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MAXIMUS Inc. (NYSE:MMS)

Q4 2007 Earnings Call

November 15, 2007, 08:30 am ET

Executives

Lisa Miles - Director, Investor Relations

David Walker - Chief Financial Officer

Rich Montoni - President and Chief Executive Officer

Analysts

Anurag Rana - KeyBanc Capital Markets

Matthew McKay - Jefferies and Company

Charles Strauzer - CJS Securities

Jason Kupferberg - UBS

Shlomo Rosenbaum - Stifel Nicolaus

Rich Glass - Morgan Stanley

Jerry Weintraub - Weintraub Capital

Steve Balog - Cedar Creek Management

Operator

Ladies and gentlemen, welcome to MAXIMUS Fourth Quarter Earnings Call. During this session, all lines will be muted until the question-and-answer portion of the call. (Operator Instructions)

At this time, I would like to turn the call over to Lisa Miles, Director of Investor Relations.

Lisa Miles

Good morning. And thank you for joining us on today's conference call. If you wish to follow along, we’ve posted a presentation on our website under the investor relations page.

On the call today is Rich Montoni, Chief Executive Officer and David Walker, Chief Financial Officer. Following our prepared comments, we will open the call up for Q&A.

Before I begin, I would like to remind everyone that a number of statements being made today will be forward-looking in nature. Please remember that such statements are only predictions and actual events or results may differ materially as a result of risks we face including those discuss in Exhibit 99.1 of our SEC filings.

We encourage you to review the summary of these risks in our most recent 10-Q filed with the SEC. The company does not assume any obligation to revise or update these forward-looking statements to reflect subsequent events or circumstances.

And with that, I'll turn the call over to David.

David Walker

Thank you, Lisa. Good morning. Today we're reporting fourth quarter record revenue and earnings per share. In addition, we have concluded the strategic review process and are launching a $150 million accelerated share repurchase program, which is immediately accretive and demonstrates our confidence in the future success of the company. Rich will talk about this in greater detail later in the call.

Let's jump right in to the details of the financial results for the fourth quarter. Today, MAXIMUS reported fourth quarter revenue totaling $201.9 million, a 17.5% increase over the same period last year.

The company reported net income in the fourth quarter of $14.2 million or $0.63 per diluted share. This includes a $2.5 million legal expense primarily related to the Accenture arbitration or $0.06 per diluted share, excluding the legal charge earnings per share with $0.69 per share.

Fourth quarter operating margin was solid at 10.8%. This is consistent with the double-digit operating margin delivered last quarter. Excluding the unusual legal and settlement cost.

Earlier in the year, we talked about the achievability of a 10% margin. The management team remains committed to continuing this strong financial delivery. We will see quarterly fluctuations related to timing or seasonality, but this target remains achievable.

Other highlights in the quarter include, cash and marketable securities of $196.7 million at September 30, 2007 and as expected DSOs were slightly higher than last quarter but remained respectable at 80 days.

Moving to results for the full fiscal year. For the full year, fiscal 2007 revenue increased 5.4% to $738.6 million, compared to $700.9 million last year. Excluding revenue from the divested businesses for fiscal 2006 year-over-year organic growth was 6.8%.

For fiscal 2007, MAXIMUS reported a GAAP loss of $8.3 million or $0.38 per share. This compares to fiscal 2006 net income of $2.5 million and diluted EPS of $0.11 per share.

In order to set the platform for next year, let me walk you through results normalized for certain items. On a full year GAAP basis, income before taxes was $3.1 million, as a result of large amount included in legal and settlement expense that is not tax deductible, we reported an after-tax loss of $0.38 per share.

This after-tax loss was driven by three main items including losses on the terminated Texas subcontract totaling $25.2 million or $0.67 a share, a $4.2 million loss or $0.11 a share related to the Ontario project and legal and settlement expenses of $44.6 million or $1.61 a share.

Excluding these items, total company income before tax for the full fiscal year would have been $77.1 million or a pro forma diluted earnings per share of $2.01.

Overall, financial results for the quarter and the year were consistent with the expectations we outlined in our call in August. The fourth quarter is traditionally our strongest quarter due to seasonality in certain business lines and benefits derived in the quarter from the timing of indirect expenditures.

While our fourth quarter results were strong we expect our first quarter to be sequentially lower due to seasonal trends and several large projects in operations and consulting, which required planned start-up costs in the first half of the year.

Let's jump in to the details by segment, starting with the operations segment, which posted another solid quarter. Revenue for the operation segment increased 23% to $141.9 million, compared to the same period last year.

For the full fiscal year, the operation segment delivered revenue totaling $503.6 million, a 6.9% increase, compared to the same period last year. Excluding revenue from divested businesses in fiscal 2006, operation segment revenue grew 9%.

The operation segment recorded fourth quarter operating income of $23.5 million or an operating margin of 16.6%, compared to a loss of $2.9 million reported in the same period last year.

For the full fiscal year, the segment had operating income of $39.1 million or an operating margin of 7.8%. Excluding the losses related to the now-terminated Texas subcontract, the segments pro forma operating margin was approximately 13.1%.

The new contract in Texas provides significant improvement in second half of fiscal 2007, the segment also benefited from strong organic growth. The segment continues to win new work, which will be a major source of top-line growth in fiscal year '08.

As previously discussed planned start-up costs required for certain new contracts will reduce sequential operating income in the first half of fiscal 2008.

Consulting segment revenue was $22.5 million for the fourth quarter with operating income of $554,000 and a 2.5% margin. Full year revenue for the segment totaled $93.7 million with an operating income of $6.4 million and a margin of 6.9%. This compares to last year's revenue of $102.8 million and an operating margin of 14.1%.

The reductions in revenue and margin compared to last year are primarily related to a couple of projects that were substantial contributors in fiscal 2006. Also, hindering revenue growth and margin expansion is the transition away from contingent fee terms for our federal healthcare practices.

As we make this shift, we're refreshing the backlog with new work in Medicaid program integrity such as our statewide fraud, waste and abuse contract in New York and our Payment Error Rate Measurement or PERM contracts in Colorado, North Dakota and Florida.

Some of these new growth areas require up-front cost and will soften earnings in the first half of the year. Moving on to the systems segment, systems revenue in the fourth fiscal quarter grew to $37.4 million, compared to $30 million reported for the same period last year.

For the full year, revenue increased 11% to $141.3 million compared to fiscal 2006. Year-over-year revenue growth was driven primarily by new contracts in the ERP division, including statewide implementations in Tennessee and Delaware.

The segment was slightly profitable in the fourth quarter earning $466,000. For the full year the segment lost $4.7 million, much of the full-year loss resulted from ongoing software investments as well as charges taken during the year relate to efforts to resolve legacy contracts.

Moving to corporate expense items and core responding profit margins. MAXIMUS achieved a solid 10.8% operating margin in the fourth quarter, SG&A was favorably impacted by timing of indirect cost largely between the third and fourth quarter as well as cost management actions.

As I stated earlier, Q1 is traditionally our softest quarter, the SG&A benefit recognized this quarter coupled with seasonality and planned start-up expenditures related to New York firm operations will result in a lower sequential operating margin in the first quarter of 2008.

Moving on to balance sheet and cash flow items. Our accounts receivable for the totaled $175.2 million in addition, we also have $1.9 million in long-term accounts receivable, which are classified within other assets on the balance sheet, which brings me to DSOs.

Over the last 18 months, Rich and I have talked a lot about management actions such as requiring or stringent business terms, enhancing our contracts and compliance team and increasing program training. The results are clearly showing in our DSOs with fourth quarter levels at 80 days.

As I stated last quarter, we have laid out a more aggressive DSO range of 75 to 85 days, which reflects our ongoing focus on tightly manage in cash and receivables throughout all levels of the organization.

As expected, cash flow was negative in the quarter principally resulting from a cash outlay of $30.5 million related to the previously disclosed settle inspect the District of Columbia.

Excluding the DC payment, cash from operations in the fourth quarter was $22.3 million with free cash flow of $14.9 million. For fiscal 2007, cash from operations totaled $51.2 million with free cash flow of $33.4 million, adjusting for the DC settlement, cash flow from operations was $81.7 million and free cash flow would have been $63.9 million.

Our efforts to focus on balance sheet optimization as well as our accelerated share repurchase program demonstrate our commitment to manage working capital an enhancing shareholder value.

And with that, I'll turn the call over to Rich.

Rich Montoni

Thanks, David and good morning, everyone. I want to kick off this morning with some late great breaking news. Last night MAXIMUS received notification from the California Department of Healthcare Services of their intent to award the California Healthcare options rebid to MAXIMUS. This is truly fantastic news and I'm very proud of our team's collective effort to solidify this win. Thanks.

We are very pleased to continue our partnership with the state in support of their efforts surrounding this critical program. The base contract is expected to run for 57 months base with additional options for three years beyond that. We hope to finalize the contract in the next couple of weeks, but we're not at liberty to provide specific contract details at that time.

Okay. Let's jump in to our other announcements from yesterday. As noted in the press release, we have recently concluded our strategic review process in conjunction with UBS our financial advisor. This is a thorough, extensive process and we considered all options.

Dynamics in the capital markets weighed in the process and while we received much interest from outside parties on a variety of fronts, we are not immune to those broader market conditions. There's been substantial tightening of availability of capital, which impacted the ability of buyers to strike acceptable terms and conditions.

As a result, we have concluded that continuing as an independent public company coupled with meaningful capitalization efficiency is the best option in the best interests of our shareholders. We're not going to talk specifically to how the process unfolded, but I would remind you that the Board initiated this process. And I can assure that the scope and the intensity of the process was very significant.

MAXIMUS has a great portfolio of assets and people and I am excited and dedicated to leading the company forward. As part of our strategy, we have three key initiatives underway.

First, we're addressing our capitalization head on. We have launched an accelerated share repurchase program, which will commence at the end of business today, this is additive to our current Board authorization program.

At September 30th, we had approximately $40 million remaining under that program and in addition we're seeking to secure a $50 to $75 million line of credit in the coming weeks.

Second, we are narrowing and concentrating our focus on core markets to fuel growth. Then concludes potential investments, partnerships and tuck-in acquisitions. Third, we may pursue selected divestitures of businesses that may not fit within our primary markets, but could be very attractive to those more focused in those markets.

Our program calls for the accelerated repurchase of shares in the amount of $150 million. We will purchase these shares effective today from UBS, which will then borrow the shares. Over the next nine months UBS will purchase an equivalent number of shares in the open market to cover the shares it borrowed.

At the end of that period, MAXIMUS' initiative purchase price will be adjusted up or down based upon the volume-weighted average price of the stock or what is reviewed to view out during this period.

The price adjustment may be settled in cash or shares of stock and we expect this program will be accretive by approximately $0.15 to $0.20 per diluted share in fiscal 2008 and it provides the company with the flexibility necessary to continue to invest and grow the business.

This is the first window of opportunity we have had in at least the last 12 months to pursue a meaningful share repurchase. Clearly, the outstanding arbitration in the unassuming strategic review process factored into the timing of share repurchases.

To refresh your memory on the Texas time line, we had entered into arbitration in December of 2006, terminated our subcontract agreement in February of 2007 and then entered into contracts directly with the state at the end of March.

Shortly thereafter, we began laying the groundwork for the strategic review process, which was announced in July. This ASR program will improve the efficiency of our capital structure, lower the cost of capital, increase earnings per share and better position MAXIMUS for the future.

In addition to the ASR, MAXIMUS still has approximately $40 million available under its previous board-authorized repurchase program, this additional authorization remains available us to for share repurchases upon the completion of the ASR program.

After the $150 million use of cash for the ASR program, cash at September 30th on a pro forma basis would have been approximately $47 million. I also note that, while we may have quarterly fluctuations our business has and is expected to generate substantial cash from operations.

However, we also intent that our moving to put in place an additional $50 to $75 million line of credit to be available for future business needs.

In addition to our capitalization program announced today, we're taking positive steps forward as we better define our longer-term vision for growth. We have a clear understanding of what businesses us with -- what businesses provide us with the most value and best fit with our strategic growth objectives.

The review process facilitated a rigorous assessment of our individual businesses and confirmed our view that refined focus is the most appropriate path as an independent company.

We’ve concluded that returns are highest when a business such as ours focuses on its core competences and this we defined to be holding a number one or number two position in the market.

Having the ability to meet clients' needs and cost effective and efficient solutions, significant growth potential in those markets then a business can drive highest returns to its shareholders. And for us that lands us squarely within our traditional BPO service offerings and certainly in government health and human services programs.

As we look at the overall portfolio, we see business has laid out across three major categories, one, those business lines that are clearly core to achieving our longer-term objectives.

Two, those businesses on the periphery of these areas that for example may share common customer bases these still make sense to have in the mix. These are typically practice areas that remain accretive and offer certain synergies.

And three, certain business lines that may not be a clear fit in our organization. And in support of this effort to focus on our operations we are actively working on alternatives for certain assets.

We successfully benefited from the divestiture of two businesses in the beginning of fiscal 2007, which were not consistent with our longer-term objectives and we're prepared to take additional action in this area.

With a wrap-up of fiscal 2007 and the completion of the strategic review process, we are entering fiscal 2008 with a much-improved business.

We spent the last 18 months placing more emphasis on quality and risk management, which has resulted in the elimination of several legacy issues, more favorable contract terms on new awards, solid cash flow, lower DSOs, improving operating margins and accelerating topline growth.

We successfully turned the Texas projects into profitable contributors, which speaks volumes about the company's solid brand reputation and perhaps more importantly, our extensive experience in providing cost-effective and efficient business process outsourcing in complex government-funded programs such as Medicaid and SCHIP.

In fiscal 2007, we resolved the majority of the legal overhangs including matters such as Ontario, the District of Columbia, Department Of Justice Settlement and we restructured our business relationships with Emergis, which turned this into a partnership.

In the coming year, we will build on the progress made in fiscal 2007 to further optimize operations in fuel growth as we emphasize those businesses which offer us more predictable reoccurring streams of revenue and sustainable levels of income.

We are investing in the necessary -- we are investing the necessary dollars to succeed in these core areas where we see potential. For example, we are investing in a productization effort around both our enrollment broker and eligibility work, primarily for our Medicaid, enrollment broker and SCHIP operations.

This is where a plug-and-play technical solution is needed in support of our BPO services. Productization is key to maintaining competitive leg up as we seek to serve a wide range of states.

Now, we're launching this new technology platform in Indiana where we just signed a new two-year $50 million base contract to provide enrollment broker services for several state Medicaid programs.

The project provides the option to extend operations for an additional two years, which would bring the total award to $26 million over four years. This is an extremely strategic award for MAXIMUS, with universal healthcare being a key component of the overall program.

In addition to serving as enrollment broker for the state's primary Medicaid program, MAXIMUS will also provide services for the state's new healthy Indiana program, or what is referred to as HIP.

The state sponsored HIP program is the principal platform for providing affordable health insurance for uninsured low-income adults. This then further solidifies our position as the nation's leading provider of Medicaid enrollment broker services. More importantly, it demonstrates our leadership in vision in assisting states with the rollout of universal healthcare.

MAXIMUS remains at the forefront of the opportunity surrounding universal healthcare initiatives. At this juncture, we believe that most state initiatives will continue to be complementary to their current SCHIP and Medicaid programs.

Let's move on to backlog, new awards and total sales pipeline, all of which I believe confirm and support our forecasted revenue growth for fiscal '08. At September 30th, 2007, backlog totaled $1.3 billion compared to $1.5 billion reported last year.

This reflects certain larger jobs moving in to rebid or option phases. You may recall that option-year revenue is added to backlog when the option is formally awarded by the client.

In fiscal 2008, we have a few large programs where the current base contract will run out in fiscal '08 and is then followed by an exercisable option period. Signed awards of September 30, 2007, totaled $569 million which compares to $717 million reported same period last year.

This is offset by an increase in awarded in unsigned at September 30th, 2007, to $310 million from $103 million at September 30th, 2006. For fiscal 2007, approximately 70% of new-signed awards are in the operations segment, which reflect a targeted effort on the growing health and human services markets.

Now, let's take a moment to focus on the sales pipeline. As of November 8th, 2007, our overall sales pipeline is at record levels and total $1.7 billion. This compares to $1.1 billion at September 30th, 2006.

As a reminder, the company reported pipeline. It only includes those opportunities where an RFP is expected to be released in the next six months. So the opportunity has to be on the horizon for it to be included.

Of the $1.7 billion pipeline, approximately 60% is attributable to opportunities in the operations segment. In addition, the majority of the overall pipeline is coming from new opportunities that are less than $50 million in value.

This reflects our continued efforts of securing new work that is less volume driven and centered around our core competencies in the area of operation management and BPO outsourcing.

Moving on to rebids, as I noted earlier, late last night we received a notice of intent to award the California Health Care Options contract to MAXIMUS, which was our final rebid -- which was our final rebid in 2007.

We'll be working to finalize that award in the coming weeks. As we look out to fiscal 2008, we have 13 rebids. These are 13 rebids expected during the year for a total contract value of approximately $280 million. Since most of this year's rebids are in the second half of the year, the impact to revenue for fiscal 2008 is approximately only $4 million.

Shifting over to option year exercises, we have 27 expected options in fiscal '08. These have a collective value of $223 million total contract value of which we expect revenue of approximately $47 million in fiscal 2008.

Moving on to guidance, we expect revenue for fiscal 2008 to be in the range of $850 million to $880 million with a diluted EPS of $2.40 to $2.65. Now this EPS range, this is before the expected accretion of $0.15 to $0.20 per diluted share from the $150 million ASR program, so that you should know that's before the accretion.

The company estimates approximately 83% or forecasted fiscal 2008 revenue is presently in the form of backlog. This metric is a very strong indicator in support of our forecasted revenue for fiscal 2008.

As we talked about the last few quarter fiscal 2008 topline growth is expected to be fueled by new work in the operations segment. We expect that consulting will return to more normalize financial performance in fiscal '08 with expected 10% growth.

On the systems side we're looking for revenue growth in the range of 10% to 15% with a much-improved operating income compared to fiscal 2007.

As David talked about earlier the first quarter is expected to be sequentially lower as a result of the planned investments related to new work and seasonality in the fourth quarter that does not repeat in Q1.

And now before I open it up to Q&A, I want to re-enforce commitment of this management team and the board of directors to creating and delivering long-term shareholder value.

We undertook this strategic review process to assess MAXIMUS's future in different scenarios and we emerged with a focused strategy and clear sense of next steps.

The repurchase plan provided us a more efficient capital structure and it is meant to send a message to our shareholders that we are intent on delivering value in this case immediately.

I believe these actions underscore our confidence and our prospects as an independent company and our outlook and current pipeline of new opportunities for the current year speaks to the anticipated growth in our operations as we shed legacy issues and focus our business on profitable work within our more narrowly defined scope of operations.

I look forward to updating you throughout the year on our progress. We also will be reaching out to the investment community throughout the year to broaden our audience and raise awareness and understanding of the growth opportunities within MAXIMUS.

I thank you for your interest this morning and now let's open the call-up to questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from the line of Anurag Rana. Please go ahead.

Anurag Rana - KeyBanc Capital Markets

Hi. Good morning, everyone. Could you please give us some information on the offers that you received on the sale of the company and whether they were above the current stock price and if the board was not interested in the price that was offered?

Rich Montoni

Anurag, this is Rich. Good morning. I'm not going to get into extensive details about the buyers' specific offers but I would say this, just let me talk about the process and give you a little bit of color.

It is clear that when we started this process in June, the capital markets were totally different. I would say who would have guessed that both the equity and the debt markets would have experienced the dynamics that they have gone through since that point in time.

And we all know there's been an incredible drop in the volume of M&A activity in the marketplace and as David said, that not a day has passed where transaction has not been tabled.

We did receive very strong indications at first nearly 70 indications of interest. We did received written and verbal offers but these started to dissipate as the market dissipated, just as you have seen about the transactions. So those who had strong initial interest did not advance to the finish line in this process.

You know, when I think about the situation again, that these folks were very, very mindful of the premium that, perhaps they sensed was factored into price and again, these are determinations to be made by buyers, not by us. But I do think as you asked that some folks were mindful of what they sensed was a premium factored into the price of the stock.

I would also add that some folks were interested in parts but not all of the business and some were preoccupied with other deals quite frankly that they had in the [hopper 40:27]. And lastly, I would say that some were simply not financially or otherwise in a position to pull it off, perhaps tide up with their own LBO issues.

So as I wrap it up, again I get back to the one predominant issue that was clear in this situation was the overall addition in deterioration of the capital markets. That helpful?

Anurag Rana - KeyBanc Capital Markets

That's really helpful. Thank you. And also your guidance for next year suggests the margins around 10%. Now after an internal review and revised focus what do you think long-term margins for MAXIMUS could be in a few years?

Rich Montoni

I don't think -- I don't want to go there at this point in time. I think what we need to do is move forward and look at those business units that require some action to get us the focus and one of the byproducts certainly will be margin, certainly we would like to take actions that improve and not deteriorate margin, but that's one element of the equation.

So when those margin improvements happen and to what extent I think is really a question to be asked on future calls but a very good one.

Anurag Rana - KeyBanc Capital Markets

Thank you.

Operator

Our next question comes is from the line of Matthew McKay with Jefferies and Company. Please go ahead.

Matthew McKay - Jefferies and Company

Good morning, guys.

Lisa Miles

Good morning.

Matthew McKay - Jefferies and Company

First question just onto you, Rich, is just what your plans are, if you plan to -- now that there's a no sale here, you know, are you going to stay with the company or you know, just kind of a little incite in to what your thinking is?

Rich Montoni

No question. I'm going to stay with the company. I won't get into details about why I like the company, what I like about the company, why I enjoy working here, that’s the longer conversation. But the short of it is I'm very submitted to the company, very pleased to be here and very pleased with this path and opportunity to take it to the next chapter.

Matthew McKay - Jefferies and Company

Okay. Good. And then, just on the winning California, congratulations.

Rich Montoni

Thank you very much.

Matthew McKay - Jefferies and Company

Yes. If I understand how that's going to work I think the existing contract runs through the end of this fiscal year for you guys. With the new contract, is going to run in parallel through this fiscal year so would it actually be accretive to your guidance?

Rich Montoni

No. I think the way this will work, I think actually the new contract is effective in January of '09, so this new contract, I'm sorry.

Matthew McKay - Jefferies and Company

Of '08…

Rich Montoni

Of '08. So for -- this is a win that really is for purposes of revenue in operations in '09 issue, not in '08 issue.

Matthew McKay - Jefferies and Company

Okay. So you are not going to get any revenue from this starting January 2008?

Rich Montoni

There's a transition period, so we're not going to get additional or double up on revenues.

Matthew McKay - Jefferies and Company

Okay.

Rich Montoni

We have already factored full operations of this project into our '08 forecast.

Matthew McKay - Jefferies and Company

Okay.

Rich Montoni

So really what this does is solidify revenue beyond fiscal '08, '09 and even beyond fiscal '09.

Matthew McKay - Jefferies and Company

Okay.

Rich Montoni

Okay?

Matthew McKay - Jefferies and Company

That is helpful. And just one last question, just I'm curious as you went through this, strategic alternative thought process and obviously, came out with accelerated stock repurchase. And just was there a good reason why you didn't think about maybe doing a more aggressive acquisition strategy?

Rich Montoni

Yes. I think there is a good reason why and there's several factors that went in to this and we really did explore all alternatives. We really do think focus is important. Quite frankly when we look at our stock price and we look at the potential of our operations and certainly you are well aware of what we have managed to do in improving that in fiscal '07 and I think we have got some pretty good headway as we go in to fiscal '08.

We think the price of the stock is right for purposes of repurchases. We think it's substantially accretive and frankly, our shareholders and we have had discussions with our shareholders, they are very receptive to some form of repatriation.

So, I don't think we're excessively capitalizes, excessively undercapitalized with this ASR program. I think it leaves us with good capitalization to consider alternatives as we move forward but we didn't want to rush into an acquisition type situation, it was not the right path for us at this time.

Matthew McKay - Jefferies and Company

Okay. Great. Thanks a lot guys.

Rich Montoni

Okay.

Operator

Our next question is from the line of Charles Strauzer with CJS Securities. Please go ahead.

Charles Strauzer - CJS Securities

Good morning, Rich.

Rich Montoni

Good morning, Charles. How are you?

Charles Strauzer - CJS Securities

Good. Thank you. Just a question just to clarify on the guidance if I could. Last quarter you gave initial '08 guidance of your revenue greater than 10% and now you have been implying kind of, your high -- your mid-high teens topline growth, which is very robust. But you are kind of sticking to the 10% margin goal and only raising the bottom end of your original EPS guidance.

Are there some factors there other than the Medicaid integrity upfront costs. There are factored into that the EPS, because the cash interests on income is going away? Is it a higher tax rate, what are the factors that going into that?

Rich Montoni

I'll ask, Walker to respond to that.

David Walker

You know, we normalized revenue. I guess the way, I think of it that we normalize for it $2.1, we are showing you our revenue increases and lot of reasons for that a lot of new wins this year.

On the fourth quarter Texas for a full year run rate under the new contract certainly drives up the topline, but that's why we have got the guidance of the 8.50, 8.80. So you take the 1011 to 141, which is increment of revenue over this year.

You know, when you put a 10% operating margin added tax affected you are talking $0.30 -- $0.29 to $0.37 a share. And so of course like all things Rich and I take on additional challenges. So there's about a $0.10 to $0.27 challenge to in fact continue to improve the operating income, so that's the basis of it.

So it's the 201 plus the $0.29 to $0.37 a share that's implied in the revenue growth and $0.10 to $0.27 a share just really from continuing to drive up margins. And certainly when we look at some of our segments, we would like to see improvement.

Rich Montoni

And I would also add Charles that again, this is before the ASR program, so…

Charles Strauzer - CJS Securities

Yes.

Rich Montoni

As you move forward with your new models you will have to factor in all of the impacts of the ASR and that would include as you refer to, there would be less other income, interest income so that would have to be adjusted. But also the big impact obviously would be in the denominator of the EPS calculation.

So you will have to do that and on top of the 240 to 265. We felt very comfortable in moving up the lower end of the range from what had been 235, keep in mind that 235 through that earlier range was very early in the year.

It was before we went through our planning process. We felt comfortable moving up the lower into the range but I would emphasis it is by definition the low end of the range.

Charles Strauzer - CJS Securities

Got it. Now, just we are trying to get, you know when you look at the various segments and you gave up, your pretty good guidance for your growth rates for the top line. But are you implying on that certain segments maybe will have less profitability year-over-year, that is the systems and consulting segments?

Rich Montoni

We are not looking for any of our segments to have less profitability year-over-year.

Charles Strauzer - CJS Securities

On a margin basis?

Rich Montoni

On a margin basis.

Charles Strauzer - CJS Securities

Got it. Great. Thank you very much. And is there any cap on the VWAP adjustment, Rich on the ASR?

Rich Montoni

I can't get into the details on that one. We're going through the legal processes of filing that document and what should be public and what shouldn't be public is something the lawyers are deal with right now Charles.

Lisa Miles

And Charlie we will be filing that as an 8-K probably earlier next week. So you will able to take a look at it.

Charles Strauzer - CJS Securities

Excellent. Thank you very much.

Rich Montoni

Okay. Thank you.

Operator

(Operator Instruction) Our next question is from the line of Jason Kupferberg with UBS. Please go ahead.

Jason Kupferberg - UBS

Thank you and good morning. Just a question on, Rich as you said pretty much all alternatives were considered here. And I was curious specifically with regard to the potential for a Dutch tender and why that might have been ultimately decided against in favor of the ASR, kind of what the pros and cons specifically as it relates to that potential option?

Rich Montoni

Yes. I think this and boy, it quickly gets almost nearly judgment Jason in terms of what form what vehicle do you select to effectuate the return to your shareholders. And we went through that whole litany of alternatives, including Dutch tender increasing an ordinary dividend, large dividend and we ended up on the ASR, because there are certain aspects to the ASR that we liked.

We liked the certainty. We liked the immediate aspects of it. We liked the immediate accretion. We felt that since we're not necessarily stock pickers it also provided us a vehicle to get the stock at what we think is fair prices.

The Dutch tender had some appeal but also had some negatives it to as well. They are not always successful. They are certainly not as fast as an ASR. So we decided to go with the ASR for that -- those reasons.

Jason Kupferberg - UBS

Okay. That's helpful. And on the Accenture arbitration any updates there and I know you had $0.06 of legal charges in Q4 for that. What are you looking for going forward? Are there going to be continuing ongoing legal expenses there and are any of those baked into the EPS guidance?

Rich Montoni

Here is where we are with the arbitration with Accenture it is basically law firm-to-law firm and representing each side as they move forward to currently scheduled arbitration in the middle of April, I believe.

So that's really the process, there is not been settlement discussions or negotiations at this time. We did accrue an additional amount in this fourth quarter and it depends how things work out.

But we believe that the accrual is necessary and sufficient to get us through the beginning of next year. And we're also exploring the viability of some insurance coverage as it relates to legal cost beyond that point in time.

Jason Kupferberg - UBS

Okay. And just broad macro…

Rich Montoni

Jason if you -- last amount of your question, we have not baked into our '08 guidance any additional legal costs for that matter.

Jason Kupferberg - UBS

Okay. And just a broad macro question obviously there are lot of question on a state local budgets now with some of the slow down of the macro economy and property taxes being down and I think there were some article about.

California is specifically yesterday facing some unexpected deficits. I mean, how are you guying looking at that, I am sure you watch it closely in arguable your businesses different to some extent now than during the last time the states faced a real fiscal crunch.

But to what extent have you tried to factor some of that in to your outlook as well, some of the stuff that might be beyond your control?

Rich Montoni

Well, I think of it this way and I do think there are some macro issues in local issues that are circling and certainly the general state of the economy does have -- somewhat delayed but does have impact on state and local budgets. The other factor is one might mention is what's going on from a political perspective with SCHIP authorization etcetera, so we watch that very closely.

It's interesting with our business model and we have learned this in prior periods you go back to the beginning of 2000, when states had similar issues is most of our product line and service offerings are tied to federally mandated programs, so the programs must continue.

Our experience is that the states generally continue with their current level of spending, so we find during steeper recession their times some risk of marginal cut back on some programs, but the more hardy programs those that are federally mandated tend to continue at the same level of spend.

So I think, that's one good thing about our business model. States do have some discretionary spend areas but we tend not to concentrate on those discretionary spend areas.

Jason Kupferberg - UBS

Okay. And just a last question for David, if I can. Operating and free cash flow expectations for fiscal '08?

David Walker

Sure. Your cash flow from operations will range somewhere from $50 to $60 million and I'll provide a little flavor for that and the free cash excluding the purchase will be somewhere in the $30 to $40 million range.

And you know one things, I'll say if you look year-over-year. We did a great job in '07 of driving down DSOs, so receivables on a cash flow perspective, actually was a net contributor. But as we grow, when we look into '08 the receivables -- and we're using 80 days in our modeling -- will consume working capital, so growth has a tendency to do that.

On our CapEx, you know we averaged about 1.8% of our revenue last year in CapEx spending capital assets but we will need some additional infrastructure, financial systems, et cetera. So we picked that additional spending in. And then we spent cap software about $1.5 million a quarter in '07 and I would expect something to continue in that range.

You know, last year we generated a lot of cash from taxes and we -- you know, fortunately we'll be in a tax paying position, it's a high-class problem and we like that. So that will change the dynamics a little bit, so hopefully that helps.

Jason Kupferberg - UBS

It does. Thanks, guys.

Rich Montoni

Yes.

Operator

Our next question is from the line of Shlomo Rosenbaum with Stifel Nicolaus. Please go ahead.

Shlomo Rosenbaum - Stifel Nicolaus

Hi. Thanks for taking my question. I want to deal in a little bit to some of your business units the margins were very high in operations segment for the second quarter in a row. We historically have thought about that segment being maybe 8% to 12% margins and now we're seeing like 17.6%, 16.6%. Can you talk, specifically about what happened in the last couple of quarters and has the bar been raised?

David Walker

You know, there's certain aspects of the operational business is somewhat seasonal, so you have to be careful for that. For example, we have a tax crediting business in there that tends to come on really strong in Q4, so that certainly plays a factor.

And some of our growth in operations will be lower risk work, but lower margin work, so that on a weighted average will blend it down next year. But there is no doubt about it the team has done a great job in '07, I think of optimizing return to shareholders and striking the right balance.

Rich Montoni

I would only add to that in Q3, we did see a non-recurring up-tick as it relates to some non-recurring in essence recoveries on the Texas project.

Shlomo Rosenbaum - Stifel Nicolaus

Yes.

Rich Montoni

So that helped the margin quite a bit and as Dave says in Q3 and Q4 we do get a respectable amount of seasonal and profit from our tax credit business, which disappears in Q1 and Q2. So you should expect to see some flux because of those dynamics.

Shlomo Rosenbaum - Stifel Nicolaus

Okay. Then on the consulting business you talked a little bit about some work that I guess was federal -- some healthcare work. Is that RevMax work that you are not pursuing over there, is that the reasons some of the work that you are getting out of?

David Walker

Well, we're pursuing RevMax we're just no longer pursuing RevMax on a contingent basis, when we are chasing after federal dollars, we you know, I think that's in our best interest. So we're still doing that on a fixed-fee per basis on basis. But with that said, you know some customers won't mind that model attractive even though we think it provides high-value proposition.

So with that said, I think we're transitioning in to some other work area. And we have been pretty successful with some wins in fraud, waste and abuse and the PERM work that we talked about.

And the nature of some of that for the fraud, waste and abuse, it's similar to RevMax and that we have to incur some costs and build some models and do some things before we start getting some transactional revenue from that.

So we're going to be spending some money towards that which ultimately will be accretive in the year, in the early parts of the year and we should see the benefits on the backend.

Shlomo Rosenbaum - Stifel Nicolaus

Now, what about some of the timing and billing of work issues and consulting features, could you give a little more detail on what that was?

David Walker

Well, there's always seasonality inside of consulting. You know, so when we have these contingent work things, you know, it could swing on an individual contract by several million dollars from one quarter up or one quarter down, so it can be volatile quarter-over-quarter and frankly as we get away from the RevMax fee for service it should have the effect to release that portion of the work smoothing and over.

But overall, you know, we looked to have an operating income margin there in excess of 10%. It is a consulting business should be much better than that.

Shlomo Rosenbaum - Stifel Nicolaus

Okay. Do you have a percentage of your work that is federally funded, just of your overall business?

Rich Montoni

We have looked at that and we believe approximately 70% of our business is federally funded. And now it may ultimately go through the states and the states would be the direct payor to us but it's federal funds that pay the states and then pay ourselves. Our estimate is about 70% our revenues.

Shlomo Rosenbaum - Stifel Nicolaus

Okay. Great. And I'm going to sneak in one last one.

Rich Montoni

Yes.

Shlomo Rosenbaum - Stifel Nicolaus

Can, are there any, you talked about some of your contracts that are being rebid and then some of the option seems like the rebids are not have been taken pack this year but there are any pretty large dollar-sized contracts that we should be keeping our eyes on for either the rebid or the options?

Rich Montoni

Yes. I think '08 shapes up to have some significant rebids/option periods, up until last night, I was thinking that HCO would be the most significant rebid event in '08 but as it works out, we're great to have that in the win column. That's a great way to start out fiscal '08 to put that one in the win column.

So as we go in to '08, the significant engagements that we're focused on would be winning the long-term Texas contracts.

Shlomo Rosenbaum - Stifel Nicolaus

Right.

Rich Montoni

Because we have some work in Texas that will run through December of '08 and then will be up for rebid. We have some other work that runs through June of 2010 which contracts on the process of finalizing but so some of that work will be up for rebid in fiscal '08, so that will be important.

And I think we also have large, we have some work that we do for the federal government, CMS in particular, quality assurance work in your federal division within our operation segment that's up for rebid. And then I think we have a New York contract where we have got some option extensions that we need to achieve.

Shlomo Rosenbaum - Stifel Nicolaus

Okay. But your biggest two or three, are these the biggest two or three, basically, you are working at the Texas, the one with CMS and then the New York contract?

Rich Montoni

That's correct.

Lisa Miles

I just want to clarify Shlomo on the rebids, Texas and the CMS work, the bulk of the rebids, New York Medicaid choice that actually is an option here that will be cited in fiscal 2008 but it's not a revenue impact until fiscal 2009.

Shlomo Rosenbaum - Stifel Nicolaus

Okay. I'll let somebody else ask and I'll get back in line.

Lisa Miles

Okay. Thanks.

Operator

Our next question is from the line of Roger Chuchen with Morgan Stanley. Please go ahead.

Rich Glass - Morgan Stanley

Hi, guys. It's Rich Glass actually. So much for that one-question rule? Can I ask you to give us a little more insight into the part of your release where you talked about refining its focus on core health and human service operations and seeking possible alternatives for certain non-core assets and basically, what we're talking about there potentially?

Rich Montoni

I would be glad to do that, Rich. What we are doing and what we have done and will continue to do -- I don't think you just do this once and then go back. We're going through all of our business offerings and assessing them vis-à-vis the criteria that I talked about in the call. And to recap that we have some that fits squarely in what we consider to be our real growth areas.

We have some that and it's a bit of, a circle in an oval peg, but still they are profitable, they are accretive, there's no compelling reason to exit that line of business and then we have some that quite frankly we don't have the time to thus manage those businesses.

We don't see them as synergistic with our other businesses and we think in the hands of others, they could do much better, the employees would have more growth opportunities, their shareholders would see greater returns.

One experience I have had over the last 18 months and this is a reconfirmation that I get on quarterly basis. It's a very pleasant confirmation and that is we do extremely well in our model when we are number one or number two.

We just, one of our key differentiators in the market is our subject matter expertise. And I think that's another way to say we really know this space better than other people. And when that happens our customers come to us. They have a strong preference to renew with us. They are very willing to have more fair negotiations about price and terms, which translates in to our margins they really are biased for MAXIMUS serving them.

And I think that's all good and I think that all translates from a shareholders perspective into greater returns that are margins. So we're going to focus the company in that direction as opposed to being a quite diversified company.

I really want to move the company to be focused on those growth areas and we're mapping that over to what we think our macro growth area is. It is very clear in our society and in our governments that they continue to have big issues as it relates to health, government management of health, fraud, waste and abuse, even in all of those areas where we see management of employment in these various governments and we're seeing some strong indications of what we do in the workforce area as coming back, particularly with DRA.

So there's a lot of things where we see strong growth and what we want to do is make that our bulls eye, be number one or two in the marketplace and I think that's going to translate in to better financial performance.

So with that as a backdrop, we are going through and looking at those business units that we think we should consider, for which we should consider alternatives. I'm not going about it as a fire sale.

I want to be reasonable about it and I'll be reasonable to the employees but we are definitely marching down the path and looking at selective divisions for other alternatives.

Rich Glass - Morgan Stanley

Okay. So we are really focusing on maybe operations here considering on what we're talking about in terms of…

Rich Montoni

Yes. Our model, I think works best when we have long-term outsourcing contracts, contracts that run two, three, four, five years and quite frankly plan A is we're going to be doing these work for these governments for not this contract but our model works very well and the industry I think is very much driven towards renewing the contract. So Plan A is that you do the work for 20 years not 10 years.

Rich Glass - Morgan Stanley

If I'm hearing it right, your systems and consulting you don't have to own, maybe they are worth more to somebody else, maybe they are a better fit. And you put in a buyback today of $150 million and then $40 million beyond that and then you might have proceeds from any other sales above and beyond that as well, which you could use for other corporate purposes, is that fair?

Rich Montoni

Yes. That is very, very fair.

Rich Glass - Morgan Stanley

Okay. Sounds good. Thanks.

Rich Montoni

Thanks. Good. Thank you very much, Rich.

Operator

Our next question is from the line of Jerry Weintraub with Weintraub Capital. Please go ahead. Jerry your line is open.

Jerry Weintraub - Weintraub Capital

I have no questions.

Rich Montoni

Okay.

Operator

Our last question is from the line of Steve Balog with Cedar Creek Management. Please go ahead.

Steve Balog - Cedar Creek Management

Thanks. The original stated reason for selling the company was there was some thought we should be part of a much larger company. If I recall something with systems expertise so that was not a financial buyer.

I would have thought that a larger company like that the equity markets, excuse me, the debt markets and getting financing wouldn't be an issue for the IBM, DDS's, Accenture's those are all companies to that class that wouldn’t matter.

That question one where does that work, are we now at a disadvantage because we're not part of larger company with the systems expertise and maybe the whole explanation of this is not to put words in your mouth but were the strategics to ones that only wanted part of the company, the operations part but then what the rest. (inaudible67:05).

Rich Montoni

David refer to all that.

David Walker

Actually again. I'm not going to get in to individual buyer situations but it's a not fair to map it over and say just the strategic just wanted parts. That's not a general rule that's fair to the situation.

We did receive substantial interest across the board and as it relates to your question on the systems piece you are right. One of the reasons for considering a combination with a strategic and perhaps, the most compelling one is to further improve the company's sure IT capabilities.

That being said we have not rested on our Laurels and as we talked about in our call, we have made pretty significant investments in some proprietary technology that gives us a competitive advantage as we offer our BPO solution in the marketplace.

And I specifically mention the productization efforts we've made an EB as well as SCHIP. That's not the type of technology solution we were looking for from a complementary partner. It would be more just think about classic ITO.

And I still think that that is a factor and I still think that that remains, how we couple with those types of providers because we don't envision ourselves as being ITO -- a pure ITO outsourcing firm.

As in the past, we have partnered with them. We will sub them in and we'll continue to do that. So we don't lose any -- I don't think we'll lose any momentum but I still think that's a potential synergy that's out there.

Steve Balog - Cedar Creek Management

Okay. Back to the other question I had, those kinds of companies that I would have thought would be interested are not in compare to financing no problem this is a smallish kind of acquisition for them.

So I guess the highest interest or they didn't want to pay this kind of those types of buyers didn't want to pay the price we needed?

David Walker

I think that's right. I think that's a fair conclusion and it's very difficult there's no generality in terms of why a strategic took a position. As I said earlier there are some factors out there that I think certain ones may have considered in the process again sensing, many were mindful of a premium being factored into the price.

I said some are interested in parts but not all of the business and I do think that some were preoccupied, you see someone else and slightly that are pre sizeable for some of those folks but you otherwise would think we would have an interest.

Steve Balog - Cedar Creek Management

Great. Thank you.

David Walker

Okay. Okay. I have one last clarifying point in response to my discussion, in response to Rich Glass' situation about consulting in systems. I want to emphasize that these are certain divisions inside these systems not persuasiveness as it relates to all of consulting or all of systems.

In fact I do think there's a very good fit for some of our consulting work that is complementary to our service offerings and product offerings in health and human services, this is one of the ways we distinguish ourselves as subject matter experts. Okay.

Lisa Miles

And operator, that ends our call today.

Operator

Ladies and gentlemen, a replay of this call will be available to you. Your replay information can be found on the press release. The direct link is reg.linkconferencecall.com/DigitalPlayback/DigitalPlaybackRegistration.aspx?recid=5826.

Ladies and gentlemen, this concludes today's presentation. Thank you for your participation. You may now disconnect.

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Source: MAXIMUS Incorporated Q4 2007 Earnings Call Transcript
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