Willis Towers Watson Public Limited Company

Good morning.

Welcome to the Willis Towers Watson Fourth Quarter 2019 Earnings Conference Call. Please refer to our website for the press release and supplemental information that was issued earlier today. Today's call is being recorded and will be available for the next three months on our website. Some of the comments in today's call may constitute forward-looking statements within the meaning of the Private Securities Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties. Actual results may differ materially from those discussed today, and the company undertakes no obligation to update these statements unless required by law. For a more detailed discussion of these and other risk factors, investors should review the forward-looking statement section of the earnings press release issued this morning, as well as other disclosures in our recent form 10-K and other Willis Towers Watson SEC filings. During the call, we may discuss certain non-GAAP financial measures. For reconciliations of the non-GAAP measures, as well as other information regarding these measures, please refer to the most recent earnings release and other materials in the investor relations section of the company's website. I will now turn the call over to John Haley, Willis Towers Watson's Chief Executive Officer. Please go ahead.

Thank you very much, and good morning, everyone, and thank you for joining us on our fourth quarter earnings call. With me here today is Mike Burwell, our Chief Financial Officer, and Rich Keefe, our Head of Investor Relations. Today, we'll review our results for the fourth quarter and for the full year ended December 31st, 2019. Then we'll provide a brief commentary on the outlook for 2020. So, as I look back on the last year, I think that our results were largely positive. We increased revenue, we improved margins, and we generated an impressive return for our shareholders. That said, we have more work to do to improve free cash flow, and we remain focused on executing against our strategy. So before diving into the fourth quarter results, I'd like to take a moment to update you on some exciting activity that's already occurred this year. Two weeks ago, Willis Towers Watson returned to Davos to participate in the World Economic Forum. Now in our second year as a strategic partner with the World Economic Forum, our delegates convene to address areas of strategic importance to our business, including climate risk, the future of work, inclusion and diversity, and cybersecurity. Quite a few members of our delegation led sessions during the week at Davos. I took part in sessions that continue the work of the Coalition for Climate Resilient Investment, a cooperative initiative which we introduced last quarter. We also launched a new offering, Climate Quantified, which helps organizations to quantify how they will be affected by the climate change trajectory and the effects of mitigation with climate-adequate and resilient solutions. We also co-sponsored Bloomberg Live's The Year Ahead Davos event, where Julie Gaybauer, head of human capital and benefits, spoke on organizational sustainability. Adam Garrard, our head of corporate risk and broking and our international geography, participated in a session on advancing cyber resilience for critical infrastructure. Carl Hess, the head of investment risk and reinsurance, joined a Friends of Ocean Action community session on increasing the role of the ocean to address some of the United Nations global sustainable development goals. All told, the company had a great lineup of events and speakers across Davos in addition to numerous client meetings. We were encouraged by the experience and are excited to play a proactive role within the global community that is working to build a more cohesive and sustainable future. Now, let's turn to our fourth quarter 2019 results. For the fourth quarter of 2019, we continued to deliver solid financial performance with 14% overall constant currency growth 6% organic revenue growth, and 270 basis points of adjusted operating margin expansion. Likewise, we had revenue and operating margin growth in each of our business segments again this quarter. This marks the sixth consecutive quarter in which we've generated organic revenue growth of 5% or greater, along with improved margins. Our fourth quarter results reflect our efforts to constantly challenge ourselves and to deliver more. Reported revenue for the fourth quarter was $2.7 billion, up 13% as compared to the prior year fourth quarter, up 14% on a constant currency basis, and up 6% on an organic basis. Reported revenue included $22 million of negative currency movement. Net income was $551 million, up 44% for the fourth quarter, as compared to $383 million of net income in the prior year fourth quarter. Adjusted EBITDA was $930 million as compared to the prior year fourth quarter adjusted EBITDA of $774 million, representing a 20% increase. For the quarter, diluted earnings per share were $4.18, an increase of 45% compared to prior year. Adjusted diluted earnings per share were $4.90. Reported revenue for the full year of 2019 increased 6% as compared to the same period in the prior year, increased 9% on a constant currency basis, and was up 5% on an organic basis. Now, let's look at each of the segments in more detail. To provide clear comparability with prior periods, all commentary regarding the results of our segments will be on an organic basis unless specifically stated otherwise. Segment margins are calculated using segment revenues and they exclude unallocated corporate costs, such as amortization of intangibles, certain transaction and integration expenses resulting from mergers and acquisitions, as well as other items which we consider non-core to our operating results. The segment results do include discretionary compensation. Revenue for human capital and benefits, or HCB, was up 4% on an organic and constant currency basis compared to the fourth quarter of the prior year. For the full year of 2019, HCB revenues grew 4% organically. The health and benefits business grew 10% this quarter. New business and product revenue continued to drive revenue expansion in North America. While our increasing market share in global benefit management appointments and new local and regional wins contributed to the growth in other geographies. Health and benefits revenue growth was also aided by the lower revenue comparable in the prior year fourth quarter. The prior year results reflect the impact of adopting the new standard, ASC 606, which resulted in certain revenue not being recognized. Retirement revenue increased 1% this quarter, primarily driven by continued momentum and a steady flow of bulk lump sum activity as the market for pension risk transfer remained attractive to plan sponsors in North America. Increased demand for consulting and advisory work in North America and international contributed to revenue growth in both talent and rewards and technology and administration solutions. HCB's operating margin improved by 20 basis points compared to the prior year fourth quarter and improved by 130 basis points for the full year. As a trusted partner to our clients, HCV combines data analytics, strategic insight, and brokerage and technology solutions to address our clients' most complex workforce and benefits challenges. Our takeaways from Davos reinforced areas we had already prioritized. Reskilling in response to technology advances, enhancing diversity and inclusion as part of sustainability, and leveraging AI to enhance the employee experience and improve well-being. As HCB's results indicate, we believe the segment's well-positioned to address these issues and provide solutions that keep pace with our clients' evolving needs and therefore continue growing profitability. Now let's look at corporate risk and broking, or CRB, which had a revenue increase of 9% on an organic and constant currency basis as compared to the prior year fourth quarter. For the full year of 2019, CRB revenues grew 6% organically. North America's revenues grew by 11% in the fourth quarter, primarily as a result of new business and improved retention. The international region's revenues climbed 13% as compared to the prior year. There was notably strong performance in construction and natural resources in Central and Eastern Europe, Middle East, and Africa. These results reflect the benefit of some one-time non-replacements. Western Europe contributed 5% growth, with the growth driven by strong new business in Iberia and France. Great Britain had 6% revenue growth driven by new business in aerospace and FinEx. CRB revenue was $877 million, with an operating margin of 30%, as compared to a 29% operating margin in the prior year fourth quarter. The margin expanded due to top-line performance coupled with continued cost management efforts. We're pleased with the CRB top-line growth for the year, as well as the margin expansion for the quarter and the overall year. CRB continues to make solid progress toward profitable growth, and we feel good about the long-term prospects of this business. The World Economic Forum Global Risks Report 2019 ranks cyber attacks among the top five global risks. Developing cybersecurity and resilience is critical to support socioeconomic growth. We believe our CRB business has established itself as one of the world's trusted experts in helping leaders adapt the right strategies to cover their cyber exposure. As cyber attacks continue to rise, we stand ready to help clients defend their innovations and build a more secure digital world. Turning to investment risk and reinsurance, or IRR, revenue for the quarter was $314 million, an increase of 12% on an organic basis and 14% on a constant currency basis as compared to the prior year fourth quarter, with meaningful growth across our core businesses. For the full year of 2019, IRR revenues grew 7% organically. Reinsurance, with growth of 19%, continued to lead the segment through a combination of net new business along with a strong retention ratio across most lines and regions. Insurance consulting and technology grew by 10% from technology product sales and growth in project revenue. Investment revenue increased 9% with continued expansion of the delegated investment services portfolio. On an organic basis, wholesale revenue increased by 15%, driven by growth across the book. Overall, the wholesale business was up 24%, including the results from Miller's acquisition of Austin Gaylor. Our Max Matisse in business grew 3%, primarily from increased commission revenue. ILR's operating margin grew 700 basis points to 9% in the fourth quarter, compared to 2% in the prior year fourth quarter. Top-line growth and greater operating leverage both contributed to the segment's margin improvement. Overall, we are pleased with the financial results of our IOR businesses. Revenues for the benefits delivery and administration segment, or BDA, increased by 53% from the prior year fourth quarter on a constant currency basis. On an organic basis, revenue grew 3% compared to the prior year fourth quarter. BDA's Expanded mid- and large-market client base and increased project work resulted in this segment's growth. We continue to see strong demand for benefits, outsourcing, core service offerings, resulting in several new client wins. For the full year of 2019, BDA revenue grew 4% organically. BDA's operating margin was 52% compared to 61% in the prior year fourth quarter due to the inclusion of Transact in the current year. BDA's operating margin improved from 19% to 24% for the full year. Transact's revenue growth exceeded our expectations. We're encouraged by Transact's performance, and we continue to be excited about our joint trajectory as this business continues to gain momentum. So, in closing, we delivered another solid financial performance for the fourth quarter and for the full year. I also want to take a moment to recognize the hard work of our colleagues around the world and extend our appreciation for the work they've done this past year and for their steadfast dedication to providing top-notch client service. Now I'll turn the call over to Mike.

Thanks, John, and good morning to everyone. Thanks to all of you for joining us. I'd also like to thank our colleagues for all their efforts and our clients for their continued support and trust in us. So now let's turn to our financial overview. Let me first discuss income from operations. Income from operations for the fourth quarter was 687 million or 25.5% of revenue up 570 basis points from the prior year fourth quarter of 470 million or 19.8% of revenue. Adjusted operating income for the fourth quarter was 809 million or 30.1% of revenue up 270 basis points from the prior year of 650 million or 27.4% of revenue. Income from operations for the full year 2019 was $1.3 billion or 14.7% of revenue up 520 basis points over the prior year of $809 million or 9.5% of revenue. Adjusted operating income for the full year of 2019 was $1.8 billion or 20.3% of revenue and up 220 basis points from the prior year of $1.5 billion or 18.1% of revenue. It should be noted that 30 basis points of our margin improvement in fiscal year 2019 was driven by transact related to the timing of the purchase. Now let me turn to EPS or earnings per share. For the fourth quarters of 2019 and 2018, our diluted EPS was $4.18 and $2.89, respectively. For the fourth quarter of 2019, our adjusted EPS was up 23% to $4.90 per share as compared to $4 per share in the prior year fourth quarter. For the full years 2019 and 2018, diluted EPS was $8.02 and $5.27, respectively. For the full year 2019, adjusted EPS was up 13% to $10.96 per share versus $9.73 per share in the prior year. Foreign currency caused a decrease in our consolidated revenue of $22 million for the quarter compared to the prior year fourth quarter, with a $0.05 headwind to adjusted diluted earnings per share this quarter. Foreign currency caused a decrease in our consolidated revenue of $192 million for the full year 2019 as compared to the prior year, with a $0.16 headwind to adjusted diluted earnings per share overall for the year. Moving to taxes, I'd like to provide you with some additional insight into our U.S. GAAP and adjusted tax rates. Our U.S. GAAP tax rate for the fourth quarter was 18.3% as compared to 19.7% for the prior year fourth quarter. Our adjusted tax rate for the fourth quarter was 19.4%, a decrease from 20.4% rate in the prior year fourth quarter. Our adjusted tax rate for the fourth quarter is lower than the prior year due to one-time discrete tax benefits. Full year, the U.S. GAAP tax rate was 18.8% for 2019 as compared to 16% for the prior year, while the adjusted tax rate was 20.3% compared to 19.5% for the prior year. Excluding discrete items, our adjusted tax rate for the full year was approximately 21%. We will give forward guidance around our tax rate. We do not project discrete items, which can be positive and or negative. Moving to the balance sheet. We continue to have a strong financial position. As a reminder, in the first quarter, we implemented the new lease accounting standard. This result had no material impact to our operating income, but did result in an increase in liabilities on our balance sheet, which were largely offset by a corresponding increase in assets. The gross up totaled approximately $1.5 billion. Our balance sheet position continues to strengthen. During the year, we successfully issued $1 billion in senior notes, offering to help with the efficiency of our capital structure and provide additional financial flexibility. Total debt at the end of 2019 was $5.6 billion, compared with $5.9 billion at the end of the third quarter. Our term loan commitment resulting from Jaron's Act acquisition had a $295 million balance as of the end of the year, down from $463 million as of the third quarter, and we had no borrowings at year-end under our revolving credit facility. Our next debt maturity due date is July 2020. Lastly, full-year free cash flow was $835 million, a decrease of $185 million compared to the prior year of $1.2 billion. The year-over-year decline in free cash flow is primarily due to higher cash tax payments of $130 million, resulting from the U.S. and global tax reform, unfavorable working capital changes, particularly in accounts receivable, and negative cash flows of transactions. In terms of capital allocation for the full year of 2019, we repurchased approximately $150 million in Willis Towers Watson stock and paid approximately $329 million in dividends. We remain committed to deleveraging in the near term, returning our leverage ratio to historic levels, improving our free cash flow position. Now that we've summarized last year's performance, let's look ahead to our guidance for fiscal year 2020. Turning to revenue, for the company, we expect organic revenue growth of around 4% to 5% and 6% to 7% on an overall constant currency basis for 2020. Our non-cash pension income, which is classified within other income net line, is expected to improve by approximately $50 million, primarily to improve returns on planned assets. Pertaining to tax, we expect our adjusted effective tax rate to be around 20% for fiscal year 2020, excluding any potential discreet items. Annual guidance assumes average currency rates of $1.31 to the pound and $1.11 to the euro. Assuming exchange rates remain at current levels, we expect FS to be a headwind to adjust EPS by 2020 by approximately $0.10 per share, and we expect most of this impact in the first quarter. Adjusted diluted earnings per share is projected to be in line with a range of $11.80 to $12.10. This guidance includes the impact from expected headwind items to adjusted diluted earnings per share, such as the currency of $0.10. Finally, we expect free cash flow to be around $1 billion, which assumes the Stanford settlement will no longer be subject to further appeal, and we will make approximately a $120 million payment in 2020. In summary, we've seen good acceleration of revenue growth and positive operating leverage this quarter. I'm pleased with the results and the continued momentum of our businesses. There is still a lot of opportunity ahead of us, and we remain focused on executing on our strategy. So before I turn the call back to John, I do want to mention this year we'll be hosting Investor Day in Washington, D.C. on March 20th, and we look forward to seeing you there. So now I'll turn the call back over to you, John.

Okay. Thanks, Mike. And with that, I'd like to open the call for questions.

As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. And our first question comes from the line of Shlomo from Rosenbaum from Stiefel. Your line is now open.

Hi, good morning. Thank you very much for taking my questions. Hey, Mike, you guys are doing such a good job in improving the organic growth rate of the various businesses, but the free cash flow is just really a sore point. Could you just comment on what is exactly the issue and how should we be thinking about that? Where are you falling so far behind and how should we think about that for 2020? what changes are happening that are going to kind of impact the company a lot more than what we've seen over the last year?

Sure. Thanks for the question, Shlomo. I guess first is, obviously, to your point, we're working very hard on it. We're not pleased with the outcome in terms of where we landed for the current year, but here's what we're doing about it. One is that we have tied variable compensation to the top 500 people in the company, to the established goal that we have, and that has been implemented. Equally, that's true for the operating committee of the organization. Additionally, we are in the process of implementing a contract management and cash management system to manage contract terms more directly and consistently And we have established a contact-to-cash task force with individuals that are 100% dedicated to focus on improved and sustainable performance in the area. So we're very focused on it, I guess, is the bottom line.

Is there any, like, one specific thing? Is it a matter of just, like, communication with the customers? In other words, is there a few items that you can point to that are saying, hey, this is just where things are not getting done?

I would tell you we look at the entirety of the process, Shlomo, and from top to bottom. So, you know, every area we can see that there's areas for improvement. Obviously, we've made some progress, but we really look at it as a totality of the process itself and are not leaving any stones unturned in terms of going after it.

Okay, great. And then, hey, John, can you talk a little bit more about what's going on with Transact? You said that it had better revenue growth than expected. Can you just give us a little bit more commentary about what you expect from this company over the next year and, you know, the general, you know, trends that you're seeing in that business?

Yeah. So I think, look, Shlomo, when we bought Transact, we expected this to be, at least for the short to medium term, a relatively high growth business. And... We had a business case, I think, where it was going to grow in excess of 20%. That's the basis we did the deal on. And we thought there was even a possibility that revenue growth could get to 30% or even 35% in the first year. We actually surpassed all those. We grew by over 50%. It has been our Transact colleagues have just done a terrific job of gearing up and taking on all this additional revenue. Our Medicare Advantage grew by about 94%, so very good growth there in what's probably the most important part of that market. We expect that We still have this expectation that we're going to continue to see this be a high-growth business for the short to medium term. And, you know, even though we have a pretty tough comparable in a base we're building on, we're still expecting to see over 20% growth for the next several years.

Okay, great. I've got just one more housekeeping question. Mike, what is the currency impact in a dollar basis expected in 2020? You noted like 10 cents on the EPS, but if I were to look at it on revenue, is there a number you guys have embedded in the guidance?

It's very nominal. This is really on expenses. I mean, it's really small on revenue. Okay, great. Thank you. No problem.

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

Good morning. Thank you for taking my questions. First up on organic, you know, for the fourth quarter, you posted some pretty impressive results, especially in CRB. And I know you provided guidance for next year around organic. Is there anything unusual to what happened in the fourth quarter? Any specific items you can call out to help us get a sense of why it was so strong?

I think our folks really worked hard with clients and delivered in the fourth quarter. I did call out... We had some one-time projects in construction and natural resources, which were a big help to that. And, you know, that's actually the nature of construction and natural resources. Projects tend to be more episodic than in some of the others. So we had a couple of those. But, frankly, Greg, when you look at it, our growth was really pretty much across the board. It wasn't like we just had one area that – was way ahead of all the others. They all performed, you know, I think at the top of what we might have expected.

Yeah. Can I pivot to the guides on the operating margin for fiscal year 2020? You're guiding to an operating margin around 20.5, and I think that's just a 20 basis point improvement over 2019. Seems like there's better opportunities, especially with the growth you're posting. Can you walk us through why you're not anticipating better margin expansion?

Sure, Greg. So as I said in my prepared remarks, when you look at Transact for fiscal year 19, it really had about a 30 basis points improvement. And we had originally targeted being around, you know, 20%. And so when you normalize that, that gets you more like 20%. And then if you look at 20.5, and we've talked about 50 to 70 basis points in an annual basis in terms of what that improvement would look like, that's really what we're targeting on a normalized basis in terms of thinking about it. Got it. That makes sense.

And then can we pivot to BDAX transact? Because it looks like the business slowed down, maybe the legacy exchanges business or – Or can you give us some color there?

Yeah, I mean, I think, you know, BDA is one we've been talking about for a while now that with the tremendous success we've had penetrating that market over the years, there's still opportunities left. But the opportunities tend to be more a few mega opportunities that are episodic now. And so... We're not surprised, you know, the sales cycle on these large ones takes some time and we're continuing to work on them, so we'll see some years where we have a big jump up, but I don't think you're going to see the steady growth because you don't have the same pipeline of clients there. It's one of the reasons why we're really focused now on our technology and operations to make sure we maintain our market leadership as the go-to marketplace for the retiree medical.

Got it. Listen, I realize you're not going to make some announcement regarding management on this conference call, but it feels like when we get to the end of this year, you know, there's going to be some retirements. And can you give us an idea of when you expect the board and the company to announce when they're, you know, who the next lineup of executives are going to be running some of the businesses? Sure.

Sure. So, you know, look, you're right. We're not in a position to provide any real details right now. But let me tell you this. The Willis Towers Watson Board of Directors, of course, they're the ones who lead the succession process for the role of CEO. And the board, acting through the governance committee, is actively engaged in the whole succession planning process. And this isn't something that, you know, has happened this year or last year or even just the year before. This has been a multi-year thinking about what our talent is and how we bring them along and how we develop them. And so the board and the governance committee are have been regularly involved in that. They meet with me and our head of human resources on a regular basis. We've engaged a third party to make sure we have an outside look at the experience and attributes of our candidates. Our expectation is that we will name a new CEO in the second half of this year, so we're going to make sure we have enough time to allow an orderly transition. But other than that, that's pretty much all I can say at the moment. Great. Thanks for your answers, John.

Thank you. Our next question comes from the line of Elise Greenspan from Wells Fargo. Your line is now open. Pardon me, Elise Greenspan from Wells Fargo. Your line is now open. Please check your mute button.

We're not hearing anything. Could we maybe move on and come back to Elise in a little bit?

Thank you. Our next question comes from the line of Mark Marcon from Bayard. Your line is now open.

Good morning, and thanks for taking my questions. First of all, CRB within North America, really good performance. How sustainable is that? And what are the specific areas of strength? And to what extent is – how big could the cyber opportunity be?

Yeah, so let me just – and Mike may want to weigh in on this. I mean, look, the CRB in North America grew, I think, 11% in the fourth quarter. 11% is a real big number. But they had very good growth even throughout the year, not as high as 11%, but still very good growth throughout the year. I think when you talk to folks in the industry generally, the middle market in particular in North America is one that people are focused on, and it's one of our relative strengths. So we feel pretty good about that. I mean, I know when we talked about our projections for this year, There was some question of was our revenue growth projections more modest, and what we said was we prefer to budget on a more modest basis, but we thought we would make sure we grew as fast as the market or faster, and I think we've delivered on that, and that's pretty much the expectation I think we have going forward. I think cyber is something where there is – fantastic opportunity long run. I think that's going to require the market developing the right kind of policies and the right kind of, you know, solutions for clients. I don't think the market is there yet, but I think we're moving towards that. And as we do, it'll be a tremendous opportunity.

Great. And then... When we take a look at the overall guidance for 2020 in terms of the 4% to 5% organic growth, you mentioned Transat should continue to grow at least 20% plus year over year, so that'll drive that segment. For the other segments, are we taking the same sort of general stance in terms of generally assuming 4% to 5% growth for each of those, and then we'll lock it up as the year goes on, or How should we think about that?

Yeah, no, look, obviously we don't disclose, we don't get into all the details of how we do it. But, Mark, when we build our overall growth for the company, we do it segment by segment, almost line of business by line of business. So we go through and we do think, for example, I mean, and just as one clear thing, CRB is going to grow faster than retirement. We just pretty much know that. So we build the models that way, and then we just give a relative growth for the company.

Terrific. And then a question for Mike. Just on the free cash flow, can you disaggregate the impact of Transact relative to the DSOs and what the major source of improvement for next year is going to be in terms of whether it's Transact normalizing or the goal for DSOs?

Yeah, so, Mark, as it relates to Transact, I mean, when we looked at Transact and we originally did the diligence and understood Transact, you know, with the revenue growth rates it was having, we knew there would be some level of cash implications to it or a drag, if you will, but we viewed minor. But given the growth rates that we had, it turned a bit more significant because of the build of what we had to do for across the board in licensed agents, investments, et cetera, and make sure that we could satisfy what we saw as the market demand. And our team there, I think, did a wonderful job in making sure that they were well positioned to be able to take advantage of that growth. So I think that's the one issue as it relates to Transact. I think as it relates to our receivables, You know, we just thought build a bit more, and as I said earlier, you know, I was really looking at the – from contracting and how we set up the contracts to ultimately how we collect that cash. So contract to cash from a process standpoint, we're very focused on it. So we did see that receivables build, and so, you know, we're very focused on improving that going forward. So hopefully that gives you some further insight.

Yeah, and maybe I could just mention that, you know, Mark, when we think about this, we had Transact, and as Mike said, when we first did it, we had the deal cost for Transact, and we knew we would have some sort of impact just from financing the growth there. We thought, well, we're not going to bother updating our forecast for that. It turned out the growth was bigger than we expected, and it became a more sizable number. as a result of that. I think the tax payments were a surprise to us, the cash tax payments being higher than what we had projected. And that's one of the things that I think Mike has done a good job of putting in a much better forecasting system for this coming year, so that we won't have those kind of surprises. But a better forecasting system, which we needed, because clearly we missed some things. And then also, we... We were focused on improving our cash collection, but we were focused on improving it without having the right kind of incentives built in to our whole compensation system. And the fact that we're now building these right kind of incentives, and I think some very significant incentives into improving our cash collection, gives us a lot more confidence going into this year.

Thank you very much. I appreciate the long-term efficacy of your incentive planning. It's always worked. Thanks. Thanks.

Thank you. Our next question comes from the line of Sunit Kamas from Citi. Your line is now open.

Thanks. I just want to go back to the free cash flow for a second. I think last quarter you guys were pretty optimistic about the 1.1 to 1.2, and obviously, as you said, came in below that. and maybe you just answered it, but I just want to clarify, I mean, what was the surprise? Was it the cash taxes or was it transact? Obviously, something happened just towards the end of the year, and I just want to make sure I'm clear on what that was.

Yeah, I mean, I think we actually lowered our cash forecast last year from the 1.1 to 1.2 down to, what, 900 to 1.1, we had said it would be. So, we Excuse me? We stayed at 1.1 to 1.2. Okay. Well, we were concerned about where it would come, I guess, anyway. But, look, we had the – Transact was bigger than we thought. We had the cash taxes, and the cash taxes were about $130 million higher. And so we knew that was going to be weighing on us to begin with. And then we had the – The decline in the receivables, though, was something that we did not expect.

That was something that was a surprise to us. And I would only add to your comment, John. I mean, we always know the fourth quarter is an outsized quarter for us just in terms of timing. So when we sat there at the end of the third quarter, we knew exactly where we had stood. We knew what we had done in the prior year fourth quarter. these couple points that John just raised influenced it but frankly we were worried about working capital build and that's why we took the guidance down at the end of the third quarter and in fact that's what we saw actually really build in receivables And so that's really the, you know, one of the improvements that we're looking at is really driving that improvement in working capital. Obviously, the driver is coming back to free cash flow. You know, we've seen some reduction in CapEx. We obviously know operating income is a big driver of it, and obviously working capital, and that's the area that, from a process standpoint, again, go back to from contracting to make sure we're looking at our terms at the beginning of So the ultimate cash collection process is really where we're going. And as John referenced, I would not underestimate what this means going forward in terms of the incentives we put in place or are putting in place throughout the organization. Yeah.

Makes sense. And I guess if we look at 2020, your cash flow guidance would imply something like, I don't know, high teens growth in free cash flow. Are you still guiding to kind of longer term that growth rate to be around 15%?

Well, we're sort of laser focused on what we're going to do for next year right now. But I would say if you look at us, where we're growing, our guidance of a billion dollars is after we anticipate paying the Stanford settlement, too. So it's closer to a 30% to 35% growth in free cash flow.

Got it. And then just lastly on the capital management or capital return outlook for 2020, I'm assuming – You're going to continue to target double-digit growth in dividends, but any color on terms of what you're expecting for share repurchases?

Yeah, so, you know, as you know, given the acquisition of Transact, last year we, you know, really had nominal share repurchases, which were really just to manage so that we weren't dilutive as it relates to our employee benefit programs, and we would anticipate doing that again as we think about 2020. Additionally, when you look at our dividend payments, you know, there are, you know, $350 or $370 million kind of range that are there. And then equally, then you've got to look at and say we've committed to paying our debt down related to transact as I referenced. If you look at our current debt to EBITDA ratios, we're more in the, you know, 2.4 range, and we're looking to get closer to 2.0. So that would really be, you know, where we're looking to, you know, deploy capital, at least as we look at 2020.

Okay, thanks.

Thank you. Our next question comes from the line of Elise Greenspan from West Fargo. Your line is now open.

Thank you. Good morning. My first question, going back to the margin discussion, you know, I understand, you know, from one of the earlier questions, you pointed to kind of neutralizing for a transact, right, and then still being within that 50 to 70 percent target. But I guess I'm more thinking about, you know, the segments and just conceptually maybe you don't want a guide to a certain level. But, you know, I thought the goal was to, you know, look to improve CRB. I know there's, you know, a delta between where you guys are and where, you know, some of your peers are running in their brokerage business. So does, like, does this operating margin guide assume that there's going to be, you know, underlying margin improvement in CRB and, you know, perhaps also in IR and HCBs? and it's just offset by kind of the accounting impact of when that transact deal comes on?

Well, I mean, I think, so, Elise, just like we do the revenue growth, you know, in response to Mark Markin's question, I was saying we project our revenue growth line of business by line of business and then build that up to the company here, and the revenue growth is not the same across all of them. We project our margin, you know, line of business by line of business, and Certainly, we see more opportunities for margin improvement in CRB, where we're trailing some of our peers in terms of what we have, than, say, retirement, where we're ahead of our peers. So those are reflected in our projections. Yes.

Okay, great. And then as we think about free cash flow for 2020 – You know, I just kind of want to understand the seasonality. I'm not sure if you guys have a sense of the timing of the Stanford litigation, and I know typically cash flow is, you know, weak in the first quarter. And then also, you know, is there any seasonality to that guide? And then another part of that question would be, does the 2020 free cash flow guide imply that I'm pretty sure a transact is negative from a free cash flow perspective? Does it take that drag into account?

It does take the transact drag into account, so start with that. I think Stanford, it seems like it's at a place where we should be able to pay it, but we thought for a couple years now we would be able to pay it, and the court system drags things on longer than we had thought. We don't have a particular time when we're estimating it during the year, but we will alert you when we've made the payment. And then clearly there's a lot of seasonality. Our cash flow is highly skewed towards the second half of the year. We have tax payments that tend to come in the first quarter. We have our bonus payments that are in the first or second quarter. And so we have a lot of cash drain in the beginning of the year.

Okay, that's helpful. And my last question is on leverage. You guys have obviously been managing down your leverage since you closed the Transact acquisition. I just kind of want to get a sense of the interest expense expected with the guide. Are you going to pay down more of your leverage as we move through 2020? Yes.

So at least the game plan is to do that. And You know, we're looking to do that, you know, as part of our capital deployment. So you should continue to see. And as you've seen us do from the third quarter to the fourth quarter, in terms of that reduction, you're going to continue to see that over the first half of 2020 in terms of us really, you know, addressing that outstanding balance, which will obviously have the corollary effect to interest expense.

Okay. Thank you.

Thank you. Our next question comes from the line of Yaron Kinnar from Goldman Sachs. Your line is now open.

Good morning. A couple more on free cash flow. First, the Transact, considering that it is still in startup mode, still growing very rapidly, how long do you see that as being a cash drag for the business?

You know, I mean, we continue to see with those kinds of growth rates that are there, which we've projected out over the, you know, next four to five years, you know, we're continuing to see that. But we only look from a cash standpoint. We only see it about a year out in terms of – so the growth rates we see over the five years, we'll really see the cash side of that equation really starting to go only a year or so in terms of its drag on cash.

Okay. Okay. And then on the DSO side, and maybe tying back to the seasonality question earlier, I would think that a lot of the contracts get renewed at the very end of the year or the very beginning of the year. So I would think that a lot of the contract changes in language with regards to DSO would be in place by the first quarter of 2020. And the variable comp adjustment that you've made is also probably in place already. Shouldn't there be a little bit of an offset to the regular seasonality just by a lift from DSO in the first quarter?

Yeah, I mean, we've got a lot of factors, you know, in that first quarter. As you rightly said, I mean, we're attacking, you know, the contractual terms that we have to be in place. You know, we're aligning it from a variable compensation standpoint. But we also have the bonus payments. We have tax payments in those amounts that come in there. And candidly, you know, we're looking to make sure, you know, we meet what we're saying, you know, we've put out there in terms of expectations, Ron. So, you know, that's the game plan. I understand the logic where you're going, but, you know, we see the first half of the year being more of a use of cash and really see it, and if you look back historically in the company, you really see it build over the second half of the year with the fourth quarter being outsized in terms of cash coming in.

And I would just point out that the changes to the variable compensation plan, which are I mean, we've discussed with the board and the comp committee. They won't be formally put in place until the end of this month at our board meeting, but we've discussed making these changes with them, so we'll have those in there. But they weren't in last year, and so we'll see the impact from them in this year, but I would hesitate to ascribe any effect to them for last year.

Okay. Okay. And then my other question is just going to the HCB margins. I think if we adjust out the accounting catch-up, the ASC606, margins actually declined by about 50 basis points year-over-year in this order. So, A, is my math roughly right? And, B, if it is, what caused that decline considering that organic growth was actually up?

Yeah, I mean, your calculation, your math calculation seems maybe a little high just in terms of how you calculate it. We didn't have it quite that way. So it may be a flat to slight decline, really, is kind of how we've looked at it, Jaron. So that would be our thoughts in terms of the numbers, just to give you that feedback.

And what would have caused that decline?

Well, there is a bit of a portfolio shift. Retirement is... which is the most profitable is growing slower than some of the others.

Okay. Thank you.

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

Thank you. Good morning. Has there been any change in your write-off of receivables, any change in bad debt trends?

No, actually we've been going after that. So it hasn't been, if anything, we've been really making progress on collecting some of the older stuff that we've had in terms of dealing with it. So no, no change in policy, no accounting change, nothing that way.

Is it fair to think that the faster organic growth and the cash drag, it's just really two sides of the same coin? that you've got more receivables in the business because you're going the top line faster? Does that make sense?

Yeah, I mean, you look at it on a year-over-year basis. You know, I mean, you know, the beginning of December 2018 and, you know, how it rolled into January of 19 in comparison to December of 19 and how it rolls into 20, there's definitely some element of that. It's always... You know, difficult to absolutely quantify it, but I think to your point, yes, I think that there's some portion of that.

And then finally, IRR, you really had the acceleration this quarter, especially thinking relative to Q3. How much of that carries over into 2023?

Yeah, there's definitely, you know, multi-year arrangements that are included in there, and there is, you know, definitely an impact that's there. But the other thing I guess I'd just point out, our reinsurance business in particular was very strong, as well as our investment business, you know, as John commented in his opening comments there, I mean, overall. So, yes, there is some impact to that.

Yeah. But, I mean, I think, you know, if you think back to a year or two ago, when particularly insurance consulting and technology investments were slower growing. And we said we thought, you know, we like the future outlook for them. And I think we're seeing that come to fruition this year. So we like where they're positioned in 2019. We feel good about them going forward. I'm not sure they're going to grow as fast as they did in the fourth quarter of 2019. But we like our positioning, and we like our growth prospects there. And I think we feel the same way about reinsurance. Look, the whole reinsurance market was very positive and very strong in the fourth quarter. We think we grew as fast as anybody else or faster, and so we feel good about that. And, you know, we think we'll perform well against the market in the future. Thank you.

Thank you. Our next question comes from the line of Meyer Shields from KBW. Your line is now open. Great, thanks.

I was hoping to start with some maybe guidance on how much margin headwind you expect in 2020 from the inclusion of Transact, I guess, earlier quarters.

So we think that's probably about, what, 1% or something like that. Yeah. Yeah. Yeah. One percent. One percent.

So one percent margin, right?

Yeah. Yeah.

Yeah, just a reminder back. Remember, we acquired Transact in July of 2019, right? And you go back from that acquisition, you had five months of revenue and five months of expense. Obviously, we're going to have it for a full year as we look into 2020.

Right. Right. No, I understand. I'm thinking this is actually very good news because it implies better underlying margin expansion. Yeah. Can you give us a sense in terms of the non-recurring CRB items in the fourth quarter, just magnitude?

Yeah, we really don't disclose individual deals or those particular aspects to it.

The problem with doing that, too, is, When there's a couple of notable ones, we note them and say, oh, those are big ones, but there might be a lot of other smaller ones, and we just don't have a system for aggregating them.

No, that makes sense. All right. Thanks so much.

Thank you. Thank you. Our next question comes from the line of Mike Zarensky from Credit Suisse. Your line is now open.

Hey, good morning. I guess starting with... a question on free cash flow. Are pension cash contributions or maybe CapEx, are those slight year-over-year headwinds?

No, we don't see it that way. As we look at next year, we don't see that, Mike, no. We see them in a reasonable thing, yeah.

Okay, and... If I just think about the organic growth outlook, would you kind of categorize organic growth as kind of being more of a tailwind in recent quarters and kind of going into 2020? And also remind us, will transacts or growth eventually move into the calculation in the back half of 2020?

Yes, so starting with your last question first, yes, transact, I mean, as soon as we get to the same store sales, then, you know, we will include it in there from an organic growth standpoint. You know, in terms of your question about tailwinds on organic growth, yeah, certain of our business, you know, if you looked at it, we've seen some pricing. So if you look back to our marketplace realities report that we put out, the most recent one in November 2019, you definitely continue to see price in the marketplace continues to be a tailwind, but equally, obviously, we've got to do the right thing for our customers and clients in thinking through that. But we have seen, you know, some pricing tailwind come through that. And if you look at our organic growth rates, you know, we've been right at the market. We look at our peers in terms of what we've been growing at. So when we put out there for our organic growth rate for – The current year, we had 4% to 5%, and we've built our budgets, and we've been pretty consistent around it, looking at 4% in terms of how we're more skewed that way in terms of how we think about it, but we're being realistic and recognizing the tailwinds that we see out there, so that's why we went with 4% and 5%.

And the only other thing I'd add to that is that pricing is only one part of the equation for us in the revenue because As prices go up, people buy less of it, and so it's the net that is what we're trying to sell for.

And I guess just lastly to follow up to that, can you remind us what roughly of your, on the insurance side of the business, the breakdown of commission versus fee? Thanks.

Yeah, Mike, we really haven't disclosed that, so appreciate the question, but we really haven't given that information yet.

Thank you. Our next question comes from the line of Paul Newsome from Piper Sandler. Your line is now open.

Good morning. Just one question left. Does the cash flow change that we had in 19 and, I guess, thoughts here in 2020, does that have an impact on the speed at which you're going to be deleveraging, you know, over the course of this year?

Yes. I mean, you know, in the sense that we kind of know where the patterns have been. You know, I guess we said a couple of responding to a couple of earlier questions in that, you know, we obviously pay bonuses, cash bonuses. At the end of the first quarter, we have tax payments. You know, we have some real outflows of cash. But then we start to see it build through the rest of the year, and the intent is obviously to really deal with that term loan that's out there over the first half of the year by the end of the second quarter.

Okay. So the term loan should be done by the end of this, or hopefully by the end of the first year?

Okay.

Thank you very much.

It's a one-year term loan, so.

Yeah, got it. Appreciate it. Thank you very much.

No problem.

Thank you. Our next question comes from the line of Brian Meredith from UBS. Your line is now open.

Yeah, thanks. I just have one or two quick ones here left. One, just curious, if I look at the Transact margins and just the impact on margins overall, if I kind of look at it on a pro forma basis, is Transact, assuming you have a full year 2020 and it was full year 2019, is it accretive? to the BDA margins and overall company margins, or is it kind of dilutive or in line? I understand that the pressure just from a timing perspective, how it's going to hurt 2020.

Yeah, so when you look at a full year, it will be accretive, you know, overall. Again, just going back, when you look at, and we talked about this in terms of where the margins ended up in the fourth quarter, we're actually down for BDA overall, and that being down was, although BDA Transact has very good margins, and we're very pleased with their margins. You know, you only had five months of expenses and five months of revenue that was included in there, and so the margin was a bit higher, and we've normalized that as we think about just the year 20, but it's your first question. It is absolutely accretive and very excited about what that growth and what we're going to see.

But accretive but lower percentage margins. So the Transact margins, when we bring Transact in, it adds to the dollars, right? of earnings we have, but it's a lower percentage.

Oh, so it's a lower operating margin percentage. I got you.

Exactly, yes.

Got you. And I was wondering if there's any difference like seasonality of Transact versus the rest of your PDA business.

Not that different compared to our regular exchange business. Our regular exchange business is a little less seasonal than Transat, but not worlds apart.

Okay. That's helpful. The last one, I just want to follow Mike's question. I just want to confirm here that in your guidance, you have nothing assumed for kind of improving organic revenue growth in the IR business or the – brokerage business, CRB business for pricing in the commercial lines marketplace? Yeah, we do. We do have something in there. Yeah, yeah. And how much roughly? And is it consistent?

We don't do, that's what we're saying, we don't do things by line of business, just segments. And that's how we build it up, but that's not how we... Yeah, we build it up, and that was an answer I made to an earlier question. We do... build up our things differentially by segment in terms of revenue growth and in terms of margins. So that's clearly impacted.

Gotcha, gotcha. Very helpful. Thank you. I appreciate it.

Thank you. At this time, I'm showing no further questions. I would like to turn the call back over to John Haley for closing remarks.

Okay. Thanks, everyone, for joining us this morning, and I look forward to seeing all of you in March.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.