Maximus Inc (MMS) 2016 Q1 法說會逐字稿

Greetings and welcome to the MAXIMUS fiscal 2016 first-quarter conference call. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Ms. Lisa Miles, Senior Vice President of Investor Relations for MAXIMUS. Thank you, Ms. Miles. You may begin.

Good morning and thank you for joining us. With me today is Rich Montoni, CEO; Bruce Caswell, President; and Rick Nadeau, CFO.

I'd 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 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 the non-GAAP measures presented in this document, please see the Company's most recent quarterly earnings press release.

And with that, I'll hand the call over to Rick.

Thanks, Lisa.

This morning, MAXIMUS reported financial results for the first quarter of fiscal-year 2016. As noted in the press release, we had a pending change order at December 31, 2015, related to a state health contract where we were already performing additional scope of work. Accordingly, the costs were incurred and recorded in our first quarter and the revenue will be recorded once the change order is signed. As a result, approximately $8.6 million of revenue and $0.08 of earnings per share shifted out of the first quarter.

We presently expect the pending change order will be signed in the second quarter, at which time we will record the revenue and related earnings. The delay in signing the pending change order is due to the State's required process, which provides up to 90 days of review by the comptroller's office. The pending change order is presently awaiting this final approval.

As you may already know, this is very common in government contracting. I want to reassure investors that this is just a shift of revenue and earnings from one quarter to the next. Our full-year results and therefore our guidance are not impacted.

For the first quarter of fiscal-year 2016, the Company's revenue grew 19% to $556.7 million, as compared to the same period last year. Of this growth, organic revenue growth was 8% and was driven by the health segment. Acquired revenue growth totaled 14% and total Company revenue was unfavorably impacted by approximately $15 million, or 3%, due to the effects of foreign currency translation as compared to the first quarter of fiscal-year 2015.

As we mentioned on our last call, both operating margin and earnings were expected to be lower on both a sequential basis and year-over-year basis, due to several programs in varying stages of start-up across all three segments. In addition, the pending change order also impacted the Company's margin by approximately 140 basis points.

As a result, operating margin for fiscal Q1 was 7.7%. If the change order had been recorded in the first quarter, total Company operating margin would have been 9.1%.

At this point in time, we still believe that we will exit the year with a full-year operating margin for the total Company in our targeted range of 10% to 15% as we see the expected benefit of the several startup projects progressing to normalized operations.

For the first quarter of fiscal-year 2016, net income attributable to MAXIMUS was $26.6 million and diluted earnings per share totaled $0.40.

Now, I will speak to segment results, starting with health services. The health services segment revenue increased 20%, driven principally by new work and, to a lesser extent, the expansion of existing contracts. On a constant-currency basis, growth would've been 22%. All growth in the health services segment was organic.

Operating margin for the first quarter was 9.2% and lower compared to the prior year. The aforementioned pending change order unfavorably impacted health segment operating margin by 260 basis points in the first quarter. On a normalized basis, if the change order had been signed during the first quarter, operating margin would have been 11.8% for the health services segment.

As expected, operating margin was also tempered by new contracts in the startup phase, including the Health Assessment Advisory Service and the Fit For Work program in the United Kingdom. As a reminder, the prior-year period also benefited from highly accretive change orders that bolstered operating margin.

During the quarter, we made steady operational progress on the Health Assessment Advisory Service contract. It is still too early to make any adjustments to our forecast since we expect that it will take some time for improving trends to materialize in the financial model. At this time, we are still running below our volume targets, but making progress each month. We continue to expect to have our productivity at the appropriate levels by late summer. We remain firmly committed to the program and Rich will provide additional details regarding our progress in his prepared remarks.

Moving onto the US federal services segment, first-quarter revenue for the federal segment increased 35% as compared to the prior year. Acquired revenue growth from Acentia was offset by expected organic declines. First-quarter operating margin for the federal segment was 7.4%. Both revenue and profit were unfavorably impacted by anticipated decreases in the legacy MAXIMUS federal business. This includes the expected closure of a customer contact center in Boise, Idaho, where we provided support to the federal marketplace.

In addition, we also experienced lower appeals and assessment volumes, due in part to previously disclosed contracts that were lost through competitive rebid. The integration of Acentia is substantially complete and performing according to plan.

Let me turn to financial results for the human services segment. For the first quarter, revenue increased 3% compared to last year. Segment revenue growth benefited from the acquisition of Remploy, which was offset by approximately $9.4 million from foreign currency translation.

As expected, operating margin in the first quarter was 7.6% and lower as compared to the prior year. This was driven by the decrease in contributions from our international welfare-to-work operations, most notably the ongoing startup of the new Jobactive contract in Australia. We still expect that the new contract will return to more normalized levels of profitability and within our target operating margin range of 10% to 15% in the second half of fiscal-year 2016.

The prior period also included the benefit of approximately $2.4 million of incremental revenue and income from a contract extension in Saudi Arabia, as previously disclosed.

Let me move on to discuss cash flow and balance-sheet items. Days sales outstanding were 75 days at December 31. While this is in line with our targeted range of 65 to 80 days, the sequential increase in DSOs was due in part to the timing of payments, as well as delays in two states that are experiencing budgetary challenges. The increase in billed and unbilled receivables unfavorably impacted cash flows in the quarter.

As a result, for the first quarter cash provided by operating activities totaled $1.4 million, with negative free cash flow of $9.3 million. Subsequent to quarter close, we have made progress on collections. We believe that DSOs in the second quarter are more likely to run towards the lower end of our targeted range of 65 to 80 days, with a corresponding benefit to cash flows from operations.

Our balance sheet remains healthy, and at December 31, we had cash and cash equivalents totaling $51 million, most of which was outside the United States.

During the first quarter, we repurchased approximately 543,000 shares of MAXIMUS common stock for $29.1 million. The weighted average price was $53.65 per share. We presently have an estimated $139.4 million remaining under the Board-authorized program.

Our balance sheet remains healthy and, with our available line of credit, offers us a considerable amount of flexibility for capital deployment. We have invested in our infrastructure and continue to pursue selected strategic acquisitions in an effort to increase our scalability and enhance our position for new market opportunities. We expect to continue with our quarterly cash dividend and opportunistic share buyback program. Above all, we remain committed to sensible and practical uses of cash for creating further long-term shareholder value.

And lastly, we are reiterating our fiscal-year 2016 guidance. As a reminder, we are guiding to revenue in the range of $2.4 billion to $2.5 billion and diluted earnings per share to range between $2.40 and $2.70. We still expect cash provided by operating activities to be in the range of $200 million to $230 million for fiscal 2016 and we expect free cash flow to range between $130 million and $160 million.

We still expect that earnings will be backend loaded, primarily due to the anticipated improvements in our various contracts that are in the startup phase and will mature throughout the year. We still expect that total Company operating margins will be in the lower end of the 10% to 15% range for the full fiscal year.

We have received a number of questions related to the impact from currency exchange rates and how that might affect our guidance. Foreign currency exchange rates continue to have an unfavorable impact. The British pound continued to significantly weaken throughout the month of January. So, looking at the guidance we laid out in our November call, the currency exchange rates at January 31 would indicate a tempering of revenue of approximately $28 million; however, the wide range within our fiscal 2016 guidance should provide sufficient room for it to be absorbed.

Thank you for your continued interest and now I will turn the call over to Rich.

Thank you, Rick, and good morning, everyone.

As Rick mentioned, we have a pending change order that we now expect to be recognized in the second quarter. If the change order had been finalized in the first quarter, we would've been in line with our expectations for Q1.

As expected, several large startups are also tempering earnings at this time. As they mature, we fully anticipate that they will be meaningful contributors to our continued growth and profitability in fiscal-year 2016 and beyond.

We believe it's appropriate to focus on our full-year guidance range because these types of quarterly fluctuations are common in our industry and we remain on track to achieve our estimates for fiscal 2016.

I'll start my comments this morning with an update on the UK assessment contract. Getting the contract on the right path to success remains a top priority for the management team and we've made meaningful progress. I first want to acknowledge a report issued last month from the UK National Audit Office, as well as the Public Accounts Committee meeting yesterday that discussed this report.

The NAO published findings from an August 2015 audit of all the assessment contracts across the country. This included our UK assessment contract. The audit only covered effectively five months of our operations. As a reminder, when we took over this contract we acknowledged that it would take 12 to 18 months before we could improve many aspects of the operations. The NAO report echoed what we said in our November call as it relates to certain performance metrics, including volumes and quality.

Let me bring you up to speed on our progress since the NAO audit and our last quarter's call. Recall that the UK assessment contract is predominantly cost reimbursable, with significant performance incentives. The largest is tied to volumes, so I'll share an update on our progress in this area. As a reminder, our ability to hit the volume targets is tied directly to three areas -- one, the number of healthcare professionals that we recruit; two, the number that complete training and graduate; and three, the productivity of these new recruits.

As I mentioned last quarter, we launched several initiatives to help drive our recruitment numbers, which have brought in a solid stream of well-qualified candidates. During the autumn timeframe, we were hiring approximately 100 new healthcare professionals each month. We currently have the required staff in the pipeline to meet our production requirements and we are now turning our attention to simply managing attrition and filling in the gaps in key locations. So real progress here and our recruitment efforts are at the appropriate run rates.

In the area of training and graduation rates, it's fair to ask, why is it so difficult for a new healthcare professional to complete training? Performing functional assessments is a new skill for many healthcare professionals, especially if they were previously working in a clinical setting or providing direct patient care. The training program is rigorous and the competency tests are challenging.

We amended certain aspects of our training to help increase success. Our smaller training classes are giving new recruits more access to experienced staff. This individualized support has yielded solid improvements in retention rates. These changes have made a marked difference and our most recent monthly data shows that graduation rates are north of 80%, so meaningful improvement in this area as well.

From a productivity perspective, it does take time for new healthcare professionals to be working at full capacity. Once they begin performing assessments, the learning curve to full productivity can take between six and eight months.

Our new recruits are becoming more experienced and are reaching increased levels of productivity, and as they ramp up, the seasoned healthcare professionals who were previously serving as mentors will return to fully productive status.

All of this has helped to increase our overall productivity, which has allowed us to make additional progress towards our volume targets. In fact, we delivered the highest number of assessments to date in January. In addition, we've also made significant headway on the more than 0.5 million cases of backlog that we inherited at the time of contract takeover. To date, we've cut that figure down to 110,000 cases. Recall at the time of our last call we had been through about one-third of the backlog, so I'm very pleased with this ongoing steady progress, both with the new incoming assessments and the cases in backlog.

We believe that the trends are indicative of the ongoing steady progress we're making to increase our capacity and boost the number of assessments we complete. We remain cautiously confident that we will have all the pieces in place to get our productivity where it needs to be by the end of summer 2016.

The NAO audit report also touched upon the areas of quality and cost. Delivering quality assessment reports is essential. The client uses our reports to make a determination about benefit levels and we recognize the importance of delivering high-quality reports.

The report indicated that we were not achieving one of the quality metrics at the time of the audit in August. To put this in context, we are meeting or exceeding 10 out of 11 service-level metrics for quality. We've implemented several measures that continue to strengthen the quality of our assessment reports.

The NAO report also compared the cost for assessment under MAXIMUS versus the previous provider. This comparison is misleading as the two contracts are fundamentally different. Our contract requires a much greater proportion of face-to-face assessments, which simply cost more to perform.

And while we've made meaningful progress on all fronts, we still have a ways to go; therefore, we believe it's premature to make any modifications to our estimates for this fiscal year. Nevertheless, we are on track to meet our volume targets that underpin our fiscal 2016 guidance.

Turning now to our health operations in support of the Affordable Care Act in the US, we closed out the third open enrollment period, or what we refer to OE3, on January 31. Unlike the previous two open enrollment periods, OE3 did not include a special enrollment extension and therefore had a shorter duration than the prior periods. Despite this compressed timeframe, call volumes across our contact centers were consistent with our expectations. This confirms our view that our ACA-related revenue has largely stabilized into a relatively steady state.

MAXIMUS continued to support our Health Insurance Exchange clients with the ACA-related activities. This includes completing redeterminations, answering tax-related questions, and managing certain aspects of consumer engagement through new digital offerings that assist Medicaid-eligible consumers with eligibility and enrollment. Additionally, we have solid market activity in adjacent markets. This includes supporting state Medicaid programs with the enrollment and credentialing of providers.

Looking ahead, we continue to expect normal course fluctuations year in and year out as states prioritize the wide-ranging set of initiatives for their public health insurance programs.

In other health-related good news, we signed the eligibility support services renewal contract with the Texas Health and Human Services Commission on December 18. The five-year-based contract is valued at $522 million. This is two years longer than our previous contract. The contract also has two additional option years.

Under the contract, MAXIMUS will continue to provide support services for many of the State's programs, including Medicaid, the Children's Health Insurance Program, the Supplemental Nutrition Assistance Program, Temporary Assistance for Needy Families, and others. The increased contract length is confirmation of our continued performance and we are pleased to close out our fiscal 2015 rebids with this key win.

As a reminder, fiscal 2016 will be a much lighter rebid year. We have 10 contracts with a combined total contract value of approximately $170 million up for rebid in fiscal 2016.

Moving on to new awards in the pipeline, we had strong awards in the first quarter, with year-to-date signed contracts at December 31 of $665 million. We also had an additional $285 million in new awarded, unsigned contracts. Our sales pipeline was $2.8 billion at December 31 and lower sequentially due to work shifting into the awarded category, most notably the Texas eligibility support services contract.

As a reminder, our reported pipeline only reflects short-term opportunities where we believe the request for proposals will be released within the next six months. As part of our long-term growth strategy, we monitor a much broader pipeline that lays out opportunities over the next three to five years. Both our reported short-term pipeline and our longer-term outlook hold a broad mix of rebids and new work. They represent opportunities in multiple geographies and all segments and include those that complement our recent acquisitions.

In summary, we are making continual steady progress with the UK assessment contract, we have a very positive working relationship with our client, and we remain confident that we will have the right pieces in place to achieve our end-of-summer goals to meet our volume targets that underpin our fiscal 2016 guidance.

Once fully ramped, the assessment contract, along with our other major startups, will deliver solid long-term shareholder value. In addition, the trends we experienced during the third open enrollment period of the Affordable Care Act in the US confirms that this business has largely stabilized.

We continue to be focused on progressing the several startups we have in progress to advance them to a normalized level and to contribute to our expected growth in the rest of our fiscal 2016 and beyond.

As you know, an important component of our long-term growth strategy is to look for opportunities where governments are transforming programs. Oftentimes, these types of contracts have front-end losses. But over time, they mature into programs that deliver recurring revenue streams, offer solid earnings contributions, and create long-term shareholder value.

All in all, we remain on track to achieve our guidance for the full fiscal year. And with that, let's open it up for questions. Operator?

(Operator Instructions). Dave Styblo, Jefferies.

Thanks for the questions. The first one would just be on the HAAS contract and kind of coming back to the improvements that you made there. It sounds like January was your best month to date. Can you kind of give us an idea of how those numbers have trended in the last few months? I think at the public hearing you had mentioned it was at 75,000, was the volume in that month.

I'm curious again if there's any sort of maybe seasonality in that or anything unusual. But just the track record there and reconciling that to perhaps what is a year two goal that the government has set forth from you. I think originally it was 1.2 million assessments, but I'm curious if that part had changed at all.

Good morning, Dave. This is Rich Montoni. Thanks for the question. I would parse it into three pieces. Help us understand the 75,000 per month and how does it fit with the run rate. Two, is there any seasonality? And three, some views on year two. Bruce Caswell, our President, is here with us today and Bruce has been spending an awful lot of time, as you might imagine, on this HAAS contract. I'm going to ask Bruce to field that question.

Sure. Good morning, Dave. So on the first question, the 75,000 was, yes, our largest volume production that we've achieved. And there is a bit of seasonality in that in that December was a lighter month, as you could expect, because there's more holidays during that period, so December was lower than the preceding month. November, you see a little bit of that dynamic.

But generally speaking, it's been a gradual march uphill with volumes and we've hit a new plateau and a new -- actually, a new peak that we are continuing to grow from with January.

And the dynamics, as we've explained, are really driven by the healthcare professionals now that we've had in training that are exiting training at a very solid rate. We mentioned that our graduation rate is now about 82% for staff through the first three months, whereas when we inherited the contract it was at about 30%, so it's a dramatic difference. And as those staff come online, they become productive and spend more time -- in the business, they become productive. And the staff, the very experienced staff that were training them, have the ability to go back to their productive work as well. So we fully anticipate seeing our productive capacity continue to grow from that January number.

You had asked a little bit about contract year two. As you mentioned and as is also mentioned in the NAO report, the volume target for contract year two is 1.2 million assessments. We are still in the process of ramping up our staff. We feel like we have adequate capacity from our recruiting channels to achieve those contract year two targets, and as I mentioned, that is really a function of the staff that we have in training moving into productive use and also the seasoned healthcare professionals that have been supporting them moving back into full productivity. So we feel like we're very much on a trajectory to hit the contract year two targets.

Dave, you've got a follow-up?

I did. Actually, just on the federal business and the human service margins, I know they are a little bit lower because of some of the startups and the factors you had called out there, around 7.5%. Can you give us a little bit better sense of maybe what the normalized margin over the long term would be in federal services? I suspect it might ramp up closer to 10%, but what would get you there?

And same thing in human services. I guess it's mostly the Australia overhang. How do we think about what that profit is in the first quarter versus getting to the 10% to 15% margin you called out for the second half?

Okay, Dave. We are going to have Rick Nadeau, our Chief Financial Officer, respond to that question.

All right, Dave. On a historical basis, operating margins in our federal segment back in the fiscal years 2013 and 2014 were abnormally high due to the increased Medicare appeals volumes, which were really highly accretive, and we also experienced lower appeals and assessments volumes, in part due to some Medicare appeals contracts that we lost. So (multiple speakers) filled that back in with more normalized margin type of work.

I think that you know that we had one contact center that we closed down in Boise in federal and that's a little bit why it's been down.

The operating margin for the US federal business should normalize around 10%. As a reminder, if you've cost-plus contracts, and we do, you will tend to see lower margins, while performance-based or transaction-based contracts will tend to operate in the target range. We do also in the federal group have one of our startup contracts which is tempering that margin. And yes, you are right, in the human services the thing that's tempering that margin is this Australia startup.

Thanks, Dave. Next question, please?

Charlie Strauzer, CJS Securities.

Hi, good morning. Just picking up on Dave's second question a little bit further there, if you kind of take a look at the core business, excluding the startups and the change order, what did the core business kind of look like from a growth perspective?

Good question. I'm going to have Rick Nadeau address that one, and Rick, maybe just address it from this most recent reported quarter of Q1.

Charlie, if you exclude all of the startups and the pending change order that we talked about, the rest of the business is running in the middle of the targeted operating margin range that we talked about, our targeted range of 10% to 15%, which does indicate that the base business is performing as we expected.

As a reminder, as these startups mature we do expect them to become meaningful contributors to our long-term shareholder values, but in the early parts of the contracts, they do depress the margins, as you know.

Great. And then if you look at the guidance range, I know it's still too early to raise the lower end of that guidance range, but as the year progresses, what would have to happen from your view to cause a raise in the lower end of that guidance? Thanks.

Charlie, I think that, similar to the answer I just gave you, I think we're going to have to see the startup contracts continue to mature, and as you know, HAAS is a big chunk of that, the biggest of the startups. So as we continue to see progress toward that -- we have made meaningful progress, but we still have a ways to go. As we see continued progress, then we would be thinking that we would be going toward the upper end of the range, but it's too early at this point.

Thank you, Charlie. Next question, please?

Tom Carroll, Stifel.

It's actually just a quick follow-up on the UK HAAS contract, again. Your slide 5 in your presentation, trying to think between the lines there a bit more in the comments and the bullets that you made about still running below volume targets, but making progress each month, and we've seen that in the data. Is there some probability that you can claw back any of what you have given up this year related to this contract or is that completely just not a possibility at this point in time?

Fair question, Tom. We are going to have Rick Nadeau address that one.

Okay. Contract year one ends on February 29. You can claw back within a year -- within a contract year, but once we get to February 29, we start the clock over again.

So we do get and are assessed volume penalties on a month-to-month basis, but the ultimate target is for the whole year, and we could make up shortfalls that we had, for example, in March or April later in that year.

But if you haven't shown improvement by February 29, you lose it in the contract year. So is that -- am I thinking of that right?

Yes. We couldn't claw back anything after February 29 in that first contract year. As a reminder -- so we get 7/12 of a contract year in one fiscal year and 5/12 in the next, so we straddle years, unfortunately, against our fiscal year.

And then secondly, just quickly, you said Acentia is essentially fully integrated. What are the best practices, opportunities, within that organization that perhaps will better support legacy federal business at MAXIMUS, perhaps improving margins? I guess that's the crux of the question.

Tom, good question. I think this, I think when we say Acentia is essentially fully integrated, I think the one area -- and this is normal course with an integration -- is what I would call revenue synergies. What can we do to move forward and drive the revenue synergies that we felt were on the table with Acentia?

The other aspects, which range from blocking and tackling, backroom functions, I think are essentially complete. I think we've made good progress. I think we've got a unified business development team. We've integrated all of that with our legacy federal business. We are advancing customer calls and sharing with the various business development aspects customer relationships, customer needs, compelling customer drivers, and assessing what we think is out there in the short term and longer term for new business development and advancing solutions to differentiate the new MAXIMUS federal.

And it just takes some time to drive what we think will be the ultimate prize here, and that's BPO opportunities within the contract vehicles that came along with Acentia.

Thanks, Tom. Next question, please.

Steven Lynch, Wells Fargo.

My first one is related to your comments about the UK health assessment contracts running below volume targets still. Can you just talk about maybe where those volume targets are in relation to the range that's built into guidance? Is that internal target, is it equivalent to the top end of guidance, the 15% operating margin, or is it closer to breakeven for that contract at the midpoint?

I believe our guidance was pretty wide with respect to HAAS, and I think it was $7 million of operating income on the low end and it was about $20 million of operating income on the upper end.

It was loss on the low end.

Yes, I said -- okay. I meant loss. If I said income, I misspoke.

$7 million OI loss on the low end and $20 million on the upper end. Yes, as you get throughout that wide range, volumes are -- this contract is very sensitive to volumes. So as you creep toward the upper end of that guidance, yes, you are implying that you are hitting your volume targets.

Okay. Got you. A follow-up question, you mentioned the exchange rate trend since November represented incremental headwind of somewhere in the neighborhood of $28 million for revenue. Is there any sense you can give us for what the EPS impact would be, if there's any?

That would be much less, and since -- it would be not material on the earnings-per-share number. And that's because you have a mix of contracts in there, some in the startup area and they are having losses to them. So the currency doesn't hurt you there.

And you also need to take into account that you have a meaningfully different tax rate that tends to buffer the EPS impact with the negative FX impacts on the revenue side. So I agree with Rick in terms of it's not material from an EPS perspective.

Thank you, Steven. Next question, please.

Brian Kinstlinger, Maxim Group.

Great. Thanks. I wanted to follow up with that volume question as it relates to guidance. You had mentioned yesterday that you expected about 900,000 cases could be achieved for the fiscal year. I'm curious if that volume is the midpoint or low point or high point of the wide range that you are predicting for your guidance in operating income.

As you look toward the upper end of that guidance range, you would be seeing us hit the second-year volumes towards that 1.2 million range.

So remember that the fiscal-year 2016 has seven months of contract year two in it, and so I think the -- we know as of this point we have three out of five of the months in fiscal 2016 and we know what they are. I think your question is better answered by as you get closer to the 1.2 million volume target for year -- contract year two, you will see us go toward the upper end of that guidance range. Did that answer your question?

Yes, it does. Much better. Thank you. And then, I guess I'm curious from a high level. What's different about your federal services segment versus your public federal IT peers? Their operating margins are well below 10%. They look more like yours. And then, I guess, as it relates to the DOE contract in there, is that fully ramped or is that still well below earnings contribution potential?

I'll answer those two in reverse. On the debt management contract, yes, we are in full revenue service, but we're still in the uptick on the P&L. So we are continuing with the startup losses and that should turn profitable during fiscal-year 2016 and then continue to ramp toward a more normal profit margin.

Having come from a federal IT business, yes, our margins are better than the typical federal IT margin and I think it's the fact that they have a lot of competition in their business and they have a lot of cost plus. Although we have cost plus -- now you are going to see a cost plus margin down around 7% on a -- generally speaking. So the more cost plus a federal IT contractor has in their mix, the lower you are going to see their margins. The fact that we do a lot of performance-based contracting tends to give us better margins.

Next question, please.

Richard Close, Canaccord Genuity.

Great. First question is as it relates to the UK contract, can you talk about when you are able -- assuming you are hitting the volume levels for year two, when you are able to recognize the performance incentives? Does that come over the course of year two or at the end of the year? Just a little bit of clarity there.

This is Rick. When the -- we actually get assessed any penalties or any awards or any incentives on a month-to-month basis, but there are true-ups. So we do recognize it over time, if that's your question on the revenue recognition side. It does not tend to be backloaded. If we did have something like that, we would smooth it in, but that's not the way the contract works. You see it over time.

Okay. And my second question may be more for Bruce. There was an interesting article on Medicaid in The Wall Street Journal a couple days ago. It talked about potential incentives to get the states that have not expanded. Can you talk a little bit about what you're seeing on the Medicaid side? What you are expecting? Any changes over the course of the coming year?

Sure. I'd be happy to, Richard. So as -- I think you're referring to basically the administration's plan to try to get a minor change in legislation that would allow for three years of complete funding for Medicaid expansion, regardless of when the state actually begins that expansion endeavor, so that states wouldn't be locked into the decline from 100% funding down to 90% and so forth that ties to the current Affordable Care Act.

So, I won't comment or speculate on the likelihood of getting that through the legislative process or the regulatory process, but certainly Medicaid expansion itself remains a very dynamic environment with a large number of states still contemplating it, some due to changes in administration -- for example, in Louisiana where Gov. Jindal termed out and we have a new governor moving ahead with expansion.

So we've said many times that it's the kind of thing that we think we will see gradual adoption over time as more states see the business case to it and the benefit from an economic development perspective in their healthcare industry. So we will continue to watch it, and I guess you could say that if a change in regulation that provides that guaranteed three-year funding is made possible, that could create an added incentive for states to take that on.

We also have spoken previously about how in 2017 there are some new tools available to the states through the Section 1332 waivers that give them the ability to make some fairly substantial changes to their programs. That could incorporate a Medicaid expansion component, as well as kind of recrafting the exchanges on a state-based level. So more to come there. I think those become options to them if this other option does not, so we'll continue to watch it.

Next question, please.

(Operator Instructions). Frank Sparacino, First Analysis.

Hi, guys. On the UK with recruiting and training seemingly in order now, what's the greatest risk going forward with the contract?

A good question, Frank, and I do think that in comparison to prior periods, it's very important to recognize that we've tackled and, I think, improved meaningfully two out of the three tougher aspects here.

I would answer the question by saying now we focus and shine the light on productivity and quality and getting those two aspects where we would like them to be, and I think on the call notes we've talked extensively about the initiatives that we have in place to continue to improve. We've had meaningful improvement here to date on the productivity side. We still think there's improvements that we can make and we have initiatives in place to achieve productivity improvements, as well as quality improvements. Those would be the areas where we now focus our attention. Bruce, anything to add on that one?

I think you are absolutely right, Rich, and we've, I think, noted that it does take up to six to eight months for the newly graduated staff to really become fully productive. And so, now that we're seeing more of those staff come through graduation at a higher rate, we will continue to track toward those higher levels of productivity, and as we said, that's consistent with our view that by the end of the summer we will be able to completely erase the backlog.

We did mention yesterday that the backlog is now down to 110,000 cases from a backlog of 550,000 that we inherited at the time of the contract, so we are very pleased with that progress as well.

Great. Thank you, guys.

Next question, please.

Peter Heckmann, Avondale Partners.

Good morning. This is Shane Svenpladsen in for Pete. Regarding the UK Work Programme, a recent government spending review suggested this program could be combined with the Work Choice program when the Work Programme is retendered this year. Does that still appear to be the case? And would you expect any material changes to those contracts if they were to be combined?

Shane, we're going to ask Bruce Caswell to answer that question.

Hi, good morning, Shane. It's a good question, and as you've noted, there has been some new guidance as a result of the spending review in the United Kingdom.

Let me just begin by setting a bit of a backdrop. The UK is experiencing really historically low unemployment rates and high employment rates as a consequence. So the government is shifting its focus to reducing the employment gap, largely for individuals with disabilities.

It's interesting to note that when the Work Programme was initially implemented, its focus was at the time on the long-term unemployed and that group is decreased by about 75% since 2011. So the government is now creating the smaller, more focused program on individuals with disabilities called the work and health program, and it is expected to absorb the Work Programme and the Work Choice program and be focused on individuals with those specific health conditions and disabilities.

So first of all, clearly helping individuals with disabilities into employment is very much a core competency of our Remploy subsidiary in the United Kingdom, and we're very well positioned to accommodate and take advantage of that change in government focus and approach.

The new tender is not out yet, so we really don't have a full sense of the size of the contract. There are early indications, as you've noted, that the contract should be expected to be smaller and we will expect to have a clearer view in terms of the timing and the size of that opportunity probably in the springtime.

So I'd probably just summarize by saying when we look at the work that we perform with both MAXIMUS and Remploy and the Work Programme and Work Choice, it's also important to note that our profitability expectations for the combined programs in fiscal 2016 are pretty low. So any proposed reduction that could happen as a result of that combination under a new contract would be more of a topline movement for us and relatively immaterial to the bottom line. Does that help?

Yes. Thanks. I'll get back in the queue.

Thanks, Shane. Next question, please.

Allen Klee, Sidoti.

If we look at three of the startup contracts -- Australia Jobactive, US DOE, and UK Fit For Work, is there a way we can quantify what the -- how that can move in terms of incremental EPS through 2016 and 2017?

This is Rick. I think what you will see, and I guess I look at the startups in the totality, is I think all of them are in the maturing phases and I think that you will see us with our operating income margin climb steadily toward the middle of that 10% to 15% target range that we have. And I think all four of the startups will be contributing to that and all four of them will be improving toward that goal. Did that answer your question?

Okay. Thank you. And then, with Medicare appeals volumes has been slower, is there any sense of if that's going to continue to trend even lower or stabilize?

Bruce?

I think that, as we noted, the volumes have come down as we lost a couple of contracts and we are seeing obviously the reflection of that, but I think we would say at this point we've reached a long-term steady state in terms of the volumes for the Medicare appeals program.

Thanks, Allen. Next question, please.

(Operator Instructions). Charlie Strauzer, CJS Securities.

Just a quick follow-up. If you look at the significant sales opportunity pipeline, like $2.8 billion versus the very light year of rebids coming up, it seems like there's a fair amount of new opportunities there. If you could help kind of give a little more granularity or color into the pipeline as to international versus domestic, and then maybe a sense of which of the three segments they kind of fall into, maybe kind of give a percentage or a rough sense of that. Thanks.

Okay, Charlie. When I take a look at the pipeline, first off I'd say relative new work versus rebid, it's a mix of both, as you would expect, and the important aspect is that a good portion, roughly half, of the sales pipeline relates to new work.

In addition, from a domestic versus international, it's really across all of our segments and international, as well as domestic. I'd say well balanced. There's no disproportionate amount of opportunities in any segment or domestic versus international.

Do you have a follow-up question?

No, that's good for me. Thank you.

Thanks, Charlie. Next question, please.

Richard Close, Canaccord Genuity.

Okay. Thanks for slipping me in here. Two questions, one with respect to the higher salaries that you mentioned in yesterday's meeting. Can you talk a little bit how you get compensated? Does that negatively impact you? Or just the dynamics on having to pay higher salaries in the UK on that contract.

And then, my second question would be on the quarterly progression of earnings. You obviously have the $0.08 that is moving from first to second quarter. I think the current consensus for earnings out there for second quarter is $0.56, so if you can talk to us about -- talk about the progression as we go throughout the remainder of this year.

Let's do this, I'm going to -- the second question we will keep second and we will ask Rick to talk about quarterly progression in earnings, and Rick, if you want to, you can talk about revenue as well.

But before we jump into that, let me take a high-level stab at the first question, which I understand -- in the HAAS contract, I believe it has been disclosed and was discussed yesterday in the government's proceedings that we are paying higher salaries to the workforce that we inherited when we took the contract over on March 1, 2015, as well as to those individuals that we hired since we took over the program.

In the process of bidding this work and negotiating this work, we felt it was necessary to pay higher salaries to be competitive and to be able to attract and retain the workforce. So we very much negotiated that ability in the contract. The nature of this contract is, to a large extent, cost plus. So that was factored into the cost equation, and provided we don't exceed the cap, Richard, it's simply a cost reimbursable item and I believe that's factored into our forecast.

And I'll handle the second question. You are correct. When we do look at the consensus estimates by quarter, Q2 is $0.56. If you add the $0.08, it is $0.64, as you noted.

From there, we look at the remainder of the year and we think your consensus numbers are reasonable. Now when we look at the consensus estimates for Q2 revenue, we see it at around $594 million. I think this is a little light, even after adding the $8.6 million of pending change order -- remember, it's not just $8.6 million of operating income; it would be $8.6 million of revenue you would add to that. But I still think that's a little light. However, I do think Q4 consensus estimate of $644 million might be a little bit heavy.

I hope that answers your question on the progression through the year. And I think that finishes the call today. We don't have any additional questions in the queue, so I'll hand it back to the operator.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation.