Willis Towers Watson - Q1 2023

Transcript

Operator (participant)

Good morning. Welcome to the WTW first quarter 2023 earnings conference call. Please refer to wtwco.com from the press release and supplemental information that was issued earlier today. Today's call is being recorded and will be available for the next 3 months on WTW's website. Some of the comments in today's call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties. Actual results may differ materially from those discussed today, and the company undertakes no obligation to update these statements unless required by law. For a more detailed discussion of these and other risk factors, investors should review the forward-looking statements section of the earnings press release issued this morning, as well as other disclosures in the most recent Form 10-K and in other Willis Towers Watson SEC filings.

During the call, certain non-GAAP financial measures may be discussed. For reconciliations of the non-GAAP measures as well as other information regarding these measures, please refer to the most recent earnings release and other materials in the investor relations section of the company's website. I'll now turn the call over to Carl Hess, WTW's Chief Executive Officer. Please go ahead.

Carl Hess (CEO)

Good morning, everyone. Thank you for joining us for WTW's first quarter 2023 earnings call. Joining me today is Andrew Krasner, our Chief Financial Officer. Our first quarter results were a great start for the year. The strong 8% organic revenue growth we delivered in the first quarter demonstrated our sustained momentum and intense focus as we continue to execute on our strategic priorities. We're particularly encouraged by the growing impact we're seeing from our recent investments in talent and technology, which have strengthened the value we're able to provide our clients and yielded improved retention and new business growth.

Operating leverage on this robust growth and the continued succession of our transformation program drove 140 basis points of adjusted operating margin expansion over the prior year, which translated into adjusted diluted earnings per share of $2.84 for the quarter, an increase of 7% year-over-year. Overall, I'm very pleased with our Q1 results and with the excellent progress we've made since this time last year. We saw top-line growth across all our businesses, reflecting the increased value of WTW solutions in complex economic environments. Amidst financial sector turmoil, high inflation, and ongoing geopolitical strife, we continue to see market dynamics that provide opportunities for WTW to respond to our clients' needs to improve outcomes and reduce risk. Now, I'd like to share some additional perspective on the reset of our near and long-term expectations for free cash flow announced this morning.

Our previous target for 3-year cumulative free cash flow through 2024 reflected our goal of substantially improving our free cash flow margin, this being in addition to achieving our revenue and margin targets. We have made timely and meaningful progress toward our goals for revenue and adjusted operating margins. We continue to believe that our long-term free cash flow improvement opportunities remain substantial and achievable. These opportunities include optimizing structural and contractual aspects of our business, enhancing our system and processes, and streamlining our working capital. We now believe that the best and most sustainable path to realizing those opportunities will take us beyond the end of 2024. Over the near term, we expect free cash flow as a percentage of revenue to improve significantly from 2022's base of 8% free cash flow margin.

Over the longer term, we still anticipate growth toward peers' free cash flow margins as the benefits from our improvement actions gain more traction and begin to drive a shorter conversion cycle. I want to make it very, very clear that we remain committed to delivering on our core operating results. Our achievements on those fronts so far, including our very solid start to 2023, give us confidence that we will be successful in delivering on those goals. Before turning it over to Andrew, I also want to update you on our grow, simplify, and transform initiatives. Our grow initiatives take advantage of the opportunities in both core and fast-growing markets using our analytics capabilities and specialist knowledge to help create a more valuable and differentiated client experience.

In Risk and Broking, our specialized approach, coupled with the strategic hires we've made over the past year, have driven accelerated growth. In Health, Wealth & Career, we've had success cross-selling new solutions and products alongside our core advisory work. Our focus on specialization has driven us to find improvements to existing solutions, new product innovation, and most recently, identification and successful execution on opportunities for strategic collaboration. For example, we just announced a partnership with Zurich involving digital trading within our broking platform, which leverages data to structure risks to allow for a more competitive placement experience. Another example of our strategic partnerships is our new relationship with Sapiens, a leading global provider of software for the insurance industry.

We've partnered with Sapiens to create integrated solutions to help insurers underwrite policies more efficiently. These are both great examples of how our innovations are driving growth by streamlining the very complex business of risk management and modernizing traditional broking while giving our customers a quicker and more efficient experience. A third example is our partnership with Transamerica to oversee administration and record keeping for our recently launched LifeSight Pooled Employer Plan in the U.S. This new product will allow employers to offer a market leading defined contribution plan and employee experience with limited demand on their internal resources. Shifting to our simplify initiatives, we believe our improved sales and retention outcomes have resulted in part from our efforts to streamline the back end shared operations of our businesses.

This has enabled us to deploy a more cohesive and consistent global model that leverages our scale and provides a smoother client experience from prospect to renewal. Our transformation program delivered $75 million of incremental annualized savings during the first quarter, consistent with the expected pacing of $100 million in incremental run rate savings we expect to generate from the program this year. This brings the total to $224 million in cumulative annualized savings since the program's inception. We continue to search for additional opportunities for savings. We believe we're making progress toward our long-term organic growth, margin expansion, and EPS targets. Continued execution of our strategic initiatives this quarter delivered healthy organic revenue growth, strong adjusted operating margin expansion, and further savings from our transformation program.

In closing, I want to thank our colleagues for their performance this quarter and their unwavering dedication. We are truly appreciative of their continued commitment to our vision and their relentless focus on our strategic priorities to grow, simplify, and transform. With that, I'll turn the call over to Andrew.

Andrew Krasner (CFO)

Thanks, Carl. Good morning, everyone. Thanks to all of you for joining us today. Our clients continue to face a host of economic challenges, including rising commercial insurance rates. Pricing increases appear to be moderating as our fourth quarter of 2022 commercial lines insurance pricing survey showed an aggregate increase of just below 5%. Data for nearly all lines continue to indicate price increases, with the exception of workers' compensation and directors and officers liability. The largest price increases came in commercial auto, followed by commercial property. We continue to focus on helping our clients with our specialized knowledge and Risk and Broking capabilities so they can make more informed decisions about how to best manage their risk in the current environment.

As Carl mentioned, we had a strong start to the year with first quarter revenue up 8% on an organic basis and solid growth across our portfolio of businesses. Our adjusted operating margin was 18.6%, a 140 basis point improvement over prior year, reflecting our growth and expense discipline along with the benefits of our transformation program. The net result was adjusted diluted earnings per share of $2.84, a 7% increase over the prior year. Let's turn to our detailed segment results. Note that to provide comparability with prior periods, all commentary regarding the results of our segments will be on an organic basis unless specifically stated otherwise. The Health, Wealth & Career segment generated revenue growth of 6% on both an organic and constant currency basis compared to the first quarter of last year.

Revenue for Health increased 8% for the quarter, primarily due to increased project work in North America related to helping clients implement legislative changes and manage plan costs, as well as from strong growth in international with new client appointments supplemented by healthcare inflation and increases in clients' covered populations. Wealth grew 4% in the first quarter. The growth was primarily attributable to higher levels of retirement work in Europe and North America, including compliance and de-risking projects along with new client acquisitions. This growth was partially offset by a nominal decrease in our investments business, which continued to be pressured by the declines in capital markets that occurred in the second half of 2022. Career experienced 4% growth in the quarter, driven by increased demand for advisory services and increases in data and software license sales.

Benefits Delivery and Outsourcing generated 7% growth in the quarter. The increase was driven by new outsourcing clients and compliance projects, plus strength in our individual marketplace with growth from higher volumes and placements of Medicare Advantage and life policies. HWC's operating margin was 24% this quarter compared to 20.7% in the same prior year period. This strong margin growth was primarily due to higher operating leverage. Risk and Broking revenue was up 10% on an organic basis and 5% on a constant currency basis compared to the prior year first quarter. Corporate Risk and Broking had an outstanding quarter with an organic revenue increase of 10% driven by growth across all regions and most lines of business, primarily from new business and improved retention.

As we've indicated, book of business settlement activity has slowed after the uptick over the last two years with only a one percentage point impact on organic growth for the quarter. Investment income was $12 million for the quarter due to higher rates and impacted organic growth for the quarter by one percentage point. North America had a strong quarter due to new and renewal business and increased retention, a result of the strategic investments and initiatives that Carl highlighted earlier. Europe also had solid new business performance across a number of product lines, including aerospace, financial solutions, and natural resources, as our focus on building and strengthening our industry and product specializations continues to deliver robust growth. International also contributed to organic growth with double-digit growth in all regions.

In the Insurance Consulting and Technology business, revenue was up 7% over the prior year period, primarily driven by increased sales and retention in technology solutions. RNB's operating margin was 19.9% for the first quarter, compared to 21.6% in the prior year first quarter. Margin headwinds reflect the inclusion of profits up until the date of deconsolidation from our now-divested Russia business in the comparable period. Absent this headwind, margins improved as a result of organic revenue growth in CRB, transformation savings, gain on sale, and interest income, partially offset by the run rate impact of 2022 strategic investment hires. As we expected, last year's key hires have begun to contribute to our performance in a meaningful way, as exemplified by the solid organic growth this quarter, and we continue to expect a ramp-up in production this year.

Let's turn to the enterprise level results. We generated profitable growth this quarter with our adjusted operating margin increasing 140 basis points to 18.6% from 17.2% in the prior year. This improvement reflects the benefits of higher operating leverage from the increased top-line growth and transformation-related savings, which we expect to continue to be a key contributor to our ongoing margin expansion and the attainment of our 2024 margin goals. Please note that the margin tailwind created by interest income and book of business settlement activity was offset by the margin headwind from the divestiture of our highly profitable Russia business, whose results were included in the prior year up until the date of deconsolidation. Foreign currency was a headwind on adjusted EPS of $0.06 for the first quarter, largely due to the strength of the US dollar.

Assuming today's rates continue for the remainder of the year, we expect a foreign currency headwind on adjusted earnings per share of $0.05. Our U.S. GAAP tax rate for the quarter was 19.5% versus 27.5% in the prior year. Our adjusted tax rate for the quarter was 20.5% compared to 21.1% in the prior year. The current quarter adjusted tax rate is lower, primarily due to the favorable impact of discrete items in the current year. The adjusted tax rate for the full year may increase moderately as a result of the U.K. corporate tax rate increase, which became effective on April 1st.

Our strong balance sheet gives us continued confidence in our ability to execute a disciplined capital allocation strategy that balances capital return to shareholders with internal investments and strategic M&A to deploy our capital in the highest return opportunities. During the quarter, we paid $87 million in dividends and repurchased approximately 432,000 shares for $104 million. We continue to view share repurchases as an attractive use of capital. We generated free cash flow of $92 million for the first quarter of 2023 compared to free cash flow of negative $10 million in the prior year. The $102 million year-over-year improvement in free cash flow was primarily driven by more favorable working capital improvements, resulting mostly from higher cash collections and lower discretionary compensation payments made in the current year quarter as compared to the prior year quarter.

Our Q1 results are reflective of the progress we've made since the beginning of 2022. We've come a long way, stabilizing the business, rebuilding our talent base, strengthening our organic revenue growth, and accelerating the transformation program to drive greater profitability in the future. We're committed to delivering the same success with free cash flow generation. Though our actions on free cash flow have not yet yielded results within the time frame we expected, we remain focused in the near term on driving meaningful improvement in our free cash flow margin for 2022's base of 8% free cash flow margin and, in the longer term, making continual progress and moving more towards peer levels. As free cash flow generation remains a high priority, we've made enhancements to our original improvement plans to strengthen our organizational focus on cash flow.

As you may have seen in our proxy statement, we have added free cash flow as a KPI for annual incentives in the executive compensation program and are working on implementing cash flow-linked KPIs for others in the organization to drive broader accountability across the company. In addition, we are focused on pursuing long-term structural and contractual improvements to the cash aspects of how our businesses operate. As you might expect, this is the area where we have the largest class of opportunities to improve, but those opportunities are the most time-consuming to realize. As a reminder, full year 2023 pension income is expected to be about $112 million. If this level of pension income remains consistent in 2024, it would pose a significant headwind to our 2024 adjusted EPS target. Pension income, which is sensitive to macroeconomic conditions, is remeasured at year-end.

Accordingly, we will provide additional guidance on our 2024 pension income expectations and the resulting impact to the adjusted EPS target when we release Q4 of 2023 earnings results. Overall, we are excited by the strong start to 2023, with business performance ramping up as expected and the benefits of our investments in talent and technology starting to meaningfully contribute to results. In addition, our successful transformation efforts and operating leverage have allowed us to continue to drive margin expansion. We have made consistent progress in our commitments for organic revenue growth and increased operating margins in EPS. With that, let's open it up for Q&A.

Operator (participant)

Thank you. At this time, we will conduct the question-and-answer session. As a reminder, to ask a question, you'll need to press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. Our first question today comes from C. Gregory Peters of Raymond James. Mr. Peters?

C. Gregory Peters (Managing Director and Equity Research Analyst)

Good morning, Carl and Andrew. I guess, let's kick off the Q&A with, you know, the organic and Risk and Broking seems to be accelerating. You know, looking over your comments in the slide deck, you know, at the same time, we're seeing some compression on operating margin. I guess as I think about that, maybe comment on, you know, where we are in the hiring cycle or reinvestment cycle of talent and, you know, how you think about organic. I know you don't really like to guide quarterly, but it seems like there's quarterly sequential improvement. How are you thinking about it for the balance of the year?

Carl Hess (CEO)

Sure, Greg, thanks. Good morning to you. I mean, we're actually very pleased, right, with the progress we've made in terms of the revenue acceleration in Risk and Broking. That's, you know, while there is some rate pressure, specifically in financial lines, and in our M&A business, where, you know, just simply economic activity in terms of merger acquisition has declined and that has an effect. We're actually really pleased with the momentum across the portfolio. We're growing particular global lines, and we continue to grow across all geographies. We do see the momentum building up the hires we've made since the last part of 2021 going into 2022.

These people continue to contribute, and we've seen momentum build up in what they're bringing to revenue and the bottom line, and we anticipate that to be a helpful accelerant during the rest of the year. In addition, the results in Insurance Consulting and Technology driven by software sales are encouraging. You know, this sort of recurring revenue helps build a base that continues to be a strong performer for us. The environment for our services remains one where we have a lot of optimism regarding that. You know, these are we are able to help clients with their risk management and risk mitigation strategies across a variety of macroeconomic conditions. I think we're pretty well poised for the year ahead.

We continue to look for good talent in the business. As I've said before, right, we'll never stop that. I think we've actually largely reloaded across the portfolio in terms of not having significant major gaps in what we're able to deliver to the marketplace, and that's been one of the reasons that the results are what they are.

Andrew Krasner (CFO)

Hi. Hey, Greg, it's Andrew. I think, just one other thing to think about as it relates to organic growth, you know, in Risk and Broking and across the enterprise as well, is that in Q2 of last year, there were, you know, $45 million of book sales. We just wanna be, you know, thoughtful about that going forward as it relates to organic growth. I think, you know, you also had a question around margin as well within the segment for the quarter. You know, Risk and Broking had a margin decrease of 170 basis points. Excluding interest income of $12 million and book gains of $7 million, the margin decrease was about 310 basis points.

However, interest income and book gains were more than offset by a $37 million operating income headwind from the deconsolidation of the Russia business, which happened in the first quarter of last year. That component equated to a 340 basis point margin headwind. Absent that, you know, some growth there in margin.

C. Gregory Peters (Managing Director and Equity Research Analyst)

Thank you for that. I just wanna follow up on that, on the margin headwinds. It feels like, you know, that we shouldn't be seeing these type of headwinds as we move through the year. Is there any point in time where you think you'll hit that inflection, where, you know, the hiring, you know, normalized hiring will reflect in the margin results? Clearly, Russia is now over with after first quarter. Just trying to see how you guys are thinking the cadence of margins this year.

Andrew Krasner (CFO)

Yeah. As you know, we don't give margin guidance by segment. you know, but with regard to the full year, we're excited about the trajectory for margin growth within Risk and Broking. As you know, we ensure, you know, to ensure we maximized our future growth potential, and as Carl mentioned, right, started making some meaningful investments in the revenue producing talent. We're now beginning to see those results, you know, from those investments to come through. We expect that momentum to continue. That combined with the efficiencies created from transformation, you know, we, you know, have confidence in the, you know, continued acceleration of margin improvement in that business over time.

C. Gregory Peters (Managing Director and Equity Research Analyst)

Makes sense. I guess the other question, I'll pivot to, you know, the free cash flow revision. You know, as part of your 2024 guidance, I know you slipped in a comment about EPS in Russia and the other headwinds there, or pension, excuse me. On free cash flow, can you talk about how the free cash flow update might affect your ability to buy stock back in the future? Maybe just give us an updated view on that.

Andrew Krasner (CFO)

Yeah, sure. You know, we, you know, think about, you know, share repurchases as, you know, one of the investment opportunities that we have, utilizing free cash flow. Of course, we balance the share purchase activity across other organic and inorganic investments and, you know, we monitor that, you know, continuously along with the rest of the capital structure. You know, we feel pretty good about our ability to, you know, continue to reinvest in share repurchases if that's the right reinvestment decision from the free cash flow.

C. Gregory Peters (Managing Director and Equity Research Analyst)

Just a point on the free cash flow guidance. Is there any unusual headwinds outside of restructuring that might hit 2023 that weren't in 2022?

Andrew Krasner (CFO)

Outside of transformation, nothing that we're currently anticipating or aware of.

C. Gregory Peters (Managing Director and Equity Research Analyst)

Got it. Thanks for your answers.

Carl Hess (CEO)

Okay, great. Thanks, Greg.

Operator (participant)

Thank you very much. As a reminder, your questions should be just one question and one follow-up. Our next question comes from Paul Newsome from Piper Sandler. Mr. Newsome?

Paul Newsome (Managing Director and Senior Research Analyst)

Good morning. Thanks for the call. Appreciate it. I'm sorry, I wanna beat on the free cash flow change. Could you really just kind of hone in a little bit more on what changed in the last three months that changed your thoughts? It just wasn't clear to me. I apologize if it's just me. Exactly what changed in the environment that changed your view on it?

Andrew Krasner (CFO)

Yeah, thanks. Thanks, Paul. It's Andrew. You know, so we previous believed that though there were headwinds and risks to overcome, there were also multiple potential paths open to us to meet our free cash flow target by the end of 2024. As you know, different circumstances and paths can produce very different cash flow results. You know, since February, we've updated our assessments of the various circumstances around free cash flow, including the progress of free cash flow improvement efforts, updated economic and financial market conditions, currency movements, business-specific dynamics, and the expected level of transformation spend. Based on those recent assessments, we believe the potential path to achieving the prior target by the end of 2024 have narrowed.

Therefore, you know, we updated our target for future free cash flow to reflect our view that while we believe we'll you know, make continual progress in improving free cash flow conversion, it's just likely to take us beyond the end of 2024 to realize the full opportunities that we see. You know, we've come a long way stabilizing the business, rebuilding our talent base, strengthening organic revenue growth, and accelerating the transformation program to drive greater profitability. We're still committed to delivering the same success with free cash flow generation. While we would have liked to have made more progress on it to date, it's just taking longer to achieve than some of the other financial goals.

Paul Newsome (Managing Director and Senior Research Analyst)

Similarly to the EPS goal, I mean, I would have thought that the best estimate of 2024's pension revenue would be this year's revenue. I think consensus is reflecting that a view that goal is gonna be difficult to achieve. Why not just sort of, you know, rip the Band-Aid off and lower the expectations?

Andrew Krasner (CFO)

Yeah.

Paul Newsome (Managing Director and Senior Research Analyst)

The expectations for EPS?

Andrew Krasner (CFO)

Yeah. We'll not know our expectations for pension income for 2024 until the end of 2023 when we perform our valuation, and, you know, expect to provide relevant updates at that time. You know, we're calling out the challenge presented by the pension income dynamics, you know, something we've talked about before and which has continued. If pension income, you know, remains pressured through 2023, and if dynamic continues in 2024, it will be meaningfully harder to reach our existing target than if pension income rebounded to where it had been in the past. Having said that, we remain focused on driving the organic growth, operating leverage and cost savings to achieve our long-term EPS target to help offset that headwind.

Operator (participant)

Thank you very much for your question. Our next question comes from Elyse Greenspan from Wells Fargo. Ms. Greenspan, your line is open.

Elyse Greenspan (Managing Director and Equity Research Analyst)

Hi. Thank you. Good morning. My first question, since you guys are, you know, calling out the pension income, obviously we have the free cash flow update, does that mean that, you know, you took another look, I guess, at the 2024 guidance and that you have confidence in the other components of the financial plan, your, you know, revenue target and margin goals? The only, I guess, component that there's concern about is pension income.

Carl Hess (CEO)

Hi, Elyse. Yeah, good morning. I think we're making great progress on our revenue goals and our margin goals. You know, things that we can control, we are driving through the organization and driving hard, and we're very happy with the progress we've made to date. You know, the reason we call out the pensions is, you know, that's driven by external interest rates and capital market returns. You know, despite having a market-leading investment business, those aren't things we can control.

Elyse Greenspan (Managing Director and Equity Research Analyst)

Thanks. My second question goes back to the RNB margin. I know you did call out some, you know, book of business gains last Q2, but you also get the benefit, right, that the investment income, you know, higher investment income that can come through this Q2. I just wanna understand the comments. It sounds like if we neutralize for Russia fiduciary investment income and book gains, right, maybe you would've got, you know, a little bit of margin improvement within RNB. If that's the case, I think it's around, you know, 30 basis points. Would you expect to at least see that 30 basis points of improvement from here?

I'm just particularly concerned with the leverage within RB, especially if you're able to continue to report high single digit organic revenue growth in the segment.

Andrew Krasner (CFO)

Yeah. Thanks, Elyse. Your math there is spot on. You know, as I said earlier, we don't guide on segment margins. We, you know, do expect that the, you know, margin trajectory, you know, to continue on a path, but, you know, it will be, you know, could be choppy quarter to quarter. We do have the, you know, potential headwind from the book sales from last year weighing on margin in Q2, for example. Over the long term, we're still very confident about the, you know, margin acceleration in that business.

Operator (participant)

Thank you very much for your question. Our next question comes from Andrew Kligerman of Credit Suisse.

Andrew Kligerman (Managing Director)

Hey, good morning. Maybe thinking about the organic revenue growth. You target mid-single digit, following 8% this quarter. You know, it strikes me that there could be materially more upside. I mean, I think your net hiring and Risk and Broking, just by our calculation, was up 7% year-over-year, maybe even more. Health, Wealth & Career, 4.5%. I get that you have a book of business headwind of $45 million in the second quarter, but you also had a 1.5 points benefit this year, this quarter from interest income, and that should persist through the year. You know, you've got inflation, which is helping drive up organic revenues.

We saw a big number from a competitor of yours. The question is that mid-single digit guidance around organic revenue growth? Is the bias for potential on the upside to that? Or, you know, what should we be thinking about?

Andrew Krasner (CFO)

Yeah, thanks, Andrew. I mean, we're obviously pretty pleased with our progress this quarter, and we do expect healthy growth for the rest of the year. You know, there is a lot of economic uncertainty out there, you know, despite the uncertainty, there's continued strong demand for our services across the portfolio. It is early in the year, right? We are not adjusting our mid-single digit organic expectations at this time. You're right, you know, the momentum in the business does look favorable. You know, that's one of the reasons we remain confident in our longer term goals, you know, closing the revenue gap with peers and continue to get to our long target, right?

You know, the strategic hiring we've made, the initiatives we talked about at the beginning of the call, all that's playing into the revenue momentum in the portfolio.

Andrew Kligerman (Managing Director)

Got it. Thank you for that. Second question, just moving back to the free cash flow in the quarter of $92 million. you know, by our expectation, we were thinking maybe you'd come in somewhere between $300 million-$400 million. just kinda hoping you could unpack what those pieces were that kinda came off course. Last quarter, despite a pressured free cash flow number, you seemed optimistic that you could still get into that 3-year figure of $4.3 billion-$5.3 billion. You figured there were ways to kinda maneuver to that. now we're looking at, you know, $92 million this quarter, and I'm wondering, you know, A, how did it get this low? What were the key pieces?

Two, you know, how do you get, you know, now that you've kind of tossed the 4-3 to 5-3, and what seemed like a good, you know, forget the margins, it seems like you could just get to $1.6, $1.7 a year. Is that something we could think about in 2025? Is that a real goal? I'll stop there.

Andrew Krasner (CFO)

Yeah, sure. Let me take that in two parts. I think first, just on the quarter, free cash flow. You know, I think this is the first time in a number of years where the free cash flow in the first quarter has been a positive number. It is typically a negative number just given it is when discretionary compensation payments are made. We feel very good about the free cash flow number for the first quarter of $92 million.

For, you know, the sort of long-term, sort of, view, which I think is what, is what you were getting at, around, you know, free cash flow generation. You know, we think we've provided sort of a balanced, view, right? For short and longer term guidance. We recognize that we have, you know, work to do in pursuit of our long-term free cash flow margin goal. We're confident that the areas we identified, you know, will help, you know, help us make sustainable, improvement. Over that long term, we do expect to see continual improvement in free cash flow margin, you know, towards peer levels.

Andrew Kligerman (Managing Director)

Okay. That, that kind of $4.3 billion-$5.3 billion, if you kind of annualize it by 2025, you think you can be in that kind of peer zone with, you know, that kind of annualized experience? Or is it still too early?

Carl Hess (CEO)

I think it's a bit early. Where we're focused on is, you know, continual improvement, you know, from where we are today and making sure that we work our way towards peer averages over the long term.

Andrew Kligerman (Managing Director)

Got it. Thanks a lot.

Carl Hess (CEO)

Okay. Thanks, Andrew.

Operator (participant)

Thank you very much. Our next question comes from Michael Zaremski from BMO. Your line is open.

Michael Zaremski (Senior Equity Research Analyst)

Hey. Great. Good morning. Okay, pension income. Any thoughts about the potential to close out some of the pension plans? If that's a possibility to take advantage of higher rates. Some of your peers have taken some structural, you know, actions and charges over the last many years to kind of minimize that volatility. Does that just not make sense from an economic perspective?

Carl Hess (CEO)

Our pension design is actually pretty immune. The open plan of the U.S., right, is the one where design changes might do anything. That's one where we've actually made design changes over prior years to reduce a lot of the volatility associated with a traditional defined benefit design. Our big plan in the U.K. is basically, doesn't have accruals for people anymore. You know, design changes wouldn't do anything there. The investment strategy we run against these plans is designed to largely preserve the funded status of the plan despite capital market interest rate fluctuations. Actually, if you look at the pension footnote, you'll see that those strategies did exactly what they were supposed to do during last year.

We're, we're pretty happy with how we managed the plans for stability.

Michael Zaremski (Senior Equity Research Analyst)

Okay. That, that's clear. Okay, last question. Just, you know, very good results in Health, Wealth & Career. Just curious, you know, with a 1% GDP backdrop in 1Q, you know, was results surprising to you? You know, one of your peers recently said on their earnings call that they feel that some of the services they provide are currently deemed to be a little less discretionary than they've been in prior decades, and kind of, as companies sort out this post-pandemic world. Any thought there? Thanks.

Carl Hess (CEO)

Yeah. We'll speak to the peers, but I think, the team has done a great job over the years of positioning us for growth under all sorts of different conditions. I do think that the relevance of the services we offer is as high as it's ever been, right? I mean, there's demand in our wealth business, for pension risk management solutions, that are indeed a bit more feasible under current economic conditions, for pension plan sponsors. There's been strong demand, for our health business. We have project activity due to legislative changes in North America and our continued expansion of our client base and helping our clients deal with healthcare inflation and the effect on their costs.

In our career business, where over the years we've taken the strong steps to make sure that, there's less an emphasis on discretionary project work and more on software and recurring revenue, continues to grow. Our, you know, the software licensing, that we're doing in that business has been a substantial part of that. Yeah, we're quite happy. You know, I guess I'd point out generally, you know, employers are still struggling with, you know, the new ways of working and the advice we can help, to help them cope with sort of, you know, the new normal in terms and, sort of, you know, the fact that despite, any potential recessionary crowds, employment levels still remain very high.

I do remain optimistic about the demand for our services in that area.

Operator (participant)

Thank you very much. Our next call comes from Robert Cox with Goldman Sachs. Your line is open. Mr. Hawkes? All right, we seem to have lost Mr. Cox. We'll move on to our next question. Our next question comes from David Motemaden from Evercore ISI. Your line is open.

David Motemaden (Senior Managing Director and Senior Equity Research Analyst)

Hey, good morning. I wanted to just ask on the free cash flow, I just wanted to get a better sense of some milestones that we can track, you know, from the 8% margin in 2022. You know, in the disclosure, you said that, or you mentioned the absence of one-time headwinds that will help you improve free cash flow meaningfully this year. That's obviously offset by the cost to achieve, for the transformation program. These one-time headwinds, that you're saying should help you improve, or the absence of these one-time headwinds that should help you improve free cash flow, could you size those for us?

Andrew Krasner (CFO)

Yeah. I think this is some of the detail, it's Andrew, that we had shared previously, we can definitely go through that again and provide some additional insight there. If you recall, there were about $200 million of headwinds from FX-related derivative payments. There was about $200 million of headwinds from tax-related timing payments, and also about $100 million of, you know, incremental one-time discretionary compensation payments that we had discussed.

David Motemaden (Senior Managing Director and Senior Equity Research Analyst)

Got it. Thank you. That's helpful. Thanks for laying those out for me. I somehow missed that.

Andrew Krasner (CFO)

Yeah, sure.

David Motemaden (Senior Managing Director and Senior Equity Research Analyst)

I guess, then the timing of the transformation program, I think there's still overall $536 million of cost to achieve that are, you know, will happen over the next couple years. Is it safe to assume that, you know, pretty equal, you know, spreading that out over the next couple years?

Andrew Krasner (CFO)

Yeah, I think that's fair. It does, you know, move around a bit, you know, quarter by quarter and year by year, you know, is when we, you know, when it hits the cash flow statement. Yeah, I think that's a safe assumption for now.

Operator (participant)

Thank you very much for your question. Our next question comes from Yaron Kinar with Jefferies. Your line is open. Mr. Kinar? All right, we can move on to our next question, which comes from Mark Marcon. Mr. Marcon is with Baird

Carl Hess (CEO)

Hey, good morning.

Operator (participant)

Your line is open.

Mark Marcon (Senior Research Analyst)

Good morning, Mark and Andrew. On Health, Wealth & Career, good, really good margin improvement. Can you elaborate a little bit on some of the key drivers there? Then, you know, I know careers, the discretionary element, you know, has been reduced, but, you know, we're starting to see some signs of cyclical, you know, slowing in some components of the economy. Are you seeing any evidence of your still remaining discretionary elements being pressured at all? How should we think about that with regards to the margins going forward?

Andrew Krasner (CFO)

It's Andrew. Thanks for the questions. On the first part regarding HWC's margin progress, I think there's really 2 components that you see there. 1 is the operating leverage just inherent in the business and 2, the impact of transformation savings more visible in the bottom line.

Mark Marcon (Senior Research Analyst)

With respect to Career, right? I mean, you start peeling back the hood and you look at the mix of services we have there, right? I mean, the demand for executive compensation services remains strong, and we believe that it will remain strong pretty much regardless of economic conditions. For work and rewards, in general, as I sort of talked about in the prior question, right, we do see continued demand for people to sort of, you know, deal with how the new ways of working affect compensation programs and benchmarking. And we've taken steps over the years, right, to, you know, be able to offer more of this as a software basis than discretionary consulting projects, which helps with the stability.

Carl Hess (CEO)

We've taken quite an initiative over the last few years to embed employee experience into all aspects of how we deliver services across Health, Wealth & Career. That's actually led to some substantial revenue momentum and demand for our employee portal software offering. We think that the business is far more resilient than it had been in times past. That's great. Obviously there's been all sorts of questions about the free cash flow, you know, target moving a little bit. You mentioned specifically, you know, changing the KPIs to emphasize from a behavioral perspective, you know, addressing some of the things that could accelerate free cash flow conversion. How long do you think it would take to get there?

Mark Marcon (Senior Research Analyst)

Like, you know, everybody's been asking, you know, does this mean 25 or 26 when we get to peer levels, you know, while we've got the public call going, is there a way to just say, you know, "Here are the specific things that we're doing and, you know, here's when we think would be a reasonable time period to accomplish that, or a conservative time period to accomplish it?

Andrew Krasner (CFO)

Yeah. I can go through some of the buckets of initiatives that we are focused on, but don't want to sort of get into specific timing 'cause we are quite focused on continual improvement in that area. You know, first is strengthening the organizational focus on free cash flow. You had mentioned the KPI for annual incentives, things of that nature. The second category is around working capital improvement opportunities across all of our businesses. We do currently see substantial opportunities across receivables, payables, and some of the other key working capital accounts.

The third area is around optimizing the cash generation profile of our business portfolio, and that, you know, that is, you know, as you might expect, one of the largest classes of opportunities, but also the most time-consuming to realize.

Operator (participant)

Thank you very much for your question. Our next question comes from Yaron Kinar with Jefferies. Happy to have you back. Your line is open.

Yaron Kinar (Lead Equity Research Analyst)

Thank you. Can you hear me now?

Operator (participant)

Yes, we can.

Carl Hess (CEO)

Yes, indeed, Yaron.

Yaron Kinar (Lead Equity Research Analyst)

Okay, great. Thanks, thanks for giving us a second opportunity here. I'll just start with continuing, I guess, down the line of questions on free cash flow. I think you mentioned that you expect a near-term meaningful improvement from 2022's margin of 8%. Do you also expect near-term improvement to 2022's free cash flow margin if we were to adjust back the one-time drags?

Andrew Krasner (CFO)

You do have to think about the transformation spend as part of that. We do, you know, expect to continue to make progress on that metric over time. You know, there may be some, you know, volatility inherent in that, but over the longer term, we do expect continual progress on that metric.

Yaron Kinar (Lead Equity Research Analyst)

With regards to the pension income and the potential drag to 2024 EPS guidance, can you maybe tell us what pension income levels or range were contemplated when the initial guidance was offered?

Carl Hess (CEO)

The initial guidance looked at a variety of, you know, different, economic scenarios. I don't think it was any one.

Yaron Kinar (Lead Equity Research Analyst)

Yeah.

Carl Hess (CEO)

Scenario for what was going on with pensions.

Andrew Krasner (CFO)

Right. I think what's changed was just the rapid, right, the pace of the movement in rates and capital returns that factored into that. It was, you know, originally set back in 2021. If you go back over, you know, the average of 7 years or so of investment, of pension income, you know, it was, you know, well north of $250 million. You know, I think just the macroeconomic environment changed, which drove sort of the big change in the pension income.

Yaron Kinar (Lead Equity Research Analyst)

Thank you.

Andrew Krasner (CFO)

Okay. Thank you.

Operator (participant)

Pardon me. Our next question comes from Charlie Lederer of Citi. Your line is open.

Charlie Lederer (VP and Research Analyst)

Hey, thanks. Good morning. Just looking at some of the drivers of strength in global lines over the last year or so, can you unpack if there are any particular lines that you're more excited about going forward? In aerospace specifically, can you talk about whether you're gaining share or more benefiting from a favorable environment?

Carl Hess (CEO)

We're very happy with the progress across all global lines. I did call out FINEX, where we've got particular challenges, not particular to us, but I think looking at anyone who's got a similar footprint, you're gonna find the same thing. It's a combination of rate and sector activity in M&A. The results are actually quite strong across the portfolio. I'm not gonna dive into particular concentrated areas, right, such as aerospace, but we're very happy with the performance of our teams and think we have great momentum going forward.

Charlie Lederer (VP and Research Analyst)

Okay, thanks. I guess, can you provide any color on TRANZACT's performance in the quarter? Wondering if you have a view on CMS's new Medicare marketing rules and whether that could have an impact going forward.

Carl Hess (CEO)

We're quite happy with TRANZACT's performance for the quarter. We expect continued growth for TRANZACT this year. We do view the issuance of the recent CMS regulations as a manageable event.

Operator (participant)

Thank you very much for your question. Our next question comes from Meyer Shields of Keefe, Bruyette & Woods. Your line is open.

Meyer Shields (Managing Director)

Thanks. I was hoping, pardon me, to get some color on where you see the needs for hiring now. Is it maintenance? Are there still some of the gaps that we saw in the aftermath of elevated attrition? I was hoping you could talk us through that.

Operator (participant)

I'm sorry, we seem to have an issue with the line. If you'll hold for just one moment.

Carl Hess (CEO)

I think we're back now, operator. I think I'd put it this way, right? We don't have major gaps anymore, Meyer, the way we did, you know, in late 21, 22. The teams have done a great job of bringing in talent across the organization, and that shows up in improved retention rates in the portfolio and some of the revenue acceleration we've seen in new business. We're quite happy with where we are. You know, as I said earlier, right, we'll always be on the lookout for good talent, because this is a people business, and good talent is how you continue to grow this business. We're happy with our human capital situation right now.

Meyer Shields (Managing Director)

Okay. Perfect. That's helpful. Second question. Does the revised free cash flow outlook impact your M&A potential or strategy?

Andrew Krasner (CFO)

Hi, it's Andrew. I think, you know, we're very comfortable with our capital position and the capital structure and the embedded financial flexibility that we have there to be able to take advantage of opportunities that come our way. No concern from our perspective there whatsoever.

Operator (participant)

Thank you very much. Our next question comes from Mark Hughes with Truist Securities. Mr. Hughes, your line is open.

Mark Hughes (Director of Equity Research)

Thanks. Good morning. On the wealth business, if we do see interest rates decline in coming quarters, how does that impact the pension project work? Maybe refresh me on that.

Carl Hess (CEO)

The wealth business has two components, right? We've got our retirement consulting business, which is, you know, largely recurring work, right? Valuations for pension plans, et cetera. We have project work in various sorts, including pension risk transfer. The market right now for pension risk transfer with funded status approved for pension plans across most major economies is a good one. Should rates decline, if equity markets rise in response to a rate decline, you probably wouldn't see deterioration in funded positions, which leaves pension risk transfer opportunities just as attractive for plan sponsors.

A lot of what we do is not just, you know, the actual transaction itself, but helping people monitor these conditions and determine whether, you know, other activities such as bulk lump sums might be attractive. We do anticipate continued demand in this particular area. I would point out that if you saw less demand for pension risk transfer, that's less assets leaving our investments business. We've got a bit of a hedge in the portfolio there.

Mark Hughes (Director of Equity Research)

Thank you.

Operator (participant)

Thank you, Mr. Hughes. Thank you everyone for your participation in today's conference. This does conclude our program, and you may now disconnect. Have a wonderful day.