Willis Towers Watson Public Limited Company
Q2 2008 Earnings Call Transcript

Published: 7 Feb 2008

[Operator:]

Good day, ladies and gentlemen and welcome to the Second Quarter 2008 Watson Wyatt Worldwide Earnings Conference Call. My name is Alicia and I will be your operator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. [Operator Instructions]. As a reminder, this conference is being recorded for replay purposes. I would now like to introduce your host for today’s call, Miss Mary Malone, Director of Investor Relations. Please proceed ma’am.

[Mary Malone:]

Good morning. This is Mary Malone, Director of Investor Relations at Watson Wyatt Worldwide. Welcome to our conference call to discuss our results for the second quarter and fiscal year 2008. I am here today with John Haley, Watson Wyatt's President and Chief Executive Officer; and Carl Mautz, Chief Financial Officer. After some brief prepared remarks, we will open the conference call for your questions. Please refer to our website for this morning press release. Today's call is being recorded and will be available for replay via telephone for the next week by dialing 617-801-6888, confirmation number 2362-9107. The replay will also be available for the next three months via the Company's website at www.watsonwyatt.com. There are a few slides that accompany the financial section of our presentation. You may log on to our website to obtain those slides. This conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including statements, among others, regarding expected financial and operating performance. Any statements made during this call that are not statements of historical fact maybe deemed to be forward-looking statements. You are cautioned that these statements maybe affected by among others the important factor set forth in our filings with the Securities and Exchange Commission and in today's news release and that consequently actual operations and results may differ materially from the results discussed in the forward-looking statements. The Company undertakes no obligation to update publicly any forward-looking statement whether as a result of new information, future events, or otherwise except as provided by Federal Securities Laws. At this time, I will turn the conference call over to John Haley.

[John J. Haley:]

Thank you Mary. Hello everyone and thanks for joining us today. We are doing this call from Reigate in United Kingdom, our largest office anywhere in the World. I am very pleased to share the results of another strong quarter with you. Our revenues for the quarter increased to $447 million, an increase of 22% over prior year. On an organic basis that excludes the impact of acquisitions and foreign currency movements, our revenues increased 9% over the prior year. On a constant currency basis, our segment revenue growth was strong across the Board, with 20% in benefits, 17% in technology and administration solutions, 15% in human capital group, 7% in insurance and financial services, and 25% in investment consulting. For the quarter, deluded earnings per share were $0.82. This is a 41% increase over the prior year $0.58 per share, reflecting solid revenue growth and increased margins. Our deluded earnings per share were better than guidance due primarily to better than forecasted operational results. Our forecasted rate for the British Pound was only slightly less than the actual exchange rate for the quarter. So the strengthening of the British Pound did not create a large variance from our forecast. However, please note that our forward-looking guidance assumes depreciation of the British Pound. We continue to see strong demand in the marketplace and we are optimistic about the growth opportunities for our business. Many of you have been inquiring about how our recession would impact our financial results. We can’t predict this with any certainty because the actual impact would be based on the severity and length of a downturn, as well as the specific countries affected. However, we think that our well chosen portfolio of services combined with our global presence provide a solid business platform even during a recessionary period. As we review each of these segments, I will discuss how an economic slowdown could affect that particular segment. Let’s begin with benefits, for the quarter benefits group revenues were $244 million, up 24% from the prior year and 20% on a constant currency basis. Strong demand for our services in all geographic regions resulted in solid growth. Europe’s growth also benefited it from our acquisitions in Germany and the Netherlands. Excluding acquisitions, currency movements organic growth was 5%. In FY ’08, we expect the geographic breakout of our benefits revenues to be as follows

[Carl D. Mautz:]

Good morning everyone. As you’ve just heard we have completed another exceptionally strong quarter. Our revenues for the quarter were $447 million. We are quite pleased with the revenue growth in each of our segments. Our operating margin increased to 13% this quarter from 11% in the second quarter of last year. Our revenues increased 22% and our income from operations increased 49%. We continue to focus on profitable growth. The benefits group had a 26% margin in this quarter, an increase from 24% in the second quarter of last year. Our benefits group tends to be stronger in the back half of the fiscal year and we’re expecting full year margins in a high 20% range. Technology and administrative solutions had a 33% margin, a significant increase from 26% in the second quarter of last year. Our margins are usually strongest in the second quarter in North America due to the timing of benefits enrollment. This quarter was even stronger as clients may change it to their pension and pension administration system in response to the pension protection act. Since some of this margin improvement was seasonal, we are increasing our full year margin expectation to the mid 20% range from the low 20% range. The human Capital Group had a 23% margin this quarter, a considerable increase from 18% in the second quarter of last year. We think our strong margin this quarter was due in part to timing as well as our data work. Forecasts for January were completed in December. We still expect our full year margins will be in the high teens. Insurance and financial services had a negative 1% margin this quarter, down from 12% in the second quarter of last year. This quarter includes approximately $1.4 million as severance cost from restructuring in Europe. We are making selected investments to strengthen this practice and we are closely monitoring the areas where our performance was below expectations. It may take us a few quarters to get our margins back in line. Investment consulting had a 35% margin this quarter, an increase from 31% in the second quarter of last year. This practice continues to grow profitably and we expect a full year margin in the low 30% range. The segment margins that we have just reviewed are before consideration of discretionary compensation and other unallocated corporate costs such as amortization of intangibles from our acquisitions. We expect our full year operating income margin to be in excess of 12% in spite of increased non-cash amortization from the acquisitions. Last fiscal year our operating margin was 12.1% and we’re anticipating a few basis points higher than that this year. Net income for the quarter was $37 million, up from $26 million in prior year. Fully diluted earnings share for the quarter were $0.82 a share compared to prior second quarter earnings per share of $0.58. Moving to the balance sheet. We ended the quarter with $104 million of cash on the balance sheet, and $107 million of debt. We strive to move our cash around the world in a tax efficient manner, and therefore sometimes there is a delay between when we accumulate cash, and when we repay our debt. We expect to have the debt repaid before the end of fiscal 2008. The business will continue to generate strong cash flows. We also used $14 million to repurchase shares during the quarter. We expect to continue to repurchase shares that will be issued through our stock purchase and stock compensation programs. Now let’s review our guidance for fiscal 2008. The slide posted on our website may be helpful for following on in this section. For fiscal 2008 we are maintaining our revenue guidance of $1.68 billion to $1.72 billion and we are increasing our diluted earnings per share guidance to $3.10 to $3.15. Note that our forward-looking guidance for the third and fourth fiscal 2008 quarters is based on an exchange rate of $1.95 U.S. to the British Pound down from $2.03 exchange rate that we used last quarter. Our projected depreciation of the British Pound has been offset by the increase in our operating performance. It further demonstrates our strong fundamentals. Our revenue guidance of $1.68 billion to $1.72 billion represents an increase of approximately 13% to 15% over fiscal 2007 revenues. This increase is after injection of approximately $16 million due to the forecasted depreciation of the British Pound and the previously announced exit from our multi-employer retirement business in North America. Our guidance by segments can be found on slide three. Our benefit revenue guidance remains the same and we are still expecting growth of 16% to 18%. We are increasing our guidance for the technology and administration solutions group to cross the 14% growth. Our guidance for the human capital group remains the same and we are still expecting 8% to 10% growth. We are revising our growth for insurance and financial services is down 5% to 7%. We are increasing our guidance for investment consulting and now expect a growth of 25% to 30%. Our diluted earnings per share for fiscal 2008 is expected to be in the range of $2.10 to $2.15, a 20% increase over fiscal 2007. If guidance assumes a 32.7% tax rate for the year and weighted average shares outstanding at 44.7 million shares for the year. We expect third quarter revenues to range from $435 million to $442 million and diluted earnings per share to range from $0.79 to $0.81 per share. Third quarter revenue guidance by segment is presented on slide four. I realize that by providing third quarter guidance and full year guidance I have also essentially given fourth quarter guidance. The guidance that we have discussed indicates that there could be some degradation in our fourth quarter margins. As we add new businesses to our portfolio through acquisitions the seasonality of our overall business can shift. For example our new German business has its peak in the second and third fiscal quarters. You will note that the operating margins in our full year guidance is greater than the 12.1% operating margin achieved last year even after consideration of the additional amortization expense. Before I turn the call back over to John I would like to close on a personal note. Today I announced my plans to retire in August. This time permits me to finish this fiscal year’s performance planned next year and transition my responsibilities. I will be fully engaged for the next seven months but I confess a change of pace is somewhat exciting. And now I will give the call back to John.

[John J. Haley:]

Thanks Carl. I really appreciate your professionalism and you dedication to Watson Wyatt and its investors. Carl has been the CFO during my entire tenure as the CEO. During the past nine years we worked together on many different and varied projects, from the early days strengthening Watson Wyatt and Company when we were a private organization, through the launch of our IPO, up to the string of acquisitions that we have done during the past few years. Carl has been a terrific partner and I shall miss him greatly. Carl and I are going to work together to ensure a smooth transition to the CFO responsibilities. In the meantime I am pleased that he is going to be with us for another seven months including two more of these earnings calls. Thank you Carl. As to this quarter’s results we are pleased with our performance and we continue to be optimistic about our prospects for this fiscal year. Now, we will take any questions that you may have. Question and Answer

[Operator:]

[Operator Instructions]. And our first question comes from the line of Aswhin Shirvaikar with Citi. Please proceed.

[Ashwin Shirvaikar:]

Thank you. And fabulous results once again. Congratulations.

[John J. Haley:]

Thank you Ash.

[Carl D. Mautz:]

Thank you Ash.

[Ashwin Shirvaikar:]

Carl, it will be difficult to see you go, but I am sure I will see you in the next seven months or so and maybe even after.

[Carl D. Mautz:]

Thank you. I plan on it.

[Ashwin Shirvaikar:]

Yes. The question I had… the first question I have is… as you guys keep meeting expectations, the market really does not reward you and your post acquisition cash balance is building up. Does it ever cross your mind that perhaps you should explore options such as going private? I mean is there specific reasons why… acquisitions aside you need to be public?

[Carl D. Mautz:]

Well, I think the… I think Ashwin the ability to do sensible acquisitions, the ability to have a seat at the table as consolidation is occurring in our industry was an important reason why we went public to begin with and well… the… we look and we see what's happened in the markets from time to time you wonder exactly how you're rewarded for your performance. But overall I must say being a public company has given us some tremendous advantages and I don’t think we would have been able to do the acquisitions that we have done in the past few years if we had been a private organization.

[Ashwin Shirvaikar:]

Right, what a take. That’s behind you and so going forward that was more of a going forward question.

[John J. Haley:]

I guess, we're not necessarily convinced that all the consolidation is over with.

[Ashwin Shirvaikar:]

Okay. Fair enough. The question I have is on insurance. Can you go into some of the reasons why you needed to have the severance cost. I may have missed it. And what are the steps other than the severance charge it took that you need to have happened for a recovery in that unit?

[Carl D. Mautz:]

Let me cover each of those two questions. As you know we've done that, two significant acquisitions in Europe as well as the taking on an additional business in Holland related to IF the insurance business. We've been combining that and pulling that, those management teams together and hence that service which we expect is completed now as we restructured those businesses to move forward. We're not anticipating any significant actions in that direction in the future. As what we're doing around the world to strengthen the business as I mentioned and as John mentioned we've been making some selected investments with additional people. This rare opportunity in our Asia region for this business and we have been bringing some people on there. We have been expanding the business in parts of Europe. We will watch that performance carefully and we also think that there is some additional opportunity with the software that we have developed. We expect some performance, we’ll see how that goes and as I noted it will probably be a few quarters before we see them returning to the profitability measures that we would anticipate.

[Ashwin Shirvaikar:]

Okay. And last question. Just a clarification, the share repurchases that you did in the quarter, that you mentioned, was that incremental over and above the normal repurchase that you do to keep your share count flat?.

[Carl D. Mautz:]

It was a normal share repurchase that we've been doing to avoid dilution from our in place stock purchase plan and any other plan.

[John J. Haley:]

We don’t, when we say that actually when we can't always perfectly match the issuance of new shares with what we buy back in a given month. But over the period of a year or so we hope to have the two of them in dollars.

[Ashwin Shirvaikar:]

Right. Thank you.

[Operator:]

Our next question comes from the line of Andrew Fones with UBS Securities. Please proceed.

[Andrew Fones:]

Hi, I’d like to also extend my best wishes to Carl.

[Carl D. Mautz:]

Thank you, Andrew.

[Andrew Fones:]

I had a question on acquisition if we do kind of see a bit of a slow down in the U.S. and perhaps in Europe. Can you perhaps explain how you think the acquisition landscape may change whether you may see additional opportunities and perhaps what you have your eye on? Thanks.

[John J. Haley:]

I think, Andrew, as we think about this, it would be more from a theoretical perspective now. That is to say we know that generally when things turn down, when there are select and other difficulties, that’s often when you can find the most attractive opportunities and those are opportunities of the most attractive price is what we say. And so we like being in a position where we can look among potential opportunities. We don’t have anything that we're talking about right now that’s a prospect that we would be going after, but we're always aware that in the professional services industry you really need to have both sides wanting to do it. There’s no such thing as successful hostile takeovers and so we’ll wait to see what develops but we're certainly alive to different possibilities.

[Andrew Fones:]

Great. Thanks. And then, just on this strong HCG results you mentioned that some work had been pulled forward. But I was wondering if you could quantify that and perhaps even despite that you still saw strength. What drove that? Thanks.

[Carl D. Mautz:]

The nature of the work that we pulled forward in our Data Services business. As to quantifying it. It might have been a point of the margin increase probably the way I’d quantify it. Fundamentally the process is performing very, very well across the entire product line. We mentioned the three compensation practices as well as organizational effectiveness they are also performing very strong. So, a good piece of the margin improvement is simply tremendous work on the part of that practice, around the world.

[Andrew Fones:]

Thank you.

[Operator:]

The next question comes form the line of TC Robillard with Banc of America Securities. Please proceed.

[TC Robillard:]

Great. Thank you. And Carl my best wishes as well although I know we’ll hear from you a couple of more times but congratulations on the retirement.

[Carl D. Mautz:]

Thanks.

[TC Robillard:]

And I just wanted to… the real question that I had is more on the margins and just trying to balance out the conservative nature that you guys have consistently had with respect to your guidance going forward versus the needs for additional investments as well as what you had mentioned on the call or in your transcripts with respect to acquisitions and things like that. But I… I'm just trying to balance it out because it just consistently seems that you guys are overly conservative and I think that goes back to what Ashwin was mentioning with respect to not getting full credit in the marketplace. How should we be balancing out where you guys should come out over the long term in the margins because you clearly have been well above the 12% in the first half? It doesn’t seem like there is that much of a drag issue going into the second half. So, I’m wondering where we can start to push this operating margin with the long-term model as we go forward?

[John J. Haley:]

Let me take… I said, the seasonality of margins across the fiscal year. Let me point out again that we certainly had strong margins in this quarter. Part of that again is amplified by some seasonal issues that… seasonal opportunities, excuse me, not issues, are occurring both in Europe as we have the German business whose strongest peak period are in our second and third fiscal quarters and we just finished the second. So, we expect that there will be some strong quarters, strong performance next quarter and then probably a little bit of a taper off in the fourth. We also had a real peak in the technology business in the U.S. not unlike what we saw in Europe, in the March quarter two years ago, almost two years ago now, resulting from all of the systems changes that needed to happen. So, while we had a very strong 13% margin overall with great improvements in technology as well as a strong benefits performance and than any other practices, there is some tapering off there. So, we’re looking at margins for the year being in the 12% to 12.5% range, I would guess for the year, coming down from that in the fourth quarter because of the seasonality. We do think that over time the margins in total in the business can improve a little bit each year at least for the next couple of years and we will give you that kind of guidance as we start to look into fiscal 2009.

[TC Robillard:]

Okay and as we’re looking at the technology segment, how should we think about 60 projects and implementation in terms of rolling into service as we’re looking out into the next couple of years? Because I understand that obviously a bunch of that backlog is much bigger projects so, is it going to be lumpy or should we see continued just more of a linear type of progression?

[John J. Haley:]

I’m sure it will be somewhat lumpy but modeling that lumpiness is always a trick. This is a large just kind of law of large numbers, a large number of projects and we will increase them because we’re just coming into the selling season for the health and welfare area. So, I would suggest that you figure that on average they’re going to take six to nine months for implementation. And I would rule them out kind of in that, time frame. If you took an average of those and then rolled it out credit in that way, I think you’d have it.

[TC Robillard:]

Okay and then just the last question, John. I appreciate all the granularity and the detail that you gave you know around recession, stress testing of your business model; just I’m being a little lazy here in terms of all the percentages that you gave. If you can roll that out as to a ballpark number as to what percent of your business you guys feel has got some pretty good recession resistance to it? I think that would be helpful?

[John J. Haley:]

I’ll let Carl handle that

[Carl D. Mautz:]

And then I’m sure John will editorialize we do that well together. If you look at the rest of this year, we have been, as John mentioned we’re here in the U.K. this week and have had meetings with our price stretchers here. I talked to the global price stretchers. The pipeline is quite full and quite solid throughout… through the rest of this year as we’re really quite enthused and excited about it. And if that’s not coming across, I just said it so you wouldn’t miss it. And we’re not seeing any indications yet of significant softening. Now we’ve mentioned some seasonality but that’s… and a couple of one time issues but those are… fundamentally the business is strong and this isn’t a significant indication of a softening.

[John J. Haley:]

Yes. And then, I think just to… without going through all the ones again to just sum it up, I think we have a couple of practices notably HCG and probably an HCG specifically in the organizational effectiveness which is about 10% overall of HCG. Those are ones that would probably be more affected by the downturn than others. We think Benefits is really quite resilient and it would take a long while for a slow down to affect us.

[TC Robillard:]

Understood.

[Carl D. Mautz:]

And I want to editorialize one more… a little bit more. I didn’t want to miss, I don’t think you should miss the TSP significance either, that business was significantly, adversely affected as we went through a slow down earlier in this decade. Capital spending and technology spending just fell off, the practice actually contracted. You noted in our comments and the script that we’re now facing the maturing of some of these projects and are now having renewals. Some 30 renewals, that’s very exciting. Those are high profitability opportunities. They are contracts that are three to five years long. So, they are a very nice foundation in the technology business out for revenue generation that we didn’t have the last time around as well as the new projects that we’re in.

[TC Robillard:]

So, is it fair to assume that it sounds like just the back of the envelope math that 80%, 85% of your business should not be affected by a recession. Just again I know that there is a lot of inputs there, but just based on assuming we’re not going into a two year recession globally. It sounds like you guys have 85% or so of your business that’s pretty resistant to that. Is that a fair ballpark?

[John J. Haley:]

I might have said 75% to 80%, but you accused me of being too conservative anyway.

[TC Robillard:]

All right. Fair enough, John. Thanks guys.

[Operator:]

The next question comes from the line of Mark Marcon with Robert W. Baird. Please proceed.

[Mark Marcon:]

Good morning. Congratulations on the terrific results for this quarter, the last six quarters. And congratulations Carl, we’re all going to really miss you. Just out of curiosity, why are you retiring, Carl?

[Carl D. Mautz:]

Because I am old.

[Mark Marcon:]

No, you’re not. You’re out running everyday.

[Carl D. Mautz:]

I want to retire while I still can.

[Mark Marcon:]

Okay. Well deserved. I have a question in terms of the longer term. You mentioned… I just wanted to ask a question with regards to why not go private since you're not getting rewarded in the public markets for your outstanding results. And you mentioned that you don’t think consolidation is over. From a longer term perspective, what do you think the industry does look like, two, three years from now? And what is Watson Wyatt’s position going to be?

[John J. Haley:]

I think what I actually said was we're not sure that the consolidation is over in the industry. We don’t know. You may remember, Mark, when we first went public, one of the reasons we gave for going public. In fact, one of the most significant ones was we wanted to be a player when acquisitions or mergers occurred. And then for a few years we did virtually none, the only ones we did were relatively small ones. And I had a lot of questions from people saying “Gee, you wanted to o public to do this, but you really haven’t done anything.” and our answer was always that we were looking for not just the right opportunities, but we also had to find willing partners to do it. And now in the period of two years, we’ve had an incredible number of different acquisitions and mergers that we’ve done. Looking out over the next couple of years, I am not sure which environment we’re going to be facing. Whether it’s going to be one where we have a lot of opportunities that we think are particularly good fits with us, or whether it’s going to be one that looks like the first couple of years after we went public where we’re willing to do something, but we just can’t necessarily find the right partners for it. I think if you look at our industry overall, there are four big players including ourselves as one of them. It wouldn’t surprise me if in five years from now there would still be four big players and it wouldn’t surprise me if maybe there’s only three. So, I’m just not sure what might happen there, what we want to do is be prepared, whatever happens we are be able to take advantage of it.

[Mark Marcon:]

Is it your general sense that whether there are four or three big players, that those players will continue to gain share at the expense of smaller players and that the industry itself is becoming more global, and that there is a consolidation among multinational companies of their practices or their service requirements with the four big global players.

[John J. Haley:]

Yes, I mean I don’t want speak for the others. I’ll think we will gain market share. But I do think that the world is becoming smaller, the world’s becoming flat as they say. And we are seeing more of an interest in clients buying our services not just because we have the capabilities to service them in a particular geography they are in, but also because we have the ability to do similar things worldwide.

[Mark Marcon:]

Okay. And then… so Carl was saying 75 to 80% might be recession resistant. 20% to 25% might be cyclically sensitive particularly the HCG organizational effectiveness practice. If we go into recession, do you think we’d still be able to grow revenue? And what do you think would happen to your margins?

[John J. Haley:]

I’ll let Carl talk about the margins. I think if you were to look at the early 2000, our revenues were flat for about three years in a row. And I think the message that we’re really trying to give you today is we think we’re in a lot better place than we were then. Now, that means we would expect at least to see some small growth in our services, even if we had a downturn… I mean small growth in our revenues. Carl, do you want to talk about the margins?

[Carl D. Mautz:]

Sure. And maybe I just add one comment to what john has just suggested. Again, the length and the severity of the downturn makes a huge difference If we’re talking about six to 12 month dip, that’s one thing, if we were to go into two year, that might cast things a little bit differently. I certainly don’t think our margins would contract, and as long as our revenue is growing I would expect to us to be able to improve our margins, although, the rate of that improvement, might slow. So, I would not… if I were modeling a couple different scenarios into the future, which I have done. I wouldn’t take margins down, I would just slow the rate at which they might improve.

[Mark Marcon:]

Okay. And it sounds like your general sense is we should under normal circumstances… normal being a period of somewhat moderate GDP growth on a world wide basis, continue to experience decent margin growth like what we’ve seen this year relative to last year?

[John J. Haley:]

Yes.

[Mark Marcon:]

Okay. The other question is just on the benefit side we’ve obviously had the Pension protection act, we’ve got the Cooper’s decision. On the human capital side, we’ve had changes with regards to executive compensations exposure. Where are we in terms of all of the various legislative regulatory changes, in terms of that and being a positive tailwind to your business.

[John J. Haley:]

Yes. I think overall what we would say Mark is that those events have certainly boosted our revenues. We think what they’ve done is they pushed us up to a new plateau. We don’t think they will necessarily have the same kind of increased growth, but I don’t think we’ll drop back either.

[Mark Marcon:]

How far along are we in the game? Are we in the… in terms of Company’s adjusting to all of these changes, and I left out the FASB changes, in terms of adjusting to all of these changes, are we benefiting, are we forfeiting, where would you say we are?

[John J. Haley:]

Well I think it probably varies with some of them. I would say, overall for the pension changes, we are probably more in the middle of the game, in the fourth or fifth inning. I think for a lot of the executive comp changes and others, we are probably closer to the eighth inning.

[Mark Marcon:]

Okay. Great. Thanks again and Carl again, congratulations.

[Carl D. Mautz:]

Thanks.

[Operator:]

[Operators Instruction]. Those are all the questions we have for today. I would now like to turn the call back over to Mr. John Haley for closing remarks.

[John J. Haley:]

Okay. Great. Thanks everyone for joining us. Carl and I are going to look forward to reviewing our third quarter results with you in May, so long.

[Operator:]

Ladies and gentlemen, thank you for joining today’s conference. This concludes your presentation and you may now disconnect. Good Day.