Affiliated Computer Services Inc. F3Q08 (Qtr End 3/31/2008) Earnings Call Transcript

Affiliated Computer Services Inc. (ACS)

F3Q08 (Qtr End 03/31/2008) Earnings Call

May 1, 2008 4:30 pm ET

Executives

Jon Puckett - VP of IR

Lynn Blodgett - President and CEO

Tom Burlin - COO

Kevin Kyser - CFO

Analysts

Julio Quinteros - Goldman Sachs

George Price - Stifel Nicolaus

Jim Kissane - Bear Stearns

David Grossman - Thomas Weisel Partners

Adam Frisch - UBS

Bryan Keane - Credit Suisse

Presentation

Operator

Good afternoon, and welcome to the ACS third quarter fiscal 2008 Earnings Call. (Operator Instructions).

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

Jon Puckett

Thank you, operator. Good afternoon and thank you for joining us today to discuss our third quarter fiscal year 2008 results. Today on the call we have Lynn Blodgett, President and Chief Executive Officer; Tom Burlin, Chief Operating Officer; 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 implied 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 Principal 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 Principals on the Investor Relations page of our website at www.acs-inc.com.

And finally, we disclaim any intention to and undertake no obligation to update or revise any forward-looking statement. I will now turn it over to Lynn Blodgett, our Chief Executive Officer, who will provide a summary of the significant events during the quarter.

Lynn Blodgett

Thanks, Jon, and thanks to everyone for joining us today. I am very proud of our team for the outstanding results they produced for the third quarter. I am also reminded that more than 63,000 very dedicated people around the globe who work hard each day to serve our customers and make ACS successful.

Let me cover some of the highlights of the quarter on slide number 3. Signings were $245 million with total contract value of $1.1 billion. The most encouraging thing to me about our sales performance this quarter was for the first time since June of 2006, both Commercial and Government have positive growth in trailing 12 month signings.

Secondly, all other lines of business contributed to our signing results so that we are building a broad base for growth. Our adjusted earning per share was solid at $0.91 and represents 17% growth over the prior year. Our free cash flow was outstanding at $161 million or 10% of revenue. Our internal revenue was about $10 million less than I had hoped that we would achieve, but internal growth was still healthy at 5%. Kevin will give you more details on where we anticipate revenue growth, earnings and cash flow to be in his portion of the presentation.

Finally, our renewal rates for the quarter were excellent and bring our year-to-date renewal rates to 92%. This means the year-to-date annual recurring revenue signings are $591 million with total contract value of $2.5 billion. Year-to-date renewals equal $434 million and a total contract value of $1.8 billion. New signings and renewals totaled over $1 billion and annual recurring revenue and a total contract value of $4.3 billion. While we have much more to do, I am pleased with the direction that we are heading.

As I stated before, we have adopted a concept, we called "Divide and Conquer" where we narrow our leaders' scope of responsibility to allow them to focus more directly and effectively. I followed this and I focused on sales, while asking Tom Burlin, our Chief Operating Officer to focus on operations. Tom will address our operations in his section. Now, let me give you more detail so sales.

Please turn to slide number 4. Our Government segment had very strong signings of $155 million of annual recurring revenue or 63% of the total signings this quarter. Let me give you some examples of signing in our various verticals. In state and local we signed a new Electronic Benefits Transfer contract with the California Health and Human Services Department. In federal, Comerica teamed with ACS to provide card processing and customer support to the US Department of Treasury. In healthcare, we signed a new MMIS contract with TennCare. In transportation, we signed a new contract to provide automatic traffic management to the Kingdom of Saudi Arabia continuing our expansion in the international transportation market.

As a result of strong quarter, government trailing 12 months signings grew by 16%. commercial signings represent 37% of the third quarter new business. In telecommunications we signed a large service expansion in our wireless customer care. In manufacturing, we signed significant new LOGP finance and accounting deal. In healthcare, we signed a new IT outsourcing contract with the major hospital in southwest. We also signed service expansion with existing clients across many verticals.

Commercial trailing 12 month new business signings increased by 31%. New business signings by service lines were 84% BPO and 16% Information Technology Solutions. I am very pleased with our strong signings over the last two quarter also.

As we have endeavored to communicate in the past signings are lumpy and can fluctuate from quarter-to-quarter. That being said, I am confident that the fiscal year 2008 signings growth will range between 25% and 30% over the prior fiscal year.

Our strong third quarter performance drove year-to-date renewal rate to 92%. Renewals for the quarter totaled $195 million of annual recurring revenue with total contracts value of $562 million.

Of note, in the quarter, we renewed and expanded our ITO contract with Nike for 5 years with total contract value of $210 million. We also renewed a major BPO contract in the federal market. We are proud to continue to serve these wonderful customers.

Please turn to slide number 5. Our new business pipeline remains strong and broad at $1.8 billion of annual recurring revenue as of March 31 2008. This is the second largest pipeline we have ever pursued even with the strong signings we have experienced over the past two quarters.

By segment, Commercial comprises approximately 69% of the pipeline with the remaining 31% in Government. My service line, 74% of our pipeline is BPO and approximately 26% is ITO which is consistent with our overall business mix. In Commercial, we are see opportunities in healthcare and telecommunications and manufacturing and finance and accounting. In Government, we are seeing pipeline strength in transportation, healthcare and state and local. I am proud of our third quarter results. So we are equally focused on building the company for the long-term.

I would like to share with you some things I think are key to ACS' long-term success. Please turn to slide number 6. ACS is a vertical BPO solution company. Our long-term success is built on several principles.

First, identify attractive solutions that can be leveraged across many customers. We have built the company to identify and attack markets that have attractive growth opportunities and can be served by a common leveragable solution. For example, eight years ago, we identified Medicaid as a vertical market that was rich with opportunity through a key acquisition which we then grew successfully.

We have become a leading provider to the Medicaid market and have built the business with revenues in excess of $600 million. We have done this by building a strong technology and service platform that we utilize in 13 states. By using this base solution to win many states is only part of the answer. Second, is keeping our solution fresh and vibrant through innovation and acquisition, so our opportunities will continue to grow.

In government healthcare, in addition to the success in Medicaid market, we have acquired three additional leveragable solutions including the pharmacy prior authorization tools, electronic health card tools and other health infomatic capabilities that all have contributed to our growth in the vertical market.

Internally, we have developed a solution for the electronic health record that is providing us with additional opportunities. By utilizing this principal, we have been able to build government healthcare vertical to provide various leveragable healthcare BPO services to 38 states. Our ability to innovate and expand our services helps to ensure we exceed our customers' expectations today and provide them the solutions for the future.

The third principle is that we must continue to add new verticals that open new markets and provide leveragable solutions. Mergers and acquisitions are a core competency to ACS. And we are using that capability to add new services and to open new markets.

Next, in order to achieve long-term success, we must never let up operationally or financially. We understand at the end of the day the best operator wins. Our focus is on reducing costs and delivering outstanding service to our clients and getting paid for the important work we do.

Our hustle and work harder than the competition philosophy must continue. Our organization structure is also an important element of our success. Our goal is to organize ourselves in a way that keeps us nimble and accountable.

As I have said earlier, we call this divide and conquer. Divide and conquer provides our leaders with reduced span of control in order to provide increased focus on operations and financial results.

To illustrate this, we recently promoted Darrell James in ITO and Michael Huerta in transportation to Executive Vice President and Group President in recognition of their achievement and to provide focus on these operations.

The next step is we must sell more. We are investing in sales with more feet on the street, with more emphasis on customer retention, with a greater focus on selling to our base, with better tools, more timely tracking of our sales activities and more attention from senior management. Our signings must continue to increase.

Next, we must focus on our people. Since the founding of the company one of the company one of the key principals of ACS is that the most important thing we can do is to ensure that our people are happy and motivated, because we know that happy and motivated people deliver superior deliver superior service to our customers which causes them to give us more business.

This in turn translates into better returns and therefore happy shareholders. We are spending more time, money and energy on training and we are fully engaged in a leader ship mentoring program which is strengthening our next generation of leadership. Finally, let me add one note to our formula for success. The final key to our formula is to do it again.

We have a repeatable process that we have replicated over and over. Our ability to repeat this process, provides us with almost limitless opportunities for expansion into the future vertical market. And I am confident that our works and then as we follow it, we will be successful.

Now let me turn it over to Tom Burlin to provide an operational overview.

Tom Burlin

Thanks, Lynn. If you please will turn to slide 9, I will begin by reviewing our segment performance starting with commercial. Total revenue growth for the commercial segment was 8% for the quarter, internal revenue growth was 5%, commercial growth was driven by increased volumes year-over-year, and sequentially in our telecommunications vertical and wireless customer care.

ITO grew year-over-year and sequentially due to growth in new and existing clients. Our HR business grew year-over-year across all service lines while the sequential growth in HR was driven by our consulting business.

Turning to profitability, on an adjusted basis year-over-adjusted operating margins declined by approximately 100 basis points and sequentially by 40 basis points due to startups losses associated with the ramp of new business.

Please turn to slide 10. Lynn spoke of innovations through acquisitions as a core competency of ACS to deepen our service offerings and extend our capabilities in new markets. This past quarter, we closed four acquisitions and announced two more after the quarter ended. Two of these were in our commercial ITO business. The first is Syan, which I covered last quarter and sds a Germany-based provider of datacenter, infrastructure services, and application-related solutions. The addition of this company is a logical next step in servicing our existing multinational clients and increasing our ability to provide IT support to our vertical BPO offerings.

sds is a solid base for recurring revenue that is similar to ACS's recurring revenue model. We are pleased with talented and leadership we are bringing on, our expertise in the German and European markets will help us expand our international presence and capabilities.

We acquired sds for approximately $63 million and it was reported in the commercial ITO business beginning in the third quarter. Its trailing 12-month revenue is approximately $40 million, and its historical operating margins are higher than corporate averages.

We anticipate this acquisition will be accretive to earnings during the first 12 months post-deal. German IT services market is forecasted to grow at approximately 10% over the next several years and it is highly fragmented with no doubt (inaudible) an IT service provided.

Also in our commercial area, we acquired Communications Development Incorporated to enhance our offerings to the commercial transportation industry. And finally earlier this week, we announced the acquisition of CompIQ to broaden our service offerings in the healthcare payors market.

If you now turn to slide 11, we have received numerous questions about the student loan business over the past several weeks, so let me take a moment and address your questions. We service student loans in both the government and commercial segments. Our government segment provides 100% of student loan processing services to the Department of Education under the common service for Bowers contract.

Under this contract, we serviced 6.6 million federal direct student loans as well as about 2.5 million defaulted loans from a number of loan programs. In commercial we serviced 2.6 million loans that have an average life of seven years under the Federal Family Education Loan Program, FFEL or the indirect loans on behalf of various financial institutions.

While these numbers are significant, it is only a fraction of the total volume of indirect loans. Due to tighten credit markets and the reduction of government subsidies, many lenders have stopped providing new loans under the indirect program.

While the exit of indirect vendors will put pressure on top line growth of our commercial student loan business, we still have a significant base installed base into 2.6 million student loans that we'll continue to service regardless of new originations.

And it might be surprising to you that our loan volume has actually continued to increase in phase of this shading market, and that we have been able to maintain our operating margins to prudently managing this business.

Another development that we are monitoring the student loan market is substantial for incremental loans audit from the direct program. As fewer lenders are providing direct loans, the schools currently participating in the indirect loan program could move to the direct loan program.

If you now turn to slide 13, I will review the Government segment. Government segment's total revenue grew 6% excluding divestures with 5% internal growth for the third quarter. Year-over-year revenue growth was driven primarily by the ramp of the eligibility contract we signed last fiscal year and growth in our transportation business, primarily in airport and urban parking and as well in the electronic toll collection business. Sequentially revenue increase as we ramp our new MMIS business and enrollment broker business in our Government Healthcare Solutions Group.

On an adjusted basis, Government operating margins decreased approximately 90 basis points year-over-year 160 basis points sequentially. Year-over-year margins declined primarily due to the ramp in the Indiana eligibility contract and lower non-recurring revenue profit in our unclaimed property business. The unclaimed property business also impacted sequential operating margins as well as the ramp of new business in our Government Healthcare Solutions group. This declined is consistent with what we expected for the quarter.

If you now turn to slide 14, continuing with review of acquisition as a formula for success, subsequent to March 31 2008, we announced our intent to acquire the Transportation Management Systems or TMS from Orbital Sciences Corporation. TMS is the United States leading provider of Global Positioning System or GPS fleet management systems which is the fastest growing segment of the transit market. We anticipate this acquisition will strengthen ACS' end-to-end transit service offerings beyond our current European base Fare Collection Solution.

Due to minimal client overlap, we believe the acquired customer base and technology solutions should provide us with opportunities to sell additional services. This acquisition, we expect to gain significant experience in the transit market. The purchase price for TMS is approximately $43 million and its trailing 12 month revenue was approximately $50 million with operating margins that are below our corporate average. Once close, we anticipate modest earnings accretion from this acquisition during the first twelve months under ACS.

We anticipate modest earning during the first 12 months. The fixed-route transit market has experienced strong growth in the United States due to state's increased investments in the public transit systems, which has grown 15% over the past decade. Market estimates continue to forecast significant growth in this area and we believe the combination of TMS and ACS will provide a strong technology platform that we can leverage across multiple customers in transportation vertical.

In summary, we had solid quarter operation; we grew revenue in both segments. As we expected our margins declined as we incurred incremental front cost related to ramping a business. This is a typical margin pressure we are seeing with new business. We closed four acquisitions in this quarter that broaden our global capabilities, strengthen our horizontal and vertical markets. I am pleased with our results and I am also confident in the future.

Now, let me turn it over to Kevin who will take you through the financials.

Kevin Kyser

Thanks, Tom. Please turn to slide 16 and I will spend a moment on our financial trends. Revenue for the third quarter was $1.54 billon and represented 7% total revenue growth and 5% internal growth. Consolidated adjusted operating margins were 11.2% for the quarter and in line with our expectations. As anticipated our segment operating margins were impacted by startup costs associated with new business and lower profit from our unclaimed property business.

Our corporate G&A expenses were down this quarter due primarily to lower procurement cost, day-to-day legal expenses and deferred compensation cost. Adjusted diluted earnings per share were $0.91 for the quarter and exceeded our expectations due to lower interest rates during the quarter, foreign exchange gains and a slightly lower effective tax rate.

Please turn to slide number 17. We provided reported and adjusted non-GAAP results for the third quarters of fiscal 2007 and 2008. We have adjusted our reported results for the ongoing stock option investigation and costs related to the potential buyout. In addition, we have excludes the impacts of a legal settlements that occurred in both periods. We believe this better reflects our operating results and mirrors the way management views the business.

Our adjusted pre-tax profit was $138 million and grew 12% over the prior fiscal year. Adjusted pre-tax profit was driven by growth in operating income and lower interest expense. A portion of our existing debt is subjects to floating interest rates and the year-over-year decline in the LIBOR rate yielded interest expense savings. The effective tax rate during the third quarter of fiscal year 2008 was 36% and finally better than our expectations due to the positive settlement of the certain FIN 48 tax positions.

Adjusted non-GAAP EPS of $0.91 grew by 17% year-over-year due to growth in operating income, lower interest expense and a lower weighted average share count from share repurchases completed earlier this year.

Please turn to slides 18 and I will cover our year-to-date results. Revenues for the first nine months if fiscal year 2008 were $4.5 billion and represented 7% total growth and 5% internal growth. Adjusted operating income was $508 million dollars and represented 6% growth over the prior fiscal year. Adjusted operating margins were 11.2% compared to 11.3% in the prior fiscal year. Adjusted diluted earnings per share were $2.58 and represented 15% growth over the prior fiscal year.

Please turn to slide 19. Cash flow was strong in the third quarter. Operating cash flow was $229 million or 15% of revenue and free cash flow was $161 million or 10% of revenue. These results were driven by improved cash collections on AR and a resulting two day reduction in our days sales outstanding.

Lower capital expenditures and additions to intangibles are also helping to drive higher free cash flow. I would not expect this trend in CapEx to continue as our strong new business signings will begin to ramp and we will spend the capital that we have committed to these contracts.

For the first nine months of fiscal 2008, we have generated $560 million of operating cash flow or 12% of revenue. Free cash flow for the first nine months was $342 million or 8% of revenue. Free cash flow grew by 172% over the prior year. Recall that this time last year we were short to our cash flow targets and we delivered with a record fourth quarter. Due to the fact that we are on target to hit our free cash flow metrics for the year, I would expect the fourth quarter free cash flow to be in the 6% to 8% range and not as backend loaded as the prior year.

I have recapped our major balance sheet categories on slide 20 as well as the most significant fluctuations from December. I will not spend much time here as most of movement in our balance sheet can be attributed to the four acquisitions we closed this quarter.

Accounts payable increased $43 million due to the timing of payments. Our deferred tax liabilities increased $42 million compared to December due to an increase in deferred tax expense. This increase in deferred tax expense can largely be attributed to accelerated depreciation from the recently enacted economic stimulus package and increased in unbilled AR, amortization of goodwill opening balances of the acquired entities.

Turn to slide 21 and let me spend a moment discussing what drives revenue growth at ACS. With a high percentage of our business under long-term contracts the key indicator of internal revenue growth is new business signings. It generally takes 9 to 12 months for signings to fully ramp to revenue, but this is dependent on the type of work we sign.

For example, we have had great success this year in winning nearly $200 million of government healthcare and electronic payment business. This type of business takes about six months longer than average to ramp.

While our near-term revenue growth will be impacted from the slower ramp, these are great long-term contracts. The second variable in revenue growth depends upon our success in renewals every quarter.

Our contracts average five years in length, so 20% of our recurring revenue comes up for renewal each year. We target a 90% renewal rate and typically give a modest discount in exchange for longer-term contract and expanded scope.

Our outstanding renewal rates help ensure that the base business does not erode. With a high percentage of our revenue tide to transaction volumes this is another variable in the revenue growth equation. We have a variety of transactions including loan serviced number of calls answered claims processed and traffic violations issued just to name a few.

Once contracts are fully ramped and in a steady state, or we may see pockets of strength or weakness transaction volumes across the entire business tend to be neutral to growth. Another component of growth relates to an area we call non-recurring revenue.

Examples of non-recurring revenues are consulting services in HR and health care, or systems integration business, unclaimed claimed property, and other short-term projects. We have to go out and sell this each and every day and historically it is grown inline with overall revenue growth.

And finally, acquisitions contribute to revenue growth. This quarter, we closed four acquisitions. I have provided the effective dates that these were include in our result in their respective trailing 12-month revenue.

In addition, I included the two deals announced subsequent to the third quarter. For fiscal year 2009, we believe these deals will provide about 2 points of acquired growth and less that one half point of internal growth. Let me explain how we factor acquisitions into the internal revenue growth calculation.

The trailing 12-month revenue of the acquired entity is treated as acquired revenue and is adjusted for no revenue losses. If an acquired entity's actual results are above or below its trailing 12-month revenue run rate it's either positive or negative to internal growth. We have consistently applied this methodology.

So as you can see, renewals, volumes and non-recurring revenue help sustain internal growth, and acquisitions provide future growth opportunities, but new business signings are the biggest driver of internal revenue growth. With the pickup in new business signings, we are confident our internal revenue growth will increase over the long-term.

Before we go to Q&A, let me provide color on the fourth quarter. For the fourth quarter we continued to expect similar internal revenue growth to the third quarter. The acquisitions we recently announced should add about 2 point of growth to the top line. We expect consolidated operating margins to be consistent with the third quarter.

Finally, we believe, we will be a penny or two above the current full year consensus EPS estimates of $3.49. In summary, the defensive nature of the business is beginning to show in this economic environment. We delivered another strong quarter of bookings that should translate into internal growth acceleration in fiscal 2009.

Our focus on working capital management is allowing us to remain flexible in the use of our capital. Lastly, we continue to use our proven acquisition strategy to deepen our BPO services and broaden our geographic reach.

Before we go to Q&A, let me reminds everyone that we are excited to host our inaugural Institutional Investor Day at the East Side Marriott in New York City on May 15, this there an opportunity for you to meet our top managers and hear our business strategy.

If you have not registered, please contact Jon Puckett in our investor relations group, and we will provide you with the information. That is all the prepared comments I have at this time. Let's open it up for questions. Obviously, we have a lot of people online, so please hold your questions to one per caller.

Operator, please begin the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question from Moshe Katri with Cowen & Company. Please ask your question.

Moshe Katri - Cowen & Company

Hey, thanks. Nice execution here and great booking numbers. You are getting a lot of questions on EBIDTA margins for the quarter. I think it will be really helpful if you can go into some of the pluses and minuses that impacted the EBIDTA margins during the quarter, maybe you talked a bit about some of the unusual items that you mentioned.

And then what is your outlook for margins? I mean you spoke very briefly about fiscal year '09 in terms of accelerating internal revenue growth, but, talk a bit about what sort of levels should we expect? Should we expect EBIT margins to be back into the 11% to 12% range next year? Thanks.

Lynn Blodgett

Yeah. Thanks, Moshe. I guess first of all we certainly understand the question, and I just want to make one comment that you made reference to unusual items. Those are actually things that are part of our overall administrative operating costs. And these were normal reductions in spend in our procurement area.

You might recall that about a year ago we were ramping up that procurement office and function. And we had some startup costs there that didn't hit us again this year, and we just saw a nice reduction in our normal day-to-day legal expenses as an example that the primary pressure on the margins really came at the operating units, and again this was inline with what we had expected to happen.

We had a pretty good impact from the Indiana eligibility contract in the government space. That was the biggest thing, and accounted for the majority of that decline, and then we also had a bit of reduction in our unclaimed property revenue that was pretty high margin business, and that was a little lower revenue this quarter.

On the commercial side, we had startup in our HR business and our F&A business. We had some transactional work where we do a lot of training to ramp up volumes and so on. And those were the things that drove the shift in terms of margin. Again, we hope that we have reflected that accurately last quarter.

And but, we certainly understand the question, Moshe. Now, Kevin I'll let you expand.

Kevin Kyser

Obviously, Moshe there are puts and takes, because our business is so diversed, there is puts and takes inside of segments and throughout the business. Obviously I think we have commented that we like the fence post of 11% to 12%, we have not changed our view on that. We still think that's achievable based upon all the new business that I have been seeing. We like that 11% to 12% range.

Moshe Katri - Cowen & Company

And you have also commented that you expected bookings by the end of fiscal year '08, annualized bookings to be up. I think its 25% plus.

Kevin Kyser

I believe the range we gave was 25% to 30% and that would be offer a fiscal year '07 bookings number; I believe about $607 million.

Moshe Katri - Cowen & Company

You have a pretty good visibility at this point on booking trends so far during the June quarter?

Kevin Kyser

Yes.

Lynn Blodgett

And we are pushing on bookings. We are happy that we had a good increase in bookings, but we are not satisfied and we need to keep pushing and raising that target and the markets are good and our ability to provide service is good and so we are really optimistic about seeing those numbers increase. There will be only caveat is that the idea that they do tend to be a little bit lumpy and so we do not want anybody to panic. All we see is a two in front of the number, we are driving bookings up. We are confident they will continue to increase but we just want you to remember that they can be lumpy.

Moshe Katri - Cowen & Company

Yes, thanks. Good job.

Lynn Blodgett

You bet. Thanks, Moshe.

Operator

Our next question comes from Julio Quinteros from Goldman Sachs. Please ask your question.

Julio Quinteros - Goldman Sachs

How are you, guys?

Lynn Blodgett

How are you, Julio?

Julio Quinteros - Goldman Sachs

I am good. I just want to go back real quickly and just in the spirit of all the risks settlements that are out there in the world today. Can you just walk us back through the non-recurring components of your model maybe on a percentage of revenue basis if possible? And then secondly related to that what type of seasonality should we expect to see from some of those components that you highlighted including the unclaimed component?

Lynn Blodgett

That is a great question. We have always put a number out there, about 85% of our revenue is recurring, and about 15% is non-recurring. What happened in that? The reason that we chose (inaudible) that we did today and just referring to a large percentage. As an example, we have a large business in our Buck consulting area that is actuarial consulting and the average contracts length and that's a $400 million business. The average contract length is 17 years. Because of the nature of the engagement letters we report that as non-recurring revenue. So you call it what you want. We think it's pretty stable revenue that has been there for a long, long time.

So that represents $400 million, you can do the math. We do have some consulting business that is as we mentioned in our systems integration area. We have an SAP operation that has one-time revenue and what we would consider very legitimate one-time revenue, you have to problem solve projects but that type of business is really in the 5% to 10% range.

Kevin Kyse

I would say Julio that probably, 5% of our revenue is what we would consider and you would probably consider truly discretionary. Again, as Lynn mentioned that the systems integration business, there is some applications development business inside of there. In addition, although we haven't seen it, I would say that the true consulting business that the non-actuarial consulting business inside of our HR is discretionary but we haven't seen any softness there at this point Julio. If I had to put a number, I would say it's about 5% of our business.

Julio Quinteros - Goldman Sachs

Okay. And then what about seasonality?

Tom Burlin

Julio, this is Tom. There are two things in our transportation business. We tend to see pick up in lane maintenance and those sorts of things. Obviously, those are activities the tenders take place in the northeast during finer weather. So, the winter months would cause those projects to slowdown. That said, there is certain lumpiness to those projects, as well as the unclaimed business. It has been a great business for us for a number of years. And as Lynn said, it's a pretty high margin business, so relatively small change in the topline revenue transfers to a fairly significant change in the bottom-line. It can change 50 basis points in the quarter if we bring revenue into the unclaimed property or not. We tend to always get as you know we provide that service to all 50 states and Puerto Rico and the district. So we are very strong provider there. It is just a matter of when we get it, not if we get it.

Julio Quinteros - Goldman Sachs

Great. And Kevin just a real quickly on the capital plans specifically on de-leveraging or any comments you can make on buybacks as well as at this points. Thanks.

Kevin Kyse

Sure, I mean obviously, our focus today is on continuing to driving working capital improvements in the business, driving down DSOs, we were successful in doing that this quarter with two days. Obviously, you have been around a long time. We love to remain flexible. And I think that is the name of the game in this economic environment with low interest rates and somewhat tight debt markets. Those are going to come back at some point, but we love remaining flexible.

Obviously, in the second quarter we were buying back shares. In the third quarter we were using capital for acquisitions. I think that proves that we are pretty flexible and like to be able to take advantage of those opportunities. The acquisition pipeline is attractive today. I think our M&A group is continuing to look at opportunities to deepen our BPO verticals. And to be honest with you, the shares are still attractive at this price. So we are going to remain flexible and keep our options open.

Julio Quinteros - Goldman Sachs

Hey, thanks a lot.

Operator

Our next question comes from George Price from Stifel Nicolaus. Sir, please ask your question.

George Price - Stifel Nicolaus

Thanks, very much. Very good numbers, particularly on the bookings, I may have missed something. So I just wanted to go back to your comments that you made on fiscal '09 and revenue growth expectations, I guess given the strong signings that you've seen would revise your expectation? I think recently you said upper single-digit top-line growth, low double-digit bottom-line growth. Would you expect to revise those based on the signings?

Lynn Blodgett

Very good question, George. The reality is that our objective of long-term is to be able to grow at or slightly above any of the markets that we serve and we have said in commercial that is in the 8% or 9% range and government is roughly 7%, so our target is get that, so that we are at those numbers or slightly above. We are not prepared here to raise those expectations. We know that revenue growth is going to accelerate, but we are at 5% right now and we are confident that in '09 you are going to an improvement in that and we expect that in the second half of the year, I can say this at this point that we are confident that you are going to see a 7% in the second half, but we are trying to be a little bit careful here because we got a lot of these new businesses, it's important we do it right. We know it's going to drive growth long-term, and calling that to, is that going to be Q1 and Q2. We are being conservative.

George Price - Stifel Nicolaus

Okay. And just anything noteworthy I guess that you have visibility on now, in fiscal '09 that will impact? We talked about the filings which was a positive side, anything you have visibility on in fiscal '09 that will be a drag? Any contracts like Georgia or Florida Medicaid or contracts like that?

Lynn Blodgett

Let Tom comment on Georgia, but overall one of the great things about this business is that it's pretty consistent. I mean as Kevin mentioned we see about 20% of our recurring base that renews every year, and in that mix you are going to have a few big ones and a bunch of little once.

We do not see anything materially different coming this year. As I mentioned in my comments, we renewed Nike this year. That was a major deal. And we are thrilled obviously to get that done. We always have a couple of ones that we just have to make sure we get and some smaller once, so nothing kind of out of the ordinary. And Tom, you want to comment about Georgia?

Tom Burlin

Yeah. I think well, let me comment about Florida. Obviously, Florida, I think we indicated F&F contract was awarded that it would take a while to make that transition. It has actually gone I think about 18 to 24 months past its initial predicted date of turnover.

I would expect that there will be a similar long tail to the Georgia contract. If it goes to a turnover, and I think as you know publicly, we have protested that award. I'd prefer saying, we have been providing excellent service to a very good customer in Georgia, and while we respect their decision, we're going to use the administrative and legal means that are disposal to present our case and hopefully prevail in that.

But even if that turns, you are probably still looking at 36 months or more before that contract turns over, so I do not know that they will have. Obviously Florida will have an impact next year, but this year we won four new MMIS contracts. So overall, I expect that our healthcare business will grow inline with the numbers Lynn represented to you.

George Price - Stifel Nicolaus

Excuse me, last thing real quick. You mentioned, Lynn, I believe that internal revenues were $10 million less than you would hope, I was curious maybe you would elaborate as to why. Thanks very much.

Lynn Blodgett

Yeah. We had a little softness in the transactional BPO area and that impacted us. And then a bit in our mortgage, we have a couple of businesses that are affected by mortgage. One is in our government space land records and the other is that we provide services for mortgage documents processing. And nothing that was drastic, but if you look at the cumulative, that's where most of it came from.

George Price - Stifel Nicolaus

Great, thanks very much.

Lynn Blodgett

Thanks, George. Thank you.

Operator

Our next comes from Jim Kissane from Bear Stearns. Please ask your question.

Jim Kissane - Bear Stearns

Thanks. And good job guys.

Lynn Blodgett

Thank you.

Jim Kissane - Bear Stearns

Is it possible to kind of walk through the margin profile of the new business you signed in the quarter by segments? I know in the past, you had done that.

Lynn Blodgett

You bet. Kevin, you want to take it up?

Kevin Kyser

Yeah. Jim, when you look at it, obviously, a big chunk of the new business is on the government side, and in electronic payment, in healthcare. And obviously those have a very nice operating margin profile, so I would say that on an overall basis this quarter's signings were probably a little higher than we have seen in the past.

However, I would just caution you that they are higher, but it will take us awhile to achieve those full margin contributions, just because of the ramp. The ramp phases are longer.

Lynn Blodgett

Yeah, and not only the ramp, but both of those businesses while they are different, they have a characteristic that is same. They have a fairly substantial fixed cost base to the operation, so as you go by live in those. You go get past the initial ramp, you go live.

As volumes grow you get better leverage in your margins, so they tend to ramp overtime as it become more mature then the margins will. Those two businesses in particular will probably be on the high side of the average that we get in the government market.

Jim Kissane - Bear Stearns

And, Kevin, I think you touched on the pricing on renewals was there an unusually high percentage of renewals in the quarter?

Kevin Kyser

No. Actually I think it was about right inline with where we expected. I think the renewals represented about $200 million of annual recurring revenue in the quarter.

Jim Kissane - Bear Stearns

And in the pricing trends there?

Kevin Kyser

Nothing, we are not seeing a significant pressure on pricing. It is the normal pricing environment. I do not think there is anything out of the norm.

Lynn Blodgett

Jim, it's always very competitive, but it really is no more competitive today than it was several years ago. We can not get too comfortable in our cost reduction programs. We have to continue to drive that down, because the customers expect more for less.

That's kind of the attitude they live by. And so we are in the cost reduction business and have been for a long time. It really has not been anything that we have seen that I would consider any material change.

Jim Kissane - Bear Stearns

And one last one, Lynn, you definitely emphasized the leveragability of your solutions during the conference call.

Lynn Blodgett

Yeah.

Jim Kissane - Bear Stearns

But if you look just generally at BPO, the market generally, are you seeing more customization relative to attritional standardized solutions?

Lynn Blodgett

No, I actually think that it's kind of going the other direction. I think people are willing to put up with a little more standardization to get a lower price. And so we are still going to be flexible and do what our customers need us to do.

But, boy, for their benefit and our benefit, anytime we can use the same thing over and over again. That is what we are going to try to do. We talked about what we have done in the Medicaid market, and how we just continue to leverage those solutions over and over again in our transactional BPO.

We have a workflow platform that we have used over and over again. That is definitely the model, and the trick is to try to make sure you deliver what the customer needs and keep things as standard as you can.

Kevin Kyser

The other thing I would add to that as third-party providers and our clients given the tough economic times, they are looking for faster return. So I think you will see, customization usually equates to transformational kind of actions. I think you are going to see few of those and higher requests for standard solutions that can be implemented quickly with good payback, and that's on a sweet spot.

Jim Kissane - Bear Stearns

That's great.

Lynn Blodgett

And, Jim, the other thing I hope came across in my comments is that we have a wonderful formula within the company and it is that we know how to go out and look for a new vertical, we know how to get it, because we are pretty good at acquisitions, and we can acquire a nice platform.

And then we have a sales engine and a good operating engine that we can apply to that and turn it into a really nice repeatable deal. I feel so bullish about it, because that gives us gives us, if we see softness in a given vertical over a long period of time, it is not the end of the world. We are very flexible that way and the company tends move to overtime and make sure it is addressing markets that need us.

Jim Kissane - Bear Stearns

Sounds great, thank you.

Lynn Blodgett

Thank you.

Operator

Our next question comes from David Grossman with Thomas Weisel Partners. Please ask your question.

David Grossman - Thomas Weisel Partners

Thank you. Given the relatively strong bookings that you have seen and the things that accompany that, do you think that you can stay within your band of free cash flow of 68% without dramatic contribution from working capital next year?

Kevin Kyser

David, this is Kevin. I really do. I think the groups have done a very good job of collecting their AR. We have got a concerted effort to improve payment terms on new business that we sign. That is just a focus. That is something we are focusing on. We drove it into the incentive comp plans. So I really feel like that we can continue to maintain 6% to 8% free cash flow as a percentage of revenue. I look at the capital intensity of the new business we signed this quarter. I would say, because it is more weighted towards the government side, it is lower capital requirement than what we historically signed. So I feel pretty good about that.

David Grossman - Thomas Weisel Partners

How about on the working capital side in terms of the new bookings?

Kevin Kyser

I still feel like we are going to be able to make modest improvements there. I do not see that impacting it all that much.

David Grossman - Thomas Weisel Partners

Okay. Thanks. Secondly, you mentioned lower interest expense. Would that continue into the June quarter? I assume it would given rates.

Lynn Blodgett

Obviously, LIBOR at the end of March, our LIBOR actually started go on the opposite way of the fed funds. That is what our interest rates are tied to. So, you will see a little bit of improvement sequentially but nothing major like you saw this quarter. And for now interest rates are where they are going to be for a while.

David Grossman - Thomas Weisel Partners

Okay. You talked about the wireless business really ramping again this quarter. Can you just give us a sense because that area and that customer is getting to be fairly large. What kind of risk management tools do you have in place around that customer given some of the business challenges that they are facing?

Lynn Blodgett

It is a very, very good question, something that we are focused on. The biggest risk that we have with that particular customer and really with any of our wireless customers is the quality of service that we provide. We are big providers in a multiple of the amount they pay us on the same types of services. Even if they have a volume decline, they are spending so much more than what they have paid to us. Our job is to make sure we are the best provider. As long as we are in there among their very best we will be the best.

Then as they have volume fluctuation, it typically doesn't affect the higher performance, it effects the lower quality suppliers. So, the number one risk mitigator is we are focused like hawks on the quality of service. We have monthly reviews with the client and quarterly reviews. I have met with the senior leadership in the last 60 days. We watched the accounts receivable very, very carefully. We are focused on everything that is going on in that account, including our ramping schedules, turnover and our collections. The biggest of risk by far is that we just need to make sure we are doing a good job.

David Grossman - Thomas Weisel Partners

Very good.

Tom Burlin

That is an area where again, we talked about the divide and concur. Mind you that we broke that out of the separate business unit. And then within our process solutions we also subdivided the focus on the wireless market because it's such an important client to us. So, lot of focus operationally on how well we performed there.

David Grossman - Thomas Weisel Partners

Very good, thank you.

Lynn Blodgett

Thanks David, next question.

Operator

Our next question comes from Adam Frisch from UBS. Please ask your question.

Adam Frisch - UBS

Hey guys, its Adam. Good afternoon.

Lynn Blodgett

Good afternoon.

Adam Frisch - UBS

And pretty nice job there, Lynn, on the bookings, I do not know what you are doing. But stay out of your office because keep staying on the road there.

Lynn Blodgett

I think everybody in the office appreciates your assessment.

Adam Frisch - UBS

I want to go over the acquisitions real quickly. What was their contribution to the operating profit line in the quarter and how do you think they will trend over the next couple of quarters until the anniversary?

Kevin Kyser

Adam, this is Kevin. I will give you some. I do not have the actual results in front of me. So, let me just give you general comments. We have provided in the highlights where once they get them fully integrated where they will be as it relates to the corporate margin. We have gave you SDS we believe that SDS is going to be slightly accretive to the corporate average operating margin, that kind of gives you the puts and the takes.

Obviously, when we have acquisitions upfront, there are upfront costs that we incur as it relates to in the first month or two, but from net-net it should be right inline, I would say.

Adam Frisch - UBS

Okay. It is like kind of a normal run they should be inline with the corporate average?

Kevin Kyser

Yeah. Obviously we closed a lot of these. I tried to layout for you kind of where the effective dates were slide one of the presentation?

Adam Frisch - UBS

Yeah. I appreciate that.

Kevin Kyser

That is the effective date from when they are included in the results.

Adam Frisch - UBS

Okay.

Kevin Kyser

If you have look at Syan, since that was the one that was there for the most of the quarter. There is probably less than $1 million of EBIT contribution.

Adam Frisch - UBS

Okay.

Lynn Blodgett

In these ensuing few minutes, we have pulled that number and it is less than $1 million.

Kevin Kyser

So I hope that is what you are looking for.

Adam Frisch - UBS

Yes. It is perfect. I wanted to ask you a little bit. You were real good on the last call about providing some color on the margins for the March quarter. Do you think that the spike in bookings over the past two quarters depressed the business unit’s level margin for the next couple of quarters, or do you see a little bit of a comeback on those two lines?

Kevin Kyser

I hate to get too granular. I mean obviously, we have said we think we will see similar margins next quarter. I think if I had to bet today, I would say that the operating margins in the business would be positively up. I do not know if it would be 10, 20, 30, but it would be those would be up. And then, we would probably have on the corporate side as we get later into the year we obviously accrue a more bonus.

I would say that the business units would be higher and that the G&A expenses in the corporate area would probably be, the corporate expenses would be higher and therefore drag a little bit on the margins in the corporate area. However, net, I think if we are going to see similar consolidated operating margins in the fourth quarter.

Adam Frisch - UBS

That we did in the third quarter? You do not expect it to go kind of outside of the 11 to 12%?

Kevin Kyser

No, we clearly feel very comfortable with that.

Adam Frisch - UBS

Okay, that is good. Well, I will save you some questions and for the other guys too. But the percentage of the business related to the mortgage industry obviously, a little bit weak this quarter anything to get real worried about or is it something that is small that, if its actually attracts, if not going to impact the whole?

Lynn Blodgett

I think the total between land records business and mortgage business the grand total is about $50 million to $55 million, something like that.

Adam Frisch - UBS

Okay. That's very small.

Lynn Blodgett

And the contribution in terms of the negative was not half of that. The largest portion of that came because of in the transaction of the BPO area and that, where there is ramps, and we are ramping up in some cases hundreds of people. We mightily be slightly behind our ramp. It doesn't take very much for that to happen. So, nothing that other than the stuff I worry about every day, which is everything. We just have to make sure we execute and do our job. There is nothing that was systemic in the fact that we have shortfall in revenue.

Adam Frisch - UBS

Okay, great. I just wanted to gage overall size to avoid some. I will get it later on. Thank you. Nice job on the bookings.

Lynn Blodgett

Operator, let's move to the next question and lets have this be the final question.

Operator

Our last question comes from Bryan Keane from Credit Suisse. Please ask your question.

Bryan Keane - Credit Suisse

Hi, good afternoon. You guys here, putting up big booking numbers. But Lynn, I was hoping to see the organic growth move. Now, we are talking about the fourth quarter being similar to the third, does that mean its just taking little longer to ramp and we will start to see it beginning in the first quarter of 09 or just looking for some extra color?

Lynn Blodgett

Yes, and as I said, I was hoping that we would see about $10 million more. We share your concern about that or your observations about it. We are very confident that you are going to see improvement in ramp or excuse me in internal growth. That is one of the reasons we spent the time that Kevin spent the time going through the drivers of our internal growth. So, we are confident. It is probably, obviously I would have liked to see it at 6, and we are $10 million behind that. But on $1.5 million of revenue, it is critical that we continue and grow and ramp was that signings there and we are able to execute. So, I am not overly alarmed about. I think it is a probably little, about a quarter behind what I was hoping for.

Bryan Keane - Credit Suisse

And then Tom, it sounds like there are pluses and minuses going on with your student loan program with DOE. Do you think it is going to be more of a benefit or drag, when you look outgoing forward here?

Tom Burlin

Well, thus far despite the credit markets we have seen a slight uptick in our direct business on program. So, we haven't seen the down side. But being practical about it, we would assume we would see down side there. But the obvious shift is over to the direct loan and you can read the papers as we do, that there is a lot of activity about whether or not the federal government is going to buyback some of those loans to put them into other programs and how they are going to support this fall, the ability of students to get their loans. As it has falls into the direct student loan side, we are the provider there. So, we are comfortable that, net, the businesses are all up about $350 million between them. We think it will be an immaterial shift between the two.

Bryan Keane - Credit Suisse

Okay. We have been saying kind of 11 to 12 bracket. We are towards the lower end when we end fiscal year '08. Is there something that could happen to get us actually an increase in March towards maybe just the mid of that range or even to the higher of the range maybe scale?

Kevin Kyser

No Brian, yes, you get there is. There are items like that we have driving incentive comp team for offshore work team for, into the organization, driving procurement, the procurement savings faster in the organization. That is what we do. We focus on that day in and day out. And there is always puts and takes to a quarter so, yeah, you bet there are. We are striving to do that. But we are also really focused on growth and the bookings and getting the growth back to where we wanted to be. This, in the short-term has, offsets the good guys that we have going on day-to-day in the business, but that is a situation where we would play out every day in order to get the bookings and the growth up. So, we feel very strongly about being in that 11 to 12% range.

Lynn Blodgett

The best thing we can do to improve bookings or excuse me to improve the margin, is to improve growth because as we accelerate growth there are other startup costs that we talked about over and over again. But the best thing we can do in terms of leveraging the infrastructure and leveraging the organization is to grow. And so, as we are able and then there is always going to be this trade-off that's what we deal with every day. You do have startup costs associated with new contracts. In the long-term as we accelerate growth that will not be a negative on the margins it will be a positive. It comes down to fact that we are able to, is that someone said you are someone that scale starts to factor in and that becomes the most powerful driver of margins.

Bryan Keane - Credit Suisse

Okay, great. Lynn, congratulations to you and the management team. It's been a really quick turnaround on these results.

Lynn Blodgett

Well, thank you. Well, I am going to take a second, just to thank our people. We have an organization that just is second to none in my opinion and I am really proud of them. So, thank you for the comment. Thank you for making that comment and thanks to everyone who joined in on the call today. We appreciate it. Thank you. We look forward to seeing you in New York.

Operator

Thank you for participating in today's conference call. You may disconnect.

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Comments

[Fred F]

When responding to the question about recurring vs. non-recurring revenue Lynn was referring to Buck Consultants, LLC (ACS's employee benefit consulting subsidiary) not "bug" consultants!

[User 105165]

Thank you for your feedback. The correction has been made. We hope you continue to enjoy our transcripts.
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