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MAXIMUS (NYSE:MMS)

F2Q08 Earnings Call

May 8, 2008 8:30 am ET

Executives

Richard A.  Montoni - Chief Executive Officer, President and Director

David N. Walker - Chief Financial Officer

Lisa Miles – Vice President, Investor Relations

Analysts

Charles Strauzer – CJS Securities

Anurag Rana – KeyBanc Capital Markets

Jason Kupferberg – UBS Equities

Shlomo Rosenbaum - Stifel Nicolaus

Steve [Valog] - Cedar Tree Management

Operator

Ladies and gentlemen welcome to the MAXIMUS second 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, Vice President of Investor Relations.

Lisa Miles

Good morning. Thank you for joining us on today’s conference call. If you wish to follow along, we have posted a presentation on our website under the Investor Relations page. On the call today is Richard Montoni, Chief Executive Officer and David Walker, Chief Financial Officer. Following our prepared comments we will open the call up for Q&A.

Before we begin I’d 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 the result of risks we face including those discussed in Exhibit 99.1 of our SEC filing. We encourage you to review the summary of these risks in our most recent 10K 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.

With that I’ll turn the call over to Dave.

David Walker

Thank you Lisa. Good morning. This morning MAXIMUS reported financial results highlighted by strong financial performance from the Operations Segment offset by softness in the Systems and Consulting Segments. As we continue to provide quality growth in our core Operations Segment and divest non-core businesses we are taking clear steps towards becoming a focused Health and Human Services Operations peer play.

Let us turn our attention to financial results.

Total Company revenue for the second quarter was $210.6 million, an 18% increase compared to revenue of $179.1 million reported for the same period last year. All growth was organic and was driven by new and expanding work in the Operations Segment. During the quarter the Company incurred approximately $5.4 million of charges which include a $2.2 million charge related to a contract modification that MAXIMUS initiated as part of the requirement to build software functionality for a large education contract in the Systems Segment.

The fixed price portion of the contract price was reduced which creates an accounting charge. The $2.2 million value was moved to an incentive feature of the contract which allows us to earn back this money provided we meet a deliverable schedule over the next 18 months. More importantly we worked to modify the contract to ensure there was clarity and a governance process related to the software development requirements.

In the Consulting Segment we also took a $2.3 million charge related to our share of a client’s reduced reimbursement of a legacy claiming project. This amount may be recovered depending on the outcome of the client’s appeal effort.

Lastly, the Company also incurred approximately $0.9 million of legal expenses principally related to the ongoing arbitration with Accenture.

Despite the $5.4 million of charges which is approximately $0.17 per share the Company reported net income in the second fiscal quarter of $9.6 million or $0.51 per diluted share. We also announced in our press release this morning the successful divestiture of two non-core divisions last week.

First, within the Systems segment we completed the sale of the Security Solutions division for cash proceeds of $5 million. Second, we also completed the sale of the Unison division within the Consulting segment for proceeds of approximately $6.5 million. We have also entered into a contract to sell an administrative office in McLean, Virginia as we take steps to streamline our operating costs.

The expected earnings per share gain from the divestitures and the building sale is expected to be approximately in the range of $0.21 to $0.24 per share and will be recorded in the third quarter.

Let us move into the results by business segment.

Starting with the Operations segment. Revenue for the Operations segment increased 33% to $159.8 million compared to $120.4 million reported for the same period last year. Second quarter revenue growth was driven by new and expanding work. Most notably from Health Operations the Texas project in both our domestic and international workforce services operations. Segment revenue also benefited from infrequently incurring revenue of approximately $6.9 million related to a large hardware and software purchase.

The Operations segment recorded second quarter operating income of $23.6 million or an operating margin of 15% compared to income of $7.1 million and operating margin of 6% for the same period last year. Once again, the sizeable expansion in operating income reflects the optimization of the current book to business, the transformation on the Texas project as well as solid margins on new work. The Operations segment continues to benefit from a predictable stream of long-term recurring revenue. Under the direction of exceptional segment and divisional leadership the segment continues to meet our operational and financial expectations. As a result we still expect this segment to deliver an operating margin in the 12-15% range for the full fiscal year. Both our growth and financial performance in Operations continues to confirm our strategy of focusing on our core Health and Human Services business offerings.

Let’s turn our attention to the Consulting segment which had revenue of $20.2 million for the second quarter and a loss of approximately $800,000. The loss reflects a $2.3 million charge related to the previously discussed legacy claiming project which the client is appealing and may be recovered at some future date. For the last nine months the Company has been very clear about its expectations for the Consulting segment as we transition away from the claiming business.

In parallel with this transition we have already established a presence in the markets principally targeting the areas of program integrity and fraud, waste and abuse. We remain optimistic about these new markets and other plans which are developing for this segment.

Moving on to the Systems segment, financial results continue to be mixed within the segment. Systems segment revenue totaled $30.5 million but lost approximately $5.9 million. The Asset Solutions and ERP divisions continue to deliver strong results but this is offset by losses in both Education and Justice. We remain unsatisfied with the continuing under performing divisions within this segment. These losses stem from software development commitments that ultimately will position them well in the market.

Rich will discuss our actions in more detail but steps we are taking include: Managing scope of existing contracts very judiciously and modifying contracts such as the education contract discussed earlier where contractual remedies are needed, tightly controlling new contract terms that may contain software development requirements, changing and supplementing the management team with individuals with proven track records and prudent cost management. Segment results will continue to be soft as we drive the necessary change.

Let’s move on to a discussion surrounding overall Company margins. The majority of the charges in the quarter impacted revenue and gross margins in the Consulting and Systems segments. Overall MAXIMUS achieved an 8% operating margin driven by the strength in the Operations segment which offset the charges in Systems and Consulting.

In the second quarter SG&A as a percent of revenue was 17.7% which was improved compared to the same period last year and was consistent with the first quarter of fiscal 2008.

Moving on to the balance sheet and cash flow items, we ended the second quarter with cash totaling $63.4 million. Total current accounts receivable for the second quarter was $175 million. We also have an additional $1.7 million in long-term accounts receivable which are classified within other assets on the balance sheet.

We continue to stay focused on cash management and day sales outstanding continue to trend favorably under 80 days with second quarter DSO’s totaling 76 days. We still anticipate DSO’s to run between 75-85 days.

MAXIMUS generated cash from operations totaling $4.5 million. Free cash flow, which the Company defines as cash from operations, as property and equipment and capitalized software is $1.5 million. For the full fiscal year we continue to expect cash from operations totaling $50-60 million and free cash flow ranging from $30-40 million.

Thank you for your time this morning. With that I’ll turn the call over to Rich.

Richard Montoni

Thanks David. Good morning everyone. Our second quarter results were mixed. They reflect our success to date in how we market and execute in our core Health and Human Services operations. We are well underway to redefining our Company as the leading peer play in Government Health and Human Services program operations. This is what we define as our core market and we believe is a strategy that will provide long-term sustained growth and increased shareholder value.

Despite our strong showing in Operations which represented over ¾ of the Company’s revenue for the period, results for the second quarter were impacted as the result of a one-up charge in Consulting, ongoing legal expenses and costs related to our continuing efforts to improve performance and address legacy contract issues within our Systems segment.

With our core Operations business firing on all cylinders, we remain focused on and are determined to achieve improvement in under-performing areas of our business and to refine our focus to our core. We are doing just that.

Just last week we closed the sale of two non-core divisions and within the Systems segment we are aggressively moving along parallel paths to improve the under-performing divisions and to actively pursue all alternatives.

Let’s first talk about the Operations segment. The results from our Operations segment for the quarter reflect strong segment leadership and contractual discipline in how we acquire and structure new rewards. As part of this diligence we have declined unacceptable [inaudible] opportunities and renegotiated inequitable contracts.

At the same time we have focused on developing and pursuing new opportunities that represent a source of new incremental revenue to ensure we are putting our Operations business on a course for long-term success. Our emphasis on sustainable, recurring revenues and profitable growth resulted in top line growth of 33% compared to the same period last year and operating margins of 15%.

Historically we have talked to an operating model for the Operations segment with margins in the range of 8-15%. However, in recent quarters we have weeded out under-performing contracts and laid in more rewarding business. As a result our margins in Operations are running closer to the top end of this range. We feel confident in the strides we have made to strengthen the segment. As a result, we are raising the lower end of our target operating range for this segment and are now expecting its margin to consistently range between 10-15%. We are in a new chapter with our core Operations and our refined margin outlook for the business is the best validation of our success in getting the segment on the right track for the long haul.

I should also mention that we have been making strides with our productization effort within the Operations segment. Another key element to streamlining our processes is advancing our technology efforts. What I’m referring to here is our emphasis on moving away from highly customized solutions to more of a component based or modular approach where we utilize plug-n-play technology anchored in the services oriented architecture from program to program.

Recently we completed our Enrollment Broker platform which is already installed in Indiana and we are also in the process of upgrading other existing clients to this technology. In conjunction with this effort we are also on a path to complete the productization of [inaudible] components by the end of this fiscal year. We believe our initiatives of coupling new technology with standardized business processes will allow us to compete most cost effectively. This is just an example of some of the operating enhancements we are working on to reflect the benefits of focus.

Turning to Consulting, performance for the segment was in line with our expectations for the period with the exception of the $2.3 million charge related to a legacy claiming project the client is appealing. Let me give you some background on this claim. Prior to taking on this job we brought in specialized legal counsel to review our claiming method. After review accounts proved our method which had been successfully utilized before. We do view this as a normal course excise and we feel reasonably confident that the client will prevail.

Regardless, as we have previously discussed we are no longer providing Federal claiming on a contingency basis. Instead our emphasis has been in other areas which overlap more with our core program management offerings. This would be like program integrity which includes combating Medicaid fraud, waste and abuse. Consulting services are very important to our customer base and they do dovetail with our core services. As such we are pursuing more opportunities to pair up Consulting services with our Health and Human Services portfolio. By aligning Consulting with our core competencies our collaborative efforts will facilitate better cross-selling while sharing best practices from state to state.

As announced today we divested our Unison MAXIMUS subsidiary through a division management led buyout. This subsidiary was part of the Consulting segment and is an airport, retail and financial consulting business. This business while a profitable contributor was outside our core competency.

We also then instigated the sale of our Security Solutions business to Cogent which again while a stable contributor was not consistent with our refined business focus.

This discussion represents a good opportunity to segue into our review of the Systems segment. As we discussed in the past the challenge in Systems has been limited to the Justice and Education divisions. These divisions are in the process of completing the build out of new software and hence our focus to complete their development stage and generate business unit improvement while meeting their contractual obligations and maintaining the integrity of the MAXIMUS brand.

As a result our near-term emphasis has been balancing commitments, completing the software development and changing the way we go to market to emphasize product standardization over customized solutions.

In the area of Justice we have initiated cost cutting measures to drive improvement which should help lessen the losses for the remainder of the year. The Justice department has been directed to focus principally on completing the implementation commitments and service delivery with our client base. The division will also limit marketing of new contracts. This narrowed concentration has allowed us to take appropriate initiatives including a reduction in force.

This week we eliminated approximately 25% of the Justice Solutions workforce and we believe this will deliver annualized savings of over $4 million some of which we expect to realize in the fourth quarter. While this is an important step in the right direction we also announced that we have new segment leadership in place. John Hines, a very well respected member of the MAXIMUS management team is stepping up to lead our efforts. John brings over 30 years of commercial software development expertise to the table and he has been with MAXIMUS for nearly a decade. In his most recent role John served as President of the Asset Solutions division which is a long standing profitable contributor to MAXIMUS.

In addition to John we have also deployed two of our top technologists to help accelerate the completion of our software products in Justice. These are some of the best and brightest project leaders who came out of our top performing divisions to serve on special assignment to help drive our software development to completion and provided oversight. The bottom line is we are intent on effecting near term change.

As noted in this morning’s press release I think the successful renegotiation of our largest education contract demonstrates our commitment to improve and bring resolution to the legacy situations. The modified terms and conditions of this agreement outline milestones necessary to achieve completion. As a result there is now a well constituted correlation between plan and the commitment milestones.

As David noted earlier the charge related to this modification is not a permanent reduction and we intend to earn the $2.2 million back as we achieve implementation of the milestones over the next several quarters.

In addition to generating operational improvements within Systems we are also taking a parallel path of exploring strategic alternatives for these businesses. As demonstrated in the sale of Unison and our Security Solutions business we have been proactive in divesting non-core holdings. While we can offer no assurances on future outcomes we are actively pursuing a variety of options for additional non-core assets and we will update you as appropriate.

Lets turn our attention to the overall market outlook. As we have said in recent quarters even while state fiscal budgets are under pressure we see this as a time when the need and value proposition of our core services remains strong. Generally state cost cutting actions have been aimed at the reduction of direct program benefits with a significant savings line and not at program administration because the need for administration remains. We have simply not seen a slow down of our work at this time.

Beyond our work domestically we are well positioned to capitalize on international opportunities that are developing in our core Health and Human Services operations including expansion of current programs. For example, in Israel where we run a major workforce services program we are encouraged by the possible expansion opportunities we see on the horizon. Also during the quarter we announced a $14.2 million amendment to our Master Services agreement in British Columbia. This is related to the PharmaNet program which we have administered since 2005. This important program links all pharmacies in British Columbia to a central set of data systems that supports many functions.

Under the amendment, MAXIMUS will lead the effort to upgrade this application to the next generation platform. We are very excited about our expanding work in Canada and our ongoing efforts and excellence in Operations outsourcing.

In addition, we are pursuing other international opportunities with substantial marketing efforts underway. We have staff on the ground in Australia, Canada and the U.K. working these opportunities. While in aggregate the potential contract values for these international activities could be quite large most indicators point to most of these programs being bid in regions similar to the approach we have here in the states. We think this approach provides mutual benefits to governments and to vendors.

These types of regional opportunities are expected to lay right within our sweet spot in terms of scope and size. I expect them to be along the line of singles and doubles rather than a grand slam. I believe that many of these opportunities may provide additional streams of revenue potentially beginning as early as the second half of fiscal 2009 and stretching beyond. Our extensive programmatic expertise and demonstrated successes should provide us a competitive leg up as we continue to strengthen our foothold in the international marketplace.

We are certainly excited about extending the breadth of our geographic footprint and serving a broader market with core service offerings where MAXIMUS is a market leader.

Lets turn our attention to new awards in the sales pipeline. This data is very encouraging and supports our position that we have not seen a slow down at this time. Starting with new signed awards as of May 5, 2008 MAXIMUS signed new awards totaling $650 million which includes approximately $200 million related to the signed California Healthcare Options rebid. In addition we have had another $149 million in awarded but unsigned contracts.

Our sales pipeline continues to grow and totaled $1.6 billion at May 5 which is driven primarily by new opportunities in the Operations segment. On the re-bid front we have been notified of award or extension on three bids totaling approximately $36 million. That leaves us with eight remaining re-bids with a total contract value estimated at $237 million the largest of which are the three Texas contracts.

Moving to option year exercises, to date out of the 27 options with a total value of $223 million up for exercise this year we have won or been notified of intent to award on 14 options which carry a value of about $122 million. This leaves us with 13 options with an estimated value of $101 million.

In summary, we have not lost an option and none of them cancelled or taken in-house due to funding issues.

Moving on to guidance. As noted in this morning’s press release we are revising our fiscal 2008 guidance principally as the result of divestitures and performance from Justice and Education divisions inside the Systems segment.

For fiscal 2008 we now expect revenue for fiscal 2008 in the range of $830 million to $850 million with GAAP basis diluted EPS of $2.55 per share to $2.70 per share. This GAAP basis guidance includes a gain of approximately $0.21 to $0.24 per share related to the sale of the Securities Solution division, the sale of the Unison division subsidiary and the pending sale of a property in McLean, Virginia. Guidance also includes a $0.07 per share impact related to the forecast of legal charges for fiscal 2008.

Additionally, guidance does not include any gains or losses from any potential future divestiture or restructuring activities. Before we open it up to Q&A, I just have a few closing comments.

At the onset of the year we shared our views of the risk assessment for the year and felt the risks were largely tied to the performance in the Systems segment. While financial results in Systems have been disappointing we have made critical needed progress and we believe we are in a better position today to effectively pursue alternatives for non-core assets. Despite the soft performance of the Systems segment the Operations segment continues to deliver solid financial results. This further confirms the advantages of our strategy to focus. As a result when we complete this transition phase in Enterprise Systems I am confident that our company will be solidified as the leading peer play provider to government health and human services. This will bring the significant added benefits and focus to our clients, our employees and to you our shareholders.

So in closing in addition to being determined to complete this transition phase we remain very enthusiastic about our future. Now let’s open up the call to your questions.

Question-And-Answer Session

Operator

(Operator Instructions)

Your first question comes from the line of Charles Strauzer of CJS Securities.

Charles Strauzer – CJS Securities

The divested businesses in the Systems segment, beyond the gain that you recorded in Q3 what is the impact on that segment in terms of lost revenue and potential profits in those businesses?

David Walker

Both of those businesses combined last year had revenue of about $30.8 million and they made about 4.3%. So they were profitable and they had declined about 11% in the aggregate in 2008.

Charles Strauzer – CJS Securities

On the operating margin for the Operations business at 10-15% obviously you are doing very well there. What are the factors that could cause the margin to go to the lower end of that range over the year?

Richard Montoni

A couple of things. I think Dave Walker in his comments said for the full year we expect that segment to deliver 12-15%. But for long term year out we have set our range for 10-15%. In terms of what are the factors there are many factors. The factors that come to mind that are most significant would be the stage of new work that we take on. Generally on the longer term contracts we find that front end we have investments. Sometimes these expenditures need to be expensed as incurred pursuant to generally accepted accounting principles. So you may find situations where new work has either a negative margin or lower margin and then as the contract matures and we start driving efficiencies we get greater margins towards the tail end of the contract.

So, the nature and timing of the contracts would be a factor. I think that is probably the largest factor.

David Walker

Quarter over quarter you get fluctuations due to timing of maybe the equivalent of open enrollment so we’ll get big expenditures that may bear lower profit on individual quarters.

Charles Strauzer – CJS Securities

Also the six contracts up for re-bid, what is the status of those? Are those RFP’s submitted? Are they in kind of the review phase?

David Walker

That is in a hold pattern at this point in time. The state has not moved forward with the RFP process. We don’t know when those RFP’s will come out at this point.

Charles Strauzer – CJS Securities

On the Program Integrity you mentioned there is a new area that you are focusing on some of the Consulting business with that. There is a number of the Medicare/Medicaid integrity contracts up for bid under the Civil Task order. Are you bidding for any of those right now?

David Walker

I believe we are very, very active in that space. We are very proud of our accomplishments and I think we lead in many of those niches if you will. We are excited about the new opportunities that are coming in front of us and we are very active.

Operator

The next question comes from the line of Anurag Rana of KeyBanc Capital Markets.

Anurag Rana – KeyBanc Capital Markets

Rich could you give us an idea of the total bookings that you recorded so far what percentage of that belongs to the Operations segment versus the other two segments?

Richard Montoni

Generally we don’t share the details behind the new contracts signed, etc. But you can rest assured that the majority is in the Operations segment. It pretty much follows the proportion of revenues and Operations by far is the leader.

Anurag Rana – KeyBanc Capital Markets

That would make sense. That brings me to my second question. Why even bother extending in the Consulting segment given that you want Operations to be the core area going forward?

Richard Montoni

I think that is a great question. My view on Consulting is this. I think that our clients need Consulting and our approach to Consulting as we go forward is to very much marry our Consulting expertise with our Operations expertise. In many regards it is our Consulting capability that leads and provides innovative views, methodologies and technology which frankly is the value add to our clients. They look to us for that. So I think provided we operate Consulting in that complementary fashion it adds value and gives us competitive advantage and quite frankly I think it can be a very, very profitable business.

Anurag Rana – KeyBanc Capital Markets

You just mentioned the Texas contract is in a hold process so should we assume if there is no RFP out you will continue doing work under the old order?

David Walker

I think that is a fair assumption.

Anurag Rana – KeyBanc Capital Markets

Lastly, I know it is too early to talk about next year but I think that your bookings as far as the first half of this year are almost double or more than double than what you did last year so far. Any kind of indications as to what kind of organic growth rate we should expect on the base off of the divestitures for next year?

Richard Montoni

It is really too soon to tell but I will tell you just to give you some directional sentiment in that context we have always said we think our business model can deliver 10% top line and 10% operating margin long term. I still think that is a fair assessment. Naturally we do have macroeconomic situations we have to deal with in this environment, but I will tell you that offsetting that and going in the opposite direction are some very significant needs that our clients are facing where we provide what I think are effective, unique solutions and they seem to be very well received at this time. Our clients are dealing with some very significant challenges to comply with new Federal rules and regulations in many of these programs in Health and Human Services. They are having to struggle with retiring workforce so they don’t have the folks to carry on the work in light of these additional requirements. To a large extent that is fueling our growth. Even when you strip out the benefit of the Texas contract year-over-year you will find that the organic growth for the company is north of 20%. So I’m not going to steer you to expect that in FY09, but it does give you an indicator that there are some very strong underpinnings in demand for what we are offering in the marketplace.

Operator

The next question comes from the line of Jason Kupferberg of UBS Equities.

Jason Kupferberg – UBS Equities

I just wanted to start with a question on the arbitration situation with Accenture. I think this is the first quarter we have seen some legal costs associated directly with those proceedings and there is a projection for $7 million I believe over the course of the fiscal year. So can you give us an update on what has incrementally changed to drive the need for those changes and where the actual process stands in its chronology here?

Richard Montoni

Where the arbitration itself stands, Jason is there is no scheduled date for arbitration at this point in time. Originally when the arbitration process was launched I believe it was said the arbitration was scheduled to occur this spring. That has been postponed and no date has been set at this point in time. So our counsel is involved in preliminary ongoing analysis, preparation and making sure we remain ready for arbitration when the date is set. The reason for the charge in this situation really relates to the circumstance of the insurance situation. We have insurance on this matter. We had been of the opinion that we had hit the deductible if you will and that the insurance company should pick up and cover legal charges from that point forward. That is a matter that is being “discussed between the parties” so until such time as the insurance company agrees to pick up that legal bill we felt it best to record it and recover it when we come to terms with the insurance company.

Jason Kupferberg – UBS Equities

So there is a possibility that those charges then get reversed?

Richard Montoni

There is a possibility but that remains to be seen.

Jason Kupferberg – UBS Equities

How should we think about for full year fiscal 2008 what the growth in margin expectations should be for the Consulting and Systems segments? Maybe you want to phrase that on a more pro forma basis I guess given the divestitures. But just so we can get a sense as the businesses stand today what kind of growth and operating income might they be able to produce over the course of the full year?

Richard Montoni

Just so I understand your question, you are looking for some directional insights in terms of margins for the full year by the segments?

Jason Kupferberg – UBS Equities

For Consulting and Systems specifically as well as their revenue growth potential.

David Walker

I would say on the revenue side you shouldn’t expect much growth in Systems. Directionally what we are doing is being very judicious about new work we take to make sure we don’t further add requirements to what is a development backlog. So, I wouldn’t expect it there. In Consulting we have got a lot of money going in to investments in new areas which is why our operating income there is not as high as we would normally like in Consulting. But again, I think those things will pay off but not in fiscal 2008.

Richard Montoni

Said another way, Jason, I would say from a top line perspective I think all of our revenue growth year-over-year 2008 over 2007 will be driven by our Operations segment.

Jason Kupferberg – UBS Equities

If we look at the year-to-date award total what would be the mix of new versus renewed work in that year-to-date contract award total?

Richard Montoni

We don’t have that metric and historically we haven’t published the metric. I will say that we disclosed in the press release and had a separate press release that the biggest award in that new contracts signed of the 615 the biggest reward was that renewal of the HCO contract which is approximately $200 million. But we are finding a significant portion of the new signed work is in fact new work.

Jason Kupferberg – UBS Equities

One housekeeping item, how much potential proceeds might you guys see from the sale of the headquarter building? Is that going to be a sale/leaseback situation or is that just excess real estate?

David Walker

It is just excess real estate. The sales price is $6.1 million. There will be taxes and a book value so it is not all gain but that is the cash price.

Operator

The next question comes from the line of Shlomo Rosenbaum of Stifel Nicolaus.

Shlomo Rosenbaum - Stifel Nicolaus

I just want to focus a little bit on some of the pinpoints in Justice and Education. Starting out with the Education contract you said it was the largest contract. When was the contract signed exactly and do feel like after you work through this you work through at least in that division a lot of the headwinds that you have on the development projects?

Richard Montoni

On the Education contract, which is a large contract that was signed originally in 2003 and it is a long term contract. I think this is a very significant and necessary accomplishment for the division. The prior contract before the amendment did not have sufficient clarity for us to effectively know what we needed to do and when we would be completed with the contract. I’m sure you can appreciate that is a very important thing to drive these contracts to completion. So this amendment gives us that benefit and I am of the opinion that the client and MAXIMUS understand what the key milestones are as a result of this amendment. We have agreed in terms of targeted deliverables and we are on the way to accomplish that.

Shlomo Rosenbaum - Stifel Nicolaus

You talked about Consulting really dovetailing with a lot of the work you do in the Operations segment. If I’m reading you correctly it sounds like the Systems segment is something that you guys could see on an ongoing basis would not be necessary. Am I reading it correctly or are there still some areas of Systems that you still think would be necessary in your end-stage goal of HHS peer play?

Richard Montoni

I don’t think there is anything in our enterprise systems segment that is closely correlated to our end-stage goal as a Health and Human Services peer play. You may recall there were five divisions inside the Enterprise Systems segment. We just sold one of them, the Securities Solutions division. That leaves us with four; Asset Solutions, ERP, Justice and Education Systems. Each of those divisions I think there is no correlation with our Operations group.

Shlomo Rosenbaum - Stifel Nicolaus

Going on to the amendment of the British Columbia contract just to understand you are going to be moving the platform to upgrading the platform. What do you consider the risk profile of that amendment? Is that something you guys have done before and can you talk about that a little?

Richard Montoni

I actually think the risk profile is very low. When we think about that and we don’t have time today to get into all the detailed points. We have a very effective working relationship with the client. We have a very, very strong team from not only an operational perspective but from a technical perspective that is dedicated on-site in British Columbia. I view this as simply an add on to our existing services. I am very, very confident there is low risk associated with this work.

Shlomo Rosenbaum - Stifel Nicolaus

Lastly, on the operating margin on the Operations segment. The first half of the year the margins coming in have been very good, 13% and then 15% for two quarters. Is there any reason to expect that going in to the second half of the year it just wouldn’t be at the upper end or even above the upper end of that range?

David Walker

You get some mixed things that happened during the quarter. We had some large things and good things that happened this quarter. At the tail end of the year we tend to…so while that was one time and should not benefit us in the third or fourth quarter on the other hand our tax crediting business that we have talked about in the past tends to kick in strong on the third and more particularly in the fourth quarter. So tend to net themselves out. So it is timing.

Richard Montoni

To sum it up I think we still see these tailwinds continuing through the rest of the year.

Operator

The final question comes from the line of Steve [Valog] of Cedar Tree Management.

Steve [Valog] - Cedar Tree Management

The Education contract was the program centered in this one contract and Rich were you involved in the renegotiation?

Richard Montoni

Yes, the challenges in the Enterprise Systems division were concentrated on this one large contract which reportedly is quite frankly very closely related to the development build commitments of the division. So we have the benefit of a focused target if you will to complete this for development and will concurrently complete our obligations to this by far our largest client of the Education Systems division. There were and are smaller clients and we have client commitments but they are of an order and magnitude less significant than this one large contract.

Yes, I was involved at a minimum on a weekly basis with the entire division and the contract itself as we moved forward in the negotiations and the legal aspects of the amendment.

Steve [Valog] - Cedar Tree Management

So it looks like we take our lump here and Education is reasonably on its feet. I’m sensing or understand the Justice division issue is a lot bigger because you are bringing in some big guns to fix that. Is the software development problem here centered around one client or is this a system that you were productizing and it just got out of hand? We have a lot of R&D against something with no revenue?

Richard Montoni

First on Education Systems I think we have positioned the division to be successful but they still need to execute. So that is not a foregone conclusion so we still have some significant management attention that will be put to that and we’ll work very hard to make sure that happens. On Justice, you are right. The Justice situation is more complicated. There are more clients involved. They have a very significant installed base of an earlier version of their software and they launched a plan a couple of years ago to build a new web based architecture which has a lot of appeal to it in the marketplace. They made commitments to some very significant clients of this company. We are focused on completing those commitments to those clients but by and large the Justice division simply didn’t balance its commitments in the marketplace with its capability to deliver those commitments in the marketplace. So we are working hard to balance those commitments, fulfill those commitments to those larger clients and focus the company. I think the right thing to do is focus on those commitments, complete the commitments and in the mean time lets not go out and sign up new commitments until we get the first part of the equation right. Then when we get that software built out and it is demonstrated to the existing client base then they will open up the doors and look to market it further but that is going to take a little bit of time.

Steve [Valog] - Cedar Tree Management

Were the divestitures dilutive, accretive or neutral?

David Walker

They were mildly dilutive and currently we are making 4% operating income.

Richard Montoni

Let me make one point on the divestitures. The divestitures were executed under the element of our strategy which is to focus the company on its core. These were not troubled businesses. They were not problematic businesses. In fact they were profitable businesses and I view the time to divest those businesses is while they are relatively healthy. They should thrive under their new ownership. I think they have exciting opportunities with the focus they are going to get from the new owners. It is just it wasn’t our focal point.

Inside the company as a whole I would like to emphasize that the two problem divisions we have have been Education/Justice challenged by software development commitments and they are very much development stage software build out enterprises and we are working to remedy those two. Aside from those two I don’t think we have any problematic divisions inside the entire company.

So we know where the challenges are. We are focused on them and they are very, very limited.

Steve [Valog] - Cedar Tree Management

Lastly, a broader question. When you first took over and there were going to be real judicious in what new business we brought on my first thought was gosh that’s great but I bet the revenue growth slows down. That hasn’t really happened. Has that surprised you or can you talk to that? I think it is kind of surprising for getting more judicious, but business is still strong.

Richard Montoni

I think on the surface I can appreciate your observation and I think it is a fair observation. But I think in business when you focus in your number one or two, especially in our marketplace where we have a customer base that places an inordinate amount of emphasis on the vendor’s ability to deliver…they place a tremendous value on your experience and confidence in your ability to execute. When that happens you win more work than you otherwise would and your ability to execute because you focus on those areas increases immensely. So I think it drives higher revenue growth than run of the mill companies when you focus on your number one or two. I also think it drives higher margins because you are better able to avoid marginal work. You are better able to execute on those projects that you have. You discover your problems sooner and you can remedy them in a more effective fashion. So in those areas where we choose to focus we have chosen to focus we are seeing those benefits today.

Lisa Miles

Thank you very much for joining our second quarter earnings call. That concludes our call today.

Operator

Ladies and gentlemen this concludes today’s presentation. A replay of this call will be available to you within two hours. You can access the replay by dialing (877) 660-6853 or international (201) 612-7415. Enter a pin number 316 followed by the conference number 271353. Again, enter account number 316 followed by the conference number 271353.

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Source: MAXIMUS F2Q08 (Qtr End 3/31/08) Earnings Call Transcript

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