Morneau Shepell, Inc. (OTC:MSIXF) Q3 2020 Earnings Conference Call November 11, 2020 10:00 AM ET

Company Participants

Stephen Liptrap – President and CEO

Grier Colter – CFO

Conference Call Participants

Stephanie Price – CIBC

Graham Ryding – TD Securities

Jaeme Gloyn – National Bank Financial

Operator

Good morning, ladies and gentlemen. Welcome to the Third Quarter 2020 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, Melanie. Good morning and thank you for joining us. On the call with me today is Grier Colter, our Chief Financial Officer.

Yesterday, after the markets closed, we released Morneau Shepell’s financial results for the third quarter of 2020. Like always, you can access the news release, financial statements and our MD&A on our website at morneaushepell.com.

Today I will review our third quarter business performance and highlights. Grier will then cover off our financials and we will open the call for questions.

To begin, we are very pleased with the quarter. It was another quarter during the pandemic where our business showed growth, improved margins and resilience during these challenging times. Overall, the third quarter is consistent with what we’ve been seeing since the pandemic began, and we have started to see the acceleration of organic growth back to historic levels. We think of our business in three ways. One, a solid core with strong recurring revenue. Two, levers that allow us to accelerate growth. Three, innovation and new technology.

Our core continues to perform well although COVID-19 is still impacting some aspects of our businesses where service has traditionally been provided in person. We have pivoted many of these to virtual delivery and that work is part of our improved organic growth. We are not 100% back, but well on our way.

Additionally, we continue to see growth in retirement solutions, disability management, pension administration and the strong recurring revenue in these businesses continue. In terms of our levers for growth, we continue to see strong sales performance from our ICBT products where we built from our earlier wins with two large provinces. In the quarter, we added new government mandates and new private sector clients and although we just launched in the United States we’re in the contracting stage with our first U.S. ICBT client.

In terms of our well-being business we won a sizable global contract to provide an EFAP for a major pharma company with employees in 40 countries. Our student support solutions business close wins at two universities in the United States. We also closed a new win with a Canadian retail chain to provide EFAP to their 20,000 plus employees across Canada. In our well-being business, we added more than 2.7 million lives through new client sales and now cover 13.4 million lives through our EFAP programs up from just over 10 million lives last quarter.

We also saw a continued adoption of our Lifeworks platform a key part of our strategy. We increased lives on the platform to 3.7 million an increase of 9% in the quarter and 63% year-to-date. The value of this ongoing migration is first and foremost to give more of our clients and their people an integrated user experience while setting the stage for an up sell to additional technology modules. We have been up selling at 10% and we increased that in the past quarter to 11% even with a large increase in the total lives available for up sell.

Another lever for accelerating growth is our U.S. and global expansion. In the quarter we saw high single-digit organic growth in our geographies outside Canada. A new measure that we are tracking is our technology recurring revenue measure and it includes our Lifeworks platform, ICBT sales, benefits administration technology and financial well-being. This suite of recurring revenue technology products grew at 8.3% and represents just over 50% of our revenue.

As we think about continuing to add new technology and innovation to our business during the quarter. We launched our expanded and integrated telemedicine solutions, our virtual care in Canada and in the United States. It’s an exciting area different from old style visits to the doctor’s office. As we continue to see excellent adoption of our platform, it gives us the opportunity to add services and telemedicine is a good example of that. It’s all about our strategy of building, buying and partnering to add new services to our platform and be the single point of contact for the employee.

We have already had multiple wins for telemedicine in Canada including with one of the largest clean power generators in North America and within days of our U.S. launch we’re in the contracting phase for our first telemedicine sale in that market. As we look forward our sales wins have been extremely strong and above historical levels. Our funnel continues to be strong and is growing across all lines of business. Our strategy is working and as a reminder, we are focused on owning the well-being space, accelerating growth through U.S. and global expansion and driving world-class delivery through people and technology. In this context, we will continue to focus on one, growing our solid core with strong recurring revenue two, using our levers to accelerate our growth and three, continuing to innovate with new technologies.

Finally, we are pleased to note that we currently have the highest levels of employee engagement in the company’s history and the highest level of client satisfaction and we just launched our second CSR report where we highlighted the well-being of our workforce benchmarked against the global working population using criteria from our mental health index that we launched earlier this year. While the mental health of the working population globally has declined significantly in the pandemic, Morneau Shepell scored materially higher against the median decline. This tells us our investments in the well-being of our people, in the resilience of our own workforce is delivering for us.

One of the consequences of the pandemic a positive one if that can be said is that it has really shown a light on the mental health issues in our communities associated with isolation, anxiety and depression that we are already growing in the workforce but these have exploded since the pandemic began. In that context, the mental health index as a global benchmark as not only a brand building asset, but a contribution we believe to addressing challenges in our communities providing insights that can really help people and governments making policy decisions. We’re really excited about the potential of the index to position us globally as a leader in mental health and help organizations measure the F in ESG.

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On that note Grier Colter will review the financials.

Grier Colter

Thanks Stephen and good morning. It was an excellent third quarter not just in results, but in momentum going forward as we grow our business. We delivered revenue growth of 7.3% compared to third quarter 2019 coming in at $240.3 million. There are three key drivers behind this revenue growth. First, organic growth of 4.3% was a significant increase more than double what we delivered in each of the previous two quarters that includes 8.4% organic growth in our United States international regions a very positive development in its own right but even more so considering the pandemic.

Also contributing to our growth was the acquisition we made last year of Mercer’s standalone large market health and pension administration business as well there were some offsets in revenue and margin from the divestiture of our health benefit consulting business earlier this year.

In the quarter adjusted EBITDA increased 13.3% to $49.6 million from $43.8 million in the prior year quarter. Adjusted EBITDA margin was 20.7% versus 19.6% in 2019. There are one-time factors arising from the pandemic like reduced travel and training costs that boost margins, but there are also heavy headwinds notably the divestiture of our benefits consulting business earlier this year. So overall, we were very pleased with this result. Adjusted EBITDA per share for the quarter was $0.71 up 7.6% from the same period last year.

In terms of profitability, the loss for the period was $2.1 million compared to a profit of 1.3 million last year and this was impacted by a provision of $10.3 million associated with the planned relocation of our three Toronto area offices into a single head office location in Downtown, Toronto at the end of 2021. The move will deliver cost savings and reduce our overall square footage while at the same time providing a modern workspace in a location that will serve our people and business more effectively. Accordingly the loss per share for the quarter was $0.03 compared to EPS of $0.02 in a comparative prior year period.

In the quarter, we generated normalized free cash flow of $21.9 million compared to $24.2 million last year. The decrease is mainly due to higher CapEx that we are making in our business. Year-to-date, we reported $729.5 million in revenue an increase of 13.7% over the same period last year along with adjusted EBITDA of $149 million up 10.9%. Our year-to-date adjusted EBITDA margin was 20.4% which is slightly better than what we anticipated for the year. The company is maintaining its policy of paying a monthly dividend of $6.5 per share.

In closing, I’d like to emphasize a few things. At the end of the quarter our liquidity position remains very strong and in line with our expectations giving us the capacity to support our growth strategy. We continue to manage our working capital very closely and has seen no degradation in the quality of our receivables; a testament to the quality of our client relationships. We had significant operational achievements in Q3. We completed the integration of our Lifeworks back office systems into one single platform for the business and accordingly there will be no additional spend here going forward. And on our Mercer integration we’ve completed the majority of the work to extract these functions from their organization. We anticipate another million dollars in Q4 at which time this work will be complete. Therefore, we expect to have the remaining 1 million for Mercer and our ERP project OpEx as adjusted items in Q4 and from Q1, 2021 it will be solely the ERP project. And lastly I want to reiterate how pleased we are with our strong organic growth for the quarter especially from our U.S. international operations.

And with that I will turn it back to you Stephen.

Stephen Liptrap

Thanks Grier. In summary, during the quarter we saw good overall revenue growth, solid and improving organic growth and a good increase in margins. I’d like to thank everyone on the call for your time so far today and we’d be pleased to now answer any questions. Melanie can you go ahead and open the line please?

Question-and-Answer Session

Operator

Certainly, thank you. [Operator Instructions] The first question is from Stephanie Price. Please go ahead. Your line is now open.

Stephanie Price

Good morning.

Stephen Liptrap

Morning Stephanie.

Stephanie Price

In terms of organic growth it was obviously solid in the quarter. Just wondering if you could talk a little bit about the puts and takes here both in Canada and what you’re seeing in the U.S. and internationally?

Stephen Liptrap

Yes. It’s Stephen here. Let me start with international and U.S. that expansion over the last number of years has really been from what I would call our new products and new areas of focus. So we have very little one-time client facing stuff that would have stopped there. So the organic growth we’re seeing there is similar to what we would have expected kind of in the high single digit range. Canada is a little bit more complicated because we’ve been here for a long time and as you know; when we moved into the pandemic we had some face-to-face services that stopped. You can think about child support. You can think about on-site trauma that we do; some of the on-site training and some of our consulting activities. We’ve been able to pivot over the last few months a lot of those to be virtual. As I mentioned, not a 100% back, but we’re doing a lot of training now virtually. We’re working with our clients from a pension consulting standpoint virtually and we’ve got some offices open from children’s support solutions. So, we are well back on our way but that really is a difference in organic growth between Canada and the U.S.

Stephanie Price

Okay. Thanks for the color and then wondering about, if you need a bit more details around the role of telemedicine. Just curious if you see it more as an add-on to the well-being product or you think it could drive kind of significant growth on a stand-alone basis?

Stephen Liptrap

Yes. We always think about the platform which is why I keep coming back Stephanie to the number of people we have on the platform and why that’s such an important measure that platform will be the place that employees will go to every single day, the place that they will go in organizations to find everything they need and we’ve really been working on how do you take that platform and one, make a global. We’ve added lives on. We’ve moved to full data residency no matter where people are so we’re complying with privacy, laws and issues no matter where people are coming onto it and we’ve been adding services where we’ve just launched in the last quarter with a large North American bank where we put pension and benefit data on the platform for them.

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Going forward, we do see adding other services and I think telemedicine is a really good example of that where people can come onto our platform, come into our system and pick up telemedicine solution as they need. We can do that through another provider out there or we can do that through our own solution whatever makes more sense for our clients. So I do think it will generate growth but I do see it as an add-on to the platform.

Stephanie Price

Okay. A great color. And then just finally for me, in terms of the accelerating pipeline just wondering how we should kind of think about the translation of that pipeline into revenue as we kind of head into 2021?

Stephen Liptrap

Yes, it’s been really interesting because our sales have been above historical levels, which I don’t know if I would have predicted when we first got into the pandemic but that has continued month-over-month. Our quality pipeline, which is what I really look at, which is anything that’s into presenting or finalist presentation stage, is up over last year. So I would see that both of those and looking at the pipeline in general will lead us to believe that over the mid and long term, we will deliver in line with historical growth levels and I always think about that as mid-single digit organic growth in Canada, don’t know whether that’s 3.5%, 4% or 5% depending on the year and then higher levels of organic growth when we get outside of the Canadian markets.

Stephanie Price

Great. Thank you very much.

Stephen Liptrap

Thanks Stephanie.

Operator

Thank you. The next question is from Graham Ryding of TD Securities. Please go ahead.

Graham Ryding

Hi good morning.

Stephen Liptrap

Morning Graham.

Graham Ryding

So that the virtual health announcement, I believe you said that you’re partnering with a firm there. Does that mean you can provide coverage right across the country and maybe it’s just some details on what you’re providing in this partnership and what they’re responsible for?

Stephen Liptrap

Yes. We’ve really got two things Graham. So, we’ve been providing virtual medicine through partnerships that we’ve announced before with some of the larger providers. This one what we announced and that’s been going on for well over a year, this one more particularly was us providing a telemedicine directly through our own system. So not needing to hand off to one of these other relationships that we’ve had. So, we have through partnerships as we do with EAP and counseling and all of the other things we do we’ve stood up a full network across Canada and we’ve now just stood up a full network in the U.S. so no matter where people are we’re able to provide virtual telemedicine support in Canada and in the U.S.

Graham Ryding

Okay. Understood. And just to be clear is this being offered within your existing EAP contracts or is this an incremental fee and add-on for your clients?

Stephen Liptrap

Yes, it would be 100% incremental. So we are out talking to our clients right now about if any of them are interested in adding those services on. We will add that on as part of our platform and how you come into the system.

Graham Ryding

Understood. And then, my last question just on the ICBT it sounds like there’s pretty good traction for you in that area. Do you feel like you’re at the forefront of this space and are you seeing any developments in terms of competition or similar product offerings?

Stephen Liptrap

Yes. ICBT has been our fastest growing product this year. As we moved in the pandemic we had a tremendous support from two of the largest provinces in Canada that wanted to roll ICBT to all residents and we’ve delivered over a 100,000 cases already. We’ve been, in the past quarter, added on a number of other government entities and some private sector and we launched down in the U.S. So, no, this is we believe that we are nicely at the forefront. There are a couple competitors in the space, but we’re very happy with our growth, our pipeline and our technology and what our team has been able to deliver.

Graham Ryding

That’s it for me. Thank you.

Stephen Liptrap

Great. Thanks Graham.

Operator

Thank you. [Operator Instructions] The next question is from Jaeme Gloyn of National Bank. Please go ahead.

Jaeme Gloyn

Yes. Thanks and good morning. First question is, just on that Lifeworks migration stats. They sound like they’re it’s advancing it pretty well and has accelerated. Can you maybe talk about what’s driving that acceleration and then the follow through is what’s the uptake on the enhanced lifeworks platform from these lives that are now migrating?

Stephen Liptrap

Yes. A really good question Jaeme. So, the first thing I would say, you would have heard me talk over a while about that we’ve got 10 million direct lives that we have access to through our EAP programs and the first thing I think that’s significant is we’ve taken that 10 million up another 2.7 million to well over 13 million in the last quarter and that really was about adding lives for our current clients as well as new wins and could be adding lives in different jurisdictions, adding part-timers or picking up brand new clients and we gave a couple examples of those. So we’re now starting with a base of 13 million versus the 10 million that I would have talked about before.

From there, we really do try and migrate those clients over to our core platform. We don’t charge them anything extra to do it. It’s a better more integrated experience and one that we believe that we can up sell from. And again, there we saw really nice growth where we’ve now got 3.7 million lives sitting on our core platform which is up 63% year-to-date. So kudos to the team who have moved in. We’ve got really good feedback from those clients.

Once we have those clients on the core platform though we do have the ability to up sell them and we cannot sell them anywhere from $1 to $4 per employee per month depending on how many modules we want. We had seen that up sell running about 10% of the people on the core platform and we saw that increase to 11% in the past quarter, which is great and also the fact that we moved from 10 million to 13 million that 11% is on a much larger base. So I think right across the whole ecosystem of our Lifeworks platform we’re very pleased with what we saw in the last quarter.

Jaeme Gloyn

Okay. That’s really interesting. Just on that 13 million, so you’ve added 3 million lives rough-rough. When you’re adding these lives, are they being added directly to the Lifeworks core platform or are there still a segment alive that they just want the legacy type product offering?

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Stephen Liptrap

Yes. It really is up to the client and a couple of different things can happen. So some of them just want legacy phone number and access, I think about really small employers where it’s just easier to do and we can turn that on overnight. Others are interested in jumping on the core platform right away and making a big splash and many others say, let’s start with the high quality EAP program that we know you folks deliver and let’s look at moving to the core platform over a period of time. So we’ve got clients in all three phases of those.

Jaeme Gloyn

Okay. And the breakdown would you be able to offer any color around a breakdown of legacy versus I guess core Lifeworks?

Stephen Liptrap

Yes. Easiest way to think about it Jaeme would be the increase that we saw in a quarter. Part of that would have come from converting current clients, who were on a trajectory and the others would have been putting some new folks on it. I don’t have the exact breakdown between those two things but it’s probably somewhere around 40/60 or 60/40 in that mix.

Jaeme Gloyn

Okay. Great. Next question is just around some of the other wellness products that we’ve talked about in the past, but around like sleep and fitness and things like that obviously telemedicine sound is a larger I guess space or at least more prevalent today. Can you talk about some of those other wellness initiatives and the success of those?

Stephen Liptrap

Yes. Obviously, I tend to look at putting things on the platform not just for the sake of putting them on, but putting things on that our clients value and to be frank are willing to pay for. So that kind of is the test as we look at it, as we looked at all the things that we were looking to put on the platform and there’s some constraint around how much we can do from our resources and technology within a quarter. The largest opportunity that we saw was really around telemedicine. So our focus in this quarter was standing up the Canadian telemedicine offering and then also getting it launched within the U.S.

We have those through the pandemic because we know a lot of people are not able to get out to gyms and different things like that. We have put physical fitness on the platform so you can actually come on to it and have a program customized for yourself and get a little bit of a personal trainer to help you out a little bit on that side. We’ve not gone down the road of sleep or anything else. Those are still on; the radar we will look at in the future. The other thing that I think is significant for the quarter though we were able to stand up. We had talked for a while about a large North American bank and working with them to get pension and benefit data on their system and from a back-end standpoint we’re largely able to stand up that in this quarter and they will be rolling it out to their employees in the next little while.

Jaeme Gloyn

Okay. That’s great. A couple more just in terms of the health and productivity solutions segment, down again this quarter I guess flats sort of quarter-over-quarter. Can you just refresh me on what was the driver of the year-over-year decline there in that segment?

Stephen Liptrap

Yes. The first thing I would say Jaeme, that’s our highest growth group. I know it doesn’t show up on those numbers and the decline is only because that’s where the health and benefits consulting business used to reside that we sold. If you strip that out and looked at organic growth within that business that is our highest growth business that is where ICBT is and we are very-very pleased with what that group has contributed.

Jaeme Gloyn

Okay. That’s good. I look forward to in that future quarters. Then the last one, I’m not sure if you’re in a position at this point to start thinking about 2021 margins, but if you are should we think about that as flat at 2020 are there integration initiatives that are starting to flow through or higher revenue, higher margin revenues going through that we should see an uptick in 2021 margins?

Stephen Liptrap

Yes Jaeme, let me start and then I’ll get Grier to add some color. I think at a really high level standpoint we’re quite pleased with where our margins are year-to-date and that should pan out for the balance of this year looking at where we are year-to-date. As we look at next year and we’re very-very early in our budgeting process, but as we look at next year we know that we’re going to have to make some investments back into our clients when you think about traveling, you think about getting in front of those clients as we’ve not been able to do except on a virtual basis. So there are some investments we will make.

However, as an organization we also look at continual improvement and we will continue to do things like leveraging technology, delivering more through our India operations and things like that. So we’ve got both of those things that we’re working through right now as we set up the budget for next year but I know Grier will add some color to that.

Grier Colter

Yes. Look I would maybe just be repeating in most areas. I think Stephen said it very well. So yes, it’s as I said in my script this year it’s slightly higher than what we expected. And we expect that to continue for the rest of the year at least and maybe continued this situation kind of rolls on. But like Stephen said, as we can kind of get back to normal some of those costs will come back as we invest in this business. And yes, other than that and obviously we’re focused on efficiency and improvement and overtime our goal is to get the margin higher and as Stephen said before it’s probably tens of basis points not tens of percentage points but I’m really just adding to what he said. So I completely agree.

Jaeme Gloyn

Great. Thank you. That’s it for me.

Stephen Liptrap

Thanks Jaeme.

Operator

Thank you. And there are no further questions registered at this time. We’ll turn the meeting back over to Mr. Liptrap.

Stephen Liptrap

Great. Thank you, Melanie. I’d like to end by expressing my thanks to everybody 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. We thank you for your participation.



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