Lisa Miles - SVP, IR & Corporate Communications Richard Nadeau - CFO and Treasurer Richard Montoni - CEO and Director Bruce Caswell - President and General Manager, Global Health Services David Walker - Former Strategic Advisor

Richard Close - Canaccord Genuity Limited Charles Strauzer - CJS Securities David Styblo - Jefferies LLC Matthew Gillmor - Robert W. Baird & Co. James Stockton - Wells Fargo Securities Brian Kinstlinger - Maxim Group Frank Sparacino - First Analysis Securities Corporation Rohan Abrol - KeyBanc Capital Markets

Greetings, and welcome to the MAXIMUS Fiscal 2018 First Quarter Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Lisa Miles, Senior Vice President of Investor Relations for MAXIMUS. Thank you, Ms. Miles. You may begin.

Good morning, and thanks for joining us. With me today is Rich Montoni, Chief Executive Officer; Bruce Caswell, President; and Rick Nadeau, Chief Financial Officer. 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 a 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 non-GAAP measures presented in these documents, please see the company's most recent earnings press release. With that, I'll hand the call over to Rick.

Thanks, Lisa. This morning MAXIMUS reported solid first quarter results. As noted in the press release, the passage of the Tax Cuts and Jobs Act in the United States on December 22 created significant benefits for MAXIMUS. As a profitable high-cash conversion business, with the majority of our earnings in the United States, we have historically had a high income tax rate. The reduction of the corporate income tax rate will increase MAXIMUS earnings, including the benefit recognized in our first fiscal quarter. Starting with revenue, total company revenue for the first quarter of fiscal 2018 increased 3% over the same period last year. This was driven by the Health Services and Human Services segment, which offset expected declines in the U.S. Federal Services segment. Part of the increase was due to the strengthening of the British pound and other favorable foreign exchange movements in the quarter. Total company operating margin improved 70 basis points to 12.8%, compared to the same period last year. Overall, the Tax Cuts and Jobs Act will have a long-term favorable impact to our earnings and cash flow. Slide #4 in our accompanying PowerPoint presentation illustrates how tax reform benefited the first quarter of fiscal 2018 and impacts for the full year. The lower U.S. federal blended rate of 24.5% was the primary driver of reducing our effective tax rate to 24.9% for the first quarter of 2018 and GAAP diluted earnings per share of $0.89. For the full fiscal year 2018, we expect our effective tax rate to be between 26% and 28%. Let me crosswalk GAAP diluted earnings per share to what earnings would have been without tax reform. Reducing the U.S. federal income tax rate from 35% to 24.5% in the quarter reduced our income tax provision by $6.4 million, before taking into account the nonrecurring items including the reduction of our net deferred tax liabilities and the toll tax. Because of tax reform, we recorded a $10.6 million reduction to our income tax provision for a remeasurement of our deferred tax assets and liabilities due to the impact of lower U.S. federal tax rates on the reversal of differences between financial reporting and tax accounting. We also analyzed and recorded a $9.5 million increase to our income tax provision for the taxation of foreign retained earnings. This is also known as the toll tax, as the U.S. transitions to a territorial tax system. Excluding the impacts from U.S. tax reform, diluted earnings per share would have been $0.78 for the first quarter of fiscal 2018. Lastly, it is important to recognize that the law also creates some negative impacts related to the deductibility of executive compensation and certain business expenses that will not impact us until fiscal 2019. Now I will speak to segment results starting with Health Services. First quarter revenue for the Health Services segment increased 3% compared to the same period last year, driven by organic growth and favorable currency exchange rates. The segment includes a sizable portfolio of contracts at varying stages of contract maturity which helped contribute to the strong operating margin of 16.4% in the first quarter of fiscal 2018. We do want to point out that year-over-year, the U.K. Health Assessment Advisory services, or HAAS, contract also contributed to segment margin expansion. HAAS experienced improved efficiency complemented by good service delivery. This resulted in a lower level of penalties and better margins for this contract in the first quarter of fiscal 2018 when compared to the same period last year. As a reminder, HAAS is a cost-reimbursable contract with incentives and penalties tied to maintaining key service-level targets. I will now address the U.S. Federal Services Segment. As expected, first quarter revenue for the U.S. Federal Services segment decreased 6% compared to the same period last year. As previously disclosed, this was principally due to some contracts that ended, including a subcontract for the Department of Veterans Affairs that ended in April of last year. On the bottom line, the U.S. Federal Services segment continue to execute well and delivered an operating margin of 12.6%, which is largely in line with the prior year. As I mentioned last quarter, our U.S. Federal Services segment was awarded temporary work as a subcontractor in support of disaster relief efforts in the wake of last year's hurricanes. We forecasted this temporary work based on the facts and circumstances at that time. In late November, the agency notified the prime contractor that these support efforts should be reduced immediately. As a result, revenue from this work will be less than our initial forecasts. This, coupled with the recent loss of a rebid, has changed our revenue outlook for the U.S. Federal Services segment for the full year. We expect that revenue from the U.S. Federal Services segment will run closer to $500 million for fiscal 2018. We have successfully secured spots on some additional contract vehicles, which will help us in the long run. While we are disappointed with some of the recent setbacks, we are committed to amplifying our business development efforts and have taken steps to make investments and secure fresh resources for these initiatives. For the Human Services segment, first quarter revenue increased 10% over the prior year. This was driven by our Australian operations and, to a lesser extent, favorable foreign exchange rate. Both of these more than offset expected revenue declines from the wind-down of the U.K. Work Programme. As expected, operating margin in the Human Services segment was lower at 5.8% and unfavorably impacted by start-up losses on some new contracts as well as higher pass-through revenue in Australia. Moving on to the balance sheet and cash flow items. In the first quarter, MAXIMUS delivered cash flow from operations of $37.9 million and free cash flow of $31.4 million. Days sales outstanding were 69 days at December 31, which is in line with our expectations and consistent with the prior year. At December 31, 2017, we had cash and cash equivalents of $196.9 million. In terms of capital allocation, we are committed to sensibly uses of cash and a disciplined approach to cash deployment. The new U.S. tax reform law also improves our cash flows and increases the returns from our U.S. businesses. Irrespective of the new law, we were already committed to investing more in new digital and innovative technologies. This includes the related operating expenses of people and processes that will be required to enhance returns from these investments. The U.S. tax reform law will make these types of investment decisions more compelling and encourage us to invest more quickly in order to take advantage of enhanced economic returns. I will wrap up my comments with guidance. For fiscal 2018, we are maintaining our revenue guidance of $2.475 billion to $2.55 billion, with a bias towards the lower half of the range. This is due to our lowered outlook from the U.S. Federal Services segment. As a reminder, we had previously expected revenue from the U.S. Federal segment to be stronger in the first half of fiscal 2018. We now expect the second quarter segment revenue to be lower compared to the first quarter of fiscal 2018 and expect that revenue from the first half and the second half will be about the same for the U.S. Federal segment. It is important to remember that we operate a portfolio of contracts, and there are other puts-and-takes in the model that allow us to maintain our total company revenue guidance range at this time. As I mentioned earlier, with the benefits from tax reform, we now estimate our effective income tax rate for fiscal 2018 to be in the range of 26% to 28%. As a result, we're increasing our fiscal 2018 diluted earnings per share guidance by $0.35 to $3.30 to $3.50. While it is still early, we think it is useful to provide some tax rate insight for fiscal 2019. We currently estimate, our effective income tax rate for 2019 should be in the range of 26% to 28%. While the U.S. federal rate is going down to 21% in 2019, some of the decrease will be negated by the unfavorable impacts related to the deductibility of executive compensation and certain business expenses. In addition to increasing our bottom line guidance for fiscal 2018, we are also increasing our cash flow and free cash flow guidance by $25 million. We now expect cash flow from operations for fiscal 2018 to be in the range of $225 million to $275 million, and free cash flow to range between $195 million and $245 million for fiscal 2018. Thank you for your continued interest. I will now turn the call over to Rich.

Thanks, Rick, and good morning, everyone. We are pleased to open the year with another solid quarter. And as a result of tax reform in the U.S., we raised our earnings guidance for fiscal 2018. Let me start off today with the upcoming CEO transition. As we announced last month, I will be handing over the baton on April 1, 2018. I am delighted that Bruce will succeed me as CEO, as we work together to ensure a smooth transition. The time is right for me to move to a new role, and I am confident that Bruce is the right person to succeed me as CEO and guide MAXIMUS in the future. So let me turn the call over to Bruce to talk about some of the initiatives we have underway.

Thank you, Rich. On behalf of the management team, we offer you our most sincere appreciation for your leadership over the last decade. Many accomplishments were achieved during your tenure as CEO, including helping governments implement major reform efforts, expanding into new geographies, divesting noncore businesses, implementing the structures and processes to better manage enterprise risk and incorporating acquired solutions and skill sets. Your vision helped transform MAXIMUS into a highly focused pre-eminent partner to governments around the globe. It's an honor to lead the team, as we keep this remarkable momentum moving forward and continue to drive shareholder value. While I look forward to sharing more about my initial priorities and agenda on our next earnings call in May, this morning, I wanted to provide some color on 2 key areas that we've been working on over the past 2 years that are core to our future. These are digital transformation and clinical evolution. From the big-picture perspective, we recognize that we operate in a changing and competitive world. Our clients rightly expect continual evolution and innovation, and we are constantly seeking ways to create more efficiencies and improved service delivery. So today, let me briefly touch upon how MAXIMUS is already transforming to meet the demands of our clients. The is first digital transformation. This is a cultural shift, as we think about digital disruption within the government services market and new models for engagement and efficiencies. We are implementing a roadmap across all of our markets looking at the pace of digital adoption and the impact of various digital enablers. While governments have traditionally been slower to adopt digital technology solutions than other industries, we are seeing their appetites increase. Our clients are at various stages of digital maturity, and we are leading and shaping the market. We are helping our clients to find and operationalize where digital technologies and innovation can have a meaningful impact in their programs. We have positive momentum with market-leading applications, performance analytics and technology. While digital consumer engagement has been an early priority area for government, our digital solutions go beyond this. Advanced analytics play an increasing role in modeling our solutions and optimizing the outcomes we deliver. Digital automation, such as next-generation interactive voice recognition and process automation, allows us to continue to drive efficiencies and improve the quality of our operations. These efforts enhance our competitive position and improve our overall service delivery across our operations particularly when delivered through our shared services centers, which we've been building over the last two years. With the benefit of U.S. tax reform, we fully intend to invest more capital and resources in implementing our digital strategy going forward. Some of these investments will bring our capacity for innovation and delivery to the next level. For our current clients, we continue to seek opportunities to introduce digital technologies to streamline and improve the programs we operate, so we achieve the outcomes that matter most to them. Beyond protecting our base through practical innovation, this transformation allows us to also pursue and develop digital offerings that will provide new revenue streams and help drive long-term growth. The second area that's of particular interest and priority is, what I referred to as, our ongoing clinical evolution. While operating customer contact centers and providing case management services will remain a foundational element of our business, we see macro trends that drive demand for BPO services with more of a clinical dimension. Healthcare costs continue to rise. People are living longer, and more people are struggling with chronic conditions, diseases and comorbidities. At the same time, there are a wide range of health conditions that are preventable through healthier lifestyles. Further, when we look closely at the social determinants of health outcomes, opportunities emerge, where MAXIMUS can help our clients address these challenges with solutions that are strengthened with our growing clinical expertise. In the past five years, we accelerated our clinical evolution through a focused strategy on programs related to assessments and appeals as well as through acquisitions, such as Health Management and Revitalised in the United Kingdom and Ascend in the United States. This allowed us to further develop our portfolio by adding occupational health and digital well-being, disability assessment services and assessments related to long-term services and supports. As our assessments and appeals business has expanded, we've seen a shift in our workforce. Our teams of healthcare professionals tend to bring a higher skill set and longer tenure. This knowledge and stability strengthen our competitive position and create a stickier service offering for our clients. So from my perspective, these are two areas that excite us today and are the priorities of tomorrow. It's important to note that digital transformation and clinical evolution are not mutually exclusive. We see opportunities that will require expertise in both. For example, telehealth is an area where MAXIMUS could further infuse digital technologies into our core clinical assessment and occupational health offerings. Our digital engagement strategies help governments and employers improve health and wellness and extend healthy independent living for their populations. This is just 1 example of how we can use health-related technologies backed by clinical expertise to help our clients address the rising costs of healthcare. Looking ahead to the future, we envision that digital transformation and clinical evolution will play a key role in our previously articulated three-point growth strategy, which remains at the heart of long-term growth, first, we want to continue growing in our current core markets; second, we want to move into adjacent markets and geographies; and finally, we want to continue to incorporate new platforms for growth. As with any guiding strategy, it will naturally evolve, so that we can meet the needs of our clients and capitalize on emerging opportunities in dynamic global markets. I look forward to providing more about my long-term vision as part of future earnings calls. Before I turn it back over to Rich, let me give you a brief update on some of our operations. We just wrapped up the most recent open enrollment season under the Affordable Care Act. As you may recall, it launched with a bit of a bang with higher call volumes likely due to consumer confusion over the status of the program. However, as open enrollment progressed, it was business as usual. Moving on to our U.S. Federal operations, there is no doubt that we've gained credibility and respect as a trusted contractor within certain agencies, but we recognize that there's more work to be done. Many of you already know that the federal government procures a significant amount of work through precompeted contract vehicles as opposed to full and open competition. The government issues task orders under each vehicle, and only those vendors who hold the position on the vehicle may bid as a prime. So it's important to be on the right vehicles. As Rick mentioned, we recently secured positions on two new federal government acquisition vehicles. The first is the GSA IT 70, which is the largest and most widely used vehicle by the U.S. Federal Government. And the second is Alliant/2, an important next-generation governmentwide vehicle. Given the challenges and the tough U.S. Federal environment, including the ongoing pause, we're making some important changes, as we continue to position MAXIMUS as a more meaningful player. We've had some disappointments with some contracts that have come to an end. We recognize the need to amplify the U.S. Federal Services segment's sales and business development efforts. And we're dedicating additional resources to follow and shape longer-term opportunities driven by emerging customer priorities. We firmly continue to believe that there remains opportunities to drive our core capabilities further into the federal market. And with that, I'll turn the call back over to Rich.

Thank you, Bruce. Let's move on to new awards and pipeline. During the first quarter of fiscal 2018, we signed $1.2 billion of awards, and we're notified of award on another $236 million worth of contracts. This brings the total year-to-date awards to approximately $1.4 billion. Overall, a solid quarter and a good start for fiscal 2018. Our pipeline at December 31 increased to $3.2 billion, of which approximately 55% is tied to new work and reflects opportunities across all 3 segments in all of our major geographies. In closing, I offer my appreciation to the MAXIMUS management team and our employees. It is with great pride that I look back at what we've accomplished together. It has been pleasure to work with such a talented group. And with that, we'll now move on to Q&A. Operator?

[Operator Instructions]. And the first question comes from the line of Richard Close with Canaccord Genuity.

First of all, Rich, it's been a pleasure working with you over these years and congratulations. Going forward, wish you the best of luck.

Thank you very much, Richard. I do appreciate those kind words.

I was wondering, Rich, if you could talk a little bit about the digital transformation and clinical evolution. It was a good introduction there. And I'm wondering, on digital transformation, how you think about revenue growth versus, maybe, margin improvement for you. And then on clinical evolution, in the BPO there, when you would think we could see revenue generation from that effort?

Sure. I'd be happy to Richard, and thank you for the question. I'd frame this by saying, like I said in the prepared remarks, this is an area that we've been working on for several years. We've referred to the digital transmission as MAXIMUS digital services, and it had, kind of, both of the components that you've mentioned. On the one hand, our primary emphasis from digital has been to meet and address and, in fact, to be in front of customer needs as it relates to largely consumer engagement. So we've spent a lot of time refining a and building capabilities for the websites that we developed and the mobile applications and so forth that power of our programs. But it's also fair to say that to some degree in the marketplace, those over time have become table stakes, and you need to be able to do more. So we've really focused our digital strategy primarily, in the near-term, on operational efficiency and operational improvement. So that would speak more to your category of margin enhancement, and I would say the ability to ensure that we deliver on the first prong of the 3-pronged growth strategy that we outlined, which is ensuring that we're protecting our base and growing from our base. So some of the examples of things without giving too much away that we've been focused on include, using advanced analytics in the way that we develop our solutions, using advanced analytics in the way that we manage our workforce to address areas like attrition, since labor is our largest cost, ensuring that as we look at our processes, we take advantage of opportunities to automate processes, so this will give a little bit of flavor over where we've focused from that dimension. I think over time, clearly, the intent is to ensure that digital solutions can help us address the second and even third prongs of the growth strategy, so our ability to move into adjacent markets and even new growth platforms. And without, again, giving away too many of the cards here, I would say that the example that we talked about, about telehealth being something that brings together both digital transformation and clinical evolution is exactly that. It's something where you can extend your capabilities, not just to provide assessments or monitoring capabilities or enhancements to well-being or occupational health offerings, but it's something where you can expand into other markets that historically have been -- not been addressable. So that's -- I would say that becomes the second priority, but something that we evolved to by building the digital capabilities or building those enablers over time. The clinical evolution piece you had asked, at what point do you see that becoming revenue-generating. The reality is, assessments and appeals are not something that's new to us. And we've been at it for some time, and in fact, we can attribute about $475 million of our revenue in the last fiscal year to the assessments and appeals business. So my perspective is that there's more white space out there. The market dynamics are such that the demand for independent medical reviews and evaluations and peer review and quality monitoring as some examples portend well for a nice robust clinical capability and the growth of our assessments business, so I would expect that, from a revenue-generation perspective, we will continue to have that be the focal point of the clinical evolution. And furthermore, obviously, seek to grow off of that base that I mentioned, just a moment ago.

My follow-up question would be for, Rick. If you can just update us on the startup expenses? What that was in the first quarter? How that's tracking? I think you said $0.12 when you initially gave guidance for the year. And just give us an update there, so we know where we are in that process of startup expenses?

Yes, Richard. Yes, we had some this quarter. And yes, I think the number we gave you last time is still like a good number. I think there'll be a biased towards Q4 on that. And then Q3 will be bigger than Q2, so I think it's going to be more back-loaded, but yes, we've been incurring them throughout the year.

Our next question comes from the line of Charlie Strauzer with CJS Securities.

Rich, I wanted to echo the same thoughts. It has been pleasure working with you over the many years we've been working together and wish you the best, and on that notes, just wanted to, kind of, get a sense of what your next role might entail and, kind of, expand more on what your plans are?

So, Charlie, I'm glad to talk about that. And I do appreciate the commentary. It's been mutual. You've enjoyed it, I have enjoyed it. So thank you very much for the kind words. In terms of my ongoing role with MAXIMUS in addition to remaining on the Board of Directors, assuming that's affirmative with the vote coming up in March, will be really providing support and advice to Bruce and the King under the title of a Special Advisor to the CEO. I would say that this CEO transition process has been one that's been a very much forefront of the Board of Directors' focus. They take the responsibility as it relates to succession planning very, very seriously, and I think we worked really hard to come up with an optimal transition plan. And part of that is my ongoing role as an Advisor and Director. And the primary goal here really is to provide a seamless transition of Bruce into the CEO role. In that capacity -- in the capacity of an advisor, I will focus obviously on providing support and advice to Bruce as is necessary. In addition, I think a natural area for me to provide assistance would be in the M&A area. As you know, we have a very active M&A program. It's an integral part of our growth strategy. And I think this is an obvious area where I can continue to provide value to Bruce and his team, particularly in the early stages of M&A that, sort of, include identifying and cultivating some potential target opportunities. And I think this could help Bruce and Rick as CFO perhaps accelerate the pace around strategic M&A. The last area where I expect I will continue to provide value would be in relationship to my involvement with trade associations. Most notably, as you may know, I am Chairman of the Northern Virginia Technology Council. That's an organization that happens to be -- it's the largest technology council in the nation. It serves about 1,000 members, and these includes folks from all sectors of the technology industry, service providers, universities, foreign embassies, nonprofit organizations and government agencies. So I think it's a good relationship and connectivity for MAXIMUS that I'll work to help make whatever connections are helpful to MAXIMUS in that context. Hope that helps, Charlie.

Definitely. And just a quick follow-up, if I could, just switching to the backlog in pipeline. You had a fair amount of signings in the quarter. Usually when you see that, the pipeline numbers typically drops, but it actually grew up by about $800 million. Can you give us a little bit more flavor as to do you think, maybe, the pause is starting to lift a little bit there?

Now that's really a good question. And when I think about pipeline and then what it all means, I think you need to consider not only as a static measure of the level of pipeline but other dynamics that interface very much with pipeline. And ultimately, we all look at these -- this data in terms of what's it mean to growth and future growth and potential. And when I think about pipeline and the related variables to pipeline, I have the following thoughts as. One, I'm really pleased that the team has been able to not only deliver, what I think is, a very respectable amount of recurring work, so I think our win rates in that regard are in line with the industry norms. And yes, we have occasional losses that we'd otherwise liked to have won. That's always going to be the case, but net-net, I think we are doing well on the win rate category with rebid work and with new work. So I don't think it's a win rate issue. I think the team has been doing a good job to replace work that we converted out of the pipeline into recurring work or new work. So I'm pleased with the ability to refill the pipeline. I think the real challenge has been, particularly as it relates to new work in the pipeline, converting that pipeline into real new work or what you might call the adjudication rate, I think, converting, I think, conversion rate. And I think that's really been the challenge. I think the underlying root causes to that are multiple. I think one, it's clearly the new administration and the U.S. Federal side of things, the U.S. administration and there's some trickle-down impact to the states in that regard. Secondly, I think we're seeing more protest in our industry which is really prolongating what, we think, are some really good new win opportunities, and it's prolonging the time it takes to convert those to real wins, into real work. And also I just think longer procurement cycles especially in the federal space is really impacting this adjudication rate. The other factor to consider is the attrition rate, and that's existing work with -- the work we did this year, what's the likelihood that it's going to repeat next year and that you always have to replace that work that attrits. You're always going to have 5% to 10% runoff. It's a normal in the industry. And it's been higher in the last couple of years, and we'd like to see it stay within the industry norm, but we've had some isolated losses that we'd like to not have lost in the normal course, and I think that's a factor in all of this as well. And as you know, we constantly work day in and day out to minimize that attrition rate and to work on that adjudication rate. Those are my thoughts on pipeline dynamics, Charlie.

Our next question comes from Dave Styblo of Jefferies.

And of course, Rich, I'd echo that too, really enjoyed the time we spent together.

Thank you, David.

You bet. Couple of questions, the first one, if you guys could give me a -- help us better understand the bridge to guidance for the increase of $0.35. It looks like $0.11 of that might be upside that wasn't contemplated in guidance before from tax reform, so that leaves you with $0.24 for the last 9 months of the year that are actually in calendar year '18 that I guess -- I would assume would have the actual U.S. tax reform benefit. That seems a little bit low to me, given your business mix and what I would have thought. I want to understand if, number one, are you guys -- is the gross-up is actually higher than that, and you're making accelerated or more investments, so that -- which you just talked about, Bruce in those couple of segments? And so that's offsetting some of the upside or just some mechanics around there, where, perhaps, you are just not benefiting as much as I would've thought you would have from tax reform in the calendar '18 part?

Yes, got it, David. A good question and unfortunately, we're going to have to pull you down in the murky area of the tax math. And we're going to leave it up to Rick Nadeau to clarify that one that -- and he can also talk about the fact that we do in fact have planned investments to actually move forward the initiatives that Bruce Caswell spoke of, Rick?

Yes, thanks, Dave. I think, the first thing you got to remember on the tax reform is that about 20% of our income comes from international operations, so they don't benefit from the U.S. tax reform. The other thing and -- is that this blend -- the tax reform act created a 21% tax rate starting on January 1, but it's a blended rate for the full year. So what the IRS has done, it's published a 24.5% federal income tax rate for companies that are fiscal year September 30 year-ends. I think, also, one that is going to cost you may be a percentage point or so is that the state tax deduction that you get for federal purposes is smaller when the tax rate in the federal government is lower. And so I think if you put them altogether, I really think we got a number that made sense to us. The way I do the math, and I can do it either on the quarter or for the full year, but let me do it on the quarter. I think if you look at it, we have 79.8% -- $79.8 million of pretax income, you should get about 13% pick-up on that. That's your 35% tax rate for federal minus your 21% for the tax reform act and then the one -- take off 1 percentage point for state. And then you figure, you only got the benefit for 3 quarters of the year, because the tax reform act kicked in on January 1. And then you take off, let's say, 18% to 20% for international. And I think that's how you get the $6.4 million, that's on Slide 4. Does that help?

I think so. And so it sounds like you are not making incremental investments as part -- the guidance does not contemplate incremental investments compared to what you guys were previously thinking. Is that fair?

Well, I think that we will. But I said in my script, I think, we all firmly believe we had investments built-in. The tax reform act helps you get to a better mathematics. You're going to get better return on the investments that you have, because U.S. Federal Government's participation in your earnings are less but you also have paybacks in there and you also have timing. So I mean, I think, it's complicated calculus, but I think we're pretty comfortable with the guidance that we gave you and staying where we were after adjusting for the tax impact.

Okay. And then you guys did a good job here of explaining a little bit more of the causes and root causes of the pause. I guess I sensed you are all just as a little bit disappointed, especially on the U.S. Federal side. And certainly these efforts around digital and clinical are efforts to, I guess, help that segment as perhaps some of the other ones too. But I'm curious how do you measure investments that you're putting into that business against an ROI which you may have been able to track in the past for, perhaps, investments that you've done to build-out of these 2 categories? Because certainly, you've -- you made some progress on them before, but I'm just curious how you think about the investments that you put forth here versus the return that you can get in the subsequent quarters or years?

I'm going to comment on Ascend, and Bruce, I think you can chime in. But when we look at investments, and in investments here, there is a broad range of investments. It could range from a pure acquisition, and I think in the past, I'll be glad to do it repeated, but we have what, I think, are very strong criteria in terms of many, many attributes. But strong criteria when we consider an acquisition. As it relates to internal-type investments, and the form of these investments, they can be partnerships, they can be licenses with firms, they could be training, they could be new hires and all of the above. And frankly, it is all of the above as it relates to the clinical and the MAXIMUS digital services initiatives that Bruce -- which Bruce spoke. And I think the biggest -- the criteria that we focus on, we would have client-by-client analysis where we will look at, basically, what does it mean to -- what's the marginal impact to this contract, revenue or contract cost. And hence, if we can meaningfully move the revenue line or the operating income line and, as Bruce spoke of earlier, most of our initiatives are more focused on the cost to operate line. So we would look for something that meaningfully impacts our ability to deliver better or same services at a lower cost. I don't think we have any rock solid. It's going to move at 1%, 2%, 5%, but I will tell you, 5% reduction in cost is a very compelling number, which gets our attention, and we do have some that promise even greater cost efficiencies. So that would be my reaction. Bruce, anything you like to add?

I agree, completely. Just picking up where you left off. Most of the -- kind of, call it internally-facing transformational investments for digital technologies, you would expect to see an ROI from them. In most -- well, the one that I'm thinking of in particular related to process automation would be within 90 to 120 days of implementing the investment. And it could deliver cost improvements on particular project where it's implemented in the range of 5% or north, as Richard mentioned. So that's a fair metric for those type of investment. I'd also give it back to your comment and federal. And just note, as we commented on -- earlier on the call that the win on the IT 70 contract and also the Alliant/2 contractor are quite substantial. And they were made possible by the prior investments, in particular, the combination with Acentia. Had we not combined with Acentia and had all of the presence in the many agencies, the calls and the vehicles, we wouldn't have been able to qualify for Alliant/2. And Alliant/2 is quite -- it's a big contract. It's a -- 61 firms have been awarded positions, but it's unrestricted, and it has a $50 billion funding ceiling. It's 5-year base plus a 5-year option. So it will be a contract of choice for many federal agencies on a go-forward-basis. And in fact, we had seen indications at some agencies that historically had awarded through full-and-open competition fully intend to pivot to Alliant/2 in the future, so it was really critical that we get on that, so how you measure the ROI from that; right? It all traces back to combining with Acentia and giving ourselves that position on what will now be a decade [indiscernible].

Right, okay. So help on the margin as well as some of those new revenue opportunities, it sounds like?

Correct.

Correct.

Our next question comes from Matthew Gillmor with Robert W. Baird.

And let me echo the congrats to Rich and Bruce on the new roles. Maybe starting with the Federal segment. First, can you give us some sense for that contract that was lost to rebid, sort of what that was? Was there any dynamics around that to note? And then second, you also mentioned in the Federal segment, there were other contracts that ended. And you've talked about the VA contract last year. And then you also mentioned that the disaster relief efforts ending sooner, but outside of those 2, were there other federal contracts to call out or was that the bulk of activity that ended?

Well, Bruce and I are going to tag team on this one. So Bruce, why don't you take the first one and speak to the 1 loss that we mentioned in the call.

Yes, the lost that we mentioned on the call actually was isolated to a single agency, and it's actually -- and it was interesting. It was a piece of work that we had a component of, but that was expanding to incorporate the work of another contractor as well. So it wasn't a pure, if you will, kind of, one-for-one loss of existing business. Importantly, that ultimately was awarded on price. Although, the primary criteria as part of procurement was best value, this is an agency that has had tremendous budget uncertainty over the course of the last couple of years, and the buying criteria changed dramatically. The buyer put less emphasis on historical knowledge of our workforce and the ability for them to write continuity at a period when we thought that's very essential for this agency and instead, chose to award at a lower price with a different composition of the workforce. Subsequent to that, we have been in conversations with them about ways that we can help augment their team going forward, so they don't have a complete discontinuity in the caliber and depth of the resources, so we would fully intend to recover a portion of the revenue from that loss, but those are ongoing discussions with that client.

And that's a stay-tuned-type situation. I'm going to add to that and just make a commentary as it relates to the other federal contracts that we've talked about in the past, that represented work we had that went away. And you need to keep this in mind, and I talked earlier about attrition rate, and there are several things that drive the attrition rate. You've got change orders, you've got things that go in-house, you've got rebids at lower rates, you have -- sometimes we know bid situation. You have start-up losses, et cetera. And most notably, you have some work that just, in the normal course, doesn't repeat, and we had 2 of those last year -- in the last 2 years. One we spoke about, I think, in the last quarter, and there was some work we did for FEMA as a subcontractor that related to disaster relief from the hurricane we experienced this fall. Naturally, that type of work ebbs and flows. In addition, last year, we had a lot of work in our federal business that related to a VA program that the VA decided to basically terminate, and we lost a fair amount of work relative to that.

Okay. That's helpful. Sorry, did I interrupt you? I'm sorry. Didn't...

No.

No.

Okay. Maybe one on the M&A environment, and I think the last call, you'd mentioned that getting beyond tax reform could help some -- get some deals over the finish line. So just curious to get your updated views on the M&A environment and the opportunities you're looking at? And if we'd expect to see some inorganic opportunities across the finish line now that tax reform is done?

Yes, I think the tax reform dynamics perhaps may have been holding things up. Now the tax reform is behind us. I think it clears the table of that issue. We still see opportunities of interest. I'd say that the deal flow is, I'd say, average. I don't think it's excessive. I would say the environment is such that, at least up through this point in time, prices have been, I'll say, hardy. So we need to be extra cautious to make sure that things have synergistic attributes, whether it's -- there are revenue synergies or cost synergies or combination of the 2. And that's how I would describe the overall M&A environment. But I do think we have real opportunities available to us, and we are very active.

Our next question comes from Jamie Stockton with Wells Fargo.

Congratulations to Rich and Bruce. I guess I'd like to focus on the digital commentary. I think that, that's very intriguing. My first question is whether you see more opportunities there at the federal level or at the state level? Just to start out with your thoughts there would be great.

All right, Jimmy. First I'd thank you for the kind words, appreciate that on my behalf and Bruce's behalf. And we're going to ask Bruce to answer this question, as to whether or not we see more opportunity in the federal or state level relative to the digital initiative.

Sure. Jamie, I would say I don't really make a distinction in the sense that as we said earlier, the primary objective initially of the digital enablers that we're investing in is to really infuse and transform the BPO solutions that we offer our clients. And I can think of examples where we're doing that for federal clients with new technologies for our call center operations, or I can think of the ways that we are going to be doing that for our U.S. health clients here domestically, and I think of examples of ways that we're progressing automation initiatives and that really cross both areas. So I think it's a balanced application, if you will, of digital transformation capabilities and something actually that's also global in nature. We talked at some length about how both the clinical evolution and the digital transformation, kind of, come together in areas like telehealth, teleassessment, telemonitoring. And we think those digital trends have global dimensions, because there are a number of countries that are really putting a big emphasis and focus on major public health crisis like diabetes and hypertension, often which go hand-in-hand and also the crisis that many governments face in enabling their aging populations to live independently. So really, I think -- this is -- hence, this is why they become big priorities for us, as they're not specific to one sector or another.

I would add to that. I think it's very, very early days as it relates to helping governments use new technology, and there's a lot of new technology out there that's getting a lot of attention. And at the state, local U.S. Federal level and international level, there's a lot of talk about this new technology and what it has to offer to citizens. But it's early days, and we're going to see some of this technology prove out to be very advantageous for our clients, and there will be other technologies that will not be advantageous, so Bruce and the team have gone through a very extensive process to identify those that we think are most promising. We're not going to share that with you for competitive reasons, but we're excited that we've managed to sort through the universe of all the new technologies that are out there and identify those that we think are most interesting to our clients, and we are in process of introducing these new solutions and infusing this technology into our existing business process, outsourcing solutions. But it's early days.

Okay. That's great. And maybe just 1 more follow-up on that. I think with some of the stuff you've already done with your call centers like the IVR technology, so you're trying to choose to enhance productivity there. You guys licensed some technology, and so you, kind of, have it in-house and ability to leverage it. As I think about something like telehealth, is that something where you would also look to have an in-house capability, you know clinicians who're doing encounters and whatnot? Or are we more likely to see partner there, and maybe use a third-party platform to enhance what you're able to do for clients?

It, ultimately, Jamie, depends on the use case. But I would say, again, without giving away too much competitive intelligence here, my primary goal would be first to have an in-house captive, in-house capability. And that's been at the heart of some of our investment decisions over the course of the last couple of years, because we think there's a logical extension. When you look at some of the platforms that we already use for some of our solutions, and they have been approved from a security perspective and a functional perspective to conform with the requirements of a number of countries, as it relates to telehealth delivery, it's a logical adjacency, right, to then use and leverage with modest additional investment those platform for the delivery of that capability. The clinicians is more of a just, again, a question of what kind of clinicians do you need? Our model, generally, is to have a combination of clinicians that are full-time employees as well as 1099s, depending on, again, the use case of the market, the type of application we're talking about, so there's not a critical distinction in terms of how that's delivered. And I'll just caveat the entire answer by saying that as the market continues to evolve, we are very dynamic in the way that we respond. And so if there are opportunities to partner with third-parties in certain areas where we want to continue to enrich our offerings and get into other adjacencies, we certainly would give that a consideration as well.

Our next question comes from Brian Kinstlinger with Maxim Group.

Rich, it was a pleasure working with you for over a decade, and I want to congratulate both you and Bruce.

Well, thank you very much, Brian. It's Mutual. We worked and enjoyed the opportunity to work together, and thanks for the kind words.

Yes. So I missed some of the call, but on Human Services, you noted the 5.8% margin was impacted by start-up cost. Can you give us a sense for, at what point you get back to where you were a year ago, which was 9%? Does that happen by the end of the year based on the start-up cost that you see?

Rick Nadeau is anxious to answer that one, Brian.

Brian, I think those start-up costs will run throughout the year and into next year. I think that if we take those start-up costs -- the startup losses, if you will, and the add them back, then we are not far from that more normal margins that you talked about in your questions. So and I think that, that is the reason the margins coming in as low as it is. But we have several contracts in start-up. And that's good, that's expansion of the business, but we will continue to incur those losses throughout the year and little bit into next year.

Great. I'm going to keep you busy, Rick. You haven't got to answer enough questions. So on HAAS, well coming upon the option period, so I'm wondering how that impacts the margins of the business? And if there's any expectation that we should think about of how margins fluctuate throughout the year, some seasonality in the any given period?

It's a good question. And I think as we've talked previously, contract goes through, it's maturity phase, and we start a new contract period on March 1 of 2018. I think we've said previously that we bid this contract within our normal range of margins. And so you would expect that in the early parts of that first contract period, we would be at a lower rate of operating income then we are as we're coming into the end of the contract period, as we have introduced innovations, as we have trained the workforce, as the workforce has got more experienced, et cetera, et cetera. So we will, as we start a new contract period, start that cycle again. We'll have a moderation of the operating income margin. We did, again, stay within our normal range, as we analyzed this and went through the pricing discussions with the customer, but that process will start again in March.

Our next question comes from Frank Sparacino with First Analysis.

I wanted to go back, Bruce, to the comment you made earlier on in the call just in terms of the assessments and appeals businesses, the size of that. I guess maybe 2 questions. So first is, I think the vast majority of that revenue is really on the assessment side, particularly on the disability assessments. And then secondly is, when I look at assessments, particularly the LTSS, I don't know how large of the business that is today, but curious, sort of, where you think that opportunity is? How large of a business is still on uncapped out in that regards?

Sure. Sure, Frank. Happy to address those. You are correct that the assessments revenue outweighs the appeals revenue for 2 reasons. One is obviously appeals are always going to be a subset of assessments in a way, if you think about it. Volumes of assessments done and not every one ultimately generates an appeal, but the assessments business is weighted by the disability assessments that we do in particular in the United Kingdom. So as it relates to long-term services and support, I've been really pleased with the, kind of, the growth and evolution of that market. And I guess what I'd say is, there are, kind of, two components. There's traditional, if you will, assessments related to Medicaid long-term care, managed long-term care, which is a market that we serve, primarily, I'm going to say, in the Northeast, presently. And as more and more states move -- continue to move their long-term care populations into managed care, we would expect that market opportunity to continue to grow. This is a little bit also related to the duals, on the duals that are in Special Needs Programs. On the Dual Eligibles, you may recall from prior years, there is a population that we serve pretty extensively under the Demonstration programs. And to the degree that they continue to be a population that stays and the federal government want to shift into our a managed-care capitated model, that will similarly drive the demand for the types of assessments that we would be capable of providing. The other dimension of Long-Term Services and Supports assessments, of course, relates to the work that we do through our Ascend subsidiary. And that's for the preadmission screening residency review, sports intensity scale assessments, and I would just comment that we've seen a robust pipeline in that business. We've been very pleased with the pipeline and pleased with our progress converting that pipeline to new business, and it seems there's a general -- I am not saying, overall trend, but there's interest in the marketplace in bringing together the types of assessments that are done into, kind of, single, kind of, aggregated contract vehicles. That's important, because it benefits a company like MAXIMUS where historically individual, kind of, more niche-y assessments might have been done by a smaller, specialized local providers. When they get aggregated into a single component, it plays well to the strengths of a companies like ours that has capabilities across multiple assessment types. So I hope that gives a little more depth in that area. Anything further Frank?

Our final question is a follow-up from Richard Close with Canaccord Genuity.

I think this was already, sort of, asked through Jamie's question in terms of partnering maybe on the telehealth. But may be Rick and Bruce, if you can comment in terms of the level of investment that you have to do with respect to digital into the clinical evolution, should we see any significant increase there in terms of CapEx?

Richard, I'll go first and then will let Bruce follow up. I think the answer is no to that. I think when we talk investment, I think it's just not CapEx, it's also operating expenses that impact that. And I think also you need to also appreciate that when we make investments in this area, the paybacks can be pretty quick in some circumstances. You're doing significant process reengineering. It's not just spending money, it's actually the commitment on the part of the workforce working on a specific contract as they reengineer the processes and make them more mechanized, if you will. Bruce?

I think the only dimension I would add is that we -- when we make investments, we're always looking, as I said earlier, to see how that platform that we have acquired gives us the opportunity to get into some adjacent markets and adjacent areas. And I think as we commented earlier, we are pleased to have the ability to combine with the Revitalised last year, because not only do they bring capabilities in the well-being area, but they enable us to address so of the adjacencies, so that's an example of an investment, if you will. That with some further investments, augment can enable that movement into an adjacent market. And then lastly, obviously, I guess you put in the overall category, it doesn't fit CapEx, but our M&A program obviously would seek to address the opportunities that we've spoken to as well.

Good. This is Rich, Richard. And I would add the following closing commentary. I agree with both Rick and Bruce, and the answer is likely will not involve a significant amount of additional CapEx. However, there are situations, opportunities where there could be a fair amount of additional CapEx, I think they're more situation-specific, opportunity-specific. And frankly, if it did require additional capital, we would pursue it knowing comfortably that it represents some pretty significant long-term growth to the company. So I would view it as good news.

Our next question comes from Rohan Abrol with KeyBanc Capital Markets.

Just amount of dawn I wanted to ask on telehealth specifically as some of the legislative moving parts. Are there any that you're specifically focused on, perhaps the CONNECT Act, the role of Broadband Act or is I guess more pertinent right now would be the CHRONIC Care Act, any commentary on specifics around those?

Around those -- it's Bruce. Around those specific acts, no direct commentary, I guess, I would say. If anything, we've been very focused on the budget situation. And have some optimism that with the likelihood and we'll not quit here of a 2-year agreement being reached prior to this evening that, that will provide some stability and certainty to our clients in the federal space as well as have a good trickle-down effect to the state marketplace. As you may be familiar in the bill that passed the Senate, CHIP has been reauthorized and funded for 10 years, which is a nice 4-year extension to the six years that was previously covered. It will be nice not to have to be talking about CHIP every week. And in addition to that, there's some interesting things. The Medicare Special Needs Programs, or SNPs, are extended for part C, for that's the managed-care competent of Medicare. That's about 1 million beneficiaries that will have extended coverage through that vehicle, if you will. And obviously, since we handle appeals in the Medicare program that provides a bit more visibility and stability as it relates to that area. But It's still early days to try to read the tea leaves on what. Some of other indicators in the budget bill might mean there's discussions in there about the Veterans Administration, for example, and some of the stabilization efforts there. So we'll continue to watch. I think if anything overall. it's good now for agencies to have a little more visibility and certainty and stability. And so if there are areas where they've been holding back RFPs or not progressing major transformation initiatives. And now they have some budget certainty, I think you're more likely to see some movement in that area. Hope that helps.

Understood. I appreciate that, and then I guess, lastly for me is, given your international exposures, is it fair to extrapolate that this, I guess, telehealth digital strategy could be applied as well in the countries you operate in outside the U.S.?

The short answer remarkably from me is, yes.

Ladies and gentlemen, we have reached the end of our question-and-answer session and are out of time for today's call. MAXIMUS thanks for your time and participation. You may disconnect your lines at this time, and have a wonderful day.