MAXIMUS, Inc. — Q1 FY2019 Form 10-Q Summary
Business context and reporting period
MAXIMUS provides business-process services to government and commercial customers in health, human services and federal programs. The filing covers the three months ended December 31, 2018, compared with the three months ended December 31, 2017. Beginning October 1, 2018, the Company reported three segments: U.S. Health & Human Services, U.S. Federal Services, and Outside the U.S.
Financial performance and position
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Revenue | $664.6 million | $623.1 million | 6.7% |
| Gross profit | $159.3 million | $152.0 million | 4.8% |
| Gross margin | 24.0% | 24.4% | Down 40 bps |
| Operating income | $74.1 million | $79.7 million | Down 7.0% |
| Operating margin | 11.2% | 12.8% | Down 160 bps |
| Net income attributable to MAXIMUS | $55.9 million | $59.1 million | Down 5.4% |
| Diluted EPS | $0.86 | $0.89 | Down $0.03 |
| Cash flow from operations | $59.3 million | $38.0 million | Up 56.2% |
| Free cash flow | $53.9 million | $31.5 million | Up 71.2% |
Cash, cash equivalents and restricted cash totaled $62.1 million at December 31, 2018, versus $356.6 million at September 30, 2018. The decrease primarily reflected the $421.8 million acquisition payment for the citizen engagement centers business. The Company reported $120.0 million outstanding on its credit facility and access to a $400 million facility. The market-risk disclosure separately reports total borrowings of $125.4 million.
Accounts receivable increased to $611.3 million, including $124.4 million of unbilled receivables. Days sales outstanding was 73 days, versus 63 days at September 30, 2018; management states that DSO would have been 69 days excluding the ASC 606 effect. Total assets were $1.67 billion and total equity was $1.12 billion at December 31, 2018.
Material changes versus the prior comparable period
- Revenue growth was driven primarily by the November 16, 2018 acquisition of the citizen engagement centers business, which contributed $101.3 million of revenue and $18.9 million of gross profit. Organic revenue declined across all three segments, and foreign currency reduced revenue by approximately $7.2 million.
- U.S. Health & Human Services revenue declined 3.3%, but operating income increased to $55.9 million and operating margin improved to 19.0% from 16.2%.
- U.S. Federal Services revenue increased 63.2% due to the acquisition, while operating margin declined to 9.8% from 12.6% because the acquired contracts are primarily cost-plus and lower margin. Organic revenue declined due to completed contracts and the absence of prior-year disaster-relief work.
- Outside the U.S. revenue declined 17.5% and operating margin fell to 2.9% from 8.7%, primarily due to ending U.K. welfare-to-work contracts, low unemployment affecting employment-services volumes, and unfavorable currency movements.
- SG&A increased to $79.7 million from $69.6 million, including approximately $2.7 million of acquisition-related costs and approximately $4 million of unusually high severance costs from an early-retirement program. Amortization of intangible assets increased to $5.5 million from $2.7 million.
- Interest expense increased to $0.6 million from $0.2 million following acquisition-related borrowing. The effective tax rate increased to 26.2% from 24.9%.
Accounting, acquisition and cash-flow items
- MAXIMUS adopted ASC Topic 606 using the modified retrospective method. The adoption increased opening retained earnings by $32.9 million and increased opening noncontrolling interests by $0.6 million. Current-quarter revenue and net income attributable to MAXIMUS were approximately $0.7 million and $0.4 million higher, respectively, than under the previous accounting guidance.
- The citizen engagement centers acquisition had estimated total consideration of $429.3 million, including $187.9 million of estimated goodwill and $122.3 million of customer-relationship intangibles. The purchase-price allocation remained subject to finalization, and an additional payment of approximately $7.5 million was anticipated in the second fiscal quarter.
- Investing cash outflow was $411.7 million, including the acquisition payment and $4.5 million of software-license costs for transferred employees. Financing cash flow was $59.0 million, including $150 million of acquisition borrowing, $41.0 million of share repurchases and $16.0 million of dividends.
- Remaining performance obligations were approximately $320 million at December 31, 2018, with approximately 65% expected to be recognized within twelve months, subject to the exclusions described in the filing.
Guidance, outlook and management commentary
- Management projected a fiscal-year effective tax rate of 25% to 26%.
- U.S. Health & Human Services operating margin was expected to range from 16% to 19% for the fiscal year.
- U.S. Federal Services operating margin was expected to be approximately 10% for the fiscal year.
- Outside the U.S. operating margin was expected to range from 3% to 5% for the remainder of the fiscal year, reflecting welfare-to-work contract reductions and low unemployment.
- The U.S. federal government shutdown reduced first-quarter revenue by approximately $0.5 million, with a similar impact expected in the second quarter. Management stated that cost controls were being used to mitigate the profit impact.
- Management anticipated approximately $23.6 million of full-year fiscal 2019 amortization related to acquired intangible assets, although the purchase-price allocation was not final.
Risks, contingencies and unusual items
- The Company depends substantially on government contracts, which may be delayed, rebid, protested or terminated on short notice and are subject to legislative, budgetary, audit, compliance and performance risks.
- An appeal remains pending in a putative securities class action concerning the U.K. Health Assessment Advisory Service. The Company stated that it cannot estimate the potential loss or range of loss.
- CMS proposed approximately $31 million of Medicaid disallowances involving historical work. MAXIMUS believes the school districts are responsible for amounts ultimately refunded and has reserved for its estimated fees; however, the filing states that a court could determine the Company is responsible for the full amount.
- Foreign currency exposure remains material. A hypothetical 10% unfavorable movement would have reduced comprehensive income attributable to MAXIMUS by approximately $11.1 million at December 31, 2018.
- Revenue recognition under ASC 606 requires increased estimates, particularly for welfare-to-work milestones, transaction-based contracts and cost-plus indirect-cost allocations. Changes in estimates reduced fiscal 2019 revenue by $1.5 million.
Key facts investors should verify
- Final consideration and purchase-price allocation for the citizen engagement centers acquisition, including the expected second-quarter true-up.
- Post-acquisition margin performance and integration costs, particularly in U.S. Federal Services.
- Receivable collections, DSO trends and the impact of the delayed payment from a significant customer.
- The effect of ASC 606 estimates and contract balances on reported revenue, earnings and future cash conversion.
- Progress and potential exposure related to the securities-litigation appeal and the approximately $31 million Medicaid disallowances.
- Compliance with credit-facility covenants following the acquisition financing and continued share repurchases and dividends.