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Executives

Jon Puckett - VP of IR

Lynn Blodgett - CEO

Tom Burlin - COO

Kevin Kyser - CFO

Analysts

Vincent Lin - Goldman Sachs

Moshe Katri - Cowen

Bryan Keane - Credit Suisse

Adam Frisch - UBS

James Kissane - Banc of America

David Grossman - Thomas Weisel

Bhavan Suri - William Blair & Company

Tien-Tsin Huang - JPMorgan

Affiliated Computer Services Inc. (ACS) F4Q08 (Qtr End 06/30/08) Earnings Call August 7, 2008 4:30 PM ET

Operator

Good afternoon and welcome to the ACS fourth quarter and fiscal year 2008 conference call. (Operator Instructions).

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

Jon Puckett

Thank you, Kelly. Good afternoon and thank you for joining us today to discuss our fourth quarter and 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 maybe 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 Principle financial measures which we believe provides useful information for investors.

We have posted both the presentation and a reconciliation of those measures to Generally Accepted Accounting Principles on the Investor Relations page of our website at www.acs-inc.com.

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 CEO, who will provide a summary of the significant events during the quarter.

Lynn Blodgett

Thanks, Jon and thanks to each of you for joining us today. The fourth quarter represents the culmination of an excellent year at ACS. When I reflect on the year with its challenges and opportunities, I am once again astounded at the strength and quality of the company.

Our recurring revenue model, our client-focused culture, our global production model, our focus on leveragable solutions, and our tireless emphasis on reducing costs have forged a company that has proven its ability to perform well in good or bad economic times, and in times of turbulence resulting from either internal or external circumstances.

I wish to express appreciation to the investment community for the trust you have shown in ACS. I also want to thank our wonderful customers and our 65,000 dedicated ACSers around the globe for their part in making this a very successful year.

Please turn to slide number 3. We knew that we had to make a material improvement in signings in order to accelerate our internal growth rates for fiscal 2009. Signings were $210 million for the quarter and $801 million for the year. This is an increase of 32% in the trailing twelve months signings, and the highest level of signing growth since September 2003.

Total contract value was $685 million in the quarter and $3.2 billion for the year. During Q4, we diversified our telecommunications client base by signing new customer care contracts with two wireless operators.

We signed expansion with several commercial ITO customers. We leveraged our student loan servicing platform with new contracts to take advantage of the disruption in that market. We signed expansions throughout our healthcare payer vertical, and signed new business in the eligibility market. On this slide you will also see the split between segments and service lines.

Please turn to slide number 4. Another focus this year was ensuring that our customer base was stable. The best indicator of customer satisfaction is our renewal rate. For the quarter and the year, we achieved a renewal rate of 92% above our goal of 90%, and signed key renewals across the organization. Q4 renewals totaled $319 million of annual recurring revenue and a total contract value of $922 million.

Renewals for the fiscal year totaled $753 million of annual recurring revenue, with total contract value of $2.7 billion. When you combine signings and renewals for the year, it totals almost $1.6 billion of annual recurring revenue, and total contract value of nearly $5.9 billion.

Please turn to slide number 5. Another key goal for fiscal 2008 was to increase our overall sales effort, while I am confident in our sales organization there is much more that we must do in this area. We have added sales people, we have pushed sales to the group level and broadened our service offerings, technically and geographically.

Our efforts not only helped us achieve record signings, but we also enter fiscal 2009 with a pipeline totaling $2 billion, the largest in our history. We are seeing major international opportunities in our Transportation group, strength in ITO, transactional BPO, customer care, finance and accounting, state and local and government healthcare. On this slide we have also provided the split between segment and service line.

Please turn to slide number 6. Our long-term goal for revenue growth is to grow internally at or above market growth rates. We then expect to add a couple of points of growth from acquisitions. Internal revenue growth for the year was 5% and we had 2% from acquisition for a total of 7% revenue growth.

Record signings this year have not yet translated into internal growth acceleration for two reasons.

First, low signings in fiscal 2007, and second; anticipated longer ramp cycles and new electronic payment contracts and MMIS contracts. Internal revenue growth was 4% with 2% from acquisitions for a total of 6%.

Internal growth for the quarter was one point below our goal for two primary reasons. First, the reduction in volumes in our transportation group due to unprecedented increases in fuel costs, and second, the delay in closing some one-time revenue in our lumpy unclaimed property business.

With our business model, the real revenue impact of signings is felt in the following year. The weak 2007 signings did not provide enough room to navigate through an event like higher fuel prices. We are solving this issue with the signings we have posted over the last three quarters, and expect average signings per quarter to continue to increase.

Kevin will discuss the expected impact of increased signings on 2009 internal revenue growth, so that you can have the best data possible for your models. One of our goals for FY08 was to deliver double-digit earnings growth and our record adjusted earnings per share of $3.53 represents 13% growth over the prior year.

We improved both operating cash flow and free cash flow in 2008. Free cash flow for the year was a record at $518 million and was a 37% improvement over the prior year.

So, FY08 in a summary. Record revenues, record adjusted earnings per share, record cash flow, record signings, outstanding renewals and a record pipeline. These are tremendous results and I am extremely proud of our company and our performance, but let me conclude with a focus on 2009.

Please turn to slide number 7. Fiscal 2009 promises to be a year of continued improvement and signings which will drive higher internal growth. Our pipeline is made up of good opportunities which are generally of moderate size in each of our lines of business.

We will keep our discipline of not relying on larger deals, but an occasional triple or home run like the treasury win this year does help drive internal growth.

My goal is to generate signings of $250 million per quarter as we enter calendar year 2009, and to have solid double-digit improvement in trailing 12 month signings over fiscal 2008.

We have a $2 billion pipeline of opportunity, and we are adding more sales people to pursue these opportunities. Second, we will continue our disciplined acquisition program by adding vertical market expertise and expanding geographically.

We will continue reviewing our business portfolio for potential divestitures of business that no longer are core or unable to meet our growth and margin requirements. Third, we will focus on leveraging repeatable solutions across our customer base and vertical market.

Each line of business has innovation initiatives to enhance our service offering. For example, we are investing in our workflow software that will benefit our transactional BPO and finance and accounting businesses.

In transportation, we launched a new version of VECTOR, our electronic tolling platform. We continue to invest in our innovative remote infrastructure management capability. Today, one-third of our servers are remotely managed in over 100 countries, and we expect to increase that percentage.

Next, we will drive cost reductions across all areas of the organization through better use of incentive-based compensation, our global procurement process, innovation and our offshore resources.

We must reduce our operating costs in order to maintain our target margins in the face of discounts on renewals and increased start-up costs due to higher new business signings.

Finally, as a result of these efforts, we expect to provide good returns to our shareholders in the form of double-digit earnings growth. Our success in fiscal 2008 in signings, in pipeline, revenue, adjusted EPS, and cash flow demonstrate that we are able to deliver excellent results. I am proud of our organization for our accomplishments this year and I look forward to an even more successful 2009.

Now let me turn it over to Tom Burlin for an operations review.

Tom Burlin

Thanks, Lynn. Please turn to slide 10 and I will review our commercial segment results. I was very pleased with our commercial results this quarter. On a year-over-year basis, commercial's total revenue grew 11% with 8% internal revenue growth which was driven by ramp of new business in ITO, increased wireless customer care volumes and our HR business as we ramp fiscal 2007 signings, and saw increases at existing clients.

Let me take a moment and comment on our HR business. We are seeing healthy growth in this business. However, we have noticed a shift in the market from multi-scope HR services among potential clients, advisory firms and HR service providers.

Clients are seeking faster payback on deals, which is resulting in fewer large investment-heavy mega deals or multi-scope HR deals.

We intend to take advantage of these changes in the market by leveraging our excellent point solutions. As evidence of the shift and our strong capabilities, we have signed two very nice learning outsourcing contracts this quarter that totaled over $10 million in annual recurring revenue with two large global companies.

Healthcare Payer also contributed growth from credit balance auditing service, customer care and claims processing services.

Year-over-year, total revenue growth was positively impacted by a recent acquisition of CompIQ, and Healthcare Payer, and our recent international acquisitions in ITO.

On a sequential basis, revenue growth was driven by the ITO business and wireless customer care volumes.

Turning to profitability, year over year adjusted operating margins were flat while sequential adjusted operating margins increased by 60 basis points due to increased revenue and operational improvements in the ITO business, wireless customer care volumes, and improved profitability on several F&A contracts that entered the operational phase.

Could you please turn to slide 11? Over the course of the quarter, we have had some repeated questions about our commercial business that I would like to address. As we have talked in the past, the student loan market is undergoing some significant changes, as many lenders have stopped providing new loans due to lower government subsidies under the FFEL program.

We see this disruption as an excellent opportunity to leverage our strong servicing platform, and our one-to-many approach to expand our client base among small and mid-size lenders in the secondary market.

We saw traction on our strategy in the fourth quarter as we signed new business with the Student Loan Finance Corporation, among others. We believe we can help larger lenders consolidate the number of loan services they utilize and drive down their operating costs. There will be other opportunities that arise out of this market disruption, and we plan to take advantage of these.

We have a strong presence in the telecommunications vertical, with particular strength in wireless customer care. Our largest client is in the wireless customer care vertical, and we are proud to have grown this relationship during fiscal 2008.

In this quarter, we signed new contracts with two other wireless operators, which will help diversify our client concentration in this vertical market.

Next, let me update you on our mortgage service business, which represents less than 1% of total revenue. It is no surprise that this business has seen some revenue contraction this year, but it might surprise that you despite the revenue decline, we have been able to maintain and even grow our operating margins by increasing offshoring, ramping new business, and being prudent with cost structure.

In summary, I am very pleased with our results in commercial segment this quarter.

Please turn to slide 13, and I will review the Government segment. Total revenue in government was flat excluding divestitures, and internal growth declined two percentage points, which was a disappointment.

We expected government internal revenue would be flat because of the grow over issues created by a record quarterly government revenue in the fourth quarter fiscal 2007.

During the quarter, we were impacted by our nonrecurring unclaimed property business, which is typically lumpy from quarter to quarter, but it was below our expectation.

In addition, transportation was negatively impacted by drivers' reaction to higher fuel prices. Our fourth quarter fiscal 2007 had higher than normal transport revenue project work. These items combined negatively impacted fourth quarter fiscal 2008 revenues by about $15 million, and internal revenue growth by 2 percentage point at the government level and one percentage point at the consolidated level.

We had a number of questions during the quarter about the impact to state and local budgets on our business. We saw growth in government lines of business that we would expect to grow in difficult times, like revenue generating services and entitlement programs.

Child and family services, electronic payment services, eligibility, government healthcare and education all grew. These trends give us confidence in our business model and its defensive countercyclical nature.

Turning to sequential growth, revenue increased 4% sequentially in government, driven by the broad growth in the areas I just mentioned. Although, it was below our expectations, we saw improvement in our unclaimed property business.

Government healthcare grew as we ramped new MMIS contracts that we signed earlier in fiscal 2008. These increases were partially offset by transportation.

On an adjusted basis, government operating margins increased 10 basis points sequentially but declined approximately 140 basis points year-over-year. The year-over-year decline was driven by lower transportation revenue. Margins were also pressured by start-up losses in government healthcare as we ramped new business.

If you would please turn to slide 14. Let me make a couple of additional comments on state and local budgets. We are seeing increased demand from our state and local clients in areas of expense that we can reduce. As an examples, our stored value cards and our electronic payment business, customer care, especially in human services and IVR.

As evidenced, the state and local pipeline has more than doubled over the prior year. We are getting traction from our solutions that help generate revenue for states like corporate net income tax compliance.

We are also seeing interest in services that make government more efficient like our collection offerings including child support, EMS, state and municipal courts.

Many of our state and local businesses involve Federal Funding or needs-based programs. These services are usually not cut but often are in higher demand in difficult times, because they are considered critical or serve the most at-risk portion of the population. In summary we like our position in the state and local market and are eager to continue to serve our great clients.

Next, let me update you on the integrated eligibility project in Indiana, a topic that has received a great deal of media attention recently, and which will continue to do so as we approach the elections in the fall.

As most of you know, IBM and ACS are part of a team that is modernizing Indiana's Welfare Eligibility Program. IBM is the prime and is providing technology. ACS is subcontracted to IBM and is providing BPO services.

It is important to note that ACS continues to provide the same general scope of work as we have from the beginning of the contract. Under the contract, we operate both the old and new modernized eligibility system.

We successfully rolled out the new system in five of the eight districts within the state. On June 23, the state postponed the further roll out of the modernization solution to address the catastrophic flooding in Indiana, and to ensure that service quality in both the old system and the modernized system was meeting the state's expectations.

We are working diligently with the Indiana Family and Social Services Administration and IBM to continue to improve customer care and enhance the timeliness of application process.

Delaying the rollout is fully consistent with the state's goals to ensure that constituents are receiving the best possible service while modernizing the system. We are also satisfied with the financial results to-date on this program.

Finally, let me update you on the direct student loan market. We are anticipating our loan volumes will increase under the direct program. However, at this point, it is uncertain as to the magnitude of the increase. We are working closely with the Department of Education to ensure that we can handle the anticipated volume.

Let me conclude with some final comments. I am confident government internal growth will return to positive territory in the first quarter, and will continue to improve throughout fiscal 2009. As we move into fiscal 2009, I am very encouraged by our operating position and I look forward to a great year.

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

Kevin Kyser

Thanks, Tom. Please turn to slide 16, and I will spend a moment on our fourth quarter highlights. Revenue for the quarter was $1.61 billion, and represented 6% total revenue growth, and 4% internal revenue growth. Consolidated adjusted operating margins were 11% for the quarter, and were within the range of our long-term margin expectations of 11% to 12%.

The year-to-year margin decline was driven by lower transportation volumes, and start-up costs related to the ramp of new business in government healthcare. Adjusted diluted earnings per share of $0.95 for the quarter grew 8% over the prior year, and exceeded our expectations primarily due to lower interest expense, and foreign currency exchange gains.

And we reported diluted earnings per share of $1.01 during the fourth quarter, however, it included $0.05 per share benefit related to the reversal of a stock option tax liability we had previously accrued, and it also included $0.01 gain on our divestiture.

Both of these items were considered non-operational and non-recurring, and have been excluded from our adjusted results. Due to the successful efforts of our legal team, I am happy to report that we have reduced expenses related to the stock option investigation and buyout lawsuit.

On slide 17, let me cover our fiscal year 2008 highlights. Revenue for the year was $6.16 billion, and represented 7% in total revenue growth and 5% internal growth. Consolidated operating margins were 11.1%, down slightly from the prior year due primarily to start-up costs related to the ramp of new business.

Diluted adjusted EPS of $3.53 represented 13% growth over the prior year. This growth was driven by the increase in operating income, a decrease in interest rate, a lower effective tax rate, and accretion from our share buyback program completed during the year.

Please turn to slide 18. Fiscal year 2008 was a strong year for cash flow generation. Recall that we target free cash flow of 6% to 8% of revenues. Fourth quarter free cash flow was $177 million or 11% of revenues. These results were driven by improved cash collection on AR that resulted in a two-day reduction in DSOs.

You will notice that on a year-over-year basis, our fourth quarter cash flow results declined due to our cash flow being more evenly spread throughout this year while the prior year was back-end loaded.

Our CapEx and additions to intangibles for the fourth quarter remained at the low end of our expected range, which also helped drive higher free cash flow. CapEx increased sequentially as we began to ramp new business.

For fiscal 2008, we generated $827 million of operating cash flow or 13.4% of revenues. Free cash flow was $518 million or 8.4% of revenues. Both of these were record levels, and I am extremely proud of our teams for their improved focus on collecting cash.

As we continue to ramp new business, our CapEx as a percentage of revenue will increase, but will remain within our historical range of 5% to 7%. We still feel comfortable with our targeted free cash flow of 6% to 8% of revenue on an annual basis.

I thought it might be helpful to reflect back on our used-up cash during fiscal 2008. We used $219 million of cash for acquisitions during the year and we used another $200 million of cash for the share buyback program.

With the strong cash flow results this quarter and for this fiscal year, we have over $450 million of cash on the balance sheet, and we continue to evaluate the best use of our capital, including share repurchases, acquisitions, and debt reduction.

On slide 19 I have recapped our major balance sheet categories that have had the most significant fluctuations. As you can see, our cash balance was $462 million at June 30 and increased to $133 million due to our cash flow generation during the quarter.

Accounts receivable increased $16 million due to the acquisition of TMS. However, our DSOs improved by two days sequentially.

Accrued compensation increased $67 million due to the timing of payroll runs and the accrual bonus as we achieved certain financial metrics towards the end of the fiscal year.

The current and long-term portion of deferred tax increased for March due to tax amortization of acquired goodwill intangibles, accelerated depreciation and differences in timing for unbilled and deferred revenue.

Turn to slide 20 and let me spend a moment on a few items that you should consider as you update your model for fiscal 2009.

We expect internal revenue growth to be in the range of 6% to 7% due to the mix of business already signed and the ramp of revenue as well as the backend loaded nature of our signings this fiscal year, I would anticipate the internal revenue growth will accelerate throughout fiscal 2009.

At our Institutional Investor Day, we provided a high level revenue model that included the ramp of new business along with the impact from renewals, price discounts and lost business. Using that model let me give you the revenue components for fiscal 2009, and demonstrate why we are confident internal revenue growth will accelerate during the year.

Fiscal year 2008 signings will contribute 7% to 8% to internal growth. Fiscal year 2009 signings will contribute another 4% to 5% to internal growth. Renewals and discounts will reduce internal growth by 4% to 5%. Contractual price reductions will reduce internal growth by 1% to 2%, and normal growth in nonrecurring revenue will add a point to internal growth. All of these components combine to generate 6% to 7% internal growth for fiscal year 2009.

With the acquisitions we have already completed, we will add approximately 2 percentage points of growth in fiscal year 2009. We will continue to work the acquisition pipeline, and close a handful of deals during the year. Obviously the impact from new acquisitions will depend upon their size and the timing of closing these deals.

Due to the ramp of fiscal year '08 signings, we believe operating margins will be at the lower end of our range of 11% to 12% for the year. In order to maintain margins within that range, we will continue to reduce costs in our business, move work offshore and leverage activity based compensation to a higher degree. We expect adjusted EPS will grow approximately 10% in fiscal 2009.

One item impacting us during the year is a non-compete agreement that will expire in November 2008 which benefits profit by $3.5 million or $0.02 of EPS per quarter. This will begin to negatively impact us in the second quarter of fiscal 2009.

We also expect our effective tax rate for fiscal 2009 will be between 36% and 37%. Free cash flow for fiscal year 2009 will be 6% to 8%. We would expect DSOs to improve during the year. We also expect CapEx to increase as a percentage of revenue due to the ramp of new business.

During fiscal year '08 and during the first month of fiscal '09, we divested three businesses which we have highlighted on slide number 21. These businesses were considered non-core, and no longer met our growth profile. We have provided this data in order to allow to you update your model.

Before we go to Q&A, let me give you some color on the first quarter. We expect internal revenue growth to be 5% and expect three points of growth from acquisitions that we have already completed.

As you update your models for the first quarter, I would recommend that you look at the historical decline in EPS from Q4 to Q1. However, adjusted EPS growth should be in the mid to high teens, and our outstanding shares at June 30th were $97.3 million due to the payment of fiscal year 2008 management bonuses in August and consistent with historical trends, the first quarter cash flow will be the lowest quarter of the year.

In summary, we had an excellent year. We are well positioned financially with a strong balance sheet. We generated excellent cash flow and we are poised to increase internal growth in fiscal 2009. I like our position as we enter this year.

That is all the prepared comments I have at this time. Let's open it up for questions. We have several people on the line, so please hold your questions to one per caller.

Operator, please begin the Q&A session.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from Julio Quinteros of Goldman Sachs. Please ask your question.

Vincent Lin - Goldman Sachs

Hi, this is actually Vincent Lin sitting for Julio. Maybe you can discuss a little bit more about the volume sensitivity of your model, and since we actually saw some negative impact from the transportation business, could you maybe quantify what is potential revenue business basis for both your commercial and your government segment on the volume sensitivity of your model, and specifically for the transportation segment; what is your expectations about a potential recovery in terms of timing?

Lynn Blodgett

Yes, great. Thanks. Good question, Vincent. Our model is very sensitive to transaction volumes. 75% of our revenue is generated from transaction volumes that we handle day in, day out. Now, having said that, in a typical year those transaction volumes tend to flush out and increased transaction volumes in one part of the business can be offset by decreases in others.

I think one of the issues that we had, and why we could not overcome the transaction volumes this quarter, was really because of the weak fiscal year '07 bookings. If you think about it, we had about $600 million of bookings in '07 and that was awfully low.

With our business model, you feel the impact of those bookings in the subsequent year, and there was really no margin for moving around on the volumes because of the weak fiscal '07 bookings. Tom, do you want to add some on transportation?

Tom Burlin

Sure. Specifically to transportation, Vincent, we were obviously surprised. This is an unprecedented increase in gas prices, but we have watched gas prices increase over several decades and have seen this market to be fairly inelastic, and that driver miles have continued to increase at about a 6% rate year-over-year. In this past quarter for the first time in three decades, we saw the first decline in driver miles.

In our transportation business that affected us to the tune of about $7 million. The good news is, we have already started to see the July volumes come in. They seem to have stabilized and even increased a little bit. So, we are perhaps seeing the effect of the drastic change and maybe some lightening of the gas prices start to stabilize in that market.

Lynn Blodgett

Let me also add that, obviously, we have had a great year of bookings with $800 million in this year. Obviously, that will generate, I would kind of walk through for you, but that should generate pretty good growth just by itself going into fiscal '09.

We think we will have more room to fluctuate and absorb some of these volume issues, should they occur in '09, but again, it is a function of booking.

Vincent Lin - Goldman Sachs

Got it, great. Then, secondly, regarding the unclaimed property business from government segment, you mentioned that there was a delay in terms of revenue being recognized during the quarter. So I am just wondering, in terms of timing, when are you expecting a recovery? I understand it could be volatile on a quarter-in, quarter-out basis. Just wanted to understand when we should expect recovery in that area?

Tom Burlin

This is Tom again. Obviously, it is a little difficult for me to be exact on that. Clearly, we expected better results in this quarter, as I indicated. There were several projects that were affected by legal challenges between the authorities and the companies involved that we did not expect. I really cannot predict at this time when those will resolve, but I would expect that we will see a steady improvement across that market throughout the course of the year.

Vincent Lin - Goldman Sachs

Great. Okay, thanks.

Lynn Blodgett

All right, thank you. Operator, next question.

Operator

Our next question comes from Moshe Katri of Cowen. Please ask your question.

Moshe Katri - Cowen

Great, thanks. What booking targets do you have for fiscal '09? Maybe, is there a way to break it down by bookings from new logos versus renewals? And you have provided internal revenue growth. Is there a way also to split it by government and commercial?

Kevin Kyser

Thanks, Moshe. The booking targets that we have for this year; as I said our goal is to reach $250 million a quarter by the time we come into January, welll see that in the second half of year. We would expect at least a double-digit improvement in trailing 12 months and that would put us in about the $900 million range for bookings. These are all new businesses. This does not include renewals from existing customers. It does include incremental volume for existing customers. But, about 60% of the volume that we have comes from new logos and about 40% from existing logos.

In terms of the bookings per sector, the pipeline is split pretty evenly about 60/40, and the bookings actually came in pretty close to that split. So, I do not anticipate anything that will be significantly different than that this year.

Moshe Katri - Cowen

What about internal revenue growth by segment for next year?

Kevin Kyser

Moshe, let me see if I can give you a little bit of color and frame it historically. In fiscal '07, I believe commercial was 4% or 5% and government was 7%. That flipped in fiscal '08. When I look out, I look at the projections to forecast the budget, I do not see a lot of difference in the internal revenue growth rates between segments.

We have challenged the business unit and Lynn and Tom have challenged them that they have to sign enough business, make an investment in the sales pipeline to grow their top lines in line with the market rates. All the business units have been told that they need to carry their fair share, and they have definitely stepped up. So I am not looking at any major swings for the year. There will be some nuances in the quarter but for the year. I am looking at pretty similar internal revenue growth rate for both segments.

Moshe Katri - Cowen

Thanks. Good quarter.

Kevin Kyser

Many thanks, Moshe.

Lynn Blodgett

Operator, next question.

Operator

Our next question comes from Bryan of Credit Suisse. Please ask your question.

Bryan Keane - Credit Suisse

Yes, hi. Good afternoon. Longer ramp cycles for bookings, is that due to normal timing as bookings ramp or does it have something to do with delays as terms deal with the economic slowdown?

Lynn Blodgett

We had some contracts and I think we mentioned this in the Investor Conference; the electronic payment card project just by their nature take a little longer. We said, you should add on about six months to what our normal ramp cycle was. We have historically considered about 35% of that year's bookings would impact us during that year. So the signings in 2008, about 35% historically would have impacted us in '08.

We suggested to you in that meeting that you should lower that number, because it should be somewhere between 25% and 30%. We actually came out at 28%, and that was due to the fact that we knew we were going to have longer ramps with the electronic payment cards, and also in our MMIS contracts. They are just contracts that take a little longer, give us a nicer tail in terms of the growth in the out years. But, it is just a fact of those deals. So it's not related at all to the economy.

Bryan Keane - Credit Suisse

Okay, great. Lynn, when you are talking about driving cost reductions, can you quantify any costs you can take out?

Lynn Blodgett

Well, that is a great question of running the business and we are challenged. If you go back through and look at the model that Kevin gave, again, of the Investor Conference, where we tried to explain what would happen relative to discounts that give and lost business and start-up costs and so on. We have a pretty good sense on a percentage basis of what costs need to come out. We have not historically given out that number, but we need to overcome the Delta between business that we lose and the impact of ramping new business. So it is a significant number but there is nothing different this year than over the past. We are in the cost reduction business.

Bryan Keane - Credit Suisse

Okay, then just finally for Kevin. You mentioned there was a $0.02 or so hit starting in the second quarter. I think it was a non-compete expire. Can you just explain that again?

Kevin Kyser

Sure. I believe there is about a five-year life on this. So, I think we would be going back to 2003. We had a non-compete, the company in which we sold the company to and traded assets, they effectively paid us for five years on a quarterly basis, and it equated to about $3.5 million of profit, or $0.02 today Bryan, there will be a partial impact in the second quarter. Then you will see it fully drop off in the third quarter and the fourth quarter.

Bryan Keane - Credit Suisse

Okay. The $3.5 million is not quarterly, that is the total?

Kevin Kyser

No, it is 3.5 quarterly and its $14 million on an annual basis.

Bryan Keane - Credit Suisse

Okay, and that just goes away?

Kevin Kyser

$0.02 a quarter, and you will see the full impact in Q3, Q4, and you will see a half of a quarter essentially in Q2.

Bryan Keane - Credit Suisse

Okay, great. Thanks for the color.

Kevin Kyser

Alright. Thanks, Brian.

Lynn Blodgett

Operator, let's go to the next question.

Operator

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

Adam Frisch - UBS

Great. Thanks, and nice quarter. On the bookings front, a third straight quarter of really solid results, I think you were calling for 180, it did to 210, and that comes on the heels of two really good quarters. Two things there, first, if you could talk about the types of contracts signed, and the margin profile of those contracts. I know the duration was a little over three years. So, if you could provide some color there? And then, also provide some color on, if you took some deals from next quarter into this quarter if you could, you said your pipeline was as big as ever, but I just want to know kind of the progression of what to expect, near term?

Kevin Kyser

Great questions there. In terms of the mix of signings and the contract term, we did sign a higher percentage of commercial contracts this quarter than government, higher than even normal. We had a couple of large customer care contracts that tend to average about three years. That is what brought that average contract length down. The types of deals that we are signing really went across the board. We signed things in our healthcare area, both on the government side and the commercial side, a lot in our transactional BPO space, deals in our HR space, finance and accounting, IT. So, one of the great things I think about the quarter is that we had contributions from virtually every line of business.

As far as pulling things forward, negatively impacting the next quarter, I would not say that happened at all. It is always a nail-biter at the end of the quarter, do you have one deal that might slip from one quarter to the next. That is why we try to condition you that the bookings are lumpy, but we feel very good about the prospects for signing for this first quarter and the second quarter. And as I say, we are expecting to continually ramp bookings and get so, we are we are averaging 250 by the time we get out of this year. We want you to remember, though, bookings can be lumpy, so do not be too concerned if we happen to have a deal that slips from one quarter to the next.

We are going to have solid bookings in the ranges that I have described in this year.

Adam Frisch - UBS

Okay, great. If I could follow up with Kevin in terms of progression from quarter to quarter, revenue growth in the first quarter is starting out pretty slow, but your full year guidance is intact, and obviously supported by the bookings. So any specific quarter that you are expecting the impact of the bookings to have a bigger impact on the internal growth and then if you can also talk about progression of margin through the year?

Kevin Kyser

Sure. It will start out at five and then it will probably step up from there. I do not know if there is any one big item that is going to just pop it from one quarter to the next. I think you will just see a nice, slow steady increase throughout the year as new business ramps.

On the margin side, we are expecting to be in the lower end of the range on the 11% to 12%. We think for the year, we are very confident we will be within that range. Obviously this quarter we had some negative impacts on revenue from the transportation, from the volume side.

In addition, from time to time, we are making investments in cost reductions. Some cost reductions do not come for free and as we invest, as we move 1800 people offshore this quarter, we probably spent about 20 bips of margin moving those people offshore.

You have got to move them off, you have got to shadow them, you have got to set up dual sites, and it is short-term pain for long-term gain and the investment that we see that in quarter will pay dividend the very next quarter and it will pay dividends for the rest of the year. So from time to time we are going to do that.

So, it is hard for me to call quarter-to-quarter, if it is going to be 11, 11.1, 11.2, it is very difficult. We do not want to be as a management team hamstrung to not make those decisions. We think it is the right long-term decision. There may be a few investments that we have to make from time to time, that take away for a couple points from quarter-to-quarter on the margin, but we are firmly committed to the lower end of the 11% to 12% operating margin range.

Adam Frisch - UBS

If I could squeeze in one more on the government side that was weak this quarter, what is in your assumptions Kevin for '09? When do you expect them to come back if at all or your assumptions are pretty…

Kevin Kyser

Yes, Adam, are we talking about internal revenue growth?

Adam Frisch - UBS

The two businesses that were a little bit weaker in the quarter, the transportation and then the…

Kevin Kyser

Transportation and unclaimed, sure.

Adam Frisch - UBS

Yes.

Kevin Kyser

The one I am very confident of, it is the bigger one, obviously it is transportation. I think Tom provided some comments that we have already seen July volumes and they have stabilized. I think that is going to be good and I think they are going to come back. Transportation actually had a pretty difficult rollover period from the fourth quarter of last year.

Recall, we had completed some projects. We had a very good revenue performance from that business unit last year. We had somewhat of a rollover issue for transportation. With the volume stabilizing, and with the rollover issues gone, the first quarter takes care of itself from that perspective.

Unclaimed, it is a smaller business and I am not ready to call how that is going to be next quarter. It is a very lumpy business for us, but I think they will do fine as we go into the first quarter.

Lynn Blodgett

I am going to add a comment, it's a general comment and that is that, I do not want people to get too concerned about the fact that we had a little bit of a bump in our transportation area or in unclaimed property. Those kinds of bumps happen all the time. The issue is that in '07, we had bookings of $600 million. We should have had bookings of about $750 million. That cost us about $90 million of the revenue out of '08.

That took all the air out of the tires, and when you are running where you do not have the momentum of those previous year bookings, then all those things become a lot more sensitive. So, do not come away from here with any undue concern about that.

Volumes are going to bump up and down. We have got transaction volumes across this business. They typically will balance everything out. When you have reasonable growth, reasonable signings, then you have a little bit of a cushion there to help you through these things. So that is the issue. The issue was the 2007 poor bookings, and these just end up being manifestations of that.

Adam Frisch - UBS

Great. Thanks so much. I appreciate it.

Lynn Blodgett

Yes, thanks. Operator, next question please.

Operator

Thank you. Our next question comes from James Kissane of Banc of America. Please ask your question.

James Kissane - Banc of America

Thanks and good job guys.

Lynn Blodgett

Thank you.

James Kissane - Banc of America

When do you expect the government healthcare margins to uptick, and can you get them back up to where they used to be about four years ago?

Lynn Blodgett

Four years ago, you are testing my memory a bit and let me comment this has occurred.

James Kissane - Banc of America

I think they were somewhat higher.

Lynn Blodgett

In the current situation, I will comment that, recall, we had tremendous margins in our healthcare business. We have talked about this a number of times. While we lived of off those margins and love those margins, we failed to invest during that time.

James Kissane - Banc of America

Yes.

Lynn Blodgett

One of the things that we are doing right now as we have talked is we are building a new platform, our enterprise platform that has driven some $200 million of sales in this past year, and is winning in some great wins that in market. So I think that there is a lesson to be learned across all of our businesses.

We need to be prudent about how much we take to the bottom line, how much we invest in our business and we are being wise about that in the future.

Specifically about the margin improvement, we had four pretty significant wins. We are ramping MMIS, either renewals or new contracts, so there has been some pressure over the past couple quarters. Those contracts will start in the latter part of this calendar year. The first one will start to go live from an operational standpoint, and I expect to start seeing improvements in that business about that timeframe, certainly as we cross over the calendar year into the second half of the year.

Tom Burlin

I think the other point I want to make, Jim, is that this platform that we have developed is, in fact, a very leverageable platform. And as we implement that across multiple states, that does give us the opportunity to push margins up, and we would expect that, but we are just going to be careful and not under invest in the business.

Kevin Kyser

And, Jim this is Kevin. Let me just add. First off, it is odd to hear Banc of America after your name obviously, but we are glad you are still with us.

James Kissane - Banc of America

It is good to be here and good to be on the call.

Kevin Kyser

While margins have come down as Tom pointed out, we still love the government healthcare business. There are good margins. They are margins that are north of the corporate average. There are a lot of good opportunities there. So while they have come down, they are accretive to our overall margins.

James Kissane - Banc of America

Okay, and one just one last one. You mentioned about the multi-scope HR contracts. Are you happy about the shift in the market or do you still want to go after the bigger mega deals?

Lynn Blodgett

You know what, we are thrilled with this shift, and in fact, as you know we have not signed a big multi-scope deal for sometime this quarter. We have actually been encouraging our organization to promote the point solutions. By that, what we mean is, now we do training for people and we have a very good training solution. We make money on it pretty much from the beginning of the contract. It is great business. We signed $10 million of recurring training business this quarter.

That is more than we signed in the big mega deal in the whole entire year before. I am happy with it. I think the upfront investment that were required by the end-to-end deal, the stress that it put on our organization and the stress that it put on the customer's organization, I think there was no great payback there. So, we are happy about it, and we are very happy with our position in the HR business. We have great point solutions.

Over a span of time, we could provide all those same services to a customer. We just do not want to go and do it in a one big bang type approach. It is a lot less risk and a lot less cost doing it this way.

James Kissane - Banc of America

I hear you. Excellent, thanks.

Lynn Blodgett

Thanks, Jim. Operator, let's go to the next question.

Operator

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

David Grossman - Thomas Weisel

Great, thank you. You have done a good job of giving us some fairly specific guidance and color on the segments, but, if you sum it up, Lynn, if you look over the last three months since you reported the March quarter, what would you say would be the biggest changes in the risk profile within the portfolio?

Lynn Blodgett

That is a good question. I have not seen anything that I think would have increased in risk. I think that we are continuing to mature in our technical offerings that we have for customers. With one quarter further into the finalization of our enterprise platform, so less risk there. Our sales and marketing engine is kicking in, so a lot less risk I see from a bookings perspective. The impact of things like the mortgage crisis, which we came through and we only have a very small mortgage business. I do not see much risk there.

And, I think most importantly, we are seeing that the pipeline is increasing across the entire business which means the biggest risk would be that new opportunities would dry up in the face of the weakening economy. That has not happened. We have seen the pipeline increase in our commercial sector all the way across, and we have seen it in government. And all those things that we were espousing, in terms of Medicaid usage goes up, and the entitlement programs that we will see grow. Those things all happened this quarter. So, I will ask Kevin or Tom if they have something that they would comment on.

I feel like the risk profile is less today than it was last quarter, and I do not think we had a huge risk a quarter ago.

Kevin Kyser

No, Lynn, I would agree with that. Obviously, one of the areas I look to, that was commented on in the quarter was the wireless diversification in the wireless industry. We have expanded there, brought on new wireless customers. They are all very good customers, and doing well. Obviously, the thing that we did not anticipate sitting here in March was the fuel prices that we talked about. That just caught us by surprise. Volumes went down, we didn't have, as Lynn said, we did not have the bookings from '07 to offset some of those volume weaknesses.

Now I think the risk profile has not increased at all, and I am confident in the new business we have signed. Customer care, a big piece of the business was in customer care as we said. Those are contracts that we do in our sleep. Then we have a very good approach there for rolling those out. So I like our risk profile right now.

Lynn Blodgett

I would just add maybe one other thing. If you look at this from a US-centric perspective, we are obviously heavily concentrated in the US, and what the economy has done, you could look at that and say say there is potential risk there. I think we are showing that we have been pretty insulated from that. However, what we are doing to lessen our dependence, if I can say that it way, on the US market is that we are doing a lot of sales and are getting traction in international markets.

We are seeing great opportunities in our transportation line of business around the world, major opportunities. And our other businesses are transactional BPO business, our finance and accounting business, our HR business, we are seeing opportunities outside of the United States. So, I guess you could look at that and say that, it will be nice to have some revenue that comes from around the globe as well.

Tom Burlin

I want to allay any fears of the transportation. It was a momentary dip; it was relatively small compared to our total business. It was unprecedented. But, weigh that against worldwide driver miles, and cars on streets are increasing dramatically in other markets. We have huge opportunities beyond the shores of the US and we are pursuing those. I do not want to walk away with anybody thinking that our transportation business is not anything but full of opportunity. I think it is going to be a growing market for us.

David Grossman - Thomas Weisel

Okay. Thanks very much. Can I ask maybe one follow-up, maybe Tom to you? You gave us a pretty good backdrop for the State of Indiana, and we all read this stuff in the press and know that there is a ton of politicking that goes around things like this. Could you just provide some perspective for us on how to think about this and why not to be concerned that this turns into a situation that has happened in some of the other states on some other large projects like this?

Tom Burlin

Yes, I think we know what you're talking about. I think, first and foremost is that, this solution is working. We have successfully rolled it out across five of the eight districts. We are servicing about 17% higher volumes than the baseline in the state. So in very generic terms, it is working and it is working effectively. That is not to say that we do not have to improve in certain areas and it is like any other large complex program. There are things that we are doing to improve our service.

But, we had a pretty big complication in the Indiana with the flooding that went on there, and I think that the State made the right decision. We were diverting a lot of attention because, clearly, we had to still service people in that area. So, we diverted a lot of attention to taking care of those flood victims. I think the commission made the right decision to halt the rollout, giving us an opportunity to look at the metrics and make sure that we had the right solutions in place for improving it.

So net-net, I would tell you, the ship is sailing, and this is the maiden voyage. We are tuning everything up right now. I expect that when we clear this work, we will be back with the go-ahead to rollout in the rest of the state and continue to see improved services.

David Grossman - Thomas Weisel

Great, thank you.

Kevin Kyser

Thank you.

Lynn Blodgett

Operator, let's move to the next question.

Operator

Our next question comes from Bhavan Suri of William Blair & Company. Please ask your question.

Bhavan Suri - William Blair & Company

Thanks. Solid bookings, guys. It was nice to see ramp in the finance accounting, and the margin improvement there. I was hoping you could provide a little color on the Federal business, growth in that business, which, when we met at the investor meeting was at the bottom of the company's various business unit. So any kind of color on how that is growing and opportunities in that space?

Tom Burlin

Sure. We are seeing the pipeline increase in that area as well, and very specifically, the non-compete that Kevin referred to applies to our Federal markets. So effective November, the non-compete expires and we can go after the full market, which will further broaden our pipeline there. The treasury, electronic payment card signings in the quarter before this last one was a Federal deal, and we successfully deployed that, and that contract is ramping. Again, it is an electronic payment card, so, the rate of ramping is different than we usually see, but that is moving along very successfully.

We signed one small contract in this period that will ramp over the next period. So that team is staffed up. We have brought sales, we have added sales in that area, and started to look at the areas of opportunity. I expect you will probably see that we will first be approaching through other providers in that market. We will be a subcontractor to many of the normal Federal contractors where we can enhance their services and decrease their costs, and make them more competitive. So, I am still very bullish on it. I think you will see some nice signings in '09 from that market.

Kevin Kyser

Bhavan, this is Kevin. Let me see if I can add a little bit of color to the slides that we put up at the, which you referred to at the Institutional Investor Day. It was a bubble slide, the one you were referring to the Federal business was below the, on the bottom of the chart as you referred to it, because of the renewal with the Department of Education, and it was below the line.

If we plotted that this quarter, the Federal business would be back above that line. There was nice growth in the Federal business in the fourth quarter, and we think probably the Federal business is going to be one of the faster growing businesses as the treasury deal ramps. Obviously it is one of the smaller lines of business in the government space, but we think that that is going to be a very fast growth and we are excited about that market.

Bhavan Suri - William Blair & Company

Super, super. One quick question if I can squeeze it in. Could you talk a little bit about, if the competitive situation has changed in the transportation business? I know there are a few more European players looking to compete in the US in that market. I was wondering what you had seen, a little color around that.

Lynn Blodgett

Sure. There is a couple things that are going on in the market here. You have see in the European and Australian competitors come in. You are seeing them more in the areas of build-to-operate, the very large scale programs where they are leasing out the toll roads. That is a big market, one that we would likely be a supplier to that market as opposed to a prime in those very large multi-year deals. But, we are seeing opportunities internationally to the contrary where we are the new player on the block, and we are going after markets that we have not traditionally approached.

So, while they maybe showing up in US markets where we are very comfortable competing with them. I think we are going to counter that by showing up in their markets where we have new offerings and better solutions. I will remind you that this is a strategy we have been talking about now for two years. Our acquisition of Transport Revenue of our fare system was to get the combination of both the operation side and the project side together so that we could move all the way across from fare transit to tolling and be both an installer and operator of those services.

We have won a couple of contracts that have those components So, we expect that in the US market, as we get congestion and we may see driver miles start to level off, you are going to see transit ridership increase and we have got some great solutions in that area and we will turn into operators in that area. So, as I said, I am very bullish about our opportunities in the transportation market. This is a momentary blip.

Bhavan Suri - William Blair & Company

Great. Thanks, guys.

Lynn Blodgett

Operator, let's move on to the next question and this will be the final question.

Operator

Thank you. Our last question is from Tien-Tsin Huang of JPMorgan. Please state your question.

Tien-Tsin Huang - JPMorgan

Hi, thanks. I just wanted to clarify, on the unclaimed property side, what is your remaining exposure there? I saw the EPR divestiture. So I was just curious how strategic is unclaimed property in general?

Lynn Blodgett

Yes. The unclaimed property business on the commercial side that we divested was less strategic to us. That end of the market had subsided quite a bit. On the government side, there is a different relationship. In every state, the district in Puerto Rico, we service them, and we have tremendous relationships with the treasurers of those states. So, in addition to just the unclaimed property business; those relationships in the business we do in those states is leveraged by the unclaimed property contracts we have.

So, I do not see us stepping away from unclaimed property business in the near future. It is very valuable, not only as a business in and of itself, but from a relationship and a present standpoint and understanding of what is going on in the state, and treasurers are very close to the financial challenges, and of course that is where we have the best opportunity to help states when their budgets are strained.

So, again, it is a great business, and we are going to stick with it and we are actually working to try to get that business to be a little bit more repetitive and have a little bit more recurring revenue nature to it as we develop some new solutions.

Tien-Tsin Huang - JPMorgan

Okay, got it. That makes sense. The remaining government piece, is that less lumpy? It sounds like in the last couple quarters you have had some volatility there.

Lynn Blodgett

I do not necessarily think it is less lumpy. What you are seeing is that, over time, we are seeing is fewer projects as the demute business went away. We are seeing fewer projects, and not as large projects. So we are becoming a little bit more dependent on fewer at-bats, if you will, in a given quarter. So, what we are doing is ramping up some of our auditing services and the compliance services that we do on behalf of the states and that will become more recurring and hopefully buffer some of that lumpiness of projects.

Tien-Tsin Huang - JPMorgan

Got it. If I can just do one more for Kevin. I do appreciate all the internal growth guidance there. Can you just remind us of the known drags to internal growth in '09 and when they hit? We got the growth down to $40 million, non-compete, I believe you have got the Florida grow over. Then, I just to clarify, will you lose some revenues when you cut Indiana over to the new system? I did not quite catch the details there.

Lynn Blodgett

No. Look, you got it. You know it pretty well it sounds like. You could probably tell everyone on the call. You are right. Florida actually goes away in July. So we are going to get a full year impact from that. The other things that are known, every year we are going to have 2% from renewals and price downs from renewals. I am sorry, 4% loss revenue loss from those.

We are going to have a couple of points on annual price reductions. We renew contracts when we sign new contracts in the out years. Some of those have step-down clauses in the pricing. There is nothing unusual during the year. We wanted to provide you the details of how we are seeing '09 just so you can see why we are confident that internal revenue growth is going to accelerate in '09 and I do not see anything out there that is just off the charts.

Tien-Tsin Huang - JPMorgan

Now the internal growth is great. It's simply better than what we had. I just wanted to make sure that we picked it up in the right quarter.

Tien-Tsin Huang - JPMorgan

Listen, Jon or I will be glad to talk with you offline if you would like to go a little deeper.

Tien-Tsin Huang - JPMorgan

I appreciate the time.

Lynn Blodgett

Yes, you bet. Well, thank you, everyone. I just want to conclude with, I am very proud of the organization as we finish this year, and I'm very proud of our people. We actually are sitting at our annual kickoff meeting and we have a group of our leadership that are gathered and they have joined us on this call. I just want to thank, again, the investment community and thank all of our great people and customers for a wonderful year. So thank you very much.

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