Willis Towers Watson PLC Q2 FY2023 Earnings Call

Good morning. Welcome to the WTW Second Quarter 2023 Earnings Conference Call. Please refer to the wtwco.com for the press release and supplemental information that is 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 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 reconciliation 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.

Good morning, everyone. Thank you for joining us for WTW Second Quarter 2023 Earnings Call. Joining me today is Andrew Krasner, our Chief Financial Officer. We continue to see our strategic initiatives resonate strongly in the marketplace as reflected in the 7% organic revenue growth we recorded in the second quarter. This solid result reflected continued strong growth across our entire portfolio of businesses despite significant challenges from outsized book of business sales in each of our segments in the prior year. Excluding book of business activity, organic revenue growth at the enterprise level would have been 9%. We're very encouraged by the sustained top-line momentum and the positive response we've seen from clients to our investments in talented technology across all our businesses. At the same time, we faced margin headwinds from those investments as well as wage inflation in prior year book sales that limited our progress on driving margin expansion and earnings growth this quarter. The continued success of our transformation program, which exceeded our expectations yet again, partially offset these headwinds. All in all, adjusted operating margin declined by 90 basis points for the quarter, which resulted in adjusted earnings per share of $2.05. Though we had a decline in adjusted operating margin this quarter, as we've said before, our progress in margin expansion won't always be linear. However, we don't expect margin declines in any full year period. Earlier this morning, we reset our 2024 adjusted operating margin and adjusted EPS targets. These updates reflect our margin and earnings performance to date and as we've called out in the previous quarters, the pension income headwinds that based on current market conditions we do not expect to subside. Importantly, they also include our current assessment of the opportunities we see ahead of us with the benefit of being halfway through our 3-year plan. We lowered our 2024 target for adjusted operating margin to 22.5% to 23.5% from 23% to 24%. While some of the change stems from the slower pace at which we generate operating leverage, it primarily reflects our opportunistic decision to further invest in talent and other key strategic initiatives, especially in our Risk & Broking segment. This incremental investment will further strengthen our long-term market position and drive continued strong organic growth beyond the 2024 forecast period. To elaborate a bit on that decision, I want to say a few words about where our R&B segment stands today and the opportunity going forward. Our differentiated service offering, underpinned by our ability to adapt to our clients' changing needs, creates an incredibly compelling value proposition and the success of this strategy in R&B so far is evident through the strong organic growth we've been able to deliver. Our focus on specialization, innovation, and top-quality client service has generated substantial momentum and opportunities we did not have 18 months ago. Earlier this month, our Aerospace team won back the Airbus account, one of the largest in the sector, on the back of our strengthened value proposition. And that success is not just happening in Aerospace; our global lines of business, such as P&C, Marine, and Financial Solutions, have continued to deliver meaningfully above-market growth, including double-digit growth in the second quarter. In North America, the build-out of 12 identified industry divisions continues at pace with colleagues and infrastructure being aligned, and we expect most of this to be completed by year-end. Our traction in the marketplace has shown us there are even more opportunities here to deliver solid organic growth well into the future. But a fixed strategy is simply not an option in today's ever-changing risk landscape. To capitalize on these opportunities and meet client-specific needs, we're continuing to advance our specialization strategy and develop innovative products and services, which will distinguish us in a way to best attract clients and talent. This requires developing differentiated offerings, increasing strategic partnerships, and expanding our reach through platforms like MGAs, MGUs, and affinity products. Of course, high-quality talent is essential to drive these initiatives and turn our vision into a reality. And we see our rejuvenated strategy and independent brand becoming a load star for that talent, which will further fuel our success. We do appreciate the need to strike a balance between investing for incremental growth in the long-term and capturing savings in the near term. While this investment in talent will partially offset the savings from our transformation program, and tailwinds from higher investment income and lower pension service costs between now and 2024, we expect these efforts will drive greater operating leverage over the long-term as productivity improves and we realize more efficiency from increased scale. Running a successful business is never a straight line. It's a journey filled with triumph and challenges, and we've experienced both over the last 18 months. On one hand, the operating margin has benefited from our accelerated progress on the transformation program, interest income has been higher, and our pension-related service costs have been more favorable than originally expected. At the same time, macroeconomic conditions have dampened demand for interest rate-sensitive businesses, such as M&A, and the inflationary environment has put pressure on our operating costs, driving up wages and travel and entertainment. We are also focused on implementing cost-saving measures primarily focused on eliminating nonessential travel. While we've seen some progress in generating margin expansion from R&B, we know there is more to do; we remain confident that the right path to delivering margin expansion includes both driving organic revenue growth through our strategic investments and executing on transformation program savings and efficiency measures. As a core part of our strategic decision to invest further in our specialization strategy and our talent base, we are excited to welcome Lucy Clarke as the global leader of Risk & Broking in the third quarter of 2024. Lucy's committed to specialization, exceptional client service, and data and analytics, all directly aligned with WTW's competitive advantages and what we're doing in this space, making her the right person to accelerate the execution of our strategy. She has extraordinary market presence, a proven track record of delivering operational and financial results, and an intense focus on talent. We are delighted she is joining our team, and I look forward to welcoming Lucy to our team in the third quarter of 2024. Until then, Adam Garrard will continue to lead the segment. And after Lucy's arrival, Adam will become the Chairman of Risk and Broking. Now let me shift gears back to our updated 2024 adjusted EPS target. The revised target of $15.40 to $17 reflects the sizable pension income headwinds we've discussed on previous calls, a modestly higher expected tax rate, and the lower adjusted operating margin. The revised target also reflects a more narrow and precise range than our original figures given that we're halfway through our target period of 3 years. I've already talked about the drivers behind our margins. So let me take a minute to cover the other 2 items. The most significant driver influencing our change to our EPS target is a sizable decline in expected pension income since we set our original 2024 target almost 2 years ago. We originally expected pension income to contribute $2 to $2.50 to adjusted EPS. As we've communicated previously, the increase in interest rates and decline in capital market returns have created significant headwinds to pension income dynamics. As a result, we now expect pension income to contribute $0.35 to $0.85, less than half of our original estimate to adjusted EPS in 2024. The change in expected pension income accounts for approximately $1.65 of the overall change in EPS target. We continue to expect pension income of $112 million in 2023 and we'll update you on our 2024 pension expectations during our fourth quarter call after the remeasurement process. The second driver impacting the EPS target change stems from the modest increase in tax rate due to our updated estimates of future tax rates based on legislative changes. We expect the U.K. corporate tax rate increase will have a modest impact starting in 2023. While we continue to evaluate the OECD/G20 guidance on the Pillar 2 global minimum tax released earlier this year, we expect the legislative changes may further increase the rate in 2024 and forward. Now before I hand it over to Andrew, I want to step back for a moment and reflect on the progress of WTW since the tumult of 2021. In 2021, WTW had $9 billion of revenue, an adjusted operating margin of 19.9%, and EPS of $11.60. The full impact of the termination of the business combination was not reflected in the company's financial results at that time. That occurred in 2022 when organic growth slowed, book of business sale activity spiked, and we needed to make substantial investments in both talent and transformation-related activities to position the company for future growth. Since that time, we've stabilized our business, built our talent base, significantly strengthened organic revenue growth, optimized capital management, returned significant capital to shareholders, and are transforming and simplifying our company to drive greater profitability. We are in a far better place from where we started. We remain committed to our strategic priorities of growth, simplification, and transformation and we are delivering meaningful strategic progress against these initiatives. We can see their contributions to our performance, including organic growth in line with our payers and $277 million of transformation savings. We remain committed to improving our core operating results to reach our revised 2024 goals and drive long-term earnings growth. I want to thank our colleagues for their dedication and performance this quarter. We are truly appreciative of their continued dedication to our vision and their relentless focus on our strategic priorities to grow, simplify, and transform. And with that, I'll turn the call over to Andrew.

Thanks, Carl. Good morning, everyone. Thanks to all of you for joining us today. Before we delve into the financials, I want to provide some additional color on our free cash flow to help paint a clearer picture of our core free cash flow performance and our outlook. First, I want to explain why we are focused on free cash flow margin or free cash flow as a percentage of revenue rather than some of the other potential metrics. The noncash nature of our pension income can distort various free cash flow conversion calculations, whether you're calculating free cash flow conversion as a percentage of net income, adjusted net income or adjusted EBITDA. We, therefore, think free cash flow as a percentage of revenue or free cash flow margin is a clearer and more meaningful metric to track free cash flow. Next, I'd like to remind you of the nonrecurring items that impacted our 2022 cash flow performance. In 2022, our free cash flow margin decreased to 8%, reflecting strong revenue growth and margin expansion partially offset by some significant nonrecurring items, including delayed cash tax payments for the 2021 gains recorded in connection with the sale of Willis Re and the deal termination fee, realized losses on foreign currency hedges and onetime retention and executive compensation costs. Adjusted for these one-time headwinds, our 2022 free cash flow margin would have been approximately 14%. We consider this a normalized baseline for 2022. Adding the approximately 200 basis point increase in transformation-related spend for 2023 gets us to approximately 12% free cash flow margin, which we think is a reasonable guidepost for 2023. Looking beyond 2023, we expect to see free cash flow margin increase driven by improved cash conversion in our TRANZACT business and the abatement of transformation-related spend. Collectively, these items are expected to contribute over 400 basis points to our free cash flow margin over the long term. Starting from the 12% free cash flow margin expected for 2023, this expansion in free cash flow margin on top of our expected organic revenue growth should drive strong long-term growth in free cash flow. Additionally, we expect incremental upside driven by improved profitability and working capital improvement actions. Thus, we think 16% plus is a reasonable long-term guidepost. I'd like to spend a few minutes expanding on how we expect each of these components to contribute to greater free cash flow and improved working capital over the long term. Let's start with improved cash conversion at TRANZACT. About 8% of our revenue comes from TRANZACT, which has tripled in size since we acquired it in Q3 2019. However, the cash conversion dynamics of this business are different than the rest of our businesses. Q4 is TRANZACT's largest revenue quarter, and that revenue consists of both fees and commissions. The commissions, which reflect both our initial placement plus estimated future renewals can take up to 5 to 6 years in total for us to collect depending on the product. Meanwhile, we incur significant upfront cash costs to place the policies, creating a working capital headwind as the business grows. In 2022, growth in TRANZACT created an approximately 200 basis point headwind on our free cash flow margin. Over the last few years of rapid growth in that business, we have generated a long-term contract asset, which is essentially a large long-term receivable. We expect to collect this over multiple years as policies are renewed. As our TRANZACT business continues to mature and cash collections from earlier periods outpace the upfront cash outflows incurred in connection with the continued top-line growth, we expect this working capital headwind to subside and over time become a tailwind and begin contributing positively to free cash flow margin. Our overall individual marketplace strategy combines TRANZACT with its strong revenue growth prospects and current lower cash flow generation with a mature business of Extend Health, which has lower revenue growth, but strong cash flow. Together, the 2 businesses give us an overall Medicare operation with a strong growth profile and positive cash flow as was the case for 2022. Moving on to the impact of our Transformation Program. We made substantial progress on the program in 2022 and have accelerated that progress in 2023. Funding the Transformation Program required approximately $200 million in cash outflow in 2022, which translated to a roughly 230 basis point headwind to our free cash flow margin. Investment in the Transformation Program will continue to pressure our free cash flow until it is complete at the end of 2024. But beginning in 2025, the abatement of program-related spending will drive an increase in free cash flow margin. The last point I'd like to cover is the upside from greater profitability. We continue to expect to drive margin expansion from current levels to our target range over the next 6 quarters. As our adjusted operating margin grows, so too will our free cash flow margin. In addition, we expect some of our specific transformation program initiatives to have a positive, but more modest impact on free cash flow margin. Our finance and operational transformation initiatives include a number of tactical working capital improvement opportunities, such as centralizing and standardizing our billing and collections processes, expanding automation capabilities, and capturing long-term structural and contractual improvements to the cash aspects of how our businesses operate. Also, the transformation of our real estate footprint should reduce our long-term CapEx needs. Together, all of these actions, along with the continued adjusted operating margin expansion beyond 2024 should drive incremental improvements in our free cash flow margin above the roughly 400 basis points we've quantified. Turning to our results for the quarter. Our second quarter revenue was up 7% on an organic basis. Excluding book of business activity, organic revenue growth at the enterprise level would have been 9%. Our Transformation Program delivered $53 million of incremental annualized savings during the second quarter. This brings the total to $128 million in cumulative annualized savings this year, far exceeding our original target of $100 million of incremental savings for 2023. Accordingly, we're raising our guidance on cumulative run-rate transformation savings actioned by the end of 2023 to $160 million. The additional transformation savings we've identified also support an increase to the total annual cost savings we expect the program to deliver by the end of 2024 from over $360 million to $380 million. I will now discuss 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, and Career segment generated revenue growth of 5% on both an organic and constant currency basis compared to the second quarter of last year. The segment had solid organic revenue growth despite significant headwinds from book of business activity in the prior year, which negatively impacted organic revenue growth by 2 percentage points. We continue to see growth opportunities across the portfolio of businesses and expect that they will continue their growth trajectory for the rest of the year. Revenue for health increased 4% for the quarter or 9% when excluding the impact of book of business activity in the prior year, primarily due to natural portfolio growth and new client appointments in international and Europe and higher levels of project work at brokerage income in North America. Wealth grew 5% in the second quarter. The growth was primarily attributable to higher levels of retirement work in North America and Europe. Our investments business also contributed to organic revenue growth with new client acquisitions and higher fees related to value-added services. Career delivered 4% growth in the quarter, driven by increased demand for reward-based advisory services and higher compensation survey participation. Benefits Delivery & Outsourcing generated 7% growth in the quarter. The increase was driven by strength in the individual marketplace with growth from higher volumes and placements of Medicare Advantage and Life policies as well as increased project activity in outsourcing. HWC's operating margin decreased 40 basis points from the prior year second quarter to 18.3%. This margin decrease was primarily due to the impact of book of business activity, partially offset by transformation savings. Risk & Broking revenue was up 6% on an organic basis and on a constant currency basis compared to the prior year second quarter. Risk & Broking had strong organic revenue growth despite significant book of business headwinds and excluding the impact from book of business settlements, Risk & Broking grew 10%. Corporate Risk & Broking had another strong quarter and continued the positive growth trajectory we have seen over the last quarters with an organic revenue increase of 7%. Excluding book of business activity, CRB grew at 11% with double-digit growth in all geographies. This outstanding result is primarily driven by strong new business, continued improvement of our client retention, and strong contributions of 13% organic growth from our specialty lines like Marine, Financial Solutions, and large and complex P&C. Our specialty lines of business are a critical area for us and we are making meaningful investments to position us for long-term success, and we are growing at a much faster pace in these lines of business. Furthermore, while rate increases continue to have a positive impact, they had a more moderate impact compared to the prior year. Interest income was up $9 million for the quarter due to higher rates. As noted in our earnings release and as a result of the cessation of the co-broking agreement with Gallagher, interest income directly associated with Risk & Broking fiduciary funds will be allocated to the segment beginning in the third quarter of 2023. These amounts were previously allocated to the corporate segment. I would just point out that this will be done on a prospective basis only, and there is no impact to the Q2 numbers. North America had a strong quarter due to new business and increased retention. Europe also had solid new business performance across most product lines, including P&C, Marine, Aerospace, and Financial Solutions. International also contributed to organic growth led by Latin America. In the Insurance Consulting and Technology business, revenue was up 3% over the prior year period, driven by increased sales in Technology Solutions and higher project activity. R&B's operating margin was 16.1% for the second quarter compared to 19.7% in the prior year second quarter. Margin headwinds reflected the impact of the gain on sale from book of business activity in the prior year, along with the adverse timing impact from prior year incentive credits that have no impact on full year margins but negatively impacted the quarter. However, we saw an increase in our comp and ben run rate due to strategic investment hires. These key hires have begun to contribute to our performance in a meaningful way as exemplified by the strong organic growth for the first half of the year. We continue to expect a ramp-up in production which we anticipate will cover the increase in expenses. We are also facing expense headwinds due to the increased client activity and inflationary increases on travel, entertainment, and marketing, that we are actively managing with strict cost management actions, which we expect to yield a greater benefit in the second half of the year. Partially offsetting these margin headwinds were transformation savings that continue to contribute as planned as well as the impact of interest income. Turning back to enterprise-level results. Our adjusted operating margin was 14.6%, a 90 basis point decline over the prior year, primarily as a result of costs related to employee headcount increases and inflation as well as headwinds from the margin impact of book of business sales in the prior year. The decline in margin was partially offset by transformation savings as well as the impact of interest income. The net result was adjusted diluted earnings per share of $2.05. Foreign exchange had a de minimis impact on EPS for the second quarter. Assuming today's rates continue for the remainder of the year, we continue to expect a foreign currency headwind on adjusted earnings per share of $0.05 for the year. Our U.S. GAAP tax rate for the quarter was 19.8% versus 10.5% in the prior year. Our adjusted tax rate for the quarter was 23.7% compared to 20.5% in the prior year reflecting the nonrecurring nature of discrete tax benefits reflected in the prior year rate. 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 $90 million in dividends and repurchased approximately 1.5 million shares for $350 million. Given our confidence in achieving the plan we've laid out, we continue to view share repurchases as an attractive use of capital to create long-term shareholder value. We also actively manage our leverage profile by issuing $750 million of new debt in May, and a portion of those proceeds will be used to pay our debt with an upcoming maturity in the third quarter. We generated free cash flow of $350 million for the second quarter of 2023, compared to free cash flow of $198 million in the prior year. The improvement of $152 million is primarily due to the non-recurrence of payments made in the prior year for certain discretionary compensation and taxes for onetime gains recorded in connection with the Willis Re sale and the income receipt related to deal termination. These tailwinds were partially offset by increased transformation program-related costs. Overall, while we recognize we have more to do, we continue to be encouraged by the meaningful traction we are getting with clients through our strategic initiatives. Delivering strong organic revenue growth is a prerequisite for sustainably growing margins, EPS, and free cash flow. We are confident in our market position and in our ability to deliver on the improvement opportunities we see today. With that, let's open it up for Q&A.

My first question is on the 2024 guidance. Carl, obviously, last year, you pulled lower guidance for Russia; there were some changes to free cash flow. Just trying to get a sense of why is this the last cut? I mean, I imagine maybe you went through and stress tested all the components of guidance to put forth something that you won't have to revise again in January with fourth quarter earnings. But any thoughts there?

Yes. Good morning, Elyse. Obviously, we prefer never to be revising at all. But we do try and take a measured approach. And when we finally think that, look, there's, as we said before, no path that we could see towards our guidance, we want to be upfront with that. As we looked into this quarter, we saw on the pension side; we just didn't see a path to pension income to be at the levels that we had thought it might be going to 2024. We thought it was the time to take a look and revise the EPS target. On the margins, right, the new target really reflects our decision to further invest in talent and the key strategic initiatives that Andrew described, especially in R&B, because we think we are in a fabulous position to capitalize on growth opportunities. We're continuing to advance our specialization strategy and develop innovative products and services to further differentiate our offerings and position ourselves to attract the best clients and talent; that is working. We are doubling down on it.

And then my follow-up, Carl, would be on the margin comment, right? So like you guys have had success with your savings program, but it doesn't seem like that's coming into numbers even though you provided up the target. So is that benefiting margins? Is it more coming later than expected? I just would have thought that that could have absorbed and helped offset some of the impact of the incremental hiring, right, that you're attributing the lower margin to.

Elyse, it's Andrew. No, it is absolutely helping offset or mitigate some of the continued and the increased planned investment. And I think what you're seeing is there's some more pressure on the Risk & Broking margins. And while we're incredibly happy with the progress and the organic growth within that business, we recognize there's more to do on margin expansion, both in the short term and the long term. I want to reassure you that we know where the margin drags are and already taking action to address those. Let me walk you through them and I'll start with the short term. So on a year-over-year basis, the most significant headwind was the book of business sales, right? And that's about 270 of the 360 basis point decline within the quarter. In the second half, we anticipate similar levels of book sales as last year. The quarterly pacing of those may vary, but second half over second half should be pretty similar. The rest is attributable to some short-term headwinds, partially offset by the savings from transformation. The short-term headwinds are from T&E and our continued investments in talent. In T&E, we're seeing the effects of inflation as well as the increase in travel post-COVID. We're working to manage this by implementing mandates around essential travel, fare caps, things of that nature. We've already seen some improvement in the T&E costs from these actions and expect that to accelerate during the second half of the year. On talent, the short-term margin headwinds are just from the gradual and lumpy ramp in productivity for new hires. We continue to expect a ramp in that production, which we do anticipate is going to cover the investments and yield a greater benefit going forward. So as a result of all that, we see the current margin headwinds as temporary and do continue to expect margin expansion within the Risk & Broking and the enterprise on an annual basis.

Let me expand on that, Andrew. Our investments in talent have exceeded our projections so far. While we haven't reached our goals yet, the pace of progress has been better than we expected, which is encouraging. Looking ahead beyond this year, we believe there's a great opportunity to enhance and expand our operations. We are successfully attracting talented individuals, which motivates us to commit further to our initiatives. Most of our investments are in talent, but we are also focusing on areas such as MGAs and MGUs, enhancing our affinity platform, and advancing our technology within the ICT sector to support the insurance industry where we see significant demand. Our focus on talent is aimed at bringing in high-performing individuals who can effectively utilize our platform, aligned with our specialization strategy. We understand this investment may result in temporary margin pressure, typically for about 12 to 18 months until we achieve full productivity from these new hires. A year ago, our goal was primarily about filling gaps and rebuilding teams after experiencing high turnover due to business disruptions. Now, our approach is more proactive, seeking talent that will drive the most profitable and fastest-growing segments of our business, particularly in the global lines mentioned earlier. I want to emphasize that we are shifting our focus from merely filling positions to a more aggressive strategy aimed at growth.

Our next question comes from Gregory Peters. One moment as we bring him to stage.

Thank you for providing more information about the free cash flow. My first question focuses on Slide 15, where you mention the long-term free cash flow target of 16%. It seems that the spending for the transformation program will soon conclude, which should be beneficial. The expected improvement in profitability appears achievable. However, I am concerned about the cash conversion in the TRANZACT business, as it has been challenging for others in converting this into free cash flow. Additionally, the slide on free cash flow didn't address Days Sales Outstanding, which has previously been a factor for the company in enhancing free cash flow. Could you provide further insights on this slide?

Yes, sure. Greg, it's Andrew. I'll start with the DSO component there. So we do expect incremental benefit from tactical working capital actions focused on opportunities that we see. And that sort of gets reflected in the long-term view on Page 15 in the plus symbol there, if you will. Some of the other actions, of course, do lead to improved working capital management as well. So that is absolutely factored into our plans over the longer term for improved free cash flow margin. Specifically, with regard to TRANZACT, when we bought that business, we did expect it to be a high-growth business, and we have far exceeded our initial expectations in that regard. And I think that's a testament to the compelling offering that the company provides to its customers and the dedication of its team members in that business. As mentioned in the prepared remarks, the business creates a working capital headwind as it grows. And since we're required to incur significant upfront cash costs, it takes about 5 to 6 years, depending on the product, to eventually collect all the cash for a sale or a substantial portion of the cash for a sale. But we were fully aware of the cash flow dynamics, right, at the time we acquired it, and it has evolved as expected. We continue to see improvement in that area as the business grows and matures. We do have that long-term receivable, which we can continue to focus on and will collect over time. We expect the business to become cash positive sometime in the next few years. And in the meantime, we do expect that drag to decline.

Okay. Fair enough. My follow-up question will focus on margins, and I know you've addressed it in your prepared comments; you just answered Elyse's questions on this topic. You discussed book sales and recruiting. From a margin improvement standpoint, I was a bit disappointed with the second-quarter results, as I expected some benefits to be reported. So when you mentioned book sales, will there be more negative impact from book sales in the second half of this year? Additionally, regarding recruiting, will there be more margin pressure from recruiting in the second half of this year compared to the first half?

Yes, sure. Let me start with the book sale question. So we do expect some level of book sale activity in the second half of the year. However, we do expect it to be roughly on par with the book sale activity in the second half of last year. The quarterly pacing of that may vary, but in aggregate over the second half should be pretty comparable.

Okay. With regard to recruiting, Greg, I guess one thing I'd note is sort of open positions of the company are at half the level they were a year ago. And so that should give you an idea of sort of overall where we're trying to do with recruitment. However, I want to point out that I think we're at a point in time, and yes, Lucy Clarke's arrival, I think, is a testament to this where the choice we've made very deliberately to specialize within R&B is it's the foundation of our growth, and it is significantly attractive to people who can actually help us generate revenue. We think that this is the time to capitalize on that. And so we do think that targeted investments in our global lines and our industry strategy, this is exactly the right time for those to be paying off. So we're going to be looking to actively find that talent.

Our next question comes from Paul Newsome of Piper Sandler.

I have another question regarding book sales. When analyzing the profit margins of the businesses, are the margins from book sales comparable to those of the rest of the business, or do the book sales contribute to margin compression for the company as these businesses are sold?

Yes. The books that we're selling generally have the same economic profile and margin profile as the broader business. So there's nothing specific about the margins of the businesses or books that we're selling.

That makes more modeling easier. Second question, a lot of what your peers have done with respect to margin improvement over time came to some very careful divestitures of businesses that you'll see every quarter from them. How does that fit into your strategy as well, if at all? Looking at sort of divesting? Are you looking at divesting some of these businesses that might have lower margins as well?

Yes. We won't comment on any specific M&A actions. But as you can imagine, portfolio management is always front and center for us. And of course, we do look across the broad base of our businesses to make strategic decisions about that portfolio.

And I'd add, we use that for our acquisition strategy as well. We're looking for businesses where we can be a better owner than the current owner.

Our next question comes from David Motemaden from Evercore.

I just had a question just on the new margin range for next year, the 22.5% to 23.5%. Could you just help me understand and think through some of the pluses and minuses that would help you be at the high end versus the low end of that outlook?

Yes, I believe that part of it will come from ongoing investment in talent and platforms, which will influence the payback period for those investments. Additionally, the speed at which we see operating leverage from the Transformation Program and any incremental savings from it will be another key factor. The timing of these elements will impact the boundaries of that range.

And then I'll just add demand across various parts of our business, right? So while I think we've got a very diversified portfolio and that has enabled us to weather storms, we do try to take advantage of conditions as we find them, like sort of demand across the portfolio, as you can see from the segment numbers; the growth remains strong there, and we're looking to make sure we stay focused on the areas where we see the strongest demand in the marketplace, whether that's in the specialty lines within R&B, our Health and Benefits Business, and focus within our Career business in a place where we see demand, which is sort of coping with new ways of working in the new normal. I'd also add, there's upside in our wealth business, especially if capital markets stay up and, in fact, we're collecting a percentage of asset fees across a large chunk of our investments business.

Yes, got it. That makes sense. And then I guess I was just on some of the hiring that you've made up to this point. Maybe you can help me understand just how far along you are in the ramp of production of those hires? And are we sort of hitting like a peak in terms of how those hires you've made in the past can contribute? And is that partially why you're sort of making additional strategic investments, or maybe you could just help me understand where we are in terms of the ramp-up of the hires you've made up to this point?

We are quite pleased with the progress of our 2022 cohort of hires; they have performed better than we anticipated at this stage. However, they are not yet fully productive, which we typically expect to take around 12 to 18 months, and we are currently averaging about 12 months on that timeline. The 2023 hires, being fewer in number and only half a year into their tenure, are meeting our expectations, although it is still early in their development. Looking ahead, we see robust demand for our specialized approach and believe we can attract talent based on our unique focus, which sets us apart from others. This supports our strategy and demonstrates its appeal to clients who want us to advance. While we find the performance of the 2022 and 2023 hires encouraging, it is not simply a matter of continuing with the same approach; it confirms our strategic direction.

Our question comes from the line of Meyer Shields from Keefe, Bruyette, & Woods.

This is on for Meyer. I just have a question on length. So given how well the organic growth has been playing out, do you guys see any changes in your investment?

Any changes in the investment given the organic growth?

Yes, yes, yes.

No. I think as Carl just alluded to, we do see continued opportunity for talent in the market. So we're not sort of filling gaps at this point as we had been historically. This is more about leaning forward and being on the offensive with regard to our talent investment strategy where we continue to see really strong opportunity for talent that aligns with our specialization strategy.

Got it. My second question is about the free cash flow guidance. I know you provided long-term guidance of 16%, but I'm curious if the improved 12% guidance for this year through to 2024 is linear or if you can provide some additional details on that.

Yes. I mean, yes, we do expect continuous improvement, but we haven't given any specific free cash flow margin guidance for 2024.

Our next question comes from Mark Marcon from Baird.

Regarding the margin change, you've reduced the margin guidance by about 50 basis points at the midpoint. Is that enough to enhance the talent pipeline? Additionally, considering the morale and retention of your long-term associates, do you believe this will significantly impact further engagement and productivity?

I believe that the 50 basis points provide us the flexibility we need. We can tailor compensation, which is highly variable for us, particularly in client engagements, to address the impact of recruitment. When it comes to morale, one of our key considerations is whether new hires will integrate well with the team, and this has been our historical approach. We expect this will continue to be central to our strategy. This aligns well with our specialization strategy, as we are not seeking individual performers; our focus is on a collaborative approach to helping clients manage risks through data and analytics. This fosters commitment and encourages a team-based environment. Overall, we see a positive cycle in our strategy that simplifies team building and reduces potential morale disruptions.

That's great. And then what's the tax rate that you're assuming for the '24 EPS targets?

Yes. We haven't specifically given that information, but if you think about the current year adjusted tax rate, it is modestly higher, as of now, year-to-date, and we expect something modestly higher on a full year basis year-over-year.

Our next question comes from Michael Zaremski from BMO.

Okay. Great. And on the free cash flow, thanks for the added color. I just want to confirm that the pension income levels or the pension changes in terms of the impacting your EPS that doesn't flow through to cash flow, right?

Correct. The pension income is noncash.

Okay. Got it. Okay. Switching gears to the segments. You've talked a lot about, and you have been for a number of quarters by investing in talent opportunistically, is this also happening in the Health, Wealth, and Career segment a bit? I just asked because margins were a little light there as well versus expectations.

We observe that talent is attracted to our Health, Wealth, and Career segment, although the situation is somewhat different compared to our Retirement & Benefits segment. We have a highly successful wealth business with a strong market position, which typically doesn't require extensive recruiting efforts. Instead, our recruitment is more concentrated in health and benefits, where we see a chance to increase our market share. We believe our global broking position allows us to keep leveraging this opportunity.

Our next question comes from Yaron Kinar from Jefferies.

My first question, Carl, is about the explanations regarding the lowered guidance for '24. It sounded to me like, excluding the pension aspect, the trends in interest and inflation were generally negative. If I understood that correctly, it seems a bit counterintuitive to my expectations of what the net impact from the broker would be. I would appreciate hearing more about that.

So when I was talking about interest rates being negative, it was with respect to the pension, right? It wasn't in respect of the fact that we do receive more interest income.

I thought you'd also talked about the pressure from higher interest rate environments on M&A activity and on operating costs, right?

No, I think the factors involved are somewhat difficult to sort out. However, we do have a significant scale, similar to others, in our M&A-focused brokering business, and the current freeze in that market is clearly detrimental. As I mentioned, it's a bit more complicated.

Yes. But I guess if we take a step back, and again, excluding the pension element, wouldn't the higher interest rate and higher inflation environment be a net positive holistically?

Not necessarily. I think it depends on the impact of inflation on different components of the income statement. So obviously, there's been a lot of wage inflation over the last 2 years, and that's not just related to new hires, right? That does impact our existing wage base. There is inflation. We talked about the cost of travel has gone up meaningfully, things of that nature, that are mitigated, right, by the impact of fiduciary income. But as Carl mentioned, we do have some interest rate-sensitive businesses, right, that get impacted by that as well like M&A-related products.

Yes. So I guess I would not call it a huge negative, but it's not nearly the positive you might take on looking at some components alone.

Okay. I appreciate that. And then if we flip to the pension component specifically, if I'm doing the math correctly. The midpoint of the new guidance, you're talking about roughly $80 million worth of pension income in '24. And I understand we'll get another update at year-end. But if that math is roughly correct, can you maybe explain why we'd see another, call it, 30% reduction in pension income year-over-year when capital markets are actually up year-to-date, and I think the level of interest rate increases has moderated a bit?

Yes. When considering our pension plans, the asset mixes play a significant role. Our largest plan is the U.K. plan, which has minimal equity exposure due to a close asset-liability match. This plan is quite sensitive to interest rates and inflation levels because of the indexation of U.K. pension liabilities. The U.S. plan has a different strategy, combining both bonds and other assets. Within the return-seeking asset pool, there is a substantial portion of alternative assets and other diversifying strategies that do not necessarily align with public equity market movements. This approach helps mitigate downside risks but sacrifices some potential gains during strong equity market periods.

Our next question comes from Mike Ward from Citi.

Andrew mentioned that strong commercial pricing was not as beneficial this quarter. We have been hearing about strength from peers and primary sources. I am curious if you are changing commissions or if it's just the comparisons. Any insights would be appreciated.

If you examine the rates on the commercial risk side, we are experiencing flat single-digit increases or even slight decreases based on local market conditions. Rate increases across various lines are slowing down, although there are still some lines, particularly U.S. property, where no reductions are currently observed. It's important to note that we operate globally, so our portfolio may not reflect typical trends seen by others. However, in property lines exposed to catastrophes, rate increases are still occurring. The casualty segment is different, as there is more stability in the global portfolio with relatively modest rating increases being implemented.

Got it. And then I think Carl mentioned potential upside in the wealth business. Any update on the outlook for that one in the second half with markets being where they are?

Yes. Currently, pension funding levels are quite strong compared to historical rates, making the potential for pension risk transfer activities high, and we hold a leading position in this area. Additionally, our investment business, which is significantly based on compensation from basis points, benefits from increased asset levels.

Our next question comes from the line of Brian Meredith of UBS.

Two questions here. Carl, I'm just curious, in the 2024 guidance, what is embedded with respect to the economic outlook? What would happen if nominal GDP goes, let's call it, 2%, 3%, would it be challenging to make your kind of guidance targets? And then what else are you embedded in that with respect to the commercial lines pricing environment?

So with respect to rate, I mean, we and brokerage aren't necessarily as sensitive to rate. It is the carriers in that, and I think I've made this point in prior calls, right, when rates skyrocket, our clients will just simply retain more risk to try and manage their budgets. So we don't see rate as having a major effect on our prospects for '24. I think with respect to sort of general economic conditions, as long as they're generally manageable, we've got a portfolio of businesses that has shown resilience in sort of good times and bad. And so providing clients are so paralyzed by volatility that they aren't willing to make decisions, we tend to do okay.

Got you. So a recession or something should matter?

A sharp and sudden recession, where clients must adjust their plans unexpectedly, is not necessarily beneficial. However, it may increase the demand for consulting projects that help manage changing conditions.

Our next question comes from the line of John McDonald from Needham.

Hi, thank you. I wanted to circle back on the pension changes, specifically the drivers behind it. You mentioned that you have a large portion of your U.K. pension funds invested in bonds, which could be negatively impacted in a rising U.K. interest rate environment. But given increased volatility and lower returns, has there been any discussion around examining pension fund allocation or restructuring a portion of your pension fund investments to reflect changes in the economic environment?

Yes. As part of our regular process, we are evaluating the strategic philosophy when it comes to our pension assets. And our ongoing conversations with our advisors include considerations around any changes needed due to changing interest rate environments. We continue to monitor those closely, but for now we believe that our current strategy is still appropriate.

Our last question comes from the line of Rob Cox from Goldman Sachs. It appears that we do not have Mr. Cox, so we will go on that as our last question. I'll give one moment to see if anyone else would like to ask questions. As I am showing no further questions at this time, and we have no closing remarks, that concludes our session. Thank you for participating in today's meeting.