Greetings and welcome to the Maximus Fiscal Year 2023 Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jessica Batt, Vice President of Investor Relations and ESG. Thank you. Please go ahead.

Good morning and thanks for joining us. With me today is Bruce Caswell, President and CEO; David Mutryn, CFO; and James Francis, Vice President of Investor Relations. 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. Actual events and results may differ materially as a result of risks we face, including those discussed in Item 1A of our most recent Forms 10-Q and 10-K. We encourage you to review the information contained in our recent filings with the SEC and our earnings press release. The company does not assume any obligation to revise or update these forward-looking statements to reflect subsequent events or circumstances, except as required by law. Today's presentation also contains non-GAAP financial information. Management uses this information internally to analyze results and believe it may be informative to investors in gaging the quality of our financial performance, identifying trends, and providing meaningful period-to-period comparisons. For a reconciliation of the non-GAAP measures presented, please see the company's most recent Forms 10-Q and 10-K. And with that, I'll hand the call over to David.

Thanks, Jessica, and good morning. We made significant progress in the second quarter executing on our financial and strategic priorities while generating strong cash flows and delevering our balance sheet by 0.5 turn sequentially. We also have strong line of sight on the drivers that will support margin improvement in the second half of the year, and as a result, are reaffirming our fiscal year 2023 financial. Finally, we divested 2 small businesses in the Outside the U.S. segment. I will now discuss our results in greater detail. Maximus reported revenue of $1.21 billion for the second quarter of fiscal year 2023, which represents 2.5% year over year growth, or 4% on an organic basis. Our organic growth more than overcame the completion of short-term COVID work that was about $100 million in the year ago quarter. Adjusted operating income margin was 7.1% and adjusted EPS was $0.80 for the quarter. This compares to 8.3% and $1.07, respectively, for the prior year period, which still included profitable short-term COVID response work in the domestic segments and lower interest expense due to the interest rate environment a year ago. Last year's second quarter was effectively the last period with meaningful short-term work in the business. The Outside the U.S. segment realized a loss and margins in the quarter were slightly below our expectations, primarily driven by the U.S. Federal segment. Let's turn there. For the U.S. Federal Services segment, revenue increased 1.9% to $584 million, which was all organic and driven primarily by volume growth in the VA Medical Disability Exam, or MDE contracts, which comprise our Veterans Evaluation Services, or VES, business. The operating income margin for U.S. Federal Services in the second quarter was 8.2% as compared to 8.1% in the prior year period and slightly lower than we…

Thank you, David, and good morning, everyone. Our second quarter results exhibited meaningful progress on our goal for solid execution and continued momentum building across fiscal 2023. We demonstrated healthy rationalization of our debt and related interest expense. We have taken action in areas of the portfolio that were not driving long-term shareholder value and are committed to further evaluation. Another quarter complete means better visibility to our reaffirmed guidance. Let me share a look behind the scenes as we enter a busy second half of the fiscal year. Top of mind for us is visibility and execution in 2 key areas: first, in our U.S. Services segment, supporting our state customers with their Medicaid redeterminations as part of the unwinding of the continuous coverage provision; and second, in our Federal Services segment, processing high volumes in our Veterans Evaluation Services, or VES, business, which include claims related to the PACT Act. On the redetermination front, the key assumptions that we discussed last quarter remain well intact. That is, we anticipate some states with larger populations, which include our current customers, spreading the work out over the allowable period, meaning there is more than a year in which Maximus will be supporting our state customers in working through this renewal workload. As a result, we anticipate an increase in volumes in our third quarter, meaning we should have full period contribution and be at run rate in our fourth quarter. I'm pleased that we recently added several modestly sized programs to support either existing customers with new eligibility work under which redeterminations fall, or new customers who are seeking assistance during the unwind phase. In addition, we are well positioned to provide assistance to other states later this summer and fall, who may find themselves in need of our expertise…

Thank you. We will now be conducting a question-and-answer session, and I will turn the call over to Mr. Francis.

Good morning and thanks for joining us. Let's first go to the line of Charlie Strauzer with CJS Securities.

Few things to talk about if we could, starting off with the redetermination restart. I've read somewhere that the 5 states have already started doing some work there and wanted to see what you've gleaned from that so far and are other states on the runway that you've heard as well?

Charlie, it's Bruce. I'll start and then ask David to, as we often do, to add some further color commentary. So to give you a sense of where the various states are in the unwinding process, you're absolutely correct. 5 states completed their first cohort of activity in April, 14 states will then complete their first cohort or batch of renewal processing in May. And then we really get what we would have referred to historically the bolus of 20 states in June, followed by 12 more states in July. And those 12 states in July, it's important, are the larger states like California, New York, and Texas. So it's that dynamic that has fed into why we're now characterizing fiscal Q3 as a transition quarter for us for the redetermination activity. It's important also to note that we have more visibility now than we did last quarter and a more refined profile as we transition into Q3 and execute, the step up from Q3 to Q4 is more pronounced than we previously expected as a consequence of this. Still early days, as I noted in my remarks, and I think it's a fair point that some have made that there could be states along the way that encounter backlogs or feel like they need to pick up the pace of processing before the enhanced federal funding of 6.2% expires at the end of the calendar year. So there may be other states that still seek outside help from companies like Maximus. I feel like we're very well positioned, and we've had a lot of conversations in that regard. There's a good balance in our portfolio between serving current clients as we restart redetermination activities with them that we've historically conducted and current clients for whom we're taking on new obligations to complete redetermination activities, as well as new clients all together. So with that, David, any thoughts?

Sure, yes. I noted in my prepared remarks that our prior assumptions are intact, which means that we still anticipate the $0.15 to $0.30 per quarter range that we've been talking about for several quarters. I will reiterate that there is still uncertainty around how precisely the volumes will flow through our programs, given that they depend in part on how beneficiaries interact with the process. And we've also not wavered in our thinking that $0.15 per quarter is a reasonable floor for expected earnings contribution after the unwinding phase. And so, as I mentioned on the last call, if we do experience volumes that bring us toward the high end or even above the high end of that $0.15 to $0.30 range. There's more likely to be a component that's temporary surge in nature and that may decline after the 12- to 14-month period.

And shifting gears to the Federal segment and looking at the VA work that you do. When you see the data that you've seen so far, do you feel like your confidence is high in terms of the profitability margins of that segment ramping in the back half of the year?

Charlie, why don't I give you some data, and David can comment on profitability and so forth as we hit the back end of the year. So this is all information that has been publicly reported in federal news network or is available on the VBA's website. So I'll just consolidate it. And it's a fair question because we really are feeling quite confident about our ability to execute in the back half of the year on these volumes. One of the recent data points is that there's been a 31% increase in the volume of new claims compared to the same period last year. So overall claim volumes are up. Another data point related to that is between August of '22 and April of 2023, the claim volume composition has become 2/3 claims received are non-PACT Act and 1/3 of the claims received are PACT Act. So you can see that volumes are up and mix is shifting now toward PACT Act. The VBA has a total claims inventory, and by inventory -- they define inventory as disability compensation and pension claims that normally require a rating decision, and those are the claims that then lead to exam service requests that we receive that we then complete. Exam service requests have within them different disability benefit questionnaires that our clinicians complete, and together they get bundled up and that completes the exam service request. Those volumes -- that volume of inventory is now over 800,000, and that number has not been seen in terms of inventory since probably about July 2013. So it's a significant inventory, of which 27% are considered backlog and the VBA's definition of backlog is a claim that's been was received has been in inventory for more than 125 days. So the VBA has been tremendous in responding to this and also obviously with their vendor community, but the VBA has grown their workforce by 15% over the past 1.5 year. Putting all of this in context, in terms of PACT Act claims, veterans have so far filed about 0.5 million claims related to toxic exposure and PACT Act conditions that are covered. And if you're going to look at this in total, for the foreseeable future, we feel that there's a very strong inventory, demand is high across the spectrum of claim applications, both PACT-related claims and non-PACT related claims, and so it's with that we have the confidence as we look at the staff that we've ramped up and the productive capacity that we've created to address that inventory and the claims volumes that are needed to deliver on our outlook for the remainder of the fiscal year. David, anything further you would add?

Yes, I guess I would just add that I said in the prepared remarks, Q2 had a timing impact on that business, meaning that costs were incurred ramping up staff but that also we're now confident that we have the capacity to meet the demand in Q3 and Q4. So that supports our view that the margin should improve over the rest of the year.

Looking at the Outside the U.S. segment, if we could, talk about the divestitures there, a little more color behind that and other potential divestitures that you see on the horizon to help bolster margins there.

I'll just comment that we have for some time, and as you would expect, just in terms of good business hygiene, continued to review portions of our portfolio that may not be considered core or strategic in their nature or not meeting financial objectives of the business. And where market conditions allow and it's the prudent thing to do, we take steps to divest those businesses. And in this particular case, we had 2 businesses: one a commercial business in the United Kingdom and the second our employment services business in Sweden that we were able to decide to and take further action on in terms of divesting. We will continue -- I can't point to any other particular business, quite frankly, on the horizon. But we'll just say that we continue to look carefully at the entire portfolio and are ensuring that we're being good stewards of capital and taking actions where necessary. I'm going to ask David, as I often do, if he has anything to add.

I'll add just a little. I mentioned a systematic review that I mentioned in the remarks and that did result in 2 divestitures. We're also concurrently looking hard at the cost structure and addressing that in areas where we've had either a decline or flattening of revenue. So I guess lastly, we're also focusing on how we can grow revenue in areas that can sustain better margins in that segment, an example of which would be the new social case survey program we won last quarter, which unlike employment services programs, which make up a large portion of that segment, it's a little less reliant on certain economic conditions for a full water pressure. So a combination of all these efforts, it will take some time to [mould] this segment, but we're committed to reaching our mid-to-high single-digit objectives for it, and we think we're looking at all the right levers.

And then shifting back to Federal, the IRS contract, we're out of the protest phase and sounds like it was resolved. Can you give us some more color in terms of how that was resolved and a sense of the share for Maximus of that contract value?

Sure. I'll be pretty brief with this. There are 4 awardees on the contract and Accenture and Maximus being the initial 2 that had received previous awards predating the protests and I believe 2 other companies, Booz Allen and IBM have been added to the mix at this point. When we look at that, though, we don't just say, well, what's the ceiling contract value and divide by 4 and that's the potential for the business. That would be an incorrect move. In fact, our view is that that contract vehicle puts in place now the environment in which task orders will be executed that are aligned with the modernization and innovation needs of the IRS. And we feel extremely well positioned given our history at the IRS and being very significant technology provider and maintainer of a number of the core legacy systems that will be subject to modernization. So we feel very good about our position and our ability to be extremely competitive on the task orders as they are released. We're hopeful now that with the protest resolved, there's a clear path for the IRS to release task orders through the summer and ideally work through the award process so that we would see meaningful contributions from those task quarters in our fiscal '24. Does that help?

That's very helpful. And just to wrap me up here, just when you're looking at the allocation of capital, I know M&A is always something that's at the forefront there. Where do you think you would like to see the leverage ratio get down to first before you resume M&A activities?

Yes, I'll take it. It's David, we have moved back now to the middle of our target range, which is 2x to 3x debt to EBITDA, albeit in the near term, we are still committed to further debt paydown. And I'd say our capital allocation strategy has not changed over this period. We do continue to believe we can create a lot of shareholder value through strategic acquisitions, in particular, as they can accelerate organic growth, which has a higher return. So, as always, acquisitions are opportunistic in nature and the timing is difficult to predict exactly when the right acquisitions will be available and we'll be able to complete them. So it's certainly possible that we'll reach the low end or lower of that 2 to 3x target range. But in any event, I want to -- I think it's worth pointing out that we're not going to waiver or deviate from our discipline around valuation and strategic fit of targets. In all cases, we look for return exceeding our cost of capital. And again, anywhere we can look for revenue synergies that accelerate organic growth, we think that can provide a much higher return than our cost of capital.

We have one shareholder question here. Let me pose it to you. Can you give an idea of what led to VES's higher cost for training? Is this more of a supply issue or more of a production issue?

Sure. This is Bruce. I'll start and then turn it over to David. It's a great question. And there are a few moving pieces here that I'd like to explain. We've learned a great deal as we've gotten into the processing of these new types of claims and had a full quarter of PACT Act volumes under our belt. As I mentioned a little bit previously, the VA has received about 0.5 million PACT Act related claims already. And as we've done this work and as is I think customary with any new initiative of this nature, these are different types of cases, different types of claims, they have their own complexities, and there's correspondingly a ramp up or a learning curve for both organizations, for the vendors supporting the VA and for the VA itself. So in this early period of transition, we're both in the process of formalizing our procedures and ensuring that we have kind of a grooved swing, if you will, for handling these types of cases. It's not uncommon for new claim types of this nature for there to be a back and forth between the vendors and the VA to clarify issues, address questions, and so forth. Another interesting data point is the VBA has reported recently that the average number of days to process from start to finish a PACT Act related claim is about 156.5 days, as a data point. In the second quarter, another one of the elements and the moving parts here was the utilization of our staff was a bit below our potential. We had more staff completing training and therefore fewer in production, which led to more overtime, and then what had been anticipated for the fully productive staff that we already had. And as I noted in my remarks, the demand is building at an increasing rate. And so since late FY '22, you'll recall that we've been making investments in lining up the business to meet the anticipated demand. And we're very confident in our ability to have the productive capacity in place required to achieve our forecast. With that, David, anything further to add?

Yes, just to lay on to Bruce's remarks. While revenue was a bit lower than we had forecast in the quarter, the bottom line impact was amplified due to the higher costs, as he mentioned, with the ramping up of staff to meet our expectations for Q3 and Q4.

That's great. That concludes the question-and-answer session. Thanks for joining us today. Operator, back to you.

Ladies and gentlemen, thank you for your participation and interest in Maximus. You may disconnect your line to log off the webcast at this time and enjoy the rest of your day.