UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended September 30, 2005
Commission file number:  1-12997

 


 

MAXIMUS, INC.

(Exact name of registrant as specified in its charter)

 

VIRGINIA

 

54-1000588

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

11419 Sunset Hills Road, Reston, Virginia 

 

20190

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (703) 251-8500

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, no par value

 

New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act:  None

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES ý NO o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). YES ý NO o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  YES o NO ý

 

The aggregate market value of outstanding voting stock held by non-affiliates of the registrant as of March 31, 2005 was $630,212,476 based on the last reported sale price of the registrant’s Common Stock on The New York Stock Exchange as of the close of business on that day.

 

There were 21,412,385 shares of the registrant’s Common Stock outstanding as of November 30, 2005.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive Proxy Statement for its 2006 Annual Meeting of Shareholders to be held on March 22, 2006, which definitive Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of the registrant’s fiscal year, are incorporated by reference into Part III of this Form 10-K.

 

 



 

MAXIMUS, Inc.

Form 10-K

September 30, 2005

 

Table of Contents

 

PART I

 

 

 

 

 

ITEM 1.

Business

 

ITEM 2.

Properties

 

ITEM 3.

Legal Proceedings

 

ITEM 4.

Submission of Matters to a Vote of Security Holders

 

 

 

 

PART II

 

 

 

 

 

ITEM 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

ITEM 6.

Selected Financial Data

 

ITEM 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operation

 

ITEM 7A.

Quantitative and Qualitative Disclosures About Market Risk

 

ITEM 8.

Financial Statements and Supplementary Data

 

ITEM 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

ITEM 9A.

Controls and Procedures

 

ITEM 9B.

Other Information

 

 

 

 

PART III

 

 

 

 

 

ITEM 10.

Directors and Executive Officers of the Registrant

 

ITEM 11.

Executive Compensation

 

ITEM 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

ITEM 13.

Certain Relationships and Related Transactions

 

ITEM 14.

Principal Accounting Fees and Services

 

 

 

 

PART IV

 

 

 

 

 

ITEM 15.

Exhibits, Financial Statement Schedules

 

 



 

PART I

 

ITEM 1.                             Business.

 

General

 

We are a leading provider of consulting, systems solutions and operations program management primarily to government. Since our inception in 1975, we have been at the forefront of innovation in meeting our mission of “Helping Government Serve the People®.” We use our expertise, experience and advanced information technology to make government operations more efficient and cost-effective while improving the quality of services provided to program beneficiaries. We operate primarily in the United States and have had contracts with government agencies in all 50 states, Canada, Australia, Israel and the United Kingdom.

 

Over the last five years, our business has experienced fluctuations in demand for certain services, primarily resulting from the budgetary and fiscal challenges that many states faced during 2001, 2002 and 2003. As a result, we experienced weakness in certain divisions primarily within our Consulting Segment and in the human services area of our Operations Segment. In 2004 and 2005, state financial conditions returned to healthier levels resulting from increased tax receipts and consequently our business has experienced a steady increase in proposals and new work in the last 24 months. For the fiscal year ended September 30, 2005, we had revenue of $647.5 million and net income of $36.1 million.

 

Market Overview

 

Our primary customers are state and local government agencies, but a portion of our business also comes from a variety of federal agencies and commercial customers. In fiscal 2005, approximately 78% of our total revenue was derived from state and local government agencies, 7% from federal government agencies, 8% from foreign customers, and 7% from other sources (such as commercial customers).

 

We believe we are well-positioned to benefit from the continuing demand for consulting, systems solutions and operations program management in an environment where governments are required to maintain or improve services to an increasing number of constituents. We believe governments will continue to review current program operations and seek cost savings through the use of outsourcing. For example, the state of Texas estimates that it will save more than $600 million over the next five years through a major outsourcing initiative to integrate eligibility for multiple entitlement programs. Much of our program management and outsourcing work is related to federally-mandated and federally-funded programs such as Medicaid and Temporary Assistance to Needy Families (TANF). As a result, we expect the demand for our existing outsourcing programs to remain stable due to the fundamental need and federal mandate for governments to provide these services to beneficiaries. In addition, we believe governments will continue to upgrade technology in order to increase cost efficiency and program productivity. To achieve these results, many government agencies are engaging outsourcing business services firms, such as MAXIMUS, for help.

 

We deliver valued-added services to government agencies by providing consulting, systems solutions and operations program management that help governments operate more efficiently and effectively. Demand for each of our services is contingent upon specific market factors related to our vertical markets and we believe that several factors which impact government spending will drive increased demand for our services, including:

 

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                  The need for states running federally-mandated and federally-funded programs to efficiently and cost-effectively meet minimum federal requirements in order to maintain federal funding levels.

 

                  The requirement of state governments to implement federal initiatives such as the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, which establishes prescription drug benefits as part of the Medicare program beginning January 1, 2006.

 

                  The desire by governments to continue to implement comprehensive solutions to drive efficiency and process improvements with the use of new technology offered by a single-source service provider that can offer long-term maintenance support.

 

                  The need for governments to operate more programs with the same level of resources. Consequently, government clients possess the desire to outsource programs to companies that have greater flexibility in balancing resources (such as workforce) with demand.

 

                  The impact of continued budgetary pressures on governments, including the need for the vast majority of states to maintain balanced budgets. These budgetary requirements increase the desire by governments to seek and maximize federal funding to which they are entitled.

 

As a result, governments seek to utilize outside companies such as MAXIMUS that possess the knowledge and resources to efficiently operate federally funded programs, maintain minimum federal requirements in order to achieve the maximum federal funding as well as to secure additional federal dollars, in areas such as Medicaid, on their behalf.

 

Our Business Segments

 

The following discussion describes our business segments and each of our operating divisions within the business segments as they existed as of September 30, 2005. From time to time, we implement certain organizational or management changes which realign our internal infrastructure and enable us to better manage our business.

 

Consulting Segment:

 

Our Consulting Segment generated approximately 17% of our total revenue in fiscal 2005. Financial information with respect to this segment is provided in Notes 16 and 17 of our consolidated Financial Statements (See Item 8 below). The Consulting Segment provides specialized financial consulting services such as assisting state and local agencies in obtaining federal funding reimbursements for their programs. The Consulting Segment also offers educational services that assist schools in obtaining federal funding reimbursements, reducing costs, and implementing our proprietary student information software. These services are provided through the following divisions:

 

Revenue Services Division. Our Revenue Services Division assists states in obtaining federal funding reimbursements for health and human services expenditures. Our revenue maximization projects are generally carried out on a contingency-fee basis determined as a percentage of funds recovered from the federal government. We also assist states in minimizing expenditures for high cost health care cases and recovering expenditures from commercial health care payers.

 

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Child Welfare Division. Our Child Welfare Division provides consulting services that help state, county, and community-based child welfare agencies improve the outcomes for children and their families. These services include children’s safety, attainment of permanent families, physical health, mental health, education of children in the child welfare system, and improving the functioning of families so that parents can care for their own children. The division also works to ensure that agencies achieve incentives and avoid penalties by complying with federal regulations. The division builds the necessary child welfare infrastructure to ensure the effective execution of core functions such as eligibility determination, rate setting, contracting, licensing, case tracking and quality assurance. The division is often called upon to directly provide and manage these core functions including eligibility determination, support for adoption assistance and quality assurance. Services are typically on a payment-for-deliverable basis.

 

Cost Services Division. Our Cost Services Division assists local and state governments in their efforts to recover available funding from state and federal agencies, enhance revenue, and operate efficiently. Service areas include cost allocation services, user fee efforts, management studies, and local government engagements which mandate specific claiming requirements under certain programs, such as the State Criminal Alien Assistance Program (SCAAP) for housing illegal aliens, FEMA Disaster Claiming Assistance, and California SB-90, which requires California to reimburse counties for state mandated activities.

 

Unison-MAXIMUS. Unison-MAXIMUS provides aviation planning and consulting services in the area of finance, business management, retail concession planning, and facility planning for airports throughout the country. The division’s primary mission is to help airports increase revenues, enhance passenger satisfaction, improve concessionaire performance, and receive community recognition.

 

Educational Services Division. Our Educational Services Division provides financial analysis, fiscal management and billing services to help schools maximize federal funding from Medicaid claiming for qualified special education students. This division also provides school districts with software to provide electronic Individualized Educational Plans and special education case management software to ensure compliance with federal and state laws, to reduce the paperwork requirements on educators, and to improve the effectiveness of their special education programs. We have provided school-related revenue maximization projects for more than 2,000 school districts nationwide. This division supports four educational suites of services including revenue enhancement, cost reduction, compliance, and student performance improvement. The division also licenses specialized software systems and consulting to higher education research institutions across the country to assist them in managing their research grants efficiently and effectively, enhancing their administrative effectiveness, and reducing and reallocating costs.

 

Educational Systems Division. Our Educational Systems Division provides consulting services, technical support, and software tools primarily to K-12 school districts, charter schools, state departments of education, and not-for profit organizations. The division licenses or provides hosting services using SchoolMAX® (our proprietary student information system). SchoolMAX® captures, retrieves, and aggregates all relevant student, family, and school information regarding enrollment, student demographics, class scheduling, grades, attendance, healthcare, discipline, special education, parental notifications, textbook management, and other critical school management functions. In addition, the division works with school districts and state governments to help satisfy certain requirements under the No Child Left Behind Act of 2001, and integration with decision support and other major educational systems such as student assessment, curriculum management, asset and facilities management, and food services.

 

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Systems Segment:

 

Our Systems Segment generated approximately 21% of our total revenue in fiscal 2005. Financial information with respect to this segment is provided in Notes 16 and 17 of our consolidated Financial Statements. The Systems Segment designs and implements our proprietary software and third party software solutions to improve the efficiency and cost-effectiveness of program administration and offers systems products in the areas of justice and asset solutions. These products and services are provided through the following divisions:

 

ERP Services Division. The Enterprise Resource Planning (ERP) Services Division works primarily with government and educational entities to implement PeopleSoft® applications and provide government specific information technology (IT) consulting services. The division delivers cost-efficient technology-based business solutions including customer information systems and utility billing, financial, human resources management, payroll, procurement, and student administration systems. In addition to implementation, integration, and training services, this division conducts return-on-investment assessments for major IT projects.

 

Technology Support Division.  The Technology Support Division provides strategic management and information technology consulting services to state agencies. Our experienced team of project management and information technology professionals applies industry recognized standards and methodologies throughout the system development life cycle. The division has assisted customers in planning, procuring, and implementing information systems in multiple projects across numerous states. The division’s services include business process transformation, change management, and the application of information technology to improve service delivery. These services also include the application of standards-based project management, quality assurance, and independent verification and validation services to assist our customers in successfully managing the development, implementation and deployment of automated systems.

 

Enterprise Services Division. The Enterprise Services Division leverages technology, software product solutions and systems integration to provide a variety of systems solutions to government customers. The division includes software development, data warehousing, and an Application Service Provider operations team. The division consolidates a number of technology practices into a single group including the MAXIMUS Security and ID Management (smart cards) initiative, electronic benefits transfer, electronic commerce, electronic payment systems and financial clearing house design, and the MAXChildcare software solution. The division also develops and implements integrated information technology system solutions for state criminal justice systems.

 

Asset Solutions Division. The Asset Solutions Division is a leading provider of software solutions that enable organizations to more effectively manage their asset infrastructure, including facilities and fleet and transit assets, as well as fuel management and distribution for fleet and transit organizations. The Asset Solutions Division serves over 600 customers including government agencies, public utilities, mass transit, educational institutions and commercial enterprises. The division offers a broad range of fleet consulting services such as competitiveness assessments, business planning, and information technology. Its software and industry expertise helps organizations streamline operations, achieve cost savings, and improve service levels. The division also assists entities with complying with the Government Accounting Standards Board reporting requirements for asset evaluation and management, and provides physical inventory control, regulatory compliance and reporting, and asset valuation services.

 

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Justice Solutions Division. The Justice Solutions Division develops, implements, and supports software programs designed to increase the efficiency of state and local court systems. Our products include case management, docketing, scheduling, and report generating software used in all stages of the judicial process. The division implements and supports a jury management software program that creates jury lists, generates notices, and monitors attendance and payments. Other service offerings include a records management software solution to automate recordkeeping functions for county recorders’ offices and the JailView® software application which is designed to assist law enforcement officials in the management of jails and the tracking of inmate records. We work with law enforcement agencies, courts, and corrections agencies to develop systems that integrate and facilitate access to criminal justice information and records.

 

Operations Segment:

 

Our Operations Segment generated approximately 62% of our total revenue in fiscal 2005. Financial information with respect to this segment is provided in Notes 16 and 17 of our consolidated Financial Statements. The Operations Segment provides a variety of program management and outsourcing services for federal and state funded public programs, and focuses on the delivery of administrative services for government health and human services programs including integrated eligibility programs, Temporary Assistance to Needy Families (TANF) funded workforce services programs, child support enforcement programs, Children’s Health Insurance Programs (CHIP), and Medicaid programs. Our Operations Segment provides these services through the following divisions:

 

Health Services Divisions.  The Health Services Divisions consist of regional divisions that provide a range of administrative support for publicly funded health services and health insurance programs, with a particular emphasis on eligibility and enrollment for state Medicaid Managed Care and CHIP. Under these public health programs the divisions provide: beneficiary outreach, education, and enrollment counseling; customized automated information systems; design and development of program educational materials; full-service call center customer services such as on-site multilingual assistance; program data collection and reporting; and program eligibility determination.

 

Medical Management Division. The Medical Management Division provides health dispute resolution for federal, state, and local government agencies. An important safeguard for members of managed care plans is the right to appeal health care decisions. The Medical Management Division operates an extensive system for the independent medical review of disputed health insurance claims using an experienced staff of legal and clinical professional. We serve as the national contractor for external appeals in the federal Medicare managed care program, and we are a qualified contractor under two new programs with the Centers for Medicare and Medicaid (CMS) including the Qualified Independent Contractor (QIC) program and the Medicare Drug Integrity Contractor (MEDIC) program. Additionally, we serve as the independent review contractor in more than 30 states, and we are the National Quality Monitoring Contractor for TRICARE, the Department of Defense managed healthcare program. We also operate a Center for Health Literacy and Communication Technologies that concentrates on producing reader-friendly and culturally appropriate information for low-literacy populations.

 

Workforce Services Division. The Workforce Services Division manages government workforce-centered service programs in the United States, Australia, and Israel. We help disadvantaged individuals transition from government assistance programs to employment and independence by providing comprehensive services, including eligibility determination, case management, job readiness preparation and search, job development and employer outreach, job retention and career advancement, and selected educational and training services. Additionally, we offer advocacy services for youth and disabled persons in the United States and rehabilitation services in Australia, assistance to employers in accessing tax credit

 

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benefits, and research and survey solutions to government agencies through our Center for Public Studies and Surveys. In tandem with the requirement for governments to modernize their voting systems under the Help America Vote Act of 2002, we provide the overall project management, training, and outreach services required to successfully implement new voting technology.

 

Child Support Division. The Child Support Division provides outsourcing, consulting, and system support services to state and local child support programs. These services include full and specialized child support case-management services, call center staffing, and program and systems consulting services. The division also has a collections unit that collects child support in hard-to-collect cases, as well as other government debts, including county and court tax and fine debts. The division provides technological services that improve automated systems, payment processing, both web-based and automated customer service, and imaging solutions. The Child Support Division has provided child support services and consultation in all 50 states and Canada.

 

Corrections Division. The Corrections Division provides a variety of nonresidential correction services including offender assessment, case management, treatment groups, educational classes, drug and alcohol testing, and the collection of fines, fees, and restitution from individuals who have been found guilty of misdemeanor offenses. Using proprietary software, the division manages offender case information, activities, and related financial information.

 

Competitive Advantages

 

We offer a private sector alternative for the administration and management of critical government funded programs as well as offering consulting and systems solutions. Although some of our competitors benefit from greater financial resources and brand name recognition, our reputation and extensive experience over the last 30 years give us a competitive advantage as governments seek out and value the level of expertise and brand recognition that MAXIMUS brings to its customers. The following is a detailed discussion of the competitive advantages that allow us to capitalize on various market opportunities:

 

Single-market focus. We are one of the largest publicly-traded companies whose primary focus is offering a portfolio of consulting, systems solutions, and operations program management specifically to government customers. This single-market concentration allows us to fully dedicate time and resources in providing quality, customized solutions to government customers. Our 30 years of experience give us a detailed understanding of the regulation and operation of government programs which allows us to apply our methodologies, skills, and solutions to new projects in a cost-effective and timely fashion. We believe our government program expertise differentiates us from other firms and non-profit organizations with limited resources and skill sets, as well as from large consulting firms that serve multiple industries but lack the focus necessary to efficiently manage the complexities of serving government agencies.

 

Wide range of services. Many customers require a broad array of service capabilities. Engagements often require creative or complex solutions that must be drawn from diverse areas of expertise within our organization. Our broad range of capabilities, as described above, enables us to better pursue new business opportunities and positions us as a single-source provider of consulting, systems solutions, and operations program management to government agencies.

 

Proven track record. Since 1975, we have successfully and profitably assisted governments by offering efficient, cost-effective solutions. We have completed hundreds of large-scale consulting, technical systems engagements, and program management operations, for government agencies serving millions of beneficiaries. The successful execution of these projects has enhanced our reputation with government agencies while improving the quality of services provided to program beneficiaries. Our track record and

 

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reputation have contributed significantly to our ability to compete successfully and win new contracts.

 

Expertise in competitive bidding. Government agencies typically award contracts to third-party providers through a comprehensive, complex, and competitive bidding process. With over 30 years of experience responding to Requests for Proposals (RFPs) and executing orals and demonstrations, we have the necessary experience to navigate these government procurement processes. The complex nature of competitive bidding creates significant barriers to entry for potential new competitors unfamiliar with the nature of government procurement. We possess the expertise and experience to assess and allocate the appropriate resources necessary for successful project completion in accordance with contractual terms. Our proposals demonstrate our ability to meet all customer requirements at a price that is both attractive to the customer and profitable to MAXIMUS. Coupled with reluctance on the part of government agencies to award contracts to unproven companies, we believe that our expertise in the competitive bidding process has contributed significantly to our success.

 

Intellectual property. We have software products that enhance our consulting, systems solutions, and operations program management offerings. Further, our ability to focus our subject matter experts to aid in the support and enhancement of our product offerings provides advantages over pure service providers dependent on third-party software.

 

In addition to our Justice, Transportation and Facility Asset Management and Education software product lines, we have developed an open architecture system utilizing a Java 2 Enterprise Edition (“J2EE”) framework and components. (Java and J2EEare trademarks of Sun Microsystems, Inc.) Current e-Government initiatives are mandating open architecture systems that will provide greater interoperability among agencies, systems, and programs, as well as enhanced flexibility and scalability. Our J2EE framework gives us a competitive advantage by aligning our systems and services offerings with these critical government standards. The J2EEframework also serves as a logical and cost-effective migration path for current customers who use our legacy MAXSTAR® Application Builder, an automated case management software product that interfaces with government databases, tracks program participant records and cases, and supports extraction and analysis of program data. We believe we enjoy a competitive advantage in re-bid situations since we can implement a state-of-the-art open standards system at lower risk and cost to the customer.

 

Our MAXe3 proprietary system solution is an open architecture, web-based system for managing operations in enrollment and eligibility projects. MAXe3 uses an innovative task management design that is a departure from current case management designs. The task management design is more efficient and better at tracking and accountability than the older generation systems. MAXe3, which resides on an Oracle platform, is easily scalable from the smallest to the largest operations. It serves as an important and unique component for state health and human services re-engineering efforts for their eligibility and enrollment operations.

 

Experienced Management Team and Subject Matter Expertise. We have assembled an experienced team of industry executives, former government executives, state agency officials, information technology specialists, and other professionals, many of whom have considerable experience in the public services industry. We have also developed strong relationships with experienced consultants who inform and advise us with respect to strategic marketing opportunities and legislative initiatives.

 

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Competition

 

The market for providing our services to government agencies is competitive and subject to rapid change. Our principal methods of competition are quality of service and pricing, and we have identified certain positive factors relating to us in “Competitive Advantages” above. Our Consulting Segment typically competes against large consulting firms such as Accenture Ltd., as well as smaller and niche players, such as Public Consulting Group. Our Systems Segment competes with a large number of competitors including Unisys Corporation, SAP America, Inc., Oracle Corporation, BearingPoint, Inc., Accenture Ltd., Deloitte & Touche LLP, Northrup Grumman Corporation, and Electronic Data Systems Corporation. Our Operations Segment, which primarily serves health and human services departments and agencies, competes for program management contracts with the government services divisions of large organizations such as Affiliated Computer Services, Inc., Electronic Data Systems Corporation, and International Business Machines Corporation. as well as more specialized private service providers and local non-profit organizations such as the United Way of America, Goodwill Industries, and Catholic Charities USA.

 

Business Growth Strategy

 

Our goal is to enable future growth by remaining a leading provider of consulting, systems solutions, and operations program management to government agencies. The key components of our business growth strategy include the following:

 

                  Aggressively pursue new business opportunities and expand our customer base. With 30 years of business expertise in the state and local government market, we continue to be a leader in developing innovative solutions to meet the evolving needs of government agencies. We believe our capabilities and brand recognition are our most critical assets and we continue to identify, respond to and secure new business opportunities in an effort to grow our existing revenue base.

 

                  Focus on core offerings and expand customer base. Our fundamental services to state and local government are consulting, systems solutions, and operations program management. We seek to broaden our customer base by delivering our core offerings, such as our health services, to new clients such as the federal government and state customers. As a result, we have placed a considerable amount of emphasis on further developing these core practice areas and expanding our customer base by leveraging existing resources to better serve clients.

 

                  Mitigate losses in underperforming units. During fiscal 2005, we downsized and stabilized certain underperforming units which remain under management review. We will continue to evaluate the businesses within the organization and will act accordingly on other underperforming practice areas that we view as non-core or non-strategic to future growth.

 

                  Grow long-term, recurring revenue streams. We seek to enter into long-term relationships with clients to meet their on-going and long-term business objectives. As a result, long-term contracts (three to five years with additional option years) are often the preferred method of delivery for customers and are mutually beneficial to them and the Company.

 

                  Recruit and retain highly skilled professionals. We continually strive to recruit motivated individuals including top managers from larger organizations, former government officials, consultants experienced in our service areas, and information technology professionals. We

 

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believe we can continue to attract and retain experienced personnel by capitalizing on our single market focus and our reputation as a premier government services consultant.

 

                  Pursue strategic acquisitions. We will selectively identify and pursue strategic acquisition opportunities. Acquisitions can provide us with a rapid, cost-effective method to enhance our services, obtain additional skill sets, expand our customer base, cross-sell additional services, enhance our technical capabilities, and establish or expand our geographic presence.

 

See Exhibit 99.1 of this Annual Report on Form 10-K under the caption “Important Factors Regarding Forward Looking Statements” for information on risks and uncertainties that could affect our business growth strategy.

 

Marketing and Sales

 

We generate new business opportunities by establishing and maintaining relationships with key government officials, policy makers, and decision makers. We have a team of business development professionals who ensure that we understand the needs, requirements, and legislative initiatives and priorities of our current and prospective customers. In conjunction with our subject matter experts and marketing consultants, our business development professionals create and identify new business opportunities and ensure that we proactively introduce our solutions and services early in the procurement cycle. We also subscribe to government procurement databases that track government bid activity and make every effort to ensure that we are on bidders’ lists as well as approved vendor lists for government procurement offices. We participate in professional associations of government administrators and industry seminars featuring presentations by our executives and employees. Senior executives also develop leads through on-site presentations to decision-makers.

 

Because we obtain much of our work by responding to RFPs issued by government agencies, we have developed and implemented a sophisticated RFP tracking and capture plan system which provides us critical information about the status of existing RFPs, actions to date and deliverables with respect to those RFPs.

 

For the year ended September 30, 2005, we derived approximately 16% of our consolidated revenue from contracts with the state of California, principally within our Operations segment.

 

Legislative Initiatives

 

There have been a number of legislative initiatives that have created new growth opportunities for MAXIMUS. Recent government actions have opened up new markets for MAXIMUS in the areas of election reform, homeland security, and education reform. In addition to these new market areas, MAXIMUS continues to help governments meet their evolving requirements.

 

There are a number of legislative initiatives to reform and modify a wide range of entitlement programs such as Medicare, Medicaid, and Temporary Assistance for Needy Families (TANF). MAXIMUS is well-positioned to meet the consulting, systems solutions, and operations program management needs of government that may result from legislative actions in these areas. MAXIMUS is actively monitoring these initiatives in order to respond to opportunities that may develop.

 

Some recent legislative initiatives that have created new growth opportunities for us include the following:

 

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Help America Vote Act of 2002 (HAVA). Signed into law by President Bush on October 29, 2002, HAVA authorizes $3.9 billion for states to improve the operation of elections through the modernization of election voting technology and statewide voter registration systems, the improved training of election officials, and increased equal access for disabled voters. HAVA directs each state to develop an election reform plan. Federal funds for each state are allocated based on a certification of compliance with federal guidelines and a variety of demographic parameters. MAXIMUS is providing election reform technology and services to state and local governments in a number of states including California, Missouri and Montana.

 

Homeland Security Presidential Directive (HSPD-12). HSPD-12, dated August 27, 2004, titled “Policy for a Common Identification Standard for Federal Employees and Contractors,” directed the U.S. Department of Commerce to promulgate a federal standard for secure and reliable forms of identification for federal employees and contractors. It further specified that such secure and reliable identification a) be issued based on sound criteria for verifying an individual employee’s identity; b) be strongly resistant to identity fraud, tampering, counterfeiting, and terrorist exploitation; c) be rapidly authenticated electronically; and d) be issued only by providers whose reliability has been established by an official accreditation process.

 

A Federal Information Processing Standard (FIPS 201) was signed by the Secretary of Commerce on February 25, 2005. Executive departments and agencies are required to use this new standard for identifying federal employees and contractors requesting access to federally-controlled facilities and logical access to federally-controlled information systems. All agencies have been directed to come into compliance with the first part of FIPS 201, which outlines minimum requirements for a federal personal identity verification (PIV) system, by October 27, 2005. All agencies must also come into compliance with the second part of FIPS 201, which requires agencies to meet detailed specifications that will support technical interoperability among PIV systems of federal departments and agencies, by October 27, 2006.

 

Our Systems Segment has specific expertise in security card technology, and has been hired by a number of federal agencies to assist with the design, development and deployment of such systems. HSPD-12 will drive the rapid adoption of these systems and we plan to pursue future work in providing assistance to agencies for the implementation of this initiative. In addition to the activity being driven by HSPD-12, there are a number of other homeland security initiatives being formulated at the federal, state, and local levels that offer opportunities for MAXIMUS.

 

No Child Left Behind Act of 2001 (NCLB). NCLB was signed into law on January 8, 2002. The act requires states to provide public school choice and supplemental services for students in failing schools; integrate scientifically-based research into comprehensive reading instruction for young children; set and monitor adequate yearly progress based on baseline 2001-02 data; issue annual report cards on school performance and statewide test results by the 2002-03 school year; implement annual, standards-based assessments in reading and math for grades 3-8 by the 2005-06 school year; and assure that all classes are taught by a qualified teacher by the 2005-06 school year. We believe that our SchoolMAX® product, a student information system, is an essential tool in helping the approximately 17,000 school districts in the country meet many of the requirements of NCLB.

 

Medicare Prescription Drug, Improvement, and Modernization Act of 2003. This law is one of the broadest changes to the Medicare program since its creation over 40 years ago. For the first time, a prescription drug benefit will be part of the Medicare program. The centerpiece of the legislation is the establishment of a prescription drug benefit program for Americans on Medicare. The government is

 

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introducing this benefit in two phases. Phase 1 is the introduction of an interim discount drug card; Phase 2, which begins in January 2006, is a full-fledged prescription drug plan with numerous cost reimbursement and coverage thresholds. The provisions in the bill provide MAXIMUS with opportunities in core competency areas such as eligibility determination, appeals and grievance adjudication, as well as outreach and enrollment functions.

 

MAXIMUS was selected by the Center for Medicare and Medicaid Services as the sole vendor to perform third party appeals for individuals who have applied to receive the Medicare discount drug card. The new law also replaces the Medicare+ Choice program that offered privately-managed insurance alternatives to seniors eligible for Medicare. The new program, named Medicare Advantage, increases beneficiaries’ choices of plans and services, and it is anticipated that there will be an increase in the number of managed care providers participating in the plan. The new program, with its additional insurer options, opens up opportunities for MAXIMUS to provide enrollment brokering, auditing, and consulting services.

 

Backlog

 

Backlog represents an estimate of the remaining future revenue from existing signed contracts and revenue from contracts that have been awarded but not yet signed. Our backlog estimate includes revenue expected under the current terms of executed contracts and revenue from contracts in which the scope and duration of the services required are not definite but estimable (such as performance-based contracts), but does not assume any contract renewals or extensions. Management estimates that approximately 82% of forecasted fiscal 2006 revenue is in the form of backlog at September 30, 2005, and will be realized as revenue in the following twelve months.

 

Changes in backlog result from additions to future revenue from the execution of new contracts or extension or renewal of existing contracts, reductions from fulfilling contracts, reductions from the early termination of contracts, and adjustments to estimates of previously-included contracts. Our contracts typically contain provisions permitting government customers to terminate the contract on short notice, with or without cause. We believe that period-to-period backlog comparisons are difficult and do not necessarily accurately reflect future revenue we may receive. The actual timing of revenue receipts, if any, on projects included in backlog could change for any of the aforementioned reasons. The dollar amount by segment of our backlog as of September 30, 2004 and 2005, were as follows:

 

 

 

As of September 30,

 

 

 

2004

 

2005

 

 

 

(In millions)

 

Consulting

 

$

131.0

 

$

120.0

 

Systems

 

143.8

 

116.3

 

Operations

 

925.2

 

1,463.7

 

Total

 

$

1,200.0

 

$

1,700.0

 

 

Seasonal Nature of Business

 

We experience seasonality in our operations segment in our third fiscal quarter as a result of open enrollments in certain large health-related contracts and in our fourth fiscal quarter as a result of tax credit work. In addition, the summer and winter holiday vacations can impact our financial results for all of our segments. Specifically, reductions in working days as a result of holidays and vacations may impact our sales and accounts receivable.

 

11



 

Employees

 

As of September 30, 2005, we had 5,227 employees, consisting of 323 employees in the Consulting Segment, 570 employees in the Systems Segment, 4,126 employees in the Operations Segment and 208 corporate administrative employees. Our success depends in large part on attracting, retaining and motivating talented, innovative and experienced professionals at all levels.

 

As of September 30, 2005, 486 of our employees in Canada were covered under three different collective bargaining agreements, each of which has different components and requirements. There are 318 employees covered by the Health Insurance British Columbia collective bargaining agreement with the British Columbia Government and Services Employees’ Union (“BCGEU”). Within Themis Program Management and Consulting Limited, we have two agreements. Under the first agreement, 155 employees are covered by a collective bargaining agreement with the BCGEU and, under the second agreement, 13 employees are covered by a collective bargaining agreement with the Professional Employees Association (“PEA”). These collective bargaining agreements expire on March 31, 2006.

 

None of our other employees are covered under any such agreement. We consider our relations with our employees to be good.

 

Foreign Operations

 

We currently operate predominantly in the United States. Our revenues derived from operations in foreign countries for fiscal years 2003, 2004, and 2005 were $26.7 million, $30.0 million, and $49.7 million, respectively. We had approximately $12.0 million and $22.5 million of long-lived assets located in foreign countries at September 30, 2004 and 2005, respectively.

 

Website Access to U.S. Securities and Exchange Commission Reports

 

Our Internet address is http://www.maximus.com. Through our website, we make available, free of charge, access to all reports filed with the U.S. Securities and Exchange Commission (SEC) including our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and amendments to these reports, as filed with or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Copies of any materials we file with, or furnish to, the SEC can also be obtained free of charge through the SEC’s website at http://www.sec.gov or at the SEC’s Public Reference Room at 100 F St., N.E., Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.

 

ITEM 2.                             Properties.

 

We own a 60,000 square foot office building in Reston, Virginia and a 21,000 square foot office building in McLean, Virginia. We also lease offices for management and administrative functions in connection with the performance of our services. At September 30, 2005, we leased 181 offices in the United States totaling approximately 1,028,000 square feet. In three countries outside the United States, we leased 41 offices containing approximately 176,000 square feet. The lease terms vary from month-to-month to six-year leases and are generally at market rates.

 

We believe that our properties are maintained in good operating condition and are suitable and adequate for our purposes.

 

12



 

ITEM 3.                             Legal Proceedings.

 

We are involved in various legal proceedings, including contract claims, in the ordinary course of our business. In our opinion, we do not expect the ultimate outcome of the legal proceedings or contract claims to have a material adverse effect on our financial condition or our results of operations.

 

(a) In the third quarter of fiscal 2004, the Company learned that two former employees, who were principals in a small business MAXIMUS acquired in 2000, had signed fraudulent guarantees on behalf of MAXIMUS for computer equipment leases. The equipment was leased from Solarcom LLC which, in turn, assigned certain of the payments under the leases to Fleet Business Credit LLC (“Fleet”) and De Lage Landen Financial Services, Inc. (“De Lage Landen”).  The Company did not have knowledge of the leases or guarantees, and much of the equipment appears to have been used in businesses unrelated to MAXIMUS. Solarcom demanded approximately $31.0 million from MAXIMUS under the guarantees, which amount represented the remaining payments under the leases.

 

On August 6, 2004, De Lage Landen sued MAXIMUS and Solarcom in the federal District Court for the Eastern District of Pennsylvania seeking recovery of damages, and Solarcom asserted a cross-claim against MAXIMUS.  Solarcom and De Lage Landen subsequently reached an agreement whereby De Lage Landen dismissed its claims against Solarcom without prejudice and Solarcom was realigned as a plaintiff in the lawsuit.  The amount claimed by De Lage Landen was part of the approximately $31.0 million originally demanded by Solarcom.

 

In order to avoid the uncertainty of a jury trial and the expense of protracted litigation, in September 2005 the Company settled the claim by De Lage Landen, and the Pennsylvania action has been dismissed.  The confidential settlement was entered into without admission of fault or liability by the Company.  The Solarcom claim against the Company in the Pennsylvania action was dismissed without prejudice with the understanding that Solarcom would amend its claim in the ongoing Georgia action (described below) to include the damages it originally sought in the Pennsylvania matter.  The Company believes that the settled De Lage Landen claim represented about 45% of the original $31.0 million in claims against the Company arising out of this matter.

 

In connection with that settlement, MAXIMUS recorded a charge of $7.0 million for the fiscal year ended September 30, 2005.  That amount includes the settlement amount paid to De Lage Landen and the associated legal expenses for the fiscal year, as well as a liability for estimated probable future defense costs of the ongoing Georgia lawsuit.

 

Solarcom filed suit against MAXIMUS on August 17, 2004 in state court in Gwinnett County, Georgia. On August 24, 2004, Fleet sued MAXIMUS and Solarcom in the federal District Court for the Northern District of Georgia. The Solarcom and Fleet actions were consolidated in the federal District Court for the Northern District of Georgia on September 29, 2004.  No date has been set yet for a trial in the Georgia action.  The plaintiffs in the Georgia matter have asserted damages of approximately $17.0 million, which includes alleged late fees and interest on the lease payments.

 

The Company believes that the circumstances related to the ongoing Georgia lawsuit are unique and that it is not possible at this time to determine the ultimate loss that may be incurred, if any.  The Georgia suit involves a different jurisdiction, different party (Fleet), different facts (including due diligence activities), and a different procedural posture (Solarcom has not been realigned as a plaintiff in Georgia).  Because the guarantees were fraudulently signed, and because the leasing company did not perform appropriate due diligence, the Company continues to believe that it is not liable under the guarantees and will continue to vigorously contest the Georgia matter. Accordingly, no provision for

 

13



 

settlement or unfavorable outcome of the Georgia lawsuit has been made at this time.

 

The Company has also reported the matter to law enforcement authorities, and has filed claims against the former employees. Those claims have been referred to arbitration for resolution. Although there can be no assurance of a favorable outcome, the Company does not believe that the remaining claims in Georgia will have a material adverse effect on its financial condition or results of operations.

 

(b) In October 2004, MAXIMUS received a subpoena from the U.S. Attorney’s Office for the District of Columbia. The subpoena requested records pertaining to the Company’s work for the District of Columbia, primarily in the area of assisting in the submission and payment of federal Medicaid reimbursement claims prepared on behalf of the District of Columbia. The U.S. Attorney’s Office appears to be investigating issues pertaining to compliance with federal health care laws. MAXIMUS does not believe it has violated those laws and is cooperating fully with the U.S. Attorney’s Office. Although there can be no assurance of a favorable outcome, the Company does not believe that this matter will have a material adverse effect on its financial condition or results of operations, and the Company has not accrued for any loss related to this matter.

 

(c) In June 2005, MAXIMUS received a subpoena from the Office of the Attorney General of Illinois in connection with a purported whistleblower investigation of potential false claims. The subpoena requested records pertaining to the Company’s work for agencies of the Executive Branch of Illinois State Government. Discussions with the Attorney General’s office indicate that MAXIMUS was one of nine contractors that received such subpoenas and that the investigation is primarily focused at this time on the procurement and contracting activities of the Illinois Department of Central Management Services. Although there can be no assurance of a favorable outcome, the Company does not believe that this matter will have a material adverse effect on its financial condition or results of operations, and the Company has not accrued for any loss related to this matter.

 

ITEM 4.                             Submission of Matters to a Vote of Security Holders.

 

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

 

PART II

 

ITEM 5.                             Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Our common stock trades on the New York Stock Exchange under the symbol “MMS”. The following table sets forth, for the fiscal periods indicated, the range of high and low sales prices for our common stock and the cash dividends per share declared on the common stock.

 

14



 

 

 

Price Range

 

 

 

 

 

High

 

Low

 

Dividends

 

Year Ended September 30, 2004:

 

 

 

 

 

 

 

First Quarter

 

$

40.62

 

$

33.12

 

 

Second Quarter

 

41.24

 

33.76

 

 

Third Quarter

 

38.20

 

33.26

 

 

Fourth Quarter

 

35.56

 

27.83

 

 

 

 

 

 

 

 

 

 

Year Ended September 30, 2005:

 

 

 

 

 

 

 

First Quarter

 

$

32.00

 

$

26.35

 

 

Second Quarter

 

35.19

 

28.59

 

$

0.10

 

Third Quarter

 

36.30

 

30.00

 

0.10

 

Fourth Quarter

 

38.85

 

35.22

 

0.10

 

 

As of November 30, 2005, there were 97 holders of record of our outstanding common stock. The number of holders of record is not representative of the number of beneficial owners due to the fact that many shares are held by depositories, brokers, or nominees. We estimate there are approximately 8,200 beneficial owners of our common stock.

 

We declared quarterly cash dividends on our common stock at the rate of $0.10 per share beginning with the quarter ended March 31, 2005. We expect to continue our policy of paying regular cash dividends, although there is no assurance as to future dividends. Future cash dividends, if any, will be paid at the discretion of our board of directors and will depend, among other things, upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and such other factors as our board of directors may deem relevant.

 

15



 

The following table sets forth the information required regarding repurchases of common stock that we made during the three months ended September 30, 2005 and cumulative repurchases under our share repurchase program:

 

Period

 

Total Number
of Shares
Purchased

 

Average
Price Paid
per Share

 

Total Number of
Shares Purchased as
Part of Publicly
Announced Plan (1)

 

Approximate Dollar
Value of Shares that May Yet Be Purchased
Under the Plan

 

 

 

 

 

 

 

 

 

 

(in thousands)

 

Inception through June 30, 2005

 

4,097,473

 

$

26.91

 

4,097,473

 

$

27,144

 

July 1, 2005 - July 31, 2005

 

 

 

 

$

30,185

 

August 1, 2005 – August 31, 2005

 

77,200

 

$

37.13

 

77,200

 

$

27,891

 

September 1, 2005 – September 30, 2005

 

33,300

 

$

35.88

 

33,300

 

$

29,451

 

Total – Quarter ended September 30, 2005

 

110,500

 

$

36.75

 

110,500

 

 

 

Inception through September 30, 2005

 

4,207,973

 

$

27.17

 

4,207,973

 

 

 

 


(1) Under resolutions adopted and publicly announced on May 12, 2000, July 10, 2002, and April 2, 2003, our Board of Directors has authorized the repurchase, at management’s discretion, of up to an aggregate of $90.0 million of common stock under our 1997 Equity Incentive Plan. In addition, in June 2002, the Board of Directors authorized the use of option exercise proceeds for the repurchase of our common stock.

 

16



 

ITEM 6.                             Selected Financial Data.

 

We have derived the selected consolidated financial data presented below from our consolidated financial statements and the related notes. The revenue and operating results related to the acquisition of companies using the purchase accounting method are included from the respective acquisition dates. The selected financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included as Item 7 of this Annual Report on Form 10-K and with the Consolidated Financial Statements and related Notes included as Item 8 of this Annual Report on Form 10-K. The historical results set forth in this Item 6 are not necessarily indicative of the results of operations to be expected in the future.

 

 

 

Year Ended September 30,

 

 

 

2001 (1)

 

2002 (2)

 

2003

 

2004

 

2005

 

 

 

(In thousands, except per share data)

 

Statement of Income Data:

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

487,260

 

$

518,698

 

$

558,283

 

$

603,774

 

$

647,538

 

Legal settlement expense

 

 

 

 

 

7,000

 

Income from operations

 

67,040

 

64,339

 

57,042

 

63,046

 

56,274

 

Net income

 

36,246

 

40,346

 

35,346

 

38,774

 

36,069

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

1.67

 

$

1.78

 

$

1.68

 

$

1.80

 

$

1.69

 

Diluted

 

$

1.61

 

$

1.73

 

$

1.66

 

$

1.76

 

$

1.67

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

21,702

 

22,675

 

20,999

 

21,589

 

21,331

 

Diluted

 

22,512

 

23,287

 

21,335

 

22,014

 

21,653

 

Cash dividends per share of common stock

 

 

 

 

 

$

0.30

 

 

 

 

At September 30,

 

 

 

2001

 

2002

 

2003

 

2004

 

2005

 

 

 

(In thousands)

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

Cash, cash equivalents, and marketable securities

 

$

115,340

 

$

95,125

 

$

117,512

 

$

139,254

 

$

178,363

 

Working capital

 

214,466

 

185,962

 

201,320

 

229,514

 

248,340

 

Total assets

 

347,715

 

352,090

 

415,020

 

464,747

 

534,562

 

Total capital lease obligations, less current portion

 

520

 

269

 

3,821

 

5,108

 

3,606

 

Total shareholders’ equity

 

301,414

 

302,129

 

333,277

 

373,548

 

405,954

 

 


(1)   During the fourth quarter of fiscal year 2001, we changed our method of accounting for revenue recognition in accordance with the Securities and Exchange Commission’s Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, effective October 1, 2000.

(2)   Effective October 1, 2001, we changed our method of accounting for goodwill and intangible assets in accordance with Financial Accounting Standards Board Statement No. 142, Goodwill and Other Intangible Assets.

 

17



 

ITEM 7.                             Management’s Discussion and Analysis of Financial Condition and Results of Operation.

 

The following discussion and analysis of financial condition and results of operations is provided to enhance the understanding of, and should be read in conjunction with, our Consolidated Financial Statements and the related Notes.

 

Forward-Looking Statements

 

Included in this Annual Report on Form 10-K are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements are based on current expectations, estimates, forecasts and projections about our company, the industry in which we operate and other matters, as well as management’s beliefs and assumptions and other statements that are not historical facts.  Words such as “anticipate,” “believe,” “could,” “expect,” “estimate,” “intend,” “may,”  “opportunity,” “plan,” “potential,” “project,” “should,” and “will” and similar expressions are intended to identify forward-looking statements and convey uncertainty of future events or outcomes.  These statements are not guarantees and involve risks, uncertainties and assumptions that are difficult to predict.  Actual outcomes and results may differ materially from such forward-looking statements due to a number of factors, including without limitation, the factors set forth in Exhibit 99.1 of this Annual Report on Form 10-K under the caption “Important Factors Regarding Forward Looking Statements.”  As a result of these and other factors, our past financial performance should not be relied on as an indication of future performance.  Additionally, we caution investors not to place undue reliance on any forward-looking statements as these statements speak only as of the date when made.  We undertake no obligation to publicly update or revise any forward-looking statements, whether resulting from new information, future events or otherwise.

 

Business Overview

 

We are a leading provider of consulting, systems solutions and operations program management primarily to government. Since our inception, we have been at the forefront of innovation in meeting our mission of “Helping Government Serve the People®.” We use our expertise, experience and advanced information technology to make government operations more efficient while improving the quality of services provided to program beneficiaries. We operate primarily in the United States, and we have had contracts with government agencies in all 50 states, Canada, Australia, Israel and the United Kingdom. We have been profitable every year since we were founded in 1975. For the fiscal year ended September 30, 2005, we had revenue of $647.5 million and net income of $36.1 million.

 

We report each of our three lines of business (i.e., Consulting, Systems, and Operations) as separate external reporting segments. See Note 17 to our Consolidated Financial Statements for our unaudited quarterly segment income statement data.

 

Results of Operations

 

Consolidated

 

The following table sets forth, for the fiscal year ends indicated, selected statements of income data:

 

18



 

 

 

Year ended September 30,

 

 

 

2003

 

2004

 

2005

 

 

 

(dollars in thousands, except per share data)

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

558,283

 

$

603,774

 

$

647,538

 

Gross profit

 

$

166,576

 

$

176,567

 

$

179,950

 

Legal settlement expense

 

 

 

$

7,000

 

Operating income

 

$

57,042

 

$

63,046

 

$

56,274

 

 

 

 

 

 

 

 

 

 

 

 

Operating margin percentage

 

10.2

%

10.4

%

8.7

%

 

 

 

 

 

 

 

 

Selling, general and administrative expense

 

$

109,534

 

$

113,521

 

$

116,676

 

Selling, general and administrative expense as a percentage of revenue

 

19.6

%

18.8

%

18.0

%

 

 

 

 

 

 

 

 

Net income

 

$

35,346

 

$

38,774

 

$

36,069

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

Basic

 

$

1.68

 

$

1.80

 

$

1.69

 

Diluted

 

$

1.66

 

$

1.76

 

$

1.67

 

 

Our consolidated revenue increased 7.2% for the fiscal year ended September 30, 2005 compared to fiscal 2004. Our consolidated revenue increased 8.1% for the fiscal year ended September 30, 2004 compared to fiscal 2003. Excluding revenue related to acquisitions, we had an overall increase in organic revenue of 7.9% for fiscal 2004 compared to fiscal 2003. As discussed in more detail below, the changes in revenue are attributable primarily to results from our Operations Segment.

 

Our operating margin was 8.7% for the fiscal year ended September 30, 2005, compared to 10.4% for the same period in fiscal 2004. This overall lower margin was primarily attributable to the impact of the $7.0 million legal settlement expenses related to the outstanding lawsuit in Pennsylvania. Our operating margin increased to 10.4% in fiscal 2004 compared to 10.2% for the same period in fiscal 2003 primarily driven by new and expanding contracts in the Operations Segment.

 

Selling, general and administrative expense (SG&A) consists of costs related to general management, marketing and administration. These costs include salaries, benefits, bid and proposal efforts, travel, recruiting, continuing education, employee training, non-chargeable labor costs, facilities costs, printing, reproduction, communications, equipment depreciation, intangible amortization and non-cash equity based compensation. SG&A increased in fiscal 2005 compared to the same period in fiscal 2004. However, our SG&A as a percentage of revenue decreased to 18.0% for the fiscal year ended September 30, 2005 compared to 18.8% for the same period in fiscal 2004 and was reflective of management’s continued focus on SG&A cost management. For the year ended September 30, 2004, our SG&A as a percentage of revenue decreased to 18.8% compared to 19.6% for the 2003 fiscal year.

 

Also included in SG&A is approximately $1.4 million, $1.0 million and $0.9 million of non-cash equity-based compensation expense for the fiscal years ended September 30, 2005, 2004 and 2003, respectively. This expense relates to restricted stock units issued by the Company. In future periods, the annual amortization expense related to these restricted stock units is estimated to be approximately $1.5 million, which amount may increase if certain earnings targets are achieved and vesting is accelerated.

 

19



 

In fiscal 2005, we recorded a charge of $7.0 million in connection with a legal settlement, as discussed in Item 3 above and in Note 14 to the consolidated financial statements contained in this Annual Report on Form 10-K.

 

Our provision for income tax for each of fiscal year 2005, 2004 and 2003 was 39.5% of income before taxes.

 

Net income for fiscal 2005 was $36.1 million or $1.67 per diluted share compared with net income of $38.8 million, or $1.76 per diluted share for fiscal 2004, and net income of $35.3 million, or $1.66 per diluted share, for fiscal 2003. The change in net income is attributed primarily to a legal expense settlement, as discussed above, and the segment results as discussed in more detail below.

 

Consulting Segment

 

 

 

Year ended September 30,

 

 

 

2003

 

2004

 

2005

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

102,620

 

$

103,312

 

$

107,339

 

Gross profit

 

$

41,764

 

$

41,925

 

$

43,575

 

Operating income

 

$

15,599

 

$

10,977

 

$

10,725

 

 

 

 

 

 

 

 

 

 

 

 

Operating margin percentage

 

15.2

%

10.6

%

10.0

%

 

The Consulting Segment is comprised of the management and financial services practice area, which includes revenue maximization services, cost services, Unison (airport financial consulting) and child welfare, and the education practice area, which includes education systems (student information systems) and educational services (school-based claiming). Revenue from our Consulting Segment increased 3.9% for fiscal 2005 compared to fiscal 2004. This increase was primarily attributable to revenue growth in the education practice areas. Operating margin decreased to 10.0% for fiscal 2005 from 10.6% for fiscal 2004. This decrease was primarily attributable to reduced operating income from the management and financial services practice areas where a large child welfare contract concluded in fiscal 2005. Revenue from our Consulting Segment increased 0.7% in fiscal 2004 compared to fiscal 2003. This increase was primarily attributable to the contributions from our educational divisions offset by decreased revenue from our Revenue Services division, which experienced delays in federal reimbursements on certain contingency based contracts. Operating margin declined to 10.6% for fiscal 2004 from 15.2% for fiscal 2003. This decrease was primarily attributable to losses in the Revenue Services division.

 

Systems Segment

 

 

 

Year ended September 30,

 

 

 

2003

 

2004

 

2005

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

133,446

 

$

139,057

 

$

137,081

 

Gross profit

 

$

58,950

 

$

54,844

 

$

50,502

 

Operating income

 

$

15,272

 

$

15,352

 

$

11,363

 

 

 

 

 

 

 

 

 

Operating margin percentage

 

11.4

%

11.0

%

8.3

%

 

20



 

The Systems Segment develops and implements both third party and proprietary software such as justice, asset, and enterprise resource planning (ERP) solutions and provides systems development from our enterprise solutions and technology support divisions. Revenue from our Systems Segment decreased 1.4% for fiscal 2005 compared to fiscal 2004. This decrease was primarily attributable to the conclusion of several large projects in early fiscal 2005 that were significant contributors to revenue in fiscal 2004. Operating margin decreased to 8.3% for the fiscal 2005 from 11.0% for fiscal 2004. This decrease was primarily due to the associated revenue and profit reductions as a result of projects concluding in early fiscal 2005. Revenue from our Systems Segment increased 4.2% in fiscal 2004 compared to fiscal 2003. This increase was primarily attributable to growth in the areas of ERP and Enterprise Services. Operating margin declined to 11.0% for fiscal 2004 from 11.4% for fiscal 2003. This decrease was primarily due to market weakness in the area of Technology Support.

 

Operations Segment

 

 

 

Year ended September 30,

 

 

 

2003

 

2004

 

2005

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

322,217

 

$

361,405

 

$

403,118

 

Gross profit

 

$

65,862

 

$

79,798

 

$

85,873

 

Operating income

 

$

25,059

 

$

35,177

 

$

38,508

 

 

 

 

 

 

 

 

 

Operating margin percentage

 

7.8

%

9.7

%

9.6

%

 

The Operations Segment includes our health operations and human services operations. Revenue from our Operations Segment increased 11.5% for fiscal 2005 compared to fiscal 2004. This increase was primarily attributable to the British Columbia Health Operations project, which enrolls British Columbia citizens into health insurance programs and was launched on April 1, 2005. The revenue increase was also attributable to new federal work in the medical management area and the increased contribution from the California Healthy Families CHIP contract, which provided a full year of revenue recorded for fiscal 2005 versus three quarters of revenue recorded in fiscal 2004. Operating margin decreased to 9.6% for fiscal 2005 from 9.7% for fiscal 2004. This decrease was primarily attributable to a $3.8 million loss related to the British Columbia Health Operations contract, which required us to run legacy systems for the first six months of operations. Revenue from our Operations Segment increased 12.2% in fiscal 2004 compared to fiscal 2003. This increase was primarily attributable to the growth in our Health Services area, principally driven by the new California Healthy Families contract. Operating margin increased to 9.7% for fiscal 2004 from 7.8% for fiscal 2003. This increase was due primarily to new and expanded work in the Health Services area described above.

 

Other Income, Net

 

 

 

Year ended September 30,

 

 

 

2003

 

2004

 

2005

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Interest and other income, net

 

$

1,381

 

$

1,044

 

$

3,345

 

Percentage of revenue

 

0.2

%

0.2

%

0.5

%

 

The overall increase in interest and other income in fiscal 2005 compared to fiscal 2004 was due primarily to the higher interest rates earned on our increased invested cash, as well as approximately $396,000 of foreign transaction gains. The overall decrease in interest and other income in fiscal 2004

 

21



 

compared to fiscal 2003 was due primarily to expenses related to a confidential legal settlement as well as interest incurred on our capital lease obligations beginning in January 2004, offset by interest income from the increase in the average balance of funds we invested.

 

Quarterly Results

 

Set forth in Note 17 to our Consolidated Financial Statements (Item 8 of this Annual Report on Form 10-K) is selected income statement data for the eight quarters ended September 30, 2005. We derived this information from unaudited quarterly financial statements that include, in the opinion of our management, all adjustments necessary for a fair presentation of the information for such periods. You should read this information in conjunction with the audited consolidated financial statements and notes thereto. Results of operations for any fiscal quarter are not necessarily indicative of results for any future period.

 

Our revenue and operating results are subject to significant variation from quarter to quarter depending on a number of factors, including:

 

                  the progress of contracts;

                  the revenue earned on contracts;

                  the timing of revenue on license sales;

                  the timing of revenue on performance-based contracts;

                  the commencement and completion of contracts during any particular quarter;

                  the schedule of government agencies for awarding contracts; and

                  the term of each contract that we have been awarded.

 

Because a significant portion of our expenses are relatively fixed, successful contract performance and variation in the volume of activity as well as in the number of contracts commenced or completed during any quarter may cause significant variations in operating results from quarter to quarter. Further, we have occasionally experienced a pattern in our results of operations pursuant to which we incur greater operating expenses during the start-up and early stages of significant contracts prior to receiving related revenue. Our quarterly results may fluctuate, causing a material adverse effect on our operating results and financial condition.

 

Business Combinations and Acquisitions

 

As part of our growth strategy, we may acquire complementary businesses to expand our geographic reach and the breadth and depth of our services and to enhance our customer base. Since the beginning of fiscal 2004, we have completed the following business acquisitions:

 

Name

 

Date

 

Description of Business

 

Segment

 

TIECorp.

 

May 3, 2004

 

Educational management software

 

Consulting

 

Manatron

 

June 1, 2004

 

Judicial software products

 

Systems

 

 

See Note 2 to our Consolidated Financial Statements for further discussion of these recent business combinations and acquisitions.

 

22



 

Obligations and Commitments

 

The following table summarizes our contractual obligations at September 30, 2005 that require the Company to make future cash payments (in thousands):

 

 

 

Payments due by period

 

Contractual Obligations

 

Total

 

Less than
1 year

 

1-3 years

 

3-5 years

 

More than
5 years

 

Capital lease obligations

 

$

5,456

 

$

1,679

 

$

3,358

 

$

419

 

 

Operating leases

 

51,711

 

17,842

 

23,354

 

9,654

 

$

861

 

 

 

 

 

 

 

 

 

 

 

 

 

Total (1)

 

$

57,167

 

$

19,521

 

$

26,712

 

$

10,073

 

$

861

 

 


(1) Total contractual cash obligations exclude the potential future cash payments required in connection with potential earn-out contingent consideration associated with purchase business acquisitions.

 

Liquidity and Capital Resources

 

 

 

Year ended September 30,

 

 

 

2004

 

2005

 

 

 

(dollars in thousands)

 

Net cash provided by (used in):

 

 

 

 

 

Operating activities

 

$

47,073

 

$

74,094

 

Investing activities

 

(68,220

)

(97,412

)

Financing activities

 

(4,371

)

(9,463

)

Net increase (decrease) in cash and cash equivalents

 

$

(25,518

)

$

(32,781

)

 

For fiscal 2005, cash provided by our operations was $74.1 million as compared to $47.1 million for fiscal 2004. Cash provided by operating activities for fiscal 2005 consisted of net income of $36.1 million and non-cash items aggregating $24.3 million, plus working capital of $13.7 million. Non-cash items consisted of $15.1 million of depreciation and amortization, $4.8 million from deferred income tax expense, $1.4 million from the income tax benefit of option exercises and restricted stock units vesting, and $3.0 million from non-cash equity based compensation. The net cash provided by working capital changes reflected increases in accounts receivable – billed, net, of $12.6 million, accounts receivable – unbilled of $1.5 million, and deferred contract costs, net, of $6.7 million, offset by increases in accounts payable of $10.6 million, accrued compensation of $5.6 million, deferred revenue of $11.7 million and income taxes payable of $4.7 million and a decrease in prepaid expenses of $2.0 million. Other working capital changes providing cash were increases in other assets of $0.8 million and increases in other liabilities of $0.7 million. The increase in accounts payable reflected increases resulting from new or expanded projects as well as normal fluctuations in payment cycles. Management expects that the favorable effect on cash flows of the increased accounts payable may be reversed in subsequent periods due to the timing of payments.

 

Cash provided by operating activities for fiscal 2004 primarily consisted of net income of $38.8 million and non-cash items aggregating $31.4 million, less cash used for working capital of $23.1 million. Non-cash items consisted of $13.2 million of depreciation and amortization, $3.9 million from the income tax benefit of option exercises, $13.3 million from deferred income tax benefits, and $1.0 million non-cash equity based compensation. The net cash used for working capital changes reflected increases in accounts receivable-unbilled of $13.1 million offset by increases in accounts payable of $5.9 million and decreases in accounts receivable-billed of $3.2 million. Other working capital changes using cash were accrued compensation of $2.0 million, deferred revenue of $2.0 million, taxes payable of $2.8

 

23



 

million, and other liabilities of $0.3 million, as well as increases in deferred contract costs of $4.8 million, prepaid expenses of $2.4 million, and other assets of $4.8 million.

 

Cash used in investing activities for fiscal 2005 was $97.4 million as compared to $68.2 million for fiscal 2004. Cash used in investing activities for fiscal 2005 primarily consisted of $2.0 million related to business acquisitions, $10.9 million in expenditures for capitalized software costs, $13.3 million in purchases of property and equipment, and $71.6 million in purchases of marketable securities, offset by a $0.4 million decrease in other items. For fiscal 2004, cash used in investing activities was $68.2 million as compared to $25.7 million for fiscal 2003. Cash used in investing activities for fiscal 2004 primarily consisted of $6.6 million for business acquisitions, $8.1 million in expenditures for capitalized software costs, $6.5 million in purchases of property and equipment, and $47.3 million in purchases of auction rate notes, offset by a $0.3 million decrease in other items.

 

For fiscal 2005, cash used in financing activities was $9.5 million as compared to $4.4 million for fiscal 2004. Cash used in financing activities for fiscal 2005 consisted of $16.1 million of common stock repurchases, $1.6 million of principal payments on capital leases and $6.4 million of dividends paid, offset by $14.6 million of sales of stock to employees through our Employee Stock Purchase Plan and Equity Incentive Plan. Cash used in financing activities for fiscal 2004 primarily consisted of $25.7 million of common stock repurchases and $1.2 million of principal payments on capital leases, offset by $22.5 million of sales of stock to employees through our Employee Stock Purchase Plan and Equity Incentive Plan.

 

Under resolutions adopted in May 2000, July 2002, and March 2003, the Board of Directors has authorized the repurchase, at management’s discretion, of up to an aggregate of $90.0 million of our common stock. In addition, in June 2002, the Board of Directors authorized the use of option exercise proceeds for the repurchase of our common stock. During the years ended September 30, 2004 and 2005, we repurchased 806,800 and 488,404 shares, respectively. At September 30, 2005, approximately $29.5 million remained available for future stock repurchases under the program.

 

Our working capital at September 30, 2004 and 2005 was $229.5 and $248.3 million, respectively. At September 30, 2005, we had cash, cash equivalents, and marketable securities of $178.4 million and no debt, except for lease obligations. Management believes this strong liquidity and financial position will allow us to continue our stock repurchase program, depending on the price of the Company’s common stock, and to pursue selective acquisitions. Restricted cash represents amounts collected on behalf of certain customers and its use is restricted to the purposes specified under our contracts with these customers.

 

Under the provisions of certain long-term contracts, we may incur certain reimbursable transition period costs. During the transition period, these expenditures resulted in the use of our cash and in our entering into lease financing arrangements for a portion of the costs. Reimbursement of these costs may occur in the set-up phase or over the contract operating period. Related revenue may also be deferred during the set-up phase. As of September 30, 2005, approximately $22.2 million in net costs had been incurred and reported as deferred contract costs on our September 30, 2005 consolidated balance sheet. Also under the provisions of one long-term contract, we issued a standby letter of credit in the initial amount of up to $20.0 million, which amount was reduced to $10.0 million on April 1, 2005. The letter of credit, which expires on March 31, 2009, may be called by a customer in the event we default under the terms of the contract. The facility contains financial covenants that establish minimum levels of tangible net worth and earnings before interest, tax, depreciation and amortization (EBITDA) and requires the maintenance of certain cash balances. We were in compliance with the covenants at September 30, 2005.

 

24



 

In July 2003, we entered into a capital lease financing arrangement with a financial institution whereby we acquired assets pursuant to an equipment lease agreement. Rental payments for assets leased are payable over a 60-month period at a rate of 4.05% commencing in January 2004. In March 2004, we entered into a supplemental capital lease financing arrangement with the same financial institution whereby we acquired additional assets pursuant to an equipment lease agreement. Rental payments for assets leased under the supplemental arrangement are payable over a 57-month period at a rate of 3.61% commencing in April 2004. At September 30, 2005, capital lease obligations of approximately $5.1 million were outstanding related to these lease arrangements for new equipment.

 

At September 30, 2004 and 2005, we classified accounts receivable of approximately $4.5 million and $6.5 million, respectively, net of a $1.0 million and $1.1 million discount, respectively, as long-term receivables and reported them within the other assets category on our consolidated balance sheets. These receivables have extended payment terms and collection is expected to exceed one-year.

 

On October 18, 2005, the Company’s Board of Directors declared a quarterly cash dividend of $0.10 for each share of the Company’s common stock outstanding. The dividend was payable on November 30, 2005 to shareholders of record on November 15, 2005. Based on the number of shares outstanding at November 15, 2005, the payment was approximately $2.1 million.

 

We believe that we will have sufficient resources to meet our currently anticipated capital expenditure and working capital requirements for at least the next twelve months.

 

Effects of Inflation

 

Approximately 15% of our business is conducted under cost-reimbursable contracts which adjust revenue to cover costs increased by inflation. Approximately 12% of the business is time-and-material contracts where labor rates are often fixed for several years. We generally have been able to price these contracts in a manner that accommodates the rates of inflation experienced in recent years. The remaining portions of our contracts are fixed price and performance based and are typically priced to account for the likely inflation from period to period to mitigate the risk of our business being adversely affected by inflation.

 

Critical Accounting Policies and Estimates

 

Our discussion and analysis of financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities and the reported amounts of revenue and expenses. On an ongoing basis, we evaluate our estimates including those related to revenue recognition and cost estimation on certain contracts, the realizability of goodwill, and amounts related to income taxes, certain accrued liabilities and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results could differ from those estimates.

 

25



 

We believe that we do not have significant off-balance sheet risk or exposure to liabilities that are not recorded or disclosed in our financial statements. While we have significant operating lease commitments for office space, those commitments are generally tied to the period of performance under related contracts. Additionally, although on certain contracts we are bound by performance bond commitments and standby letters of credit, we have not had any defaults resulting in draws on performance bonds or letters of credit. Also, we do not speculate in derivative transactions.

 

We believe the following critical accounting policies affect the significant judgments and estimates used in the preparation of our consolidated financial statements:

 

Revenue Recognition. In fiscal 2005, approximately 78% of our total revenue was derived from state and local government agencies; 7% from federal government agencies; 8% from foreign customers; and 7% from other sources, such as commercial customers. Revenue is generated from contracts with various pricing arrangements, including: (1) fixed-price; (2) performance-based criteria; (3) costs incurred plus a negotiated fee (“cost-plus”); and (4) time and materials. Also, some contracts contain “not-to-exceed” provisions. For fiscal 2005, revenue from fixed-price contracts was approximately 33% of total revenue; revenue from performance-based contracts was approximately 40% of total revenue; revenue from cost-plus contracts was approximately 15% of total revenue; and revenue from time and materials contracts was approximately 12% of total revenue. A majority of the contracts with state and local government agencies have been fixed-price and performance-based, and our contracts with the federal government generally have been cost-plus. Fixed-price and performance-based contracts generally offer higher margins but typically involve more risk than cost-plus or time and materials reimbursement contracts.

 

We recognize revenue on fixed-priced contracts when earned, as services are provided. For certain fixed-price contracts, primarily systems design, development and implementation, we recognize revenue based on costs incurred using estimates of total expected contract revenue and costs to be incurred. The cumulative impact of any revisions in estimated revenue and costs is recognized in the period in which the facts that give rise to the revision become known. For other fixed-price contracts, revenue is recognized on a straight-line basis unless evidence suggests that revenue is earned or obligations are fulfilled in a different pattern. With fixed-price contracts, we are subject to the risk of potential cost overruns. Provisions for estimated losses on incomplete contracts are provided in full in the period in which such losses become known. We recognize revenue on performance-based contracts as such revenue becomes fixed or determinable, which generally occurs when amounts are billable to customers. For certain contracts, this may result in revenue being recognized in irregular increments. Additionally, costs related to contracts may be incurred in periods prior to recognizing revenue. These costs are generally expensed. However, certain direct and incremental set-up costs may be deferred until services are provided and revenue begins to be recognized, when such costs are recoverable from a contractual arrangement. Set-up costs are costs related to activities that enable us to provide contractual services to a client. These factors may result in irregular revenue and profit margins.

 

Revenue on cost-plus contracts is recognized based on costs incurred plus an estimate of the negotiated fee earned. Revenue on time and materials contracts is recognized based on hours worked and expenses incurred.

 

Our most significant expense is cost of revenue, which consists primarily of project-related costs such as employee salaries and benefits, subcontractors, computer equipment and travel expenses. Our management uses its judgment and experience to estimate cost of revenue expected on projects. Our management’s ability to accurately predict personnel requirements, salaries and other costs as well as to effectively manage a project or achieve certain levels of performance can have a significant impact on the

 

26



 

gross margins related to our fixed-price, performance-based and time and materials contracts. If actual costs are higher than our management’s estimates, profitability may be adversely affected. Service cost variability has little impact on cost-plus arrangements because allowable costs are reimbursed by the customer.

 

We also license software under license agreements. License fee revenue is recognized when a non-cancelable license agreement is in force, the product has been delivered, the license fee is fixed or determinable, and collection is probable. If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer. In addition, when software license contracts contain post-contract customer support as part of a multiple element arrangement, revenue is recognized based upon the vendor-specific objective evidence of the fair value of each element. Maintenance and post-contract customer support revenue are recognized ratably over the term of the related agreements, which in most cases is one year. Revenue from software-related consulting services under time and material contracts and for training is recognized as services are performed. Revenue from other software-related contract services requiring significant modification or customization of software is recognized under the percentage-of-completion method.

 

EITF 00-21, Revenue Arrangements with Multiple Deliverables, requires contracts with multiple deliverables to be divided into separate units of accounting if certain criteria are met. While EITF 00-21 has not had a material impact on our financial statements, we apply the guidance therein and recognize revenue on multiple deliverables as separate units of accounting if the criteria are met.

 

Impairment of Goodwill. We adhere to the Financial Accounting Standards Board’s Statements of Financial Accounting Standards No. 141, Business Combinations (“FAS 141”), and No. 142, Goodwill and Other Intangible Assets (“FAS 142”). Under these rules, goodwill is not amortized but is subject to annual impairment tests in accordance with FAS 141 and FAS 142. Goodwill is tested on an annual basis, or more frequently as impairment indicators arise. Annual impairment tests involve the use of estimates related to the fair market values of our reporting units with which goodwill is associated. Losses, if any, resulting from annual impairment tests will be reflected in operating income in our income statement.

 

Capitalized Software Development Costs. Capitalized software development costs are capitalized in accordance with FAS No. 86, Accounting for the Cost of Computer Software to be Sold, Leased, or Otherwise Marketed. We capitalize both purchased software that is ready for resale and costs incurred internally for software development projects from the time technological feasibility is established. Capitalized software development costs are reported at the lower of unamortized cost or estimated net realizable value. Upon the general release of the software to customers, capitalized software development costs for the products are amortized based on the straight-line method of amortization over the remaining estimated economic life of the product, which ranges from three to five years. The establishment of technological feasibility and the ongoing assessment for recoverability of capitalized development costs require considerable judgment by management including, but not limited to, technological feasibility, anticipated future gross revenues, estimated economic life, and changes in software and hardware technologies. Any changes to these estimates could impact the amount of amortization expense and the amount recognized as capitalized software development costs in the consolidated balance sheet.

 

Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts at an amount we estimate to be sufficient to cover the risk of collecting less than full payment on our receivables. On a regular basis we re-evaluate our client receivables, especially receivables that are past due, and reassess our allowance for doubtful accounts based on specific client collection issues. If our clients were to express dissatisfaction with the services we have provided, additional allowances may be required.

 

27



 

Deferred Contract Costs. Deferred contract costs consist of recoverable direct and incremental set-up costs relating to long-term service contracts. These costs include system development and facility build-out costs that are expensed ratably as services are provided under the contracts.

 

Income taxes. To record income tax expense, we are required to estimate our income taxes in each of the jurisdictions in which we operate.  In addition, income tax expense at interim reporting dates requires us to estimate our expected effective tax rate for the entire year.  This process involves estimating our actual current tax liability together with assessing temporary differences that result in deferred tax assets and liabilities and expected future tax rates.  Circumstances that could cause our estimates of income tax expense to change include: the impact of information that subsequently becomes available as we prepare our tax returns; revision to tax positions taken as a result of further analysis and consultation; changes in the geographic mix of our business; the actual level of pre-tax income; changes in tax rules, regulations and rates; and changes mandated as a result of audits by taxing authorities.

 

We may also establish tax reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we may not fully succeed.  We adjust these reserves in light of changing facts, such as the progress of a tax audit, new case law, or expiration of a statute of limitations.

 

ITEM 7A.                    Quantitative and Qualitative Disclosures About Market Risk.

 

We believe that our exposure to market risk related to the effect of changes in interest rates, foreign currency exchange rates and equity prices with regard to instruments entered into for trading or for other purposes is immaterial.

 

ITEM 8.                             Financial Statements and Supplementary Data.

 

The following consolidated financial statements and supplementary data are included as part of this Annual Report on Form 10-K:

 

Report of Independent Registered Public Accounting Firm

 

Consolidated Balance Sheets at September 30, 2004 and 2005

 

Consolidated Statements of Income for the years ended September 30, 2003, 2004 and 2005

 

Consolidated Statements of Changes in Shareholders’ Equity for the years ended September 30, 2003, 2004 and 2005

 

Consolidated Statements of Cash Flows for the years ended September 30, 2003, 2004 and 2005

 

Notes to Consolidated Financial Statements

 

28



 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors

MAXIMUS, Inc.

 

We have audited the accompanying consolidated balance sheets of MAXIMUS, Inc. as of September 30, 2005 and 2004, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended September 30, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of MAXIMUS, Inc. at September 30, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended September 30, 2005, in conformity with U.S. generally accepted accounting principles.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of MAXIMUS, Inc.’s internal control over financial reporting as of September 30, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated November 22, 2005 expressed an unqualified opinion thereon.

 

 

/s/ Ernst & Young LLP

 

 

McLean, Virginia

November 22, 2005

 

29



 

MAXIMUS, Inc.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

 

 

 

September 30,

 

 

 

2004

 

2005

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

91,854

 

$

59,073

 

Marketable securities

 

47,400

 

119,290

 

Restricted cash

 

1,379

 

2,193

 

Accounts receivable – billed, net

 

111,834

 

124,477

 

Accounts receivable – unbilled

 

42,280

 

43,774

 

Prepaid expenses and other current assets

 

9,673

 

7,270

 

Total current assets

 

304,420

 

356,077

 

Property and equipment, net

 

25,693

 

31,156

 

Software development costs, net

 

18,251

 

23,953

 

Deferred contract costs, net

 

15,475

 

22,162

 

Goodwill

 

84,886

 

86,832

 

Intangible assets, net

 

9,807

 

7,756

 

Other assets

 

6,215

 

6,626

 

Total assets

 

$

464,747

 

$

534,562

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

27,476

 

$

38,151

 

Accrued compensation and benefits

 

21,224

 

26,828

 

Deferred revenue

 

21,195

 

32,898

 

Income taxes payable

 

 

4,695

 

Deferred income taxes

 

1,930

 

277

 

Current portion of capital lease obligations

 

1,649

 

1,502

 

Other accrued liabilities

 

1,432

 

3,386

 

Total current liabilities

 

74,906

 

107,737

 

Capital lease obligations, less current portion

 

5,108

 

3,606

 

Deferred income taxes

 

10,766

 

17,225

 

Other long-term liabilities

 

419

 

40

 

Total liabilities

 

91,199

 

128,608

 

Commitments and contingencies (Notes 10 and 14)

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, no par value; 60,000,000 shares authorized; 21,319,847 and 21,451,302 shares issued and outstanding at September 30, 2004 and 2005, at stated amount, respectively

 

147,966

 

150,883

 

Accumulated other comprehensive loss

 

(345

)

(522

)

Retained earnings

 

225,927

 

255,593

 

Total shareholders’ equity

 

373,548

 

405,954

 

Total liabilities and shareholders’ equity

 

$

464,747

 

$

534,562

 

 

See notes to consolidated financial statements.

 

30



 

MAXIMUS, Inc.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

 

 

 

Year ended September 30,

 

 

 

2003

 

2004

 

2005

 

 

 

 

 

 

 

 

 

Revenue

 

$

558,283

 

$

603,774

 

$

647,538

 

Cost of revenue

 

391,707

 

427,207

 

467,588

 

Gross profit

 

166,576

 

176,567

 

179,950

 

Selling, general and administrative expenses

 

109,534

 

113,521

 

116,676

 

Legal settlement expense

 

 

 

7,000

 

Income from operations

 

57,042

 

63,046

 

56,274

 

Interest and other income, net

 

1,381

 

1,044

 

3,345

 

Income before income taxes

 

58,423

 

64,090

 

59,619

 

Provision for income taxes

 

23,077

 

25,316

 

23,550

 

Net income

 

$

35,346

 

$

38,774

 

$

36,069

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

Basic

 

$

1.68

 

$

1.80

 

$

1.69

 

Diluted

 

$

1.66

 

$

1.76

 

$

1.67

 

 

 

 

 

 

 

 

 

Cash dividends per share

 

 

 

$

0.30

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

Basic

 

20,999

 

21,589

 

21,331

 

Diluted

 

21,335

 

22,014

 

21,653

 

 

See notes to consolidated financial statements.

 

31



 

MAXIMUS, Inc.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(In thousands)

 

 

 

Common
Shares
Outstanding

 

Common
Stock

 

Accumulated
Other
Comprehensive
Income (Loss)

 

Retained
Earnings

 

Total
Shareholders’
Equity

 

Balance at September 30, 2002

 

21,509

 

$

150,298

 

$

24

 

$

151,807

 

$

302,129

 

Net income

 

 

 

 

35,346

 

35,346

 

Unrealized loss on marketable securities, net of tax of $29

 

 

 

(53

)

 

(53

)

Foreign currency translation

 

 

 

(66

)

 

(66

)

Comprehensive income

 

 

 

 

 

 

 

 

 

35,227

 

Employee stock transactions

 

732

 

15,170

 

 

 

15,170

 

Repurchases of common stock

 

(1,041

)

(21,944

)

 

 

(21,944

)

Non-cash equity based compensation

 

 

939

 

 

 

939

 

Tax benefit due to option exercises

 

 

1,756

 

 

 

1,756

 

Balance at September 30, 2003

 

21,200

 

146,219

 

(95

)

187,153

 

333,277

 

Net income

 

 

 

 

38,774

 

38,774

 

Unrealized loss on marketable securities, net of tax of $26

 

 

 

(40

)

 

(40

)

Foreign currency translation

 

 

 

(210

)

 

(210

)

Comprehensive income

 

 

 

 

 

 

 

 

 

38,524

 

Employee stock transactions

 

927

 

22,482

 

 

 

22,482

 

Repurchases of common stock

 

(807

)

(25,656

)

 

 

(25,656

)

Non-cash equity based compensation

 

 

1,036

 

 

 

1,036

 

Tax benefit due to option exercises

 

 

3,885

 

 

 

3,885

 

Balance at September 30, 2004

 

21,320

 

147,966

 

(345

)

225,927

 

373,548

 

Net income

 

 

 

 

36,069

 

36,069

 

Unrealized gain on marketable securities, net of tax of $153

 

 

 

241

 

 

241

 

Foreign currency translation

 

 

 

(418

)

 

(418

)

Comprehensive income

 

 

 

 

 

 

 

 

 

35,892

 

Employee stock transactions

 

619

 

14,645

 

 

 

14,645

 

Repurchases of common stock

 

(488

)

(16,055

)

 

 

(16,055

)

Cash dividends ($0.10 per share per quarter)

 

 

 

 

(6,403

)

(6,403

)

Non-cash equity based compensation

 

 

1,372

 

 

 

1,372

 

Tax benefit due to option exercises

 

 

2,955

 

 

 

2,955

 

Balance at September 30, 2005

 

21,451

 

$

150,883

 

$

(522

)

$

255,593

 

$

405,954

 

 

See notes to consolidated financial statements.

 

32



 

MAXIMUS, Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

 

 

 

Year ended September 30,

 

 

 

2003

 

2004

 

2005

 

 

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income

 

$

35,346

 

$

38,774

 

$

36,069

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation

 

6,249

 

7,040

 

7,874

 

Amortization

 

4,981

 

6,110

 

7,271

 

Deferred income taxes

 

(2,310

)

13,361

 

4,806

 

Non-cash equity based compensation

 

939

 

1,036

 

1,372

 

Tax benefit due to option exercises and restricted stock units vesting

 

1,756

 

3,885

 

2,955

 

Changes in assets and liabilities, net of effects from acquisitions:

 

 

 

 

 

 

 

Accounts receivable - billed

 

(8,354

)

3,158

 

(12,643

)

Accounts receivable - unbilled

 

(1,176

)

(13,138

)

(1,494

)

Prepaid expenses and other current assets

 

(355

)

(2,366

)

1,961

 

Deferred contract costs

 

(3,051

)

(4,866

)

(6,687

)

Other assets

 

59

 

(4,752

)

(828

)

Accounts payable

 

9,965

 

5,866

 

10,675

 

Accrued compensation and benefits

 

2,631

 

(1,995

)

5,604

 

Deferred revenue

 

9,004

 

(1,950

)

11,703

 

Income taxes payable

 

512

 

(2,837

)

4,695

 

Other liabilities

 

(1,149

)

(253

)

761

 

Net cash provided by operating activities

 

55,047

 

47,073

 

74,094

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Acquisition of businesses, net of cash acquired

 

(14,715

)

(6,605

)

(1,946

)

Purchases of property and equipment

 

(6,825

)

(6,476

)

(13,337

)

Capitalized software development costs

 

(4,359

)

(8,078

)

(10,922

)

Increase in marketable securities

 

(34

)

(47,300

)

(71,649

)

Other

 

222

 

239

 

442

 

Net cash used in investing activities

 

(25,711

)

(68,220

)

(97,412

)

Cash flows from financing activities:

 

 

 

 

 

 

 

Employee stock transactions

 

15,170

 

22,482

 

14,645

 

Repurchases of common stock

 

(21,944

)

(25,656

)

(16,056

)

Payments on capital lease obligations

 

(155

)

(1,197

)

(1,649

)

Cash dividends paid

 

 

 

(6,403

)

Net cash used in financing activities

 

(6,929

)

(4,371

)

(9,463

)

Net increase (decrease) in cash and cash equivalents

 

22,407

 

(25,518

)

(32,781

)

Cash and cash equivalents, beginning of period

 

94,965

 

117,372

 

91,854

 

Cash and cash equivalents, end of period

 

$

117,372

 

$

91,854

 

$

59,073

 

 

See notes to consolidated financial statements.

 

33



 

MAXIMUS, Inc.

Notes to Consolidated Financial Statements

For the years ended September 30, 2003, 2004 and 2005

 

1.  Business and Summary of Significant Accounting Policies

 

(a) Description of Business

 

MAXIMUS, Inc. (the “Company” or “we”) provides consulting, systems solutions and operations program management primarily to government. The Company conducts its operations through three business segments: Consulting, Systems and Operations. The Consulting Segment provides specialized financial consulting services such as assisting states, local agencies, and schools in obtaining federal funding reimbursements for their programs, and implementing cost reductions strategies, as well as providing technical services and software products. The Systems Segment provides systems products including justice and asset software solutions as well as systems development, design and implementation to improve the efficiency and cost-effectiveness of program administration. The Operations Segment provides a variety of program management services, primarily the delivery of administrative services for government health and human service programs.

 

The Company operates predominantly in the United States. Revenue from foreign-based projects and offices was less than 10% of total revenue for the years ended September 30, 2003, 2004 and 2005.

 

(b) Principles of Consolidation

 

The consolidated financial statements include the accounts of MAXIMUS, Inc. and its wholly-owned subsidiaries. In addition to the Company’s wholly owned subsidiaries, the financial statements as of and for the fiscal year ended September 30, 2005 include a majority (55%) owned international subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation.

 

(c) Revenue Recognition
 

In fiscal 2005, approximately 78% of our total revenue was derived from state and local government agencies; 7% from federal government agencies; 8% from foreign customers; and 7% from other sources, such as commercial customers. Revenue is generated from contracts with various pricing arrangements, including: (1) fixed-price; (2) performance-based criteria; (3) costs incurred plus a negotiated fee (“cost-plus”); and (4) time and materials. Also, some contracts contain “not-to-exceed” provisions. For fiscal 2005, revenue from fixed-price contracts was approximately 33% of total revenue; revenue from performance-based contracts was approximately 40% of total revenue; revenue from cost-plus contracts was approximately 15% of total revenue; and revenue from time and materials contracts was approximately 12% of total revenue. A majority of the contracts with state and local government agencies have been fixed-price and performance-based, and our contracts with the federal government generally have been cost-plus. Fixed-price and performance-based contracts generally offer higher margins but typically involve more risk than cost-plus or time and materials reimbursement contracts.

 

We recognize revenue on fixed-priced contracts when earned, as services are provided. For certain fixed-price contracts, primarily systems design, development and implementation, we recognize revenue based on costs incurred using estimates of total expected contract revenue and costs to be

 

34



 

incurred. The cumulative impact of any revisions in estimated revenue and costs is recognized in the period in which the facts that give rise to the revision become known. For other fixed-price contracts, revenue is recognized on a straight-line basis unless evidence suggests that revenue is earned or obligations are fulfilled in a different pattern. With fixed-price contracts, we are subject to the risk of potential cost overruns. Provisions for estimated losses on incomplete contracts are provided in full in the period in which such losses become known. We recognize revenue on performance-based contracts as such revenue becomes fixed or determinable, which generally occurs when amounts are billable to customers. For certain contracts, this may result in revenue being recognized in irregular increments. Additionally, costs related to contracts may be incurred in periods prior to recognizing revenue. These costs are generally expensed. However, certain direct and incremental set-up costs may be deferred until services are provided and revenue begins to be recognized, when such costs are recoverable from a contractual arrangement. Set-up costs are costs related to activities that enable us to provide contractual services to a client. These factors may result in irregular revenue and profit margins.

 

Revenue on cost-plus contracts is recognized based on costs incurred plus an estimate of the negotiated fee earned. Revenue on time and materials contracts is recognized based on hours worked and expenses incurred.

 

Our most significant expense is cost of revenue, which consists primarily of project-related costs such as employee salaries and benefits, subcontractors, computer equipment and travel expenses. Our management uses its judgment and experience to estimate cost of revenue expected on projects. Our management’s ability to accurately predict personnel requirements, salaries and other costs as well as to effectively manage a project or achieve certain levels of performance can have a significant impact on the gross margins related to our fixed-price, performance-based and time and materials contracts. If actual costs are higher than our management’s estimates, profitability may be adversely affected. Service cost variability has little impact on cost-plus arrangements because allowable costs are reimbursed by the customer.

 

We also license software under license agreements. License fee revenue is recognized when a non-cancelable license agreement is in force, the product has been delivered, the license fee is fixed or determinable, and collection is probable. If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer. In addition, when software license contracts contain post-contract customer support as part of a multiple element arrangement, revenue is recognized based upon the vendor-specific objective evidence of the fair value of each element. Maintenance and post-contract customer support revenue are recognized ratably over the term of the related agreements, which in most cases is one year. Revenue from software-related consulting services under time and material contracts and for training is recognized as services are performed. Revenue from other software-related contract services requiring significant modification or customization of software is recognized under the percentage-of-completion method.

 

Beginning July 1, 2003, EITF 00-21, Revenue Arrangements with Multiple Deliverables, requires contracts with multiple deliverables to be divided into separate units of accounting if certain criteria are met. While EITF 00-21 has not had a material impact on our financial statements, we apply the guidance therein and recognize revenue on multiple deliverables as separate units of accounting if the criteria are met.

 

35



 

(d) Cash Equivalents

 

The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. Cash equivalents are valued at cost, which approximates market.

 

(e) Accounts Receivable and Allowance for Doubtful Accounts

 

Accounts receivable are recorded at their face amount less an allowance for doubtful accounts. We maintain an allowance for doubtful accounts at an amount we estimate to be sufficient to cover the risk of collecting less than full payment on our receivables. On a regular basis we re-evaluate our client receivables, especially receivables that are past due, and reassess our allowance for doubtful accounts based on specific client collection issues.

 

(f) Restricted Cash

 

Restricted cash represents amounts collected on behalf of certain customers and its use is restricted to the purposes specified under our contracts with these customers.

 

(g) Marketable Securities

 

Marketable securities are classified as available-for-sale and are recorded at fair market value with unrealized gains and losses, net of taxes, reported as a separate component of shareholders’ equity. Realized gains (losses) and declines in market value judged to be other than temporary, of which there were none in 2003 and 2004 and $(288,000) in 2005, are included in other income. Interest and dividends are also included in other income. Marketable securities consist primarily of short-term auction rate bonds. At September 30, 2003, 2004 and 2005, accumulated unrealized gains (losses) on marketable securities, net of tax, included in accumulated other comprehensive income (loss), were approximately $(50,000), ($90,000) and $150,000 respectively.

 

(h) Property and Equipment

 

Property and equipment is stated at cost and depreciated using the straight-line method based on estimated useful lives not to exceed 39.5 years for the Company’s buildings and between three and seven years for office furniture and equipment. Leasehold improvements are amortized over their useful life or the remaining term of the lease, whichever is shorter. Direct costs of time and material incurred for the application development of software for internal use are capitalized as property and equipment. These costs are depreciated using the straight-line method over the estimated useful life of the software, ranging from three to seven years.

 

(i) Software Development Costs

 

Capitalized software development costs are capitalized in accordance with FAS No. 86, Accounting for the Cost of Computer Software to be Sold, Leased, or Otherwise Marketed. The Company capitalizes both purchased software that is ready for resale and costs incurred internally for software development projects from the time technological feasibility is established. Capitalized software development costs are reported at the lower of unamortized cost or estimated net realizable value. Upon the general release of the software to customers, capitalized software development costs for the products are amortized over the greater of the ratio of gross revenues to expected total revenues of the product or on the straight-line method of amortization over the estimated economic life of the product, which ranges

 

36



 

from three to five years.

 

(j) Deferred Contract Costs

 

Deferred contract costs consist of contractually recoverable direct set-up costs relating to long-term service contracts in progress. These costs include system development and facility build-out costs that are expensed over the period services are provided under the long-term service contract.

 

(k) Goodwill and Intangible Assets
 

The Company applies Statements of Financial Accounting Standards No. 141, Business Combinations (“FAS 141”), and No. 142, Goodwill and Other Intangible Assets (“FAS 142”). Under these rules, goodwill is not amortized but is subject to annual impairment tests in accordance with FAS 142. Annually, the Company performs a fair value analysis of its reporting units using valuation techniques prescribed in FAS 142. Based on the analysis performed as of July 1, 2005, the Company determined that there had been no impairment of goodwill.

 

Intangible assets from acquisitions, which consist primarily of customer contracts and relationships, technology-based intangibles and non-competition agreements, are amortized over five to ten years, based on their estimated useful lives.

 

(l) Long-Lived Assets (excluding Goodwill)

 

The Company follows the provisions of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“FAS 144”). FAS 144 requires that long-lived assets be reviewed for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be fully recoverable. An impairment loss is recognized if the sum of the long-term undiscounted cash flows is less than the carrying amount of the long-lived assets being evaluated. Any write-downs are treated as permanent reductions in the carrying amount of the assets. The Company believes that the carrying values of its assets as of September 30, 2005 are fully realizable.

 

(m) Income Taxes

 

Deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted rates expected to be in effect during the year in which the differences reverse. The effect on deferred tax assets and liabilities due to a change in tax rates is recognized in income tax expense in the period that includes the enactment date. A tax benefit or expense is recognized for the net change in the deferred tax asset or liability during the year and the current tax liability for the year.

 

(n) Comprehensive income (loss)
 

Comprehensive income (loss) includes changes in the balances of the items that are reported directly as separate components of shareholder’s equity. Comprehensive income (loss) includes net income plus changes in the net unrealized gain (loss) on investments, net of taxes, and changes in cumulative foreign currency translation adjustments.

 

(o) Foreign Currency
 

The assets and liabilities of foreign operations are translated into U.S. dollars at current exchange

 

37



 

rates and revenue and expenses are translated at average exchange rates for the period. The resulting cumulative translation adjustment is included in accumulated other comprehensive income (loss) on the consolidated balance sheet. At September 30, 2003, 2004 and 2005, accumulated foreign currency gains (losses) included in accumulated other comprehensive loss were approximately ($45,000), ($255,000) and $(673,000), respectively. Foreign currency transaction gains (losses), including foreign currency gains (losses) on short-term loans with our foreign subsidiaries, are included in other income and were approximately $511,000 and $396,000 for the years ended September 30, 2004 and 2005, respectively. Foreign currency transaction gains (losses) were not significant for the year ended September 30, 2003.

 

(p) Earnings per Share

 

FAS 128, Earnings Per Share, requires dual presentation of basic and diluted earnings per share on the face of the Consolidated Statements of Income. Basic earnings per share exclude dilution and are computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Diluted earnings per share include the incremental effect of stock options and restricted stock units calculated using the treasury stock method.

 

(q) Fair Value of Financial Instruments

 

The Company considers the recorded value of its financial assets and liabilities, which consist primarily of cash and cash equivalents, marketable securities, accounts receivable and accounts payable, to approximate the fair value of the respective assets and liabilities at September 30, 2004 and 2005.

 

(r) Stock-Based Compensation

 

The Company currently accounts for stock options using the intrinsic value method in accordance with APB 25, as interpreted by FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation. Accordingly, no compensation cost has been recognized for the granting of stock options to our employees and directors for the years ended September 30, 2003, 2004 and 2005, respectively, as all stock options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. If stock options granted during these years had been accounted for based on their fair value as determined under FAS 123, the pro forma net income and pro forma net income per share would have been as follows (in thousands except per share data):

 

38



 

 

 

Year ended September 30,

 

 

 

2003

 

2004

 

2005

 

Net income, as reported

 

$

35,346

 

$

38,774

 

$

36,069

 

Add: Stock-based compensation expense included in reported net income, net of taxes

 

568

 

627

 

830

 

Deduct: Stock compensation expense determined under fair value based method for all awards, net of taxes

 

(6,916

)

(5,714

)

(4,226

)

Net income, as adjusted

 

$

28,998

 

$

33,687

 

$

32,673

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

Basic - as reported

 

$

1.68

 

$

1.80

 

$

1.69

 

Basic -as adjusted

 

$

1.38

 

$

1.56

 

$

1.53

 

 

 

 

 

 

 

 

 

Diluted - as reported

 

$

1.66

 

$

1.76

 

$

1.67

 

Diluted - as adjusted

 

$

1.36

 

$

1.53

 

$

1.51

 

 

The weighted average fair value of stock options was estimated at the date of grant using the Black-Scholes option pricing calculation with the following assumptions: volatility of 58% for 2003, 55% for 2004 and 46% for 2005; risk free interest rate of 3.0% for 2003, 3.1% for 2004 and 4.0% for 2005; dividend yield 0%; for 2003 and 2004 and 0.7% for 2005 and an expected life of the option of 5.7 years in 2003, 5.4 years in 2004 and 5.1 years in 2005. The grant-date weighted average fair value per option of options granted was $13.79 in 2003, $18.20 in 2004 and $13.48 in 2005.

 

(s) Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates used by the Company include estimates of profits or loss on contracts in process, estimates of collectibility of receivables, evaluation of asset impairment and accrual of estimated liabilities.

 

2.  Business Combinations

 

No businesses were acquired by the Company in fiscal 2005. At September 30, 2005, the Company recorded $1.3 million as additional goodwill in connection with an earn-out payment pertaining to a business acquired in 2002. The earn-out payment was attributable to that business achieving certain performance objectives. In fiscal 2004, the Company acquired the businesses described below in business combinations accounted for as purchases. The accompanying consolidated financial statements include the results of operations of each acquired business since the date of their respective acquisition.

 

On May 3, 2004, the Company acquired substantially all the assets of TIECorp. for $3.2 million. In conjunction with the purchase, the Company recorded intangible assets, primarily non-competition agreements and technology related intangibles, of $3.4 million, and other net liabilities of approximately $0.2 million, which have been assigned to the Consulting Segment. Per the terms of the acquisition agreement, additional consideration of up to $16.5 million may be paid based on achievement of certain future performance objectives by TIECorp. This additional consideration will be expensed as incurred. The TIECorp. business is engaged in the development and marketing of instructional management software programs and related products and services in the educational field. The primary reasons for the

 

39



 

acquisition were to expand the Company’s presence in the educational software field and to strategically complement the Company’s current product and service offerings in the educational market.

 

On June 1, 2004, the Company acquired certain assets of Manatron, Inc. for $1.8 million. In conjunction with the purchase, the Company recorded goodwill of $1.5 million and intangible assets, primarily customer contracts and relationships, of $0.8 million, and other net liabilities of approximately $0.5 million, which have been assigned to the Systems Segment. The acquired assets relate to the design, development, marketing and support of judicial software products for county, city and township governments. The primary reason for the acquisition was to increase the Company’s market share in the justice solutions arena.

 

Following are the unaudited pro forma results of operations for the Company as if the companies identified above were acquired at the beginning of the period being reported (in thousands, except per share data):

 

 

 

Year ended

 

 

 

September 30, 2004

 

Revenue

 

$

605,519

 

Net income

 

39,242

 

Diluted earnings per share

 

$

1.78

 

 

3.  Contract Receivables and Deferred Revenue

 

Uncompleted contracts consist of the following components (in thousands):

 

 

 

Accounts
receivable -
unbilled

 

Deferred
revenue

 

September 30, 2004:

 

 

 

 

 

Revenue

 

$

797,301

 

$

527,729

 

Billings

 

755,021

 

548,924

 

Total

 

$

42,280

 

$

21,195

 

 

 

 

 

 

 

September 30, 2005:

 

 

 

 

 

Revenue

 

$

595,073

 

$

773,748

 

Billings

 

551,299

 

806,646

 

Total

 

$

43,774

 

$

32,898

 

 

Unbilled accounts receivable and deferred revenue relate primarily to contracts wherein the timing of billings to customers varies based on individual contracts and often differs from the period of revenue recognition. At September 30, 2004 and 2005, there was approximately $2.7 million and $5.6 million, respectively, billed but not paid by customers pursuant to contractual retainage provisions. Such balances are included in billed accounts receivable in the accompanying consolidated balance sheets.

 

At September 30, 2004 and 2005, approximately $4.4 million and $5.3 million of billed long-term contract receivables, net of reserves of approximately $1.0 million and $1.1 million, respectively, are included in other assets.

 

In evaluating the net realizable value of accounts receivable, the Company considers such factors as current economic trends, customer credit-worthiness, and changes in the customer payment terms and collection trends. Changes in the assumptions used in analyzing a specific account receivable may result in a

 

40



 

reserve being recognized in the period in which the change occurs.

 

Changes in the reserves against billed accounts receivable were as follows (in thousands):

 

 

 

Year ended
September 30,

 

 

 

2003

 

2004

 

2005

 

 

 

 

 

 

 

 

 

Balance at beginning of year

 

$

3,165

 

$

4,997

 

$

6,551

 

Additions to cost and expense

 

2,132

 

6,401

 

4,253

 

Deductions

 

(300

)

(4,847

)

(3,646

)

Balance at end of year

 

$

4,997

 

$

6,551

 

$

7,158

 

 

4.  Property and Equipment

 

Property and equipment, at cost, consist of the following (in thousands):

 

 

 

As of September 30,

 

 

 

2004

 

2005

 

 

 

 

 

 

 

Land

 

$

2,462

 

$

2,462

 

Building and improvements

 

11,699

 

11,656

 

Office furniture and equipment

 

36,011

 

46,901

 

Leasehold improvements

 

2,504

 

3,711

 

 

 

52,676

 

64,730

 

Less: Accumulated depreciation and amortization

 

(26,983

)

(33,574

)

Total property and equipment, net

 

$

25,693

 

$

31,156

 

 

5.  Software Development Costs

 

Software development costs consist of the following (in thousands):

 

 

 

As of September 30,

 

 

 

2004

 

2005

 

 

 

 

 

 

 

Capitalized software development costs

 

$

30,918

 

$

40,770

 

Less: Accumulated amortization

 

(12,667

)

(16,817

)

Total Software development costs, net

 

$

18,251

 

$

23,953

 

 

During 2005, the Company wrote off approximately $1.1 million of fully amortized software development costs and the related accumulated amortization. Capitalized software amortization expense for the years ended September 30, 2003, 2004 and 2005 was approximately $3.8 million, $4.5 million, and $5.2 million, respectively.

 

6.  Deferred Contract Costs

 

Deferred contract costs consist of contractually recoverable direct set-up costs relating to long-term service contracts in progress. These costs include system development and facility build-out costs totaling $18.2 million and $29.0 million at September 30, 2004 and 2005, respectively, of which approximately $7.6 million is leased equipment at September 30, 2004 and 2005. Deferred contract costs are expensed ratably

 

41



 

as services are provided under the contracts. For the fiscal years ended September 30, 2004 and 2005, accumulated amortization of deferred contract costs was approximately $2.8 million and $6.8 million, of which $1.1 million and $2.6 million, respectively, is the accumulated amortization of capital lease assets included in deferred costs.

 

7.  Goodwill and Intangible Assets

 

Changes in goodwill for the years ended September 30, 2004 and 2005 are as follows (in thousands):

 

 

 

Consulting

 

Systems

 

Operations

 

Total

 

Balance as of September 30, 2003

 

$

6,811

 

$

42,678

 

$

32,268

 

$

81,757

 

Goodwill activity during year

 

 

1,881

 

1,248

 

3,129

 

Balance as of September 30, 2004

 

6,811

 

44,559

 

33,516

 

84,886

 

Goodwill activity during year

 

14

 

637

 

1,295

 

1,946

 

Balance as of September 30, 2005

 

$

6,825

 

$

45,196

 

$

34,811

 

$

86,832

 

 

The following table sets forth the components of intangible assets (in thousands):

 

 

 

As of September 30, 2004

 

As of September 30, 2005

 

 

 

Cost

 

Accumulated
Amortization

 

Intangible
Assets, net

 

Cost

 

Accumulated
Amortization

 

Intangible
Assets, net

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-competition agreements

 

$

3,475

 

$

2,994

 

$

481

 

$

3,475

 

$

3,141

 

$

334

 

Technology-based intangibles

 

4,870

 

756

 

4,114

 

4,870

 

1,644

 

3,226

 

Customer contracts and relationships

 

7,475

 

2,263

 

5,212

 

7,475

 

3,279

 

4,196

 

Total

 

$

15,820

 

$

6,013

 

$

9,807

 

$

15,820

 

$

8,064

 

$

7,756

 

 

Intangible assets from acquisitions are amortized over a period of five to ten years. The weighted-average amortization periods for non-competition agreements, technology-based intangibles, and customer contracts and relationships are approximately five years, six years, and eight years, respectively. The weighted-average amortization period for total intangible assets is approximately seven years. The estimated amortization expense for the years ending September 30, 2006, 2007, 2008, 2009 and 2010 is $2.0 million, $2.0 million, $1.6 million, $1.1 million, and $0.4 million, respectively.

 

8.  Earnings Per Share

 

The following table sets forth the components of basic and diluted earnings per share (in thousands):

 

 

 

Year ended September 30,

 

 

 

2003

 

2004

 

2005

 

Numerator:

 

 

 

 

 

 

 

Net income

 

$

35,346

 

$

38,774

 

$

36,069

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

Weighted average shares outstanding

 

20,999

 

21,589

 

21,331

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Employee stock options and unvested restricted stock awards

 

336

 

425

 

322

 

Denominator for diluted earnings per share

 

21,335

 

22,014

 

21,653

 

 

42



 

9.  Credit Facilities

 

In June 2003, in connection with a long-term contract, the Company issued a standby letter of credit facility in an initial amount of up to $20.0 million, which amount was reduced to $10.0 million on April 1, 2005. The letter of credit, which expires on March 31, 2009, may be called by the customer in the event the Company defaults under the terms of the contract. The facility contains financial covenants that establish minimum levels of tangible net worth and earnings before interest, tax, depreciation and amortization (“EBITDA”) and requires the maintenance of certain cash balances. The Company was in compliance with all covenants at September 30, 2005.

 

10.  Leases

 

The Company leases office space under various operating leases which typically contain clauses permitting cancellation upon certain conditions, including the early termination, non-renewal or material alteration of the related customer contract. The terms of these leases typically provide for certain minimum payments as well as increases in lease payments based upon the operating cost of the facility and the consumer price index. Rent expense for the years ended September 30, 2003, 2004 and 2005 was approximately $21.3 million, $23.3 million, and $23.1, respectively.

 

On July 15, 2003, the Company entered into a capital lease financing arrangement with a financial institution, whereby the Company acquired assets pursuant to an equipment lease agreement. Rental payments for assets leased are payable over a 60-month period at a rate of 4.05% commencing in January 2004. On March 29, 2004, the Company entered into a supplemental capital lease financing arrangement with the same financial institution whereby the Company acquired additional assets pursuant to an equipment lease agreement. Rental payments for assets leased under the supplemental arrangement are payable over a 57-month period at a rate of 3.61% commencing in April 2004. At September 30, 2005, capital lease obligations of approximately $5.1 million were outstanding related to these lease arrangements for new equipment.

 

Minimum future payments under leases in effect as of September 30, 2005 are as follows (in thousands):

 

 

 

Capital
Leases

 

Operating
Leases

 

Year ended September 30,

 

 

 

 

 

2006

 

$

1,679

 

$

17,842

 

2007

 

1,679

 

13,740

 

2008

 

1,679

 

9,614

 

2009

 

419

 

6,086

 

2010

 

 

3,568

 

Thereafter