Earnings Call Transcript - MMS Q3 2025

Operator, Operator

Greetings, and welcome to the Maximus' Fiscal 2025 Third Quarter Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jessica Batt, Vice President of Investor Relations for Maximus.

Jessica Batt, Vice President of Investor Relations

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

Bruce L. Caswell, President and CEO

Thanks, Jessica, and good morning. I'm excited to share another record-breaking quarter for Maximus earnings. For the third quarter fiscal year 2025, adjusted diluted earnings per share reached $2.16, a 24% increase year-over-year. We realized 15% growth in adjusted EBITDA. Finally, Q3 revenue of $1.35 billion is growth of 4.3% on an organic basis year-over-year. Congratulations to the tens of thousands of Maximus team members responsible for these accomplishments. In what has been for many in the government, IT and consulting sector, an uncertain environment, we have remained resilient, focused on our customers and on consistent quality delivery at scale. Since our Q2 earnings call, we've seen clarification of certain priorities of the administration and the introduction of new legislation, the impacts of which will cascade to our state customers. We have come to expect this over decades of serving our government customers, and we believe that we are ideally positioned to respond. A core capability of Maximus is our ability to translate policy changes into operational models, largely performance-based that deliver accountable outcomes aligned with the mission of our customers. In short, I believe we are purpose-built for the operating tempo of today's environment. As part of our business update, I'd like to share why we believe that we are well positioned to assist both federal and state clients as the details of recent legislation and regulatory changes become more clearly understood and implementation planning begins. Let's first look at the One Big Beautiful Bill Act, which we believe could create meaningful addressable opportunities for us following proposed changes in Medicaid and SNAP. Turning to Medicaid, the administration continues to focus on managing federal spending on Medicaid. The legislation will impose certain administrative activities while shifting more enforcement responsibility to the states. Most notably, there's now a twice yearly up from annual requirement to determine eligibility for the Medicaid expansion population, which comprises an estimated 21 million people across the 41 states that have expanded Medicaid coverage to those making up to 138% of the federal poverty level. States must review their program processes and implement changes to ensure compliance by December 2026. Our U.S. services team will be working closely with current and prospective state clients to help them meet these new requirements while continuing to deliver exceptional customer service. As I noted on our last quarterly call, in many cases, this could include assisting beneficiaries in transitioning to a marketplace plan to provide continuity of coverage. Secondly, the recent legislation codifies Medicaid work requirements for the expansion population, while some states through Waiver authority are seeking to include certain individuals in traditional Medicaid categories. Starting January 1, 2027, states will be required to verify with participants completion of 80 hours per month of qualifying activities. This is a major policy change, but not one with which we lack familiarity. During President Trump's prior administration, at the direction of one of our state clients, Maximus developed and implemented operational modifications designed to make beneficiary work requirement reporting as accessible and efficient as possible while meeting policy objectives. With this new statute in effect, we are again working with our state customers to demonstrate how to modify program operations to comply with the new law while maintaining a high level of quality of beneficiary engagement. Notably, the new law prohibits managed care plans from performing work activity verifications or handling exemption requests, which would constitute a conflict of interest. As an established conflict-free partner, Maximus has the independence necessary to support our state clients with compliance under the new legislation. Our human-centered and technology-supported approach to compliance with the new law efficiently leverages existing program investments like contact center infrastructure and digital services. Our goal is for beneficiaries to engage through whatever modality is best for them: call, text, mobile app and so forth, and that their experience is respectful and empathic. The last piece of the bill I'll discuss is its impact on state supplemental nutrition assistance programs, or SNAP, driven by a nearly 11% national payment error rate in 2024 according to the USDA. The new legislation enacts eligibility accuracy requirements in order for states to maintain federal funding levels. Beginning with 2025 or 2026 data, states with higher SNAP payment error rates will be required to cover more of the program's cost, shifting what was once a fully federally funded benefit partially onto state budgets. Last quarter, we discussed the recent OPM guidance that increases flexibility states have to use contractors and contracted employees to execute programs. This policy change allows companies like Maximus to help states meet new requirements, whether in Medicaid, unemployment insurance, or in this case, SNAP. We're excited to help our current and prospective clients implement technology-led solutions that increase efficiencies, accuracy, and provide a consistent high-quality customer experience. I'm pleased that subsequent to the quarter close, we executed a contract modification with one of our long-time state customers to take on an expanded role in supporting SNAP administration. With a strong track record of partnering with state governments to navigate and implement complex policy changes, we are increasingly confident in the growth trajectory of our U.S. Services segment over the next 18 to 24 months as implementing regulations are formalized and states move from planning to operationalization of these new policies. Beyond the bill, we are seeing a heightened focus on reducing spending and increased efficiencies and greater use of technology at the agency level. We believe this is an excellent opportunity to implement more efficient technology-led models for the delivery of citizen services and program missions. As I mentioned last quarter, I'm pleased that we had minimal impact this fiscal year from any change in contract actions. We believe this speaks to the nature of the services we provide and our earned reputation for delivering quality outcomes accountably under performance-based contracting models. Looking ahead, as has been the case for years, federal and state budget priorities and cycles reflecting macroeconomic trends will shape our FY '26 outlook. David will share more color in his prepared remarks and how specifically we've considered budget headwinds and policy-driven tailwinds in our early outlook for fiscal year 2026. Now let me turn to the business more broadly. During our 2022 Investor Day, we committed to investing in our leadership team and building strength through client relationships and laid out a strategy for growth through targeting adjacent agencies. This time last year, I shared that we were expanding our growth team through leaders and teams aligned to specific U.S. federal markets, civilian, defense, and health. The combined success of these two strategies is evident in our recently announced win at the Department of Defense. Maximus secured a $77 million contract with the U.S. Air Force Life Cycle Management Center to provide cybersecurity and cloud-based services, aiming to enhance innovation and operational readiness across the DoD. The contract spans a base year with four 1-year options and a potential 6-month extension. Under this contract, Maximus will work to deliver scalable and resilient cybersecurity, cloud, and engineering support across multiple security domains. Congratulations to the team members who worked diligently to make this possible. We believe this win is further evidence of our ability to expand into adjacent agencies and deliver capabilities aligned with the mission of our Air Force customer. We're proud to have the opportunity to play an increasing role supporting our country's national security priorities. Our 2022 strategy also emphasized expanding our technical capabilities, which in the federal government often require independent certification to broaden the aperture of our pipeline. As part of that forward-looking approach, we recently achieved Cybersecurity Maturity Model Certification or CMMC Level 2, an important milestone. Effective mid-December 2024, CMMC 2.0 is a DoD initiative designed to standardize and elevate cybersecurity practices across the defense industrial base. Our recent CMMC Level 2 certification validates our enhanced cybersecurity posture as a defense contractor. We also anticipate that it should position us to compete effectively across the entire federal government contracting landscape as these standards are likely to become the norm. This added certification has already resulted in the expansion of our pipeline with potential new work in new addressable areas in FY '26. Within the U.S. Federal segment, we expect that these and other accomplishments will contribute to the ongoing success we are seeing in our financial results. In 2022, we set a target of 10% to 12% operating income in the segment. This year, we are forecasting to meaningfully exceed this target. Now let me turn to awards reporting and the pipeline. Through the third quarter of fiscal year 2025, signed awards totaled $3.4 billion of total contract value. Further, at June 30, there were $1.4 billion worth of contracts that have been awarded but not yet signed. These awards translate into a book-to-bill of approximately 0.8x using our standard reporting for the trailing 12-month or TTM period. In a BPO-centric business like ours, with average contract length and values at the higher end of the industry, the TTM book-to-bill metric is naturally sensitive to rebid timing. We've seen this in recent quarters, characterized by lower-than-normal rebid levels. As such, we view book-to-bill as only one measure of future growth. To illustrate, our book-to-bill at the end of the third quarter of fiscal year 2024 was 0.6x. Since then, revenue has grown 4.3% and adjusted EBITDA 15%, underscoring how on-contract growth is another important source of organic growth, providing added strength and resilience to our portfolio. We continue to view book-to-bill as a valuable metric, but one that must be interpreted in the full context of contract timing, backlog dynamics, and overall financial performance. Our total pipeline of sales opportunities at June 30 was $44.7 billion compared to $41.2 billion reported at March 31. The current pipeline is comprised of approximately $3.1 billion in proposals pending, $1.2 billion in proposals in preparation, and $40.4 billion in opportunities we are tracking. Of our current pipeline, approximately 63% represents new work. Additionally, 67% of the $44.7 billion total pipeline is attributable to our U.S. Federal Services segment. I'll wrap my remarks with a brief recognition of Maximus' 50 years of service, which we celebrate this year. Since 1975, Maximus has served as a delivery partner for government, turning legislation and policy into real-world results. Our work spans some of the nation's most complex high-volume programs delivered with speed, precision, efficiency, and accountability. Leveraging this strong 50-year foundation, we are excited about Maximus' future and our rapid transformation as a technology partner and solution provider to government. Let me give you an example of where this is showing up today. I'm excited about our role in the upcoming National Defense Industrial Association, or NDIA Hackathon, which we are cosponsoring with organizations, including AWS and Palantir. This first-of-its-kind event will be held at George Mason University's Fuse facility and the Washington Convention Center in late August. The Hackathon is intentionally designed to address real operational problems facing the U.S. military today and accelerate the access to innovative technology for our service men and women. Championed by our Chief Digital Information Officer and Chief Technology Officer and reflecting the impact of our defense and national security team, we believe this is another demonstration of Maximus leading the way with innovation. Our drive to accelerate access to technology and its practical application to national security mission objectives reflects an imperative of our nation and a strategic differentiator for Maximus. And with that, I'll turn the call over to David.

David W. Mutryn, CFO

Thanks, Bruce, and good morning. We had outstanding third quarter results, particularly on the earnings side, driven by solid execution on programs where our government customers increasingly rely on us for efficient handling of greater work output. These results reflect high demand in what are predominantly performance-based arrangements across our contracts. We are raising guidance again this year to not only account for the performance this quarter, but to also capture improved clarity for the upcoming fourth quarter as compared to our thinking on the last call. I'll end my remarks today by sharing early thinking on our expectations for fiscal year 2026, which precedes formal guidance this November. Turning to the results for this third quarter of fiscal year 2025. Maximus reported revenue of $1.35 billion, representing 2.5% year-over-year growth or 4.3% on an organic basis. The U.S. Federal Services and the outside the U.S. segments both posted positive organic growth, with the U.S. Federal Services segment being the main driver of our consolidated results. The U.S. Services segment delivered results in line with expectations. On the bottom line, the Maximus adjusted EBITDA margin was 14.7%, and adjusted EPS was $2.16 for the quarter, which compares to 13.1% and $1.74, respectively, for the prior year period. This quarter's adjusted EBITDA margin is noticeably above the high end of our target range. This can happen in periods where volumes are stronger than anticipated, thanks to our ability to gain operating leverage on incremental volumes. This leverage is partly the result of our intentional investments in technology, workflow optimization, and cost models. Turning to segments, revenue for the U.S. Federal Services segment increased 11.4% to $761 million. Growth was all organic. We've seen a favorable trend this year where volumes on certain programs, especially in our clinical portfolio, have continued to come in at an elevated run rate. Two years ago, we deliberately invested in added capacity for our clinical work, and that action is now paying dividends as we can scale up to meet the high demand. The operating income margin for the segment in the third quarter was 18.1% as compared to 15.5% in the prior year period. This has set a new high watermark for the segment margin and is a testament to our ability to process elevated levels of work to help our customers. As I mentioned, those elevated levels, which can be unplanned, have a significant effect on the bottom line. For the U.S. Services segment, revenue decreased slightly to $440 million as compared to the prior year period revenue of $472 million. Last year's results were positively impacted by the excess volumes tied to the Medicaid unwinding exercise that was largely completed during the first three quarters of fiscal year 2024. I'd like to acknowledge our success in addressing the unwinding exercise last year, demonstrating how change can promote opportunity. As noted in Bruce's prepared remarks regarding Medicaid and SNAP, we see a similar opportunity for Maximus to rapidly implement policy and legislative changes in support of our customers. The segment's operating income margin for the third quarter was 10.2% compared to 13.0% for the prior year period, which benefited from the excess unwinding volumes. In our view, the segment continues to perform and execute well, and we are focused on driving bottom line improvement headed into next fiscal year when we expect stronger volume levels even before taking into account new market opportunities. Turning to the outside the U.S. segment, revenue decreased to $147 million for the quarter, primarily due to divestitures of multiple employment services businesses in prior periods. The related decrease in revenue was partially offset by organic growth of 7.3% and a slight currency benefit. The segment's operating income margin this quarter was 4.0% and compares to a small loss in the prior year period. We're pleased to report ongoing margin stability in the segment with our goal over the longer term to drive further margin improvement through continued scaling in our present markets. Turning to cash flow items. Cash provided by operating activities was a net outflow of $183 million, and free cash flow was a net outflow of $198 million for the quarter. As we saw last quarter and anticipated for this current quarter, we saw a continued cash flow impact by payment delays. Days sales outstanding, or DSO, stepped up again to 96 days for this quarter, which, as I remarked on the last call, we expect to be at peak. It's also well above our historical range and a dynamic that we view as temporary. The payment delays and corresponding higher DSO were primarily driven by two programs, both of which have had positive updates in July that I will take a moment to describe. The first is one of our major U.S. federal programs. We experienced administrative delays that led to a significant increase in our billed AR balance as of June 30. I'm pleased to report that we made meaningful progress and collected more than $300 million related to this major U.S. federal program in July. The second is one of our large state-based programs that we disclosed last quarter. We faced administrative delays tied to a pending contractual extension of our work, which drove an increase to our unbilled AR balance. The positive update is that we received the fully executed extension in July, which prompted $224 million moving from unbilled AR to billed AR. This alone brings our unbilled AR back into a normal range. We anticipate collecting this balance in the fourth quarter. The positive impact of these two items gives us confidence in our expectations for a strong fourth quarter of free cash flow as evident in our updated free cash flow guidance. As a reminder, the exact timing of payments can impact reported free cash flow at September 30. We ended the third quarter with total debt of $1.67 billion, resulting in a consolidated net total leverage ratio of 2.1x. High near-term borrowings necessary to cover the higher DSO have increased this ratio, yet we are still at the low end of our target range of 2 to 3x. As a reminder, this ratio is our debt net of allowed cash to consolidated EBITDA for the last 12 months as calculated in accordance with our credit agreement. Going forward, by September 30, we expect the ratio to be comfortably below 2x. The delay in collections has also prompted a more constrained approach to capital allocation, though we believe the recent improvements should enable us to return to our historic approach. This includes seeking potential opportunities on the M&A front and resuming opportunistic share repurchases, utilizing the approximately $66 million remaining under the current $200 million Board of Directors share repurchase authorization. Moving to updated guidance for fiscal year 2025. We're announcing our third consecutive guidance raise, which reflects the exceptional results this quarter as well as an improvement to our outlook for the fourth quarter, thanks to better visibility and less uncertainty compared to our prior thinking. For revenue, the midpoint is increasing by $100 million to a range of $5.375 billion to $5.475 billion. Our implied full year organic growth rate now stands at about 4% over the prior year. Our full year adjusted EBITDA margin guidance for fiscal year 2025 is now approximately 13%, which is a 130 basis point improvement from prior guidance. Our adjusted EPS guidance increases by $1 at the midpoint to range between $7.35 and $7.55 per share. At the midpoint, this reflects year-over-year earnings growth of 22%. With the positive updates to the temporary conditions impacting DSO that I mentioned, we expect a strong finish to the year for free cash flow. We are raising our free cash flow guidance to between $370 million and $390 million. We anticipate DSO falling back to more normal levels next quarter, thanks in part to the now finalized state extension and expected imminent payment. To be clear, our guidance assumes that we will collect the $224 million now billed related to that contract prior to September 30, 2025. A few words on segment operating margin assumptions. The U.S. Federal segment is now forecasted to deliver a margin of approximately 15%. U.S. Services segment is expected to be around 10.5% and outside the U.S. is expected to be between 3% and 5% for the full fiscal year. We expect interest expense of approximately $81 million and our full year tax rate expectation of between 28% and 29% is unchanged. As a reminder, the higher tax rate on a full year basis is tied to the divestiture-related charges in the first quarter. The weighted average shares expectation is also unchanged at 58 million shares on a full year basis. I'll wrap up by sharing our early thinking on our expectations for next fiscal year. As always, this precedes official guidance that we will provide for fiscal year 2026 on the year-end call in November. As context, a year ago, we expressed some caution on fiscal year '25 year-over-year growth given the excess volumes we experienced in fiscal year '24, most notably related to our support of Medicaid programs. Our initial guidance for the year that we provided in November, then adjusted in December for the divestiture was revenue of $5.25 billion and adjusted EPS of $5.85 at the midpoint. Since then, our midpoints have increased by $175 million for revenue and $1.60 for adjusted EPS. We have successfully delivered on higher volumes, particularly in our clinical portfolio in the U.S. Federal segment while also continuing to drive technology and process efficiencies in our cost structure. We are purpose-built to enable us to scale up to meet increasing demand, recognizing that from time to time, components of our business that are volume sensitive can be less easy to precisely predict. As we now look to fiscal year 2026 revenue, it's still early enough to have wide-ranging scenarios. Two areas of focus that are dynamic and create a wider range of scenarios are: first, volume-based contributions that we are not certain will recur at the same level as they have in fiscal year 2025. Second, we are carefully watching for signs of budget constraints and efficiency objectives from customers, which may create opportunities in the long run, but may create near-term headwinds on both the federal and state sides. We are staying equally focused on the opportunities in front of us, some of a material nature that could be decided in early fiscal year 2026. This includes proposals sitting in both our in preparation and submitted buckets that, if successful, we anticipate could mildly contribute to fiscal year 2026 and then make stronger contributions to fiscal year 2027. We're also spending time now preparing for opportunities tied to the One Big Beautiful Bill. The exact implementation timeline related to these opportunities is uncertain, and therefore, we are prudently forecasting the revenue contribution in fiscal year 2027, although it is possible some portion could come in fiscal year 2026. All that said, at this stage, our preliminary thinking is we have visibility into an anticipated revenue range that is roughly in line with or possibly just slightly below our now raised fiscal year 2025 guidance. There are also scenarios of modest revenue growth, which we believe would result from some combination of less volume moderation on current programs, less impact from budget constraints coming to fruition, and acceleration in revenue from the opportunities we've discussed and updates to the administration's priorities that increase demand for our services. I'll add that our early view also contemplates that in fiscal year 2027, we could see acceleration of organic growth that maps to these opportunities. Stepping back, we believe this demonstrates the business is running in a disciplined manner while we execute on our growth strategy that aligns with our customers' priorities. On the margin front, our current view is we expect next year's adjusted EBITDA margin to remain near the high end of our 10% to 13% target range. This was consistent with the implied guidance for our fourth quarter of about 12.5%. This represents a significant improvement to our fiscal year 2024 adjusted EBITDA margin of 11.6% and our initial fiscal year 2025 guidance of approximately 11%. We believe the sustainability of these higher levels reflects our continuous improvement of productivity and efficiency in our delivery while accommodating our growth investments. The final component to this early view is interest expense, where we anticipate a meaningful reduction next fiscal year. Once more, this represents our early view of our expectations, and we plan to provide formal guidance in November as usual. In conclusion, we're pleased that recent performance shows us meeting our targets that we have set for ourselves and communicated to shareholders in recent years with respect to both our organic revenue growth rate target and our goal to grow earnings faster than revenue. From fiscal year 2022 to today's fiscal year 2025 guidance, organic revenue growth averages 7%, comfortably achieving our mid-single-digit target. In addition, during that same period, we have been able to grow earnings by almost 20% on a compound annual growth rate basis. Looking forward into fiscal year 2026 and beyond, we believe that our organic revenue growth potential remains well intact. And with that, we will open the line for Q&A.

Operator, Operator

Our first question comes from the line of Charlie Strauzer with CJS Securities.

Charles S. Strauzer, Analyst

Could you start by discussing the Big Beautiful Bill and how Maximus might benefit from potential opportunities? What are the main drivers behind those opportunities? Additionally, do you have the flexibility to pursue more outsourcing projects at both the state and federal levels, such as unemployment or social security?

Bruce L. Caswell, President and CEO

Sure, Charlie. I appreciate your question and your observations. As we've examined market opportunities, it’s worth noting that the prospects in other program areas are actually more significant than those in the Medicaid sector. To elaborate, the One Big Beautiful Bill Act, or OBBBA, has notable implications for our U.S. Services segment, particularly within Medicaid and SNAP to start. There's a greater focus on program eligibility and work requirements, which I mentioned earlier. We believe these will positively influence U.S. Services organic growth, although we're not factoring them heavily into our fiscal year 2026 guidance at this time. We see them as contributing to growth in fiscal year 2027 due to the time needed to move from legislation to implementing regulations, which we understand won't be finalized until June 2026. States will then have until December 2026 to prepare for implementation in January 2027. Historically, we have seen the U.S. Services segment capable of low to mid-single-digit organic growth, while the federal side trends toward mid- to high-single digits. We anticipate that the Medicaid work requirements and the need to reassess eligibility for the expansion population twice a year will provide a positive boost to the U.S. Services growth rate, potentially moving it to the mid- to high-single-digit range over time. Given our extensive experience in Medicaid with numerous states, we are well-prepared to tackle this opportunity. Looking at SNAP and unemployment insurance, we already observe macro challenges from states that may pose some initial headwinds in fiscal year 2026. However, we see these challenges also creating opportunities. With new guidance from OMB, states have increased flexibility to collaborate with private vendors, and Maximus stands ready to assist them in these areas. Our experience during the pandemic has solidified our credibility in serving states for unemployment insurance. While it's still early and the outcome at the state level is uncertain, we believe these opportunities could lead to larger contracts than those in Medicaid. Recently, one of our key state customers expanded their contract with us for more work in the SNAP area, indicating the potential for new opportunities that could drive the U.S. Services segment toward double-digit growth over time. Although we are cautiously optimistic for fiscal year 2026, we see significant momentum heading into fiscal year 2027. Right now, our conversations with customers are just starting; many are still in planning mode while they wait for legislative clarity. We've successfully worked with states in the past to implement similar requirements, and we have an updated playbook ready that doesn’t require extensive new investments in technology. We're focused on adjusting our existing infrastructure to manage Medicaid eligibility and consumer engagement effectively. With that, David, do you have any additional comments?

David W. Mutryn, CFO

Nothing to add.

Bruce L. Caswell, President and CEO

I hope that helps, Charlie. Other questions?

Charles S. Strauzer, Analyst

Certainly. Thinking of, from looking at these opportunities, obviously, it's very early, but any chance of any kind of quantification of what the benefit might look like given the wide range, obviously?

Bruce L. Caswell, President and CEO

Well, I tried to provide a little bit of that just in terms of what it could mean for the growth rate for the overall segment. I think you can impute from that that with work requirements and the enhanced eligibility requirements, we think it could lift U.S. Services from mid-single digits to high single digits. Certainly, depending on the timing and size of opportunities in other areas, including assisting states with SNAP and assisting states with unemployment insurance, it could conceivably tip into the low double-digit area. The SNAP proposition is particularly interesting because many states are looking at their payment error rates and doing the math and stating that they could lose hundreds of millions of dollars in federal funding. So the cost-benefit is pretty straightforward. If they can make an investment of a fraction of that to address some key items that are bottlenecks in that process leading to higher error rates, then there's a huge return for them, and that always becomes a compelling platform for seeking assistance from companies like Maximus.

Charles S. Strauzer, Analyst

Great. And just looking at your competitive advantage against potential competitors that are out there. When you think about the conflict-free nature of your business, are there many competitors that can claim the same level of conflict-free?

Bruce L. Caswell, President and CEO

We've said for many years that we've made a very deliberate decision to remain independent and conflict-free and in particular, have no direct or indirect financial relationships with payers or providers, which is very critical to the work that we do in the Medicaid space and to a certain degree as well with Medicare. It was very important to us that from a work requirement standpoint, this work needs to be done in a conflict-free manner where beneficiaries are reporting, obviously, whether they're engaged in work, but more importantly, whether they may have a qualifying condition that could exempt them from those requirements. As I noted, that then becomes really off limits in terms of managed care plan engagement with beneficiaries. That's an important element of the law that's been passed that I think is only now becoming recognized within the state community, and we're helping to ensure that that's the case. In terms of other companies in a similar position, we've noted smaller privately held companies that have similar characteristics. But I would just say size matters in this market, and we have an established presence as the Medicaid managed care enrollment broker in about 23 states presently. We probably serve roughly 60% of the individuals nationally in the Medicaid program. As evidence in the results this quarter, scale is everything in this area of the business. We think that the invested infrastructure that's been bought and paid for by government can be easily modified at an incremental expense and not a massive new cost of investment, which puts Maximus in a great position to help address these opportunities and creates a bit of a competitive barrier.

Charles S. Strauzer, Analyst

Very helpful. And then looking at the recent DoD win for the Air Force, is defense going to become more of an increasing focus for you guys?

Bruce L. Caswell, President and CEO

The short answer is yes. I appreciate the question. I feel like I'm disadvantaging David here in terms of questions, so I hope you have one for him too. We've long recognized that our core capabilities across the company have a role to play in the defense community. We had a lot of work on our plate historically integrating acquisitions and expanding in certain areas of the civilian world that has not been a focus. However, this has been something we've been planning for quite some time. In 2021, when we combined our business with Veterans Evaluation Services, we identified what we call a synergy pipeline. Those are the opportunities where we know that once combined with VES, we've now got the right to win in areas that include the DoD and particularly the defense health community, which has been a focus. I've been pleased that of the three pipelines that we look at, which are the civilian pipeline and federal, the health pipeline, and then the defense pipeline, the defense health area has been moving nicely. It's kept going. We are now seeing pipeline opportunities that we first identified back in 2021 coming to fruition and going through adjudication and that could lead to growth drivers for the company as we traverse FY '26 and really get into FY '27. Although it seems a little back-end loaded, the technology modernization challenges that we're seeing in the civilian area are also present in the defense community. Some of the core competencies and skills that we need to bring to bear in assisting customers are the same whether we are moving application stacks into the cloud or modernizing them. This is evident in the Air Force win that I mentioned, which showcases the capability of Maximus to be a trusted partner in delivering mission-oriented work for a defense customer. Overall, if we back up a bit, the administration is saying they want a greater focus on performance-based contracts where it's practical. They want to open up the supplier community and engage more commercial providers. As you know, Maximus has deep experience and capabilities regarding performance-based contracting. We're putting all of these pieces together, and we feel that while the defense pipeline is a substantive portion of our pipeline presently, it has much greater potential for us over the long term than the current defense revenues we have today. In conclusion, I believe we view a strong opportunity set that's out there that's really untapped by us and we are encouraged by the early indication of our right to win as evidenced by the Air Force award.

Charles S. Strauzer, Analyst

It certainly does. And David, not to leave you out, looking at the guidance for the rest of the year, thank you for giving us the operating margin ranges. But could you share with us the splits of the top line for Q4 by segment?

David W. Mutryn, CFO

It's probably a little too early to say because I think some of the same kind of risks and opportunities that I pointed to are present in both of the larger two U.S. segments. Both have a wide range of scenarios. Some a little different than the other, with the U.S. services market being more sensitive to the timing of any opportunities. So I'm hesitant to give segment level guidance at this stage.

Charles S. Strauzer, Analyst

Got it. Okay. That's fair. Moving on to initial thoughts, if you achieve the FY '25 revenue target in FY '26, considering the operating leverage of your model and the efficiencies gained by segment, should we expect to see some growth in earnings per share even if revenue remains flat next year?

David W. Mutryn, CFO

Yes. Good question. We're pretty specific with our thinking for the EBITDA margin, which, of course, you could think of a range around. In my prepared remarks, I pointed to the implied margin for Q4 of this year being about 12.5%. As we look at FY '25, we've just reported an extraordinary quarter with an EBITDA margin of 14.7%. I think it would be reticent to expect another quarter like that to recur and lift the future period, so that kind of explains maybe why we're looking at 12.5% next year versus closer to 13% in our guidance for fiscal year '25. However, I would point out on the earnings front, which I said in my prepared remarks, but didn't quantify is that our interest expense could be another tailwind to our EPS. If we look at our projected cash flow right just here ahead of us in the fourth quarter, as well as through next year, absent M&A or share repurchases, the deleveraging we anticipate would drive interest expense being $20 million to $25 million lower next year. So that could be like a $0.30 EPS type year-over-year improvement there. That provides some bottom line potential as well.

Operator, Operator

Our next question comes from the line of Brian Gesuale with Raymond James.

Brian A. Gesuale, Analyst

Appreciate the color and really strong results here. A couple of questions. I want to maybe start off with the VA. You had made a lot of investments in the back office to increase both efficiency and capacity. Can you talk about where we're at with those investments you've made?

Bruce L. Caswell, President and CEO

Sure. I'd be happy to, Brian. I'll start, and then I'm going to turn it over to David for some additional thoughts. Yes, we began by investing in building out our network. The key, we believe, on this contract is to have a very broad national network that includes the ability to reach into rural areas. We've also invested heavily in the infrastructure field, literally the vehicles that we use for mobile clinics, so we can meet veterans on their terms, often in places like Walmart parking lots to ensure we're serving veterans wherever we possibly can. Infrastructure investments include brick-and-mortar buildings, modernized vehicles, and so forth. There have also been investments in building out the clinical network so that we've got the broad array of specialists needed, particularly because with the PACT Act, for example, a logical case would be that there are a lot more people that need pulmonary lung function tests. To achieve this, you must build that out. Then there's been technology investments. We've been thoughtful and phase-wise in introducing technology because, in some ways, you're changing the engine in the plane while it's flying. The technology that we had been using was not as modern as other technologies enabling us to identify potential errors in a process early on and avoid them. The new technology we are introducing is all focused on the veteran experience and on expediting claims through the process with high accuracy and less need for individuals involved in routine and mundane tasks in processing the claims. It's still early days, and we'll be rolling those capabilities out as we close out this fiscal year and enter the next fiscal year. We expect that this will enable us to really step up, again, in that area, the throughput of the business and simplify our quality process. The last thing I'd say is that we are real partners with the VA, wanting to provide the best experience for veterans. In some cases, that means doing a greater job to get through complicated medical records. It's not uncommon to have an average case file, including a medical record, 3,000 to 5,000 pages in length. Without giving too many details, I will just say we've invested heavily in two areas where AI and machine learning can be of great assistance. Initially, one area, as I talked about on a prior call, is helping to organize that information, which is heterogeneous in nature, involving printouts from electronic medical records, case file notes, results from clinical tests or exams, and getting all of that organized in a way where there's a common taxonomy and can be navigated quickly. We've done an excellent job, enabling us to present information to clinical reviewers much more simply. The next goal is to ensure that if there is relevant, timely information in that medical record that meets the requirements of the VA, we extract it and make use of it to minimize the requirement for veterans to necessarily be seen if they have been seen previously in the last six months and that visit's results could be sufficient to meet the requirement of the exam. A little bit down in the weeds for you, but those are examples of where technology investments are progressing over time, will take hold, and continue to improve the veteran experience while streamlining the way we operate the business. With that, I'll turn it over to David for a few comments.

David W. Mutryn, CFO

Yes. Maybe just a housekeeping item that reminded me of the technology rollout that Bruce noted, taking place around the end of our fiscal year here is one driver that we expect to have our depreciation expense grow next year. On the other hand, our intangibles amortization is anticipated to go down by about $11 million from $25 million to $26 million. So our total depreciation and amortization should be somewhat similar year-over-year, but I wanted to point out that dynamic.

Brian A. Gesuale, Analyst

I appreciate all your comments. Given the sensitivity of our business to volumes, especially with the VA work, how do you see things evolving over the next few quarters? Currently, our inventory levels, both packed and non-packed, exceed 700,000. You have increased capacity, which seems to be benefiting customers, as evidenced by a 23% sequential rise in processed claims. How should we approach this in the upcoming quarters? While we don't have everything in hand, what could be reasons to slow this growth? It looks like we have a solid outlook for strong VA growth at least through June.

Bruce L. Caswell, President and CEO

I'll begin and then turn it over to David. First of all, the VA has been very public about their effort to push to reduce the overall backlog of inventory levels. They issued a press release in June stating that they're ahead of their goal for the highest number of claims processed in FY '25. So we know it's been a big push, and we know that their efforts are to complete that by the end of this fiscal year, making great progress in that regard. Our current view is that the unprecedented levels we saw in the June quarter are likely to moderate somewhat as a result. We've reflected that in our guidance. You asked kind of what are the factors that would cause that. Well, the main one would be that as each of the vendors ends up with the capacity they now have, working through their component of the backlog, we're going to reach equilibrium or a steady state where the processing timeliness for the entire system is in a good place, and veterans' cases are being processed and handled timely, and veterans are getting great service, and the inventory becomes more kind of at a working level over time. We think that we're on that path. The vendors collectively have made great progress with the customer to reduce the inventory levels, and we've seen that reflected in the charts that are publicly published. So we're going to continue to focus on that objective, which they've stated is key. But I'd also note that over time, a long-term steady state inventory level and backlog level exists where these programs operate. There will always be some, and you can carry that with the capacity in the system while still meeting timeliness and quality requirements that veterans need. Another point I'd leave you with is that veterans are often needing to be seen and requesting to be reassessed when they believe that there's a change in their condition. More than half, maybe closer to 2/3 of the incoming volumes in the program are those types of cases, veterans that need to be reassessed. As they progress in their journey, they require reassessments, and there will always be some inventory of incoming volume to ensure veterans receive the adequate level of benefit they deserve. With that, I'll turn it over to David for his thoughts.

David W. Mutryn, CFO

Yes. I agree. Just to characterize the June quarter in particular, as Bruce said, it was a quarter with high volumes coming in, plus we improved our own speed to process claims. We saw the kind of double benefit to our own case load and claims completed, which drove especially strong results. We actually saw a similar dynamic on some of our smaller clinical programs in the segment where we had tremendous execution quality during that quarter, driving down our own case load. So while we expect some moderation from those especially high levels in Q3, we also see sustained ongoing performance.

Brian A. Gesuale, Analyst

Right. And so I guess a few questions off of that. One, if I recall last quarter, the Federal segment had a favorable FEMA contribution that went away sequentially. Can you quantify that? In fact, if that did occur because these numbers still look good, absorbing that. And then secondly, I guess the previous equilibrium run rate or capacity in the industry was about 640,000 completed claims per quarter. It was 800,000. Are you suggesting we go back to 640,000? Because the comps just seem very easy to me.

David W. Mutryn, CFO

Yes. So for FEMA, one of the areas of work we do is supporting disaster response, which can be difficult to predict, and we're there to help as needed. I don't have the precise size off the top of my head for what it was. I would point out it's more of a BPO type work, involving staffing up and staffing down, not the same dynamic as a volume-based program where we just have more volume come in that we can work. So it's not as sensitive.

Brian A. Gesuale, Analyst

Okay. Appreciate that color. Just maybe a couple of quick ones to wrap up here. As I look at the margin setup over the next few quarters, you mentioned that it will be on the higher end of your range that you typically guide to. I also want to weave in the Big Beautiful Bill Act as well. If I think about VA volumes being above what they had been, that's generally a very good contribution. And then I guess you mentioned '27 for some OBB impacts, favorable impacts. Would it be possible to see some of those Medicaid redeterminations that come in at extremely high margin levels incrementally come in '26? I would assume the timing would be a little earlier than fiscal '27 for that part.

David W. Mutryn, CFO

So first, recognize that, that requirement only applies to the expansion population, which is about 20% of the overall Medicaid population. That one, too, is required to be in place by the end of calendar 2026.

Bruce L. Caswell, President and CEO

I would agree with David that it's not likely that states would want to begin sooner with that. However, it's still early days, and those conversations are just starting. It could be that some states have the flexibility to begin sooner, but they may seek to do that in some cases.

Brian A. Gesuale, Analyst

Okay. Yes. No, that's exactly what we're hearing, that some of the states are moving ahead quicker than the bill requires. Just final one for me to sneak in, and then I'll jump back into the queue. Can you talk about some of the headwinds? It seems like everything else is pretty much going well above anything we could have foreseen. We're hearing about some impacts. Maybe you could talk about what's going on at the SEC as well as maybe anything with the IRS or any other customers that you want to discuss.

Bruce L. Caswell, President and CEO

Yes. I'll begin with some high level and let David address specifics related to the SEC, etc. I'm really pleased that the impact of contract actions across our portfolio has been minimal. If we had to put a number on it, conservatively less than 0.5% of our FY '25 revenues. As we look toward FY '26, as many people have seen, the shift now that's occurred has seen individuals who were previously assigned to the Dodge take positions within the agencies to continue addressing the primary objectives that Dodge was established for, such as software and process modernization and driving efficiencies. So we're shifting to having conversations about efficiencies gained and how programs can be structured and delivered. As you know, a point of contention with the Department of Education will be how student loan servicing will be handled. If that function were to move over to another department like Treasury, how would that be structured? There are opportunities for us to re-evaluate the borrower experience. We are seeing in this environment that opportunities for contract consolidation and technology applications are increasing. We feel our business model and value have held up well during this stage, and we are moving toward the next phase that focuses on efficiencies and redesigning delivery. David can add further color as it relates to specific customers or sectors you mentioned.

David W. Mutryn, CFO

Yes, Bruce summed it up well. As we look at what we've seen as far as rate cuts initiated by Dodge, they are still relatively small considering our revenue base, at less than 0.5% of our total revenue. This would also include some impacts you've mentioned that would not be all that impactful given the revenue base.

Operator, Operator

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