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

Towers Watson & Co. (NASDAQ:TW)

Q4 2012 Earnings Call

August 14, 2012, 09:00 am ET

Executives

Aida Sukys - Director, IR

John Haley - CEO

Roger Millay - VP & CFO

Analysts

Shlomo Rosenbaum - Stifel Nicolaus

Sara Gubins - Bank of America Merrill Lynch

Julio Quinteros - Goldman Sachs

Ashwin Shirvaikar - Citi

Tim McHugh - William Blair & Company

Jeff Volshteyn - JP Morgan

Tobey Sommer - SunTrust

Mark Marcon - Robert W Baird

Operator

Good day ladies and gentlemen, and welcome to the fourth quarter 2012 Towers Watson Earnings Conference Call. My name is Jeff and I will be your coordinator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today Ms. Aida Sukys, Director of Investor Relations. And you have the floor madam.

Aida Sukys

Thank you, Jeff. Good morning. This is Aida Sukys, Director of Investor Relations of Towers Watson. Welcome to the Towers Watson earnings call. I am here today with John Haley, Towers Watson’s 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, 13082830. The replay will also be available for the next three months on our website. Our website also contains a few slides that are complementary to today’s call. Those slides include certain reconciliation information required by SEC Regulation G.

This call may include forward-looking statements within the meaning of Section 21 of the Securities Exchange Act of 1934 that involves risks and uncertainties. A discussion of forward-looking statements and the risk and other factors that may cause actual results or events to differ materially from those contemplated by forward-looking results, investors should review the forward-looking statement section of the earnings press release issued this morning, a copy of which is available on our website at www.towerswatson.com as well as other disclosures under the heading of risk factors and forward-looking statements and our most recent Form 10-K and in our other filings with the SEC. Investors are cautioned not to place undue reliance on any forward-looking statements which speak only as of the date of this earnings call.

During the call, we may discuss certain non-GAAP financial measures such as adjusted EBITDA, adjusted net income and adjusted earnings per share. For a discussion of these non-GAAP financial measures, as well as a reconciliation of these non-GAAP financial measures to the mostly closely comparable GAAP measures, investors should review the press release and the accompanying financial tables we posted this morning.

After our prepared remarks, we will open the conference call for your questions. Now I'll turn the call over to John Haley.

John Haley

Thanks Aida. Good morning and thank you for joining us. Today, we’ll review our results for the fourth quarter of fiscal 2012, our guidance for the first quarter of fiscal 2013 and discuss some of the high level expectations for the full fiscal year, for the full-year of fiscal 2013.

Overall, we had a strong fiscal year 2012 with 5% revenue growth and strong profit growth. However, we experienced some challenges this quarter. Despite these challenges, when we step back and look at where we're headed for fiscal year 2013, we see many signs indicating continued growth and strengthening of our business.

Reported revenues for the quarter were $826 million, a decrease of 3% over prior year reported revenues and flat on an organic basis. Our organic growth rate, adjust for changes in foreign currency exchange rates, acquisitions and divestitures.

Our adjusted EBITDA for the quarter was $161 million or 19.5% of revenues, up from $159 million or 18.7% of revenues last year. For the quarter, diluted earnings per share were $0.91 and adjusted diluted earnings per share were $1.25. Adjusted diluted earnings per share increased 18% over the prior year; this increase was due in large part to the benefit we received from the fourth quarter tax rate.

There were a few factors that impacted revenue performance this quarter. Risk and Financial services was very strong overall; we experienced accounting and business impacts from our ERP transition in North America and had weaker results from our Talent and Rewards segment.

As we have discussed overtime, we adjust our discretionary compensation pool based on earnings performance. Giver our revenue and profit shortfall this quarter, funding levels have been adjusted accordingly and Roger will discuss this in more detail a little later in the call.

We continue to be confident in our growth strategies and see great prospects for the future of Towers Watson; although there are challenges in Europe and the slowdown in our clients discretionary spend has impacted our Talent and Rewards business we are pleased with the EMEA results. The economic news from China has been concerning us well, but today, we continue to see positive results from the Asia-Pacific region.

Despite the bump in our U.S. operations this quarter, there are several positive trends we expect to build on in the near future. Healthcare Reform and pension derisking are creating opportunities for our consultants and of course being a market leader of the emerging retiree exchange business puts Towers Watson in a unique position.

I must say I am even more excited about Exchange Solutions today than when the acquisition of Extend Health was announced. I am continuing on the foundation we build and we continue to strengthen for solid long-term growth and profitability.

Now let’s look at the performance of each of our segments. On an organic basis, Risk and Financial services grew six percent, Benefits grew 1% and Talent and Rewards was flat. We saw good growth momentum in many of our lines of business. As a result of the ERP system deployment in the US, we experienced significant billing delays which increased revenue reserves at the segment level as compared to last year.

While we may progress this quarter, there is still work to do get our billing processes back to normal. By phasing the deployment in the new system, the business impacts felt were identified and mitigated in the early stages of EMEA rollout. So while we expect to experience some business impact as we deploy globally, we don’t anticipate the impact being as great as what we have seen in the US. The Benefits and Talent and Rewards segment were hardest hit by these transition issues.

For the quarter, the Benefits segment had revenues of $473 million. Benefits segment revenues were up 1% on a constant currency basis. The Americas region revenues were flat, EMEA revenues increased by 3%. Retirement revenues decreased by 1% on a constant currency basis driven by a 2% decrease in Americas revenues. The pipeline of work continues to look good particularly in the areas of derisking lump sum projects.

However, the ERP related issues noted earlier affected the quarter’s results. The EMEA retirement revenues were flat this quarter. Projects were delayed pending the drafting of regulations issued in June. Technology and Administration solution revenues increased by mid-single digits on a constant currency basis; EMEA had a very strong quarter with high single digit growth. We continue to add new clients and the pipeline looks strong. We had mid single digit constant currency revenue growth in health and group benefits where growth was driven by product sales. There's been intense client engagement since the Supreme Court decision to uphold healthcare reform.

We held a series of client webcast which highlighted the implication of the mandate on the corporations and more than 1700 participants attended. Going forward the benefit segment should show modest growth with sustained momentum in TAS and HGB supplemented by project activity and retirement.

Now let me turn to risk and financial services. For the quarter, the risk and financial services segment had a strong quarter with revenues of $199 million. Revenues were up 6% on a constant currency basis on good performance across the lines of business. Risk consulting and software revenue increased by 5% on a constant currency basis with strong growth in North America consulting and in software globally. We remain cautious about Europe as discretionary spending seems to be tightening.

We were pleased to see the continued growth trend in brokerage, a strong renewal in new business season with favorable pricing conditions drove the growth to mid single digits this quarter. Investment had double digit constant currency growth. The Americas region had mid single digit growth while both Asia Pacific and EMEA experienced double digit growth. We had a strong focus on marketing in EMEA and are seeing these efforts pay off. In general, the pipeline of investment work looks good globally. We expect risk and financial services to maintain its positive momentum.

Now let's move on to Talent and Rewards. For the quarter the Talent and Rewards segment had revenues of $130 million with revenues flat on an organic basis. Rewards, Talent, and Communication grew by 4%. The Americas region revenue increased by 6% and the pipeline continues to look good.

EMEA revenues decreased by 10% as discretionary spending continue to tighten across continental Europe, and we’ve seen spending drop in the UK as well. Data service and technology revenues decreased by 12% on a constant currency basis with declines in all regions. The decline was driven by our data services business, which experienced impacts from the rationalization of our legacy product platforms over the past year and [amortization] of the accounting processes.

This change shifted revenues into the first and second quarters of the fiscal year. We did see a drop in European sales in the fourth quarter and are cautious about potential slowdown in mid-market subscription sales during fiscal 2013.

We expect to see growth in data services in the first half of fiscal year 2013. The Executive compensation consulting environment continues to be strong in the US and the Asia Pacific. While we had seen some softening in Europe the previous quarters, EMEA’s revenues grew by 4% this quarter. We continued to be watchful of the environment in Europe but we feel we’re well positioned there.

Overall, we continue to see good opportunities in Talent and Rewards but are monitoring the survey business and the pipeline for rewards; talent and communication work in EMEA carefully. We expect to see mixed results in Talent and Rewards given the pressure in Europe, offset by continued growth in activity in Americas and Asia Pacific.

The acquisition of Extend Health was formalized at the end of May. For the quarter, Exchange Solutions reported $4 million of revenues net of deferral revenues for the purchase accounting rules. We had a very successful sales season and will be enrolling a record number of members during the [form] enrollment period which will be an excess of the previously forecasted 30%. We will provide more details on the exchange solutions business during our Analyst Day event next month.

To a great extent, we are where we should be as we begin our third full fiscal year and prepare formally [exit] integration activities. We have leveraged the broad base of Towers Watson to expand in growing markets such as corporate healthcare. We have enhanced our leadership in retirement to assist clients with their financial risks around the fine benefit pensions. We globalized our client management process and we have extended our leadership position in risk consulting. We have good opportunities and strong teams in our businesses.

We had a very good fiscal year and the performance in the fourth quarter is not indicative of the strength of our business model or the activity we see in the pipeline. I have every confidence in our long-term growth strategies and our leadership team. We have positioned fiscal 2013 cautiously as the global economic environment is becoming more uncertain.

We see this fiscal year as a year of a simulation, cost management and targeted prudent investments. Before I turn the call over to Roger, I would like to thank all of the Towers Watson associates for a terrific fiscal year. We have had to manage through some very complex market issues this year while also deploying globally ERP system, yet you are focused on serving our clients and continuing to develop leading edge market solutions is not wavered.

Now I will turn the call over to Roger.

Roger Millay

Thanks John and good morning to everyone. As John mentioned, we had good success in fiscal year 2012. We drove through some major initiatives that are strengthening the company and we generally met or exceeded our key financial goals.

However, the fourth quarter was tough and fell short of our expectations driven by a few driven by a few notable factors.

Organic revenue overall was flat for the quarter below what we expected. We were surprised by the shortfall although, perhaps it is in totally shocking given the clearly more challenging macro environment and that we deployed new billing process and systems for the majority of the company in the middle of year.

As John mentioned, the shortfall was driven by the impacts of our ERP conversion and the talent and reward segment. Our adjusted EBITDA margin came in at 19.5% about as expected but only because we had a lower bonus accrual in response to our disappointing financial performance.

There were couple of items driving overall financial performance, I want to cover in more detail. First the ERP conversion impact, we continue to recover from the billing process delays created in the early months of the North America deployment. We had a vigorous billing and collections push in North America in the June quarter in response to elevated receivable level at the March quarter end.

Overall, North America's receivables were reduced this quarter with good progress made on unbilled receivables. We will continue to press on this billing and collections backlog until our DSO is back to normal. The impact on revenues comes from reserves and adjustments provided through the billing and collection process.

At this point, we [haven't] experienced similar issues in our EMEA deployment. However, we continue to expect unbilled and billed receivable balances to remain elevated as we complete the ERP roll out over the next few quarters. The significant area is bonus accrual. Overall, our discretionary compensation expense was $29 million lower than last year's fourth quarter. The lower accrual level reflects our shortfall against revenue and income goals. We cultivated a strong pay for performance culture and we review discretionary funding levels carefully each quarter.

Due to the overall strong fiscal year, we are pleased to say that bonuses will still fund at planned targeted levels given the performance earlier in the year. Our fourth quarter revenue shortfall translated into a slight decrease in the benefits and talent reward segment margins. As a reminder, our segment margins are before consideration of discretionary compensation and other unallocated corporate costs such as amortization of intangibles resulting from merger accounting and transaction and integration costs.

For the quarter, the benefit segment had a 31% NOI margin, Risk and Financial Services had a 22% NOI margin and Talent and Rewards had a 12% NOI margin. Net income attributable to controlling interests for the quarter was $65 million; adjusted net income was $90 million.

This quarter we had $21 million of transaction and integration costs versus $21 million last quarter and $23 million in last year’s fourth quarter. About $5 million of these expenses relates to transaction costs for the Extend Health acquisition. The majority of the remaining costs in this line continue to be related to our large IT initiatives, integrating both the ERP software and hardware platforms of the company.

A hardware platform project is scheduled to be complete in the September quarter, the new Oracle ERP system is deployed throughout the Americas and most of EMEA covering almost 90% of our revenues. We are moving forward with finalizing EMEA in November and starting the deployment in Asia Pacific as planned.

The normalized tax rate for the quarter was 34%; the forecasted rate was 37%. This will be the last quarter a normalized rate will be reported.

Diluted earnings per share for the quarter were $0.91, up 52% from $0.59 last year. Adjusted diluted earnings per share were $1.25.

Moving to the balance sheet, we continue to have a strong financial position. As of June 30, we had $408 million in cash available for our use. Free cash flow was forecasted to come in slightly below our original guidance of $275 million to $300 million. It actually came in much lower than anticipated at $192 million. Two main factors contribute to the short fall. A continued drain from the ERP billing issues and higher levels of fixed asset purchases, the majority of the fixed assets purchases related to the ERP system implementation and the hardware platform project.

We had $208 million of borrowings outstanding from our credit facility at the end of the quarter, which is mainly related to the acquisition of Extend Health. We also secured a five-year term loan in the amount of $250 million to fund the purchase. The term loan amortizes at a rate of $6.25 million per quarter beginning in September 2013, with the final maturity of June 2017.

Last quarter, the board authorized a $150 million stock repurchase program. Given the borrowing for the Extend acquisition, we are not utilizing that authority at this time. Under our anti-dilution repurchase authorization, we purchased a 136,000 shares during the quarter and 192,000 shares in July to offset the dilution related to Extend Health options.

Now let’s review our outlook for fiscal year 2013. Today, we will provide you with fiscal year 2013 first quarter guidance as well as some context for our full-year fiscal 2013 outlook. As a reminder, we will provide full fiscal year guidance at our Analyst Day on September 14.

For the first quarter, we expect revenues will be in the range of $805 million to $825 million. On a constant currency basis this correlates to a growth rate of 2% to 4%. We expect adjusted diluted earnings per share to be in the range of a $1.5 to a $1.10. Our adjusted EBITDA margin is expected to be around 17.5%. There is a point worth noting regarding this guidance. Exchange Solutions has strong seasonal swings in its business model.

During the first half of the fiscal year staffing has ramped up to accommodate enrollment deadlines. However, revenues only begin to be recognized when the policies become effective. The majority of our policies are effective January 1. As a result, profitability is low in the first half of the fiscal year depressing our profit margins. The acquisition of Extend Health changes the year-over-year comparisons for adjusted EBITDA and adjusted diluted EPS.

For the first quarter, we are assuming an average exchange rate of $1.55 to the British pound and an average exchange rate of $1.25 to the euro. We expect an income tax rate of around 37% and diluted shares outstanding of about 72 million.

Now we will review our fiscal year first quarter guidance for the segments. We expect revenue growth in the Benefit segment to be 0% to 2% on a constant currency basis. The NOI margin for benefits is expected to be about 30%.

Next in the Risk and Financial Services segment we expect constant currency revenue growth will be in the 1% to 3% range for the quarter. We expect the NOI margin to be the low to mid 20% range.

Moving to the Talent and Rewards segment we are forecasting constant currency growth in the range of 1% to 4%. We expect the NOI margin to be in the low to mid 20% range. Finally we expect Exchange Solutions revenue of approximately $12 million which is net of deferred revenues we are not able to recognize due to acquisition accounting.

On a pro forma basis we are expecting Exchange Solutions to grow about 20%. As discussed previously due to the seasonality of the Extend Health business model, the anticipated strength of this year's enrollment increase and the impact of the deferred revenue write-offs, we anticipate NOI loss of approximately $7 million in the first quarter.

For fiscal year 2013 overall, we are targeting mid single digit constant currency revenue growth with an adjusted EBITDA margin around 19% to 19.5%. Our comparables will be more challenging especially in the first half of the fiscal year. We continue to be cautious about Europe, the news of an economic slowdown in China and how both of these economies impact the US.

We will also continue to work through our billing issues in North America and to finalize the global ERP deployment. Despite our caution and operational concerns, we are seeing some positive trends as well. The work around de-risking in lumpsum payouts appears to be gaining traction and we certainly feel good about our healthcare consulting and exchange opportunities. We have also discussed some of the positive momentum, we are seeing in certain lines of business in Europe and Asia Pacific.

I am pleased with our overall performance this fiscal year. As a result of the tremendous efforts made by our associates in all parts of the company, we saw much success during the year which makes the fourth quarter results even more disappointing. We are keeping a close watch on variables that could impact our performance, understand the factors that impacted our fourth quarter results and we feel we are taking appropriate measures to mitigate these issues. However, the business has good underlying momentum and I continue to be optimistic about our future performance.

Now I will turn it back to John.

John Haley

Thanks Roger and now we will take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first quarter comes from the line of Shlomo Rosenbaum with Stifel Nicolaus. Please proceed.

Shlomo Rosenbaum - Stifel Nicolaus

Roger, can you quantify how significant ERP issues were on revenue, because the revenue lines were below expectations, just about everywhere and certainly versus the high end of the range. And I was wondering if you had like a dollar value, was it $20 million, $30 million, $40 million something that you can put to that?

Roger Millay

It’s tough to be totally precise about those impacts, but what we can see is the impacts quarter-over-quarter, year-over-year on the reserves and adjustments line and that was around $20 million. Of course, the other factors are, there is distraction that goes on as a result of the efforts, the billing focus, but you can't really quantify that, so I would say at least $20 million.

Shlomo Rosenbaum - Stifel Nicolaus

And is this something that should be reversing once you work through some of the issues?

Roger Millay

Well, you would hope that, I mean that's the opportunity with the delay we have quite strict reserving requirements and that are based on aging. So you know there is a great opportunity for us to recover some of that as we collect the aged receivable, so that would be the hope, but no guarantees as we work through that.

Shlomo Rosenbaum - Stifel Nicolaus

And with Risk and Financial services, you actually did have a pretty decent revenue, but net operating income was decently lower than what we were thinking about; was there anything else going in that unit that we should be paying attention to?

Roger Millay

Well, I think one of the things is you know, the brokerage business bounces around quarter-to-quarter. So this was seasonally a softer period in brokerage which brought the overall margin down. So I think just seasonally we would expect a little bit lower margin in our RFS this quarter; that’s the biggest thing I have noted.

Shlomo Rosenbaum - Stifel Nicolaus

Okay, and if we could just squeeze in a couple of little things. Data and Surveys, is that very discretionary; that’s been the highlight for you guys for the last probably over a year and it’s been strong seems to be coming down all of a sudden. Is there a particularly discretionary or something else going on?

Roger Millay

Well, I think you know, there is a bit of discretionary spend in there, so I think we noted in the script that we did see a little bit of a decline in Europe and this is the compensation surveys specifically that we’re talking about now, but the biggest impact in data surveys and technologies is this time being an accounting impacts overall related to the consolidation of the two legacy company survey platforms so that was going on over the last year.

We moved to one platform and of course one accounting methodology and it does relate back if you recall we had a similar situation in the September quarter. This was kind of a parallel to that and things should even out next year because then we will be comparing on the same business to the same business on the same type of accounting methodology. But there is, we did note in Europe also that beyond those impacts we think there was just a decline in business that was probably somewhat cyclically oriented.

Shlomo Rosenbaum - Stifel Nicolaus

Then how much interest expense should we expect going forward for third quarter?

Roger Millay

I think that’s something we will give you; I mean it shouldn’t change all that much, I don’t think in the September quarter and that’s something when we give full guidance, we will give you.

Operator

Our next question comes from the line of Sara Gubins with Bank of America Merrill Lynch. Please proceed.

Sara Gubins - Bank of America Merrill Lynch

For the guidance for the first quarter, could you talk about what’s driving margins down in Benefits and Risk and Financial services but growing in Talent and Rewards?

Roger Millay

Dealing with the last piece, Talent and Rewards is just cyclical, that’s the normal cyclical pattern that they are stronger in the September and December quarters. In terms of the other two, I think it’s -- are you looking at down versus the…

Sara Gubins - Bank of America Merrill Lynch

Year-over-year?

Roger Millay

I think it’s for the most part it’s just us settling into the EBITDA margin levels that we’ve talked about really since the beginning of the deal. And so with low levels of organic revenue growth these are the levels of NOI margins that equate to that kind of 19% to 19.5% EBITDA margins. Apart of what’s going on in the P&L now for the last year is as we’ve added resources over the past year, you are now seeing the effect of that, so I think that’s a part of it is well.

John Haley

I mean I just finally Sara, I think if we think about lets say Benefits, if we think about it performing at a level that we think is a very high level, we think that’s an NOI of about 30% of or so and so that’s what we gave in the guidance. Now, last year we had historically high rate for the first quarter, we just decided not to continue to project it at that historic high rate, but we think 30% NOI is a very good performance level for Benefits.

Sara Gubins - Bank of America Merrill Lynch

And then separately, I don’t think you had planned to hire across the segments in the fourth quarter; did you follow that plan?

Roger Millay

Yeah, I think, the hiring was quite similar to the third quarter. We hired people I think in all the segments; that was a few hundred people again pretty similar to the third quarter and again some of the hires again similar to the March quarter; some of those hire is related to the build up in Asia of some of the kind of centralized administrative services that we are building there. I think that was fairly similar.

John Haley

And one of the things that happened in our fourth fiscal quarter is that we are hiring new university graduates every year, so we are always hiring some of them.

Sara Gubins - Bank of America Merrill Lynch

And just last one, health and group benefits revenue was up in the mid-single digits; was that generally in line with what you were expecting; do you think we should see a ramp from here?

John Haley

We were expecting something in the mid-to-high single digits for the healthy group benefits. I think we've, I think during the call we referenced the response we've had to the Supreme Court decision and I think that the level of interest in what's going on there has been even higher than we had anticipated whether that develops into additional work and additional growth in revenues I think we will see but we are encouraged.

Operator

Our next question comes from Julio Quinteros with Goldman Sachs.

Julio Quinteros - Goldman Sachs

Maybe just real quickly to start on the assumptions for Europe as you guys think about the build out for at least the first quarter of fiscal 2013, maybe by segment, can you just walk us through real quickly how you are thinking about some of the demand trends for benefits for Risk and Talent and Rewards in Europe specifically?

Roger Millay

I'll hit some of the highlights and John might have some thoughts too. I think Europe’s actually interesting for us at the moment because we do have some within some of the lines of business some very positive things going on. So there are kind of pushes and pulls, I mean I think we referred to it in the remarks that if you look at Talent and Rewards that is our most cyclical business and we are continuing to watch for pressure there.

And particularly in the line of business that we call rewards and Talent and Communication which is the most projects oriented. In terms of the benefit segment particularly in the administration business they have had some very good trends, they have had some very good clear wins over the last year and we see that benefiting revenues heading into 2013 and you see growth there. In terms of retirement in EMEA and they've been kind of flattish to modestly down I think the last couple quarters and I think probably being in that kind of area you know, is roughly what we would expect.

In our RFS, the businesses are doing quite well there. You know, I think similar to this quarter, maybe not the some high level but investment is growing. The brokerage business is continuing to do reasonably well and the risk consulting area is doing quite well as well. So you know, kind of neck-to-neck at the moment. We do have some good trends going on that offset cyclical weakness that we see in Talent and Rewards.

John Haley

You know, I guess the only thing I would add is that there are a couple of areas in benefiting Europe where we see some potential for some growth and it's fundamentally due to delayed legislation. There is a whole area around auto enrollment and DC budgeted revenues that we had, we have faced them in the expectation that activity related to an auto enrollment would have started earlier in this calendar year, but the final regulations weren’t published by the UK government until the beginning of February and so that’s delayed our consulting activity.

We spent a fair amount of time building our service offerings and our sales plans around auto enrollment in the UK. This work has being chargeable, you know, non-chargeable at this stage but it is work that would support our consulting activities over the coming months. So we see the auto enrollment work commencing in the first quarter of fiscal ’13.

The other area is around enhanced transferred values and these so called pies the pension increase exchanges. There had been some concerns expressed by the UK pensions’ minister over the use of these liability management exercises by companies, a new code of conduct came out in June of 2012 and a number of high value projects that had been hold we think should commence.

Julio Quinteros - Goldman Sachs

May be just two quick ones on the free cash flow guidance for the first quarter given all the movements around the European billing situation what is your expectation for first quarter free cash flow?

Roger Millay

We are not guiding on free cash flow at this point and again we will talk about that more in the Analyst Day. Of course, the September quarter for us is the quarter in which we generally have negative free cash because of the bonus payment. So I think the way we are managing the business one you have the bonus payment if you take that out we all know that we need to push on the North America receivable situation and it’s stabilized I think in the June quarter and now we got to push it down and that should be actually a source of cash as we move forward here in the next couple of quarters, but we have got some work to do that. Otherwise, I think it’s kind of business as usual, but so the net of that is hopefully some positive trends, we got to pay the bonuses some negative free cash but we will give you more specifics on the Analyst Day.

Julio Quinteros - Goldman Sachs

Okay, so minimum the DSOs will be kind of the biggest push in terms of any improvement from here or getting DSOs to actually move down from here.

Roger Millay

Yeah I think that’s right.

Julio Quinteros - Goldman Sachs

And then just trying to go back on the margin point that you made earlier just want to make sure I understood I thought I heard you say something anywhere on the 17 and some change but can you just go back to the margin point about the first quarter and then you expectations for fiscal 2013 please?

Roger Millay

Yeah important point, so let me do with and without exchange solutions margin discussion. So without exchange added in, we expect for the year to be managing through margins that are consistent with a levels that we have been talking about for the company and let's call it that 19% to 19.5% range and this is adjusted EBITDA margins we are talking about now.

Exchange solutions has very distinct financial seasonality. I mean it is business seasonality but really it impacts the financials. So in the first half of the year because in particularly in growth mode because they add a number of people and a good portion of those are temporary resources in order to facilitate the enrollment of new members into the exchange.

And we said in the first quarter we don’t expect to loose about $7 million in the NOI line, they have an increase in expenses and the revenues don’t come in until people are enrolled and the related policies begin and that’s when we start getting the commission revenue.

So again imagine September and December quarters they have a lot of people, no commission revenue starting in January most of the policy come on in January 1st that is when the revenue comes on and we take the commission revenue over the policy period and the temporary labor goes away.

So what that means is you have a real dampening for the company of adjusted EBITDA margins in the first half of the fiscal year. So that's why we are staying around 17.5% for the September quarter, but yet the Extend acquisition which is now Exchange Solutions is fully on track in terms of growth and the prospects we see forward. I know that was long winded, but hopefully that helped you.

Operator

Our next question comes from the line Ashwin Shirvaikar with Citi.

Ashwin Shirvaikar - Citi

I have a few questions. I guess, talking about the billing issues, could you provide some details as to what exactly you mean by billing issues. These are projects and work that you've done and the bills did not go out for some reason because of the implementation of the new system, our people not adequately trained to use the system, what's going on.

Roger Millay

Yeah, so what happened was we launched the US I guess it was December 1 I think, right and we launched Canada last August. The Canada launch of course that's a smaller part of the company. We noted in the first couple of months of billing some challenges in working with the new system.

We noted some which isn't unusual in these things, some particular changes that were needed in the Oracle software to fully accommodate all the operational impacts that people have as they take their time month to month, assess how much of that time will be billed and then issue the bill.

When we launched the US, of course the volume of bills and time sheets in the US is multiples of what it was in Canada, that just the working through that process was more time consuming and more cumbersome and we had a backlog and we weren’t able to work through and our people weren’t able to work through it.

And as timely fashion as usual and so we ended up with a backlog, again of just during the month issuance of bills. So it's all projects, it's a work that’s being done. And it's with those delays of timing, you know, just billing assessments that backed up and we’re working through that now.

So, it really is more and kind of execution of the billing process backlog and then we had changes that we’re making in to the system to facilitate the process going forward and that’s been going on at the same time. So, we've got to work through the backlog and you know, again we turned the corner on that but it's just a high volume that we got behind on.

Ashwin Shirvaikar - Citi

So revenue was hurt in Q1 and Q1 will continue to be hurt because it's what you’ve done, but you’re not able to bill because there are continued delays in putting the T&E data in to your system?

Roger Millay

Yeah, I mean that’s close actually. The only little bit of a tweak I would make to that is that if you notice on the balance sheet, the change from the March quarter to the June quarter and the receivables line is that the unbilled line came down.

So it was up quite a bit in the March quarter. And so that was more working through the lag in taking time and turning it into a bill. So in the June quarter, we had pretty decent success in that. We got a lot of bills out but of course they weren’t all collected. So now the bubble so to speak transferred more to the billed receivables line. So now it’s turning more relatively into collect the bills rather than get the bills out the door. And again both in what we can whip which is the unbilled as well as the billed, we have these reserving levels that start at 90 days kick in and we reversed the revenue.

And so if we work through this process expeditiously now, that’s the opportunity actually is to issue those bills, collect the money and some of those reserves will come back and that’s what we would be hoping to see over here over the next few months.

John Haley

Yeah, so I think the only thing I would add Ashwin is that I think you said we would continue to be hurt in the first quarter and as Roger just pointed out not only won’t we necessarily continue to be hurt in the first quarter, but indeed there is an opportunity for us to recapture some of this thing.

Ashwin Shirvaikar - Citi

But is that opportunity to recapture in your guidance because you have turned the corner, but the fact is that your DSOs went from 37 to 35. Last year they were 30 and 30.

John Haley

No the opportunity is not in our guidance.

Ashwin Shirvaikar - Citi

Okay. And I wanted to clarify that. The second thing is on the NOI loss, I missed the details behind the NOI. Is that loss included in your guidance?

Roger Millay

For Exchange Solutions.

Ashwin Shirvaikar - Citi

Yes.

Roger Millay

Yes, it is included in the guidance.

Ashwin Shirvaikar - Citi

That is included in the guidance, okay. Am I right in may be assessing the Q1 impact from the billing issues at also, say call it to $20 million to $30 million in terms of the opportunity?

Roger Millay

Well that is almost by definition I suppose if we got the reserves back to the normal levels -- you are asking how much is the opportunity?

Ashwin Shirvaikar - Citi

Yeah

Roger Millay

So almost by definition, you know that would be it. I mean you can – look, these things when you are processing kind of millions of things through a system, getting all the way back to normal and assuming full recovery you know we'd hope for that result. But I am not sure that -- we are obviously not giving guidance to that level. So we just got to work it through, that is the theoretical opportunity but you know we are more focused on getting the work done right now.

Ashwin Shirvaikar - Citi

Absolutely and you feel confident with the system as it is, the changes and tweaks you have made that when you roll it out to Europe and you roll it out to Latin America it should not cause similar issues?

Roger Millay

It is interesting and so again the work changes that we were making in the fall and early winter that really just got finalized in the last few months that really accommodated all the nuances of the business let me say. So it is interesting that as we rolled out to the UK, which of course was rolled out March 1st, you know we are not seeing any issues and we had a second wave on May 1st in EMEA. And so we are definitely seeing that as the company gets more experienced in working with the new systems in process; it’s going more smoothly and we are quite confident, we’re very confident with the changes that we put in. So we know that every month we are getting very close to a stabilized level. So that's why our emphasis is more on cleaning up kind of the backlog from six to nine months ago.

John Haley

Yeah, I mean these are pains related to the initial implementation, not really, we feel pretty confident about that this is a good platform going forward Ashwin, so the only, let me just also mention something just your question for about exchange triggered it, but the seasonality that we are seeing in exchange and as Roger said that is in our guidance, that's exactly what we knew about from the beginning before we acquired it and I think we had talked about that seasonality at the time of the acquisition, so there is no surprises here. This was what we knew all along and how we knew it would play out.

Ashwin Shirvaikar - Citi

And last thing not so much of a question, as a suggestion, the last two years, three years now, this is the third year, I know you've tried a few different things for full year guidance would be nice to get to a consistent look and feel as to how you do it; I know you've tried giving full year guidance at your Investor Day, last year you gave it on earnings, this time you are doing sort of half and half, but as a suggestion would be good to get it all in one place and in a consistent manner?

John Haley

Yeah, I actually think we are doing same thing this year as we did last year which is to, our plan was to give it at Analyst Day, but then we have some very inquisitive analysts Ashwin who follow us who like to get a little bit of a preview during this call.

Operator

Our next question comes from the line of Tim McHugh with William Blair & Company. Please proceed.

Tim McHugh - William Blair & Company

Yeah, just one more question maybe on the ERP system. Why were the issues some more concentrated in the retirement practice than elsewhere in the business? It seems like that’s where you describe the most the impact being?

John Haley

Yes, it’s more in retirement, more in Benefits than Talent and Rewards, but retirement obviously is a huge part of Benefits. You know, for one thing, so why is it less concentrated in Risk and Financial Services. They are less on the, if you take brokerage, not really impacted all, kind of what the change impact for the most part are the kind of pure hours and rates and fixed billing consulting parts of the company, so again, you know, more retirement. Also impacted TAS and Talent and Rewards.

Tim McHugh - William Blair & Company

I mean were there smaller impacts on those other areas that you just didn’t call out or was it really that concentrated?

John Haley

No, they were smaller impacts that we didn’t call out in. Again retirements, the retirement is 40% of the company. Don’t know often how much it is at North America, but you know, we called out the areas that have the biggest impact on the company.

Tim McHugh - William Blair & Company

And then on Extend, your comment that it would proforma kind of be 20% growth, if I look back at the historical, I think that implies kind of like $18 million of revenue; is that the right way to think about it and differential be in the write off of preferred?

Roger Millay

That’s the right way to think about it.

Tim McHugh - William Blair & Company

And then so I think you said before kind of $15 million of deferred will be written off, so as the bulk of that going to be felt in the first half of the year as well?

Roger Millay

Yeah it is.

Tim McHugh - William Blair & Company

And that’s pure profit, I mean do you, that doesn’t fall straight to the bottomline that so another word would be a $1 million loss?

Roger Millay

Yeah, it’s pure profit because it was just our deferred revenue that Extend had on its balance sheet that if they hadn’t been acquired would have just come through revenue; there are no associated costs or anything and so we lose the benefit of that pure profit.

Tim McHugh - William Blair & Company

And then lastly on Extend just the, I think your comment was it’s tracking better than kind of the 30% growth you had anticipated, is that 30% kind of proforma, was that proforma growth without taking out the deferred revenue impact; so I am trying to understand is it 30% times $67 million they did last year or is it, just walk us through?

Roger Millay

The comment was around enrollments and so I think John gave that saying that -- and of course what we are talking about in the seasonality and the revenue behavior, this all ties together. So I think what John said was that they are tracking to an enrollment period here in this fall that is supportive of the at least 30% level that we had talked about previously. And you are right, so there is a relationship between what we talked about in revenues and how they enroll, but I think John’s comment was more on enrollments.

And so that really the purpose of saying that is just to say what we see in the early months of the acquisition here, what’s going in their business is supportive of the model that we use to value the business. And of course, the fact that enrolling a lot of people, so not only is there a seasonality, but actually during that seasonal period where you a have a high enrollment period, the financial impact is exacerbated, because they add more temporary people to add for the big enrollment period.

Operator

Our next question comes from the line of Jeff Volshteyn with JPMorgan. Please proceed.

Jeff Volshteyn - JP Morgan

Just following up on Extend, there is a stock comp adjustment in this quarter, is it a one time or is it an ongoing stock compensation?

Roger Millay

It’s not ongoing; they had some options because they were positioning to go public and we carried those over; kind of we look at it from merger acquisition point of view; it was very similar to the restricted stock program that Towers then had coming into the Towers Watson merger and so we carried those unvested options over from Extend structure into Towers Watson, so that’s all it is. It’s not an ongoing program.

Jeff Volshteyn - JP Morgan

And I know you have been working with Extend since I think August 2011, how have your sales force been trained, what’s the progress on being able to fully understand their product services and so for your core sales force?

John Haley

Well, our healthcare consultants have work with our clients to evaluate all sorts of aspects of what they could do with our healthcare plans and they retiree population for those who have retiree medical is a big part of that. And so we’ve looked at exchanges as one possible solution around retiree medical and our consultants had looked at what was available on the marketplace and concluded that Extend Health was the premier exchange solution and so they have been working with them in that fashion is understanding a client problem how do we deal with it and extend offer the best solution to that which is continuing right now that Extend as part of us.

Jeff Volshteyn - JP Morgan

So the ramp up for sales folks was basically not small?

John Haley

Right.

Jeff Volshteyn - JP Morgan

And on a bigger picture question, we are getting closer to the November elections, you mentioned increased interest in healthcare consulting post the core decision, are there any dynamics in the elections now that your clients are asking about and sort of republican administration versus democratic administration, how will that change the dynamic and demand for healthcare services?

John Haley

Well, I think clients probably have those kinds of questions. I'm not sure that they, I'm not sure anybody has a definitive answer to exactly how that's going to play out so we might get questions about what if new administration would this or what if the existing administration would try to do this. But I don't think there's necessarily any pattern to that.

Operator

Our next question comes from the line of Tobey Sommer with SunTrust.

Tobey Sommer - SunTrust

I wanted to ask you a question about what the ultimate benefits of the ERP implementation might look like?

Roger Millay

So maybe two themes there, first is we had to, we didn't have one ERP system to run the company. So that's why its part of integration because the two legacy companies, you know, basically had pretty almost complete overlap and product areas and we need to put teams together. You know, we couldn’t run the business on one system. So is facilitating running the company. You know, there are some cost savings in the corporate area that will have been coming out and will continue to come out you know, as we said all along, not huge numbers that are going to move the margins at this point.

They have been gradually coming out but to the extent that there are savings here over the next several quarters, you know, will either be spending of the environment that we are in. you know, what we said a few quarters ago was reinvesting in growth and that’s if the environment is supportive of that. You know, we would have that option but otherwise, it's embedded in the margin guidance that we’ve been giving.

Tobey Sommer - SunTrust

Thanks and then I guess in the QA opportunity to kind of collect on the bills in normalizes not (inaudible) but is there an ongoing negative impact assuming in the first quarter guidance?

Roger Millay

No, I mean we really kind of any state was assumed in the guidance. So there is not, we wouldn’t have allowed people to forecast quite frankly continued difficulties. So you know, we’re holding ourselves to the standard of holding study and improving overtime you know, and then hopefully gradually recovering some of those reserves that I talked about earlier.

Tobey Sommer - SunTrust

Okay and I was wondering if you could comment on what you are seeing in the more cyclical part of the Talent and Rewards you talk about the discretionary spending in Europe are moderating just kind of any color you can give us on the scenarios in the coal mine that you have in your business? Thanks.

Roger Millay

Yeah I think what you tend to see in these environments and again it’s pretty isolated for us really the two places that they said that we saw it manifested this quarter is just you start to see people talking about clients talking about while we anticipated doing this project but it’s delayed we are not sure and you go through some period where they don’t just cancel projects but you are kind of in limbo and then projects come through and so that’s the environment that we have seen develop over the last couple of quarters.

It stayed pretty isolated to those areas that we have been talking about really overall, so at the moment it’s not as dramatic a downturn as we saw in the Talent Rewards business back in the ‘08, ‘09 period but we are as we said in I think in the remarks we are very watchful of whether that trend is going to become more significant.

John Haley

And I think as we have talked in the first three quarters of the fiscal year EMEA was surprisingly strong especially in Talent and Rewards. Now in the fourth quarter the revenues for Rewards, Talent and Communication dropped by 10%, the exact comp was up by 4% but then we also saw in data service and technology drop in European sales in the fourth quarter. So I think one of the reasons we have been cautions throughout the whole year about EMEA was just that we might see a bit of drop we have seen one of that in the fourth quarter and I guess the question now is just what we are we likely to see going into 2013.

Tobey Sommer - SunTrust

Right that makes sense and just one clarification with the margin guidance you have in the first quarter what kind of articulated expectation of similar 90% and 90.5% for year? Does that imply like the back half you are going to be may be you have a big 20% or higher normalized to the overall annual rent?

John Haley

The cyclicality of the exchange solutions will help us in the back half. First thing in the first quarter it will help us to similar extent in the back half.

Operator

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

Mark Marcon - Robert W Baird

One more question just to understand the ERP situation just a little bit better is the primary bottleneck occurring at the consultant level or is it you know within payables and receivables within the finance function or is it at the client we are just not receiving the information correctly or perhaps not being in agreement with it?

Roger Millay

Well the with exception perhaps certainly not being in agreement whether part I know I think it is in all areas that’s what happens in these situations when you have a delay and you have some ambiguities around the information which in some circumstances we've had here and so it's in all areas. I mean the way the whole billing and collections area works for us is the consultants on the front line of the business are very involved in that and so whether it's -- let's say regardless of who is actually making a specific collections call let's say it's not done without the input of the consultants. So it circles around the front end of the business, but the process, challenges that we've had involve all three areas I think that you mentioned.

Mark Marcon - Robert W Baird

Okay, but there's no sense that this has changed something in terms of the way that the clients perceive the bills and no disagreement from the perspective in terms of the value of the services rendered.

John Haley

No. Not like that.

Mark Marcon - Robert W Baird

And then with regard to Extend, just to understand the deferred to a greater extent, if we think about last year they ended up doing roughly $67 million and do we just strip out the $15 million in deferred and think of that as being kind of our base level of revenue that we are going to build off of for this 20% to 30% growth. Is that one way to think about it?

Roger Millay

I think we maybe mixing [queries] there a little bit but because you are talking about the 20% to 30% growth. So we are talking about growth rates both from a pro forma point of view as well as what we are going to experience. So when we've been talking about the 30%, yeah that is pro forma assuming that they got the deferred revenue on the same pattern that they would have if they were independent. So I think maybe that’s what you’re saying by adding it back.

Mark Marcon - Robert W Baird

Right. So, I am just saying 30% growth on top of what base should we?

Roger Millay

Yes, it's on top of their historic base. So the 67 million for their FY12.

Mark Marcon - Robert W Baird

But then stripping out the deferred?

Roger Millay

Yeah, I mean, it's really adding to the deferred back to fiscal 2013. Right because that’s when they would have got.

John Haley

Here is the way to think of it. We will have a growth rate that will get us -- on the 67 million we will have some growth. We will take 15 million out of that. And after we take the 15 million out of it, we still will have a 30% growth rate.

Mark Marcon - Robert W Baird

Okay, so I mean everything is going according to plan from that perspective and that should be highly profitable in the first half of fiscal 2013?

John Haley

Everything is going to plan or better.

Mark Marcon - Robert W Baird

And then can you just talk a little bit about the impact with regards to derisking on the retirement side – the projects that you’re seeing and what happens to the follow on work or how does that tail look post a de-risking exercise and I am assuming when you're talking about de-risking, we’re talking about some of the things that Ford and GM have been in the news about recently?

John Haley

Yeah, so when we look at those kind of activities where they are -- in the one case, you’re basically offering lump sums to existing retirees and in the other case you are -- it’s a mixture of lump sums and annuitizing the pension liabilities. In cases where companies are offering lump sums there is a business boost for us potentially in our TAS because of the administration around the lump sum offering.

Also retirement and some of our communications work -- can come into play, where they are additionally doing the annuitizing of pension liabilities we could get work in RCS in brokerage and investments in addition to the others.

RCS really has the relationships and understands how to structure insurance products so we could help consult with the insurance companies who might be interested in this market. So I think that you get potentially any or all of those can get involved in some of those kind of derisking.

When we are talking about things where the derisking is basically taking out liabilities for retires in these fashion, that won’t tend to affect the ongoing work that we would do around say pension valuations and other work that we would do for the retirement plan because the retirement plan itself is an ongoing entity.

It’s just that some of the retiree liability has been stripped out of it. I mean you could conceive of other derisking where you had a complete buyout of the pension plan and you just terminated it or sold it to an insurance company or something. Those things are much harder to do, those are kind of things that could affect our ongoing work there.

Mark Marcon - Robert W Baird

And so basically the things that are occurring have no negative impact on the ongoing work, but at the same time for right short term project work?

Roger Millay

That’s correct.

Mark Marcon - Robert W Baird

And then with regards to your own pension liability is there impact we should think about with regards to comp for this coming fiscal year as it relates to that.

Roger Millay

With regards to comp?

Mark Marcon - Robert W Baird

Yes, like how much you are going to end up expensing for pensions?

Roger Millay

So you see that the liability on the balance sheet is increased this quarter and that is driven by the discount rates being so low at this point and expense will be up in fiscal 2013 and we will have more color on that in the analyst day for the guidance.

Mark Marcon - Robert W Baird

I mean that’s all in encapsulated within the 19 to 19.5?

Roger Millay

It is. It is all encapsulated there, yeah.

Operator

Ladies and gentlemen since there are no further questions in queue I would now like to turn call over to Mr. Haley for closing remarks.

John Haley

Okay well thank very much everyone for joining us on this morning. We look forward to seeing you at Analyst Day which will be on September 14 and we look forward to reviewing our first quarter results with you in November.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a wonderful 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: Towers Watson's CEO Discusses F4Q12 Results - Earnings Call Transcript
This Transcript
All Transcripts