Maximus Inc (MMS) 2006 Q1 法說會逐字稿

Ladies and gentlemen, welcome to the MAXIMUS first quarter earnings conference call. [OPERATOR INSTRUCTIONS] At this time, I I would like to turn the call over to Lisa Miles, Director of Investor Relations.

For today's call we have posted a presentation for you to follow along with. The presentation can be found on the Maximus website at www.maximus.com. Click on Investor Information, and this will take you to to the appropriate page, where you'll find the presentation link, which is located directly underneath the webcast link.

Before we begin, I would like to remind everybody that a number of statements being made today will be forward-looking in nature. Please remember that such statements are only predictions, and actual events or results may differ materially as a result of risks we face, including those discussed in Exhibit 99.1 of our SEC filings. We encourage you to review a summary of these risks in our most recent 10-K filed with the SEC on December 12th, 2005. The Company does not assume any obligation to revise or update these forward-looking statements to reflect subsequent events or circumstances.

On the call is today is Lynn Davenport, Chief Executive Officer, and Rich Montoni, Chief Financial Officer. And with that, I will turn the call over to Rich for a discussion of our financial results.

Good morning. And thanks for joining us. As noted in our 8-K filing 2 weeks ago, we implemented organizational changes which shifted certain divisions and projects between segments. Consolidated historical numbers did not change, but there were some minor shifts between our 3 operating segments. I'll provide segment commentary later in the call, which reflects these new alignments. Before I get into the detailed results, I would like to cover 2 matters. First, we adopted FAS 123R in this quarter, and started expensing stock options. The impact in this first quarter was approximately $900,000 pretax, or $0.025 per share. We adopted this new accounting principle on a prospective basis. All future quarters will be impacted for option expense, but the financial results for periods prior to adoption have not been restated. Please consider this as you review the period-over-period results, consolidated, as well as segment results. During the first year of adoption, we will provide on a pro forma basis what the comparable prior period would have been had we expensed options, so as to provide an options adjusted comparable. For the first quarter of the prior year, the pro forma pretax net income would have been $13,562,000. Net income would have been $8.2 million, and diluted EPS would have been $0.38.

Second, we had a couple of offsetting P&L items. In last night's press release, we disclosed a $600,000 foreign currency transaction gain, in interest and other income, which was largely offset by $500,000 in legal expense associated with an internal review related to the previously-disclosed subpoena from the U.S. Attorney's Office for the District of Columbia. The ongoing investigation relates to Federal Medicaid reimbursement claims assistance on behalf of the District.

Moving into financial results. Revenue for the first quarter increased 7% over last year, to $162.7 million, all top line growth was organic. The sequential decline in revenue was expected, and was due principally to our Operations segment. We had 1 project that we opted not to rebid, and the revenue rolled off in the quarter. In addition, pursuant to the Texas project, certain work was curtailed as we transitioned to the new program.

Net income for the first quarter totaled $8.9 million, or $0.41 per diluted share. Again on an options adjusted basis, that compares to last year's net income in diluted EPS of $8.2 million, and $0.38, respectively. Net cash provided by operating activities totaled $5.1 million, and this was after the payout of bonuses. Cash, cash equivalents and marketable securities remained healthy at $172.4 million, and this was as of December 31st, 2005.

Segments. Again, it's important to keep in mind that fiscal '05 as reported segment results exclude stock option expense, while FY '06 results include the impact of option expense.

Our Consulting segment. Revenue for the Consulting segment in the first quarter was $23.6 million, which was comparable to the same period last year. The segment's first quarter operating income totaled $2.5 million. Continued improvement in the revenue services division drove operating margin up by 120 basis points to 10.7%. This segment's margin may fluctuate as a result of the contingency-based work associated with many of our consulting engagements.

Our Systems segment. First quarter revenue for the Systems segment increased 11% to $36.3 million, compared to last year. This was driven by growth in ERP solutions, asset solutions, and educational systems. While total Systems revenue grew year-over-year, first quarter income of $3.9 million and a margin of 10.7%, returned to more normalized levels, and there were -- which were lower compared to last year. These decreases resulted from lower license revenue, and reductions in profit from a Smart Card integration job that contributed significant profit in the first quarter of fiscal '05.

Our Operations segment. First quarter revenue for this segment grew 8% to $102.8 million, compared to last year, driven principally by a British Columbia contract which launch in the third quarter of fiscal 2005. First quarter operating income in the segment was $6.1 million, and operating margin was 5.9%. An expected loss on the British Columbia project for the quarter contributed to the reduction in margin. Excluding the loss, operating margin would have been 8.5% for the Operations segment. While we generally don't provide financial details by project, in this case it's necessary to give additional visibility on how the British Columbia project impacts overall Company results. For the full fiscal year, we expect that the British Columbia contract will lose approximately 4 to $5 million. We believe this quarter was the turning point, with more than half of the expected FY '06 loss being recorded in the first quarter.

During the quarter we incurred additional expenses which were necessary to improve services and achieve our operational goals. The project was within service timelines by the end of November, and in full compliance with service level requirements in December. As a result, no penalties were incurred in November or December. Quality service to the citizens of British Columbia is extremely important to MAXIMUS, and our brand recognition. So our first priority was getting the backlogs and service requirements back to levels that meet our clients' expectations. In fact, the British Columbia Minister of Health was quoted last week as saying that the service levels at the end of 2005 were among the best on record.

The project team has done a tremendous job of improving the overall quality and service level. There is still much to be done in the areas of productivity and profitability improvement. While challenges remain, as is the nature of the start up of large outsourcing jobs, management initiatives are underway to bring this project in line. We're still tracking towards our financial goals of getting this project to break even by the end of the year, but it's possible that the timeframe may be pushed into early fiscal 2007. This is dependent upon several factors, including the timing of the improved operating results, as well as the timing and cost of the new system build up.

Expenses and operating margin. Beginning this quarter, we expensed options as selling, general and administrative expense. This amounted to approximately $900,000 in this first quarter of fiscal 2006. This therefore impacts the comparability of year-over-year comparisons. As to operating margins, as you know, the Company's stated goal is to achieve a total Company operating margin of 10%. We would like to do this by the end of fiscal 2006. This would include the impact of expensing options. While on the surface this may seem aggressive, the margin issues are isolated. Looking at overall Company margins excluding 2 specific items, and that would be the $500,000 legal expense and the loss on the British Columbia project incurred in this quarter, total Company operating margin would have been approximately 9.7%. Also of relevance to margin, we do review our cost structures on an ongoing basis, so as to fund areas of investment and to drive SG&A efficiencies. All of this helps demonstrate that MAXIMUS can achieve a 10% operating margin on a sustainable basis. Hopefully higher. Yet, we're not there today. Lynn will address those actions we have taken, or plan, to get us there.

Interest and other income. Before I get into the balance sheet metrics, I just want to touch on the year-over-year increase in other income. Of the $2 million in other income this quarter, 600,000 related to the foreign currency transaction gain. As we've discussed in previous calls, the balance of the increase is driven mostly by ongoing cash management strategies, with more cash and higher yielding auction rate notes. Balance sheet matters, total accounts receivable for the quarter were $170.8 million. As a result of seasonality in the quarter associated with additional holidays, DSOs totaled 99 days. This does include $5.4 million included in long term accounts receivable, which are classified within other assets on our balance sheet.

Cash balance, stock repurchase activity, and cash flows. Cash from operations totaled $5.1 million, and as expected, was impacted by our annual bonus payout. This payout was a larger performance-based distribution compared to the prior fiscal year. We ended the quarter with a very healthy liquidity balance of $172.4 million in cash, cash equivalents, and marketable securities. The Company repurchased approximately 118,000 share of MAXIMUS common stock during the quarter, offsetting the effect on shares outstanding from employee stock purchases. At December 31st, we had 26.4 million available under our ongoing stock repurchase program. We continue to review the uses of cash. Top priorities remain the funding of ongoing operations, share repurchases in our quarterly cash dividend. Acquisition activity is also a top priority, cash use as we continue to review M&A opportunities, with opportunities under active review.

Guidance. There's no change to full year guidance. We still expect double-digit top and bottom line growth, with revenue in the range of $710 million to $725 million, and GAAP diluted earnings per share of $1.87 to $1.92. As a result of the timing of projects and new work, the Company expects certain 1 time events and profit shifts throughout the remainder of the year. In the second and third quarters, we anticipate lower margin, nonrecurring revenue associated with hardware sales from 2 voter-related contracts in the Operations segment. Right now, we anticipate about $6 million in revenue in the second quarter, and about $10 million in the third quarter. Relative to earnings per share, our third and fourth fiscal quarters are traditionally the strongest, as a result of seasonality in certain business lines, as exhibited in prior years. We also anticipate higher margin contingency-based revenue services claims to be recognized in the second half of the year. As a result, we expect full year EPS to be more back-end loaded.

And finally, I'll provide updated segment guidance, which reflects the organizational shifts disclosed in our 8-K filed 2 weeks ago. On a full year basis, we expect revenue from the Consulting segment to be similar to fiscal 2005 levels, with an expected margin north of 10%. In the Systems segment, we also expect revenue for fiscal 2006 to be comparable to full year fiscal 2005 revenue, with an anticipated margin in the mid to high single-digits. And lastly, we expect the majority of total Company top line growth will come from the growth in the Operations segment. We currently expect revenue from the Operations segment to grow about 15% over fiscal 2005, with operating margin in the mid to high single-digits. And with that, I'll turn the call over to Lynn.

Good morning, everyone. As you may recall from our last analyst call, we started this year with 3 basic objectives. Namely, we want to fully integrate the new management team that we put in place in October into our organization; we want to continue to strengthen our basic quality, profitability and delivery efforts; and finally, we want to accelerate our growth efforts, building on our recent sales successes. We have made progress against each of these objectives over this past quarter. However, we are not where we want to be in terms of our profitability levels. We are taking a number of additional actions to address this issue. In this regard, we have had, as you know, an issue on our project in British Columbia that impacted our earnings in the first quarter. Even though we made, if not exceeded slightly, our overall financial goals for the quarter. We have made progress in addressing these issues. But we need to learn from this experience and to do better in the future. I will address this matter in some detail in my comments this morning.

Overall, our plan for this year calls for double-digit revenue and earnings growth over fiscal year 2005. We are on target with this plan. But we also know that our plans are back-end loaded due, in part, to the seasonal nature of our business, as well as the challenges we face in implementing our large new jobs. As such, we will continue to watch our business closely, and take actions as necessary to achieve our goals for the year. We have worked hard over this past year to establish a reputation for meeting our commitments. We want to continue to build on this reputation. With these comments in mind, I will first talk about our highlights for the quarter. I will also take further about the steps that we are taking to improve our overall profitability, and to meet our priority goals for the year. Finally, I will talk about our prospects for the future, and our outlook for our market.

Notwithstanding the challenges we face, we made progresses the quarter, as I already indicated, against each of the objectives that we have set for this year. First, our new team is now in place and up to speed. We believe we have a strong and stable organization for the future. Second, we worked hard this quarter to get on top of the large new products that we started over the past months, especially our projects in Texas and British Columbia. Third, we took a number of important steps to help meet our growth goals for the year. Perhaps most important, we submitted proposals with a value of nearly $500 million during the quarter, which gives us optimism for the future. We also had new contract sales of $130 million, which we believe is good, considering that British Columbia was signed in a prior period, and accounted for our strong comparable results last year. Further, we continue to push our efforts to expand our pipeline. In this regard, we now have an overall pipeline over $1.3 billion that we are actively working, which is running at record levels for our firm. Finally, we were able to make these major marketing and implementation efforts, and still make our financial targets for the quarter, as well as to slightly exceed the consensus estimates for the quarter.

With respect to British Columbia, we added temporary staff, we made a number of key management changes, we put in place a series of new and expanded project controls, we spent a considerable amount of senior management time and effort, including a significant amount of my own personal time in and efforts. We have the potential to have a very good year if we can delivery successfully on our big jobs, and turn all the opportunities we have into sales. We know that this will not be an easy task. However, we believe we have put in place the team and the processes that can make us successful in achieving this goal.

While I will discuss our progress in meeting the overall goals that we have set for ourselves in just a moment, I want to spend a little more time on our immediate profitability challenge. This issue is an operational issue, not a financial issue. We need to do better on all our jobs to make sure that we meet all of the requirements set by our clients on time, and within the budget set for our work. We have worked hard over the past several months to address the issues we face in British Columbia. We have also taken a number of additional steps to help make sure that we avoid similar issues on other projects in the future. We are now in compliance with all major service level requirements on the British Columbia project. We did not receive any performance penalties in November or December, and we believe we have met all performance targets for the month of January.

We are also making progress in implementing a new technology solution to improve our service to the public, and to support our day-to-day operations. As Rich indicated, we did have to absorb a significant loss on this project in the first quarter to cover the additional temporary resources that we had to add. However, we have learned a lot during this period, and are now in a better position to predict volumes and manage staff levels to continue to meet performance expectations. We have also seen a significant upturn in our overall productivity in recent months as a result of the changes that we have made. This has allowed us to reduce our costs, improving our financial picture for the future. We made the correct decision in British Columbia, even though this may have impacted our overall short term profit margins and earnings as a firm.

Namely, our goal at MAXIMUS is that quality comes first. Without quality you cannot sustain a successful practice or retain the support of your clients over time. At the same time, we also know that we will only meet our financial expectations as a firm, if we achieve financial improvement on the British Columbia contract. To this end, while we could lose as much as $4 million to $5 million this year, as Rich indicated, believe as Rich also indicated, that we have reached a turning point on the projects with the changes that we have made. Namely, the greatest portion of our loss occurred in the first quarter because of the additional temporary staff we had to add. We believe that options actually exist to reduce our exposure in the months to come, if we continue to improve our productivity, and accelerate the implementation of our new technology solution.

We have an excellent client in British Columbia, and an excellent team. I really believe that, long term, this project is going to be a very good project for British Columbia, its citizens, our employees, and our firm. We have taken steps to avoid or minimize the risk of similar problems on other projects in the future, with the priority objectives that we have set for ourselves, beginning with our new management team. I will now turn to each of these priorities and where we stand against each priority.

First, as you know, we significantly strengthened our management team over the past quarter. In this regard, we added Mark Andrekovich to serve as our new Chief of Human Capital. His immediate priority is to help us find additional strong people to staff the new jobs we have won, and to make sure we are successful in these jobs. We have signed Sue Pepin, who is one of our most experienced and successful division presidents to serve full time as our overall Quality Control Officer. Her immediate priority is to look at the lessons learned in British Columbia and other large projects, and to help us put in place better systems and procedures to address these lessons.

We have brought in 4 new people from other larger and well known firms to head our major operating segments. We made this change to take advantage of the opportunities that we have in the marketplace and to successfully deliver on our projects at all levels. We signed John Boyer, who started our largest and most successful practice, our health services practice, starting a new federal practice, representing a major new marketing and business thrust for MAXIMUS. Each person has completed an assessment of their market and their business, and has developed their own action plan for how they can make sure that we best meet our objectives for the remainer of this year. We will update you on the results of our actions plans in our upcoming analyst calls. We also plan to schedule another investor conference in the future, and you can meet our new team in person.

As a second key priority, we know that we have a continuing challenge to make sure that all of our jobs are successful, and to achieve the maximum profitability possible. This initiative is at the heart of the profit improvement efforts that I just discussed. Most important, Sue Pepin, who is the new head of our Central Quality Control function, has worked closely with Rich and me to further strengthen our quality control and monitoring processes. As I said earlier, we have designed these processes to address the specific types of issues that have impacted us in British Columbia and our other large projects.

In Consulting, we have worked to improve our financial position over the last fiscal year, principally in our revenues services practice. We are starting to see some positive results from our efforts. As an example, we recently won new projects in North Carolina, Wisconsin, Illinois, and several other states. And also exceeded our performance targets for our revenue services practice for each of the past 2 quarters. And most important, we have the potential to have a very profitable year in revenue services this year. Within Operations, in addition to the progress that we have made on our British Columbia project, we have also made significant progress on our new project in Texas, where we are a member of the team with Accenture, that is implementing a new welfare eligibility services program for the state. In this regard, we have met our milestones for the transition and launch of the enrollment broker program for the CHIP and Children's Medicaid programs.

We have also launched the phased roll-out of the fully integrated eligibility function on January 20th. We continue to watch this project very closely, and there are a number of items on our watch list. However, we are generally pleased with how things are going so far. With respect to our Systems practice, Drew Cramer, who is our new Systems segment leader, has worked to strengthen our overall project control efforts and to initiate a comprehensive project review process across all areas of this practice. This past quarter, we were successful in closing a major new courts win in Atlanta, and in making significant job progress in our justice solutions practice. Overall, we believe that we are making meaningful progress in improving our quality control and job performance efforts. We continue to watch our business closely, and will make changes and take actions as appropriate.

As our third and final priority for this year, we are working hard to expand upon the sales and marketing successes that we had this past fiscal year. Most important, we have moved aggressively to take advantage of the opportunities that we see in the eligibility systems and services area, and health services, building our successes last year in Texas, British Columbia, Massachusetts, Georgia and other states. We are currently tracking major opportunities in at least 15 states. We are also in the latter stages of a number of major procurements in this area, which provides us considerable optimism for the future.

In addition to taking advantage of the big opportunities that exist, we are also working hard to expand our successes in our more traditional consulting and systems areas. We need these areas to be strong to balance our efforts in outsourcing, so we are not wholly dependent on large outsourcing deals that are highly competitive, and can take a long time to complete. In this regard, Bob Sullivan, our new Consulting segment head, has moved quickly over the past quarter to refocus and reinvigorate our consulting efforts. We are beginning to see some important successes, as evidenced by the progress in revenue services I spoke about earlier. In addition to our recent successes in revenue services, we also won a large systems planning and support project in Pennsylvania this past quarter, as well as a large operations improvement project in Virginia. We were also a part of the winning team on the Michigan MMIS system implementation effort. Which gets us into a new, and potentially very large market area. Similarly, we are pushing hard in some key child welfare markets, where Federal compliance audits are underway, building on a project that we recently won for the state of New York.

We are making the same type of push with our new team in the Systems area. While we are early in our Systems improvement efforts, we are encourage by some of our recent results. For example, we have seen procurements pick up in our security solutions division the last couple of months, and year-to-date have signed $9.5 million in new awards, and have another $5 million that has been awarded, but it unsigned. We also continue to experience strong and steady growth in our asset solutions division, with recent new wins in San Diego, Denver, and Indiana. And as I mentioned earlier, we secured a court automation project in the city of Atlanta, which gets underway this quarter. Finally, as you know, we have started a major new push into the Federal area. We believe that we are off to a good start in this area, as well. We are encouraged by the results that we have seen so far in our efforts. As example, we have become a leading CMS contractor on the new prescription drug program, with 3 related contracts, including pharmacy discount card appeals, part D appeals, and medic, fraud and abuse. We are also awaiting a decision on several major proposals that we submitted this past quarter.

As a last point, in addition to building our pipeline, we continue to look for strategic acquisitions to complement our organic growth. As you know, we have the wherewithal to pursue acquisitions. We have also substantially expanded our capacity to pursue and handle a major acquisition with a new team that we have added in recent months. However, as I have also said over my past calls, we will maintain a disciplined approach in assessing all acquisition opportunities. We also continue to look first to build our Company through our organic growth efforts. Overall, I feel good about our prospects in our market. In particular, we continue to see big opportunities in the areas of eligibility systems, health services, and outsourcing, where we have been very successful. We believe this success opens up opportunities in these areas and other areas, and may not be as readily available to other firms who have not had our sales success. With that, I would now like to turn our attention to our rebids, options, and pipeline, where I'll provide a status update. We continued into the first quarter with a solid win rate on current jobs. We started the year with 17 rebids on the table. The total contract value of our rebids totaled $188 million, with a $30 million impact in fiscal year 2006. To date, we have won 7 rebids for a total contract value of $57 million, and a fiscal year '06 impact of approximately $18 million. That leaves us with 10 rebids for the remainder of the year. Moving on to option year exercises, there is no change from our last conference call. All 14 option exercises remain outstanding. These carry a total contract value of approximately $77 million, with a fiscal year '06 impact of about $20 million.

Moving into new sales awards in our sales pipeline. Our year-to-date contracts signed as of February 1st, 2006, totaled approximately $130 million. Awarded but unsigned awards were $161 million. This is lower in comparison to last year, but as you know, fiscal 2005 was an exceptionally strong year for new sales awards for MAXIMUS. In fact, it was a record year. Our bookings tend to be cyclical, based on procurement cycles in our various markets. As a result, last year we had a couple of big jobs that really drove our bookings, and we are working through our largest backlog ever. While we're working really hard to win a number of new opportunities across all segments, it may be unrealistic to maintain the same level of sales in fiscal 2006. However, we are certainly going to give it our best shot.

We are also excited about our prospects for the year. In this regard, our sales pipeline remains quite robust, with opportunities at all levels of our business, and at all stages of our pipeline. As of February 1st, our pipeline totalled 1.3 billion, and consisted of proposals pending of approximately $464 million, proposals in preparation of $190 million, and RFPs tracking of $633 million. In summary, we have put a strong team in place. Our core markets are healthy. We have a variety of excellent opportunities ahead of us. We're working through a record backlog. We have a large sales pipeline. And finally, we have made progress in implementing our large new projects, and addressing some of our most pressing operational challenges. With that, I am also well aware that we have to continue to do belter in the quarters to come, especially in improving our profit margins and in turning the large opportunities that we have into new and profitable work. Our objective for the remainder of the year is to show significant progress in meeting these expectations. While challenges remain, we are confident that we can meet the financial targets that we have set for ourselves for this year. And with that, I'll open it up for questions.

[OPERATOR INSTRUCTIONS] Matthew McKay, Jefferies & Co.

Good morning, guys. I would like to just first focus on the British Columbia. And first of all, maybe if you could just quantify what you've paid in penalties during the quarter. And then just go over some of the -- how you're going to avoid making some of the temporary costs that you're seeing there, not become more permanent. I just need more color on that. And then finally, just going over the hedging strategy that you have on the -- with the Canadian contract, just so we can get some predictability on what it's going to mean on the P&L.

Okay. It's Lynn Davenport. Let me start with first, in terms of the penalty. We have with us one of the financial people from that project. Katherine, what are the penalties, to date? Roughly about $250,000 a quarter, Katherine? In the quarter. Okay. $250,000 for the quarter. With respect to the project. The project started -- we won the job in November of 2004. We actually started operations in April of 2005. And it is a large project. What we're doing is taking over responsibility for answering calls from the public about their healthcare program, and enrolling both their recipients and their providers in the program. And we are also modifying their computer system at the same time. And the first thing that happened, early in the project, there was just a really huge increase in call volume, that jumped from about, if I remember right, about 60 or 70,000, to well over 150,000 or so, for a couple of months. And that really -- that was a real issue for us. So it caused some problems in terms of meeting these performance requirements.

And we had to respond. We did so a number of ways. We added a number of temporary staff. We changed our management team. We worked hard to put in place new processes and procedures. We worked hard in our computer part of our project to modify it. And I think we've been pretty successful in the last -- in November and December, and we believe in January. We're now performing well within all of the performance standards. That's good, because that was our first objective, was quality. It cost us some money. As Rich said, it cost us about $2.6 million. So the question is, what happens going forward? We've now made some reductions. Probably around about 1.5 million in the quarter. Some of those temporary costs have now been -- have been modified. So we're probably -- we saved in the quarters going forward, about $1.5 million per quarter. We still have a shortfall. As Rich mentioned, we had think we might lose as much as 4 to $5 million in this job in total. And we have a pretty active program underway to continue to, A, deliver first, and 2, to try to do all we can to make sure the job is a financially successful job. And we are looking at -- we watch our productivity closely, we look at our work load, we look at our work load with respect to staffing. We're working hard at our opportunities to modify further through computer tasks. We have a whole series of tasks we're going to have to complete this year that have costs with them. So there's a whole number of things we're working on, and we think that if we continue to do well, we have will opportunities to further our economies over the course of the project. Does that answer your question? Maybe you have -- maybe you have a little bit more you might want to ask to make sure I'm -- .

Yes, I guess it's relative to your expectations when you were bidding on the contract, are you finding that your overall cost structure is actually higher now, now that you're actually in there doing the work? Or are you going to be able to bring those costs down to sort of a -- where you thought they were originally going to be?

We think ultimately we're going to be at where we thought. Maybe even a little bit better, because we think we can accomplish quite a bit through productivity and transformation, or systems improvements. Obviously to date, it's cost us more than we thought it was going to cost us. But we think long term, we can make this project successful at the standards the client set for us, maybe improve upon those standards, and meet the business case that we've set for ourselves in the original proposal. Now, it's taking a little bit longer to get past that, that hump, that's for certain. But I think long term, we feel good this is going to be a successful project for everybody, on the terms that originally bid it.

Okay. Great. And then just on the foreign exchange strategy going forward here?

Rich?

Foreign exchange strategy, we're taking a look at our alternatives, and it's been good news that the relative changes in the rates have been favorable, Matt. We're likely to take a look at our capitalization structure to mitigate that.

Okay. So we should expect some volatility just from quarter to quarter, based upon the Canadian dollar, I would assume?

Yes, obviously it's the relative strength of the Canadian dollar vis-a-vis the U.S. dollar that gave us the favorable translation adjustment this quarter. I wouldn't count on that to be a recurring item of that magnitude.

Okay. Great. Thanks, guys.

[OPERATOR INSTRUCTIONS] Charles Strauzer, CJS securities.

Good morning. Just I've got 1 quantitative and 1 qualitative question. Rich, the quantitative question is, if I look at your guidance range for top line revenue guidance, and then extrapolate out the guidance you just gave by segment, you're saying basically, flat year-over-year for Systems and Consulting, 15% growth in Operations. That basically gets you to the low end of your range. What needs to happen to kind of get you to the higher end of that range, and -- because you basically only gave set numbers for the segments?

Yes, I think that's right, Charlie, and you're right, the comments tend to lean towards the lower end of the range. I'd tell you, in all 3 segments, there is potential upside. I wouldn't say it leans towards any 1 particular segment. You know, we have several divisions at a minimum in all of our business units. So I think it's a matter of, if I were to tell you just from a natural classification, it would be in the area of license revenues, certainly could help us, project performance, and contingency based type matters would be the 3 general categories that would lean it towards the upper end of the range.

Let me add something, also. There's really 2 major things we're watching here. 1 is, we talked in my comments and Rich's comments about profit margins and productivity. And as we said, we're not at the margin we want to be. So bottom line income is impacted to a large extent, by our ability to make sure that we manage our jobs well enough to not have a British Columbia situation. And so managing at the bottom line is certainly 1 piece. Performance, we sort of put a whole lot of pressure in this firm on job delivery, on cost management, on performance. And that whole management team we've put in place is really focused on that agenda. 1 of the reasons we put Sue Pepin as Quality Process, is to really make sure we're doing all we can to really drive bottom line, job performance, which ultimately leads good profitability. That's 1 piece that is going to tell us whether we are at the top or lower end of our range.

The second piece is the sales opportunities. Some of these are back ended, but we have a number of opportunities right now. As I said, we put out almost $500 million worth of proposals this past quarter. Some are going to come due this year, and some of that is going to help too. So obviously, if we are successful in getting last year's kind of sales performance, we will have some of that benefit this year, also. So it's really those 2 things we're putting our whole management focus on. 1, operations performance, in terms of profit margin and sales. And the more we can do those 2 things, the more we're going to be at the top end of that line. And we have all of the pieces there in front of them, we just have to execute now. And that's what we're trying to do.

That kind of leads me to my qualitative question for you, Lynn. If you look at the Operations segment, that's doing very well. And the Systems and Consulting is flat. And, if that doesn't change, if Systems and Consulting remain flat, and you start going into your budgets for next year, and it looks like it's going to flat again, maybe even down, at what point do you say does it makes sense to even continue to be in these businesses, and maybe focus 100% on the operations business?

Good question. It's something we look at always. You want to have a little bit of balance in your business, first of all. Operations is good business, but the procurements take a long time. They're highly competed, and every operations procurement starts with kind of a British Columbia situation. So we want to have enough balance in our portfolio, if you will, to kind of fill in the gaps between those large operations and sales. So that's why something like Consulting and Systems is interesting. And also, consulting can be, if you will, the forerunner to identifying new opportunities and ideas that become operational successes.

So right now our hypothesis that we could take our consulting practice and our systems practice, and get it back to prior performance levels. That's why we made a lot of organizational changes, brought in new people. And we are starting to see some results that are positive in that regard. However, if it doesn't work, we're going to go to plan B. It's what you're talking about, is looking really hard at which pieces of the business work and don't work. We ask those kinds of questions of ourselves every day. Each of the new people that's involved -- that's come in, is working right now. We're calling it an action plan, to make sure we make the rest of the year. They are finalizing those plans within the next week or 2. And we're look at all kinds of questions, near term and longer term. And clearly, the ultimate viability of the business is one of those kinds of questions. But we've kind of set some internal time lines, we make decisions around the kind of questions you're asking. We were kind of watching those points pretty closely. It's a good question. Something we watch every day.

And would acquisitions fit into that equation in those 2 segments? Or do you think you would be looking acquisitions more on the operations side?

Acquisitions are something we're thinking a lot about. We've stepped up internally the process of thinking of acquisitions. The question is where do you put your acquisitions? Seems to me, the best place to put your acquisition is the place where you think you have the strongest potential to grow, as opposed to where you want to fix something that's not working. So you're going to see our acquisitions is going to be in the places that we think really have the most breakout potential to be take us to the next level, to build on what we already got started well, and places where we have synergy to support. I don't think it's a good idea, something that's not working, to try to acquire something to turn it around. That's probably the -- that latter situation is where you probably start looking at other options, such as divesting yourself of that program.

Great. Thanks for your answers.

[OPERATOR INSTRUCTIONS] Matt Conrad, FBR.

Hi, good morning. This is Matt Conrad from FBR. Wanted to ask a couple of questions. Looks like you're do a lot of investing in management, which you spoke of. Could this cause a hiccup in operating margins? Are they new additions, or are they replacements?

Little bits of both. We replaced a number of people over the last 6 months. And so to a large extent, each of the persons that has come in replaces somebody else. But there has been also, some additive investment. Hiccup in terms of operations? There's probably a little bit of a settling in cost. It all happened here, in the first quarter. A new team took place and got involved. And they're -- you know, they're getting on top of their operation. And so there's probably a little bit of a situation where a person now knows a little bit more which rocks to look under. And so we've probably had a little bit of an operational impact there.

And Matt, I would like to add to that. I did have some comments in the body of my report, addressing what was happening in the margin. So obviously, British Columbia was a factor, but there is other factors that come into play from a consolidated margin perspective. Certainly we do have some costs related to new management, as Lynn mentioned, but also option expense. You need to remember the option expense. It was about $900,000 in the quarter, and it hit us in this first quarter, and it did not exist in prior periods.

Okay. And do you think that that 900,000 will continue? Or was that a spike because of new management?

Oh, no, the $900,000 is a result of the adoption of FAS 123R, so that will -- that's with us, I think, for the long term.

Okay.

And I would also say that that impacted us about -- when you run the math, I think it's about 60 basis points.

Okay. Great. And then just to follow-up on Charles' question regarding the M&A. He looked at it kind of from an internal perspective. Externally, what do you see as the -- as the atmosphere in state and local and federal, as far as pricing and quality companies?

I see -- my overall commentary would be, not a whole lot of change in the state and local arena. I think federal properties are very much in demand, and there is not quite as many as there were a couple of years ago. There seems to be a fair amount of consolidation that has happened in that space. There's still opportunities, but fewer than in the past. And I think valuations are pretty high in that space.

Okay. Thank you.

Jason Kupferberg, UBS.

Good morning, guys. I just want to ask a question on the EPS in the quarter first, make sure I have the numbers right here. You guys said about a $0.025 cent impact from adoption of FAS 123. I thought last quarter you guys expected the impact to be more like $0.04 to $0.05 a the quarter. If that's right and had the impact actually been $0.04 to $0.05 in the quarter, you would have been more about $0.39 than $0.41, kind of low end versus high end of the guidance range? Am I -- got the math right?

I think in the math is right. I mean it actually was $900,000 on the quarter, and I think the math does work out to $0.025. We also have RSUs that we issue, so there's a mix factor that comes into play. But the expected cost of what we call LTE, Jason, was slightly less. And the reason for that is, when we forecast numbers, we have to forecast expected forfeitures under FAS 123R. And forfeitures were a bit higher than we had forecast, and that caused it to be less than what was underlying our guidance number.

Okay. And then -- ?

I think we previously forecasted I think $0.39 to $0.41, if I recall our notes, Jason.

Right, right. And just a question on the full year guidance. You mentioned 2 revenue spikes coming on a couple of these voting projects, I think totaling about 16 million over the next couple of quarters. Was that 16 million in your original guidance? Because you kind of raised the guidance for the Operations segment from 10 to 15% growth, to 15%. Is that delta this 16 million?

I think all along we've had this -- that forecasted in our revenues. But I'm not -- can you rephrase your question for me Jason?

Well, we did have some shifts in the restatement, so that's why we provided updated guidance by segment. So perhaps that may have caused the shift in growth on a year-over-year basis.

Okay. So I guess then the question just is, was the 16 million from these product sales in the original guidance?

I believe it was, Jason.

Okay. And just on the legal expense front. You mentioned the 0.5 million from the DC subpoena in the quarter. Is there potential for anything further there? Or is it case closed? And can you give us an update on the lawsuit with the fraudulent employees from last year?

Let me take part one. And that's a good point. The $500,000, need to go back to last year when we recorded $7 million for the year, as it relates to legal expense on the SPI matter. At that point in time, we adopted a policy whereby basically, we would record any settlement costs and estimated legal costs for significant matters, and its estimated future legal costs for significant matters. So pursuant to that policy, we accrued the $500,000 in this quarter. And that $500,000 is our best estimate at this point in time of the current work as we know it to be. Now, that doesn't mean that there might be an additional phase above and beyond that. It's obviously, we have to see what the results of the process, Jason. So -- but this is our estimate of at least the foreseeable future.

Now with respect to your second question, David Francis, why don't you take that.

Since the last call, there haven't been any developments on the lawsuit down in Georgia, and we still don't have a trial date set for that.

Okay. But roughly, the spring time frame still, I think, is what you had said last quarter, is that -- ?

We were expected late spring, it may move further out than that, since we don't have a date yet.

Okay. And, sorry, last question. Not to beat the British Columbia issue to death, but just kind of how that manifests itself going forward in your pipeline. It sounds like you guys have taken away some lessons learned. Does it make you any more of - for lack of a better term - gun shy, in terms of going after bigger deals as a prime contractor, recognizing some of the inherent operational and financial risks that can kind of underlie these big projects?

No. We have really established our reputation in the last couple of years on the big projects. British Columbia, HCO in California, Healthy Families Massachusetts. Big projects are inherently going to have big challenges. That's just the reality of them. What you do is, you take them on, you work through them. Each of our projects has kind of a certain life cycle where it's tough at the beginning, we sort out all the pieces, you start to get economies, and it starts to stabilize and normalize. That's just the path with these projects. We tend to jump on them quickly, and that's why there's so much emotion about this. But this kind of what we do, it's the future we see for ourselves. We want to continue to get better at it, because everybody wants to get better at what they're doing. But that's just the way these businesses work. We're going after, not shying away from these opportunities. We just want, as we go after them, to continue to get stronger and stronger in our ability to do them.

Okay. Thanks.

[OPERATOR INSTRUCTIONS] Shlomo Rosenbaum, Stifel Nicolaus.

Hi , this is Shlomo Rosenbaum from Stifel Nicolaus. I just wanted to ask you a little bit about the SG&A costs. Just noticed that sequentially, it is up pretty high. And I would think that the British Columbia costs, where you're adding personnel, should have been in the gross profit line. And I just wondered if you can give us a little bit more color on what's driving the big push up in SG&A costs, quarter-over-quarter?

Shlomo, this is Rich. That's a good point. You're right, that the absolute dollar amount of SG&A was $31.6 million for the quarter. That's up about $2 million over the comparable quarter in the prior year, and I believe about $3.4 million sequentially. Is that is the data that you're looking at?

Yes, I'm looking at last quarter of 26.7 million in SG&A, and this quarter of like 30.2. I'm Xing out the stock option expense.

Okay. All right. And I've got total SG&A of 31.6 for the quarter. So I think that's the number that we should be tying into. In either case, the main factors in that are, first off, again, you need to remember that in this quarter we have FAS 123, or option expense, to the tune of about $500,000 -- $900,000. And we also have some additional new management expense in that category. And the third thing I would say, is that we do have some costs that, depending upon what professionals are doing, and this would be the cost of consultants and professionals, who are in the normal course are working on projects, would be charged to cost of sales. If they work on proposals, and we've had a lot of work of late in that category, they charge what's called B&P, and it's a thing peculiar to government contracting. They charge it to SG&A. So you'll get shifts between cost of sales and SG&A. The work that we're doing in British Columbia, all of that work is cost of sales work. It's not SG&A work. So B.C. dynamics are not a factor in our SG&A line. It's these other items that I mentioned. So consequently, my suggestion, because you do get these shifts between cost of sales and SG&A, is really to focus on the operating margin. And when you do that, you'll get back to looking at that 8.1% for the quarter. And when you factor out the - as I said in my text - when you factor out B.C. and legal expense, you get back to a more normalized 9.7%.

So can you just walk me through a little bit of the delta, last quarter to this quarter, and how much you can allocate? Obviously, you had 900K from the equity expense. Can you walk me through how much more you thought was because of bid and proposal, and how much more was just new management hires? Is there a way to break that out?

Yes. Well, in total. For total Company?

Yes. Just walking through the delta on your SG&A line.

Yes, I would tell you that -- well, you've got the $900,000. The new management costs would be in the - and this is an estimate of what the new management cost is directly, and you have to load it - would be $500,000 at a minimum. And bid and proposal cost, I would estimate to be in the category of $1 million in the quarter.

And that's the delta you're talking about?

That's correct.

Okay. Additionally, I just want to talk a little bit about the Operations group. If you could just walk me through. In the last few quarters, there's just been sequential decline. I know that part of it was the New Jersey contract, and part of it, you were talking about a contract you decided not to bid. Can you just walk me through the step down from June '05 level, 111.3 million, to 108 million, to 102.8 million. Just give us some of the moving parts in that. What stepped it down?

I'll take you from the 108 to the 102. And most of that really is -- and I'm not going to go back to Q3. 108 to the 102, and I think that's about a $5.2 million delta. I think I addressed that and said there's 2 main drivers to that. We have 1 project that we no bid. Order magnitude in the 2 periods we're talking about is about $2 million for them. And same order of magnitude as it relates to the impact from the Texas IE transition phase. And the rest I don't think is attributable to any particular driver.

es, and just a reminder, Shlomo. In the third quarter of that fiscal year, we do have open enrollment in some of our large health contracts. And as a result, you can see a bump up in revenue there.

Okay.

And it's most notable if you take Q2 and go to Q3. You'll see Q2 of FY '05 was $97.8 million.

Right.

Now spiking up $111.3 million. The -- you've got several drivers, including B.C. there, but also, you also have, as Lisa just mentioned, the open enrollment, which generally happens every June quarter. So you should see that on a year in, year out basis.

Okay.

Does that help?

Yes. If I can squeeze in another one. I just wanted to ask about, if you can give us some of the milestones that are coming up on both Texas and British Columbia, just walk us through that again.

Let's start with Texas. A lot of the milestones in Texas have been achieved. As I said, Texas has 3 big parts. 1 was to take over responsibility for their CHIP program, in Children's Health Insurance Program. The second, the Medicaid. The third, to put in place this integrated eligibility function for their TANF and food stamp and Medicaid programs. Anyway, the CHIP implementation project went live in November, as did the Medicaid project in November. The big one is the IE, Integrated Eligibility, taking over the whole welfare function to both the state. It's their seventh, I believe, pilot. So the first was in the Travis county, which is Austin area, and that went live January 20th. And so there's 6 more pilots to go live with this process across the state. But we've made -- we and our partners in the project have made substantial progress in putting all of these various programs in place. There's been enormous investment of people, in time and processes, and technology, and we're still working hard behind the scenes to get everything continued to be put forward. But Texas is -- it has some major continuing milestones between now and -- I think, Katherine, it's really the fall, really, basically. And this fiscal year. So that's Texas.

And British Columbia, the major operational milestones, in terms of putting in place our operation, and making sure that we deliver within accordance with standards has happened. Now their challenge is to make sure we stay on those standards. We watch it very closely. And to continue to get improved service, in terms of responsiveness to the client, and in efficiency, in terms of productivity. So the operations piece is okay. Now, there's timelines now on the technology side. And there's a whole series we've already put in. We have -- are building a web system to support their operation, and the first piece of that is ready to go here in January. It's a premium assistance area. And there's several more rollouts between now and June on the web system. There's another system, called the claims processing system. There's a series of scheduled events that we're working out with the client now, to put that system in place over the next months and year. So there's still an active amount of technology to put in place in British Columbia between now and early next calendar year.

Okay. So is there something that is -- one area that stands out, that's significant, that we should sort of be looking for any announcement on, within the British Columbia contract, as part of these technology implementations?

Well, no. As we keep getting things done, we will be making announcements. But there's not -- there's just a whole series of planned implementation tasks that we're working on.

Okay. Thanks a lot.

Dana Walker, Kalmar

Good morning. Could you talk about the revenue development that you expect in Texas?

The revenue development?

Well, if you add the additional -- the additional regions for the IE part of this, compared to the present run rate.

We expect that the revenue is going to increase as -- over the next quarter, as we roll out this new -- this new application. We forecasted previously, Dana, $45 million for the full fiscal year for Texas, and that was fiscal year '06. We started -- the work we have been doing was about $30 million a year. So if you look at '06 over '05, net net Texas, we expect to add about $15 million. And then when we think we're all up and running and fully operational, that is expected to be -- the 45 is expected to grow to $85 million a year. And I think that's going to happen in '07.

When you talk about there being transitional issues, though, in the first quarter, is that -- does that suggest that you did not sustain that 11 or 12 million a quarter in December? Or does that mean that you slipped from the $30 million annualized clip in December?

It means that we slipped, I believe, from the $30 million annualized clip, because there was some work that we had been performing under the prior contract. And then there's other work which was basically outreach work, where under the old system, the prior configuration, the prior set up of call centers, et cetera, called for an outreach program, which made sense. The state would -- because they wanted to be effective. They wanted to get these benefits to the population. They would have to spend dollars and outreach to the population to inform them of the potential of benefits. Under the new system, that outreach cost went away. So we had a little bit of a belly, where we went down a little bit in this quarter, from the classic $30 million, and we expect that as we pick up the additional work with these new rollouts, that we'll get back to that $30 million clip, and beyond.

The British Columbia operating drag that we saw in Q1, can you compare that to what we saw in the latter couple of quarters of fiscal '05?

I think we previously informed folks, it was about $3.5 million for those 2 quarters in total, in the second half of fiscal '05.

Lynn, you talked about how the revenue services businesses is beginning to act far better. Aside from lots of attention, maybe you would summarize what you're doing that's going well, and what that suggests about the next couple of years, both margin and revenue development-wise.

Well, we've put in place a different set of individuals who are managing the practice, and I think that's brought a lot of reinvigoration. We have been able to win some -- a number of new jobs recently, which is good. We're looking -- in terms of the practice, I think what's turned it around the most, is that we just really, really focused on the basics. The basics of just making sure that all this documentation is pulled together, and we work closely with the Feds, and we just really -- it's a business of a lot of minutiae, and you've got to get the minutiae right. And so I think we have really, really pushed ourselves to really -- the world of approvals has changed. The Feds are very demanding and aggressive, and they're looking at the processes. And you've got to make -- and they -- what you do is a series of laws that really kind of -- they keep changing. You have to keep kind of moving ahead of the curve, if you will, in this practice area. I think we're getting better at moving ahead of the curve. So that's probably -- that's given us some confidence.

The question about going forward in this practice area, it's probably never going to be the -- some of the high margins that we might have seen in the in past, because there's been a lot of changes in terms of the -- the jobs are at a much smaller a percentage of recovery amounts and so on. So we think we have the potential this year to have a profitable practice. And that's good. That's a start. In terms of where it goes forward, we think this is going to be a good 15% margin business. And that's probably a 15 to 20% margin business, and that's probably a goal for it right now.

How would you describe, moving to a different topic, your pipeline in integrated eligibility?

Well, the pipeline is real good integrated eligibility. There's about 15 states that we're talking to and watching closely. The jobs are potentially very large. We're not the only firm that knows about this. However, we've been pretty successful to date, and we think that gives us a real advantage. We would like to be one of the firms that have won the jobs, as opposed to the firms trying to explain to the client by having not won in the past, is a good thing. So we think we have a pretty good starting advantage. It's a strong pipeline. It's big complicated jobs. The issue with the pipeline is the amount of time that seems to be it takes to win these jobs. That's been the biggest issue. Texas took a long time. The next stage that's out there right now that we're involved in, are taking a long time. But I think as a pipeline, it is a very healthy, strong pipeline.

How many of these might you suppose are '06 time frame events?

Well, in terms of the win, it may happen in '06. In terms of the benefit -- I mean in term the revenue and income benefit, it's probably more like an '07 event. I don't want to get into the specific opportunities we're involved in right now, but I know them pretty closely. And even some that might make decisions relatively soon, it's going to take a while, if experience proves out from the past, in terms of contract negotiations and the planning process and so on. So I think that one of the things that frustrates, in terms of efforts, that this great set of opportunities, we're really working them hard. But we're making a lot of effort here at '06 for '07 wins. And so that's good, but that's an issue. But I don't think too many of them are going to turn to be big bottom line winners this year.

Final question from me. Your child support business used to be very lucrative. Seemed to go through a swoon period. How would you describe it today?

I would call it a business we're watching pretty closely. It has not been as strong as it once was. This is a practice area that's changing. It's hard to get states really interested in the child support question, which bothers me, because there's about $80 billion worth of uncollected child support money in this country. That seems like a problem, and therefore a problem is an opportunity. But new federal laws are coming along, are looking at some ways at restricting opportunities in that area. So this is a practice -- somebody asked earlier about what do you do about pieces that are not working real well. This is a practice we're looking at really hard. We've put a good, new person in charge of it. We're making a lot of efforts. We need kind of work here, as all firms do that play in this space, to kind of figure out how best to serve the client. How do we get states to go after that unrecovered amount of money. This is an area of a fair amount of strategic discussion internally right now.

Would you remind us what percent of your revenue it accounts for?

Rich?

Less than 10%, Dana.

Is the change in view, or the scrutiny, a function of the economics of the business and the way that you engage for the customer and with the -- the folks that are not paying their bills, different? Or is there some other reason?

I'm not sure I follow the question. You said, a change of view. In terms of our view of this business, what we're looking at, you mean?

Well, I presume that it's less interesting because it's tougher to make money, and it's tougher to envision how you grow. I'm curious, though, how the economics of the business that you have right now appears.

Well, the economics of the business we have right now, don't appear good enough to us. We're just not winning enough. We don't have enough bottom line performance. So that's a concern. The question we're struggling with is -- or working with, is how do we reposition this business to win more work, and provide more benefit to the client, so they're going to want to pay it. We're looking at how to -- it's kind of a classic case of business planning. Trying to figure out what is the burning challenge that states have, and then trying to figure out what are the right kinds of solutions, and to really work with the states to understand that our solutions are appropriate. We have to work kind of internally. They are self focused, and then we have to really make a push with the clients. But right now, it's just not a practice area. We need to win more, and we have fairly low margins in some of our projects there. So it's a -- we're spending a lot of time thinking about what is the next best course for this practice area.

Are you watching particular service providers that are succeeding in this area, who have a different approach to market?

Well, we are. But this is not a practice area that there's been a whole lot of success. What you really have is several players kind of working in kind of a -- this is not the overall industry, business does not seem to be growing in this area.You have people kind of taking work from one another, but it's not really an area where there seems to be real expansion in the opportunity areas. For example, you mentioned [inaudible] eligibility. Well, there's a lot of new work there, a lot of states that are looking at that. There's a lot of opportunities in areas -- MMIS. And so that creates additive new opportunities. To a certain extent in child support, you see kind of everybody kind of fighting within kind of a -- kind of a fixed area of business. So it's -- I think it's a challenge across the board. Not just a MAXIMUS challenge, it's a challenge for this industry, about child support per se. It's an issue.

Thank you for your candor.

I want to thank everyone for joining us today on the MAXIMUS first quarter earnings conference call. And with that, that concludes this morning's call.

Ladies and gentlemen, a replay of this call will be available to you within the hour. You can access the replay by dialing 1-800-207-7077, and entering pin number 4504. Once again that phone number is 1-800-207-7077. Pin number 4504. Ladies and gentlemen, this concludes today's presentation. Thank you for your participation. You may now disconnect.