MAXIMUS, Inc. (NYSE:MMS)
Q1 2016 Earnings Conference Call
February 04, 2016 09:00 AM ET
Lisa Miles - Senior Vice President of Investor Relations
Richard Montoni - Chief Executive Officer
Richard Nadeau - Chief Financial Officer
Bruce Caswell - President
David Styblo - Jefferies
Charles Strauzer - CJS Securities
Thomas Carroll - Stifel
Stephen Lynch - Wells Fargo
Brian Kinstlinger - Maxim Group
Richard Close - Canaccord Genuity
Frank Sparacino - First Analysis
Shane Svenpladsen - Avondale Partners
Allen Klee - Sidoti
Greetings and welcome to the MAXIMUS Fiscal 2016 First Quarter Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [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 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 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 reconciliation of the non-GAAP measures presented in this document, please view 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’re already performing the additional scope of work.
Accordingly, the cause were incurred and recorded in our first quarter and the revenue will be recorded once change order is signed. As a result, approximately $8.6 million of revenue and $0.8 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 states required process which provides up to 90 days of review by the controller’s [ph] office. The pending change order is presently awaiting this final approval.
As you many 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 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 startup 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 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 extend the expansion of existing contracts. On a constant currency basis, growth would have 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 on the U.S. 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 operation 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 market place.
In addition, we also experienced lower appeals and assessment volumes due impart 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 start-up 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 impart 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. 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 pursue selective 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 in opportunistic share buyback program. Above all, we’ve remained 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 back and loaded primarily due to 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’ve 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.
Thanks 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 orders have been finalized in the first quarter, we would have been in line with our expectations for Q1. As expected, several large startups are also tempering earnings at this time.
As the mature, we fully anticipate that there 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 comment this morning with an update on the U.K. Assessment contract. Getting the contract in 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 U.K. 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 out U.K. Assessment contract. The audit only covered effectively five months of operations. As a reminder, when we took over this contract, we acknowledge that it would take 12 to 18 months before we could improve any 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. Recalling that the U.K. Assessment contract is predominantly cost reimbursable was 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 in 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 our recruitment numbers which are brought in a solid stream of well qualified candidates. During the autumn timeframe, we were hiring approximately 100 new healthcare professions each month. We currently have the required staff and 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 in our recruitment efforts are at the appropriate run rates.
In the area of training and graduation rates, it’s fair to ask why that’s so difficult for a new healthcare professional to complete the training. Performing function assessments is a new skill for many healthcare professions especially if they were previously working in a clinical setting or providing direct patient care. The training program is regress and the competency test are challenging.
The amended certain aspects of our training to help increase success. Our smaller training classes are giving new recruits more access to experience staff. This individual line support has yielded solid improvements and retention rates. These changes have made a market difference. And our most recent monthly data shows that graduation rates are near 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 a ramp up, the seasoned healthcare professionals who are 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 half a 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’ve been through about a third of the backlog, so I am 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, the ongoing steady progress we’re making to increase our capacity and boost the number of assessments we complete. We’ve remained cautious and 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’re not achieving one of the quality metrics at the time of the audit in August. To put this in context, we’re 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 cause for assessment under MAXIMUS versus the previous provider. And 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 caused more to perform. And while we made meaningful progress on all fronts, we still have 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 than underpin our fiscal 2016 guidance.
Turning now to our health operations and support of the Affordable Care Act in the U.S., we closed out the third open enrollment period or what we refer to is retreat on January 31st. Unlike the previous two open enrollment periods, only three 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 and this confirms our view that 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. And this includes completing redeterminations, answering tax related questions and managing certain aspects of customer engagement through new digital offerings that assess Medicaid eligible consumer with eligibility and enrollment.
Additionally, we have solid market activity in the adjacent markets. This includes supporting state Medicaid program with the enrollment in credentialing of providers.
Looking ahead, we continue to expect normal course fluctuations year in and year out as states prioritize in 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 a 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 systems program, temporary assistance for needy families and others.
The increased contract length is conformation of our continued performance and we are pleased to close on our fiscal 2015 rebids with this key win.
As a reminder, fiscal 2016 will be a much lighter rebid year. We have ten contracts with a combined total contract value of approximately $170 million up to rebid in fiscal 2016.
Moving on to new awards in the pipeline, we had strong awards in the first quarter with a year-to-date sign contracts at December 31st of $665 million. We also had an additional $285 million in new awarded on the sign contracts.
Our sales pipeline was $2.8 billion at December 31st and lowered sequentially due to work shifting into the awarded category most notably the Texas Eligibility Support Services contract. As a reminder, our reported pipeline only reflect 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 on reported short term pipeline and our longer term outlook for the 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 U.K. Assessment contract. We have a very positive working relationship with our client. And we remain confident that we’ll 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 U.S. confirm 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 were governments are transforming program. Often times, these types of contracts have front end losses. But overtime, they mature into program 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 then, let’s open it up for questions. Operator?
Thank you. We will now be conducting a question-and-answer session. Please limit yourself to one question and one follow-up question. If you’d like to ask additional questions, you may reenter the queue. [Operator Instruction] Our first question comes from the line of David Styblo with Jefferies. Please proceed with your question.
Thanks for the questions. First one would just be on the half contracting 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 trend in the last few months and I think at the public hearing, you had mentioned it was at 75,000 was the volume in that month, I am curious again if there is any sort of maybe seasonality in that or anything unusual, but just the track record there and reconciling that to perhaps what is a - what is a year two goal that the government have set forth from you, I think originally it was 1.2 million assessments but curious if that part had changed at all?
Good morning, Dave. This is Rich Montoni. Thanks for the question. I would parse it to three pieces, help us understand the 75,000 per month and how is it fit with the run rate. Two, is there is any seasonality. And three, some view on year two. Bruce Caswell, our President is with us today and Bruce has been spending an awful lot of time as you might imagine on this house contract. I am going to ask Bruce to feel 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 and that December was a lighted month as you could expect because there is more holidays during that period. So December was lower than the preceding months. November, you see a little bit of that dynamic. But generally speaking, it’s been a gradual March, you know uphill with volumes and we’ve hit a new plateau in the new - actually a new peak that we are continuing to grow from with January.
So - and the dynamics is we’ve explained our really driven by the healthcare professionals now that we’ve had in training that are exiting training had 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 staffs 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’d asked a little bit about contract year two. As you mentioned and is also mentioned in the NAO report, the volume target to 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 professional that have been supporting them moving back into full productivity. So we feel like we are very much on a trajectory to hit the contract year two targets.
Next question please. Dave, you got a follow-up?
I did. Actually just on the Federal business and the Human Service margins are a little bit lower because of the some of the startups in the factors you had call it 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 that might ramp up closer to 10%, but what would get you there and same thing in Human Service, I guess it’s mostly the Australia overhang how do we think about what that profit is in the first quarter versus getting 10% to 15% margin you called out for the second half?
Okay, Dave. I’m going to ask Rick Nadeau, our Chief Financial Officer respond to that question.
Hi Dave. On a historical basis, operating margins in our Federal segment back in the fiscal years ‘13 and ‘14 were abnormally high due to the increased Medicare appeals volumes, which were really highly accretive. And we also experience the lower appeals and assessments volumes impart due to some Medicare appeals contracts that we lost. And so that back in with more normalized margin type of work and I think that you know that we had one contact center that we closed down Boise in Federal and that’s a little bit why it’s been down.
The operating margin for the U.S. Federal business should normalize around 10%. You know as a reminder, if you get cost plus contracts and we do yields 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 house, one of our startup contracts, which is tempering that margin.
And yes, you are right in the Human Services, the things that’s tempering that margin is this Australia startup.
Thanks Dave. Next question please.
Our next question comes from the line of Charles Strauzer with CJS Securities. Please proceed with your question.
Hi, good morning.
Good morning, Charlie.
Hi Rich. 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 is the core business kind of look like from a growth perspective?
Good question, I’m going to ask Rick Nadeau address that one and Rick maybe just address from this most report quarter of Q1.
Yeah, 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 talk about, our targeted range of 10% to 15%, which does indicates that the base business is performing as we expected. You know as a reminder, you know as we startup some material, we do expect them to become meaningful contributors to our long term shareholder values. But in the early parts of the contracts they due to press 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 you know as the year progresses, you know what would kind of have to happen from year-over-year to kind of cause of raising the lower end of that guidance? Thanks.
Yeah, 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 ours is a big chunk of that, a biggest of the startup. So as we continue to see progress toward that, you know we have made meaningful progress, but you know we still have 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.
Our next question comes from the line of Tom Carroll with Stifel. Please proceed with your question.
Hey guys, good morning. Actually just a quick follow-up on the U.K. HAAS contract again, your slide five in your presentation trying to think between the lines there are a bit more in the comments and the bullets that you made about you know 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. I’m going to ask Rick Nadeau address that one.
Okay, contract year one ends on February 29th. You can claw back within a year within a contract year but once we get to February 29th, we start the clock over again. So we do get an assessed volume penalties on a month to month basis but the ultimate target is for the whole year and we could make up short falls that we had for example in March or April later in that year.
But if you haven’t shown improvement by Feb 29, you lose it in the contract year, so is that - might get that rate?
Yes, we couldn’t claw back anything after February 29th in that first contract year. As a reminder, so we get 7/12s of a contract year in one fiscal year and 5/12s in the next. So you know it’s - we straddle years unfortunately against our fiscal year.
Yeah, and then secondly just quickly, you said Acentia is essentially fully integrated, I guess what are the best practices, opportunities within that organization that perhaps who better support legacy federal business at MAXIMUS perhaps improving margins? I guess that’s the cruxes question.
Tom, good question I think. So when we say Acentia is essentially full integrate. I think the one area that and this is normal course with an integration is really what we call revenue synergy, so what can we do to more forward and drive the revenue synergies that we felt were on the table with stenches. The other aspects which are ranged from blocking and tackling backroom functions I think are essentially complete. Either we make 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 where this business development aspects, customer relationships, customer needs, compelling customer drivers and assessing what we think is out there in short term and longer term for new business development and advancing solutions to differentiate the new MAXIMUS federal. And it just take some time to drive what we think will be the ultimate price here and that’s PPO opportunities within contract vehicles that came along with Acentia.
Thanks, Tom. Next question please.
Our next question comes from the line of Stephen Lynch with Wells Fargo. Please proceed with your question.
Hey, guys, thanks for taking the questions. My first one is related to your comments about the U.K. Health Assessment contracts running below volume target still. Can you just talk about maybe where those volume targets are in relations to the range it’s filled in the 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?
Yeah, I believe our guidance was pretty wide with respect to us. 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 is loss on the lower end.
Yeah, I said - okay, have loss, I said income, I missed, $7 million 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 volume. So as you creep toward the upper end of that guidance, yes you are implying that you are hitting your volume targets.
Okay, gotcha. Follow-up question, you mentioned the exchange rate trends since November represent an incremental headwind somewhere the neighborhood of $28 million for revenue, is there any sense you can give us for what the EPS impact, if there is 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 a new account that you have a meaningfully different tax rate that tends to buffer the EPS impact with the negative FX effects on the revenue side. So like we would tell, it’s not material from an EPS perspective.
Thank you, Stephen. Next question please.
Our next question comes from the line of Brian Kinstlinger with Maxim Group. Please proceed with your question.
Great, thanks. I wanted to follow-up with that volume question as it relates to guidance. You’d mentioned yesterday that you expected about 900,000 cases could be achieved for the fiscal year, I am curious if that volume is a midpoint of low point or high point of the wide range that you are predicting for your guidance and operating income?
As you look toward the upper end of that guidance range, you would be seeing us hit the second year volumes toward that 1.2 million range. So remember that the fiscal year ‘16 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 ‘16 we know what they are. I think your question and is better answered by, as you get closer to the 1.2 million volume target for a year, contract year two, you will see us go toward the upper end of that guidance range. Does that answer your question?
Yes, it does, much better. Thank you. And then I guess I am 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 are still in the uptick on the P&L, so we are continuing with the startup losses and that should turn profitable during fiscal year ‘16 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, you know you are going to see a cost plus margin down around 7% on generally speaking. And so the more cost plus, the federal IT contract 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.
Our next question comes from the line of Richard Close with Canaccord Genuity. Please proceed with your question.
Great, first question is as it relates to the U.K. 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, is that come over the course of year two or at the end of the year just a little bit of clarity there?
Yeah. This is Rick. When - we actually get assessed any penalties or any awards or any incentives on a month to month basis but there are true up. So we do recognize it overtime if that’s your question on the revenue recognition. It’s not - it is not tend to be back loaded. If we did have something like that we would smooth it in but that’s not the way the contract works, you see it overtime.
Okay. And my second question maybe more for Bruce. There is an interesting article on Medicaid in the Wall Street Journal a couple of days ago talked about you know potential incentives to get the states that have not expanded. Can you talk a little bit about what you are seeing on the Medicaid side, what your - expecting any change over the course of the coming year?
Sure, I’d be happy to, Richard. So I think you are 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 endower. 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, yeah, I won’t comment or speculate on the likelihood of getting that through the legislative process, the regulatory process, but certainly Medicaid expansion itself remains a very dynamic environment with you know a larger number of states still contemplating it, some due to changes in administration for example on the Louisiana, where Governor Jindal turned out and we have a new Governor moving ahead with expansion. So we’ve said many times that it’s a kind of thing that will I think we see - we think we will see gradual adoption overtime as more states see the business case to it and the benefit from an economic development perspective in their healthcare industry.
So we’ll continue to watch it and I guess you could say that if a change in regulation that provides that guarantee three year funding is made possible that could create and add it incentive for states to take that on. We also have spoken previously about how in 2017 there are some new tools available for the states through the Section 1332 Waivers that give them the ability to make some fairly substantial changes to their programs that could incorporate the Medicaid expansion component as well as kind of re-crafting the exchanges on a state based level. So more to come there, I think those become options to them if there is other option does not, so we’ll continue to watch it.
Next question please.
[Operator Instructions] Our next question comes from the line Frank Sparacino with First Analysis. Please proceed with your question.
Hi guys. On the U.K. with recruiting and training seemingly in an order now, you know what’s the greatest risk going forward with the contract?
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 three tougher aspects here. I would answer the question by saying now we focus in China light on productivity and quality and getting those two aspects where we would like them to be. And I think in the call notes, we’ve talked extensively about the initiatives that we have in place to continue to improve. We have meaningful improvement here to date in the productivity side, we still think there are 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 on?
I think you are absolutely right Rich and we I think noted that it does take up to six to eight months for the new the graduated staff to really become fully productive and so now that we are seeing more and more the stuff come through graduation at a higher rate. We’ll continue to tract for those entire levels of productivity and as we said that’s consistent with our view that by the end of the summer we’ll be able to completely raise the backlog. We did mention yesterday that the backlog is now down to a 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.
Our next question comes from the line of Peter Heckmann with Avondale Partners. Please proceed with your question.
Good morning. This is Shane Svenpladsen for Pete. Regarding the U.K. work program, recent government review suggested this program could be combined with the work choice program when the work program as we tendered this year, does that still appear to be the case, would you expect any material changes to those contracts if they were to be combined?
Okay. Shane, we are going to 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 assessment review in the United Kingdom. Yeah, let me just begin by setting a bit of a backdrop, the U.K. 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 of visibility. It’s interesting to note that when the work program was initially implemented, its focus was at the time on the long term unemployed and that group has decreased by about 75% since 2011. So the government is now creating this smaller, more focused program on individuals with visibilities called the work and health program and it is expected to absorb the work program and the work choice program and be focused on individuals with those specific health condition and visibilities. So first of all, it’s clearly helping individuals and visibilities into employment is a very much a core competency of our Remploy, subsidiary in the United Kingdom and we are very well positioned to accommodate and take advantage of that change in government focus and approach.
The new tenders not out yet, so we really don’t have a full sense and - of the size of the contract, there are early indications as you’ve noticed that the contract should be expected to be smaller and we’ll expect to have a clear view in terms of the timing and the size of that opportunity probably in the spring time. So I’d probably just summarize by saying when we look at the work that we perform without MAXIMUS and Remploy in the work program and work choice, it’s also important to note that our profitability expectations for the combined programs in fiscal ‘16 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 top line movement for us and relatively a material for the bottom line. Does that help?
Yeah, thanks. Okay back in the queue.
Thanks, Shane. Next question please.
Our next question comes from the line of Allen Klee with Sidoti. Please proceed with your question.
Yes, hi. If we look at three of the startup contracts, Australia and jobactive U.S. and U.K. fit for work, is there a way we can quantify what the - how that can move in terms of incremental EPS for ‘16 and ‘17?
I think that what - this is Rick. I think what you’ll see, you know 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, now four of them will be improving toward that goal. Does that answer your question?
Okay, thank you. And then with Medicare appeals volumes has been lower, is there any sense of if that’s going to continue to trend even lower or stabilized?
Yeah, 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 stead state in terms of the volumes with Medicare appeals program.
Thanks, Allen. Next question please. Operator, next question please.
I am sorry. [Operator Instructions] Our next question comes from the line of Charles Strauzer with CJS Securities. Please proceed with your question.
Hey, just a quick follow-up. If you look at the significant sales opportunity pipeline like 2.8 billion and versus the very light year or rebids coming up, it seems like is a fair amount of new opportunities there. If you could help kind of give a little more granularity or color into the pipeline and so you know international versus domestic. And then maybe a sense of you know which kind of you know which are the three segments they kind of fall into, maybe kind of give a percentage of you know reference of that. Thanks.
Okay, Charlie. Well, 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 expect. And the important aspect is that a good portion roughly have 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 is 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.
Our final question comes from the line of Richard Close with Canaccord Genuity. Please proceed with your question.
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 with the dynamics on having to pay higher salaries in the U.K. on that contract?
And then my second question would be on the quarterly progression of earnings, we 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 could talk us about - talk about the progression as we go throughout the remainder of this year?
Good. Let’s do this. I am going to - the second question will keep second and we’ll ask Rick to talk about quarterly progression and earnings and Rick if you want, you can talk about revenue as well. But before we jump into that let me take a high level stand. 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 1st, 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 that 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 and the contract. The nature of this contract is to a lot of extend 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 know you are correct, when you 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, you’d 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 might be a little bit heavy.
I hope that answers your question on the progression to the year. And I think that finishes the call today and we don’t have any additional question on 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.
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