Affiliated Computer Services, Inc. F4Q09 (Qtr End 06/30/09) Earnings Call Transcript

Affiliated Computer Services, Inc. (ACS)

F4Q09 (Qtr End 06/30/09) Earnings Call

August 6, 2009 4:30 pm ET

Executives

Jon Puckett - VP, Investor Relations

Lynn Blodgett - President and CEO

Kevin Kyser - CFO

Tom Burlin - COO, Government

Tom Blodgett - COO, Commercial

Analysts

Ashwin Shirvaikar - Citigroup

Julio Quinteros - Goldman Sachs

George Price - Stifel Nicolaus

Jason Kupferberg - UBS

Bob - William Blair

James Friedman - Susquehanna Financial Group

Jim Kissane - Merrill Lynch

Tien-Tsin Huang - JP Morgan

David Grossman - Thomas Weisel Partners

Suji De Silva - Kaufman Brothers

Eric Boyer - Wells Fargo Securities

Presentation

Operator

Welcome to the ACS fourth quarter and fiscal year 2009 conference call. Today's call will consist of prepared statements by ACS, followed by a question anticipate answer period. All participants will be able to listen only until the question-and-answer session begins. The call is webcast live from the company's website and is available for replay purposes. If you have any objections, you may disconnect at this time.

I would now like to turn the conference call over to Jon Puckett, Vice President, Investor Relations. Mr. Puckett, you may begin.

Jon Puckett

Good afternoon and thank you for joining us today to discuss our fourth quarter and fiscal year 2009 results. Today on the call we have Lynn Blodgett, President and Chief Executive Officer; Tom Burlin, Chief Operating Officer, Government; Tom Blodgett, Chief Operating Officer, Commercial and Kevin Kyser, Chief Financial Officer.

As always, I must caution everyone that any statements on this call that are not historical facts may be considered forward-looking statements within the meaning of the federal securities laws. As you know, forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed in or imply by these statements.

Additional information concerning these factors is contained in the company's filings with the SEC. Copies are available from the SEC's website, from the ACS website, or from ACS investor relations. We have also provided a presentation on our website that we will refer to during our discussion. We will reference certain non Generally Accepted Accounting Principle financial measures, which we believe provide useful information for investors.

We have posted both the presentation and the reconciliation of those measures to Generally Accepted Accounting Principles on the investor relations page of our website at acs-inc.com. Finally, we disclaim any intention to and undertake no obligation to update or revise any forward-looking statements.

I will now turn it over to Lynn Blodgett, who will provide a summary of the significant events during the quarter and the fiscal year.

Lynn Blodgett

Thanks, John and thanks to all of you for joining us today. Please turn to slide number 3. 2009 was a year of unprecedented challenges and a year that demonstrated to me the real strength of ACS. I am proud of our management team and of our 74,000 employees. I am also grateful to our wonderful customers for the opportunities that they have provided us.

In 2009, a year that most would consider to be the worst economic environment in many decades, we posted record revenue, record earnings per share, record new business signings and a near record free cash flow. In a year where most of our competitors showed double-digit revenue erosion, we grew 6% excluding divestitures, a significant difference in growth. I believe that our performance leads our sector in nearly every metric and demonstrates again, how resilient our business model really is.

Let me give you some specifics, new business bookings were $271 million for the quarter and $1.018 billion for the year. I think it is worthy a mention that our fourth quarter bookings were the second highest in our history, bested only by the third quarter. Back-to-back record bookings show how really well our sales teams work and how well our service offerings stack up against our competition.

Record revenue of $1.7 billion for the quarter and $6.5 billion for the year, show that not only are we booking sales, but that those sales are translating into revenue. Adjusted EPS of $0.99-cents for the quarter, and $13.73 for the year, both ahead of consensus and a record for the year.

It's also noteworthy to remember that we operated in the same economy as everyone else and that we had to overcome headwinds in nearly every one of our markets. But we did and rather than shrinking, we grew in bookings, profit and revenue.

The year 2009 contained many important and difficult strategic initiatives. Fortunately we began most of these before the full extent of the economic downturn was evident. One was Project Compete. We replaced approximately 4,000 higher cost employees with employees in low cost areas. This effort that involved people from every line of business and every administrative area was executed with precision, compassion and efficiency.

We, in fact, reduced our cost by over $100 million and perhaps even more important than that, we refined our global production model and improved our ability to mover higher tier work to lower cost areas. This will help us reduce costs even more in the future and improves our ability to save our customers more money, as we move more of their higher tier work to low cost areas.

The money we saved through Project Compete has allowed us to accelerate efforts in several key areas. Number one, sales, we have added about 100 sales people and the support structure associated with them. This cost which amounts to about one-third of the total savings has been entirely covered by the fruits of Projects Compete.

A dramatic improvement in bookings. For example we booked as much in the last two quarter as we did in all of 2007, is a direct result of this investment.

Number two, out of cycle discounts for customers. We have worked with many of our customers who have faced unprecedented budgetary pressure to assist them with discounts that are above and beyond those that we are required to provide under the contract. We have done this because it’s the right thing to do.

We have helped our clients as a true partner and received valuable goodwill and increased contract term or other valuable consideration that places us in a much stronger long-term position. Nearly all of these discounts have been funded by Project Compete.

Number three; Investment in innovation. We currently have many projects underway tat are fundamentally changing the way we deliver our services to our customers and enhancing their offerings, and making them more competitive in their markets.

For example, I recently was in Houston and visited our customer, the Metro Transit Authority. They showed me the system that we have implemented in about 750 buses. This new system, which features contactless ticketing and the ability to replenish the card on the bus has allowed our customers to dramatically reduce operating expenses and is a tremendous convenience for the customer which will increase ridership.

This system is applicable to cities around the globe. These investments have been funded in large part by Project Compete. As I look forward into 2010, we will continue our strategy of aggressive cost control, including more, moving more of our mid-tier functions to low cost production locations.

We will also continue to invest in sales and marketing. Last year, we hired nearly 100 sales people and we plan to add about the same number this year. Our strong bookings and the associated revenue have helped counter much of the downward pressure caused by the economy and has allowed us to grow when as I said earlier, most of our sector declined in revenue and we must continue expanding our sales and marketing investment.

Finally, we must continue to execute on acquisitions. Our track record of successfully identifying companies that add to our competitive position through technology broader geographic coverage, increased scale and other benefits remains a core competency to ACS. We plan to accelerate our pace of acquisitions in FY'10. Last year, we added about $180 million of revenue through acquisitions.

Although we will always maintain our degree of discipline and not do a deal just to make a number, I expect to see a contribution from acquisitions of approximately 5%. With our strong bookings and increased emphasis in acquisitions, I expect total growth of about 10% with about half coming from acquisitions and half from internal growth.

Our ability then to navigate fiscal 2009 and deliver record results across the board gives me confidence that our business model is sound. The actions we took this year improved our competitive position and will continue to fuel our growth.

In closing, I have the greatest respect for my team. They are professionals of the highest caliber who have been able to accomplish truly outstanding things this year. With such a team, with clients who know our commitment to them and with a growing list of prospects who need and want our services, I am optimistic about our prospects in fiscal 2010.

Now, let me turn it over to Tom Burlin, who will provide a government operations update.

Tom Burlin

Thanks, Lynn. If you please turn to slide six for an update on our government business, our state and local business grew above corporate average in fiscal 2009, due to increased volumes in electronic payment services and employment benefits and the children in youth services.

Recall, the majority of the services we provide to our government clients either generate revenue or save the money. Many states and local municipalities are experiencing their tightest budgets in receipt memory and we are seeking to reduce their cost to service delivery. While we empathize with these clients, this difficult environment brought some more opportunity for ACS.

We expect the increased demand that we say in electronic payment services will continue in fiscal 2010 through the cost savings we can deliver with our leveragable solution.

Next let me update you on the Indiana eligibility contract. We are part of a team, led by IBM that is modernizing the welfare eligibility system in Indiana. Earlier this year, IBM submitted a corrective action plan to the state and we are heavily involved in implementing it.

Under the plan we are working with IBM in the coalition team to provide increased support, process enhancement, system improvement to better serve the constituents. To help us successfully implement the plan, we added headcount during the fourth quarter which we estimate will impact ACS by approximately $10 million in the first half of fiscal 2010. We are committed to working with the state and IBM to successfully deliver this contract and we'll update you on our progress.

Let's move on to our direct student loan contract. Today we process a 100% of direct student loans for the Department of Education and generated approximately $225 million of revenue in fiscal 2009. We expect the contract to continue through the middle of fiscal 2012 under the remaining two performance base period and the contract may also be extended at the discretion of the department for an additional two option years.

We were not down-selected in the title for procurement and we protested the department's decision. We will follow the federal protest process and update you as we have more information.

Now let's cover some fiscal 2010 opportunities. In addition to electronic payments, we expect incremental revenue opportunities and government healthcare from the stimulus package. Specifically the high-tech act allocates nearly $36 billion on spending in healthcare information and technology.

The government has allocated approximately $300 million for state Medicaid agencies to implement health information exchanges. Our experience in developing HIEs like in Alabama positioned us well in this market. The state Medicaid market is also poised for growth as 23 Medicaid deals will come up for renewal or a bid between now and December 2010.

We estimate the market opportunity of these 23 deals ranges from $700 million to $800 million in annual recurring revenue. Four of the 23 deals are ACS Medicaid clients, including Texas. Of the remaining 19 opportunities, 15 are with our competitors and four are Greenfield opportunities.

We believe the investment we have made in our enterprise Medicaid platform positions us to take share in this market. Also, fiscal 2010 will be the first full year of open competition in the federal market and we are excited about the opportunity this presents for us.

Finally, we expect to capitalize on our innovative solutions in transportation market as we help our client spot prospects, address global issues like traffic management and congestion. As I look to fiscal 2010. I'm confident that our business model will continue to deliver strong performance.

If you will now turn please to slide seven, we acquired Pharm/Dur on June 30 for approximately $10 million. Pharm/Dur generated trailing 12 months revenue of $6 million and provides pharmacy auditing and verification services. This acquisition positions ACS as a leader in this market and allows us the opportunities to leverage these services to our state Medicaid client and prospects.

Now, let me turn it over to Tom Blodgett, who will provide an update on the commercials operations.

Tom Blodgett

Thanks, Tom. Now, please turn to slide nine. The commercial business delivered record bookings of $418million in the last six months of FY'09. A significant win in our Healthcare Payer business was in the area and helped our performance.

This important and strategic success was a direct result of our investments in technology and innovation. This solution transforms the way our clients communicate with their customers and results in higher quality, while significantly reducing our clients operating costs. I am pleased to report that this specific implementation is ramping well ahead of plan and our current pipeline includes over $250 million of new prospects with our fortified outbound fulfillment solution.

There have been several questions about a couple of our large accounts, Sprint and GM. Let's begin with Sprint, which has been a very important and long-term partner to ACS and represents about 4% of total ACS revenue. We provide them with various services, including finance and accounting, and a broad spectrum of customer care. Although our transaction volumes were down in fiscal year '09, we exceeded our financial targets with Sprint for the year. In particular, we saw a significant growth in the prepaid program called BOOST.

We hope to expand services based on Sprint’s recently announced acquisition of another prepaid vendor Virgin Mobile USA. Through the years, we have worked very hard, made significant investments and enjoyed a prominent position in the wireless market. This broad position provides a stable and predictable business model, which allowed us to grow faster than our corporate average in this fiscal year and we expect this growth to continue.

Now, let's cover GM, another important and significant long-term customer that represents 2% of total ACS revenue. We provide GM with global finance and accounting and human resource services in Europe. In an effort to assist this key client with their short-term needs and solidify our long-term relationship, we discounted in the fourth quarter certain services we provide them.

While this action will have a near-term negative impact on revenue and margin, we believe it was the right thing to do. We look forward to serving this great client for many years to come.

An exciting area for growth in fiscal '10 is the commercial student loan market. During fiscal 2009, we signed several new business deals with regional loan services and increased our market share in this space. Our size and scale provides us good opportunities to consolidate servicing from smaller loan services or large commercial banks. Due to our value proposition we expect to expand this business well above corporate average.

Finally, we expect to continue to grow internationally. Over the last 18 months, we have closed five acquisitions outside of the United States with deals in Germany, Latin America, the Caribbean and two deals in the United Kingdom. These acquisitions have added about 10,000 employees and $290 million in annual revenue.

This expansion helps to increase our presence in these local markets and allows us to provide additional services to our multi-national clients. Our M&A pipeline includes international acquisitions that will further expand our global footprint including Eastern Europe and Asia.

Please turn to slide 10. During June, we closed the acquisition of Anix, a UK based IT service provider, which will expand our presence in this market, a strong sales engine that Anix has developed, should help us sign more business in this market. Anix generated trailing 12 month revenue of approximately $70 million and the purchases price was $51 million. Anix operating margin are consistent with our ITO business.

Now, let me turn it over to Kevin who will provide additional details on our operating and financial results.

Kevin Kyser

Thanks Tom. Please turn to slide 12 for a quick overview of the fourth quarter. Revenue was $1.7 billion in the quarter and earned 6% excluding divestitures and 3% internally. Internal revenue growth for all of fiscal 2009 was 3.5%, about 3% below our beginning of the year expectations, due to a two point drag from the economy and a one point drag from the exchange rates.

Fourth quarter operating margins were in line with our expectations at 10% after considering the impact of deferred compensation costs. The accrual of management bonus and startup costs from the record new business pulled operating margins below 11% this quarter. Diluted EPS was $0.99 for the fourth quarter and exceeded our expectations

We saw a benefit from lower Project Compete spending as our process is more efficient than we anticipated. We also had a lower effective tax rate, which was offset by an equipment write-down in our transportation business.

Please turn to slide 13. We signed $271 million in annual recurring revenue during the quarter. Fourth quarter signings were particularly strong in communications and consumer goods, as we expanded existing client relationships.

In ITO, we launched a new strategic partnership with Novell and in Total Benefit Outsourcing, we signed seven new client logos.

In government, we saw strength in state and local, particularly in constituent services, in public transportation and in government health care as we added Virginia MMIS to our Medicaid client list.

For the year, we topped the $1 billion mark in bookings, which represents 27% growth over fiscal 2008. Total contract value was $4.5 billion or 43% growth over the prior year. Total contract value of all new sales and renewals was $9.3 billion in the year. Our renewal rate was 84% in the quarter as we renewed $267 million of annual recurring revenue and $768 million in total contract value.

For the year, our renewal rate was 85% and below our target of 90% due to the loss of the Georgia MMIS contract and the decision to not renew some less profitable contracts. Even after the two highest course of signings in our history, the pipeline remains $2 billion, and its split 55% commercial and 45% government. We have included our typical signings renewals in pipeline charge as an appendix to this presentation.

Now turn to slide 14 and I'll discuss the commercial segment. Commercial revenue topped the $1 billion mark for the first time, improved 5% excluding divestitures with 2% coming from internal revenue. We experienced internal revenue growth in healthcare payer and commercial education. The 2% internal revenue growth was impacted by the continued softness in HR consulting and project work in systems integration.

Adjusted operating margins in the commercial segment were 11% in the fourth quarter, a 130 basis points improvement over the prior year. This improvement was primarily driven by operational efficiencies in our HR business. In addition, existing contracts in F&A continued to mature and provide good year-over-year EBIT growth.

Turn to slide 15 and let's discuss the government segment. Government revenue was $683 million for the quarter and represented 7% total growth excluding divestitures and 5% internal growth. The primary drivers of the internal growth were higher volumes in electronic payments and education solutions. Project work and volumes in transportation continue to be weak and had a negative impact on internal growth in this segment.

Operating margin in the government segment was 14.8% in the fourth quarter, a decline of 290 basis points from last year, the lower volumes of transportation along with the $6 million equipment write down negatively impacted margins in the quarter.

The federal non-compete, which expired in November of 2008 was contributing to the EBIT in the prior year and the first part of this year and was worth about 50 basis points of margin decline in the quarter. As Tom mentioned earlier, we are focused on successfully delivering on the Indiana contract and we added workforce, which negatively impacted margins as well and will continue to impact margins in the first half of fiscal 2010.

Turn to slide number 16 and we will discuss cash flow for the quarter and for the full year. We had a strong finish to the year with record free cash flow of $326 million in the fourth quarter or 19% of revenue. For the year, we finished at the top end of our stated range with $514 million of free cash or 8% of revenue.

CapEx and intangible additions increased this quarter as we expected to $100 million as we continued to spend on our new business wins. CapEx and intangible additions for the year ended at $363 million or 5.6% of revenue. With the record new business signings and strong pipeline, I expect CapEx and addition to intangibles to continue to increase going into fiscal 2010, but still remain in the 5.50% to 6.50% range.

Turn to slide 17; I will review some of the major balance sheet categories at June 30. With the strong cash flow finished in the year, our cash balance was $731 million at June 30. Accounts receivables decreased $79 million from March 31st and we had a six day improvement in DSOs.

Accrued compensation and payroll increased due to the achievement of our growth hurdles and the resulting accrual of management bonus. Current debt increased due to the reclassification our $250 million senior notes from long-term. These notes naturally mature in June 2010 and we expect to pay these off with cash on hand.

Please turn to slide 18, for an update on Project Complete. During the quarter, we increased our global production headcount by almost 600 taking the total headcount under this project to just over 3,600. In the quarter, we incurred $4 million of transition costs, which was below our expected range of $6 million to $8 million as we were continuing to see higher efficiency from our offshore workforce.

Offsetting the transition costs, we reduced our overall severance accrual by $3 million as we do not expect to payout the full severance we originally reported.

During the first quarter of fiscal 2010, we expect to incur $3 million to $5 million of transition costs as we wrap up Project Compete. Project Compete has been a successful program for us and we will achieve the full annually run rate savings of $40 million in the second quarter of fiscal 2010.

Before we go to Q&A, let me provide our goals for fiscal 2010 and give you some color on the first quarter.

Please turn to slide 19, for fiscal year 2010, we expect total revenue growth of approximately 10% with approximately half from acquisitions and half from internal sources. In order to support this internal revenue growth acceleration, we expect bookings will grow double-digit in fiscal 2010. If the economic cycle improves and has a positive impact on our underlying volumes and project work, we would expect internal revenue growth to be higher.

Turning to EPS; as you update your estimates for fiscal 2010, let me highlight a few items for your consideration. First, as I mentioned earlier, Project Compete will benefit margins by approximately 50 basis points in fiscal 2010.

Second, due to the severity of the economic environment in the fourth quarter of fiscal 2009, we assisted certain clients and provided out-of-cycle discounts for sole-source extensions or contractual considerations. This will negatively impact revenue and EPS in the short-term, but will tie up revenue and profit for the long-term.

Third, we will spend additional money on the Indiana Eligibility Contract in the first half of the year to ensure its success.

Fourth, the GM discount that Tom mentioned and that we provided that client will impact revenue and profit throughout fiscal 2010.

Lastly, because bookings exceeded our target by over $100 million in fiscal 2009, we will have higher incremental startup costs that will impact margins and earnings in the short-term. . With these factors in mind, we are expecting fiscal year 2010 EPS growth in the low to mid-teen percent range and operating margins similar to fiscal 2009.

Project Compete is benefiting the margins and has allowed us to find the out-of-cycle discounts, the GM discounts that I mentioned and the additional costs on the Indiana. Contract. Free cash-flow is expected to be between 6% and 8% of revenue. The effective tax rate for fiscal 2010 should be approximately 36%.

For the first quarter of 2010, we are expecting we are expecting total revenue growth of 4% to 6% with about half from acquisitions and half from internal sources. We anticipate out-of-cycle discounts and continued weakness in volumes, and project work to continue impacting internal revenue growth.

Margins are expected to be in the mid-10% range, in the first quarter due to the client discounts, increased costs related to the Indiana eligibility contract and incremental startup costs from higher bookings. Margin should increase throughout the year.

As you update your models, I recommend that you take into consideration the historical EPS decline from the fourth quarter to the first quarter. EPS for the first quarter is expected to be in the range of $0.92 to $0.95, consistent with prior year’s cash flow in the first quarter will be light, due to the payment of management bonuses.

That is all of the prepared comments we have at this time. Let's open it up for questions. We want to hear from as many callers as possible. So I am going to ask that you ask your initial question and then we will allow you one follow-up question. Operator, please begin the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question today comes from Ashwin Shirvaikar of Citigroup.

Ashwin Shirvaikar - Citigroup

My question is on your revenue target, you said half from acquisitions for the full year, which implies roughly $310 to $350 million of acquired revenue. So could you talk a little bit about what kind of acquisitions you have in mind? What is your pipeline looking like, things of that sort?

Lynn Blodgett

Thanks, Ashwin, this is Lynn. The type of acquisitions that we are looking for is as Tom Blodgett mentioned, we have three or four that are in Eastern Europe and one in Asia actually that we have been seriously considering. We are also looking at potential acquisitions in the government space that can help us in the area rounding out at our overall healthcare offering.

In the commercial space, we will continue to look for acquisitions that provide us with platforms we can leverage. We have done some nice acquisitions in our customer care area. That seems to be an area that we will continue to focus on.

Ashwin Shirvaikar - Citigroup

Okay and a separate question on Indiana. To get a worst case analysis of, if Indiana gets canceled, what is the financial impact to ACS?

Tom Burlin

Ashwin, this is Tom Burlin. It’s tough to quantify that because we can’t anticipate what course that may take. Obviously, we are deeply involved in the operations, today. We operate both the modernized and the as-is components of it. So, even a cancellation would take some type of unwinding. So, kind of tough to answer that.

What we are focused on obviously is its success where we have added several hundred people to that account, meet regularly with IBM and the state. Our focus right now is to be successful in this cap and to execute on it and continue to service Indiana.

Operator

Our next question comes from Julio Quinteros of Goldman Sachs.

Julio Quinteros - Goldman Sachs

I know there is a lot of moving parts to this to the story for fiscal '010 given everything that you guys just talked about. I guess to get to the point, I mean when can we expect to start to see the leverage in the business from the restructuring benefits and all of the things you guys have been working on for the last 12 months or so.

Obviously there is some incremental things to contemplate but at this point, can we expect to see a margin model here down the road that’s better than 11%, better than 12%? How do we think about that?

Lynn Blodgett

Yes, Julio let me see if I can maybe lay it out for you. Obviously, this economy has impacted us. We see opportunities to take a little bit of an offensive approach here and help some of our clients out and assist them as they are struggling. Those were the kind of the discounts, the out-of-cycle discounts that we talked about.

I clearly think there is a leverage point here. And I think what we took on with Project Compete is allowing us to be offensive here. I think if we hadn't done Project Compete we probably have to go along with defensive, but it really allowed us to play a little bit of offense here and help some of our clients out. Now, from time-to-time, things will be going to bump. Like on Indiana, we haven’t been perfect in that situation and we’re stepping up to the platen to make things right there and do what's right.

But clearly, I think there are leverage points here inside of our business. The operating margin should be down the first part of the year, but they should progress upwards throughout the year. We should exit the year above the 11% range and I'm very confident in that, when you look at the platforms we have in our business, the many platforms that we have, whether it's around loan processing or Medicaid or whatever the case maybe. We’ve got platforms that we can truly leverage.

Tom Burlin

I think, to Julio, the thing that everybody needs to look at is that the impact of the economy that we've said a couple of points last year, and then we'll see the full year impact of that this year. That revenue that has gone away is typically a higher margin revenue. So as we see the economy improve, not only do we see an uptick in revenue growth, but it should lead to margin expansion because that's some of the highest margin worth. So, as you do that incremental, it makes a big difference. Does that help?

Operator

Next in queue we have Bryan Keane with Credit Suisse.

Bryan Keane - Credit Suisse

Kevin, I was just hoping you could run through the math, looking at the bookings for the year. I think bookings are up 27% year-over-year, and I know you have done an exercise before we you talk about getting into internal revenue growth, so if we are at 5%, if you can walk us through how to think about that? How much is pricing taking off, renewals and so forth?

Kevin Kyser

I would say that things are not deferring too much from our revenue model that we laid out for you back in May of last year in terms of the price discounts. Let me quantify that, I exclude the out-of cycle discounts out of that 2% number.

I would say the things that are a little bit different are the economy where volumes typically are flat for us. Volumes around, whether it's transportation, project, or things of that nature, had probably a 2% impact on us in the fiscal year, and in the fourth quarter, actually had a 3% drag for us. So, I would say that's a little bit different in the revenue model.

In addition, this is something we have been mentioning over the last several quarters is the ramp rate, so, if you look at a $1 billion in fiscal bookings, we saw about 22% of revenue contribution in the year.

If you will recall, when we laid that out for you last year in May, we kind of thought it was 25 to 30. For the '09 bookings into 10, we are projecting about 55%, incremental contribution where we typically see 60 to 65. So a little bit lighter, but I would tell you that the first and second quarters can be characterized as slower than normal just because of the mix.

I would characterize the fourth quarter our record quarter as faster than our historical average, and I would characterize the fourth quarter that we just completed as right on average. So what we are seeing the bookings turn somewhat, but we are still not getting a full contribution as we would expect from '09, but just because how we started off the first half of the year.

Bryan Keane - Credit Suisse

You expect organic growth to accelerate through the year and margin to accelerate as some of the volumes come on from the ramp up of business? Is that correct?

Kevin Kyser

Yes. That is correct. Also, we've got some Indiana cost burdened in the first quarter and in the second quarter, we want to get that thing back on track, so that cost is going to be more heavily weighted towards the first half of the year. The GM discount will be spread pretty evenly across the year.

The startup costs will be more slanted towards the first part of the year on the margins, because that's when you see a quick pickup in your bookings, you got to spend a lot of money to bring those bookings on, and we, unlike our peers, have to expense all of that startup costs, where many of our peers, all of our peers hang up some of that transition cost. We are expensing it. So, it does have a negative impact on our margins.

Bryan Keane - Credit Suisse

The last question from me is, besides Indiana and GM, there were some other contracts that you had, some discounts to it. How many more of those?

Kevin Kyser

Right now a handful, and we got some more we got to execute on, but they are very selective. Obviously, we are not giving this discount for nothing, right? We are giving the discount to tie up the revenue over a longer term.

Operator

Our next question comes from George Price of Stifel Nicolaus.

George Price - Stifel Nicolaus

Thanks. About 10% over all growth and basically flattish margin. How are we getting the low to mid-teen EPS growth Kevin? What's kind of the drivers down below the operating line I guess?

Kevin Kyser

I think you should have probably a lower interest expense right? I mean the rates have come down, we should get a full year impact of that this year.

George Price - Stifel Nicolaus

Anything else in there?

Kevin Kyser

No, that's the biggest piece.

George Price - Stifel Nicolaus

Okay. Can you guys quantify deferred comp and what the impact was in the quarter?

Kevin Kyser

Yeah, I think it was about $8 million. So that was about 50 basis points. And it turned negative. Here's how that swings. As the market improves, it becomes a drag on operating margins as the overall market declines, it becomes a help on operating margins. And that's why we are spiking it up just so you can take it, just so you can spike it out and see -- obviously, if there is whatever, if there is an improvement above the line there is a bad guy below the line and they effectively offset this, so there is no impact on EPS.

So the $8 million without that 10% margins would have been 10.5% margins that’s consistent with the color that we gave at the end of the third quarter.

George Price - Stifel Nicolaus

I just wanted to get it on a pretax basis, it nets out?

Lynn Blodgett

Yeah. It’s the [zero] on a pre-tax basis. That’s right.

George Price - Stifel Nicolaus

Your deferred comp, your bonuses for performance and step-on actually causing is it to miss targets, is what I was getting at?

Lynn Blodgett

No. The deferred comp has nothing to do with our bonuses. So I probably wasn't clear about that. Deferred comp is when our employees deferred their compensation into a trust. There is earnings on that and there is earnings that we have to pay them and they effectively offset. So deferred comp is not associated with management bonus.

Operator

Next in queue, we have Jason Kupferberg with UBS.

Jason Kupferberg - UBS

Thanks a lot guys. So a question on fiscal '10 in terms of what you provided for in your guidance. Are you expecting any material change in the broader pricing environment versus what you discussed historically and have you built any additional cushion into the margin outlook in fiscal '10? In case you need to do any additional off-the-cycle discounting above and beyond what you have already described there?

Lynn Blodgett

Jason this Lynn. First of all in terms of overall pricing environment, we haven't seen and I heard Kevin mention in his part of the prepared comments, that is staying pretty true to what we've seen over the last three or four years.

The exception are these unusual things we have already spiked out. We have anticipated in the number that we've given you for FY10, that we will have some additional discounts that we'll give. We think that we've got most of them that we can see right now dealt with, but we have baked in some portion of the additional discounts.

Jason Kupferberg - UBS

Okay, that's good. My follow-up is on Indiana. Is there any material amount of assets related to this contract on your balance sheet that could be at risk of impairment?

Lynn Blodgett

For us, it's not a development project. IBM is doing a lot for the development, most of the development. For us, it's building in our back office processes and things of that nature. So we don't have a big CapEx requirement with this. We may have some leasehold improvements. We might have a couple of leases there but nothing of a major amount.

Operator

Next in queue, we have [Bob Ansari] with William Blair & Company.

Bob Ansari - William Blair & Company

A couple of questions, just one on pricing again, you said it’s been a handful of customers that you sort of done this out- of-cycle discount. What's the risk that you get more customers back to you or, how far through that are you?

Tom Burlin

This is Tom, I'll take a shot on the government side and ask Tom comment on the commercial side. Most of these clients, and particularly in government, there are certain segments of our market. The IP infrastructure market in particular has been hard hit, especially in this case. We have a concentration of projects on the west coast where their economy has been damaged probably even more severely than the national average.

So on those situations and based on our long-term relationships with those various counties. They asked us and in some cases we proactively sort them out and really, I think it's the one as Lynn said its right thing to do. I think we will be in as proactive, as our clients are being active to us. Normally I think over there it is not unusual. I think we have put in a little bit more for these in the future.

But I don't think we are going to see a rush of our clients through the door to do this. This is something that you would have to have a pretty stable and long-term relationship with us and very trusting relationship I think.

Tom Blodgett

This is Tom Blodgett, let me just add. We are fortunate that we are in such a healthy financial situation to be able to provide limited and selective assistance to our clients.

I think it’s important to recognize that when we do this, we end up with a much stronger relationship, whether that's longer-term or more favorable conditions.

So even in the event that we did have additional clients that approached us with a specific need, we would structure a deal that was good for them but also very good for ACS. So, we are not worried about being overrun by these kinds of requests.

Bob Ansari - William Blair & Company

Okay. And I guess a follow-up on the sales add for next year for 100. I looked at the IT bookings, and they were better kind of than they had been in the prior quarters as a percentage of total bookings, and one of the focus areas was to add sales resources to kind of grow the IT business.

Is that the focus for the 100 adds next year end? So, how should we think of IT growth versus BPO growth coming into 2010?

Tom Blodgett

Let me take a shot that and then maybe Burlin can from the government side. We are continually looking, because we are in multiple markets as you know, and we take a look at those, it seem to be providing the most potential. At the current time, clearly international, where we've made some investment and acquisitions is an area where we will invest in sales to help supplement those successes.

Also, I mentioned in the area of outbound fulfillment, a new technology that is really dynamic, and we've already got $250 of annual recurring revenue in our pipeline. So, we'll invest in sales there.

In the commercial loan business where we are seeing a great opportunity, we'll make investments. So, I think we make those adjustments as we go, and as we see where the opportunities are we'll continue to invest.

Tom Burlin

Sure. I think I would just add to that in the government market. We have a very diverse market there. If I had to focus on the areas where we were continuing to add resources transportation is offering a lot of opportunity in the enforcement business that we are seeing legislation move. We are seeing opportunities to drive revenue in various congestion schemes and other parking schemes.

As cities are stressed for revenue, they are turning to these kinds of revenue generating, so we are ramping up our transportation sales force both domestically and internationally.

Then last, we have got a great opportunity in the federal space to extend both our BPO and ITO markets there. So, we've added talent into the federal space to start driving sales there.

Operator

Our next question comes from James Friedman with Susquehanna.

James Friedman - Susquehanna

Kevin, after the third quarter conference call, I thought you had reduced your free cash flow assumptions for quarter and for the year. It was coming in at about the low end of the 6% target, which would have given you $200 million maybe coming in at 326. I'm trying to figure out what the overage was due to?

Kevin Kyser

I guess I under estimated the team's ability to collect cash just to be honest with you. I'll say I was surprised as well as you about that. As we were getting into the quarter, I was like, this is too good to be true, but I'll tell you, we applied a lot of pressure to it. We didn't like the way our third quarter performance was, and we just put more focus on it.

We reduced DSOs six days, which is a pretty major improvement. I don't think we’ve ever seen that type of improvement.

Obviously, our largest quarter of free cash flow, and we had our largest quarter of CapEx in addition to intangibles. So, in my mind it was a great quarter end of the quarter, and put us in a good position from a cash balance perspective.

The only thing that we have to do is, especially these days in this economy, we need to stay on top of our AR. So, everybody is mindful of that, and everybody is being real vigilant there, and it's paying off.

Tom Burlin

If I can just add to that. Several accounts, where we were in the red, we went and improved our performance, and when you perform, clients pay. So, kudos to the teams out there that focused on performance, we were able to collect.

James Friedman - Susquehanna

If my analytical skills are failing me, would you have any estimate of what the day reduction in DSO yields in free cash?

Kevin Kyser

I used to have the number. Lets see. Isn't it like $10 million a day?

James Friedman - Susquehanna

Yes, sounds right. Then a housekeeping detail. You mentioned the equipment write down, that’s a little obscure, but if you could allude to what that is and how that impacted the numbers?

Kevin Kyser

Sure. We had some equipment that was sitting on the books, and we needed to catch up depreciation on it. The equipment had been deployed, it's about $6 million, and it ran through depreciation and amortization. A one time event, and then that's what put some margin pressure on the government segment.

Operator

Our next question comes from Jim Kissane of Merrill Lynch.

Jim Kissane - Merrill Lynch

Thanks and great job on filings and the cash flow. Do you have a sense of the margin profile on the new business that you're putting up right now, and maybe also on the acquisitions that you are looking at. To get my second question in, just given the tough environment out there, do you think you need to expand and possibly extend Project Compete?

Lynn Blodgett

I think that I'll go backwards. I think in terms of Project Compete, as we pointed out earlier; we've spent a lot of time and money in building the infrastructure, the recruiting infrastructure, the training infrastructure to deal with the mid-tier type of employee that we are moving. As that's now established, we'll don’t have to incur that cost again.

So we are definitely going to continue to move mid-tier and lower-tier work to this low cost area. So in a way, yes, we will be continuing Project Complete. We are not going to cull it out, because we think we have absorbed sort of those startup costs, if I could say it that way. Now in terms of margin on the work, I'll ask Tom Blodgett to answer that.

Tom Blodgett

I think that in terms of the margins on our traditional work, we don't see any significant changes. Let me address your questions about margins on acquisitions. We have had a great track record. It's part of our culture. But we know how to do acquisitions, we know how to do the right ones, we have a discipline and if you take a look at the acquisitions that we accomplished, that generated new revenue for us in FY '09, the margins were solid, in line with our corporate margins if not a little bit higher.

So, one of the reasons you are seeing a continued emphasis on acquisitions and we are giving it some more focus is, because we believe acquisitions are good. They are good for our revenues, they are good our expanding market and they are good for e-bid.

Jim Kissane - Merrill Lynch

I guess as your valuations come in, I guess somewhat better than the past, going back to the '07 timeframe?

Tom Blodgett

I think it would be fair to say that acquisition is one of our core competencies. We know how to do it and I think we did better. I think when we do an acquisition, we know how to help them get better. First of all we buy successful companies and then without breaking them, we add something that helps them get better, including improved margins.

Operator

Our next question comes from Tien-Tsin Huang with JP Morgan.

Tien-Tsin Huang - JP Morgan

Congrats on the bookings. I had a follow-on question on one of Jim questions. The $40 million in savings from Project Compete, does Indiana and the out-of-cycle discount, I think you call it. Does that eat into the savings to the point that you are sacrificing some your investments and innovation or sales in order to get to that flat margin target for fiscal 2010?

Lynn Blodgett

Great question and the answer is no. We have run through the numbers pretty carefully internally and we are certainly as I mentioned about sales, we are investing. We invested to bring on a 100 people, we are going to bring on 100 more and in terms of innovation, we have been able to start up these projects that we talked about that have been equal to about another third of the savings. So, it's not eating into it.

Tien-Tsin Huang - JP Morgan

Okay. The mix is the same. Good to know. My follow up is just on the transportation side. Any signs of the volumes getting better at all and how much of a drag to '09 revenues did you experience from the weaker volumes in transportation?

Lynn Blodgett

I would have to say that I don’t see the volumes improving right now. I think they are staying, we have apparently seen the bottom. They are flattened out now for a couple of quarters. But I don't see that picking up and I think we probably saw a about a one-point drag on growth that resulted in those volumes.

Tien-Tsin Huang - JP Morgan

That’s one point to overall growth. Right?

Lynn Blodgett

Yes, to the company. Yes.

Operator

I think we have David Grossman with Thomas Weisel.

David Grossman - Thomas Weisel Partners

In terms of the margin profiles for the year, I think, Kevin, you talked about 10.5% for the year and exiting at 11.

Should we assume that given the front end cost of the bookings in the state of Indiana that you kind of start in the 10% range and then you kind of radically increase up to 11% exiting the year?

Kevin Kyser

No, actually, David, I said fiscal year '10 operating margins would be similar to fiscal year '09. I think fiscal year '09 in the 10%, 9% - 11% range, somewhere there and we said they would be similar to those. So we would expect to open the year about 10.5%.

Correctly as earlier stated as you put it with Indiana really hitting us hard in the first quarter and then if that kind of lessens the startup costs for this surge in bookings is overcome, then our margin should pick up throughout the year. And we should actually exit the year above 11%.

So again, when we were contemplating the increase in the operating margins is going into fiscal ’10. We didn't really have a good sense that obviously that General Motors was going to file bankruptcy and we needed to do something to keep them as a client.

We didn't have this out-of-cycle discounts factored in. That's one of the things. It's a long-term decision to keep those clients around and help them out during this time. And then obviously, Indiana, we didn't have the idea that it would be this impact our margins that much.

So again, we are thinking fiscal ‘10 margins are going to look a lot like fiscal '09 and we should improve the margins throughout the year.

David Grossman - Thomas Weisel Partners

So again your benchmark for '09 is 10.9% or 11%?

Kevin Kyser

Yeah. I think its about 10.9 once you kind of back out the deferred comp and things like that, 10.9%.

Operator

Next in queue we have Karl Keirstead with Kaufman Brothers.

[Suji De Silva] - Kaufman Brothers

Thank you for taking my question. This is [Suji De Silva]. I'm filling in for Karl. First question is around bookings. Could you just give us little more color on what specifics are in those offering or strength and weakness there and looking forward to fiscal '10, in what position do you see strength throughout?

Tom Blodgett

Sure. Let me talk to it from the commercial side. We're seeing strong bookings especially in the fourth quarter in our communication and consumer goods. So even though there is a movement of wireless activity, overall, the bookings are strong in that area as we continue to expand our market share.

Also, in our Healthcare Payer and other areas as we have begun to market our Outbound Performance solution that I talked about, we've seen some good bookings and we see a strong pipeline. So I think that will continue to be strong.

Then in the commercial consumer loan business, student lending business, we're seeing a consolidation and we're able to take advantage of that. So, I think again, overall, bookings are very strong and especially in those specific areas.

[Suji De Silva] - Kaufman Brothers

Okay.

Tom Burlin

I would add to that in the government space, Kevin mentioned that we added Virginia. We are pleased and proud they added Virginia to our portfolio of Medicaid clients. I talked about the opportunities we see going forward there. So we expect more of that. We had a great win in our international public transit business.

We want to be in Lima, Peru, to do a build-to-operate on the transit system, and I point that out now only because it's a 15-year contract that runs a little over $12 million a year, which are great into the revenue stream and stay there for a long time.

The other thing is, it's a manifestation of our strategy, which was to take our public transit business from largely a project-based business of installing ticketing devices and gates and those sort of things to adding the back end annuity business to it, and getting in to the build-to-operate model. We see more of those opportunities coming.

[Suji De Silva] - Kaufman Brothers

Okay. Any pockets of weakness in the quarter?

Tom Burlin

I just think our regular. One of the things that has been offset here, obviously, is the project works, so our nonrecurring revenue in the bookings and the bookings in those areas have retracted tracked on project work, it's going down.

[Suji De Silva] - Kaufman Brothers

Okay. Then one quick one on project. It sounds like you are going to continue this a little bit more, but not maybe call it out, both for this quarter and it looks like September slower than expected. Should we expect it to continue at this lower level or could it ramp up at all going forward?

Tom Blodgett

Since a high percentage of this activity affects our commercial business, let me comment. I think one of the advantages that we gain through the exercising and the activity that we went through in FY09 with Project Compete was we developed a process and systems and infrastructure to be able to effectively move positions offshore

So, for example, recruiting in these outlying areas has been built up. So, as we look forward, I think that we are going to continue at the same pace, but without all the same costs.

So, I think it probably will become more business as usual as we continue to move. We'll also be focusing in FY10 on maybe moving up the food chain a little bit, and looking at mid-tier people, middle management people that will have a greater impact on our cost model.

[Suji De Silva] - Kaufman Brothers

Okay. So you are targeting 4,200 heads for September I believe. Should it be about that pace we've seen over the last four quarters if are we continue this?

Tom Blodgett

I think the numbers might change because, again, we are going to change the demographics of the targeted person.

Operator

The last question for today comes from Eric Boyer with Wells Fargo Securities.

Eric Boyer - Wells Fargo Securities

Hi, thanks. Just a follow-up to an earlier question. On the volume declines, the 3% negative impact to revenue growth in the fourth quarter. I think you said transportation was 1% of that decline, that's now at least stable. Have the other areas that contributed to the other 2% of revenue decline bottomed out yet?

Kevin Kyser

The other areas would be around our consulting business, whether it be in HR. and obviously you can see what the other public competitors are doing in that space, but they are probably declining somewhere in the mid-single digits to double digits, and clearly, we will write in that range. So, has that bottomed out? I hope so, but I don't see it coming back any time soon.

Then, I think the other big area would be project work in our IT business, systems integration type work that I hope has bottomed out. However, it's hard for me to call the bottom on some off these, but that as well as healthcare consulting.

So, that’s kind of flavor for what some of the others places you can look to kind of triangulate that. We are hopeful that the drag won’t increase although we will see a incremental drag going into the first quarter from these out-of-cycle discounts that we have.

Eric Boyer - Wells Fargo Securities

Okay. Thanks. Then just on customer care business outside of Sprint, can you just talk to volumes and the sales cycles you are seeing there?

Tom Blodgett

Sure, because I mentioned, fortunately, we have a pretty good market share here, and we deal with most of the major wireless providers. It seems at least to some extent when one is seeing churn, an another one is picking up those clients.

So, at the same time, we’re seeing struggling with one, we’re seeing additions to another, and overall we’re optimistic about the growth this area. In '09, we grew greater than our corporate average and we expect that to continue.

Eric Boyer - Wells Fargo Securities

Thank a lot.

Lynn Blodgett

Okay. Thanks very much. We are going to wrap things up. I just wanted to first of all thank all of you for participating in the call today.

Just in summary, I think we had what I would consider a great year in 2009. I mean it was a year that presented an awful lot of challenge and our people really stepped up, and I think did a great job.

We made some investments as we pointed out, some investment with some of our margins, but it's the right thing to do. We had made one set of negotiations with some client where we gave up $12 million, and ended up picking up $260 million in additional contract values. These are deals that we think are the right things to do.

We really expect in 2010 to have strong growth, 10% and roughly half coming from internal and half from acquisition. We think our EPS growth is going to be strong. We expect to continue to have very strong bookings, and we think all of that will add up to a very strong year in 2010.

So I wanted to thank all of our people and thank each of you for participating today. Thank you very much.

Operator

This concludes today's conference, you may disconnect at this time.

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Comments

[Tom Armistead:]

CEO projects 10% revenue growth. They are reducing costs by moving jobs to low cost areas, something that usually works in computer services. They have added 100 sales staff and plan to add 100 more, funding the expense with savings from moving jobs to low cost areas. New bookings for the two most recent quarters have been excellent, validating the sales strategy.

Putting this together with the article by Paul Price seekingalpha.com/artic... I plan to go long within the next few days.

Aug 10 09:19 AM