Morneau Shepell Inc. (MSIXF) CEO Stephen Liptrap on Q4 2019 Results - Earnings Call Transcript

Morneau Shepell Inc. (MSIXF) Q4 2019 Earnings Conference Call March 11, 2020 10:00 AM ET

Company Participants

Stephen Liptrap - President and CEO

Grier Colter - CFO

Conference Call Participants

Stephanie Price - CIBC Capital Markets

Jaeme Gloyn - National Bank Financial

Graham Ryding - TD Securities

Operator

Good morning, ladies and gentlemen, and welcome to the Fourth Quarter 2019 Conference Call for Morneau Shepell Inc. Please note that this conference call will contain forward-looking statements which reflect management's current beliefs and expectations regarding the corporation's future growth and results of operations. Actual results can differ materially from those anticipated.

I would now like to turn the meeting over to Mr. Stephen Liptrap, President and Chief Executive Officer of Morneau Shepell Inc. Please go ahead, Mr. Liptrap.

Stephen Liptrap

Thank you, Maude. Good morning and thank you for joining us. On the call with me today is Grier Colter, our Chief Financial Officer. Yesterday, after markets closed, we released Morneau Shepell's financial results for the full-year and fourth quarter of 2019. Like always, you can access the earnings release, financial statements, and our MD&A on our Web site at morneaushepell.com. Today I will briefly summarize our performance for the business at year end, and with Grier covering the financials, and then as usual, we will take your questions.

As we indicated in the earnings release, we delivered very solid year built on a foundation of strong growth on the top and bottom line. Good organic growth across our lines of business, accelerated total and organic growth in the U.S., integration of the LifeWorks acquisition, and build out of our well-being platform, and closing and integrating the acquisition in mid-year of Mercer's standalone large market health and defined benefit pension plan administration business in the United States, which as many of you know, opened up a large corporate market for our services.

In 2019, we are pleased with our overall growth, the expanded margins, and the significant steps we made against our five-year strategic plan. With LifeWorks, we are pleased that we delivered what we expected in terms of the platform, integration, and synergies; not to mention changing the conversation with our clients from EAP to the total well-being of their employees. 2019 was a year of strategic expansion as we continue to deliver profitable growth while maintaining strong client satisfaction levels.

Turning briefly to the fourth quarter last year, we delivered results that are consistent with the full-year for the most of the reasons I have already mentioned. In addition, I will cover some key business highlights. With LifeWorks, we won two large mandates for total well-being solution, one, to a large Canadian communications company, and another to a midsized public sector client. In the United States, in the quarter, we landed a sizeable mandate for an EAP program with a fast-growing fintech company. The total well-being market is a high potential, high growth opportunity for us. The sales cycle, however, is longer as solutions impact more parts of an organization, and need to be more integrated. We are confident that our value proposition in this evolving market is uniquely strong.

To-date, we have converted over 2.2 million lives to our core well-being platform, up from 1.8 million in the previous quarter, and we anticipate seeing that number continue to grow. Our health and productivity business turned in a strong fourth quarter as our focus on absence management and mental health takes hold in the market. One of the solutions that we are most excited about is our Internet Cognitive Behavioral Therapy, iCBT, which named AbilitiCBT, a therapist-assisted internet-based CBT program that can be accessed from any device anytime. We recently sold this solution to an existing large public sector client. We are also about to launch a pilot project in partnership with CAMH to provide our solution to patients in their mood and anxiety outpatient clinics. It is highly atypical for CAMH to use an outside provider for mental health services. It speaks volumes about the level of confidence they have in our solutions. These wins represent positive steps towards leveraging our strength in this promising high growth market for mental healthcare offered on digital platforms.

We are also starting to see considerable interest in iCBT in the U.S., which tends to be an early adopter market for these kinds of technology-enabled solutions. We are actively pursuing opportunities to roll-out our solution in the U.S. ahead of our original schedule, which bodes well for growth opportunities in other geographic markets outside of Canada.

Our administrative solutions business has been on a growth trend for some time now. Thanks to strong organic growth, some significant wins, and our acquisition in Mercer's large market pension and benefits admin business. In Canada, we won a large one-time implementation of a faith-based organization over the next three to five years. In the U.S. we won a significant admin contract with a large retailer, and finally, in our retirement solutions business in Canada, we won a contract for core actuarial services with a large public sector client.

As many of you know, last week on March 2, we announced the sale of our benefits consulting business to Hub International, a diversified global insurance broker. As part of our strategic planning process, we continuously assess our businesses across the enterprise to ensure that they align with our strategy to be the clear market leaders in the businesses in which we operate, to be the leader in total well-being market, and to accelerate growth through global expansion, and drive world-class delivery through people and technology.

While benefits consulting has been an important business in Canada for Morneau Shepell with great clients and a talented team, it no longer fits into our roadmap for the future. Hub International on the other hand is committed to the growth of benefits consulting as a core business, which makes them a great partner for this transaction. The transaction will allow us to more effectively leverage distribution partners such as insurance carriers and brokers for many of our services.

With the closing of this strategic acquisition, we have also entered into partnership with Hub. Hub has selected us as a key partner in delivering Internet Cognitive Behavioral Therapy, or iCBT, and other employee well-being services to their clients. The transaction is a win-win situation for all parties. It's a clear example of a business that has different value in different hands.

Going forward, we are focused on the businesses where we are or can be the clear market leaders, top three in the market where we compete. As part of that approach, we want to invest our capital and grow our business in support of our strategy, which has three pillars today: own the total well-being space globally, accelerate growth through geographic expansion, and leverage technology to deliver a seamless experience for our clients and their employees.

Over time, we expect our Canadian business to produce growth in the mid single-digit range with high single-digit growth in the United States and outside North America. As we move forward today, we do so with the confidence that Morneau Shepell is well-positioned strategically, operationally, and financially to deliver profitable growth.

On that note, let me turn it over to Grier to review the financials.

Grier Colter

Thanks, Stephen, and good morning. 2019 was a solid year for financial results, and we made progress in taking our global expansion to the next level by executing on the strategy that Stephen talked about.

Let's turn to the numbers for the year. Revenue grew 23.1% to $888.9 million, with adjusted EBITDA increasing by 33.2% to $182.5 million. Stephen mentioned the main factors in this upswing in our results being the mid-year acquisition and Mercer standalone, large market administration business in the United States, a full-year of LifeWorks revenue, and organic growth across our core lines of business, which came in at 5.7% for the year. Adjusted EBITDA margins increased to 20.5% from 19.0% in 2018. This increase is primarily due to the impact of adopting IFRS 16 and transformation initiatives, partially offset by Mercer being a lower margin business.

For the fourth quarter of 2019, the company produced revenue growth of 23.3% versus prior year, to $247.5 million. Adjusted EBITDA increased 34.7% to $48.0 million, with adjusted EBITDA margins increasing to 19.4% versus 17.8% in Q4 2018. The factors in the company's improved quarterly performance include revenue from the Mercer acquisition, organic growth across our core lines of business, and the impact of adopting IFRS 16.

The fourth quarter represents a strong finish to the year, and we are pleased with the integration of our acquisitions, and more recently, the transaction announced subsequent to the quarter with Hub. As Stephen has mentioned, the sale of our benefits consulting business enabled us to divest the business that was less strategic to us, and it provides the company with additional liquidity that will be redeployed as a component of the company's overall capital allocation strategy. Despite the divested business having higher margins, which will have a small negative impact on our overall margins, WE are very happy with the economics of this transaction.

Ultimately, we are generating results our shareholders expect from us, and these will be critical in funding our growth plans. Adjusted EBITDA per share for the year was $2.76, a 21.1% increase, compared to $2.28 per share in 2018. Profit for the year was $19.0 million, compared to $21.8 million last year. The decline is due to higher amortization charges related to acquired intangibles from acquisitions, and due to higher finance costs. Normalized free cash flow for the year increased by $18.4 million to $93.5 million, compared to $75.1 million for the same period in 2018, due to higher cash flow from increased adjusted EBITDA. The company is maintaining its policy of paying a monthly dividend of $6.05 per share.

And finally, a few comments about our strategies to maintain our financial strength and flexibility as we go forward. In Q4 2019, the company increased its existing revolving credit facility by $100 million with the same terms and conditions. Combined with the proceeds from the sale of our benefits consulting business, we have the capacity to execute on our strategy, and finally, in December, the company issued a redemption notice in respect to the outstanding $80.7 million of convertible debentures. Of the principal amount, $79.2 million was converted into 3.2 million common shares at a conversion price of $25.10 each. The remaining $1.5 million was redeemed through a cash payout as face value.

And with that, I'll turn the call back to Stephen.

Stephen Liptrap

Thanks, Grier. Before we move to the Q&A, I'd like to address the question that is likely on your minds that our response to COVID-19.

We're committed to and prepared to address the evolving risk posed by COVID-19. We've activated our comprehensive business continuity pandemic plan, and have very active executives and management groups coordinating our response globally. We have regular communications with employees, updating them as new information is available. We're continually assessing and updating our approach based on the changing environment, including things like travel restrictions for non-essential travel, SELF-quarantines in certain situations, working from home, restrictions on large gatherings of people, et cetera. We're communicating best available information and advice to help protect our employees. We're also providing support to our clients and their people. In terms of impact to the business based on how things are unfolding at this moment, we anticipate the impact to be fairly neutral.

In some areas, we're seeing an increase in service, like more cases in the absence and disability business. And in others, we're seeing a slight decrease like face-to-face training. It is a fluid situation and will continue to evolve, and as I've said, it's something that we're very actively monitoring.

I'd like to thank everyone on the call for your time so far today. We would be pleased to now answer your questions. Maude, could you go ahead and open the line?

Question-and-Answer Session

Operator

Certainly. Thank you, Mr. Liptrap. [Operator Instructions] Our first question is from Stephanie Price from CIBC. Please go ahead.

Stephanie Price

Good morning.

Stephen Liptrap

Good morning, Stephanie.

Stephanie Price

Maybe just on COVID-19, since you just mentioned it, can you talk generally about what you've seen historically in terms of the EAP well-being utilization in kind of downturns and periods of uncertainty?

Grier Colter

Yes, really good question. I'll put it into two parts, Stephanie. First would be recession or a financial downturn where - when that happened during the financial crisis previously, we saw an uptick in calls coming into our EAP related to stress and anxiety as you could imagine, and more clients would ask them to go on site and help them with downsizings and things like that. In our pension administration business, we would have seen more activity relating to needing to do calculations for people around retirement and things like that. If I take it more specifically to your question around COVID-19, when we take a look back at SARS or H1N1 or something like that, we did not see a large uptick, we would have seen a small uptick in calls and things like that, but nothing material or substantial.

Stephanie Price

Okay, thanks for the color. And then, in terms of the Mercer acquisition, looks like revenue was a little bit higher than it was modeling this quarter. Can you talk a bit about the growth you're seeing in the business and whether it was in line with your expectations?

Stephen Liptrap

Yes. I'll start, Stephanie, it's Stephen, then I'll turn it over to Grier. I think the first comment I would make is as we've been out talking to our new clients, yes, Mercer clients, we've been really pleased with the interactions, been really pleased with their openness to talk around how do we do things differently, what other things can we do together, which really opens a lot of doors to continue to partnerships to build. As you would have noticed, the revenue is higher than what we would have expected. That obviously put some pressure on margin percentages, not margin dollars, obviously, and that really is, I would say, tied into a couple of things. It's tied into less turnover of those clients that we would have expected, and some one-time work that I think came our way as those clients saw a long-term player in the industry rather than necessarily an organization that they weren't sure we're going to be in that business longer-term.

Stephanie Price

Okay. And when you think about that - oh sorry, when you think about that one-time work, should we think about going into the next quarter as well, or was this pretty much wrapped up in the quarter?

Grier Colter

Yes, one of the things I would add. It's Grier, Stephanie. I view this as when we looked at what we thought Mercer would be and what it has been, we're obviously very, very pleased with both revenue and EBITDA. When we made the assumptions in our acquisition model, we made some assumptions about clients that would stay and clients that would maybe not stay, and a big part of the outperformance is that we've had a really good result in terms of clients that we've been able to continue to work with. So, I guess the reason why I'm saying that I think it's - there are some opportunities to grow this portfolio. I think it's really that we saw some outperformance at the beginning of it, and so, it's not like we're going to see this outperformance again and again and again. So, I wouldn't look at as hyper growth more as we're really pleased. Everything's converted a lot better than we thought. We've got great value here, but don't look at it as a huge growth engine.

Stephen Liptrap

And I do think just on your question around one-time, Stephanie, I do think that was a little bit of pent-up demand rather than necessarily those growth rates continuing.

Stephanie Price

Okay, thanks. And I'll throw one more into that. You mentioned the iCBT quite a bit in your prepared remarks, Stephen, I was wondering how you kind of sell that into - is it mainly existing well-being clients and it's like kind of a revenue add to your existing revenue in the well-being space, or how do we think about that?

Stephen Liptrap

Yes, we really think about it as part of what I would call our continuum of care, which moves from the lower end of the continuum where you're talking about recognition and having people feel involved in a workplace up to eldercare, childcare, up to the other areas that exists from an EAP, think about anxiety, depression and things like that, and then it really moves into iCBT. So, at a very simple level rather than going to see a counselor face-to-face, you're essentially moving through modules online with a counselor in the background assisting you as required. And then beyond that, when you do need the face-to-face or you move into being off-work, you move into our disability management business. So, iCBT was a really nice fit into that overall continuum. We do sell it as an extra product, and we've seen good take up on that. Again, it's very small. It is in our health and productivity business, but we do see that as being a growth driver in that business, and that did help contribute to the nice growth that we saw in Q4 in health and productivity.

Stephanie Price

Great. Thanks so much.

Stephen Liptrap

Thanks, Stephanie.

Operator

Thank you. Following question is from Jaeme Gloyn from National Bank Financial. Please go ahead.

Jaeme Gloyn

Yes, thanks. Good morning.

Stephen Liptrap

Good morning, Jaeme.

Jaeme Gloyn

First question is just going back to that one-time work component of Mercer, how much would that have contributed in the quarter, I guess, what I'm trying to get at is what would be sort of the run rate revenues, is it the $36 million that you generated or is it something a couple of million dollars lower or - a little bit more color?

Grier Colter

Yes. So, let me say it again. So, I think the run rate is probably a pretty good one, Jaeme, aside from seasonality and stuff like that, but I think that's a good run rate. So, it wasn't so much as it was the one-time nature of it. It was that we converted more, had an ongoing relationship with more than we thought. So, don't look at it as one-time, but it converted. So I guess an increase one-time over what we thought but it will continue. So, it's recurring.

Jaeme Gloyn

Okay, that's great. In terms of the benefits consulting transaction with Hub, it was noted in the statements there'd be a small gain, do you have any additional color you can provide as to the size of that gain in Q1?

Grier Colter

Yes, sure. So, I look at it the two different pieces, I look at our cash flow. So, one thing, I think it's important to understand is that there's no cash tax on this transaction. So the net, we should be able to take $64 million, $65 million kind of zone out of this and redeploy that cash. Obviously, in the interim, we'll apply it to our credit facility until we find a place for it. On the accounting side, I'm just going to give you a number obviously, there's still stuff moving around, but it's probably in the -- it's in the $30 million to $40 million. I know it's a wide range, but it's in the $30 million to $40 million range on gains.

Jaeme Gloyn

Okay, that's quite substantial. Shifting to free cash flow and normalized free cash flow ticked down year-over-year this quarter primarily because of what looked like higher CapEx tied to the Mercer transaction. First off, I guess, how much of that $14 million CapEx tied to Mercer is going to repeat in 2020, and then second part would be can you refresh us on what your CapEx budget and plans are for 2020 and 2021?

Grier Colter

Yes, so for Mercer, it's not recurring. So, on the CapEx side of that, I'm not going to get into specific numbers necessarily, but the Mercer is not, it's not recurring. It was some one-time capital that we made, if I said the kind of 50% zone going forward, that's probably close. In terms of CapEx for 2020, it will be somewhat elevated versus kind of where we came in, in 2019 if I said $60 million type zone that's probably relatively close, plus or minus as we -- there's a bunch of kind of one-time initiatives that will be taking place over the next 24 months. So I think the capital will be elevated to that period, and then when it comes through to 2022, that's where we see the CapEx kind of coming back into a more normalized zone.

Stephen Liptrap

And Jaeme, it's Stephen, a little bit of color just on the elevated pieces. Most folks know we're looking at a new office location in Toronto, capital tied to that as we move through, we're implementing workday across the enterprise to have an integrated systems between finance, HR and time entry and things like that, and in addition, we've got some work just to do to meet some client commitments that we're quite excited about in terms of the LifeWorks platform. And as we've talked before getting pension and benefit data integrated into that platform.

Jaeme Gloyn

Okay, and I just wanted to, I was actually going to follow-up on that, but since you mentioned the pension and benefits component and what you're working on there, can you give us a little bit of update around how that's progressing, any feedback from clients from initial testing, and then maybe comment around timing?

Stephen Liptrap

Yes, I think a couple of things. So the first thing, we are working very closely with one client, who is very determined to lead with us in the marketplace, and we're co-developing and it's going well, the teams are working very hard. I think we've got fairly aggressive timelines that we're still working towards having this done by the end of Q2, and we're on track, but they are aggressive timelines. We have tremendous amount of interest from other clients in that, but we're really focused on getting it done on first of all, and then everyone else was kind of waiting and we will move forward and talk to them as we get through the development.

Jaeme Gloyn

Okay, great. And then last theme for me and I'll re-queue for some maybe some quick I had is around margins. I'm trying to just sort of run some math here and make some adjustments to neutralize for the IFRS 16 impacts and then Mercer so. Stop me if I'm going a little bit too off track here. Taking a look at the adjusted EBITDA of $48 million, if I use the $4.7 million payment of lease liabilities as the adjustment for IFRS 16, is that a correct adjustment, and that would lead me to about a 17.5% adjusted EBITDA margin just on the IFRS 16 impacts, is that fair?

Grier Colter

Yes, and I got to be honest I'm not going all your math, what I would say is the IFRS 16 adjustment is order of magnitude, probably 130 basis points or something like this. What I would do is when I kind of reset where the margins are, right. So when you look at last quarter, I think we're in 19.6. This quarter was 19.4 EBITDA margin. What we said on the last call, which we continue to think, is the right zone is that our overall EBITDA margin for 2019 will be consistent with 2020. So that came at 20.5. We're still thinking the same, so obviously we have built margin improvement into our forecast for the year and we're still confident we will achieve that.

Jaeme Gloyn

Okay. Well, I'll take it offline then and maybe run through some different numbers. Thank you.

Grier Colter

Okay.

Operator

Thank you. [Operator Instructions] The following question is from Graham Ryding from TD Securities. Please go ahead.

Graham Ryding

Hi, good morning.

Stephen Liptrap

Good morning, Graham.

Graham Ryding

Maybe I could just start on the free cash flow side. You know, I heard your comments on the CapEx, just working capital or non-cash working capital see a bit of a drag in 2019. Is there any color there on what specifically is driving that? And is there any expectation that will be less of a drag going forward. Just thinking about free cash flow and payout ratio?

Grier Colter

Yes. Hi, Graham, this is Grier. So, I think if you look at 2019 and a whole lot, why don't you just talk about Q4. I think that's probably more relevant here. So the working capital in Q4, the primary reason why that moved was the web, and so, our web is a little bit higher. A big reason for that is we have one specific client where we're doing a fairly large implementation. There are milestones in the contract. So we built up $5 million or $6 million in whip for the specific client that projects going on plan as went well that kind of stuff. It's just we've built up an unusually large amount for this particular client with I mean -- that to me explains most of it, we should see that reverse in Q1.

Graham Ryding

Okay, that's helpful. Your comments around integrating pension administered into the LifeWorks platform or app. You're working on one client, then, you're looking to roll it out with the rest. Is there any - I guess, the benefit there I would presume from a client's perspective is just it's a better overall product and for you it would be better client satisfaction retention. Is there any economic benefit from actually integrating pension and benefits admin into the LifeWorks platform?

Stephen Liptrap

Yes, Graham. It's Stephen here. The first thing I would say is, I do believe as you move into a platform world that the winners will be the ones who have people using the platforms on a regular basis, and we think we've got a very strong usage on the current platform as we've rolled it out. But we think adding pension and benefit data will just drive substantially more. Second thing I would say is as I'm out there talking to CEOs, CHROs what we see quite often is they've got a number of programs in place in their organizations that have no utilization. And it's really a fact that it's buried on a website and hard to get to. And if we, again can have something that employees are going to and using every single day for all of the information they have, it just becomes way more valuable than trying to find something buried. So we think it's phenomenal from an end user satisfaction standpoint, we think it's really good from our clients standpoint to answer your question on economics. Yes, we have someone who is a current client with pension and benefit, and we're integrating that data onto the LifeWorks platform. There is no direct economic benefit.

If we've got someone who would like the pension and benefit data put on the system and it's not residing on our systems, obviously there will be a charge to do that. And there would be obviously an economic benefit tied to it. But I think the bigger thing is I think that it is you think this platform continuing to expand and us putting more and more products, services and solutions on the platform, we will over time add solutions that we can charge an extra $1, $2 per employee per month, and there will be things that our clients and HR leaders truly value in their employees values. So I think it's just setting the platform up, getting more utilization, and then that will be the thing that gives us more and more and we will be able to recognize economic benefit over time.

Graham Ryding

Understood, makes sense. So then just one last question, it was an acquisition just earlier this week announced, Aon and Willis Towers Watson, just wondering from your perspective, any impact on the competitive landscape or read-throughs to your business if that deal does go through and close?

Stephen Liptrap

Yes, really good question. Obviously, we have been close to following it, and I think it has been on and off the room and not for a good year, as we think about it. What I would say, first of all, if you think about what that business really is, it's somewhere between insurance and consulting. So, for the most part, we don't play in the insurance space, and we've got a retirement solutions business that would play in consulting, but we're not in the benefits space anymore, as you know. So, it would be what they have would tie to a very small part of our business when we think about it, and it is a Canadian only part. The one other thing I would say though is, as you think about less and less players in the space, as our fees come up in the retirement solution space, there are less people bidding on it, and that is a business that we like it fits into our total well-being model and everything. So, we would expect over time, probably more opportunities showing up just with less competitors in that space.

Graham Ryding

That's it for me. Thank you.

Operator

Thank you. A following question is from Jaeme Gloyn from National Bank Financial. Please go ahead.

Jaeme Gloyn

Yes, thanks. Two quick follow-ups, first, just looking at the note for the financial statements showed a $7.5 million negative adjustment on the goodwill for LifeWorks, looks like it was netted out by other adjustments, but maybe you can walk me through what drove that?

Grier Colter

You got me, Jaeme, I don't - we're going to have to take that one offline.

Jaeme Gloyn

Okay. And then, second one, just going back to the margins, I meant to also ask, last quarter, we talked about Mercer being about 100 basis points drag, given the revenue was much larger this quarter, is that number still appropriate, or is it something different?

Grier Colter

Yes. On Mercer, it's certainly north of 100 basis points. It's probably closer to kind of 120-130.

Jaeme Gloyn

Okay, that makes sense. Thank you.

Stephen Liptrap

And Jaeme, just building on what Grier said before, the way I kind of think about it is we've got a run rate going right now on margins somewhere between 19.4 and 19.6, and we're working fairly hard before the Hub fees get started into add, we would anticipate about 100 basis points, as we move into 2020 on that number. Obviously, that will be pulled down a little bit with the transaction with Hub just because it benefits consulting business on slightly higher margins.

Jaeme Gloyn

Of course, thank you.

Operator

Thank you. We have no further questions registered at this time. I would now like to turn the meeting back over to Mr. Liptrap.

Stephen Liptrap

Thank you, Maude. I'd like to end by expressing my thanks to everyone on the call. We continue to appreciate your interest in our company, and we look forward to other opportunities in the future, including these calls to keep you up-to-date on what we're doing to drive our growth and success as a business. Thank you.

Operator

Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.