Willis Towers Watson Public Limited Company
Q4 2017 Earnings Call Transcript

Published: 8 Feb 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the Willis Towers Watson's Q4 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will be given at that time. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Aida Sukys, Director of Investor Relations. You may begin.

[Aida Sukys:]

Thank you, Adrian. Good morning everyone. Welcome to the Willis Towers Watson Earnings Call. On the call today with me today are John Haley, Willis Towers Watson's Chief Executive Officer; and Mike Burwell, our Chief Financial Officer. Please refer to our website for the press release issued earlier today. Today's call is being recorded and will be available for replay via telephone through tomorrow by dialing 404-537-3406, conference ID 5494338. The replay will also be available for the next three months on our website. This call may include forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995, which may involve risks and uncertainties. For a discussion of forward-looking statements and the risks and other factors that may cause actual results or events to differ materially from those contemplated by our forward-looking statements, investors should review the Forward-Looking Statements section of the earnings press release issued this morning, a copy of which is available on our website at willistowerswatson.com, as well as other disclosures under the heading of Risk Factors and Forward-looking Statements in our most recent annual report on Form 10-K and in other Willis Towers Watson filings with the SEC. Investors are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this earnings call. Except as required by law, we undertake no obligation to revise or publicly update forward-looking statements in light of new information or future events. During the call, we may discuss certain non-GAAP financial measures. For a discussion of these non-GAAP financial measures as well as reconciliations of the non-GAAP financial measures, under Regulation G, to the most directly comparable GAAP measures, investors should review the press release we posted on our website. After our prepared remarks, we'll open the conference call for your questions. Now I'll turn the call over to John Haley.

[John Haley:]

Thanks, Aida, and good morning, everyone. Today we'll review the fourth quarter and the full year 2017 results, as well as provide outlook for 2018. Closing out the fourth quarter of 2017 signified the end of the second year of our three year integration plan. 2017 was an eventful year. We completed a number of organizational changes and corporate initiatives during the year and we made great headway in advancing our innovation efforts. From an organizational perspective, our key priority was finalizing the restructuring of the Corporate Risk and Broking business with a specific objective of achieving revenue growth in North America by the third quarter of 2017. This was accomplished as planned. The operational improvement program concluded as of December 31 with $95 million of gross savings and we achieved our multiyear goal of $325 million of annual gross savings. As a result of an extensive review of our portfolio of operations, we divested approximately 10 businesses including a portfolio of programs and executed a couple small bolt-on acquisitions. Last, we added some key talent such as Mike Burwell who came on board as our new Chief Financial Officer in October. Mike has certainly hit the ground running and I couldn't be more pleased with the transition. From an innovation perspective, we introduced our first CEO Circle Award, a program meant to encourage innovation among our colleagues and to provide a path to bring the best ideas to market. We introduced a number of new solutions and analytics during the year and I'd like to highlight just two of the new client solutions we are very excited about; the Asset Management Exchange or AMX and our proprietary benefits accounts platform. AMX is a new market place designed to transform institutional investment for the benefit of the end saver. It aims to create a smarter, easier and cheaper way to connect asset owners to those who manage their money. We are very pleased with the reception we received from the UK and Ireland markets in a relatively short time frame. As of the end of December 2017, AMX had over $3 billion in assets under management and we are planning on expanding into several other markets during 2018. The second initiative is our benefit accounts or accounts business, which is the administration tool for account such as health savings and health retirement accounts. We received our non-bank custodial status last year and enhanced our accounts proprietary platform to integrate with our marketplace and health and welfare administration systems for a seamless transition for our clients. Ultimately, we anticipate that Willis Towers Watson's account platform will eliminate the need for us to use third party providers in the future. We limited the release to a small number of clients this past enrollment season. We are very pleased with the preliminary results thus far and we plan to continue to expand the program in 2018. So, moving on to our merger synergy objectives. The original merger objectives included decreasing the tax rate from approximately 34% to 25% by the end of 2017, and realizing $100 million to $125 million in cost savings as we exited 2018. We surpassed our tax goal in the first year of the merger with the 21% adjusted tax rate and we continue to be under our goal with a 22% adjusted tax rate for 2017. Turning to the cost savings goal, on a merger to-date basis, we've saved almost $130 million and we are raising our savings goal to $175 million as a run rate as we exit 2018. Mike will talk about these efforts a bit later in the call. Our merger objectives also identified three specific areas of revenue synergies; global health solutions, the U.S. mid-market exchange, and large market P&C. We've already achieved more than 70% of our three year global health solutions synergy sales goals. Our sales pipeline continues to be strong and we expect to achieve our revenue goal in 2018. As we mentioned on our last call, the mid-market healthcare marketplace sales were muted in 2017 as compared to 2016. We added several large former Willis' clients last year and we believe that the ACA debate may have delayed decision making for the fall 2017 enrollment period. We continue to believe there are significant potential for the mid-market exchange business and we are focused on its growth. Through the end of 2017, we had approximately $50 million in synergy sales. Given our cumulative sales through 2017 and a new business pipeline, we believe that we'll be at the lower end of the $100 million to $250 million goals as we exit 2018. Turning to the P&C synergies, we had about 70 new client wins in the large marketplace with merger to-date sales of more than $100 million. We anticipate those revenues being recognized over a three year period in most cases. We are happy with the overall traction in acquiring new clients in the large marketplace, but our average sale size has been less than our original estimates. We continue to build our pipeline and add to our talent base. We anticipate we'll end 2018 with about $150 million of revenue synergies sales rather than the $200 million original merger goal. While this would be a bit short of our original goal, it's clear that the U.S. large market space provides a significant long-term growth opportunity for Willis Towers Watson. Finally, we've seen revenue synergies develop between Reinsurance and Insurance Consulting and Technology or ICT teams. Now this wasn't a revenue synergy we discussed publicly at the time of the merger, but we recognize that these two groups had relationships and solutions that complemented one another. We've sold more than $25 million of reinsurance broking and consulting work as these groups have been teaming up and utilizing one another's tools and analytics. So, now let's turn to our results. Reported revenues for the fourth quarter were $2.1 billion, up 8% as compared to the prior year fourth quarter and up 5% on a constant currency and up 6% percent on an organic basis. Reported revenues included $54 million of positive currency movement. We observe growth in all our segments and regions for the quarter. Reported revenues for the year were $8.2 billion, up 4% as compared to the prior year and up 4% on a constant currency basis, and up 5% on an organic basis. Reported revenues included $27 million of negative currency movement. Adjusted revenues for the year were up 3% as compared to the prior year and up 4% on both the constant currency and organic basis. Net income for the fourth quarter was $253 million as compared to the prior year fourth quarter net income of $148 million. Adjusted EBITDA for the fourth quarter was $484 million or 23.3% of total revenues as compared to the prior year fourth adjusted EBITDA of $419 million or 21.7% of total revenues. This was an increase of 160 basis points in adjusted EBITDA margin. For the quarter, diluted earnings per share were $1.84 and adjusted diluted earnings per share were $2.21. Currency fluctuations net of hedging had a $0.04 positive impact from the fourth quarter adjusted diluted EPS. Net income for the year was $592 million as compared to the prior year net income of $438 million. Adjusted EBITDA for the year was $1.9 billion or 23.2% of total revenues as compared to the prior year adjusted EBITDA of $1.77 billion or 22.3% of adjusted revenues. This was an increase of 90 basis points in adjusted EBITDA margin. For calendar 2017, diluted earnings per share were $4.18 and adjusted diluted earnings per share were $8.51. Currency fluctuations net of hedging had a negative impact of $0.12 on the 2017 adjusted diluted EPS. Now let's look at each of the segments in some more detail. As a reminder, beginning in 2017, we made certain changes that affected our segment results. These changes were detailed in the Form 8-K that we filed with the SEC on April 7, 2017. All of the revenue results discussed in the segment detail and guidance reflect commissions and fees or C&F on a constant currency basis, unless specifically stated otherwise. Our segment margins are calculated using total segment revenues and are before consideration of unallocated corporate costs such as amortization of intangibles, restructuring costs and certain transaction and integration expenses resulting from mergers and acquisitions, as well as the other items which we consider non-core to our operating results. The segment results include discretionary compensation. For the fourth quarter, total segment commissions and fees grew 5% on a constant currency basis and 6% on an organic basis. Human Capital & Benefits or HCB commissions and fees fourth quarter growth was 2% and organic growth was 4% as compared to the prior year fourth quarter. Our Technology and Administration Solutions or TAS commissions and fees increased by 15%. All regions had strong commissions and fees growth due to new client implementations. In addition to implementing new clients, we've been providing additional support for existing clients in Great Britain with respect of legislative changes that we've discussed in previous calls. Health and Benefits commissions and fees declined in the fourth quarter by 4%, primarily as a result of the sale of our Global Wealth Solutions business in the international region. Organic H&B growth was 4%. North America's large market continued to see strong growth in both project work and product sales, which was offset slightly by a decline in the middle market C&F. Great Britain C&F grew as a result of global health solution implementations. Talent & Rewards fourth quarter commissions and fees grew 4% primarily due to an increase in corporate transaction projects, software sales and in compensation survey revenues. This growth was slightly offset by lower demand in the advisory businesses in North America. Retirement commissions and fees growth was 3%. Great Britain led the C&F growth for the segment as a result of additional work generated by pension legislation and derisking projects. North America C&F grew as a result of increased consulting and administration work despite the lower demand for Bulk Lump Sum work. International also had strong growth in large part due to our acquisition of Russell's actuarial business in Australia earlier this year as well as an increase in consulting demand in Greater China. The fourth quarter operating margin for the HCB segment was 22%, flat from the prior year fourth quarter. The margin reflects some planned segment investments and restructuring charges. For the full year HCB C&F revenues grew 2% with 2% growth on a constant currency basis and 3% growth on organic basis and had an operating margin of 24%. Overall, we continue to have a very positive outlook for the HCB business in 2018. Now turning to Corporate Risk & Broking or CRB. Fourth quarter constant currency and organic commissions and fees were up 7% as compared to the prior year fourth quarter. North America CRB had solid growth of 4% driven by increased new business, strong retention and forensic accounting claim work related to increased natural disasters. International had 20% C&F growth as a result of strong growth in Latin America especially in Brazil and energy related business in CEEMEA. Asia had solid growth as a result of new business and soft comparable in the fourth quarter of 2016. Western Europe C&F grew by 7% led by performance in large accounts in Iberia, France and Italy. Great Britain commissions and fees increased by about 1% due to growth in the natural resources and energy lines, which was partially offset by a decline in retail and the delay of a large renewal to 2018. Client retention was approximately 93% this quarter. The CRB segment had a 28% operating margin as compared to 29% in the prior year fourth quarter. The margin decrease is due in part to a planned increase in corporate allocation related to the Gras Savoye acquisition and a one-time credit in the fourth quarter last year. For the full year of 2017, CRB C&F revenues grew 4% on a reported constant currency and organic basis and had an operating margin of 18%. We're pleased with the momentum in our CRB business globally. Now to Investment, Risk & Reinsurance or IRR. Constant currency commissions and fees for the fourth quarter increased 2% and organic increased 4% as compared to the prior year fourth quarter. As a reminder, the Reinsurance line of business represents treaty based reinsurance with some facultative business produced in wholesale. The bulk of our facultative reinsurance results are captured in the CRB segment. Wholesale C&F grew by 8% due to new marine business and favorable timing. Insurance Consulting and Technology or ICT had 8% C&F growth driven by strong software sales. Reinsurance commissions and fees declined by 1% in the fourth quarter. Growth in International was offset by softness in North America and adverse timing in specialty. However, as a result of improved investment returns, total reinsurance revenues remained flat for the quarter. Investment commissions were down slightly, but overall revenues increased by about 1% as a result of increased performance fees and delegated client wins. Max Matthiessen grew by 7% through strong new business and increased assets under management. Segment commissions and fees included a decline in the portfolio and underwriting business as a result of the divestiture of many of our small programs. For the fourth quarter, the IRR segment had a 2% operating margin down from 8% for the prior year fourth quarter. The fourth quarter 2017 margin was impacted by planned investments for new technology and analytics and the divestment of various U.S. programs. For the year, IRR C&F revenues grew 2% with 3% growth on a constant currency basis and 4% growth on an organic basis and have an operating margin of 24%. We continue to feel positive about the momentum of the IRR business for 2018. Commissions and fees for the BDA segment increased by 11% from the prior year fourth quarter driven by increased enrollments, our individual marketplace commissions and fees increased by 11%, and the rest of the segment increased by 10%. Increased membership and new clients drove the revenue increase in our group marketplace. The Health and Welfare and North America pension outsourcing business has continued to grow primarily due to new clients and customized Active Exchange projects. Let me turn to the 2018 enrollments. We had a very strong group marketplace enrollment season as we added approximately 200,000 lives. As anticipated, we enrolled approximately 35,000 retirees in the individual marketplace. As we mentioned in our previous call, the individual marketplace exchange enrollment process is changing as the businesses mature. Enrollments will be spread more evenly throughout the year, so we continue to expect another 45,000 to 55,000 retirees to enroll during 2018. The BDA segment had a 22% operating margin as compared to 11% in the prior year fourth quarter. The increase in margin was a result of the individual marketplace enrollment cycle being scheduled more evenly throughout the year, which allowed us to align staffing and costs more appropriately. For the full year of 2017, BDA, C&F revenues grew 12% on a reported constant currency on organic basis and had an operating of margin of 21% which represents a 260 basis point increase over the prior year. The BDA segment is in a period of transition as the market and our market approach are continue to evolve. We continue to be optimistic about the long-term growth of this business. So, as I mentioned earlier 2017 was an eventful year. We can't forget that so many of our colleagues and clients suffered losses during the many catastrophic events that occurred around the globe during the year. Our colleagues never lost sight of the important work we do in times of crisis and their client focus was unwavering. I'd like to thank our colleagues for their efforts in supporting our clients in what was a difficult year. And of course I'd to thank our clients for the great support you've given over the last two years. Before turning the call over to Mike, I'd like to congratulate Alice Underwood and Mary O'Connor for having the named Women to Watch by the Business Insurance CLM Women to Watch recognition program. The award honors professionals doing outstanding work in risk management and commercial insurance. Recipients are recognized for their leadership, accomplishments and commitment to the advancement of women and diversity in the insurance industry. Alice is the global leader of the company's Insurance Consulting and Technology business, and Mary is the head of Client, Industry and Business Development in Great Britain, and also serves as the global leader of the Company's Financial Institutions Industry. They couldn't be more deserving of this honor. Now I'll turn the call over the Mike.

[Mike Burwell:]

Thanks John. And I'd like to add my thanks and congratulations to our colleagues for all of their efforts this year and especially ending the year with such strong momentum. I've been impressed by the talent, to drive for excellence and our client commitment that I've witnessed through our organization in particular over the last four months. I came to Willis Towers Watson at a time when our colleagues were in full crisis response mode and they work with their clients to assess the impacts of the recent catastrophes. Seeing this client commitment in action during my first few weeks here was a great introduction into Willis Towers Watson and made me very proud to be part of this organization. But now for some additional insight into our financial results. Income from operations for the fourth quarter was $110 million or 5.3% of total revenues. The prior year fourth quarter operating income was $88 million or 4.6% of total revenues. Adjusted operating income for the fourth quarter was $436 million or 21% of total revenues, an increase of 17% over the prior year. Prior year fourth quarter adjusted operating income was $374 million or 19.4% of total revenues. The key drivers of this increase were both strong revenue growth and prudent expense management. Income from operations for the year was $738 million or 9% of total revenues. The prior year operating income was $551 million or 7% of total revenues. Adjusted operating income for the year was $1.77 billion or 21.5% of total revenues, an increase of 9% over the prior year. Adjusted operating income for the prior year was $1.62 billion or 20.4% of adjusted revenues. Again the key drivers of this increase were both strong revenue growth and prudent expense management. Let's move on to taxes, I'd like to provide you with some additional insights into our U.S. GAAP and adjusted tax rates. The U.S. GAAP tax rate for the fourth quarter was negative 221.4% and the adjusted tax rate was 21%. In connection with our initial analysis of the impact of the U.S. tax reform, we recorded a one-time discreet net tax benefit of $204 million in the fourth quarter. This net benefit includes a $208 million tax benefit as a result of the corporate rate reduction impact and the re-measurement U.S. net deferred tax liabilities are primarily related to the merger related acquisition intangibles. For the year, U.S. GAAP tax rate was negative 20.5% and the adjusted tax rate was 22%, which surpassed our guidance adjusted tax rate of 23% to 24%. U.S. tax reform is relatively new, and as such we anticipate that the U.S. treasury may issue further clarifications, interpretations or guidance, so there is a possibility that our guidance could be updated during the year. Moving to the balance sheet, we continue to have a very strong financial position. In terms of capital allocation, we purchased approximately $70 million of Willis Towers Watson stock in the fourth quarter, bringing the total for the year to approximately $710 million, including the cancellation of shares related to the settlement of shareholder litigation. And as you may recall, our expectation was that the buyback was about $0.5 billion of shares for 2017. Over the last two years, we have repurchased or cancelled on the 8.4 million shares, as we believe this was in the best interest of our shareholders. We also increased the dividend by 10% in 2017. Free cash flow for the year was $562 million, a decrease from $715 million for the prior year. The year-over-year variance was related to an increase in payments for discretionary compensation as we had a full year of discretionary bonus payments in 2017 whereas we had a partial payment in our partial year in 2016. We have higher capital costs this year due to our increase in integration efforts. The interest charges and the costs related to shareholder appraisal settlement and our prepayment of our corporate taxes in the fourth quarter. Before moving on to the 2018 guidance, I'd like to remind everyone that new revenue and pension accounting standards were implemented as of January 1, 2019. On January 10, 2018, we filed an 8-K report and hosted a conference call to discuss the potential impact to the Company in the segment results. As we discussed on the call, we don't anticipate any material change on an annual basis, but the seasonality will change for some segments as the result of new revenue standard. A more detailed discussion and examples can be found in our 8-K filing. The 2018 financial results, we've called this using the ASC 606 standard that our disclosures will include results as if the 2017 U.S. GAAP standard was implemented. As such, the guidance which we will provide you today will continue to be on the 2017 U.S. GAAP standard. We want to ensure that investors have a clear line of sight between our merger goals and our 2018 results. So now, let's review our full year 2018 guidance for Willis Towers Watson. For the Company, we expect constant currency revenue growth to be around 3%. As John mentioned in his introduction earlier in the call, we've been reviewing our portfolio. And during 2017 and in January of 2018, we sold businesses with revenues totaling $65 million, so the 3% revenue growth equates to 4% organic growth. For the segments, we expect commissions and fees constant currency revenue growth to be in the low-single digits for HCB, CRB and IRR and to be in the mid-single digits for BDA. Transaction and integration expenses expect to be approximately $140 million. As John mentioned earlier, we have already exceeded our original savings estimates of $100 million a $125 million. Depreciation expense is expected to be approximately $210 million. The adjustment EBITDA margin is expected to be around 25%. The adjusted effective tax rate is expected to be around 24%. As I alluded to you earlier, new treasury rules could materially impact this expectation. We expect free cash flow of approximately $1.1 billion to $1.3 billion in 2018. We had previously committed to delivering a minimum of $1.3 billion of free cash flow. The reason for the range as we settle the Stanford claim for $120 million in 2016 and expected to pay the funds in 2017 in the months approved by the court. Although the settlement was granted, we are still in the process of litigating an appeal. We hope this settlement will approve by late 2018, but it's dependent on the court. We've increased our integration budget by about $60 million in order to save an additional $50 million in merger synergies, for a total savings of $175 million. There are two areas where we see opportunity for additional savings. The first is expanded scope of implementation of our ERP system. We shifted our focus creating a global system rather than focusing on our major centers of operations. This will enhance data collection and greater financial efficiency. The secondary investment is in real-estate and data centers. We've been successful in consolidating and optimizing office and data centers, and surpassing our initial savings goals. We expect to aggressively continue these efforts. And I'd also like to address the steps we have identified during 2018 budgeting progress that makes us comfortable in guiding to the $1.1 billion to $1.3 billion of free cash flow. We see specific opportunities in the following areas; enhanced operational performance, reduction of program cost and capital expenditures, increased working capital, refining our hedging programs and a one-time non-recurring cash event which took place in 2017 such as the shareholder settlement and prepayment of corporate taxes. We plan to repurchase $600 million to $800 million of Willis Towers Watson stock during 2018 and expect to end the year with approximately 131 million shares outstanding. This would be a net reduction of 7 million shares since the merger, and at the top of the estimated range we discussed at the Analyst Day in 2016. Adjusted diluted earnings per share, is expected to be in the range of $9.88 to $10.12. Annual guidance assumes average currency exchange rates of $1.33 to the pound and $1.18 to the euro. So, before I turn the call back to John, I want to remind everyone that we'll be hosting an Analyst Day in Washington D.C. on March 16, 2018 and Meet the Leader session in London on March 22, 2018. We look forward to seeing you all at one of these events.

[John Haley:]

Thanks very much Mike. And now, we'll take your questions.

[Operator:]

[Operator Instructions] Our first question comes from Kai Pan with Morgan Stanley. Your line is now open.

[Kai Pan:]

Thank you and good morning. My first question is on margin. So, if you look, organic growth had been very strong and the margin improvement had been a bit slower than expected. So, I just wonder why you don't have sort of like a higher leverage on the margin and what give comfort for like 25% margin in 2018, and that seems like a big jump like 200 basis points from the 2017 levels.

[Mike Burwell:]

Kai, thank you for the question. You know we think – we're still confident and comfortable with the 25% EBITDA margin for 2018. In order to – we've seen a couple of investments that we've made in the current year. One, we referenced in the HCB segment which is both restructuring as well as further technology investments that we've made there. And second in the IRR segment, our AMX investment is what we referenced and John alluded to that in his opening comments, are investments that we've made. So, we feel good about the margin that we have delivered, little over 23% for the current year and we see a bridge and a path forward and we think that's reflective in terms of what's happened in the current year, but we see an absolute path, the 25% margin and that's what we've touched on.

[Kai Pan:]

Okay. Then my follow-up question is on the organic growth front. If you look at across the segments, they increased and the one weak spot is the Reinsurance. Could you talk a little more because some of your competitor peers have, they seem to have a very strong organic growth in Reinsurance? And also, how do you contract your strong organic growth overall versus your seems like lower guidance on the sort of merger synergy.

[Mike Burwell:]

Well, I guess the first is, again remember on Reinsurance, we take faculty, and that is included in our CRB segment overall. So, you know when we look at the Reinsurance segment, we feel very good about where it sits and what it's delivered overall when we see it. So, I guess we're not uncomfortable with where we are in our operations associated with Reinsurance. You know looking out to future in terms of overall organic revenue growth, we're comfortable really being in that, you know 3% to 4% range that we have historically touched on and we think that make sense for the business given where market condition are and so, I really got no more to say than that's kind of where we are. I don't John anything you'd add to that.

[John Haley:]

Yeah, I mean I think, Mike I agree with what you said. I guess the only thing I'd add is that when you look at the revenue synergies, we said, we expect to be ahead on global health. We expect to be at the low-end on the mid-market exchange business and we expect to be about maybe $50 million below our target on the large company P&C, but we have about $25 million of revenue synergies that we hadn't accounted in terms of the Reinsurance at ICT. When you add those all up, it gets to a point which is pretty damn close to about where our revenue synergies were. And frankly, what we're focused on is making sure that we have a company that is growing and if we grow little bit slower in one area and faster in another to counter it, that will be just fine. But we like the fact that we're getting growth from all areas and we have a great deal of confidence going into 2018.

[Operator:]

Thank you. Our next question comes from Greg Peters with Raymond James. Your line is now open.

[Greg Peters:]

I just wanted to go back a couple of comments that you made. You raised the immigration expense savings to $175 million and you also referenced refining the hedging program. On the $175 million, is that expected to all fall at bottom-line or is there going to be a reinvestment in part of that $175 million? And then can you run through the cost or the savings that you expect to get out of the refining of your hedging program?

[John Haley:]

Yeah. So, let me – I'll take the first part of that and I'll let Mike explain the hedging, because I just get frustrated talking about it. But – the $175 million, that's part of our merger cost synergies, and in the merger cost synergies, we expect every penny to drop to the bottom-line.

[Greg Peters:]

And John, that just – that comes by the end of the fourth quarter of 2018, correct? It's not something that…

[John Haley:]

I say fourth quarter, yeah, that's a fourth quarter run rate exiting 2018.

[Greg Peters:]

Perfect.

[Mike Burwell:]

And Greg on the hedging program, something John and I have been looking at, I specifically have been look it and really revaluating you know how we do it, what instruments we'll use, what's the length of time that we've put in place, and so we' reevaluated that activity. I think we've streamlined it, we've given a greater focus and tension, et cetera and we're optimistic as we look forward that we'll see enhanced management of that going forward.

[John Haley:]

I think we do feel – we've done – we've spent a large part of 2017 understanding the hedging, and as Mike says, evaluating it and trying to set up the best program going forward in 2018. And I think both Mike and I have a lot of confidence that the system we have now is better than what we had before.

[Greg Peters:]

Does this mean that there is going to be a little bit more volatility in your reported results around currency or – I'm just trying to read through the tea leaves here?

[Mike Burwell:]

No, the whole promissory Greg is the opposite actually, is a bit less volatility than what we've had historically.

[Greg Peters:]

Just the last – the second question is around free cash flow. I understand your guidance for 2018. Can you just talk to us about some of the drivers in 2017, because it was down relative to 2016?

[John Haley:]

Yeah, I think as I mentioned in the comments Greg, you know what we had seen is first is bonus payment, so in 2017 we had a full year of bonus payments that were recorded in 2016. We only had a partial year that was included in there. We did spend some additional CapEx both in real estate in which we've seen benefits and we'll see benefits for ongoing forward as well as well as technology and I mentioned we had paid some taxes in the fourth quarter which we believe were not appropriate tax strategy for us and so we made some additional tax payments in the fourth quarter. So, those things were the principal changes between fiscal year 2016 and fiscal year 2017 from a free cash flow standpoint.

[Operator:]

Thank you. Our next question comes from Shlomo Rosenbaum with Stifel. Your line is now open.

[Shlomo Rosenbaum:]

Thank you for taking my question. Hey Mike I want to focus more on the free cash flow like the last question, and just asking to bridge some of the 2017 to 2018 guidance. Just with some specifics, so there are some high level numbers that are not going to recur like how large was that tax payment that you made in 2017 that will obviously reduce the tax payment in 2018? What else is sticking out over there? And then, just to understand more clearly, are you expecting to make the settlement payment in 2018 and that's why the reduction from $1.3 billion to $1.4 billion to $1.1 billion to $1.3 billion. Just trying to understand some of the moving parts and what are some of the highlights that we can understand that bridge?

[Mike Burwell:]

Sure. Well, let me see if I can be helpful on that color. So, first is, you know again coming from 2016 to 2017, let's take 2017 to 2018 just in terms of our thinking. Again, when you look at 2016 to 2017, so cash tax payments you know was roughly in the $50 million range. And you think about it, we had disclosed the shareholder litigation that we had paid was around $33 million and CapEx that you can see in there is roughly $82 million and we had you know the bonus payments in there were $80 million to $90 million kind of range where the biggest pieces that really bridge you from 2016 to 2017. And then as you look out to 2018, what we really see is, you know some operational improvements. You're obviously going to have reduced spending from a T&I perspective, integration perspective and restructuring perspective, and what we see is improvement in working capital and CapEx. So, you know when I look at those components, you know that's $500 million to $600 million that we see in aggregate of opportunities that are there. It's like gets you up in that – around that $1.3 billion free cash flow. And your last question was, when we expect to pay the Stanford litigation, but right now the reason we did go with that range $1.1 billion to $1.3 billion was if indeed we paid in 2018, then obviously we'll reduce that down to $1.1 billion, expect we don't pay it, we would obviously be at the $1.3 billion and that might get pushed in 2019. Obviously we're at the mercy of the judicial system in terms of how that process moves forward. So, hoping I provide a bit more color.

[Shlomo Rosenbaum:]

It does a bit although, it would be nice if you could get just some brackets around some of the – some of the elements like $500 million to $600 million, is there something that accounts for $100 million to $200 million. I understand the Stanford is $200 million, but what about some of the other items there.

[Mike Burwell:]

Yeah, I mean I think if you look at our T&I, reduced restructuring in T&I spending. You know you are in the $250 million to $300 million just to give you some further information, insight to that.

[Shlomo Rosenbaum:]

Okay. And then just in terms of the margins in the quarter, there is lot of talk about increased investment in some of the areas – in some of the units. Just one way to quantify that, just so that we get a sense as to what was planned and what was kind of accelerated in the plan. And John maybe you want to kind of address you know what are you expecting to get out of some of those investment again?

[John Haley:]

Yeah. Do you want to talk about what was the acceleration?

[Mike Burwell:]

I mean so, first, again, we have been investing and John touched on it in terms of highlighted it, what we believe are significant investments around AMX and the IRR segment. We're continuing to look to expand that geographically, and so obviously we need to adapt that appropriately in the particular territories in which it's going to operate et cetera. And we believe that that was the right investment to make so that we can continue to leverage that given the positive response that we've seen you know in Ireland and the U.K. and frankly, it's moving at a very rapid pace, and so we view that as an appropriate investment in terms of being able to leverage that looking 2018 and beyond. And the HCB segment was you know frankly we thought we needed to – take the restructuring actions to better align the business and position it for longer term profitability. You know the Julie and team did that and executed within the quarter. We did not include it in our restructuring charge, because we view that as it relates to the prior years and for next year we keep this clear in terms of what was going to happen, and we see that as further productivity. So, we would have been more in that 23.5% kind of EBITDA margin just to come back from a quantification standpoint on an adjusted EBITDA margin basis had we not made those investments, just to kind of quantify and give you some perspective on it in terms of how we think about that.

[Shlomo Rosenbaum:]

Hey great. Thank you so much.

[John Haley:]

Okay and so let me just Shlomo give you a little bit more color to maybe Mike's thing on the – he mentioned $500 million to $600 million of free cash flow improvement in 2017 to 2018. And as we look at that and think about the numbers, we're focused on the grand total, not so much the specific buckets. But if we look at the buckets, we're actually planning for operations to be about say 27% of the total, DSO improvement to be about another 27% of the total and then the CapEx reduction to be maybe 45% of the total. But what we're really focused on is the total as opposed to the individual pieces. But that at least gives you some idea of the relative sizes of what we're working with. The main investments that we've been making and we – you know we're doing a little more restructuring to get some of the – we're taking a little more charges there to get some of the additional benefits in the cost synergies. We have those going on. But this year, the major investments that we've been making in the business, one Mike talked about some of the restructuring we've done in HCB and as he noted, we let that flow through and affect our margins as opposed to separating that out in restructuring charge where we look at this as some necessary restructuring, but maybe little closer to business as usual.

[Mike Burwell:]

And John we didn't adjust it out in the adjustment numbers either.

[John Haley:]

Right, so it's not – it's not in – it's not adjusted at all in there, so we're treating it as business as usual. But we think that will pay off just as the work we did in HCB, the year before it paid off in some better margins this year too, improving the margin from what they would have been. We've invested heavily in AMX and brought that out and we've also been investing quite heavily in new technology and new tools in the brokerage business generally. So, these – and that's actually the most significant investment we're making right now is in some of the new technology and new approaches in brokerage. We also have some investments in analytical tools in HCB. So, I think one of the things that we were focused on doing this year Shlomo is making sure that we as a company, we're focused on the future and investing in what's going to be generating the future revenue flows and the future profits in 2019, 2020 and beyond. And we wanted to make sure, that was moving ahead as we did this. We're still very focused on delivering the results for 2018, but we don't want that to be at the expense of future growth.

[Operator:]

Thank you. Our next question comes from Mark Marcon with Baird. Your line is now open.

[Mark Marcon:]

Good morning. First of all I want to congratulate you on all of the progress that's occurred over the last two years. You did a lot of things that a lot of people were skeptical of. So, congrats on that and it seems like things are well within range for 2018. I'd actually like to look beyond 2018 first and just think about incrementally what are some of the – what are some of the things that you could continue to improve upon as we look out beyond 2018, because it looks like the 10-10 is within range. What areas are you most optimistic about? Where are the areas where the free cash flow could improve even further? How should we think about that?

[John Haley:]

So, I would say this I think if you look at our margins and compare them to our competitors, where you would see the biggest difference is probably in CRB and so we think that that is probably an area where we are – I mean I love the progress that we have made in CRB from the fourth quarter of 2016 to today. If we keep on that – I think there is further improvement that we can make in 2019 and beyond. And also the investments that I just talked about that we're making, as I said, we're putting more money in investments and making sure that we are at the forefront technologically in CRB than anywhere else. And so, I see that as also something that we contribute there. I think there is some things we can do just as a matter of housekeeping and better management that will improve things. Both Mike and I think our DSOs are far too high, and we think that there is some significant improvement. We expect to make some improvement in 2018, but frankly we expect to make improvement for several years, year-on and year-out in the DSOs. And so, we see that as an area that we can improve on. And then finally, we've been spending a lot of time on making sure that we're encouraging and fostering innovation. And I mentioned the CEO Circle Awards we have a number of other programs. It's my belief that most of the best innovation comes from the people on the front lines, who are dealing with clients every day and trying to – they see what the problems are and they come up with solutions for them. And what we want to make sure is that we have the right kind of environment in this company where people can bring those solutions forward and we can institutionalize them and get them out to market quickly. And we think we've done a number of nice things in the last couple of years to bring that forward and we think that will pay off.

[Mark Marcon:]

That's great. And with regards to the innovation, I mean that's part of the culture and I was wondering if you could talk a little bit about some of the metrics that you are looking at with regards to engagement and our retention, particularly in CRB where you have made a ton of progress?

[John Haley:]

Yeah. So, we did our first annual – our first all associates engagement survey in the early part of 2017. And we did that – actually before we started to see some of the real up turns that we had. It was in the very early part of 2017. So, it's not necessarily with all the good results we've had here factored in. But it was a – overall, we were very pleased with the results. We got over 86% of our people responding to it. I think the most important thing was that in terms of feeling about the Company sharing our values and approving the values of the Company and what we were trying to do, we had extraordinarily high alignment. We had some things that people indicated that we needed to work on in terms of improving some of the efficiencies in the way we make it easier for people to do the work. We look at engagement surveys as not report cards, but really is areas for us to identify that we can work on to improve the Company. And so, we are taking that feedback. We have a whole program to roll that out. We'll probably do another survey in another year or so. And I expect we'll see some improvement in the areas that our colleagues have identified for us. On innovation generally though, we have a new venture investment committee that is a committee that reviews ideas that people have. We have invested a lot in infrastructure to make it easy for people to identify some new ideas to get the appropriate support to develop business plans for them. And to bring them forward, we have a pretty rigorous approach to which ideas will pilot test, and then of the ones we pilot test, which ones will put into development. And I think the idea behind that is to say, going forward, we want to have may be a little bit – any ideas that we're supporting we want to make sure we give them sufficient support that they get a fair chance to do it. But we also want to have a culture of best failure, so we want to get out of things that aren't working. But we are pleased with the whole development across the ranks, Mark.

[Mark Marcon:]

Great. And then just to number of questions real fast. The $175 million in run rates savings that we were going to get to by the end of 2018. Can you just give us a pacing for what's incremental in terms of coming through as the quarters fall through? And then from a DSO perspective, what would be a realistically ambitious goal and what would be like an audacious target in terms of where you can get the DSO too?

[John Haley:]

I'm going to let Mike to take both of those.

[Mike Burwell:]

Sure. When you look at the incremental $50 million, big piece of that is the continued program around real estate particular as we see that optimization continuing to happen. We have certain leases coming due and we'll refine the program that we've learned over the last couple of years. And we believe that we can see incremental benefits from what we've done to-date. And that's the biggest piece of what you are going to see in that $50 million happening in fiscal year 2018. Coming back on your – remind me…

[John Haley:]

What's a realistic and what's an audacious goal?

[Mike Burwell:]

So, I think a realistic goal is clearly getting that down by five days. I think is realistic. Immediate goal every day is worth $0.01 a share, it's $21 million a day for us. So, we see that, I mean I think 20% reduction would be more of an audacious goal that we would have out there in terms of what we would look to do. And so, as John mentioned, the both of us are very focused on it, as well as frankly the entirely leadership team in terms of managing and driving it in a very focused way. So, we understand what it means to free cash flow. We know what it means in terms of creating opportunities for us to be able to redeploy that free cash flow and return it to potentially investors is an important element to that. So, hopefully that helps.

[Operator:]

Thank you. Our next question comes from Mark Hughes was SunTrust. Your line is now open.

[Mark Hughes:]

Thank you. In the CRB segment, a very strong international organic growth, was there some timings benefits of that, your guidance for low-single digits is consistent with what you've had historically, but seems like Q4 was quite strong, is there some reason it should decelerate that much?

[John Haley:]

Well, I think when you look at international you have really a tale of just two very different years between 2016 and 2017. And we mentioned that we thought that there were a lot of things, just a lot of unfortunate breaks in 2016 on international. We thought the actual performance of that business was really much better, but a lot of things brought it down. So, I think we had some easier comparables in 2016. The performance in 2017 has just been outstanding, I think really the whole year. And so, it's a little bit better in this fourth quarter, but it's really good performance the whole year.

[Mark Hughes:]

And then, your large case P&C, it sounds like you're making some progress, but would like to make more, is there – are you finding this is just something that's going to take longer or it is just hard to do?

[John Haley:]

Yeah. I would say that I think, well two things about this. One, we put the $200 million goal out there, and that was really taking us from – it was an additional 2% market share we'd estimated. But it was really about a 40% increase in our market – in what our total revenues were, because we're going from 3.5% to 5.5%, so a pretty big increase there. We are not getting quite as far along as we thought. But even when we've had the $200 out there, we expected that would be something that we would build on in future years and continue to grow our relative market share there. So, if it comes out the way we are planning now, will have gone from about 3.5% market share up by 1.5% to about 5%, and you know 5.5% something like that, and we expect to continue to grow that over future years. I think it's probably, I mean it's fair to say, it's probably been a little bit harder than we anticipated or at least it's been a little bit slower than we anticipated. And so, I think I mentioned we actually are not as far off on the number of cases that we had brought in, but the average case size is a little bit smaller than we had anticipated.

[Operator:]

Thank you. And our last question comes from Elyse Greenspan with Wells Fargo. Your line is now open.

[Elyse Greenspan:]

Hi. Good morning. Just trying to tie up some stuff, if I look at the earnings guidance that you guys gave, obviously the 10-10 that you guys have pointed to throughout the merger is included within that. It seems like expense saves, you know more positive on, revenue synergy are coming in a little bit lighter than you had expected in a couple of the bucket, tax more or less about in line a little bit better. So I guess I am trying to tie it all together and just understand how you kind of got to your guidance and maybe why it wouldn't be a little bit higher? And then, is the 25% EBITDA margin goal? Is that embedded within the guidance that you set forth for 2018?

[John Haley:]

Yeah. So, I'll give you some thoughts Elyse, and then maybe Mike will want to jump into. Look the 25% EBITDA goal is embedded within there also. I think what I would say is that when we thought about the 10-10. And you will remember from that back in 2016 we did the Analyst Day, we said everything doesn't have to go perfect. We have some things that can balance as to where they are. I think frankly, we have a lot of things going right at the moment and we feel pretty good about that, which we think it gives us great momentum going into 2018. We do expect we'll lose about $0.06 a share as a result of the new tax bill. And so, if you take the $0.06 a share and added that to our guidance, we have the 10-10 just about – almost it wouldn't be quite dead center, but it'd be real close. And so, that's about where we had been targeting the whole time that we thought 10-10. We always said it wasn't a slam dunk by any means, but we thought we had a plan to get there and I think we still feel that way. Mike, do you what to add anything?

[Mike Burwell:]

Yes. I was going to add John. I think, Elyse back on the margin, I think we've made those investments. We believe they will pay off going forward. We are obviously focused on variety of different things. As John said, we have a lot of things going right. But obviously we are planning for to drive it as a management team, but we'll have some things that will come up and we think we put the appropriate measures in place, but we think that 25% makes sense and are therefore rolls up to those overall goals adjusted by taxes as John said.

[Elyse Greenspan:]

So the 25% is included in the 2018 target?

[Mike Burwell:]

It is.

[Elyse Greenspan:]

Okay. And then as we think about the saves from the OIP and then the higher merger saves. As you guys come up with this guidance, just because it's really hard for us from the outside to see how much might actually be falling to the bottom line. Is there any way you can kind of talk to how much bottom line savings you are seeing as you think about 2018? And then this might relate to the saves going up, but I did noticed the integration costs that you pull out of adjusted earnings went up in the quarter and was – and had a plan this year. What rolls on the higher costs there?

[Mike Burwell:]

Yeah. So first, Elyse, the higher costs were principally related to additional technology and real estate costs that we had spent activities on. We also had the shareholder suit that came back overall in terms of what we spent additional money on the $33 million that we had as it relates to shareholder litigation settlement was included in there. So, those are the principal biggest pieces of that incremental amount. On OIP, as John referenced the $95 million, our best estimate of it right now is roughly around half that we've seen in terms of fallen to the bottom line. And equally we talked about $175 million next year in terms of what that looks like as an exit rate amount. So, I know you're trying to go back to those pieces, but those are the biggest chunks that are included in there.

[Elyse Greenspan:]

Okay, great. And then one last question on, it seems like it's taking a little bit longer for some of the larger account wins that you guys did, pointed to with this merger. Is that something that maybe – how do you think about 2019, is it something where you see the synergy is continuing, maybe more coming in over the longer term or is it something where maybe the ability, the gain – higher share in that market might just – it's either taking longer or do you think you might not get to the original target?

[John Haley:]

Now we'll get to the original target and go past it.

[Elyse Greenspan:]

Okay. Thank you very much. I appreciate the color.

[John Haley:]

Okay.

[Operator:]

This does conclude our Q&A session. I would now like to turn the call back to Mr. John Haley for any further remarks.

[John Haley:]

Okay. Thanks very much everyone for joining us this morning. And we look forward to talking with you or seeing you in March.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.