Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Mary Malone - Director of Investor Relations

John J. Haley - Chairman of the Board, President, Chief Executive Officer

Roger F. Millay - Chief Financial Officer, Vice President

Analysts

Andrew Fones - UBS

Tobey Sommer - SunTrust Robinson Humphrey

Paul Ginocchio - Deutsche Bank

Ashwin Shirvaikar - Citigroup

Mark Marcon - Robert W. Baird

Shlomo Rosenbaum - Stifel Nicolaus

Timothy McHugh - William Blair & Co.

Presentation

Watson Wyatt Worldwide Inc. (WW) F4Q09 (Qtr End 6/30/09) Earnings Call August 13, 2009 9:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Q4 2009 Watson Wyatt Worldwide Earnings Conference Call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference at which time you may participate. (Operator's Instructions) I would now like to turn the call over to 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 fourth quarter of fiscal year 2009. I am here today with John Haley, Watson Wyatt's President and Chief Executive Officer, and Roger Millay our Chief Financial Officer.

Please refer to our website for this morning's 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 39038885. The reply will also be available for the next three months on our website.

There are a few slides that accompany the financial section of our presentation and you may log onto 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 may be deemed to be forward-looking statements. You are cautioned that these statements may be affected by the important factors 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.

After our prepared remarks we will open the call to your questions. Now I will turn the call over to John Haley.

John J. Haley

Thanks, Mary. Good morning, everyone, and thank you for joining us. Today we will discuss Watson Wyatt's financial results for fiscal year 2009 with a focus on the fourth quarter, and we will provide guidance for Watson Wyatt for fiscal year 2010. We will also give an update on the status of our planned merger with Towers Perrin.

The slowdown in the global economy continued to affect us, but we've executed well in the current conditions. Our revenues for the fiscal year were $1.68 billion, down 5% from prior year, but up 3% on a constant currency basis.

For the year, our reported diluted earnings per share were $3.42. Our diluted earnings per share include $0.12 of severance and $0.35 of foreign currency translation losses. On a constant currency basis, adjusted EPS that excludes severance is $3.89.

For the quarter, our reported revenues were $397 million, a decline of 13% from prior year and 4% on a constant currency basis. Our performance varied by segment. On a constant currency basis, Benefits was flat, Technology and Administration Solutions increased 2%, Human Capital Group declined 27%, Insurance and Financial Services declined 6%, and Investment Consulting increased 14%.

These results reflect the stability of the Benefits and Technology and Administration Solutions segments, and the variability of our more project-driven segments, Human Capital Group and Insurance and Financial Services. The recovery continues in Investment Consulting as it is experiencing good growth.

For the quarter, diluted earnings per share were $0.73, a $0.22 decline from the prior period's $0.95 per share. The strengthening of the US dollar resulted in a $0.10 reduction to our EPS and severance reduced EPS by $0.07. Therefore, if we exclude the effects of changes in forward exchange rates and severance, our EPS is $0.90.

Our operating margin increased to 12.8% this quarter as we were very focused on containing costs. Business is performing as expected in areas where we have a well-established market position, mature relationships, and recurring business. As anticipated, demand was down in the parts of our business that are more project driven.

The uncertain economic conditions are affecting benefit programs and workforce demographics at many companies. We continue to assist our clients with practical solutions for reducing costs and managing risks.

Now we'll review the performance of our segments. For the year, Benefits Group revenues were $960 million, a decrease of 3% from prior year, but up 4% on a constant currency basis. For the quarter, Benefit Group revenues were $234 million a decrease of 8% from prior year and flat on a constant currency basis.

The trends from last quarter continued and we had modest growth in our retirement services in the US and the UK. The growth was offset by modest declines in demand for our retirement services in continental Europe and Asia Pacific, and for healthcare consulting.

While it is difficult to predict future results in these uncertain times, we expect that our core retirement services will continue to do well in the US and the UK. We have modest expectations for healthcare consulting in countries where we have a smaller footprint. In the US, employers are interested in ways to improve the operation of the retirement programs and better manage risk.

The retirement plan decisions employers make over the next few years will be critical to the viability of the country's voluntary retirement system and will have an economic impact on employers, regardless of who bears the direct financial risk in the benefit design.

We will continue to provide practical and innovative solutions to our clients.

In Europe, European Pensions Magazine recently named Watson Wyatt their consultancy of the year for the second year in a row. The judges base their decision on our standing service to pension fund clients, dedication to the delivery of pension plan consulting, superior understanding of the market's needs, and commitment to excellence. This is a tribute to our very talented team.

We continue to have a solid base of revenues that is relatively predictable within our retirement practice.

Now let's move onto the Technology and Administration Solutions Group. For the year, revenues were $188 million, a 3% increase over prior year and 11% on a constant currency basis. For the quarter, revenues were $45 million, down 7% from prior year, but up 2% on a constant currency basis. On a pre-deferral basis, constant currency revenue growth was 1%. In this segment, our constant currency growth in the UK was offset in part by a modest decline in the US. In the UK, our growth was due primarily to new clients that had gone live within the past 12 months. The decline in the US was due to less change order work at existing clients than is immediately recognizable as revenues, and to an increase in the amount of revenue deferred.

Last year we mentioned that proposal activity had increased. We are pleased to report that we have had some good wins in both the UK and the US. The wins in the UK will contribute to revenue growth in FY10 and the wins in the US will initially result in deferred revenues as we complete the system implementation work. Roger will discuss FY10 guidance in more detail.

We continue to have excellent client retention rates and a stable platform of revenues globally in this segment. The administration services that we provide are a compelling proposition for companies looking to control costs, and we expect to gain market share.

Next let me turn to the Human Capital Group. For the year, revenues were $173 million, a 12% decrease from prior year and an 8% decrease on a constant currency basis.

For the quarter, revenues were $35 million, down 31% from prior year and down 27% on a constant currency basis. The trends for March continued into the fourth quarter. Demand was soft in all regions. Compensation, organizational effectiveness, and data services all declined when compared to prior year fourth quarter.

Our colleagues in the Human Capital Group are now beginning to see an increase in proposal activity and we're hopeful that we're seeing the bottoming of the cycle in this practice. As the business landscape continues to change, many companies will be operating with a smaller workforce. We are well positioned to assist companies with flexible targeted plans designed to attract and retain critical talent in this new reality.

Now I'll discuss the Insurance and Financial Services Group. For the year, revenues were $117 million, a decrease of 1% over prior year, but up 13% on a constant currency basis. For the quarter revenues were $23 million, down 21% from prior year and down 6% on a constant currency basis. This was a particularly soft quarter in Europe. We had less project activity this quarter than in the past two quarters. We have also seen some falloff in demand as companies defer work or take projects in-house. It is difficult to predict the timing and magnitude of projects, but there's still activity in the sector. We think there may be some transaction work as companies continue to evaluate capital adequacy.

Lastly, Investment Consulting reported revenues of $161 million for the year, a decrease of 5% from prior year, but an increase of 10% on a constant currency basis. For the quarter, revenues were $42 million, a decrease of 3% from prior year, but an increase of 14% on a constant currency basis.

We are pleased with our growth in this segment. We've seen an increase in our implemented consulting activities, due in part to several expanded client relationships. We're also seeing an increase in strategy products. Many funds are evaluating their investment strategy and risk tolerance; they are concluding that continued diversification of portfolios is the right way to control risks going forward. We continue to be optimistic about the longer-term growth prospects for this segment.

Wrapping up, I'd like to thank your associates for their continued commitment to quality client service. We've executed well in these uncertain economic times and we continue to focus on sound business fundamentals and disciplined cost control. We will continue to stay close to clients to help them respond effectively to these uncertain times.

Now I'll turn the call over to Roger.

Roger F. Millay

Thanks, John, and good morning to everyone. We continued to operate effectively in the last part of the year. In addition to the Towers-Watson announcement, we spent a good deal of time in the quarter assessing our business momentum relative to the cost-control actions we've taken and validating our view of the new fiscal year.

While we did suffer a constant currency revenue decline this quarter, it fell into the rage of our expectations and we're pleased that our earnings came in slightly better than our expectation, despite a higher than forecasted income-tax rate.

For the quarter, our operating income margin was 12.8%, an increase from 11.3% in the prior year quarter. Excluding severance costs, our operating margin was 14.0% for the fourth quarter.

As John noted, the performance of our segments vary and we've had profitability pressure in our more project-driven areas. We've had some layoffs in our under-performing areas, and we'll continue to monitor our costs. Some of our segments will perform better than others and we may have some variability in our quarterly results, but we're focused on preserving our margins.

The Benefits Group had a 30% margin for the year, an increase from 29% last year. For the quarter, the Benefits Group had a 30% margin, consistent with the fourth quarter of last year. These margins are consistent with our expectations for benefits.

Technology and Administration Solutions had a 24% margin for the year, a decline from 26% last year. For the quarter, Technology and Administration Solutions had a 19% margin, a decline from 26% in the fourth quarter of last year. Excluding severance, the margin was 20%.

Margin declined significantly in North America due mainly to a decline in change order work. Human Capital Group had a 7% margin for the year, a significant decline from 18% last year. This year includes approximately $3.3 million of severance. For the quarter, the Human Capital Group had a loss of $5 million. The loss includes $2.4 million of severance. We are closely monitoring our loss generating offices and are downsizing under-performing locations.

As we said last quarter, we're focused on reshaping the practice to make it more profitable for the longer term.

Insurance and Financial Services had a 15% margin for the year, a significant increase from last year. All regions performed better this fiscal year. For the quarter, Insurance and Financial Services lost $2 million. This loss includes about $500,000 of severance. The loss this quarter is due to a decrease in project work.

Investment Consulting had a 28% margin for the year, a decrease from 35% last year. For the quarter, Investment Consulting had a 33% margin, a decrease from 35$ in the fourth quarter of last year. We think the long-term sustainable margin for this segment is around 30%.

The segment margins that we've just reviewed are before consolidation of discretionary compensation and other unallocated corporate costs such as amortization of intangibles resulting from our acquisitions. Net income for the year was $146 million, down from $155 million last year. Net income for the quarter was $31 million, a decrease from $42 million last year.

Fully diluted earnings per share for the quarter were $0.73 as compared to $0.95 in the prior year fourth quarter. Diluted earnings per share for the quarter include $0.10 of foreign currency translation losses and $0.07 of severance.

Moving to the balance sheet, we ended the fiscal year with $210 million of cash and no debt. We generated $228 million in cash flows from operating activities this fiscal year and had a strong fourth quarter, generating $144 million of cash from operations. Our liquidity position is also very strong.

Now let's review our guidance for fiscal 2010. I should note that all of this guidance contemplates Watson Wyatt as an independent company without the merger with Towers Perrin for the full fiscal year 2010. The slides posted on our website may be helpful for following along in this section.

On slide three we've created a baseline fiscal 2009 that excludes severance from our quarterly reported results. Internally this is how we're evaluating our performance. Our fiscal 2010 reported results will include some severance, as we did not complete all of the actions identified in fiscal 2009. Our fiscal 2010 results will also be impacted by merger costs and by changes in foreign currency exchange rates.

Our forecast for 2010 generally assumes that market conditions remain as is for the next several quarters. On a constant currency basis we're targeting both revenues and adjusted diluted earnings per share to be roughly flat with fiscal 2009 levels. Our constant currency revenues are expected to be in the range of $1.61-$1.68 billion. Our constant currency adjusted diluted earnings per share are expected to be in the range of $3.45-$3.55. Adjusted diluted earnings per share excludes severance and other nonrecurring merger costs.

For fiscal 2010, our forward-looking guidance assumes an average exchange rate of 1.65 US dollars to the British pound and an average exchange rate of 1.40 US dollars to the euro. These foreign currency exchange rate assumptions result in foreign currency translation losses in the first quarter of fiscal 2010 and translation gains for the remainder of the fiscal year.

On a GAAP basis, we expect revenues in fiscal 2010 to be in the range of $1.63-$1.70 billion. We expected adjusted diluted earnings per share to be in the range of $3.50-$3.60. This guidance excludes $4 million of severance that we expect to incur in fiscal 2010, more than half of which will be in the first quarter. It also excludes merger costs. We expect $8-$10 million of merger costs will be expensed in the first quarter of fiscal 2010 due to the adoption of the new accounting standard for business combinations that requires acquisition costs to be expensed. We will have additional merger costs in the second quarter of fiscal 2020.

This guidance assumes an income tax rate of 34% for adjusted EPS in fiscal 2010. The actual rate may be higher due to the non-deductibility of certain merger costs. We also assume no significant changes in diluted shares outstanding during the year.

Our capital expenditures plan for fiscal 2010 was put together before we announced the pending merger and included approximately $50 million in CapEx for the year, split roughly 50-50 between purchases and capitalized software costs. We expect to have strong cash flows in fiscal 2010. Due to the timing of cash receipts and payments, we typically borrow from our credit facility in the first quarter and then repay the debt during the fiscal year. In fiscal 2010 we may borrow up to $10 million or so in the first quarter, and we would expect to have that repaid by the end of the second quarter.

Now I'll walk through the guidance for each of the segments. Please note that the slides on our website show both reported and constant currency revenue guidance. Since constant currency is the better measure of underlying business performance, I'll focus my remarks on the constant currency guidance.

Let's start with Benefits. For fiscal 2010 we've changed the reporting of the administration business in Germany, which has been in the Benefits practice since the Heissmann acquisition.

To the Technology and Administration Solutions practice, we believe this change will benefit operating effectiveness and growth. As a result, in our segment reporting we're reclassifying our Germany administration business from Benefits to Technology and Administration Solutions. On slide four you can see the fiscal 2009 Benefits and Technology and Administration Solutions results, after the reclassification. On a constant currency basis and after the reclass, we expect flat to very modest revenue growth in the Benefits practice and have a range of 0%-2% growth. This guidance reflects the relatively stable and predictable revenues in this segment, and the slower growth that comes further along in an economic downturn. We expect margin will be in the high 20% range.

In the Technology and Administration Solutions Group, after the reclassification of the Germany administration business, we expect constant currency growth in the range of 1%-3%. This growth reflects the new clients in Europe for which we started administration work during fiscal 2009 and for which we will have a full year of revenues in fiscal 2010. We expect margin will be in the mid-20% range.

In the Human Capital Group we're expecting challenging conditions to continue. Our constant currency revenue projection is for a 16%-26% decline in revenue. The wide range reflects the project nature of the segment. We expect to move the business back to breakeven during the fiscal year, but may start out with a loss.

In Insurance and Financial Services we expect a decline of 5%-11% in constant currency revenues. This segment also has a significant project component. In fiscal 2009 we had a few large projects that we do not expect to recur. We're expecting margin in the low double digits. Lastly, we're expecting constant currency revenue growth in Investment Consulting of 7%-10% in fiscal 2010. Client activity has begun to return to more normal levels as market conditions have improved. We expect margin will be in the high-20% range.

In summary, for fiscal 2010 we're projecting roughly flat constant currency revenues and adjusted diluted earnings per share. We also expect to preserve our baseline operating margin before consideration of severance and merger costs.

Now I'll provide a brief overview of our first fiscal quarter of 2010. We expect revenues to be in the range of $385-$400 million, which on a constant currency basis would be in the range of $405-$420 million, essentially flat to down 3%. In the first quarter of fiscal 2009 our operating margin, excluding severance, was 12%. We expect to have a similar operating margin, excluding severance and merger costs, in the first quarter of 2010. We expect adjusted diluted earnings per share to be within the range of $0.68-$0.73. Adjusted diluted earnings per share excludes severance and transaction costs.

This guidance was for Watson Wyatt's current business and does not include the effects of a merger with Towers Perrin. We announced our intent to merge with Towers Perrin in June, and anticipate the transaction will close during our fiscal 2010. As we approach the closing date, financial information and expectations regarding the combined Towers Watson will gradually become more available, beginning with the initial S4 filing later this month.

We're committed to running disciplined businesses before and after the pending merger. Now John will give you an update on the status of the merger.

John J. Haley

Thanks, Roger. Since we announced the merger, Mark Mactas and I have been holding employee meeting with associates at both Watson Wyatt and Towers Perrin. We're gratified by the reception we're getting and are delighted that associates at organizations are embracing the future prospects of the new organization.

I'm also pleased to report that we are working through all of the pre-closing requirements and we're planning for integration. Last week we received clearance from the US antitrust authorities. The European Union antitrust authorities are still reviewing the transaction. By the end of this month we expect to file the S4. As of now, we're still on track for a shareholder vote in the fourth quarter of calendar year 2009.

We're really excited about the merger and the opportunity for Towers Watson to address merging financial and people management issues with world-class expertise. Now we'll take your questions.

Question-and-Answer Session

Operator

(Operator's Instructions) Your first question comes from the line of Andrew Fones with UBS. Please proceed with your question.

Andrew Fones - UBS

Yes. Thanks, John. I was wondering if you could just kind of give us a sense of how Towers Perrin's results looked for the third quarter and whether you're kind of satisfied with the performance of their business in this touch economy, post the initial announcement? Thanks.

Roger F. Millay

I think in general the themes are pretty similar to what we said, I don't know, five weeks or so ago, that there were a lot of parallels in between our practices and Towers' business, and that general trends are pretty similar, so I think we're still in that same pattern.

John J. Haley

I mean, I guess just to elaborate on that, I mean, obviously we haven't disclosed any of the real detailed financial information on Towers Perrin or for our projection for Towers Watson and that won't come until after the S4. But Towers Perrin is in similar businesses to us, although the mix of business that they have is different, but they're affected by the same overall economic factors. So the results on them may be slightly different simply due to mix, but it's probably not due to overall economic factors acting differently on either one of us.

Operator

Your next question comes from the line of Tobey Sommer with SunTrust Robinson Humphrey. Please proceed with your question.

Tobey Sommer - SunTrust Robinson Humphrey

Thank you. I was wondering if I could get a little more color about some assumptions embedded into your guidance. I am curious what — and I may have missed this, I apologize as you did give an awful lot of detail. I am curious as to what the cash flow may be implied in the earnings range, and then also what sort of assumption you're using for the bonus number in fiscal 2010. Thanks.

John J. Haley

Yeah. In terms of cash flow we didn't give specific cash flow numbers for the year. I think our discussion was a little more general. The main reason for that is that the full year, from an overall merger cost point of view, is obviously unpredictable at this point, but we continue to expect, as I said, a strong cash flow year, but we didn't give a specific number.

Tobey Sommer - SunTrust Robinson Humphrey

So ex the acquisition related variability, something consistent with historic norms?

John J. Haley

Yeah. I would say something in that same range.

Tobey Sommer - SunTrust Robinson Humphrey

Okay. And then is there anything you can share with us about the implied expectation for the bonus in the context of guidance?

Roger F. Millay

I'm sorry, I missed that question.

John J. Haley

He's asked if there was anything we could share about the bonus in the expectation of —

Roger F. Millay

Yeah. I mean, I would say just in general — I don't know, John, if you want to address that as well, but in general, the way we modeled the year, the focus, as we said in the remarks, was to hold operating margin and EPS roughly flat. So through the year the bonus level will be impacted by what the results of the company are, the bonus level may be a little bit lower depending on performance, but our focus will be on retaining margins. And then of course the other complication we're going to have through the year is that we're likely to have about a six-month stub year and we'll be attentive to that as well. So that's why we're focused on the margin and the EPS level.

Tobey Sommer - SunTrust Robinson Humphrey

Okay. Thank you very much.

Operator

Your next question comes from the line of Paul Ginocchio with Deutsche Bank. Please proceed with your question.

Paul Ginocchio - Deutsche Bank

Thanks. Just go back to Towers in the fourth quarter, can you give us any more specificity on the revenue? I think you were down 4% on a constant currency basis in the fourth quarter and you're looking for sort of zero to minus 4 in the next year. Can you give us just a little bit more clarity on what Towers Perrin was looking like? Was it worse or better than you in the fourth quarter and is their revenue range about similar? And the same thing on the margin — I think this is something that investors are quite focused on. Thanks.

Roger F. Millay

Yeah. We don't have any specific numbers for Towers that are comparable to ours at this point, so again, as I said, I think the first preview on actual numbers with Towers will be in the S4 later this month.

Paul Ginocchio - Deutsche Bank

Okay. So how do you know what the expected dilution that you talked about in the last call is going to be if you don't have those numbers?

Roger F. Millay

Well, I mean, certainly we had numbers when we came up with the accretion dilution numbers and we used projections to do that, and that's what we discussed. That's the basis for the discussion in June, and as we said at that time, the next step in the disclosure of the numbers that we expect for the combined company and the next step in specifics on Towers Perrin numbers will be in the S4. I think we're at the same place in what we said before.

Paul Ginocchio - Deutsche Bank

Okay.

Operator

Your next question comes from the line of Ashwin Shirvaikar with Citigroup. Please proceed with your question.

Ashwin Shirvaikar - Citigroup

Hi, John. Hi, Roger. Coming out of the last downturn, the whole Benefits unit took a couple of years to start doing well and eventually sort of needed the Pension Act to breakout, if you will. What do you expect this time around, given that in August the composition of the unit is different both geographically and in terms of just having the healthcare being a bigger component of it?

John J. Haley

Yeah. I guess I'm not necessarily sure that it was the Pension Act that I would have necessarily said was the difference there in the last time in changing it. But I do think that after the slowdown — what we tend to notice is when there's an economic slowdown, Benefits, particularly retirement consulting, isn't really hit that much. In fact, some of the work that they might lose in project work gets substituted for with other work, and I think we saw that this last year when our Benefits was up 4% on a constant currency basis.

What tends to happen to Benefits is it's a little bit slower sort of in the calm after the storm, and that's why we're projecting a 2% constant growth for Benefits for FY10. So we're looking at what happened in the past and saying we expect the scene to be a little bit slower. It's tough to speculate as to how long that 2% would be correct for, but it would be a little bit slower and then it'll start growing at the more normal rates.

Overall though, Benefits is really a pretty stable business. It might grow at four or five or might only grow at one or two, but it doesn't tend to be subject to the same big swing.

Now the 2% growth rate that we gave you for next year is composed of a number of factors. One is, we think the overall retirement business will continue to do pretty well in the US and the UK, which are our bigger markets, and maybe not quite as well in some of the smaller markets. That's certainly what we've seen this year and it's what we would expect for next year.

We have reasonably modest expectations, I think, for healthcare. I feel pretty good about the assumptions we've made for healthcare. I think if anything there's some upside there rather than some downside.

Ashwin Shirvaikar - Citigroup

Speaking of the smaller countries where you don't expect results to be that good, at the time or slightly before the Towers' announcement, you guys were going through sort of a rationalization process, if you will, to try to see if you should stay in all these countries or withdraw or what you should do. Is that process now on hold or are you still continuing along that path independently?

John J. Haley

Well, I think, Ashwin, we're always looking at the overall geographic location and where we should be and where we can most add value, and we approach that both from the viewpoint of are there places we need to get bigger and we need to make sure we have very strong operations in? It was one of the reasons for the Bronze deal back in 2007 as well as the Heissmann deal. We also looked at — you may remember several years ago we decided to exit the business in New Zealand because we didn't think it fit our overall geographic footprint.

So we continue to look at those things and to assess them, but when we make those decisions, we try to do it in the context of what the long-term strategy is and not of what's happening in a particular year.

Ashwin Shirvaikar - Citigroup

Right. If I can squeeze one more in on the expense side, as I look at the margin performance this quarter, obviously a good performance there, but the contributors to that good performance seem to be some combination of low variable comp and sharp decline in the use of subcontractors, neither of which in the long term seems particularly sustainable. So can you comment on that, what is going on, first of all, and have you changed your stance with regards to your prior statement that maybe fiscal 2008 margins were at an unsustainable level and maybe fiscal 2007 was a better level?

John J. Haley

Yeah. Well, I'll let Roger talk about the contractors. Let me mention about the variable comp. Our variable comp does go up or down as the business performs better or worse. For the overall fiscal 2009, we had quite a good variable comp bonus pool, which we just announced to our associates this year. As we look into FY10 we expect the results to be a little more challenging in FY10, and if we did, our variable comp bonus pool wouldn't be quite as good as it was this year and so we've taken that into account in the projections we've given you. Roger, do you want to address the subcontractors?

Roger F. Millay

Yeah. And maybe I'll comment more broadly on the margin question. First, you also have to consider that there's the $0.07 of severance in there, so I think you have got the bonus effect, but a good portion of that is offset by severance, and margin still would have been up this last year on that net basis.

But second, broadly, we're focused on cost control in all discretionary areas, and we're confident in our ability to manage and visibility into the expense load to manage ourselves to flat margins, and we've been very focused on that over the past several months.

I think in general, about contractors, I mean, there are a couple things in there I know of specifically. One is, some of that's related to project consultancy support that we've gotten that was one of the actions that we took as we pulled back on cost. The other area contributing to that is just related to client expense pass throughs that are also down along with other areas this quarter.

But again, I want to emphasize the broader theme, that we are managing our expenses and you'll see reductions across the board, and we are seeing reductions across the board.

Ashwin Shirvaikar - Citigroup

Okay. Thank you.

Operator

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

Mark Marcon - Robert W. Baird

Good morning. I was wondering if you could talk a little bit, and I know we have the S4 coming out later on this month, but is there anything in terms of your discussions that you've seen thus far with Towers that would lead you to believe that the dilution expense or the dilutive aspects of the merger may be different than what you previously announced? Or is there anything that you've seen thus far that would lead you to change anything that you've said back in June?

John J. Haley

Well, I think we don't have any new financial information, as Roger said, from what we had in June to today. I mean we've been focused on getting our own financial results together to be able to do this call. Towers is working on theirs now, but we haven't see anything so we really don't have anything new to tell you on that.

Mark Marcon - Robert W. Baird

Okay. But so far you haven't seen anything that seems materially different than what you were thinking previously?

John J. Haley

No. And I think the reason I would say this is because we haven't really seen anything different. We just don't have any new financial information at all.

Mark Marcon - Robert W. Baird

Okay. And then can you talk a little bit about the reception? I know you've gone out and you've done meetings together; what's the overall tone in terms of how people are going to get together, the herbivores and the carnivores, et cetera?

John J. Haley

(Laughs) I think it's been terrific. Mark and I went out over a period of — we did the announcement the first week. I guess that was June 29th, and then it was up to the beginning of July and it was the week after that we started out and we did three different — for three weeks we went out and visited a number of our locations.

And the first week or so I think people were still somewhat surprised and a little bit in shock at the announcement, but everybody got the strategic rationale, and as people started having a chance to think about it and process it, there's a great deal of enthusiasm and excitement about the possibilities.

And I think Mark and I started out with our own enthusiasm and excitement about it, but we sort of got energized by the reception we were getting from our associates, too, and I think it's everything we could have asked for.

Mark Marcon - Robert W. Baird

Great. And it sounds like the leadership teams for the various practices will be announced fairly shortly?

John J. Haley

Well, we've announced, for the most part, all the direct reports of Mark and myself. We have a group working diligently on a plan for how we're going to do leadership selection and we would like to make those decisions as soon as possible, but we also want to make sure we take the time to make the right decisions, and we're constantly working on that right now. So I can't really give you a timetable for that, but our preference is to do it sooner, but also to make sure we get things right.

Mark Marcon - Robert W. Baird

Okay. And can you talk a little bit about PCIC and how you expect that to be impacted by the deal?

Roger F. Millay

Well, John may have some more depth, but from an accounting point of view, again, PCIC will be consolidated in the acquisition and as a result of that consolidation we need to look at the reserving for E&O across the board for the new company and come up with the methodology for the new company. And part of the S4 discussion will be around what we think that will look like. So we're working on that now and shortly you'll have more color on that.

Mark Marcon - Robert W. Baird

Can you just mention — we're basically going from four to three now, right, in terms of partners? Or is it three to two?

John J. Haley

It is three to two.

Mark Marcon - Robert W. Baird

So when we do that, is the other player still committed?

Roger F. Millay

So I think in terms of the structure going forward, that's something that the teams are still working on, the actual business structure.

Mark Marcon - Robert W. Baird

Okay, all right. And can you — the last question for now, can you just talk a little bit about the cash flows for this coming quarter? What do you expect to pay out in terms of the severance charges as well as the bonuses that you've accrued for fiscal '09?

Roger F. Millay

Yeah. The severance charge is probably about $2.5 million or so — it's a good portion of the $4 million that I mentioned for the year, and the bonus payout is going to be between $165-$170 million.

Mark Marcon - Robert W. Baird

Okay, great. I'm going to jump off and jump back on. Thank you.

Operator

Your next question comes from the line of Shlomo Rosenbaum with Stifel Nicolaus. Please proceed with your question.

Shlomo Rosenbaum - Stifel Nicolaus

Hi, guys. Thank you very much for taking my questions. I wanted to follow along the line of questioning that Ashwin was asking on the discretionary bonus compensation. If I just go through the individual business units in the quarter, it seems like you guys really flexed the discretionary bonus comp, and that's one of the strengths in the model where you're able to really move that comp up and down. Could you give us the absolute number of bonus comp in the quarter?

John J. Haley

I think you have that in the press release, and it's $23 million.

Shlomo Rosenbaum - Stifel Nicolaus

Okay. If it was, I didn't see it. I'm sorry. And then just along that line of reasoning, given what's going on with the merger — and I know there's competitor interest in seeing that there's going to be some dislocation amongst the employees because of this merger — do you still see the ability to flex the bonus compensation over the next year in the same way that you've been able to in the past, or do you really think that you're going to have to be more mindful of retention?

John J. Haley

Well actually, we have essentially a pay-for-performance model where our associates can expect to do a lot better when we do well and they expect to do less well when the business does less well, and we've followed that in the past. That's been something we followed consistently up and down.

I think when we look at the bonuses we're paying out for FY 2009, I would say they are very competitive in the marketplace, and given the performance that we expect to see over the next year or so, we expect again to be very competitive in the marketplace.

The theory of this is we need to make sure we have a fair return to our investors, but we also need to make sure we reward our people, because if we don't reward our people right then we don't have a business.

Shlomo Rosenbaum - Stifel Nicolaus

I agree. I want to take a different track just in terms of the Human Capital Group, I want to understand your comments a little bit better. Are you saying that you're noticing a little bit of an uptake in demand towards the end of the quarter? Is that right way to look at it?

John J. Haley

Yes. We are seeing some interest in potential projects. Now, I wouldn't want to read too much into that, but it is a bit of a — what do they call those, green shoots or something? I think it's a bit of a hopeful sign.

As Roger and I have said over the last couple of quarters, our commitment is to try, in calendar 2010, to get the Human Capital business to at least break even, and we're going to do that and that's our focus. Whether that occurs in this next quarter or whether it's delayed until the quarter after that we'll have to see, but we're committed on getting it to break even.

Shlomo Rosenbaum - Stifel Nicolaus

Which areas of Human Capital were you seeing the sign of the light?

John J. Haley

Well, compensation is the biggest part of our Human Capital business. It's about two-thirds of it, so that's where we'd obviously see the most interest.

Shlomo Rosenbaum - Stifel Nicolaus

Okay. And then just going back to the PCIC question, is the PCIC affiliate project the affiliate income that we're seeing below the line?

Roger F. Millay

Yeah. That's most of it.

Shlomo Rosenbaum - Stifel Nicolaus

Okay. So how should we think about that going forward? Normally we've been sort of led to believe to expect just nothing in that line because there's so much variability, but there's got to be some profitability there. Do you have any thoughts about that going forward?

Roger F. Millay

Yeah. I think my reaction to that is I'd hesitate at this point to give expectations because again, we've got to decide on what the structure going forward — and I presume you're referring to after the deal, right, and what happened?

Shlomo Rosenbaum - Stifel Nicolaus

Yeah, when you consolidated.

Roger F. Millay

Right. We have to decide what the structure is going to be because obviously that's going to have an impact on what the results are and the conclusion on the E&O reserving policy; again, from an E&O point of view, you've really got to look through now what's happening in the two companies and come up with what it's going to look like on a consolidated basis, and that's one of the things we're looking at in the S4. So again, you'll see more when we file.

Shlomo Rosenbaum - Stifel Nicolaus

And then I'm going to squeeze in one last one. Just before the merger, are you guys in your EPS guidance anticipating profitability there?

John J. Haley

I'm sorry, profitability where?

Shlomo Rosenbaum - Stifel Nicolaus

From that affiliate income.

Roger F. Millay

I think modest profitability — $1-$2 million. There are some other things in there like our venture in Dubai and South Africa, but again, the big piece of this year was PCIC.

Shlomo Rosenbaum - Stifel Nicolaus

So you think $1-$2 million a quarter?

Roger F. Millay

For the year.

Shlomo Rosenbaum - Stifel Nicolaus

Oh, for the year. Okay. Thanks a lot.

Operator

Your next question comes from the line of Timothy McHugh with William Blair & Co. Please proceed with your question.

Timothy McHugh - William Blair & Co.

Yes. I wanted to ask about potential positives and negatives from regulatory changes that are being discussed. Obviously, the healthcare reform and the potential opportunities it could create for your healthcare in the (inaudible) segment. And then I understand there's a bill in the House that includes some restrictions on compensation consultants and the independents. Can you talk at all, if you've looked at that, if that would or would not have any impact on your business?

John J. Haley

Yeah. So I think on the healthcare we'll have to see what happens. Any changes, if there's healthcare legislation that continues to use the employer-based system in the country and that introduces some changes to that, that's probably positive for us because we consult with the employers on that and basically as things change, as legislation or regulation changes things, then they will turn to us for advice.

I think how much that might change things or how much of a boost that could give is hard to say, and it probably depends on exactly what form the legislation takes. I think the only kind of legislation that would be really bad for us if either you went to a single-payer national health insurance, which would basically take away a lot of our consulting, but that's not something that we see coming down.

Now on the exec comp legislation, there I guess both the House and the Senate have drafted similar legislation there. And it requires a nonbinding shareholder vote on executive comp and independent compensation committee members, independent compensation consultants, and some enhanced disclosure.

Basically, we think that it's probably a little early there too to say that will happen. We think that the market opportunity for compensation consultants in general will probably increase from the passage of the legislation. That is a question for us of how much share do we get. I think one of the things that — a sensible approach to sort of compensation consultant independence, I think overall would probably be helpful for us, and we'd like to see the legislation or the regulators address that.

Timothy McHugh - William Blair & Co.

Okay. So in general, you wouldn't not be conflicted out of a lot of them from other consulting services?

John J. Haley

Well, I mean, I think that gets to a question of what you might think is a sensible approach or not. I think if somebody came in and were to say if you did any work for one company you couldn't work on their compensation consulting, obviously that would be bad for us.

If they were to say that the issue is not so much whether you do any more work, but what size the relationship is overall, I think that would be something that would probably be helpful for us. I mean, I think if you're a small company that does only compensation consulting and you have 5% or 10% of your revenue comes from a single client, you've got an issue about maybe the objectivity with which you give advice to them, even if you don't do any non-compensation work. The fact that we may do 1/2% of our revenue for somebody on non-compensation work shouldn't seem to be an issue compared to the other.

So it's a question of whether I think they can get a sensible view of what objectivity and independence is.

Timothy McHugh - William Blair & Co.

Okay. And then, Roger, can you give us the severance expense from the fourth quarter — was that primarily in human capital or did that flow across a couple of different segments? Can you give any detail on that?

Roger F. Millay

It was a mix, and I think it's HCG — I actually only have the annual numbers here, but there was a mix of benefits and HCG, I think, when you look at annually the biggest pieces in some like the communications practice and the kind of admin-type functions. So things that would be in the other line for us.

Timothy McHugh - William Blair & Co.

Okay. And then somewhat up a little bit on that is the margin guidance for Insurance and Financial Services for next year is obviously nicely improved from what you just did in the quarter. What does that reflect? It doesn't sound like you're assuming any significant change in the demand environment for that.

Roger F. Millay

Yeah. I mean, we remarked a little bit in the initial remarks that that's more of a project related business, which makes it a little more unpredictable. That is a business that's very attentive to what does the pipeline look like and what are the costs related to that, and I think has been actually over the year because they had a tough '08 and then a big surge in business in '09, and they've been constantly kind of looking at do we have the right cost levels relative to what the pipeline looks like. So I think they're ready to do that in fiscal year '10, and we want them to be on that low double-digit margin level, which as you say is up versus fiscal '08, but we're going to be very attentive to that and what the project pipeline looks like.

Timothy McHugh - William Blair & Co.

Okay. Thank you.

Operator

Your next question comes from the line of Andrew Fones with UBS. Please proceed with your question.

Andrew Fones - UBS

Yes, thanks. Actually, Tim asked most of what I was going to ask, but I just wanted to followup on whether there was any merger related costs in the fourth quarter? Thanks.

John J. Haley

No. As I said, really, the merger-related costs in the first quarter are related to the change in accounting which through our fiscal year of '09 we were able to defer recognition of those costs, and moving now into the new fiscal year under the new accounting standard we have to expense them.

Roger F. Millay

They had been put on the balance sheet.

Andrew Fones - UBS

Okay, thanks. That's all I had.

Operator

Your next question comes from Mark Marcon with Robert W. Baird. Please proceed with your question.

Mark Marcon - Robert W. Baird

A couple of quick questions. One, can you talk a little bit about the Investing Consulting business? I mean, the areas where you saw the pickup, what specifically drove that and how do you think that that's going to proceed?

Roger F. Millay

Well, I mean, again, first, I have to say as a newcomer to the company this year, I have to say I've been really impressed with how the investment consulting guys have managed through this very difficult market, and so we were really pleased with the fourth quarter, and 14% constant currency growth — we were really pleased to see — if you follow back, I think, from the December quarter through the June quarter, there was a gradual kind of reopening up of our work, and now, as we said, it's spread pretty much across most of their business areas and we look forward to that continuing into fiscal '10, and it's great to have that kind of a business in these times that's close to a double-digit growth business projected for the year.

John J. Haley

And just to followup, the source of the growth was really in two areas. One is the implemented consulting activities, which is really where we take over a lot more of the investment operation for organizations and we've had a couple of expanded client relationships where we've done that. The other is an increase in strategy projects. A lot of funds — I mentioned this in my remarks, are evaluating their investment strategy and risk tolerance.

Mark Marcon - Robert W. Baird

Okay. And it sounds like some of the tools that you were using previously on the implementation side that were frozen and you couldn't use — maybe some of those have opened up a little bit?

Roger F. Millay

Yeah. Even those — you're talking about the risk projects, and again, that's kind of to the theme of what I said earlier. Even those areas have become regenerated and we're starting to see growth there. I mean, we're again pretty much in everything that they've done, maybe not at the robust levels of two years ago and even a year ago, I suppose, but we're seeing thawing in all of the areas that were difficult earlier in the year.

John J. Haley

Yeah, but I don't think structured products was one of the ones that we saw as the growth areas. They really were from the implemented consulting and the strategy projects.

Mark Marcon - Robert W. Baird

Okay, and then can you talk — a question about Towers. Do they have any tapped partly or multi employer plans on the DB side?

John J. Haley

I think they have very, very few, if any.

Mark Marcon - Robert W. Baird

Very few?

John J. Haley

Yeah.

Mark Marcon - Robert W. Baird

Okay, great. Thank you.

Operator

(Operator's Instructions) Your next question comes from the line of Ashwin Shirvaikar. Please proceed with your question. Ashwin, your line is open.

Ashwin Shirvaikar - Citigroup

Just a quick housekeeping question on the tax rate, should we expect the elevated level of tax rate that we saw in the fourth quarter to continue in the near term because of severance?

John J. Haley

No. The reason for the elevated tax rate this quarter was really kind of year-end true ups that mostly related to the geographic allocation of income and the tax rates in those areas. So the 34% rate that we've given guidance for the year is what we expect, again, excluding the impact of merger related costs that are not deductible. So we anticipate more steadiness in the tax rate versus the fourth quarter.

Ashwin Shirvaikar - Citigroup

Right, thank you.

Operator

And there are no further questions at this time. I will now turn the call back over to management for any closing remarks.

John J. Haley

Okay. Thanks everyone very much for joining us, and we look forward to updating you after the next quarter.

Operator

Thank you for your participation in today's conference call. This concludes the presentation, you may now disconnect. Good day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Watson Wyatt Worldwide F4Q09 (Qtr End 6/30/09) Earnings Call Transcript
This Transcript
All Transcripts