Maximus Inc (MMS) 2007 Q2 法說會逐字稿

Ladies and gentlemen, welcome to MAXIMUS's second quarter earnings conference call. During this session, all lines will be muted until the question and answer portion of the call. If you need audio assistance, please press star 0, and an operator will assist you.

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

Good morning. Thank you for joining us for the MAXIMUS second quarter earnings conference call. If you would like follow along, we have posted a presentation on our website under the Investor Relations page. On the call today is Rich Montoni, Chief Executive Officer; and David Walker, Chief Financial Officer. Following our prepared comments, we will open the call up for Q&A.

Before we begin, I would like to remind everyone that a number of statements being made today will be forward-looking in nature. Please remember that such statements are only predictions, and actual events or results may differ materially as a result of risks we face including those discussed in Exhibit 99.1 of our SEC filings. We encourage you to review the summary of these risks in our most recent 10-Q filed with the SEC on February 8th. The Company does not assume any obligation to revise or update these forward-looking statements to reflect subsequent events or circumstances. And with that, I will turn the call over to Dave.

Thanks, Lisa. Good morning. This morning, the Company reported second quarter revenue totaling $179.1 million, a net income of $2.4 million, or $0.11 per diluted share. As outlined in our Press Release, financial results are comprised of three components. Losses on the Texas contract, legal provisions, and base operations. For the second quarter, revenue from the Texas project was $11.2 million, and generated a pre-tax loss of $6.5 million, or $0.18 per diluted share. You may recall that we had estimated that the second quarter pre-tax loss on the Texas project was expected to be in the range of $13 million to $18 million. Results from Texas were better than expected due to the recognition of deferred revenue and collection of previously reserved receivables. This was somewhat offset by costs incurred for work performed under the new contracts where we are unable to recognize the revenue in the second quarter. This will provide a benefit in the third quarter, as we expect results for the Texas project will be slightly more accretive in the quarter.

The Company is now operating under new contracts being performed directly for the Texas Health and Human Services Commission. Beginning in the third quarter, we no longer planned to separately disclose the results of the Texas program. Looking forward, we expect the Texas project will go from a loss position to become a positive contributor to earnings. Rich will talk more about the new Texas contracts later in the call.

Legal costs, the second component of our financial results, had a pre-tax expense in the quarter of $6.1 million, or $0.16 per diluted share. These legal costs primarily relate to estimated future legal expenses for our ongoing arbitration with Accenture, and a final settlement for previously disclosed legal matter relating to a contract in Ontario. Base Operations, which excludes results from the Texas project and legal expenses, delivered $0.45 per diluted share in the second quarter.

Let's move into the results by business segment, starting with Consulting. Consulting segment revenue was $23.2 million for the second quarter. And operating income totalled $1 million, for an operating margin of 4.4%. The Consulting segment performed as expected during the quarter. If you recall, I explained during our last quarterly call that we expected the results to be softer in Q2 as a result of timing associated with completion of work and customer required actions or work acceptance. On a year-to-date basis, the operating income margin was 8%.

Moving into the System segment, as expected, the System segment showed improve over last quarter. Systems revenue in the second fiscal quarter totalled $35.4 million, compared to $32.2 million reported for the same period last year, and $34.5 million reported last quarter. This revenue growth is primarily from new contracts in the ERP division. The segment returned to profitability in the second quarter with operating income of $93,000. During the quarter, the new work in the ERP division drove the improved results. Over the last several months, we successfully managed the ERP division to a solid rebound with a refreshed backlog of profitable contracts. At the same time, we're winding down a couple of legacy contracts which created cost overruns in fiscal 2006.

The improvements and ERP helped offset weakness in the Educational Systems division. Education launched an enterprise version of its SchoolIMAX Student Information Systems at the end of last fiscal year, and will continue to deploy both technical and sales resources, which will continue to impact profitability for the remainder of the year.

As we discussed on our last quarterly call, we see many large software licensing opportunities in the market. These contracts have longer procurement and installation cycles, and generally require licensed revenue to be recorded ratively. While this intellectual property has tremendous potential to provide long-term value for our shareholders, 2007 remains a transition year for the Systems segment.

Turning to the Operations segment. Revenue for the Operations segment totalled $120.4 million for the second quarter, compared to revenue of $121.2 million for the same period last year. Revenue for the second quarter of 2006 was higher relative to 2007 by $6.9 million from a large voter hardware sale and the Corrections business which has since been divested. In the current quarter, the Operations segment posted operating income of $7.1 million. For the first time since the second quarter of last year, the Operations segment has returned to profitability. This is principally driven by the curtailment of the Texas losses. Excluding the Texas loss, the operating income for the segment was $13.6 million, or an operating margin of 12.4%, which compares favorably to $12.8 million in the same quarter of the prior year similarly adjusted for Texas. The normalized 12.4% operating margin is a solid indicator that the underlying Operations business remains healthy. Sequentially, the Operations segment revenue grew $18.5 million, and operating income grew $23.1 million over the first fiscal quarter of 2007. This growth largely reflects the contract charges recorded during the first quarter on the Texas and Ontario projects of approximately $16 million. Reductions in the Texas operating loss of $5.5 million and expansion of other margins also contributed to the operating income improvements.

Moving on to balance sheet and cash flow items. We ended the second fiscal quarter with cash, cash equivalents and marketable securities of $177.3 million. Our accounts receivable for the quarter totalled $165.8 million. We also have $2.1 million in long-term accounts receivable which are classified within other assets on the balance sheet. DSOs improved in the quarter to 85 days, a reduction of 11 days over last quarter. About five days of this improvement is a temporary benefit associated with recognition of deferred revenue on the completed Texas contract and collection of previously reserved receivables. But approximately six days of the DSO improvement demonstrates that we are making solid headway in our efforts to achieve better contract terms and complete older fixed price milestone contracts.

Cash flow in the quarter was very strong. Cash provided from operating activities totalled $17.5 million in the quarter, with free cash flow of $14 million. Approximately $10 million of this cash flow which derived from large subcontractors and vendors as well as tax refunds received in the quarter. Other uses of cash include $2.2 million used to pay a quarterly cash dividend of $0.10 per share in February.

In summary, we see continued improvements in our balance sheet. We were actively focusing on optimizing contract management and performance. As we wind down the old Texas contract, we should expect to see margins return to more normalized levels over the coming quarters. Excluding the impact of the Texas project during the quarter, operating margin for the consolidated Company would have been 8.9%. As I noted earlier, the Operations segment would have delivered a normalized 12.4% operating margin. We believe a 10% operating margin is a reasonable objective for the total Company, and we continue to take the necessary steps to meet this objective in the short-term. And with that, I will turn the call over to Rich.

Thanks, David. And good morning, everyone. I believe the quarter's results reflect solid progress with several important developments at MAXIMUS, and give us a positive outlook that the clouds are in fact lifting and there are clearer skies ahead. The results evidence the progress that we've made with our strategy to optimize our current business and remedy legacy projects in overhang matters. Inherentness has been the implementation of management controls designed to improve the risk profile and profitability of new work that we sign up. Let's look at the components of the $0.11 of GAAP earnings per share as outlined in this morning's Press Release.

During the quarter, we had a provision for legal expense of $6.1 million pre-tax, or $0.16 per share; a pre-tax operating loss on the Texas project of $6.5 million, or $0.18 per share, and Base Operations delivered pre-tax income of $16.5 million, or $0.45 per share. The legal provision in the quarter relates principally to two matters. A legal settlement in Ontario, Canada, and for future estimated legal expenses related to the ongoing Accenture arbitration. We decided to settle the Ontario matter to avoid the cost, risk and distraction of litigation. The provision for additional future arbitration costs is based on recent run rates, which have been higher than originally estimated, and should be sufficient to cover costs at least through September 30, 2007. Naturally, should the matter be settled before then, these costs would not be incurred.

The Ontario settlement is consistent with our previously stated strategy of managing legacy issues aggressively in clearing out the remaining significant matters that still exist today. We continue working to resolve both the D.C. matter and the outstanding arbitration in Texas. As with any outstanding legal matter, we are limited in our disclosures and cannot provide any additional details at this time related to potential outcomes. But the bottom line is that we're working to resolve these overhang matters in a timely manner, get them behind us, and move forward with growing our business over the long term.

Let's turn our attention to the positive new developments in Texas as we outlined in this morning's Press Release. We're very pleased that we have turned a large operating loss into what we expect to be a collection of profitable contracts in the second half of the year. We've signed four new interim contracts directly with the Texas Health and Human Services Commission. We believe that these new agreement with the Health and Human Services Commission are reflective of our commitment to the state throughout this process. Despite the challenges of our previous role as subcontractor, we remain committed to the state. Our customer loyalty helped maintain the integrity of our brand in the marketplace. We also believe that the new agreements reflect the professionalism of our employees throughout the history of the Integrated Eligibility project in Texas. We expect these contracts may evolve as the commission seeks to transition services and come to a decision on how these programs will operate over the longer term. Today, we are in the first phase with interim agreements that run for 60 days on each of the four programs. Following that, it's likely that the commission may consider extended but still short-term agreements as they work through transition plans and ultimately recompetes.

Let me summarize the four agreements. First, on the Enrollment Broker contract, a service which we've actually been managing for the state of Texas since 1997, we signed a 60-day agreement effective March 15. It's our expectation that we will reach a long-term agreement for the Enrollment Broker work that will likely carry us through June of 2010. The second agreement became effective March 15th, it spans 60 days and covers Eligibility services. The third agreement covers Systems work under the CHIP program and became effective April 1. This also runs for 60 days. And lastly, we signed a 60-day agreement effective May 1st on the CHIP Operations Program where MAXIMUS is responsible for the enrollment of children whose family have too much income to qualify for Medicaid, but can't afford private insurance.

It is our expectation that these contracts in aggregate will initially produce revenues on a monthly basis of approximately $10 million. With these contracts now contributing to profitability and no longer representing a loss, on a go-forward basis we will no longer report Texas separately. Results from these operations will be included as part of results for our total operations. We are very pleased to have reached direct contractual agreements with the Texas Health and Human Services Commission which brings much of this chapter to resolution. As the future operations of the new Texas contracts, those in place are interim agreements and will expire from May 15th to June 30th. We expect these contracts will be renewed or extended, again in the short-term, until longer contracts can be put in place.

As mentioned before, we expect that over the longer term, the Enrollment Broker work will remain substantially the same, and a long-term contract will run through June, 2010. The contracts underlining the remaining work will depend upon the direction the state plans to take. So we will have to wait and see. But for practical purposes, much of the work will need to be done at least for the foreseeable future.

Since I assumed the role of Chief Executive Officer one year ago, we implemented, improved processes, strengthened personnel, and have moved decisively to address legacy issues. In the second quarter, we started to realize some of the benefits of this direction. As we have discussed in prior calls, with new specific management controls now in place, we have been much more disciplined in the upfront process in terms of bidding, pricing, and project scope. As a result, the work we are bidding on and winning is of higher quality with more favorable terms. Of course, we continue to work through cleaning up some of our legacy contracts and overhangs, but at the same time we have been refreshing the backlog with quality work.

I'm very pleased with the progress we have made. We are clearly getting traction and making headway, which is reflective in our new award signed as of May 2nd, which tops out at just over $300 million. With more than half of our new awards coming from contract sized between $3 million and $30 million, which also reflects our move toward more profitable, less volume driven business. We've also secured another $82 million of awarded but unsigned contracts. As outlined in the Press Release, the overall Sales Pipeline remains healthy with potential opportunities in excess of $1.2 billion. We see several opportunities throughout all segments of the business, with the overall macro environment driving strong demand, particularly in areas such as Health and Human Services.

The Deficit Reduction Act has clearly influenced demand in areas such as workforce services, where states are now required to have a 50% work participation rate and the definition of work activities has changed. As a result, we've seen increased activity in this area with more jurisdictions moving towards an outsourcing model. We recently expanded a current project with new work that was previously performed in-house. The work expansion nearly triples the size of that project alone. We've also witnessed some jurisdiction designing procurements for larger organizations and shying away from community based organization. Along these lines, we secured a new five-year, $44 million Workforce services job in Tennessee. This work was previously performed by a network of small community based organizations.

Switching gears to the Health business, on our last conference call, I told you that we were notified of an award on a new Enrollment Broker job. During the quarter, we started work on this new Enrollment Broker project for the state of South Carolina. This work was previously performed in-house and was won through a competitive bid. On April 1st, we started the implementation phase, with an expected go-live date of August 1st. Under this new statewide initiative, we are launching a regional rollout with all operations across the state, expected to be up and running by February 1, 2008. The project is set to run through March of 2010, but there are also two one-year option years available.

In the Consulting segment, we have been advancing ways to expand into broader areas. During the quarter, the segment won a new project to provide program management, change management and business process reengineering to the Department of Conservation in a large western state. This is a great example of the Company's cross collaboration and cross-selling efforts. The effort will largely focus on integrated the Oracle business suite into their business processes, and we are excited about this single agency project that has been very well defined from a scope prospective.

As David touched upon in his comments, I'm also pleased with the improvements we made in certain areas of the Systems segment, most notably in our ERP division. The division came off a particularly challenging year in fiscal 2006, in part due to some of the contractual terms that we agreed to when we signed on to these projects years ago. As fiscal '06 came to a close, the division was able to navigate these legacy projects to completion, while at the same time, they secured new work and refreshed their backlog as they moved into fiscal '07. We are seeing improvement in the overall Systems segment, but the results do remain mixed, with solid performance from the Asset services and ERP divisions, offsetting softness in the Educational Systems division.

In conclusion, where do we go from here? We have talked this morning about how we are gaining traction in some of our businesses, and how we are addressing legacy issues, and implementing both changes and processes and personnel. While we've had to contend with some high profile challenges, I am proud of what our team has accomplished in recent quarters. Of course, there's still more to do. We will continue our detailed initiatives including our business review committee, our quality and risk management initiative, and our ongoing training with focus on project execution. Our Board of Directors continues to re-evaluate the Company's capitalization. Our cash and marketable securities remains substantial at $177.3 million. And with our positive quarterly cash flow capability, we recognize that this may not be the most efficient use of our cash in the long-term.

Presently, there is no specific intent to affect a cash distribution, such as resuming our share repurchase program. However, as soon as we resolve the arbitration in the D.C. matter, you can expect that we will address the excess capitalization. For now, our focus is on returning the business as a whole to an operating margin of 10%, which we believe is attainable. I know that's a number that's been floated around before, but with the Texas operating losses substantially behind us, we were intent on returning to this level of operating profitability built on quality, not volume. In order to reach the 10% threshold, we will need all three of our segments to contribute.

In Consulting, our target operating margin for the segment is 15% plus. We think this segment should be able to contribute 15%, but realized that it can fluctuate as the timing of work does fluctuate. Similarly in Systems, we do see some margin fluctuation, but our overall target is really returning this segment to a 10% margin contributor. It has not performed there over the last several quarters, and we don't expect it to be there in fiscal '07. But as we look beyond this year, we expect that our Systems business will achieve that 10% target, even greater in the long-term.

In Operations, our target operating margin for the segment is typically in the range of 8% to 12%. The wide range results from differences in margin contributions across some of these divisions in the overall mix. We typically see the Health business perform at the higher end of the range, certainly when we have mature programs in place. But on the other side, the Child Support and Federal businesses typically run in the high single digits.

As disclosed in this morning's Press Release, the Company now expects total revenue in the range of $740 million to $770 million, and GAAP diluted earnings per share of $0.85 to $0.95, which includes the Texas project results and legal expenses through the second quarter of fiscal 2007. Our revised full year guidance does not include any costs associated with legal settlements that may occur in the back half of fiscal 2007. In addition, we also established preliminary fiscal 2008 guidance. Our continued efforts to improve the base business along with strong demand in the state and local markets are largely the basis for this early outlook. As a result, we preliminarily expect revenue growth of roughly 10% in fiscal 2008, with diluted earnings per share for fiscal 2008 in the range of $2.30 to $2.60. And with that, let's open it up for questions.

(OPERATOR INSTRUCTIONS) The first question comes from the line of Charles Strauzer with CJS Securities.

Good morning.

Hi, Charlie.

Congratulations on getting this thing turned around much faster than I think any of us thought it would. And my first question, really goes to Rich. If you look at the things that have happened in Texas, you've done a very good job at kind of quickly separating yourselves from the issues there and committing yourself to the state, but there seems to be a lot of negative sentiment within the legislature there in terms of the privatization in general, and there's been some proposed legislation in various parts of privatization to temporarily suspend that kind of work there. Can you talk about that and also talk about the -- has there been a trickle down effect you've seen in other kind of larger projects around the country?

Charlie, thanks for the nice compliment. In regards to the topic that you raised, that is an age old question and dynamic that we experience in the industry. We have pressures and resistance we get from labor unions and certainly democratic-type initiatives and sentiments lean towards more in-house-type initiatives. So it's an interesting question to contemplate, where does the equilibrium ultimately end up. We do hear sentiments and really demands, performance-type demands coming from the communities, coming from the politicians, and rightfully so. It's the nature of the programs that we operate in. They are very social in nature. They're very close to the communities and very important to the politicians that are entrusted with these funds and with these programs. So I think you should just normally expect to get -- to be under the lime light, if you will. That being said, in my mind the big drivers are these states just have more cases that they have to deal with and they're more complex cases. So you have opposing directions here. Net-net, I think we're seeing it end up with more of the states going -- leaning toward outsourcing. I have maintained for several years that's the long-term trend, and I think we were seeing confirmation of that today. And I think we've talked about some instances, even on this call, where we've had states go from a typical in-house-type operation towards outsourcing it. And in my mind that's the dynamic, and it's really moving in our favor.

Great. And then just my follow-up, is really if you look at the capitalization just expanding on your comments there. Can you talk a little bit more about some of your preferences for the balance sheet and really gives a sense -- you want to keep a powder drywall, the moving pieces were still moving, and it seems like as you get a little bit more confidence in the business, the operations, the margins going back in the right direction, give us a sense of where you are now versus maybe where you were maybe 60 or 90 days ago.

Boy, I think we're much closer to a determination. We've maintained for well over a year that strong capitalization can only play in our favor as we weather these couple challenges. Certainly from an operating perspective, we feel much more comfortable than we had six months ago, with Texas -- two big pictures comments; one, the Texas project itself operationally turning that around. And then I think overall operations we feel much more confident in terms of our ability to sign up new work with new terms and conditions and execute on the work that we have, including dealing with the legacy issues. So operationally, much different than six months ago. We still have a couple matters that are in the stage of completion. But certainly we think we are very, very close towards in the short-term, wrapping up those matters, and that certainly creates a very, very different platform upon which our Board will consider appropriate capitalization. I think there is a universal recognition that as is, we're overcapitalized.

Very good. Thank you very much, and congratulations again.

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

Good morning, guys.

Good morning, Jason, how are you?

Good, good. Thanks. Just wanted to ask a question on the arbitration with Accenture. I know you're limited in terms of what you guys can say. But I guess one of the thought processes in the past has been that once Accenture and Texas could finalize their negotiations on the prime contract, that might potentially pave the way some momentum to build in terms of bringing Texas arbitration with you guys to a conclusion. Now that Accenture and Texas have obviously finished their negotiations, it sounds like based on your response to the last question, that you guys are making a good amount of headway in terms of wrapping up your arbitration proceedings. Is that the right way to think about it?

Jason, you may know something I don't. But I don't -- I'm not aware that Accenture and the state have wrapped up their negotiations. I do believe that they have had negotiation sessions, but I don't know that they have been completed. But that being said, I do think the stage is set for the three parties to work in some form or fashion to a resolve if a resolve is available from a negotiating perspective in the short-term.

Okay. And just a question on the fiscal '08 guidance. We're halfway through fiscal '07 at this point. Wanted to get a sense of what kind of gives you guys the confidence to put the fiscal '08 numbers out there, and perhaps more importantly, how much conservatism do you feel is baked into that outlook relative to previous years?

Good question, Jason. And my thoughts on the fiscal '08 guidance include the following points. First off, it is very early on. They are -- it's very much preliminary guidance. We have launched our planning sessions internally. We have done a tops-down analysis. As you may know, our traditional planning process is that we wrap it generally in the September time frame, and we plan to do that again this year. So at this point in time, it's really not appropriate to give you what I consider to be drill down division level details on the guidance. But we have done a tops-down analysis, which is factored into the guidance that we gave you today. And the basis for the fiscal '08 guidance, I'll give you a couple of data points. One, it's dramatic in nature, and that would include the fact that we do think the macro environment is very strong. And secondly, again, we believe we are starting to realize the operational and financial benefits of our strategic plan in fiscal '07, focusing on optimizing our current book of business, and writing new work that has reasonable terms and conditions and training our folks how to manage projects. So when we add all that up, we do think that we are starting to get solid ground in that regard. I think that's reflected in our FY '08 numbers, and when you add all that up financial, I think the big takeaway would be driving this Company to a 10% operating margin plus, which I think is certainly implicit in our FY '08 guidance. And the other data point that I would give you is, and it gives me comfort that the range we've put out there is a reasonable range, is in terms of the right benchmark for FY '07 upon which you would judge the reasonableness of the FY '08 guidance, I think that $2 and $2.10 Base Operations is a good range to judge -- to use to judge that FY '08 guidance. You need to remember that in that base number of $2 to $2.10, we have still in that number that Ontario loss that we took in the first quarter, that impact was I think $0.11 to $0.12 which is netted in that $2 to $2.10. So I think when you pull all that together, we should get the comfort that's a reasonable, not a stretch goal at all, achievable. But I don't think it's something that is extremely soft. I put it in a category of a very achievable goal that fits within our plan and accomplishments as we see them today.

Okay. And then just one quick clarification. On the four Texas agreements, can you just give us a sense, A, of the relative size of those four as they roll up to the $10 million a month revenue contribution. And B, are they structured on a time and materials basis or some other kind of pricing structure.

I can't get into the size of each of them. I think in my call notes, I shared with you it's about $10 million per month. I can't get into the detail of each one. The structure is the really hybrid pricing which means there's various price points. Some are fixed in nature, and some are variable in nature. But you can be sure that we've spent a fair amount of time to look at those terms and conditions, and we feel comfortable with our ability to perform. The other comment I would have on the Texas projects themselves is the profit margin on them. It's a very fair profit margin to MAXIMUS and to the state and, yes, the profit margin could be higher. But we wanted to drive fairness, and I would also say in closing, these new contracts as we go forward are by no means intended to be nor are they a recompense for the losses we've incurred on the prior contracts as subcontractor.

Okay. Thanks.

Thank you.

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

Good morning, everyone. Congratulations on a good quarter. As I look at just FY '07, you did about $340 million if the first half of '07, and you're guiding somewhere between $400 and $430 million in the second half, would it be possible for you to give an idea of how we should look at it giving the timing of some of these new contracts?

From a revenue perspective, all of FY '07, I think we guided upward from 740 to 770 and a midpoint of 755. Going from our prior guidance, and I got some roll forward data for you that helps me triangulate that data. The biggest factor is the additional revenue short-term from the four Texas contracts, we factored some of that into the equation, but not all of it because that is, as I mentioned in my call notes, subject to change, depending upon what the state of Texas decides to do as they extend or renew these contracts. So we've factored some of that into the equation, not all of it. And that's the biggest factor. And I think when you factor that in, you should start to understand at least our thinking in terms of that range of 740 to 770.

Okay. Thanks. And also, as part of the overall demand environment, I see that the bookings or total sales were very strong compared to somewhat weak in the first quarter, and the second quarter seems to be really good. Is there anything specific that you are looking at right now, or is it fairly across the board?

I think in terms of those dynamics, I think across the board we are seeing strong demand, but it's strongest really in our operations group. One, because of their size, their depth, but there truly is some fundamental strong demand in that part of our business. I also think we still have very, very strong demand in our Enterprise Systems segment. They have challenges as it relates to building our product, and they also have some issues with relay recognition in some of their profitability and revenue recognition being kind of pushed to the right because we're going toward more a ratable recognition. But there is still strong demand there as well.

Okay. And just one more. I also see a comment that it says more than half of the new award sign up between 3 and $30 million. So we can presume that this is going to be your goal strategy going forward as well?

I think we have been explicit about that as we go forward, and this is an integral element of our risk management. We're looking for profile that we feel comfortable. We like larger, obviously, is better because of the growth potential, et cetera. So we avoid very small contracts. On the other hand, we don't want to pursue such large contracts that the risk profile becomes inordinate. So this is very much our sweet spot. It makes sense for us as a Company, and I would say it makes sense for many of our customers. I think at the end of the day, we have to be cognizant of what's successful for the customer in change management and government-type operations. The larger the engagement, the more difficult it is for them to manage the change. So I'm very pleased with the correlation between the work that we are winning and our strategy to target that.

Thank you.

Thanks, Anurag.

(OPERATOR INSTRUCTIONS) The next question comes from the line of Shlomo Rosenbaum with Stifel Nicolaus.

Hi, guys, and very nice quarter with you guys came out of this smelling like a rose with the Texas contract. I just have a few questions surrounding that. I believe the annual guidance for fiscal year '07 excluding the revised Texas contracts before everything came out was supposed to be about $2.00 to $2.10. Is there someway you can update us on what the core business guidance would have been excluding the Texas contracts? Different analysts have been trying to get at that with different questions.

Sure. Let me talk about that. And when I think about the readvised guidance for fiscal '07, what I'd like to do, Shlomo, is walk you through from what it was previously total Company, and I think previously the guidance out there was a median of $0.60 per share. And walking that forward to where we are today, and I think the new median is $0.90; the median of the $0.85 to $0.90. So we've got a $0.30 increase in the overall guidance for the year, and that comes about there's really three factors that get you there. As we've talked, the Texas contract will lose less than we had expected. And we had said 13 to 18, and now I think when you add the numbers, it's more in the category of $30 or $30.5 million. So that's -- when you translate it into EPS, it's about a $0.40, I think $0.41 improvement. We did have -- we had legal expense in the second quarter that we had not factored into our earlier guidance, and that impact was a negative, I think, approximately $0.16, right, David? So when you net those two, we're about $0.24, $0.25 improvement over the $0.60 median in the old guidance. It gets you to $0.84, $0.85. And then the remaining balance to get you to the $0.90 really is additional improvement we expect in our Base Operations. Most of that comes from the four new contracts in Texas, which we -- obviously, given the timing, was not in our prior guidance. So we had some uplift there. We toggled back our expectations for our Enterprise Systems a bit because we think some of that will slip to the right. But net-net, we still had improved expectations for our Base Operations which had been $2 to $2.10. We chose not to increase that range because frankly, what happened is we went from the lower end of the range to the upper end of the range, and just decided to stick with the $2 and $2.10, and that's how we ended up with the revised median of $0.90.

So I have to go review these numbers again. Are you saying that most -- if you would have not -- once you stood back beforehand you exclude the legal settlement and what happened in Texas, you still would have been on your Base Operations within the range of $2 to $2.10?

But I think at the lower end of the range now, -- (multiple speakers) -- and kind of more towards the upper end of the range. And movement in the range we didn't think it was -- we didn't want to get aggressive and take it north of the $2.10.

Okay. That's fair. I just want to ask you a little bit about recompetes, and wondered if you can talk about the status of the Medicale recompete, and if you could give us the run rate of revenue on that contract, and then I'm also going to ask you about British Columbia.

Okay, fine. We -- in this quarter, we submitted that proposal for HCO -- California HCO. It's up to the client in terms of -- it's a lot of work for them to go through and sort through that. We expect we'll come to a determination likely in the July/August time frame. That's when we currently expect award notification. But that could slip. The other thing which I think you are aware of, but it's important to remember is it's such a large project. If there is a change, a change would really not occur until our fiscal '08. And the annualized run rate on that project is approximately $45 million.

And British Columbia?

Dave, British Columbia? Oh, the run rates on British Columbia?

Yes, the revenue and the EPS and the outlook, is it making money now?

It's more -- first off, our plan was to get it towards break even, and we're accomplishing that plan. In prior years, it lost substantial amounts of money. It's getting to the point where I believe it may have made a little bit of money in this quarter, but for all practical purposes, it's operate around break-even, which is good news. And the annualized run rate, I believe, is in the vicinity of --

It runs about $8 million a quarter.

Yes, $8 million a quarter, -- (multiple speakers) -- a year.

And the timing of what it makes or does and is tied to operational costs. So it was marginally break even this quarter, and overall we are expecting it to be okay for the year. And we certainly made operational improvements, but we're still focused on the long-term outlook and improvements and (multiple speakers) things. We've got a ways to go, yet.

We do. But I would also tell you that in my mind, the British Columbia project has accomplished a lot. And they had an aggressive plan to get themselves from a position where they were losing an unacceptable amount of money, now that they've gotten break even, they are out of the worry zone and more in the normalized project zone. We obviously have improvements that we need to make. On a go-forward basis, we're probably just going to capture that in the normal operations, and probably get away from disclosing its P&L separately.

Okay. One last thing just in guidance, the last free cash flow guidance for '07 I believe was zero to $10 million. Is there any update to that?

David?

Yes. We had previously given you cash flow guidance of operating cash flow in the 20 to 30 range and free cash flow zero to 10. While we've upped the revenue range, we think that cash flow guidance is still in the right ballpark. Generally, when you drive up revenue, it will take consumed operating capital, but we still think we can manage inside that range. You can expect Q3, by the way, there is a lot of obligations that we need to pay, and these legal bills we accrued need to be paid, et cetera. We could actually have some negative cash flow from operations in Q3, but that should turn around in Q4.

Okay. I will let someone else ask a question. Thank you very much.

Okay.

Thank you.

One last opportunity, ladies and gentlemen. (OPERATOR INSTRUCTIONS) The next question comes from the line of Matthew Mckay with Jefferies & Company.

Great. Good morning, guys.

Hey, Matthew. How are you?

I'm doing very well, thank you. Sounds like you guys are doing a lot better, too.

I think that's exactly right.

Now that we are moving passed some of these issues, I would like to talk a little bit about priorities on the investment side. And both in terms of business development. If you look into maybe some, hire some more people in that department, or anything on that side? And then maybe Systems in the back office you may be looking to upgrade or buildings. Just anything kind of what your priorities are in terms of investments in the operations.

This is that great topic. Really sets the stage almost for our next call as we lay out strategic directions. But I will tell you my thoughts are first and foremost, we haven't been silent as it relates to business development and growth opportunities. In fact, it's a bit of the unfortunate element on having to focus on such large issues in the past that really hasn't given us the opportunity to talk about the good things that are happening in our business. We think there's many, many good things that are happening. The ongoing thoughts I have are we've done some very meaningful personnel changes. We've hired a couple of new division presidents, we've terminated some other division presidents inside our Enterprise Systems. We're very pleased with the new hires we've made, with those presidents, and we're working really hard in developing a plan to move forward with the thesis that I've had all along that we've got some hidden shareholder value with the proprietary software that we have in the Enterprise Systems. So that's a project that I think is very exciting and could have some very significant payoff associated with it. I think about our Consulting group where Consulting Services certainly are in strong demand, and we, as a Company, are well positioned. We were taking a look at some new products and services in that area. And in the whole area of and Human Services, I've talked about what I think is a new wind of growth behind the human services piece and the Deficit Reduction Act, and I think that's early on in the growth curve. And I don't even need to mention why we believe there is potential, growth potential in the Health Operations world. That's probably the strongest growth potential that we have. When you add all that up, we see lots of growth potential short-term, not theoretical. We do have a planning session towards the end of this month where we pull of our presidents together and segment GMs, and the specific purpose of that is to lay out the particular products and services that we are going to focus on in fiscal '08. And where the investments will come from. So I going to have to defer those particulars until our next call. But a great question, Matthew.

Okay. Any chance you would do like an analyst day around when you report next quarter just to flush out a lot of this?

I think that's a good concept. I don't want to say yes right now, but let us take it under advisement.

Okay, great. Thanks guys, great job.

Thanks.

Our last question is a follow-up question from the line of Shlomo Rosenbaum with Stifel Nicolaus.

Thanks for taking the follow-up from me. Just a few housekeeping items. The reserve day that was collected during the quarter on Texas, can you give me how much that was?

Sure. There were two elements to it. There was some money that we had collected up front and got amortized for the life of the program called deferred revenue, and we recorded $5.9 million related to that. And then we had collected cash in the quarter of $4.2 that we previously reserved. So tally, $10.1 million.

Okay. And any of the Texas work, will that all be in Operation segment, or will any of the work be in any of the other segments?

All Operations.

Okay. And the legal settlements, you alluded to some legal settlements coming in 2H '07, is that specifically to Accenture, or is there something else that might be in the works?

The reference really was to the two remaining large overhanging issue that we have, obviously to the arbitration with Accenture, so correct in that regard. And we also have the D.C. situation out there as well. And it's possible those two items may, not necessarily, but may come to a resolve, a negotiated resolve.

Okay. And are there any other significant recompetes coming up in the next 12 months that we should be aware of?

Not really. The big one is HTO. We do in a normal course have recompetes, bids out there, which by the way are doing very well. But nothing in order of magnitude of HTO.

Okay. Great. Thanks a lot.

Thank you.

At this time, we have no further questions. Ladies and gentlemen, a replay of this call will be available to you within the hour. The replay information can also be found on your Press Release. The direct link for the replay is http://reg.linkconference call.com/digitalplayback/digital playbackregistration.aspx?recid=5406. Once again, the replay information can be found on the Press Release. Ladies and gentlemen, this concludes today's presentation. Thank you for your participation, and you may now disconnect.