Nov 2, 2006
Executives
Bill Lackey - Director of IR Van Honeycutt - Chairman and CEO Mike Keane - CFO Mike Laphen - President and COO
Analysts
Adam Frisch - UBS George Price - Stifel Nicolaus Julio Quinteros - Goldman Sachs Bryan Keane - Prudential Ashwin Shirvaikar - Citigroup David Grossman - Thomas Weisel Rod Bourgeois - Bernstein Greg Smith - Merrill Lynch Tien-Tsin Huang - J.P. Morgan
Operator
Good day everyone and welcome to the Computer Sciences Corporation Fiscal Year 2007 Second Quarter Conference Call. Today's call is being recorded.
For opening remarks and introductions, I would like to turn the call over to Mr. Bill Lackey, Director of Investor Relations.
Please go ahead sir.
Bill Lackey
Thank you operator. Good afternoon everyone.
Welcome to CSC's second quarter fiscal 2007 Earnings Call. Our quarterly results were issued earlier this afternoon, and I hope you have had time to review the press release.
Van Honeycutt, CSC's Chairman and Chief Executive Officer, will begin with some opening remarks; then Mike Keane, Chief Financial Officer, will review the quarters financial. Mike Laphen, President and Chief Operating Officer, will be joining Van and Mike for the question-and-answer session.
As always, this call is being webcast live at CSC.com, and we welcome those joining us via that process. Any information we cover that does not directly and exclusively relate to historical facts constitutes forward-looking statements under federal securities laws.
For a written description of the factors that could cause actual results to vary from these statements, please refer to the section entitled risk factors in CSC's Form 10-K for the fiscal year ended March 31, 2006. On today's call we will reference certain non-GAAP financial measures.
Reconciliations to these non-GAAP financial measures are provided in the tables attached to the earnings press release, and will be posted on the investor relations section of CSC's website. The non-GAAP financial measures referred to during this call are not meant to be considered in isolation or as a substitute for results prepared in accordance with GAAP.
We assume no obligation to update the information presented on this call. And importantly, as previously announced, the company's Board of Directors has established a special committee of Directors to conduct an independent investigation into CSC's option grant practices in response to investigations by the SEC and the U.S.
Attorney's office in the Eastern District of New York. The company and the special committee are cooperating with the SEC and the U.S.
Attorney on these matters. The company will delay filing its quarterly report on Form 10-Q for the second quarter until it has completed its internal review and has determined the tax and accounting impacts.
The preliminary results which CSC reported today and will discuss on this call are subject to adjustment when those impacts have been determined. The company does not intend -- does not expect to provide any update on the status of the internal investigation until it has been completed and we will not address these matters on the call today.
I am now happy to turn the call over to Van.
Van Honeycutt
Thank you, Bill. Our quarterly results were on plan and with our restructuring efforts continue to position us well for the future.
We had solid quarterly U.S. federal government revenue growth in this important and growing market.
Our operations in Australia and Asia delivered double-digit revenue growth, aided in large part by growth in existing accounts. Revenue for the quarter was in line with guidance and our announced business awards for the second quarter were quite strong and represent the largest quarterly total in the company's history at $8.8 billion.
We are pleased with the award from the UK National Health Service, valued at 3.7 billion over the next nine years. This win plays to one of our major strengths, which is successfully managing long-term, highly-complex and critically-important programs.
Our U.S. federal pipeline continues to grow and is at about 35% over last year's comparable period.
We are encouraged by the quality and quantity of both the federal and commercial pipeline, and they position us well as we enter the second half of the year. We continue to make good progress on the restructuring program involving workforce reduction, and are on schedule.
I will briefly review our guidance for the year and third quarter, as Mike Keane will provide additional details during his remarks. For the year, earnings per share guidance remains in the range of 3.71 to 3.81, with revenue anticipated to be up approximately 2-3%, excluding acquisitions.
For the third quarter, ended December 29, we anticipate revenue in the range of 3.6 to 3.7 billion, and EPS to be in the low to mid $0.80 range. Mike Keane will now address our financial performance for the quarter.
Mike Keane
Thanks, Van, and thanks, everyone, for joining us today. Financial highlights for the second quarter include revenues of 3.6 billion, up 1% as reported, and essentially flat in constant currency against the second quarter last year and in line with our guidance.
Earnings per share of $0.70 from continuing operations before special items in line with guidance and down $0.01 against the prior year due to a $0.04 charge from stock option expense from FAS 123R. In addition, spending on legal and other expenses relative to our stock option-granting practices inquiry and lawsuits had a $0.01 adverse impact on the quarter.
Cash inflow for the quarter of 140 million, before restructuring funding, represents 181 million improvement over the second quarter of last year and is currently ahead of our internal plan. Our trailing 12 months return on investment of 9% before special items is in line with our expectations.
Before moving forward, let me make a few basis of presentation remarks. First, except as indicated otherwise, all results presented pertain to continuing operations.
There were some discontinued operations impact last year but not during the second quarter. Second, quarterly results comparisons include the $0.04 earnings per share FAS 123R stock options expense previously mentioned.
Third, quarterly and year-to-date result comparisons exclude the impact of special items, consisting primarily of the restructuring charge for the second quarter of fiscal 2007 and the Nortel contract asset impairment for the second quarter of fiscal year 2006. Finally, quarterly results comparisons includes the impact of our stock repurchase, which provided a $0.01 benefit to earnings per share during the second quarter.
I'd like to discuss some headline news first. Our signings for the quarter were very strong, including the $3.7 billion incremental NHS agreement reached on September 28, 2006.
Our team plans to work with Accenture to transition IT responsibilities and approximately 300 staff members by early January 2007. The agreement is structured to avoid any significant initial cash investment by CSC, providing incremental ROI benefit, and is essentially conforms to the terms in our existing NHS contract.
We are excited about the new opportunity and we plan to be successful. To elaborate, the IT infrastructure for additional services will be hosted and controlled in CSC-owned facilities.
We do not plan to rely on third parties for data center operations. Also, we have developed a strong working relationship with iSoft, and are expecting that the development will proceed more effectively and efficiently with only one project manager and only one product development direction.
In the event where iSoft may not reach certain milestones on schedule, we have secured rights from iSoft to complete the software development ourselves if we so choose. Finally, we believe we have built a strong relationship with the NHS authority and local trust.
Our collaborative approach with these parties has worked well, as demonstrated by our strong deployment track record with the Northwest and West Midlands IT programs. Now let's discuss our revenue trends in more detail.
Revenues for the second quarter of fiscal 2007 were $3.6 billion, representing 1% growth as reported, but down slightly in constant currency from the same period last year. CSC revenue growth has historically been driven through three avenues, internal growth, acquired growth, and new major outsourcing contracts.
The last is a separate category because it is a hybrid of internal growth usually combined with higher upfront investments and staff transfers, both characteristics of acquisitions. In a typical quarter, CSC tends to achieve on at least two if not all three categories.
Recent quarters, however, have been an exception. Various factors including the recent strategic alternatives efforts, reduced mixed of acquisition, and new major outsourcing contracts.
However, we remain focused and active on all three paths. I cannot comment specifically on our acquisition activity, but I will say that we are addressing our strength in the outsourcing pipeline and view the NHS agreement as a significant step forward.
Now, let's examine our revenues by segment. Our U.S.
federal segment generated $1.3 billion of revenues, achieving almost 7% growth over the same period last year. The segment growth was led by our defense business, including new programs and expansions at existing programs with defense-related customers.
Completing the picture, federal segment growth was also broad-based, including civil agencies, our New York eMed contract and a foreign government project. We continue to succeed in the strategic core marketplace, winning new contracts, creating value for our customers with adaptable solutions and leveraging each success into an opportunity to deliver more value to our investors.
The growth achieved in our federal segment also improves our revenues from long-term sources defined as the total federal and commercial outsourcing revenues to a very healthy 81% of our total revenues. Global commercial segment revenues for the second quarter were $2.3 billion, lower as -- 2% lower as reported and 4% lower in constant currency from the same period last year.
The lower revenue comparison is partially attributed to the terminations at Nortel and Sears, and a temporary slowdown last year in our new commercial awards. Offsetting that reduction somewhat, certain lines of service improved year-over-year including applications outsourcing, which posted a nearly 10% growth over the second quarter last year.
Excluding the impact of Nortel and Sears, global commercial revenue increased by 1% over the second quarter last year. A further breakdown of our global commercial performance down into global regions is as follows.
North American commercial outsourcing revenues were almost 4% lower for the quarter, due primarily to the terminations and wind-downs of the Nortel and Sears contracts. Excluding those, revenues grew at nearly 3%, primarily attributed to the growth in some of our larger existing outsourcing contracts.
North American consulting and systems integration revenues declined by 7%, primarily attributable to the loss of large -- of a large contract after a key utility customer was acquired, and softness in our Oracle ERP practice. Headcount and bill rates increased over the last year's comparable quarter, while utilization was comparable.
We are forecasting a stronger second half fueled by our India Advantage initiative, increased demand for the enterprise system optimization offering, and increased growth in our healthcare and federal consulting practices. We are encouraged that our weighted pipeline of North American consulting and systems integration opportunities is the highest that it's been in over a year.
European revenues were 4% lower as reported and 8% lower in constant currency. The lower revenues were mainly attributed to several accounts in our Northern and Nordic regions, the Nortel contract partial termination, and some year-on-year price reductions at several key accounts, as well as lower volumes on discretionary customer projects.
Our Western European region is improving growing revenue at double-digit rates again, but our Central and South regions are still soft and continue to be a focal point of our restructuring effort. The Northeast and Eastern England regions of the NHS contract will help offset these reductions in future quarters with some incremental benefit expecting to begin in our fourth quarter.
The NHS agreement and the restructuring cost savings will both help improve our performance in the Northern region. Our Asian and Australian operations continued to generate solid growth in the second quarter.
Asia generated 13% growth as reported and 8% in constant currency. Asian revenue growth is primarily driven by a combination of new contracts and increased activity within existing core accounts.
Our Australian operations generated 12% revenue growth as reported and in constant currency. Growth was primarily attributed to achievements in our Paxus recruitment business, as well as the expansion of existing outsourcing contracts.
In support of our global commercialized IT outsourcing, BPO and other commercial offerings, and as we've outlined in our previous call, we continue to increase our offshore presence with several sites in India as the core focus. Year-to-date, we've increased our India workforce by nearly 2000 employees, bringing our directly-employed workforce to nearly 7000 employees.
We have almost doubled our presence since the second quarter of last year. Offshore employees now represent 17% of our global commercial operations with India contributing 13%.
India now represents our third-largest country employment base. CSC India operations are rated as one of the top 10 companies to work for among all industries in India by a Business World survey, thus enhancing our ability to recruit and retain highly-skilled individuals.
Now, turning to awards. Announced awards for the first and second quarters have totaled 11 billion led by federal operations.
This record achievement year-to-date nearly doubles our year-to-date signings for the same period last year and comes close to approaching our total amount awards of $12.1 billion during all of fiscal year in 2006. Our federal pipeline continues to grow with 40 billion of opportunities, an increase of approximately 35% at the same time last year, scheduled to be awarded over the next 17 months.
Given our strong position in this sector, we expect to capture more than our fair share of these opportunities. Now moving over to the income statement.
Our cost of services as a percentage of revenues for the quarter was 80.3%, an improvement of about 20 basis points over the prior-year quarter. This improvement is primarily attributed to initial restructuring cost savings, the partial termination -- and the partial terminations of certain lower-margin outsourcing contracts.
Our selling, general and administrative expenses, at 6.3% of revenues, reflected a 50 basis point increase over the second quarter of last year. The increase resulted from increased marketing and bid and proposal activities, as well as an increased stock-related compensation from both the adoption of FAS 123R and accelerated vesting of certain restricted stock shares due to executive retirement.
Depreciation and amortization expense, at 7.4% of revenues for the quarter, was about 30 basis points favorable to the same period last year. With the improvement resulting from continued focus on our capital efficiency.
Year-over-year, net interest expense as a percentage of revenue increased, going from 47 basis points to 86 basis points, primarily related to interest on our share repurchase financing. Summing these expense ratio, we achieved a pre-tax margin of 5.1%, 39 basis points lower than the pre-tax margin, before special items of 5.5% during last year's second quarter.
The change was primarily attributed to increases in selling, general and administrative expenses and the incremental stock repurchase interest expense. However, the mix of revenue also had lower capital requirements, resulting in an improving ROI on a trailing 12-month comparison.
Our effective tax rate for the quarter was 33.5%, excluding special items. We continue to expect our full-year effective rate before special items, to be inline with guidance at the mid 30% range.
On the topic of restructuring, in April of 2006, we announced a restructuring plan to be carried out during fiscal 2007 and early fiscal 2008. The charge recorded in the second quarter of fiscal 2007 includes 38 million for workforce reduction costs and 3 million for asset impairment.
As of September 30, 2006, approximately 2800 separations have been completed. We are moving forward on our restructuring plan and we are on track to achieve our forecasted savings.
We have also identified potential increased savings opportunities as a result of our employee reductions, thus allowing increased rationalization of certain real estate and data center facilities. We expect to complete this analysis within the next quarter, which may lead to an increase in both our restructuring charge and incremental future savings.
Moving on to earnings before special items, second quarter diluted earnings per share were $0.70 for continuing operations before specials, down $0.01 against the second quarter last year, despite a $0.04 increase in FAS 123R stock option expense, and a $0.01 adverse impact from expenses related to our stock option investigation and lawsuits. In essence, improvements to our net income from our core operating income were offset by the incremental FAS 123R options expense.
We remain on track to achieving our full-year guidance, absent any costs related to our restructuring or stock option investigation and lawsuit activities. Now, moving to our balance sheet, we ended the second quarter with 703 million of cash and equivalents, compared to 1 billion at the end of the first quarter.
Major drivers of our cash balance this quarter were cash expended relative to the stock purchase, and 117 million expended towards our restructuring efforts and to capital expenditures. Total interest-bearing debt of 2 billion is up 639 million over the end of the first quarter, primarily due to the share repurchase financing.
Our total receivables decreased by over 90 million during the second quarter, related to improved cash collections on U.S. federal and North American outsourcing contracts.
As a result, our DSO for the quarter decreased to 99 days from 103 days last quarter. This increase is inline with the expectations, as we are targeting our overall DSO to improve the low 90s by year-end.
The prepaid expenses and other current assets balance has increased a little -- little over 67 million in the second quarter of 2007, primarily related to increases in deferred costs on certain federal and commercial programs. As previously reported, we have submitted 16 requests for equitable adjustment on two large federal contracts.
We have now converted most and expect soon to convert the balance of the requests into interest-bearing claims totaling in excess of 900 million. Moving on to cash flow from total operations, as indicated earlier, we ended the second quarter with 703 million of cash and equivalents, representing nearly a 305 million total cash outflow for the quarter.
Free cash flow including restructuring for the quarter was $77 million inflow, but before restructuring cash flow of 62 million outflow, was 140 million inflow. That's an improvement of 181 million over the second quarter last year.
Year-to-date free-cash flow including restructuring was 357 million outflow but before restructuring cash flow of 117 million outflow was a 240 million outflow. This resulted in an improvement of 147 million over the first half of fiscal 2006.
Net cash from operations of 281 million for the second quarter of fiscal 2007 represents an improvement of 50 million relative to the prior-year period, primarily attributed to a 121 million increase in cash flows from receivables as a result of strong collection efforts, mentioned in our federal and North American outsourcing businesses. This is partially offset by higher cash taxes and incremental interest expense related to the stock repurchase.
The net cash from operations year-to-date was a $68 million inflow, about 172 million lower than the first half of last year, as a result of lower net income, including specials, and higher cash taxes paid, partially offset by lower cash outflows associated with accounts payable and accruals. The net cash outflow for investing activities also improved over last year's comparable quarter, primarily related to lower capital expenditures, reduced outflow associated with new outsourcing contracts.
Year-to-date, net cash flow used in investing activities was $285 million, about 338 million better than the first half of last year, primarily attributed to better capital efficiency in terms of property, plant and equipment, outsourcing assets, and other investing cash flows. Now, before I conclude my remarks, let me walk you through our current guidance -- current guidance for fiscal 2007, which is clearly a transition year for us.
We expect full-year revenues in the range of $14.9 to $15.1 billion, representing between 2% and 3% growth for the year. Our full-year earnings per share, excluding restructuring charges and costs from the stock option review and including the $0.10 share repurchase impact, is estimated to be between 3.71 and 3.81 per share, with a greater-than-usual fourth quarter contribution.
Let me discuss why that is. While we always need crisp execution across all our activities, we have particular attention focused on the following.
First, signing the incremental NHS agreement by early January. Next, achieving the milestones for revenue and profit recognition on the NHS contract, both our existing contract and the incremental work and executing a smooth transition from Accenture.
To explain further, one needs to appreciate revenue and profit recognition in the current NHS stages are tied to milestones and movement in achieving a milestone by just a week or two could impact a particular year's -- particular quarter's results. Also, key to our fourth quarter performance is continuing to achieve progress on our global restructuring by working through the appropriate discussions with Works Councils in Europe and executing knowledge transfers as appropriate for work transition to lower-cost regions, and capturing and implementing the identified new business in our pipeline.
Given these factors, while we have not reduced our guidance range, it is probably more weighted to the lower-end of the $0.10 range. As reported in earlier calls, the tax provision for fiscal 2007 is estimated to yield an effective tax rate in the mid-30% range.
Finally, with respect to our full-year free cash flow, excluding restructuring funding, despite the improved cash flow dynamics in the first half of the year, with some of the business execution shifting to the fourth quarter and the expected mix, we may have an increased use of working capital this year. In addition, interest expense is up from our original cash flow guidance as a result of our accretive stock buyback.
These factors could impact our cash flow guidance by $50 to $100 million, which would result in a range of $400 to $500 million for the fiscal year. In closing, key takeaways from the quarter-end results include; first, we are very pleased about our [third] new business signings and the new NHS agreement.
These awards bring our first and second quarter signings to a record total of $11 billion. Second, our restructuring is proceeding on plan and should continue to produce better performance and competitive position going forward.
We continue to benefit from the cost savings, and we believe we will be very well-positioned going into the next fiscal year. Third, we continue to be sharply focused on returns and cash flow dynamics and how we bid and how we execute.
And in combination with the improved commercial pipeline opportunities, we remain optimistic about our future performance. At this time, I'd like to turn the call back over to Bill.
Bill Lackey
Thank you, Mike. Operator, we're ready for calls.
Once again, the drill being two-part questions are preferably not to be asked. And, we will do our best to answer your questions one at a time, and hopefully we'll get to everybody who is in the queue.
Alright, operator; we're ready for the first question.
Operator
(Operator Instructions). And, we'll begin with Adam Frisch with UBS.
Adam Frisch - UBS
Hello, okay sorry, did not know that. I just wanted to ask you a quick question on the composition of the bookings.
Of the $8.8 billion, 3.7 is from NHS, 2 is from a large government deal, and that gets you to about 3, excluding the mega-deals, was there anything else that was kind of chunky in there?
Mike Keane
There is a large Air Force program, an Air Force logistics program, ECSS. That was awarded under an IDIQ contract.
And, I think the incremental upside over what we had previously announced on that particular contract was about $250 million. But the total value of that program is $650 million.
Adam Frisch - UBS
Was that 650 included in the total 8.8, or just the 250?
Mike Keane
Just the 250.
Adam Frisch - UBS
Okay, you spoke last quarter about rebuilding your sales pipeline, now that the strategic review is complete and your future was more settled than it was maybe nine months ago. So what's happening with your sales pipeline, and do you think that bookings breakout of the 2 to 3 billion range, they've been in for the last few quarters, in the next few quarters?
Mike Laphen
Well, yes. I am Mike Laphen.
We're very pleased with our acceptance back into the major outsourcing market. We have a very good pipeline right now, up significantly over a year ago.
We are also including in that pipeline now midsize deals, which we have more recently put an extra focus on, and we'll be announcing an award in that segment probably next week. So we're pretty pleased with where we are right now.
We're getting to the down selects. We've been well received back into the market.
I don't want to forecast what the booking numbers will be, but we're at 11 billion right now. We certainly expect to exceed our $12 billion target -- actually from last year, and hope we are well on the way back to our previous highs in the order of 14 to 16 billion.
Adam Frisch - UBS
Okay and then two quick housekeeping. The increased bookings, obviously year-to-date are reflected in your '07 guidance.
But looking into '08, should we expect margins and free cash flow to tick down a little bit because of the increased bookings?
Mike Laphen
No, I wouldn't expect that at all.
Adam Frisch - UBS
And then finally, your plans for use of cash and your balance sheet capacity -- are you on kind of a growth initiative here, or do you look to reduce debt further even though it's at low levels, or more buybacks? If you could just kind of help us prioritize there.
Mike Keane
I think you have to work backwards from our target capitalization structure. Our target capitalization structure is about 25% to 30% debt to capital.
We believe that at the end of the share repurchase program combined with internal generation of cash, we'll have plenty of room on the balance sheet to fund our growth. That growth can come either from organic growth, can come from outsourcing, large outsourcing contracts, or acquisitions.
So there's -- I think that we'll do what's necessary to stay within that range and we would prefer that it be through a combination of growing the business.
Adam Frisch - UBS
Okay thank you.
Mike Keane
Next question please operator.
Operator
We will go next to George Price with Stifel Nicolaus.
George Price - Stifel Nicolaus
Hi thanks very much for taking my question. Just if I could explore a little bit more detail, maybe the full-year guidance weighting to the low-end.
Can you maybe talk a little bit more about -- what I'd like to know is really how conservative are the assumptions? You talked about potential slippage or milestones, working with some of the Work Councils, etcetera.
How conservative -- when you say the low-end, how conservative are you being? What are you assuming there?
And I guess, what incrementally would you identify as risks even to the low-end?
Mike Keane
Well I'm trying to give you an idea that we feel that if you had to put a probability factor in the 3.71 to 3.81 range that we think it's a higher probability to be at the lower end of the range. And it's because there's a multiplicity of factors occurring, and any one of those not occurring could cause you to be at the lower end of that range.
So, we're just trying to give you better insight in terms of our assumptions in the forecast.
George Price - Stifel Nicolaus
Okay fair enough. And one other question, just in terms of maybe M&A plans.
Where would you focus the most? I mean what would you think is the most likely target area for deploying cash for acquisitions?
Would it be offshore for example, given, say, what Capgemini just did with Kanbay? Thanks.
Van Honeycutt
Well we are currently looking at a number of acquisitions. We would not exclude any.
As you know, we're quite pleased with our federal business. And indeed, we could -- we would be quite interested in expanding through acquisition, in our federal business, especially if it came with a large amount of security clearances with the people.
We also have some interest to expand and improve our European business. And as we look at the whole BPO landscape, or Intellectual Property landscape, we also have interest there as well.
So, it's broad-based, and quite frankly opportunistically-driven.
George Price - Stifel Nicolaus
If I could ask you one more thing, on the consulting side in North America. You mentioned one utility client, I guess, where there was a -- did you say they're required, there was M&A involved?
Mike Keane
That's correct.
George Price - Stifel Nicolaus
Okay and then weakness on the Oracle side. I guess things have been pretty good in general on the North American side.
Is there anything more macro-oriented you could attribute? The other weakness in terms of Oracle to or just understand that would be great?
Thanks.
Mike Laphen
There was -- this is Mike Laphen. There was some weakness in the Oracle market for a limited period of time.
It impacted us somewhat. That has turned around.
And the utilizations for that practice are back up to where they historically had been. So again, as we look forward, we're optimistic about the North American consulting.
George Price - Stifel Nicolaus
Thank you.
Mike Keane
Next question please operator?
Operator
We will go next to Julio Quinteros, Goldman Sachs.
Julio Quinteros - Goldman Sachs
Hey guys Real quickly on the free cash -- the revised free cash flow numbers, could you just talk about kind of the puts it takes from where we were at the beginning of the year or year two, to the revised number of 400 to 500, because when I wrote down I just want to make sure that's the right number, for free cash flow…
Mike Keane
Right, the two major impacts are in the category of interest expense and working capital. And it's a number, as you know, that's very volatile, it could be very lumpy.
And it's going to depend on what business is driving that number in a particular quarter. The interest expense is fairly easy to figure out.
We've taken on about $600 million of debt, and so that's going to yield close to about $40 million in incremental interest expense for the year. So, that's one impact.
And we had not factored that into our initial beginning-of-the-year guidance, on cash flow. Of course, the offset of that is we're getting accretion in terms of the stock buyback.
The second item is basically the working capital element. And if the mix of business changes, as we see it currently changing, it could have in the short-term a usage of cash, as we exit the fourth quarter.
But of course, that being working capital-related, should return to us fairly soon, within early part of 2008. So, those are the two major factors.
Julio Quinteros - Goldman Sachs
Okay great. Then just for clarification on the fourth quarter assumptions for NHS.
Can you just walk right above through those again? There was a couple of moving parts; I just want to make sure I understand all of them.
Mike Keane
Okay first is that our expectation is to finalize the signing of our agreement by early January.
Julio Quinteros - Goldman Sachs
Okay.
Mike Keane
And also be able to smoothly transition from the Accenture work into our camp, including taking on up to about 300 of their employees. The second part is then if we were timely on that, being able to begin the deployments under the incremental business, as well as, continue the deployments under our initial NHS contract.
So, there's number of milestones that we expect to reach in the fourth quarter. And my commentary there was the fact that, even a one-week slip in terms of achieving a milestone could have an impact on the way both revenue and profit is recognized.
Julio Quinteros - Goldman Sachs
Okay and you guys are running forward with the old ISO system, or are you moving with the new sort of -- the new-generation ISO system?
Mike Laphen
Well -- Mike Laphen. We're doing both.
We continue to use the legacy environment and then there's an interim solution that will be fielded subsequent to that. And then the -- what's known as the Lorenzo--
Julio Quinteros - Goldman Sachs
Lorenzo right--
Mike Laphen
Yeah that's June '08, I believe, is the expected delivery date on that.
Julio Quinteros - Goldman Sachs
Okay great thanks guys.
Mike Keane
Next question please operator.
Operator
We will go to Bryan Keane with Prudential.
Bryan Keane - Prudential
Yeah hi good evening I guess, Mike, when do we see -- some of the restructuring benefits to hit the P&L? And when do we get up to that full 150 ramp up and then I think it's 300 ramp up?
What's the timing on that?
Mike Keane
Yeah well we're already starting to see some of the benefits as expected. But it's still the early part.
You'll see that we had indicated that the total savings this year, impact would be about 150 million pre-tax. We probably have seen somewhere just under 40 million of that in the first half and we should see the rest of it in the second half.
And also as we indicated before, we thought 2008, would be a closer proxy to the run rate savings, even though we won't capture a full-year savings. And we expected that to be about a $300 million pre-tax savings.
Mike Laphen
I would just add at the operating level, exclusive of the stock option impact, we'll be up 100 basis points on the margins, this fiscal year over last fiscal year. And, now that's a combination of some impact of the restructuring, improved performance, and so forth.
But -- and some of that gets mingled together. But I think we're seeing good solid improvement in the margins.
Bryan Keane - Prudential
And that 100 basis point improvement is in fiscal year '07. I assume it's got to be almost as good if not better in fiscal year '08?
Mike Laphen
We expect continued improvement in '08.
Bryan Keane - Prudential
Okay and then just finally, CSC has been successful, I think, with the UK NHS contract overall, and Accenture has struggled and we get a lot of questions asking the differences, so maybe you could just give us a few lines on why you guys have been successful and why you think you can take over Accenture's business and be successful.
Mike Laphen
I think it's a couple things. One is our technical approach was different, and our -- and the capabilities that we could bring to bear on the solution were a different set than what Accenture could bring; that is, being a full-service provider, we were able to house the necessary items in our own data centers, whereas Accenture subcontracted that out.
I think their contractual arrangement was much more complex than ours from a subcontract standpoint. The fielding approach was absolutely different.
We went forward with the hospitals, getting -- making good ground quickly and have done 50%, I believe, now of the hospitals. And, Accenture started at, I believe, at the doctor level, doctor office level.
So, really different approaches and different solutions.
Bryan Keane - Prudential
And, you plan to do the same, I guess, approach that's been successful when you take over Accenture. One of the things is you're not going to taking over in the mean billion losses position.
Mike Laphen
No.
Bryan Keane - Prudential
Okay, thanks.
Mike Laphen
The next question please, operator.
Operator
We will go to Ashwin Shirvaikar with Citigroup.
Ashwin Shirvaikar - Citigroup
Hi, the question is going back to the 3.71 to 3.81 range. How realistic is it to maintain that range in sort of implying upwards trend of about 15 in the fourth quarter.
So the question becomes, are there sort of very back-end-loaded restructuring benefits and onetime milestone benefits from NHS, what's going on there?
Mike Keane
I think you pretty well captured it there. As we indicated, there's a number of items that have to fall in line.
We try to identify that for you. We agree that it is back-end-loaded, but that's kind of the nature of the ramping of the restructuring savings as well.
And, it's also in terms of, as we had indicated at the beginning of the year that the results were skewed towards the second half of the year.
Ashwin Shirvaikar - Citigroup
And then if I could ask you to comment on the industry dynamics. We are supposed to be in a services recovery at most legacy companies like CSC, EDS, Unisys can barely get to mid-single digits for growth.
Is this still an attractive industry for you guys, from your viewpoint?
Van Honeycutt
Well, yes. Obviously we think it is.
I think that we're seeing our federal business somewhat in a growth spurt. It's going to do quite well for us.
We see -- we've already said that we've seen a resurgence in some of the outsourcing business. I think, we'll have some interesting announcements for you in the next 30 days or so.
We have also started addressing, which heretofore we've somewhat stayed away from, the so-called mid mid-tier market. I also believe that a lot of work that we've done on certain aspects of the BPO will start bearing some fruit now.
And so, I think that it's an excellent market for us to be in.
Mike Keane
I think, we also have to identify that we, which we've mentioned a couple times, we lost a couple major -- a couple major contracts, had terminations last year. And, we're starting to move away from the unfavorable comparisons of excluding that from prior-year, year-to-year growth results.
Mike Laphen
Next question.
Operator
We will go to David Grossman with Thomas Weisel.
David Grossman - Thomas Weisel
Thank you. Mike, just going back to the free cash flow question, could you maybe be a little more specific about how the mix has changed vis-à-vis your expectations going into the year?
And I guess, secondly, we're kind of projecting flattish free cash flow year-over-year now for '07 versus '06. How should we think about free cash flow then in fiscal '08, given the reversal of the working capital and the cost-cutting initiatives?
How should we think about the acceleration 12 months out?
Mike Keane
David, the mix is difficult to explain, other than to say that we have a variety of different type of revenue sources, some which have a fairly quick paying in terms of the billing cycle. And then, there's others where it just takes a little longer because there's some transition costs involved, and the recovery of those tend to be more milestone-type payments as opposed to your normal 30 days billing and collection.
So, all I'm trying to say is that, obviously, there's a mix of work that's going to take -- takes a little longer to come back. And, also as some of that revenue accelerates towards the end of the year, and some of that profitability accelerates toward the end of the year, just giving our overall DSOs of about -- we expect around 90 days at the end of the year -- that just pushes some of that collection into the next quarter.
So, that's really the best way I can explain that dynamic. In terms of looking out to the future, we see the free cash flow dynamics improving.
And at this stage, based on a preliminary outlook, we would expect 2008 to be better than 2007. As we said, 2007 is a transition year for us.
David Grossman - Thomas Weisel
Should we think about the base growing in '08? Should we think about the old guidance as the base, or are you thinking of the base in terms of the new guidance?
Mike Keane
I would say that the base -- we still have the 500 number on that range. So, you could use that as your base.
David Grossman - Thomas Weisel
Okay and then I guess, in terms of the share buyback, could you help us understand what the dynamic is after you completed the big piece in, I guess, mid-July, are you now free to go into the market under the authorization to be buying back now, and if you have been buying, can you give us an idea if you've been buying shares back? And if so, how many in the current quarter?
Mike Keane
Okay, well as of the beginning of July, we purchased $1 billion worth of stock. That brought in about $14.7 million shares and it's under an accelerated share repurchase program contract we have with Goldman Sachs.
That contract could extend anywhere from 6 to 12 months and from that July period, as they complete their repurchase to basically fill their short position, if you will. There would be a true-up that occurs at the end of that, based on some volume weighted average pricing, and some pricing that we have that tied to their dynamic.
And at the end of that period, we have submitted a buying program to basically successfully fall inline with that. But we are currently precluded from going in the market and buying additional shares.
David Grossman - Thomas Weisel
Okay do you have any estimate of when that will be completed?
Mike Keane
Well it will be -- I don’t -- I think that if you had to take the midpoint between six and 12 months that we would be completed with Phase I of the program, just about at the end of our fiscal year.
David Grossman - Thomas Weisel
So, all the incremental buyback would come in fiscal '08?
Mike Keane
That's correct. And we had originally projected that would occur evenly throughout that, the next four quarters.
David Grossman - Thomas Weisel
Okay. And then just one last question.
Maybe this is for Mike Laphen. Can you give us an idea of what kind of milestones you have set up for iSoft, and just an idea of maybe -- I know it's been a very short period of time, but could you give us a sense of since that new deal was announced, what's been done, kind of how they're tracking, and what kind of controls have been put in place to ensure that the development continues and continues at pace with your expectations?
Mike Laphen
Yeah well it's rather detailed milestones, frankly, that we track very thoroughly. They have -- to date they have met all the milestones.
We have the right to step in, if we so choose, if a milestone is missed. We have infused 70 staff with the iSoft people; some in Chennai in India, some in the UK.
So, we're very involved and very aware of what the situation is. And we'll continue to monitor it very closely, and we'll take the appropriate steps if and when necessary.
David Grossman - Thomas Weisel
But when is the first major milestone?
Mike Laphen
We've already had a major milestone.
David Grossman - Thomas Weisel
Okay.
Mike Laphen
And they've successfully made it. There's milestones -- almost I'm going to say monthly, but probably bimonthly.
So, they're very frequent.
David Grossman - Thomas Weisel
Okay very good thank you.
Mike Keane
Next question please operator.
Operator
We'll go next to Rod Bourgeois with Bernstein.
Rod Bourgeois - Bernstein
Hey guys the 40 million of interest expense that's hitting your free cash flow guidance, for the year. How was that a recent surprise causing you to take your free cash flow guidance down at this stage of the year?
Mike Keane
Well I said from the beginning of the year. And someone could say that maybe last quarter, we could have factored that in.
But basically, at that time we were -- just the 40 million itself, would have left us within the range that we talked about before.
Rod Bourgeois - Bernstein
Right, you mentioned the REAs are -- there's cash that's in interest-bearing accounts at this point. Is there any interest being earned on that at this stage?
Mike Keane
No. There's no cash being earned.
But basically as the process works, once you submit the claim, the clock starts in terms of what -- if you have successful completion, you not only receive your recovery, but you also receive interest on it from the time you submitted the claim.
Rod Bourgeois - Bernstein
Got it, so that just accrues there. Okay.
Mike Keane
By the way, it doesn't accrue in our financials.
Rod Bourgeois - Bernstein
Sure.
Mike Keane
But it accrues economically.
Rod Bourgeois - Bernstein
Sure that makes sense. The prepaid balance sheet item is now at 1.4 billion.
Can you give us some visibility into what's being causing the growth in that account? Are there specific contracts that you can point to where the prepaid growth is coming from?
And a second part to that; is this prepaid account and the increase in it related to some of the contracts involved in the REAs?
Mike Keane
Well if you look at some of the -- any large outsourcing contracts, you're going to have deferred amounts build up from time to time. And of course, one of the large ones is NHS, where we're under milestone-type payments.
So, until such time that you're allowed to bill as you reach a milestone, you'll have certain costs that basically move into work-in-process, if you will, which is our deferred costs. And there's other federal programs that from time to time, have those same dynamics.
There is a small amount of costs that have increased relative to the programs that are under claim, but those are still, as we believe, fully collectible.
Rod Bourgeois - Bernstein
Right so would you say that the majority of the increase in prepaid is coming from your existing -- the NHS contract you had prior to the Accenture wins?
Mike Keane
I'd say a good part of it. I don't know if it's the majority.
Rod Bourgeois - Bernstein
Okay now is your previous NHS contract, is that currently cash flow-positive?
Mike Keane
Well over what period, I guess, would be the question.
Rod Bourgeois - Bernstein
Well, would you expect it to be positive for the first half of the year that you've just reported?
Mike Keane
No. I think it's slightly negative in the first half of the year.
But that's -- and that's basically due to the timing of the milestones in collections.
Rod Bourgeois - Bernstein
Okay great. And then can you give us any thoughts on the timing of these REAs and when you might recapture that?
Is that this year or is that next year in a contribution to the cash flow in '08?
Mike Keane
We have not -- we have not included it in our guidance for this year. So, if we were to collect it this year that would be upside.
It would be reasonable to think that we have an opportunity to collect it in fiscal year 2008. But we'll have -- we review progress on that daily.
Rod Bourgeois - Bernstein
Okay, great. Thank you guys.
Bill Lackey
Operator, we have time for two more questions please.
Operator
All right we will go next to Greg Smith with Merrill Lynch.
Greg Smith - Merrill Lynch
Yeah, hi. Good afternoon.
With the NHS contract and the big swing factors, depending on milestones, is that also going to be an issue for 3Q, or is it just really a 4Q issue at this point?
Mike Keane
More of a 4Q issue, but also it's an issue -- it's going to be an issue throughout the entire contract.
Greg Smith - Merrill Lynch
Okay. That makes sense.
And then you guys said, you identified through your restructuring efforts some incremental cost savings. Can you give a little more detail on what those were, and is there any way to quantify kind of an annual run rate and when that may actually go into effect?
Mike Keane
I'm sorry; could you repeat that?
Greg Smith - Merrill Lynch
In the discussion you mentioned that you have identified some additional cost-saving opportunities above and beyond what you were targeting previously. Want to get some more color on that and any quantification?
Mike Keane
Well I can't give you quantification or else I would have given you quantification, because we're currently doing the analysis. But what it involves, just to give you a little more color on that, is we've -- as we've reduced employee headcounts.
Our folks have done a really good job of finding opportunities in certain geographic regions to be able to identify opportunities to consolidate remaining employees into one piece of real estate, so offices as may be, or even certain data centers. And as a result of that, we now see that we have an opportunity to move people and to consolidate them into, let's say, from three facilities into one facility, and therefore, we would have an opportunity now to offload -- either sell property, or we have an opportunity to sublease space, turn out the lights, save on utilities, save on lease costs, and -- or even possibly reduce our capital invested in real estate.
So, we are examining all those at this point in time. And that actually means that the restructuring program has been very successful.
Greg Smith - Merrill Lynch
That's very helpful. And as you guys talk about BPO and think about the growth opportunities you see in BPO, what specific areas are you targeting at this point?
Mike Laphen
We're more favorably disposed to the vertical BPO markets, in particular financial services, as well as healthcare. We believe the horizontal ones -- horizontal BPO plays are more likely to be driven to a commodity play very quickly.
And in fact, I think some of that is already happening. So we believe there needs to be some intellectual property wrapped around the BPO to have it as a good economic proposition for a long-term value.
Greg Smith - Merrill Lynch
Okay thank you.
Bill Lackey
One last question please, operator.
Operator
And we have Tien-Tsin Huang with J.P. Morgan.
Tien-Tsin Huang - J.P. Morgan
Okay, can you quantify the growth force in North American consulting and systems integration, excluding the loss of the utility client, and maybe comment on pricing and bookings as it relates to consulting and SI?
Mike Laphen
I don't know what the -- I think, the impact -- you know, we'll have to get back to you. I don't have it off the top of my head.
Tien-Tsin Huang - J.P. Morgan
Net pricing and I guess, the bookings?
Mike Laphen
I'm sorry, the pricing in the what?
Tien-Tsin Huang - J.P. Morgan
Pricing in bookings in the consulting and systems integration business.
Mike Laphen
Yes, the pricing is about constant, about flat. And the bookings, as I said, are improving.
And, the pipeline is the best we've had in the last 12 months.
Tien-Tsin Huang - J.P. Morgan
I just wanted to make sure I confirmed that correctly. And, then on BPO, can you just give us a quick update on HR, BPO, and how the Aon relationship is going?
Mike Laphen
That has ended, so we're not pursuing that any longer with Aon, and have elected not to go forward with that.
Tien-Tsin Huang - J.P. Morgan
Is HR still an area of focus, or are we now just looking at financial services and healthcare as the primary focus there?
Mike Laphen
Financial services and healthcare are the primary focus.
Tien-Tsin Huang - J.P. Morgan
Thanks for the reminder.
Bill Lackey
Thank you, operator. I guess that will do it.
We'll see you for our third-quarter call.
Van Honeycutt
Thanks a lot, everybody.
Bill Lackey
Thank you very much.
Operator
And ladies and gentleman that does conclude today's call. Thank you for your participation.
You may now disconnect.