlemen, thank you for participating in today's Perot Systems Fourth Quarter 2008 Earnings Conference Call. You may now disconnect.

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