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MAXIMUS Inc. (NYSE:MMS)

F3Q09 Earnings Call

August 6, 2009 9:00 am ET

Executives

Lisa Miles – Vice President Investor Relations

Rich Montoni – Chief Executive Officer

David Walker – Chief Financial Officer

Analysts

Charles Strauzer – CJS Securities

Brian Kintslinger – Sidoti & Company

Jason Kupferberg – UBS

George Price – Stifel Nicolaus

Operator

Welcome to MAXIMUX third quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the call over to Lisa Miles, Vice President Investor Relations.

Lisa Miles

I would like to point out that we have posted a presentation to our Web site under the investor relations page to assist you in following along with today's call. With me today is Rich Montoni Chief Executive Officer, and David Walker Chief Financial Officer. Following Rich's prepared comments we will open the call up for Q&A.

Before we begin, I'd like to remind everyone that a number of statements being made today will be forward-looking in nature. Please remember that such statements are only predictions and actual events or results may differ materially as a result of risks we face including those discussed in Exhibit 99.1 out 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.

And with that, I'll turn the call over to Dave.

David Walker

This morning we reported third quarter financial results that were in line with expectations despite a challenging environment for our clients. We continue to deliver consistent results focusing on the fundamentals with an emphasis on profitable sustainable growth.

This morning MAXIMUS reported third quarter revenue totaling $185.2 million up 1% on a constant currency basis compared to the same period last year. Eighty-nine percent of total company revenue came from the operations segment providing a recurring stream of predictable revenue.

Third quarter net income from continuing operations totaled $15 million with diluted earnings per share of $0.84. This included approximately $4.8 million or $0.16 per diluted share in legal expenses and a large insurance recovery related to the arbitration settlement in December. Excluding this net benefit, earnings from continuing operations were $0.68 per diluted share and in line with expectations.

For the last two years MAXIMUS has consistently delivered on its goal to achieve a 10% plus operating margin and this quarter is no exception. For the third quarter, operating margin totaled 10.7% driven by a 12.1% margin from the operations segment with consulting approaching breakeven for the third quarter. All in all it was another clean solid quarter.

Let's turn our attention to segment level results. For our fiscal 2009 third quarter the operations segment posted revenue of $165.5 million an 8.3% increase over last year on a constant currency basis driven by organic growth in the base business.

Sequential growth over the second quarter was driven principally by a full quarter's contribution from the recently launched Pennsylvania Medicaid managed services program and a healthy stream of revenue from our Australian Employment Services operations as we completed work under the old contract. The operations segment continues to meet top line and bottom line expectations with third quarter operating income of $20 million and a 12.1% operating margin.

This morning we announced a notification of award on a significant new win in the United Kingdom to provide employment and job training services under the U.K.'s Flexible New Deal program. We estimate that the five-year program will be worth approximately $200 million in USD.

Revenue recognized under this new U.K. contract will initially lag behind costs. This means that in fiscal 2010 we expect to generate approximately $15 million in revenue from this new program, and we anticipate that the program will lose between $0.05 and $0.10 per diluted share in the first half of fiscal 2010.

However, we expect a positive contribution in the second half of fiscal '10 and anticipate that it will be fully accretive in 2011 with margins well within our targeted range of 10% to 15%. Like other large contracts of this sort, there will also be startup expenditures for this new U.K. contract, the majority of which will be in fiscal year '09. But in the category of good news, our current outlook for startup expenditures for our expansion in Australia are expected to be sufficiently lower to offset our startup costs in the U.K.

Moving on to the consulting segment, results for the quarter were in line with our expectations. Consulting segment revenue totaled $19.7 million and the segment is nearing breakeven with a nominal loss of $146,000. Revenue was lower compared to last year, largely reflecting the wind down of the old [RevMax] business and timing of several large ERP projects, which had strong revenue in the prior fiscal year and, as planned, are ramping down in the current year.

A modest operating loss reflects aggressive cost cutting initiatives that are offsetting the revenue decline. We continue to focus on bringing the consulting segment to consistent profitability through tightly managed labor utilization, aggressive cost controls and by bringing the last remaining legacy contracts to successful resolution.

Moving on to balance sheet and cash flow items, MAXIMUS continues to maintain and generate healthy levels of cash with no debt. Our clients value financial stability which has received more focus by our clients as selection criteria and as part of their competitive procurement process.

Our strong balance sheet and financial stability differentiates us in the marketplace. For the third quarter MAXIMUS generated cash from operating activities related to continuing operations of $12.4 million and free cash flow from continuing operations of $6.3 million, which includes the insurance recovery. We ended the third quarter with cash totaling $91.7 million at March 31, 2009. In addition, we have $24.7 million available under our line of credit. We continue to tightly manage cash and receivables.

DSOs were 73 days in the quarter. The DSOs are well within guidance, but an anticipated increase of six days in the quarter relates to the timing of certain milestone billings on two large programs where we are in the process of delivering technology refreshes. The progress on these milestones is tracking nicely and a significant payment on one milestone was received after the quarter closed. We anticipate our DSOs will remain in the low 70s next quarter as we complete selected planned milestones.

We did not experience any DSO increase due to California budget problems in the quarter. California payments on our significant contracts are current. Overall, DSOs continue to trend within our expectations of 65 to 80 days. But we always expect to experience some fluctuations quarter-to-quarter principally related to timing and milestone billings.

Under the company's board authorized repurchase program we did not purchase any shares during the quarter. At June 30, 2009, MAXIMUS had $54.1 million available under the program. In the third quarter we also paid a quarterly cash dividend of $0.12 per share, a cash use of $2.1 million.

Before I turn the call over to Rich, I'll wrap up with fiscal 2009 guidance. We are reiterating fiscal 2009 guidance for continuing operations of revenue in the range of $745 million to $755 million. For diluted earnings per share from continuing operations, we continue to expect $2.75 to $2.85 for the year. And I want to emphasize that this excludes the one-time $0.16 benefit from the legal and settlement reimbursement.

As a reminder, the fourth quarter is fueled by seasonality in the operations segment the largest driver of which is our tax credit business. And lastly cash flow guidance, we continue to expect operating cash flow from continuing operations for the full year to be $35 million to $45 million with free cash flow from continuing operations of $15 million to $25 million.

Thank you for your time this morning. Now, I'll turn the call over to Rich.

Rich Montoni

As David noted, we are pleased to deliver another quarter of consistent financial results. We've been very successful in the first nine months of fiscal 2009 in positioning the company for sustainable, long-term profitable growth. Despite market challenges we continue to win new business, renew and expand existing relationships. In addition, we have aggressively position the company to benefit from emerging opportunities resulting from new legislation and a shift towards public private partnerships in the administration of government programs.

By focusing on our core Health and Human Services markets, we have driven increased client satisfaction, reduced risks, and solidified our reputation as the preeminent provider in the market today. As a result, we have strengthened existing client relationships. This is a priority for us in any market environment, but of particular importance in today's challenging climate.

Let's talk about new business. During the quarter, Texas notified us on a tentative rebid award that will consolidate work MAXIMUS has performed under two previous contracts. Other significant rebid awards in 2009 include Georgia Families Medicaid and CHIP, Iowa CHIP, Virginia Medicaid and Roman Broker Services, the Social Security Administration's Ticket to Work program, and the expansion in Australia for the Jobs Services Program where we doubled our annual revenue run rate.

To date, we have won 91% of the total contract value that was up for rebid in fiscal 2009. Everything we've done over the last three years to focus on key markets, improve quality, and optimize the business has enhanced our ability to solidify our base for future growth.

In addition to building on existing relationships, our selective approach to new work has resulted in several new key awards. This would include our Medicaid Managed Care project in Pennsylvania, in our child support operations contract in Shelby County, Tennessee.

This morning we also announced a notification of award in the United Kingdom where we've been selected as the preferred provider by the Department of Work Intentions for the delivery of employment services in southeast England. We expect to sign the contract imminently. The $200 million five-year contract is another strategic win that allows us to broaden our international footprint with services within our core competency. This work is very similar to our domestic and our Australian Work Force Services operations.

In addition, we are in dialogue with our partners at all levels of government as Federal stimulus money begins to flow. In fact, MAXIMUS won the first stimulus funded contract to come out of the Centers for Medicare and Medicaid Services related to the new Cobra provisions. Under this one-year contract, MAXIMUS will assist with expedited reviews in information services regarding Cobra Premium Assistance benefits. We're also engaged on two other area related projects and are bidding on other area opportunities.

So even in today's market environment, we've demonstrated our ability to strengthen existing relationships and win new opportunities. These rebids, work expansions, and new awards are offsetting some limited cutbacks in scope in nondiscretionary work that we've experienced on certain domestic projects. As we've said in the past, we expect to see some pluses and minuses, but the net impact will be positive growth and this is how we see it playing out today.

The biggest pullback has been in California but the situation remains fluid and circumstances continue to evolve. Our work in California is centered around three programs. There's no expected impact to our business for two of the three, but let me walk you through each one.

First, we provide administrative and enrollment services to the Medicaid program. We do not expect any operational or financial impact to the work that we do under this contract. While the Governor made cuts to the program, they were outside of the managed care population, which is the group we serve in California.

Second, we also perform work under CalWorks. This is the welfare to work employment program. At this time, we do not anticipate any financial impact in fiscal 2010 for the work we do under this program. CalWorks is funded at the county level so the impact of the budget shortfall varies by contract region. At this time, we expect case loads to decrease in regions where recipients are transitioned out of the CalWorks program but we anticipate in case loads in other regions. So a net neutral effect on CalWorks but naturally we'll continue to monitor this situation closely.

The largest impact will be felt in the CHIP program where program funding was reduced. On July 17, the state instituted a cap on new enrollments to the CHIP program. We anticipate that this will have an immaterial impact on the fourth quarter but for fiscal 2010, we've reduced our financial expectations for the CHIP program by about $12 million in the top line.

We based our preliminary assumptions on what we know today and it's a balanced middle of the road view. The program is seeking additional funding to plug the gap through an outside foundation that has provided funding in the past. However, at this time it's not certain exactly how the potential new funding to the CHIP program would affect MAXIMUS.

Long-term opportunities, I'd like to talk about our outlook in longer term opportunities. During our last call, we provided a preliminary top line growth target for fiscal 2010. While we have not completed our annual planning process for the coming fiscal year, we still believe that our preliminary 7% top line growth estimate for fiscal 2010 remains realistic.

The 7% estimate compares to the midpoint of our fiscal '09 guidance range. This represents our best take on 2010 at this point and bakes in our new UK win, which offsets reductions in our base business principally related to the state fiscal environment in California.

Of course, we still have other work that remains on the runway where we are awaiting decisions. This could improve our outlook. However, any offsetting factors including further reductions in our base business would also have to be factored in. But based on what we're seeing today, we continue to believe that we will be able to offset any reductions with additional new business awards.

While we're not providing 2010 bottom line guidance today, we continue our disciplined approach to new work with a focus on profitable long-term growth. As we have said many times in the past, we view revenue as a means towards an end, a means towards increase profitability. This is a key philosophy we will carry with us into 2010 and beyond. We will provide formal guidance when we report our fourth quarter results in November.

New legislation, let's talk about some of the longer term opportunities stemming from recent legislative changes. This includes CHIP, which remains a very promising area for us because of the expanded reauthorization legislation. We've talked a lot about CHIP in recent quarters and how as an organization we are taking a long-term approach to this opportunity. We still believe its going to take time but we remain encouraged by recent shifts towards expansion.

Recently we've seen some movement toward expansion in CHIP programs with 13 states expanding their programs over the last five months. In Iowa, for example the legislature approved a measure to offer health insurance coverage to all children in the state expanded CHIP funding to cover families making up to 300% of the Federal poverty level.

Other states, like California, continue to be challenged by the lack of necessary state funding needed to receive additional Federal dollars to broaden coverage. It's obviously a very fluid situation that is yet to play out, but we recognize the need to be well prepared to respond to the demand as it materializes.

We are also anticipating new opportunities at the Federal level as health reform remains the dominant domestic policy issue for Congress and the White House. With our focus as the leading pure play provider in health and human services, this reform initiative provides a wide range of opportunities for MAXIMUS.

President Obama has taken on health reform as a must do initiative. Several committees are working on legislation designed to reform our current health system and we expect legislative language after the August recess.

While passage of any of these bills remains to be seen, several common themes exist where MAXIMUS is well positioned to be a partner in providing solutions for health reform. We are identifying areas where we can bring the most value and how we can best capitalize on any opportunities.

Most importantly, the bills include provisions for program management, such as the administration of health exchanges or gateways to increase enrollments to effective outreach in education. All of this work is the very same work we are currently doing on a state level for Medicaid and CHIP where we have an established leadership position. We are the go-to partner for quality and effective administration for CHIP and Medicaid.

These bills also include fundamental changes to Medicaid to insure individuals with higher incomes. While the specific eligibility levels have not been determined, this would represent growth in our core Medicaid program administration business.

Also included in these bills is language surrounding monitoring the quality of care and providing medical review, appeals and dispute resolution. MAXIMUS is recognized as the industry leader in government sponsored healthcare appeals work. We complete more than 180,000 appeals annually, providing healthcare appeals work under Medicare directly for CMS, as well as for 30 state regulatory agencies.

We see great opportunity to use our best practices to capitalize on these provisions. We also believe we are uniquely positioned, as an independent vendor with no ties to healthcare providers or insurance companies. This independence will be critical as these opportunities emerge related to health reform initiatives. In fact, we see independence as a cornerstone of healthcare reform.

As part of our effort to optimize our positioning ahead of legislation, we've implemented several efforts to promote our brand, secure our seat that the health reform table and create a path to success. We launched a comprehensive media campaign to further increase brand in running government sponsored programs at the state level. The campaign included targeted print, radio and online advertisements in legislative publications like Roll Call and Congressional Quarterly.

To supplement these advertisements, we've enhanced our online presence with a Web site dedicated solely to health reform, which is generating strong traffic and growing interest. I suggest you check it out at www.maximusforhealth.com.

Despite the variables regarding the outcome of the current legislation, health reform will likely continue to be a focus of the Congress and the current administration over the long run. We believe MAXIMUS will be a key player contributing in meaningful ways to translate new policies into action. No matter how it shakes out, there will be ample opportunities for MAXIMUS.

Let's turn to new awards and pipeline. At August 4, 2009, we have year-to-date signed contracts of $877 million and new contracts pending, this is awarded but unsigned, totaling $542 million. Our strong sales numbers is further validation that we can achieve solid long-term profitable growth despite the challenging environment.

Our pipeline of new opportunities remains quite healthy at $1.2 billion and we continue to see emerging opportunities across our core markets both domestically and internationally. The decrease in pipeline numbers simply reflects the shift of contract dollars into the awarded categories.

Let's talk about cash. Our cash position increased to $91.7 million at quarter end, on the strength of healthy cash flows. Our strong balance sheet with no debt speaks to the strength of MAXIMUS as a reliable partner for our government clients.

We intend to maintain a healthy cash balance for the foreseeable future, but as we've demonstrated through our ongoing dividend and repurchase programs, our company's board and management believe that excess capital is best returned to shareholders whenever possible. We also continue to look at acquisition opportunities with our immediate focus on smaller tuck-in acquisitions to compliment our business portfolio.

So in summary, our results for the 2009 third quarter demonstrate that we continue to perform and deliver despite the choppy waters of the current economic environment. State and local budgets remain under pressure; however, as we are in the business of administering rather than provisioning health and human service programs, demand for our services remains encouraging.

Over the next several years, the government will continue to face the challenges of budgetary constraints, and when they take a look at true costs of delivering services, they may become more inclined to seek out public private partnerships as a means to effectively and efficiently manage government.

This advantage should become increasingly clear as governments and their citizens factor in the true cost of government, meaning that they factor in the cost of pensions and other benefits owed to government employees.

Our recent successes stem largely from our focused operations and market leadership and our offsetting scope reductions. While we're not immune to the impact of the current economic climate or the impact of it on our government clients, through a combination of successful rebids, contract expansions and new awards, we are guiding MAXIMUS towards a year of top line and bottom line growth in fiscal 2010.

And before I open it up to questions, I just want to thank our employees who are simply doing a tremendous job in continuing to provide high quality services and deliver value to our clients in a very challenging client environment. Thanks to them.

Operator?

Lisa Miles

[Latonya], this is Lisa, I would like to make one clarifying point, before we actually open up to questions.

Operator

You can go ahead.

Lisa Miles

I just want to point out to everyone, related to the new contract in the United Kingdom I would like to correct one prior statement. The project is expected to lose between $0.05 and $0.10 in fiscal 2010. The loss will be front-end loaded, but we do expect the project to be profitable in the back half of the year.

And with that, we're ready for questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Charles Strauzer – CJS Securities.

Charles Strauzer – CJS Securities

Rich, ink up on your slide about healthcare reform and also talking about kind of the independence that is critical to any kind of package that were to come out. There's been a lot of talk in the media recently about Affiliated Computer Services, your primary competitor in enrollment broker service, losing some contracts after the federal government has informed them that their commercial work violates federal law as a conflict of interest.

Can you talk a little bit more about that and the essential opportunities that may open up in terms of new rebids, new RFPs that are kind of coming down the pipeline? And when you look at your slide about the kind of proposals pending in RFPs tracking, are any of those potential RFPs in the RFP tracking line?

Rich Montoni

I'd be glad to talk about it, Charles. First off, from a high level perspective, we do believe and we've held this belief for quite some time, and we're pleased to see that in most of the discussions, if not all the discussions that we read about healthcare reform, independence is a cornerstone. And we think that's true, when you look at the various components of a healthcare system and then you focus on what MAXIMUS does, and we do several things where we think independence is very critical to the success of that system.

You can look at enrollment broker work, you can look at dispute resolution work, you can look at eligibility work and you go across the components of the supply chain, I think it's quite obvious that independence is very, very important. It's also very important when you study other industries, so I think there's an opportunity there for not only the leaders to make sure the independence remains at the forefront of any healthcare reform.

But there's an opportunity for MAXIMUS to maintain its independence and we've been working very hard, not just this month, but for several years to best position MAXIMUM from an independence perspective. So we're happy with the position. We're delighted that it plays well into this very significant dynamic in healthcare reform. And then I think you get down into specific situations, and we do in fact see it playing out to our advantage.

I believe that we were the beneficiary of one recent award because we were independent. We do have one other situation where I think we're advantaged, and perhaps one other competitor is precluded, or maybe precluded, because of the independence situation. But more importantly, I think it's not a specific opportunity but rather just a global trend that's going to increase the demand for those firms that are independent in nature.

Charles Strauzer – CJS Securities

Obviously, they talk in one of the articles about Florida being one of the larger contracts that was being managed by ACS and I think with them potentially being precluded from rebidding on that contract, have you seen an RFP from the state for that service given that the contract expires next year?

Rich Montoni

I believe there is an RFP that's been received as it relates to Florida.

Charles Strauzer – CJS Securities

And, obviously, there aren't any other very large competitors in the space that could be deemed independent, obviously, when you look at the EDS of the world, etc. Have you seen any new potential competitors emerge that could bid on that contract?

Rich Montoni

No, we really have not seen new competitors on that contract that we expect. I mean it's difficult to say for certainty, but more so just in that space it's very difficult for folks to get into that area. And we haven't seen new entrants into that space.

Charles Strauzer – CJS Securities

Can you talk a little bit more about the CHIP situation? When you have obviously it's such a high importance placed on CHIP by the federal government when they reauthorized the bill earlier this year, clearly there was bipartisan support there.

Do you think that the federal government will take some action to help bolster some of these states that were trying to increase some of the enrollment rolls for that program? Now that the states are kind of strapped a little bit for cash here, do you think they'll kind of step in and help out?

Rich Montoni

I think they would like to. I think the CHIP situation, when we think about the CHIP situation first off we believe it's long-term. I mean the legislation was intended to increase the participants over a five-year period not a one-month period, and I do think that there is activity.

We know there is 13 states that have taken action to increase, improve their CHIP program based upon the new authorization. I'd like to think that the federal government would encourage the states to continue to increase the CHIP beneficiary population. Whether or not they will actually step up and facilitate it from a financial perspective is a good question that's difficult to forecast. I'd like to think so, but we'll have to see what the federal government does.

Operator

(Operator Instructions) Our next question comes from Brian Kintslinger – Sidoti & Company.

Brian Kintslinger – Sidoti & Company

First question I had was, last quarter in your Q you mentioned the ERP project that had some cost overrun. I'm wondering if that occurred in the third quarter and then how we should think about that going forward, maybe when it ends, if we're going to see more loss on that contract that's depressing Consulting profitability?

David Walker

Yes, we actually took a charge of $1.3 million on that contract and it was really offset by savings so it's a contract that's well along the way. I think we've defined what we need to do. I think we're honing in on it and I think it's our last large legacy issue that we're very focused on.

Brian Kintslinger – Sidoti & Company

Does your guidance assume you'll have another type charge for the third quarter, for the fourth quarter again and maybe will that continue into next year as well?

David Walker

Well like any fixed price contract we monitor it closely. But at this point what we booked is what we anticipate today we would take as a charge. But there could always be some small charges, but net-net next quarter we expect consulting to continue improve and that's the plan we've been executing on. And frankly the guidance we gave people is that we'd approach breakeven towards the end of the year and show a small profit by the end of the year, and we're still focused on that plan.

Brian Kintslinger – Sidoti & Company

David, how much ERP revenue is about to falloff in the next six months or so? It sounds like you've got three big contracts winding down, is there still a large chunk of that left?

David Walker

We don't give guidance on individual programs. We have some contracts that are maturing and we have some other new work in the pipeline, so it's still a viable organization. I will say that, obviously, we do a lot of bid reviews on those to make sure the risk profile of the new contracts don't look similar to the legacy contracts. So we're very pleased with that.

Rich Montoni

One thing I'd add, Brian, on as it relates to the one legacy contract in the ERP situation, I think if you were to look over last year we've done a very good job to improve the quality of the portfolio of the work in consulting such that now with that one remaining legacy contract, I think the portfolio is in much, much better shape. I'd actually say good plus shape.

And the other thing I would say about that one contract is the advantage of having worked it quite hard over the last three, four quarters is that we've really gotten good insights into the project, we've accomplished a lot in specifying the scope, nailing the scope, aligning resources just to get the job done.

So while there's no certainty that we won't have losses on it in the future, I'd like to think that they're going to be not material in nature. So I think it's much different than it was a year ago, especially from a portfolio perspective.

Brian Kintslinger – Sidoti & Company

The last question on that contract, can you tell us when that contract, since we don't know which it is, when that one particularly ends?

Rich Montoni

I think it's got about a one-year tail to wrap up.

David Walker

That's right.

Brian Kintslinger – Sidoti & Company

And on Australia, I'm just curious you said the dilution wasn't as much as you thought can you give us a sense for what those costs were? And then are we still not to expect revenue until maybe the end of the fourth quarter or the beginning of the first quarter?

David Walker

With Australia we provided expectations that it would be about $0.20 a share in the last half of the year. And we've actually done a little better than that. And the good news is with the U.K. win we have startup costs and we think we can live within the total guidance that we've already provided. So I would say we are managing right to the numbers and the guidance that we've been providing and we're reiterating that guidance.

Brian Kintslinger – Sidoti & Company

And at what point, I'm curious, when will those new facilities be operational? I mean obviously there's a lead time to find work for their citizens, but I'm just curious where that is and when revenue might start being produced on that contract?

David Walker

July 1 was the start date for Australia and most of those facilities are up and running. There's some lagging costs that we're continuing to do, some of it is system related. And when you look at the CapEx that's where a lot of it you'll see. So there's a lot of furniture, fixtures things like that hitting, but we're up, we're running, we working.

Rich Montoni

I would actually add that I think that the Australian team did just an excellent job, damned near flawless in terms of launching that contract. It really went according to plan without a hitch, and I think it's a testimony to that team.

David Walker

I do, too.

Brian Kintslinger – Sidoti & Company

On the Texas contract I'm not sure since it's been preliminary to have pricing or anything like that, but I was pricing and the question because of Texas, maybe because California in the past was there any technical refresh that should be expected early next year for that?

Rich Montoni

Brian, we don't have a big technical refresh on the Texas contracts. We're still in negotiations with the state on the new contract. It's really a normal course and frankly I think the reason the contract hasn't been signed is I don't think the state in particular thinks there's any urgency and they're focused on some other matters within the state outside of our contract. So as we move forward, we'll disclose the terms of the contract. But we're not anticipating materially different financial results from that contract.

Brian Kintslinger – Sidoti & Company

The last question I have is on Cal Healthy Families, given you expect a modest reduction in revenue there what are your plans to – how does it impact profitability? Do you need to reduce costs or redeploy some of your employees? Give us a sense for that please.

Rich Montoni

Absolutely the way we manage it, and the good news is our model has a lot of these costs are variable costs and we can adjust costs accordingly. So our mantra in these types of situations is to seek to preserve our margin percentage in these situations. And from a total company perspective, obviously, any dollar margin loss on that one particular contract, we look to offset with new opportunities.

Operator

(Operator Instructions) Our next question comes from Jason Kupferberg – UBS.

Jason Kupferberg – UBS

Just wanted to ask a question regarding next year, if I'm not mistaken I think last quarter you guys had thought preliminarily that margins should up year-over-year in fiscal '10 and without being specific but directionally that they should be up. Now you've got this U.K. contract coming online, which is obviously going to be dilutive. You have the revenue reduction on Healthy Families, which you just touched on. So is an up margin year still the most likely scenario in your opinion for fiscal '10?

Rich Montoni

First off, I think it remains to be seen from our detailed planning, Jason, so this discussion obviously is very preliminary in nature. But I think you can look at those two situations as situations that need to be offset, I'd like to think from our planning processes and there are still a number of things out there that need to materialize that I think could very well not only offset but improve the situation.

From a management perspective and I want to make this perfectly clear, we worked really hard to change the culture here at MAXIMUS. We've talked and shared with you the business review process we go through, including the U.K. contact, went through that process.

We are not a company that focuses on revenue for the sake of revenue. We've very bottom line oriented, so we'll continue to focus on the bottom line and margin next year as we go forward. And there's lots of management actions we can take such that I'd like to think that we are well positioned to maintain if not improve our margin in fiscal 2010.

From a new business perspective, I think the real wild card is what's going to happen from the stimulus dollars and what's going to happen from healthcare reform. So it's hard to bake that numerically into our expectations today but they're very, very sizeable and they could very well surprise us and even in fiscal 2010.

Jason Kupferberg - UBS

And follow up question on the U.K. contract, can you talk a bit about the pricing model here, I mean just when people kind of hear costs ahead of revenue upfront, just given past experience I understand that this contract seems more consistent with service offerings you've provided to other customers so it's not like this is unchartered territory for you guys from an implementation and an execution standpoint.

But how would you characterize the overall pricing model and the risk profile here to make folks comfortable that you'll truly achieve your ultimate margin and cash flow targets over the five year life of the contract?

Rich Montoni

I think that's a great question, Jason. I do think you're right that the nature of this contract, while the contract is very large in nature, it's work that's very, very familiar to us. And when you peel back the onion and look at what we're doing here, it's very simple, very basic. There's about a dozen locations that we're responsible for opening, very similar to the 37 new locations in the past quarter we opened in Australia.

It's the same management team ultimately – this subsidiary by the way that has this work that's owned by our Australian subsidiary and the management reporting line are the same team in Australia that will be responsible, in fact developed this business in close consultation with the customer base. So I've very, very confident in the capabilities of the management team.

I'm very confident this is work that we've done a number of times. It's just our core area. So unlike some of the other projects we've had in the past that are perhaps more technology in nature. You may recall the Texas challenges and even the British Columbia startup situations, there's a lot more new technology involved there. We just don't have that risk factor here.

The other thing I would say from a pricing perspective, the pricing structure on this, it's a hybrid type arrangement. One aspect of it is we do receive and upfront fee, which is quite substantial. And then there's another element of the fee, which is performance-based, the drivers to the performance really are the number of placements and the longevity of those placements.

And when we went through our business review situation, we were very insistent upon some base level of cost to mitigate our risk and we feel comfortable with the structure, it's the right balance of covering our bases, but also motivating us and rewarding us based upon what we deliver and it's very comparable to the Australia situation.

The fact that we do get cash flow, a significant amount of cash on the front end means that this project will be cash flow positive from day one. However, as to why it generates GAAP losses, we just have to look to the accountants of the world and the new accounting rules and regulations. And as you well know, sometimes revenue, GAAP recognition of revenue doesn't equal cash flows and that's what we have in this situation.

Jason Kupferberg - UBS

Can you talk a little bit about the competitive process you went through to win the deal and to what you extent you have subcontractors on the contract.

Ron Montoni

I can do that. First off, there's one key point here and this is something that we're seeing I think across the board and it's something to watch. I do think that these difficult times for governments where they're more strapped for dollars than they historically have been and then the social challenges, the number of cases, the complexity of cases are increasing.

I think we've really seen the screws tighten as it relates to the propensity of governments to consider outsourcing or change the way they do business, and I think that was really a driver in the United Kingdom. I think the leaders of that country took a look at their unemployment situation, the trends and really decided to reengineer how they do welfare to work across the whole country. We're picking up a piece of this work. There are other companies who are also awardees, so this is a subset of a total country reengineering. And as part of that, they've looked to world class companies who do this including MAXIMUS.

So we're one of several, as I've said, there's a dozen locations. We will directly handle half of those locations and we've got a couple of subcontractors who are very experienced that will take over the other six.

The last point I would make is this has been in the making for a couple of years and our small acquisition in the U.K. in this geography about a year ago was an integral part of this plan so that we do have a company that's been in this market for quite some time, experienced with a workforce, with good management, local management that's going to be very helpful to this situation.

Jason Kupferberg - UBS

Just last question, how come no buybacks in the quarter, any particular reason?

Ron Montoni

That's a good question. We're always opportunistic about it. In this environment, particularly with California where it was at that time, we felt it was a good time to have, if anything, more cash than less cash. It's proved in this market to be really a differentiator. I think it was a key differentiator in one particular award that we have solid financial stability. We do have some M&A opportunities out there that are more tuck-in in nature, so we add it all up it wasn't the right quarter to repurchase shares. It doesn't mean we wouldn't consider it in the future.

Operator

(Operator Instructions) Our next question comes from George Price – Stifel Nicolaus.

George Price - Stifel Nicolaus

Just wanted to confirm, Lisa, I see it in the slides but I just wanted to confirm that I understood the clarification there at the end of the call I was distracted for a second, on the U.K. deal. So $15 million in revenue in fiscal '10, the $0.05 to $0.10 loss is for the year with that impact front0-end loaded and you expect positive contribution in the back half of fiscal '10?

Lisa Miles

That's exactly right.

George Price - Stifel Nicolaus

Okay and normal operations range for this kind of deal in fiscal '11?

Ron Montoni

That's right, normal operations, fiscal '11 and this is the type of business where we expect to deliver a 10% to 15% operating margin.

George Price - Stifel Nicolaus

Can you give us a sense even qualitatively maybe about how the startup and transition cost will split between the first and second quarter of fiscal '10?

David Walker

Actually, the startup cost will hit largely in fiscal year '09 and will live inside the estimate that we gave you for Australia. So our results in Australia are favorable enough to cover the startup cost in the U.K. and substantially most of them will in fact be incurred in '09.

George Price - Stifel Nicolaus

Okay, I guess the impact in the front end of the year of revenue not tracking with cost.

David Walker

So that's more the revenue recognition. Yes, what happens and again we talk about the accountants, if you think about the worst case model, that's the accounting today. So it's not necessarily in line with economics or cash flow. It's just where the accounting community is.

So it tends to book any fixed fee ratably over periods to be determined when you get into the fine print of the contracts. And then there's pieces of the contract, very similar to Australia that says when you've employed people for certain periods of time you get these extra incentive payments, so that's the nature of the contract. So it tends to take a while to build up to a normal revenue run rate.

George Price - Stifel Nicolaus

So I guess in terms of trying to think about it versus the first and second quarter of fiscal '10, greatest impact in the first quarter relatively evenly split?

David Walker

Yes, that's exactly right.

George Price - Stifel - Nicolaus

Sorry, which one?

David Walker

First half, it'll ramp up over time until it hits a run rate.

Lisa Miles

The losses is greater in Q1 because the revenue builds over the first 12 months of the program, George.

George Price - Stifel - Nicolaus

Shifting kind of to bring Australia back in, can you go through, to the extent you can, can you go through maybe how you see the expected accretion of the Australia contract maybe offsetting some of that impact in either the first half of the year or just in general for the year. You expected same thing, right, you can't recognize all the revenue on Australia but you expected that it would be more accretive in the first half of fiscal '10, correct?

David Walker

Yes.

George Price - Stifel - Nicolaus

Would you expect that to largely offset, entirely offset what you're going to see in the U.K.?

Ron Montoni

George, we don't look at it that way when we do the detail planning we have hundreds of projects so we bottoms up plan the year. I will say this from a U.K. perspective I think we launched that project on July 1 so by September 30 of this year it should be pretty much in full mode – I'm sorry, Australia. It should be pretty much in full mode by September 30, so I think the ramp for Australia will have occurred in the fourth quarter.

George Price - Stifel - Nicolaus

In terms of the pricing structure that you mentioned in the last question of having an upfront fee that's substantial, and then ongoing you have a performance-based fee. So that's going to be positive for cash flow in fiscal '10. How should we think about that contract relative to kind of how these deals run overall in general? How should we think about that, say, in fiscal '11 from a cash flow basis? Are you stealing any cash in fiscal '10 from fiscal '11?

Ron Montoni

I think that's actually correct, so I think it'll be more breakeven cash flow in fiscal '11, maybe a nominal cash flow loss in fiscal '11. And then in years three, four and five I think the terms of the contract are as such that it should be normal level cash flow.

George Price - Stifel - Nicolaus

So mechanically the deferred revenue will go up, right?

Ron Montoni

Yes.

George Price - Stifel - Nicolaus

Assuming the 7% growth that you've laid out in the anticipated cost and what we've already talked about, is it reasonable to expect – well, actually I think you made that comment on margin. You expect margin, I believe, to be probably at least to maintain, right?

Ron Montoni

That's our goal is to maintain and seek to improve margins.

George Price - Stifel - Nicolaus

Last question, in terms of the recent rebids, which is nice to see a high rebid number, given the current fiscal environment are there any pricing reductions that are materially different from what you would normally encounter as a result of those rebids?

Ron Montoni

You know, really nothing in the order of magnitude of the California program where they're just cutting back on that program. So we're not seeing significant pressure just on pricing alone. Most of the adjustments come from scope of work adjustments, and on scope of work adjustments aren't seeing anything order of magnitude like California.

Operator

There are no further questions in queue at this time. I would like to turn the call back over to management for closing comments.

Lisa Miles

We just wanted to thank everyone for joining us for the MAXIMUS third quarter conference call. And with that, today's call is over.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: MAXIMUS Inc. F3Q09 (Qtr End 06/30/09) Earnings Call Transcript
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