Maximus Inc (MMS) 2014 Q1 法說會逐字稿

Greetings and welcome to the Maximus FY14 first-quarter conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Lisa Miles, Senior Vice President of Investor Relations for Maximus. Thank you Ms. Miles, you may now begin.

Good morning. Thank you for joining us on today's conference call.

I would like to point out that we have posted a presentation on our website under the Investor Relations page to assist you in following along with the call. With me today is Rich Montoni, Chief Executive Officer; David Walker, Chief Financial Officer; and Bruce Caswell, President and General Manager of the Health Services Segment.

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 and 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-K filed with the SEC. The Company does not assume any obligation to revise or update these forward-looking statements to reflect subsequent events or circumstances.

Today's presentation may contain non-GAAP financial information. Management uses this information in its internal analysis of results and believes that this information may be informative to investors, in gauging the quality of our financial performance, identifying trends in our results, and providing meaningful period-to-period comparisons. For a reconciliation of non-GAAP measures presented in this document, please see the Company's most recent quarterly earnings press release.

With that, I will turn the call over to Dave.

Thanks, Lisa. This morning Maximus reported first-quarter revenue of $406.6 million, a 42% increase compared to the same period last year. As expected, organic growth in the quarter was significant at 37%.

Top-line increases for the quarter were attributable to the forecasted growth in our domestic Health business, much of which was tied to contracts from the Affordable Care Act. Total segment operating income totaled $53.3 million in the first fiscal quarter, and operating margin was 13.1%. For the first quarter, income from continuing operations, net of taxes, totaled $33.8 million or $0.48 per diluted share. This is a 55% increase to diluted EPS compared to $0.31 reported for the same period last year. Earnings in the quarter were ahead of our expectations, driven principally by the increase in the Health segment.

Let's jump into results by segment, starting with Health Services. The Health Services segment delivered an exceptionally strong quarter, with revenue increasing 70% to $299.2 million compared to the same period last year. Top-line increases were fueled principally by organic growth resulting from new work and expansion of existing contracts, most notably those related to the Affordable Care Act. As a reminder, the open enrollment period for Health Insurance Exchanges commenced on October 1, and as expected, drove volumes and revenue in our Customer Contact Centers.

Health segment revenue was stronger than expected, delivering strong transactional volumes. We also provided additional high-value support to existing and new clients for business process diagnostics, business process reengineering, and greater shared services delivery as part of the ACA rollout. Rich will talk more about the specifics in his prepared remarks.

Health Services segment operating income in the first quarter of FY14 more than doubled compared to the same period last year and totaled $41.6 million with an operating margin of 13.9%. Operating margins for the Health segment were higher compared to the same period last year. Health segment operating margin in the first quarter outpaced our expectations resulting from the higher-than-expected accretive revenue. Two main factors drove the over-delivery in the Health segment in the first quarter. First, we simply experienced higher level of activity in our Health Insurance Exchange Customer Contact Centers in the latter part of the first quarter.

Volumes in October and early November were tracking relatively in line with forecasts. However, overall volumes came on much stronger than expected in the back half of November and through December. This volume growth resulted, in part, from the ongoing technology challenges that made it difficult for consumers to enroll online. In addition, as the December deadline loomed to enroll in a subsidized health plan for coverage starting in January, many consumers turned to the Customer Contact Centers in order to complete their enrollments. In many of our projects, we increased staff and added overtime hours to help our clients deal with the demands and challenges. Rich will touch upon some qualitative examples of where we added scope and scale to our staff in support of our clients' ACA efforts.

We do expect that this financial benefit from expanded scope on certain exchange contracts will continue into the second quarter as we stepped up to help our clients manage the considerable change associated with the ACA rollout. We continue to provide increased support to some clients through the open enrollment period, which is currently slated to end on March 31 and coincides with the end of our second quarter. Additionally, we have a handful of change orders in the works that will benefit the second quarter. Some of these change orders reflect work already performed where we have not finalized the change order and therefore revenue lags behind.

Secondly, we experienced stronger-than-expected results in our health appeals work due to higher than forecasted case loads. As we discussed last quarter, we had initially forecasted that appeals volumes would step down relative to the peak we experienced in the second half of FY13. The results were bolstered in the quarter because the case loads did not decrease as much as we expected, coupled with greater cost efficiencies. So, in summary, the Health Services segment was ahead of expectations, which contributed to stronger revenue and operating income. We have increased our health forecast for the remainder of the year to reflect the uplift from ACA and the upward revision of health appeals volumes.

Let's now turn our attention to the financial results for Human Services. For the first fiscal quarter, revenue for the Human Services segment decreased 3% to $107.4 million compared to $110.3 million last year. However, on a constant currency basis, revenue would have increased 2%. As a reminder, the prior-year period benefited from highly accretive performance-based payments in our domestic welfare-to-work business, which bolstered both revenue and profit in Q1 of last year. First-quarter operating income for the Human Services segment totaled $11.8 million, delivering an operating margin of 10.9%. Our overall outlook for the segment remains unchanged for FY14.

Moving on to cash flow and balance sheet items. Cash flow in the fiscal first quarter with strong, driven by increased earnings and receivables collections. As expected, DSOs improved on a sequential basis to 67 days in the quarter, which remains well inside our target range of 65 to 80 days. As a reminder, our target DSO range has been in place since the fourth quarter 2008. For the first quarter of FY14, cash provided by operating activities from continuing operations totaled $42 million and free cash flow was $34 million. As a reminder, free cash flow is defined as cash provided from operating activities, from continuing operations, less property and equipment and capitalized software.

During the quarter, we continued to purchase shares of Maximus common stock under our Board-authorized program. In Q1, we repurchased 505,738 shares for a total of $22.5 million. At December 31, 2013, we had approximately $74.9 million available for share repurchases under this program. Subsequent to quarter close and through January 31, we repurchased an additional 214,200 shares for approximately $9.2 million. As we've said in the past, we consider our buyback program to be opportunistic in nature and our recent purchases reflect our overall preferred approach to buying back shares.

At December 31, we had $120.6 million in cash and cash equivalents, of which approximately 65% is held overseas. The strength of our balance sheet provides us with a great deal of flexibility in deploying capital and we are focused on sensible deployment of cash. We continue to execute buybacks, pay our quarterly cash dividend, make investments in the Business to drive organic growth, and manage a strategic acquisition program.

Lastly, guidance. As noted in this morning's press release, we are increasing our FY14 revenue and earnings guidance. We now expect revenue in the FY14 to range between $1.6 billion and $1.68 billion. We expect earnings per diluted share from continuing operations to range between $1.95 and $2.05. Going forward, we believe that the seasonal revenue and earnings pattern for Maximus has changed. Based on what we know today, we expect to experience stronger results in the first half of each fiscal year associated with the open enrollment period for the Health Insurance Exchanges under the ACA. We strongly recommend that this seasonality be considered when building longer-term financial models.

Let's walk through the changes that are uplifting our guidance numbers in FY14. First, our new guidance bakes in the over-delivery in the first quarter. Second, as I mentioned earlier, we increased our scope of work on a number contracts in support of our clients' rollout of the Affordable Care Act. In addition, some of these scope increases included change orders that didn't fall into Q1. Much of this benefit is expected to occur in the second quarter and will bolster revenue and earnings in the quarter. The exact timing of change orders is always difficult to predict as procedures vary by client but we are currently on target for these to be executed in the second quarter.

Third, we have readjusted our forecast to reflect current volume levels in our health appeals work. As a result, we now expect that our revenue and earnings in our fiscal second quarter will be bolstered by the ongoing scope increases in some of our ACA work and change orders. We are also increasing our cash flow guidance for FY14. We now expect cash provided by operating activities derived from continuing operations to be in the range of $180 million to $205 million and we expect free cash flow from continuing operations to be in the range of $140 million to $165 million. Thanks for joining us this morning and now I will turn the call over to Rich.

Good morning and thank you, David. We are pleased with our solid start to FY14, having achieved top- and bottom-line results that beat expectations and allow us to raise our outlook for the remainder of the year. These results are even more impressive when you consider the demanding market environment for private sector government partners that operate highly visible health and human services programs.

For Maximus, our continued success is based upon our ability to understand the needs of our client as we provide the appropriate level of support during these challenging times. This morning, I would like to focus my commentary on how we are doing just that -- adding value to our clients through scalable, flexible, and responsive operations. Challenges within the implementation of the Affordable Care Act have dominated the headlines for several months. As the federal government and several states faced problems with the technology side of their exchanges, our Health Services team found opportunities to provide alternatives and implement comprehensive contingency plans for both existing and new clients.

Our solutions allowed the exchange workflow to continue while our clients and their systems' vendors addressed the technology speed bumps. The technical deficiencies created the immediate need for direct consumer contact in order to continue the application and enrollment process. For example, a number of states did not anticipate the need for a large volume of paper applications or the additional effort required to assist consumers in completing applications through their web portal. In response, we quickly ramped up staffing and trained workers, bridging the gaps in the HIX workflows and helping enrollments to continue.

As David noted, volumes in many of our HIX Contact Centers came on strong during the last six weeks of calendar 2013. In response, we added more than 1,300 staff across our Contact Centers to handle the volumes. The surge in calls came from consumers who were unable to enroll into health plans online and needed additional assistance over the phone. In addition, many of these consumers were trying to meet the December deadlines in order to get insurance coverage effective January 1, 2014.

In the month of December, our incoming calls were more than 30% higher than forecast in our state Customer Contact Centers. Our flexible staffing model allowed us to respond to our clients' forecast in the peaks and valleys of call volumes. With the first open enrollment period presently scheduled to end on March 31, we will continue to staff to the ebb and flow of volumes and activities that are part of the cyclical nature of HIX operations.

However, our client-centric solutions even provided support to clients outside of our eight HIX Customer Contact Centers. Let me give you a couple of examples. For a new clients, the State of Oregon, Maximus provided an operational review of the business processes that led to Maximus providing call center and other operational overflow capacity to assist consumers in completing enrollments. The operational assistance was provided to ease workload from exchange workers overwhelmed by high volumes of paper applications. Cover Oregon ultimately asked us to handle both inbound and outbound calls to help consumers complete their health plan shopping and selection, all leveraging an existing Customer Contact Center.

This allowed for a vastly improved workflow, as Cover Oregon was able to offload tasks related to plan selection completion so that exchange workers could focus their efforts on eligibility determinations. We've spoken for years about how this model, in which Maximus employees act as sous chefs to state or county eligibility workers is a demonstration of the partnership model through which our clients derive value. In Colorado, we were able to help the state overcome a major influx of applications through our existing contract vehicle and business process reengineering. As you may know, consumers must be deemed ineligible for Medicaid before being considered for a subsidy. As a result, the state experienced a surge in consumer applications. Incorrect and inaccurate applications were not able to get a real-time Medicaid eligibility determination online.

In October 2013, the state, in close monitoring of the Maximus application volumes, asked us to increase our level of commitment to process applications. At the same time, we faced a daily average intake of new cases that was significantly higher than what our operations are normally staffed to handle. We worked hand-in-hand with the state to produce and implement a very aggressive plan to clear the applications and maintain the daily inventory of new cases. The goal was to ensure that everyone who applied online received the appropriate outcome within 24 hours so they were able to receive benefits by January 1.

In response, Maximus and the state quickly hired and trained additional staff in three locations. Together, we successfully executed the plan and met the deadline to get thousands of Coloradans enrolled in health plans for the state's exchange and through Medicaid and ChipPlus. Maximus, in conjunction with the state, has processed more than 32,500 cases since October. We are still receiving nearly 300 new cases daily and will continue to process them within one business day. While these are just a couple of examples, we are certainly pleased to be a go-to partner to help a number of clients deal with the growing pains of the Affordable Care Act. It is important to note the growing pains are common with large system rollouts and it typically takes time before a system is running at optimal performance. We believe the need for our additional assistance in this area will continue for quite some time, particularly when reenrollment cycles are considered.

Looking beyond this first open enrollment cycle, we expect the Affordable Care Act to continue to serve as a multi-year growth driver for our US operations. As we have said in the past, some of the states currently on the federal marketplace will likely start to look to operate their own exchanges over the next several years. At the same time, some states may also consider enhancing their public insurance programs, including expanding Medicaid. An October 2013 survey of the states conducted by the Kaiser Family Foundation predicts that 2014 will be a transformative year for Medicaid, with increases in both spending and enrollment.

Maximus is already responding to this long-term transformation, as we see material increases to our existing Medicaid enrollment broker business through contract amendments and change orders. We continue to believe, over the long term, that more states will expand Medicaid. Some will follow the standard path, while others will seek to set their own terms through waiver requests negotiated with the Centers for Medicare and Medicaid Services. We believe we are well-positioned for either scenario, but recognize reality that state legislators and federal waiver requests often move slowly. Medicaid expansion remains a long-term, multi-year growth opportunity that doesn't reach its steady-state until 2016 at the earliest.

As Medicaid expansion continues to proceed, we also remain engaged with a number of our state clients on their dual-demonstration project. Dozens of governors have made this a priority agenda item as they look for real solutions for these super utilizers of Medicaid and Medicare. While the federally-guided state demonstration projects don't provide a large financial contribution to Maximus, the duals market is an important plank in our long-term services and supports platform.

We are currently working with five states to address cost, quality, and care coordination among the duals population. This includes California, which is largely considered a leader in creating a potential blueprint for this population. We also received some very positive news in Illinois, where we have been working with the state to help root out Medicaid fraud. As you may recall, our eligibility and enrollment verification project was designed to help ensure that only those eligible for Medicaid are actually receiving coverage and services.

The project was slated to end in December, however, on December 17, the state received a supplemental arbitration order allowing Maximus to retain some work through June 2015. We are very pleased to retain a meaningful level of responsibility in support of the state's ongoing initiative to reform their Medicaid program. Also, within our Health segment, our federal services business again delivered solid financial results, reflecting the team's ability to deliver on increased levels of appeals. The Maximus federal team has done a great job to manage increased volumes, while at the same time winning new work that is centered on our core capabilities.

Moving on to our international operations where we recently completed a small tuck-in acquisition to complement our Human Services business in Australia. Maximus acquired workforce services assets from Centacare, a provider of welfare-to-work and disability employment services under the Job Services Australia and Disability Employment Services programs. This tuck-in acquisition expands our geographic footprint in Australia, while maximizing the utilization of our existing operational capacity to serve the government. The transaction closed on January 31, 2014 and is expected to contribute approximately $10 million in new annual revenue.

Moving on to rebids, on our last quarter's call, we mentioned that FY14 will be a light year for rebids and overall total awards. Thus far, we are pleased with our progress of the 15 contracts worth a total of $225 million up for rebid; we have won 3, with a total contract value of $46 million. Wrapping up with our new sales awards in the pipeline. For the first quarter of FY14, signed awards were $347 million. At December 31, 2013, we had an additional $50 million in new contracts pending -- those unsigned contracts where we have received award notification and are in contract negotiations.

Sales pipeline at December 31, 2013 was $2.4 billion. Compared to the same period last year, as expected, the pipeline is lower due to the record number of awarded contracts in FY13 that moved out of the pipeline and into our sales awards. As a reminder, we expect normal fluctuations in our pipeline, primarily as opportunities convert into new sales. On a sequential basis, the pipeline is comparable to the fourth quarter of FY13. The pipeline remains robust and includes opportunities across multiple geographies and both segments.

In closing, our plans for long-term growth continue to be shaped around our three strategic priorities, which include: enhancing our US operations by supporting clients through the next phase of the Affordable Care Act; growing our federal business, as demonstrated by superb growth in the past couple of years, including this quarter; and expanding our international operations with Health and Human Services opportunities in multiple geographies. Underpinning this growth will always be providing the highest level of service for our government clients.

They entrust us to operate highly-visible programs. We take this responsibility most seriously and strive to provide top-notch customer service for citizens and to achieve important program outcomes for our clients. We are pleased to offer an even brighter outlook for the remainder of the year and for FY15 and beyond. Our long-term growth outlook remains optimistic.

Before we move on to questions and answers, I would like to take a moment and thank our Chief Financial Officer, Dave Walker, for all that he has done to drive success for Maximus. In December, David announced his intent to retire later this year, but he will remain with the Company to provide support for special projects. We kicked off the search process in tandem with the announcement in December. We have good stream of qualified candidates but expect the process to take several months.

While we would like to someone identified by the summer, David has assured us that he will remain in a full-time position until we find the right person. David leaves big shoes to fill, but we are fortunate that he will remain with the Company in this new downshifted role, providing valuable support for special projects. Thank you, David. And thank you to all of our employees worldwide who continue to deliver each day on our commitments to our valued clients.

Now, let's open it up for questions. Operator?

We will now be conducting a question-and-answer session.

(Operator Instructions)

Charlie Strauzer, CJS Securities.

Can you hear me okay?

We can hear you fine.

My two question are very simple. Just when you look the influx of some of the higher volumes from the ACA enrollment and some of the appeals work that you saw higher volumes there, too. Is this more the emergency triage, one-time related, or do you think there will be longer-term opportunities that will come out of this?

Also, the second question will be other larger opportunities that are not -- that are in the pipelines for domestic and international. Can you talk a little bit more about that, as well?

Okay, Charlie, we will it give a go here. On your first question, as it relates to the additional volumes we are currently experiencing under the Affordable Care Act, it is helpful to break the discussion area into two pieces -- the appeals work that we do and the additional work that we are doing and I expect we will continue to do for the foreseeable future related to ACA/the Health Insurance Exchanges.

In general, on that topic, we think that the Affordable Care Act will have, I would say, more legs and longer legs, if you will, than previously anticipated. By that I mean, we were pleasantly rewarded this quarter with additional scope from our clients, additional needs, and our teams did a great job to step up and provide surge support.

I do think that, that will continue in that these large transformations, as well know, these large system transformations oftentimes take longer to reach the point of optimal operations. I do think, while technology will step up -- should step up and play a very important role, the populations with which we work do need face-to-face services. That is what we are very, very good at.

So I think that this is going to last longer than most folks anticipate and our role will continue longer than most folks anticipate. We also think there will be additional work in terms of scope and services. We have talked about HIX 2.0, really is transferring into the Affordable Care Act 2.0, so I would expect there will be additional work, including things such as some states decide to move off the federal exchange onto their own state-based exchange.

As it relates to the appeals work that we're doing, we have been very fortunate -- and all of that is related to the Medicare program, we haven't really gotten into the appeals that we will do as it relates to our separate contract under the Affordable Care Act. But the federal appeals for the Medicare program, as you know, for last year have been running higher, the volumes have been running higher, and we expect that at least in the short-term, they are going to be running higher at that higher level.

I don't think they're going to spike any higher than they have been. We have been working on backlog and that's going to keep us quite busy for the short term. And then clearly, we need to keep an eye on what happens as it relates to ACA-related initiatives, regulations, et cetera, and the future balance that is to be achieved with changing regulations and the extent to which RACS move into other areas of audit focus. Is that helpful on your first question?

Very much so. Thank you.

On other large opportunities, I'm really pleased with the quality of the opportunities in the pipeline. When we look at it, we do see significant opportunities across the board, across the geographies, and across the segments.

As you would expect, some of those are related to our Health business and the Affordable Care Act, but we have meaningful opportunities outside that as well. The best way I would describe it is it is very diversified, and a good portion, the majority of the work in the pipeline represents new work, which you would expect given the fact that we have got a light rebid year coming up so the rebid piece plays less of a role than perhaps historically it had.

Great. Thank you very much.

Brian Gesuale, Raymond James.

Nice job in the quarter. David, congratulations on retirement.

First one is actually for you. You look really relaxed on that picture on Slide 22. Was that Photoshopped, or does pending retirement feel that good? (Laughter)

I am always pretty relaxed, Brian. (Laughter)

Seriously. I wanted to talk a little bit about pipeline. Could you maybe give us a little color on the pipeline; that is domestic versus international, as well as maybe any Health and Human split?

Well, Dave and I are going to tag team on this one, Brian. This is Rich.

That is a follow-on as it relates to the prior question, pipeline quality. Again, I would go back and say it remains at a very high level, essentially consistent with the prior period, and the split is very pleasing between domestic and international, Health and Human Services.

When I think about it, Brian, I really do think that what is playing out here is the long-term thesis that we have had on the table, that as these governments move forward and try to deal with their fiscal challenges, coupled with the demographic challenges, increasing populations, and more folks needing assistance from their government, it continues to open up opportunities for Maximus long-term.

We have got some things that are really new work with new geographies and, again, those take time Brian. These, particularly federal governments, can take quite a bit of time for them to reengineer a program, be it a health program or a welfare program, but we remain excited and convinced that, that trend is real and it will continue for quite sometime and we're very well-positioned.

As a reminder, Brian, about 23% of our work is outside the US in FY13. We are seeing our opportunities track generally with our mix.

The other thing I would remind us is that we do have a goal to increase our Health business outside of the US, piggybacking on the nice platform and brand that our Human Services has laid before us. Again, our goal is to expand our Health business outside the US and we are starting to see some real opportunities bubble up in that context.

Okay, terrific. Rich, wondering if there's any specific geographies -- you've highlighted Canada and the UK in the past -- any geographies where you are particularly excited as you look out over the next 12 months?

I have got to tell you, I don't have any bias -- it almost feels like a horse race where they are all engaged, they do play [up] one another. It's fascinating to see how the world operates today.

At a country level, there's a very significant appetite for country leaders to learn what other countries are doing and share best practices and lessons learned. We play a meaningful role in that when we visit with our clients and our prospects.

It also happens with our teams. So we will see a -- as an example, we'll see an exciting win in the US and then the folks up in Canada will run with it. Or we will see some best practices here in the US and our prospects and clients in the UK are very interested to speak with to our US leaders, we will have them visit, we'll have them share some details on the program.

And last, I don't forget our folks in Australia. They continue to do a great job, and while at one point in time, we looked at the mountain tops in Australia and felt that it may be more of a steady-state business, but based upon the performance of that team, they continue to receive additional assignments and I still see it as some pretty good growth opportunities.

Okay, thanks very much.

Richard Close, Avondale Partners

Just really quick, I'm curious if you guys can talk a little bit about the health margins -- obviously stronger than what we were looking for. Can you talk a little bit about the trends in that or what you expect maybe in the second quarter based on the number of change orders and volumes that you're talking about?

That they great question, Richard. Let me generally just talk and reiterate about what we expect by segment for the whole year and for the quarter. In Human, our guidance really remains unchanged. We expect revenue to be fairly flat to slightly up, but in the lower half of our 10% to 15% range.

On points, in Health, which has really been driving our Business as of late with Health Insurance Exchanges, as you know, and we're going to continue to be bolstered by open enrollment. We saw the spike happen late in this quarter and that will continue into Q2. You will see Q2 up and the margin is going to go with that, just simply because of the continuation of what we saw in Q1.

As well, some contracts by contract type, we had to get an equitable adjustment. We will see those lag into Q2, but some of the work and cost had already been incurred. So you expect our margin to have some seasonality improvement in Q2. But if you look at the margins in Health overall for the year, it will be at the higher end of our 10% to 15% range so the margins will be very strong in Health.

A follow-up question. On the outperformance of ACA versus appeals, I assume it's more skewed toward the ACA than the appeals.

If you can talk a little bit about appeals going forward, everything that's going on with the RACs you mentioned, the rebid process, and the regulatory. I am curious to get your thoughts on appeals backlogs going forward and then the impact of the 2-Midnight Rule on those potential backlogs?

Let me start at a high level and then I will turn it in for Rich and others to chime in. First of all, as a reminder, the appeals actually perform better than our expectation. We actually expected them to turn down more than may have. We just didn't see that, which is what bolstered us. It is less that the appeals were growing, that they really haven't turned down, okay?

When we look at the delivery and the over-delivery in Health, it is really across the board. ACA certainly is strong, but we have seen all of our programs come on strong. The whole portfolio is performing very well. We happen to be at the right place where there is a lot of needs and that is what it is reflecting.

Richard, on the moratorium, as a relates to the RACs, and just to set the discussion, we do know that last week CMS extended the moratorium on RAC claims for what is referred to as short inpatient stays. At this point -- and we do know that those are prior moratoriums, so this is just an extension of that date -- we have not seen a material impact as a result of the moratorium and we have not seen a slowing of the case loads coming in.

That being said, we do understand the trends. I do think there is a lag factor. So given the lag factor, but given the backlog, we don't see a short-term impact to us as it relates to this extended moratorium. I would also say, remember, that the work we do here is just one element of the appeals work that we do. We do expect that if the RACs are defocused from the short-term inpatient stay type work or claims that they will focus in other areas.

I view this as not meaningful to FY14, again, given the backlog and given the lag factor, more relevant to 2015 and beyond. What will be interesting to monitor is what the RACs do is to refocus. We happen to believe there are some pretty significant additional areas for improvement as it relates to the claims work in the Medicare program.

Okay, thanks. Congratulations on your successful execution here.

Frank Sparacino, First Analysis.

Rich, just following up on that. As it relates to the appeals for the exchanges, maybe just talk about your expectations in timing, when you will start to see some of that work come in, in a meaningful way.

Also I assume there is a correlation related to the call center volume activities that you have had that have been better than expected due to the technology challenges. I assume there is a similar parallel that relates to the appeals. But maybe just talk on those two things?

That's fair. I' m going to ask Bruce Caswell to respond to that, Frank.

Good morning, Frank. Thanks for the question.

As you're well aware, we handle the appeals for the -- at the federal marketplace level, and as has been in the press recently, a reasonable backlog has been building up, but at the same time, we have been working to resolve upwards of about 4,000 appeals that can be resolved through just an administrative process -- outreach to the consumer, working with them to clarify their application, and ultimately to resolve that.

While the technology challenges remain, there are business process workarounds that lead to increased labor on our part and it's important to note that, that is a cost-reimburseable contract. There's really not a financial risk associated with the scope issues in that appeals work. We are continuing to handle the eligibility appeals that come in and triage them -- those that can be handled -- and then work hand-in-hand with our client to identify additional workarounds to the business process and prioritization of the technology remediations that are really the responsibilities of other contractors, to get that program stabilized.

And just a follow-up on the last question. On the Medicare appeals business, can you give us a sense as to -- it seems like your confidence in that business looking forward has a lot to do with the backlog that you have.

There has been a lot of talk, obviously, about the Level 3 appeals of the backlog issues. Do you have a substantial backlog right now, as it relates to the Level 2 that you're working on?

Frank, it's fair to say that not all RACs obviously perform at the same level of efficiency. Our understanding would be that some of the RACs have more backlog that they're working through than others. As a consequence, the higher volumes that we have seen are likely a function of that effect.

As we have said, as we continue to move forward, not only do we currently not see a decline in that, but it's likely that the RACs are going to continue to substitute a way to other types of appeals that they'll looking at. It's interesting, under the final rule, the CMS-1599-F final rule related to the 2-midnight stay, it's really just the patient's status reviews that RACs look at, that are excluded from this process.

But importantly, there are other types of other claims that the RACs can continue to work in an inpatient hospital environment. Those would include coding reviews, reviews for medical necessity of a surgical procedure, and so forth. There are some reviews in that area that they continue to work and that we continue to see, and then obviously, we anticipate they will continue to substitute a way to other areas.

Thank you, guys.

Brian Kinstlinger, Sidoti & Company.

The first question I have, I see the Department of Education award is still under protest. Can you remind us if you're actually generating revenue as a result from this contract?

And then if the GAO keeps this contract in your hands, does this change your guidance in any way for this year? In the top or bottom line?

Let me refresh folks in terms of where that protest stands and then I'm going to ask Dave Walker to address your specific question as it relates to revenue and guidance for FY14.

As you are aware, that protest, and it is akin to a legal matter, so we can't give you a whole lot of details, but the GAO is handling that protest. They are scheduled to render their opinion on the protest on or before February 20. So that is a significant date. Dave Walker, as it relates to revenue, what would you add?

Brian, there's a group of probabilities on this thing. We do have in a weighted basis, a small amount of revenue in our 2014 guidance, but it's very neutral to earnings. Really it affects next year for us.

Specifically, I don't think, regardless of the outcome of that, I don't think we would amend our guidance for FY14 for that event.

Oh, no. Right. Yes.

Then Dave, you mentioned the new seasonality. If I have it right, revenue peaks in the second quarter and then goes slightly lower sequentially, the third and fourth quarter.

But if we think about EPS -- as in the fourth quarter, you have generally had a low amount of very high-margin revenue that typically spikes earnings. Will fourth quarter still be seasonally strong in earnings or do you think not so much?

Not like it had, because some of the businesses that tended to drive that seasonality are not as large relative to the whole portfolio mix. Really, you will see -- if you just think about at a macro of your modeling beyond 2014, the first half of our year is going to be our strongest permanently because of HIX.

For this particularly year -- not only because of the momentum going into Q2, but the change orders hitting in Q2, as well -- you have an exceptionally strong quarter in Q2. We will still do generally okay in the fourth quarter, but not like it was proportionally. We used to have what is called a hockey-stick model and now it will be much more front-loaded.

Great. Thanks so much.

(Operator Instructions)

Dave Sagalov, Jefferies.

I hopped on the call a little bit late so I apologize if this has been asked and answered. Just taking a step back and staying on the appeals business, is that still -- can you give us an updated amount of the percentage of revenue that, that drives?

On the appeals business, I assume you're talking strictly about the Medicare appeals business, we don't disclose the percentage of revenue as it relates to individual divisions or service line offerings. We are not able to give you that percentage, Dave.

On a higher level, you've talked about the federal operations being around 10%. So my understanding was that the RAC component was less than 3%, that you may have spiked that once or twice.

Again, I can't get into whether it's 3% or the 10% but it is within the 10%, so you can deduce that it's less than 10%, the Medicare appeals per se.

Got it. And then just moving along to the business that you basically raised guidance for. It sounds like some of it is organic. Some of it could be from states that are having trouble and you're helping them out. Do you have a sense for how much of this might be one-time in nature and could roll off as we go into next year?

It's a great question. I think it's less than one might think.

I do think you should expect that some of this work will pull back. On the other hand, it's going to take longer to pull it back. You need to remember that reenrollment is going to be here again before you know it.

I also think that -- the wild card in the whole equation, Dave, is how long will it take not only to fix the technology underlying this, but to really optimize the processes so that the system in its total is working for people in a very efficient fashion.

It's going to take multiple quarters for all of that to work out. It's going to extend well into FY15 is my sense at this particular point. I also think what all of the noise that we're seeing is going to create pretty significant demand for appeals in the Medicaid/Affordable Care Act space.

That's really helpful. On that point of it -- extending it to 2015, can you speak to the term of the contracts? Obviously, in some of the periods leading up until now, it was contained within a year, but are you suggesting that the terms of this contract bleed over for a one-, two-, or even three-year period, as you help these states out?

Bruce?

Yes, I would be happy to answer that, Dave. Generally are HIX service center contracts are multi-year in natures so they would continue into the 2015 enrollment period and beyond. That is obviously consistent with our overall business model of developing decades-long relationships.

I would also maybe like to add a little more depth to it too, to say, the work we are doing to support our clients in the Affordable Care Act is not just limited to running the service centers. There are many existing clients in the Medicaid space that have needs at their level to comply to the Affordable Care Act, like modifying their business processes to handle the new eligibility rules around modified adjusted gross income; to look as they see a higher influx of Medicaid applications for support in processing those, that sous-chef work that Rich referred to; and to work, as Rich has also referred to, handling eligibility appeals.

Our eligibility appeals work is not just at the federal level but, for many of our state clients, we can help with, if you will, the teeing up of an appeal and the completion of a case, such that then, ultimately a state Medicaid employee can make that determination. It's actually a very rich tapestry, if you will, of ACA support functions.

Furthermore, as we enter the summer months, you're probably quite aware that the qualified life events in through which people can actually continue to apply for and gain coverage during the non-open enrollment period are fairly rich. They can include everything from enabling individuals that have a change in income that affects their subsidy to select a plan; if you move to a new area that offers different plans, that's a qualifying life event; typical ones like marriage, birth, adoption, losing coverage through divorce, things like that.

While we certainly would expect some seasonality reflecting the close of open enrollment presently, which is scheduled for March 31, and I say that presently, because there is certainly some talk about a potential extension there, and then the reopening November 15. There are additional, if you will, volumes and services related to that type of work and those transactions that you see during that interim period.

Dave, just a reminder, our Health contracts tend to have three-year base, two-year options, so they tend to be about five years. Some higher or lower, but they average just shy, all our contracts, of under five years, and these are no different. Generally, change is our friend.

Right.

And I'd add one point to that. Most of the additional scope work we're doing is just piggybacking on the existing contracts, so in the form of change orders, and some of them it is just already just hardwired in.

The exception would be the additional work -- the work we are doing for new states that heretofore haven't been customers, and we have received inbound calls to action to help those states. I talked about one of them, Oregon, on my call notes.

Rob, we will go and take one last question today.

Brian Kinstlinger, Sidoti.

Just one. We've talked a lot about the appeals for Medicare. I'm not sure we talked too much about the appeals work for the federal exchange. I am curious, when that contract has -- provides you revenue run rate that is mature, I think it lags the enrollment period, and so when is the seasonality also for the contract?

Brian, we touched upon it earlier, but that contract is very, very young in terms of its start up. We are engaged, we are working with our client, we have built a great relationship with our client to help them meander through all of the technological changes, as you would expect, that one would experience as you're trying to handle appeals for the Federal Health Insurance Exchange.

Given the complications, and it looks like the volumes are going to get there sooner or later, I do think that the table is set for some pretty significant volumes on the Federal Health Insurance Exchange. I don't see this reaching full equilibrium until the FY15. That is my gut.

Just a reminder, that contract is reimbursable. It's lower margin, but it self-adjusts, as they are having interfaces or technology challenges, as new clients always will have, and we conform our technology, et cetera. It self-adjusts to size.

Sometimes, that's stuff that we're doing that is out of scope normally with the original bid. You won't see it in our pipeline numbers. So sometimes in our organic growth is actually some of that new business as we help our clients cope with change. In that regard, it is obligated.

Great. Thank you, guys.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.