MAXIMUS, INC. quarterly report, Q3 FY2020

Maximus, Inc. 10-Q Summary

Business context and reporting period

Maximus provides business process services to government agencies, including health and human services administration, assessments and appeals, technology solutions, and employment services. This unaudited Form 10-Q covers the three and nine months ended June 30, 2020, Maximus’s fiscal third quarter, compared with the corresponding 2019 periods.

The company operates through U.S. Health and Human Services, U.S. Federal Services, and Outside the U.S. segments. COVID-19 materially affected operations beginning in March 2020, with the greatest disruption in international employment and face-to-face assessment programs.

Financial performance and liquidity

Metric	Q3 2020	Q3 2019	Nine months 2020	Nine months 2019
Revenue	$901.3 million	$730.7 million	$2.538 billion	$2.132 billion
Gross profit	$185.6 million	$174.2 million	$514.2 million	$502.9 million
Gross margin	20.6%	23.8%	20.3%	23.6%
Operating income	$87.3 million	$83.6 million	$203.8 million	$239.5 million
Operating margin	9.7%	11.4%	8.0%	11.2%
Net income attributable to Maximus	$64.5 million	$62.9 million	$150.8 million	$180.7 million
Diluted EPS	$1.04	$0.97	$2.37	$2.79

Q3 revenue increased 23.4%, primarily from the acquired citizen engagement centers business, peak activity on the Census Questionnaire Assistance contract, and COVID-19-related work such as unemployment insurance support and contact tracing.
Nine-month revenue increased 19.0%, but operating income declined 14.9% and net income attributable to Maximus declined 16.5%, reflecting lower margins, COVID-19 disruption, and higher expenses.
SG&A was $89.6 million in Q3 and $283.7 million for the nine months. The company recorded $8.8 million of bad-debt expense during the nine months, related largely to COVID-19 payment concerns and a billing dispute.
Cash flow from operations was $96.1 million for the nine months, versus $263.7 million in 2019. Free cash flow, a non-GAAP measure, was $67.6 million versus $229.2 million.
Capital expenditures were $28.4 million. Cash used for investing activities was $27.4 million, including $2.6 million for acquisitions and $3.3 million of proceeds from the sale of Q2 Administrators.
At June 30, 2020, cash and cash equivalents were $81.5 million, or $96.0 million including restricted cash. The company reported approximately $145 million of credit-facility borrowings and $255 million of remaining credit availability.
Total debt was $152.2 million, including the current portion. A 1% increase in interest rates would have increased annualized interest expense by approximately $1.5 million based on outstanding revolving borrowings.
Accounts receivable totaled $829.7 million, including billed and billable and unbilled receivables. Days sales outstanding was 84 days at June 30, above the company’s 65-to-80-day target range; more than $90 million was collected from U.S. state and federal customers during the following week.
The company adopted the new lease standard on October 1, 2019, recognizing operating lease right-of-use assets of $171.0 million and operating lease liabilities totaling $178.1 million at June 30, 2020.

Material changes versus the prior comparable period

U.S. Health and Human Services: Q3 revenue increased 15.7% to $337.0 million, while operating income increased 12.5% to $61.0 million. Gross margin declined to 27.6% from 29.8%, partly because COVID-19-related contracts generally carried lower margins. Nine-month operating margin declined to 17.3% from 19.1%.
U.S. Federal Services: Q3 revenue increased 54.0% to $450.1 million and operating income increased 15.7% to $39.2 million. Margins declined because revenue grew faster than profit and the mix included lower-margin work. The Census Questionnaire Assistance contract generated approximately $380 million of revenue in the first nine months and was expected to generate approximately $500 million for fiscal 2020.
Outside the U.S.: Q3 revenue declined 22.4% to $114.2 million and the segment recorded a $5.8 million operating loss versus $5.0 million of operating income in the prior year. Nine-month revenue declined 19.1% and the operating loss was $33.5 million versus $13.9 million of operating income. Employment-services outcomes and face-to-face assessments were significantly disrupted by the pandemic.
Management reduced estimates for international employment outcomes, including an approximately $24 million revenue reduction in the second fiscal quarter. Additional estimate changes reduced revenue by $1.4 million in Q3 and $9.1 million for the nine months.
The company repurchased approximately 2.8 million shares for $167.0 million during the nine months. The repurchase program was paused on March 25, 2020, with $150.0 million remaining authorized for potential future purchases.
Maximus sold Q2 Administrators on May 1, 2020, for $3.3 million and recognized a $1.7 million gain.

Guidance, outlook, commentary, and risks

Management expected U.S. Health and Human Services full-year operating margins of 17% to 18%, with U.S. Federal Services margins of 8% to 9% for the remainder of the year.
Management expected continued COVID-19-related work and eventual benefits from increased employment-services demand, partially offset by temporary changes to performance-based programs, budget pressures, and policy changes.
The Outside the U.S. segment was expected to continue recording operating losses through the remainder of fiscal 2020, although management did not anticipate a significant fourth-quarter loss.
Significant acquisition activity was paused because of pandemic-related uncertainty, although smaller strategic transactions remained under consideration. Share repurchases were also paused, while management did not anticipate disruption to quarterly dividend payments.
COVID-19 created uncertainty in contract volumes, collectability of receivables, reimbursability of incremental labor and health-related costs, employment outcomes, and revenue estimates. The company incurred additional sick pay, idle labor, sanitization, health-screening, and related costs.
Other key risks include government budget reductions, delayed customer payments, contract termination or performance penalties, audits and investigations, cybersecurity and protected-information risks, foreign-exchange exposure, employee retention, litigation, and the potential for goodwill or other asset impairment.
CMS has asserted two Medicaid disallowances totaling approximately $31 million against a state agency involving historical work. Maximus has reserved its estimated fees and believes the school districts are responsible for most potential repayment exposure, but acknowledges that a court could determine the company responsible for the full amount. One approximately $12 million disallowance was upheld by a district court and appealed; the approximately $19 million second matter remained pending before an administrative appeals board.
Management stated that disclosure controls and procedures were effective and that no material change in internal control over financial reporting occurred during the quarter.

Investor verification points

Verify the durability and margin contribution of the Census Questionnaire Assistance and other COVID-19-related contracts, particularly as the CQA contract was expected to end or change in fiscal 2021.
Monitor receivable collections, days sales outstanding, bad-debt reserves, and payment delays from state-government customers.
Assess whether international employment outcomes, face-to-face assessments, and the Outside the U.S. segment recover as restrictions ease.
Reconcile reported debt, credit-facility availability, cash balances, lease liabilities, dividends, and the timing of any resumed share repurchases.
Evaluate the potential financial exposure from the CMS Medicaid disallowances, government audits, contract disputes, and other contingencies.
Review the assumptions underlying performance-based revenue estimates, goodwill impairment testing, and the adoption of the expected-credit-loss standard scheduled for October 1, 2020.