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Edited Transcript of MSI.TO earnings conference call or presentation 6-Nov-19 2:00pm GMT

Q3 2019 Morneau Shepell Inc Earnings Call

TORONTO Nov 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Morneau Shepell Inc earnings conference call or presentation Wednesday, November 6, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Grier Colter

* Stephen Liptrap

Morneau Shepell Inc. - President, CEO & Director

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Conference Call Participants

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* Graham Ryding

TD Securities Equity Research - Research Analyst of Financial Services

* Jaeme Gloyn

National Bank Financial, Inc., Research Division - Analyst

* Stephanie Doris Price

CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Software and Business Services Research Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Welcome to the Third 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.

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Stephen Liptrap, Morneau Shepell Inc. - President, CEO & Director [2]

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Thanks, Laurie. Good morning, and thank you for joining us today. On the call with me today is Grier Colter, our Chief Financial Officer. He joined the company in October; and Scott Milligan, who was previously CFO and now our Chief Corporate Officer.

Yesterday, after market closed, we released Morneau Shepell's financial results for the third quarter of 2019. Like always, you can access the earnings release, financial statements and our MD&A on our website at morneaushepell.com. Today, I'll review our performance in the quarter, and Grier will cover off our detailed financials. Scott is here to participate in the Q&A, bringing required historical information, once we open the call for questions.

Before we dive into the results, I thought I'd provide a little historical context on where Morneau Shepell is today and what we have achieved in the past decade. Since 2009, we have tripled the size of our business. As part of that, we are on track to double the size of our Canadian revenues by the end of this year. We also expect that by the end of the year, our U.S. and international business will be larger than our entire company was in 2009. During this period of strong growth over the past decade, we continue to be profitable, improving EBITDA margins along the way. Behind all those numbers in growth is a commitment to creating and delivering shareholder value, and our commitment remains as solid as ever.

Now onto the quarter. As we indicated in the earnings release, we delivered another quarter of profitable growth, in line with our expectations. Our results reflect continued progress with our growth strategy and our focus on strengthening our power brand in the employee well-being space.

Let me mention a few key business wins in the quarter by our lines of business. Beginning with LifeWorks, our well-being business. We are building on our market strength as one of the world's largest providers of total well-being solutions, and employee and family assistance programs. To date, we have converted over 1.8 million lives to our core well-being platform, up from $1.4 million in the previous quarter, and we anticipate seeing that number continue to grow. In the quarter, LifeWorks delivered new sales wins along with upsell opportunities. In the U.S., our LifeWorks division won several important contracts with global companies to bring their employees under our well-being platform and integrate services across a broad continuum of care that we believe differentiates us in the market. One contract is with a global freight and transportation company operating in dozens of countries, another win of the large industrial and aerospace organization also worldwide in scope. The potential significance of these wins goes beyond growth in our U.S. operations today. We see growth opportunity to support North American multinationals that need total well-being solutions for their employees globally. We already support a large number of global companies outside North America, and we will continue to scale our operations efficiently in these growth areas.

In retirement solutions, we had a significant sale to a financial services company headquartered in Western Canada. We have been selected to become their record keeper for their retail business clients.

Turning now to our health and productivity solutions business, we are pleased by a major sale to one of Canada's largest transportation companies. We are working to optimize their approach to workers' compensation, which can be a significant cost center as it relates to issues such as long-term disability and be very -- and help people return to work healthy and productive.

And finally, under our benefits and pension administration solutions business. The highlight of the -- in the quarter, of course, is the acquisition of Mercer's stand-alone, large-market, health and defined benefit pension plan administration business, which closed in August. In addition to bringing in significant and profitable revenues, this acquisition fits with all 5 pillars of our strategic plan. For one, it accelerates our growth in the U.S. market for health and welfare solutions particularly in the large corporate space.

Second, it strengthens our portfolio of technology-enabled HR solutions. To emphasize how vital that technology strategy is to our business today and for tomorrow, we appointed our first Chief Data and Technology Officer this year. In joining our executive leadership, Kaytek Przybylski brings deep expertise in areas such as cloud computing and digital transformation, both vital competencies in delivering technology-enabled HR solutions.

Third, given the talent in the Mercer organization, we have a tremendous resource for continuing to be a leader in delivering new and innovative HR solutions to the market.

Fourth, by bringing in the Mercer client base and its core technological capabilities, we have acquired assets that make our operations more scalable and efficient as we keep growing.

And finally, we believe the total package of Mercer clients, technology, people and market position will contribute to our objective of owning the employee well-being space. We have been very impressed with the Mercer people joining our team, bringing deep expertise and experience in an important growth market for us.

Finally, a few words as we move towards the end of the year. We expect our Canadian business to keep producing growth in the mid-single-digit range, with a low double-digit or high single-digit growth in the United States and outside North America. As we move forward, 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 the call over to Grier to review the financials.

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Grier Colter, [3]

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Thanks, Stephen, and good morning. It's exciting for me to have joined the team here at Morneau Shepell, and I look forward to working with our partners going forward.

As Stephen noted, the quarter is in line with expectations. We are pleased with our accelerating growth in the U.S., while maintaining our performance in Canada. The company reported $224 million in revenue, an increase of 22.5%, up $41.2 million over the same period last year. Organic revenue growth in the quarter was 6.2% and that number has been solidly in our range of expectations all year. These results were primarily due to the impact of the LifeWorks and Mercer acquisitions and from increases in organic growth and our pension and benefits administration business. Adjusted EBITDA increased by 28.9% to $43.8 million, up from $34 million in the same quarter last year. The increase here is primarily due to revenue growth, the acquisitions and the impact of adopting IFRS 16. Adjusted EBITDA per share was $0.66, a 22.2% increase compared to $0.54 per share in Q3 2018. During Q3, the company generated normalized free cash flow of $24.2 million compared to $23.1 million in Q3 2018.

Turning now to year-to-date. We reported $641 million in revenue, a 23% increase. Adjusted EBITDA came in at $134.4 million, up 32.7%, and adjusted EBITDA margins increased to 21% compared to 19.4% last year at this time. Subsequent to quarter end, as part of our strategy to ensure adequate access to capital to support both organic and inorganic growth, we exercised the accordion feature on our revolving credit facility and received full bank support for an additional $100 million in capacity. And finally, on our dividend, the company is maintaining a policy of paying a monthly dividend of $0.065 per share.

Before I hand the call back over to Stephen, I'd like to briefly say that the company has a solid model for delivering profitable growth and creating shareholder value. Financially, our revenue and EBITDA growth, recurring revenue profile and cash flow generation are all indicators of the company's ability to execute on its strategy, which Stephen referred to earlier.

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

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Stephen Liptrap, Morneau Shepell Inc. - President, CEO & Director [4]

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) And the first question is from Stephanie Price from CIBC.

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Stephanie Doris Price, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Software and Business Services Research Analyst [2]

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Stephen, I think I heard you correctly, you mentioned low double-digit or high single-digit growth in the U.S. as the outlook for next year. In the past, I think you've talked about double-digit growth in that region. Can you talk a little bit about the puts and takes there in that guidance?

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Stephen Liptrap, Morneau Shepell Inc. - President, CEO & Director [3]

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Yes. And it's really around the fact that as we did the Mercer acquisition in the U.S. and we've got a much larger base than we did before, the 10%, 12% double-digit growth in the U.S. might be 9%, 10%, 11%, something like that. So it's fairly close but it's just on a larger base than what we had before. If you think about the 2 pieces that came over with Mercer as well, Stephanie, the defined benefit pension piece is probably a little bit lower growth, and the health and benefits admin piece is probably a little bit higher percent growth.

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Stephanie Doris Price, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Software and Business Services Research Analyst [4]

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Okay. Okay. And then in terms of the credit line, they increased by about $100 million post the quarter. Grier, maybe this one's for you. Welcome. Can you talk a little bit about the capital structure and the leverage ratios that you're comfortable with going forward?

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Grier Colter, [5]

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Yes, Stephanie. So I mean, yes, this exercise of the accordion was really just to give us a little more flexibility. And you look at where the facility is versus where we we're kind of running it -- longer term I think we'll have a look at other options to term it out, but I think, no, there's nothing I would say that's imminent. Ultimately we want to set the capital structure up to be flexible to achieve our capital-allocation goals and that's what we'll do. But I think nothing really specific, I would say.

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Stephen Liptrap, Morneau Shepell Inc. - President, CEO & Director [6]

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And Stephanie, it's Stephen, just to jump in. I think we'd expect to continue to be somewhere between 2 and 3x leverage.

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Stephanie Doris Price, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Software and Business Services Research Analyst [7]

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Okay. Perfect. And then maybe just one other quick one for me. Stephen, you mentioned technology coming with the Mercer acquisition. Can you elaborate a little bit on that technology?

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Stephen Liptrap, Morneau Shepell Inc. - President, CEO & Director [8]

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Yes. It was actually quite an interesting one from our standpoint because Mercer was actually running a system, SBC, which is very similar to an acquisition that we did a number of years ago. So we're very familiar with the technology, which is really why we don't have to convert the clients over to our system as we did with the Mercer acquisition that we had in 2012 in Canada.

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Operator [9]

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(Operator Instructions) The next question is from Graham Ryding from TD Securities.

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Graham Ryding, TD Securities Equity Research - Research Analyst of Financial Services [10]

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Just want to start on -- just some color around the EBITDA margin this quarter. If I make an assumption on IFRS 16 being roughly 130 basis points, it looks like margins are actually down year-over-year. So can you maybe just provide some color on what was driving that?

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Grier Colter, [11]

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Yes. Sure, Graham. So why don't I take a shot at this and the guys can jump in where I miss. So yes, you've got it right on the IFRS 16 piece. I think the margin in the Mercer business is a little bit lower. I'm not sure how much we talked about this at the time, but this was a great deal. It just happened to be a lower-margin business. So there's, call it, 100 basis points on a run rate basis headwind on that. And then the other side of that is just efficiencies we've seen, kind of, year-over-year. So those are kind of the 3 buckets. So net-net, year-over-year, there is an improvement. But you're right, IFRS is part of that, and there's a headwind on Mercer and then improvements that we've made in efficiencies of the businesses.

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Graham Ryding, TD Securities Equity Research - Research Analyst of Financial Services [12]

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So if we were to strip out the Mercer headwind because it was not a full quarter, right, it was just 6 or 7 weeks, I believe, so if we were to strip that out, what was the -- like, what would the margin lift have been year-over-year excluding IFRS?

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Grier Colter, [13]

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So I'm -- so without or with? So let me say here, without Mercer. So we had a 1% or 100 basis points year-over-year without Mercer, just got -- because it was 2 to 3 months. So if I said 100 basis points, it's like 60 to 70 basis points or something like that, right? This is just real simple (inaudible) math.

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Graham Ryding, TD Securities Equity Research - Research Analyst of Financial Services [14]

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Okay. Okay. And then, I guess, what's your expectation going forward? There's a few moving parts here. You've got $15 million, I think, of cost synergies that you've targeted for 2020 from LifeWorks. And then you've got transformational savings, which I think are approaching $10 million run rate. Is there any overlap there? Or do I have those numbers right? Is there any overlap there between those 2 pieces of efficiencies?

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Grier Colter, [15]

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No. And I'll take another shot at this. But I think just ongoing, the way we think about this, so there are efficiencies that we have taken out of the business, there's efficiencies that we're expecting to see. It's kind of early days. I'm just getting my hands around this thing. But -- and we're also just putting together our forecast and budgets for next year. I think, again, we're going to see headwinds on the Mercer acquisition as it becomes more of a full year, so you'll see a little bit of that. And then some of the work that we've done to date that hasn't been kind of full year appreciation, we'll see some of the offset of that. So if we could achieve kind of more like what our full year-to-date margin level is, that's kind of what we're looking at. So in this quarter, it's not necessarily representative of what we would see going forward.

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Graham Ryding, TD Securities Equity Research - Research Analyst of Financial Services [16]

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Okay. So just to be clear, year-to-date, I think you're at 21%, is that -- that's a reasonable target at this point unless you -- unless your revise this higher?

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Grier Colter, [17]

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Yes, you got it Graham.

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Operator [18]

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Your next question is from Jaeme Gloyn from National Bank Financial.

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Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [19]

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Just want to follow-up and clarify that last line of questioning. The 21% that you're talking about, that would be a reasonable run rate for 2020, inclusive of all of the items here, well, I guess, IFRS 16 is not a factor anymore in 2020, but Mercer and transformation.

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Grier Colter, [20]

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Yes, Jaeme, it's Grier. So yes, that's -- we keep taking it with a grain of salt there, right? I mean, we're early on in the budgeting process. Just lot of pieces that come together, but I'd say that's -- at this stage that's kind of what we see as our target for next year.

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Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [21]

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Okay. Can you talk about the transformation plan just a little bit? The expenses related to that project continue to sort of pop up. I think last quarter, we talked about those expenses nearing an end here in 2019, but still they're -- it's pretty elevated. I'm just looking for a little bit more color around where you see those expenses trending by the end of the year. And will it, for sure, be done in 2019? Or will some of this spill into 2020 as you move forward?

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Stephen Liptrap, Morneau Shepell Inc. - President, CEO & Director [22]

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Yes, Jaeme, it's Stephen. Let me start, and then I'll turn it over to Grier. I think the first thing I would say is the project will be done this year. We're just in the midst of wrapping it up. There'll be a little bit in Q4, but we'll be fully wrapped up in Q4. The project was really focused on 2 things. It was focused on, first of all, really dealing in -- with our working capital, and we've seen some nice improvement there. We're down a couple days DSO, so that was very good. And then there was some run rate savings in our businesses that pretty much are starting to show up in the bottom line as well. So yes, we're through that project and it will be done by the end of the year.

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Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [23]

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Okay. And related to LifeWorks, a little bit of a change in disclosure, so it's hard to pull out what LifeWorks generated this quarter. Are you able to give us a little bit more color around the performance of that unit in terms of revenue growth on an organic basis? And I'm thinking back to previous quarters where you've disclosed that LifeWorks generated sort of around the $30 million mark per quarter. I'm wondering where that sits today.

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Stephen Liptrap, Morneau Shepell Inc. - President, CEO & Director [24]

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Yes. Let me start. It's Stephen here. I -- a couple of things. So I think we are on that run rate with LifeWorks. As you can imagine, as we win new deals, it's hard to figure out what's attributable to LifeWorks and what's attributable to our old ESS business. So we really look at it as a combined entity, but I think the run rate is very consistent and then the new stuff we're adding on top and obviously, that'll be much cleaner as we move into next quarter. A couple of other quick comments on LifeWorks. So I think the strategy is dead on. We're very excited by that. The client feedback has been tremendous around both the products where we are, the work we've done to put it together, but also what we see going forward. And I think I've talked before about starting to put other data from our other lines of business onto the platform, think about pension, think about benefits. And there's a tremendous amount of interest from our clients, and the teams are working really hard to get that done for early next year. The teams are fully together. The synergies are nicely on track. As I said before, the sales cycle is a little bit more complicated rather than the EAP selling a full suite, so it might be a little bit slower than what we would have seen in the old EAP world. But no, we're pleased with where we are.

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Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [25]

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Okay. And just last one for me. I want to just go back to the margin outlook. As I look at my previous forecast, it's coming in probably about 80 to 100 basis points below that. In terms of going back to where you thought 2020 might be, are there any areas that haven't delivered as much margin expansion as you expected, whether it'd be LifeWorks or this transformation project?

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Stephen Liptrap, Morneau Shepell Inc. - President, CEO & Director [26]

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It's Stephen again, Jaeme. I think the big one in the numbers is really the Mercer piece, to be honest. As Grier said, we had a pickup from IFRS, we had a pickup from the transformation working, we had a pick up from the LifeWorks synergies, and those are all on track. And then Mercer, which was a phenomenal business, just operates at a lower margin and is picking up the large corporate clients in the U.S. But I think as we've said before, that's probably 100 basis points in total. But from what we paid and what we got and the key clients and the opportunity, I would do that deal any day.

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Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [27]

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Okay. Yes, I'll just clarify that, I had that 100 basis points built into that forecast as well. So there's -- it just feels like there's something not on point right now. That's all. Okay...

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Stephen Liptrap, Morneau Shepell Inc. - President, CEO & Director [28]

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The one other thing I would say, Jaeme, to keep in mind is the -- and you guys can pull up the numbers, but the quarter was relatively flat in our retirement solutions business, which, as we've talked before, we expected because we had a large project from a number of years ago. A regulatory project kind of ramping down this year, so that would have been down and our Administrative Solutions business had a very strong quarter, that would have been up. And the margin between those 2 businesses are quite a bit different, right? Retirement solutions being a consulting business has quite a bit of higher margins than the Administrative Solutions business. So that might be the difference as well.

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Jaeme Gloyn, National Bank Financial, Inc., Research Division - Analyst [29]

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Okay. That's helpful there. And then last one for me, just in well-being, noticing the quarter-over-quarter decline in the revenues there. Is there some seasonality at play that may not have been there in the past?

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Stephen Liptrap, Morneau Shepell Inc. - President, CEO & Director [30]

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I think seasonality would be similar to what we would have seen in the past. In a few of our businesses, Q3 tends to be a little bit softer. We see that both in well-being for the number of cases, we just get less cases when people have time off in the summers, and we get less consulting business in Q3. So we really do look at quarter versus quarter in the prior year versus sequentially.

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Operator [31]

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The next question is from Graham Ryding from TD Securities.

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Graham Ryding, TD Securities Equity Research - Research Analyst of Financial Services [32]

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Just wanted to follow-up on just the free cash flow. When I look at it on a last 12-month basis, including working capital, it fell this quarter. I'm just wondering if there's any color there on what was driving, sort of, the higher working capital? And is there anything that's in your outlook that expects us to normalize or what's your free cash flow, sort of, outlook?

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Grier Colter, [33]

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I mean, there's -- you're talking -- Graham, you're talking Q2 versus Q3?

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Graham Ryding, TD Securities Equity Research - Research Analyst of Financial Services [34]

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Yes. Like the payout ratio, I think, went to 86% or something -- 89% or something on a last 12-month basis, and it just seems to be that if you look at that, the drag of working capital on your free cash flow, it seems to have increased sort of relative to the last couple of quarters. So I'm just wondering what's driving that.

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Grier Colter, [35]

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Yes. So I think -- I mean, again, I think this is another one -- there is some seasonality in the working capital. I don't know if that's what's driving this here, but if you -- a better way to look at this, I think, is the year-over-year, and we're pretty happy with the working capital year-over-year. It's one of the things that we've made good progress on with the transformation items. But I think when you look at it, Q2 versus Q3 is maybe not the best way to look at it.

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Graham Ryding, TD Securities Equity Research - Research Analyst of Financial Services [36]

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No, no. I was looking at sort of on a trailing 12-month basis why the trend has sort of declined. I think it's $60 million of free cash flow last 12 months versus $75 million the last couple of quarters on it.

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Grier Colter, [37]

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Why don't I suggest we -- because the working capital item has got a lot of stuff in it, right, so I wonder if we maybe just take this one off-line.

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Graham Ryding, TD Securities Equity Research - Research Analyst of Financial Services [38]

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Sure.

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Operator [39]

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There are no further questions registered at this time. I'd now like to turn the meeting back over to Mr. Liptrap.

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Stephen Liptrap, Morneau Shepell Inc. - President, CEO & Director [40]

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Thank you, Laurie. 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 of the business. Thank you.

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Operator [41]

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