I think we're good here. Thank you very much everyone for attending what is Stifel 2018 Cross Sector Insight Conference. Appreciate everyone being here. I'm Shlomo Rosenbaum, business services analyst from Stifel. Joining me today is Mike Burwell, the Chief Financial Officer of Willis Towers Watson. The presentation format is really fireside chat minus the cigars. I'm just going to ask Mike to give an introduction to the company, just a general overview. I'm going to start off with just asking some questions about some of the key debate items that I hear from investors. We're going to open this up, and I highly encourage people, investors to ask questions and anything you wanted to do, and hold Mike's feet to the fire.
Great.
Mike, if you wouldn't mind giving us an introduction.
Sure. First is, I guess we need to move the next slide, right? You know what this stuff, right? Just make sure we do that. Next slide. Thanks. I've been at Willis Towers Watson for seven months. I was at PricewaterhouseCoopers for 31 years prior to that. It's been great. Enjoyed the role so far. Just a reminder back, Willis Towers Watson came together between Willis and Towers Watson, two $4 billion businesses that came together to create an $8 billion business today, that last year generated EBITDA of $23.2. Roughly 43,000 people are colleagues, and we operate in 140 countries. Half the business is New York or North America based. Just make sure you guys are paying attention. When we look at it, we look at obviously 22% in GB, 16% in Western Europe and 12% international.
The biggest segment we have is overall human capital and brokerage business or HCB business in terms of what it is that we do, which is the biggest piece of it. Second piece of it is our brokerage business or CRB. Third is our IRR business, and we have what we call benefits delivery and administration, which has principally been our exchange business overall. That's principally the company. It's gone through this merger since 2016 in terms of these two companies coming together.
Maybe just as you start out, one of my first questions is going to be just dealing with talking about the merger. Maybe talk about what was legacy Towers Watson, what was Willis, and just really quickly, the rationale for putting these two companies together.
Yeah, sure, Shlomo. The two companies coming together was not a normal scale merger. The Towers Watson side was in the retirement area, consulting, HR consulting, and benefits administration. You had the Willis side that was insurance and reinsurance principally in terms of the largest components to it. Those two businesses come together and a view that advisory, brokerage, and consulting was really where the market was going to be into the future, and that's actually what's happened two and a half years into it. That indeed was John's vision in terms of how he saw the two companies coming together. Frankly, the individual who was running Willis at the time had the same view. They had the same strategic view in terms of bringing the company together. I would say 2016, in terms of the merger, was a bit rocky.
Candidly, internationally we had some blips that have since improved. I think John's focus overall, again, I've been here seven months, but at that time was a bit around do you understand what it means to be profitable businesses? Willis had had a history of setting expectations and maybe not meeting those expectations over a period of time, as I understand it. A lot of what I call adjustments or earnings before bad stuff kind of stuff. That was really not where we needed to be going forward. 2016 was a bit of a rocky road. As you move into 2017, John then assessed who really understood what it meant to drive profitable growth. One of those individuals, he then changed out Tim Wright, who was running our CRB business, or think about it as our brokerage business.
He put Todd Jones into that role, and asked Todd to really drive it going forward. Todd really did three things, and that is that he focused on retention of clients. He said, "Hey, look, when I look at the broker and the support structure, much like lawyers even, that can move down the street pretty easy. How do I bring infrastructure behind that to support that such that they're Willis Towers Watson clients, not my clients?" We've seen our retention rates go from 93%-95% overall in the business. Second thing he did is he took a layer of middle management out, and he changed out of our 25 market leaders in North America, he changed out 12 of them. It didn't just happen. He went in the role in December 2016.
In the third quarter of 2017, you really saw our growth higher than our competitors in terms of organic growth. That continued out in the fourth quarter of 2017 and continued on in the first quarter of 2018. What you saw was this evolution of two companies coming together, who's on first, how do we work together, continued acceleration in terms of serving clients, some management changes. Then we've continued to see acceleration happen through the first quarter of 2018, where the market was definitely looking for a third option beyond MMC and Aon in our perspective. Those are great companies run by very good management teams. At the scale before, at $4 billion, we're not able to play at the same levels, and financial history that wasn't there. In the first quarter of 2018, we had 17% new business generation happening overall.
We're continuing to see that traction, Shlomo.
The rocky start, there's a lot of, I would say, legacy Willis investors that have come from a position of disbelief. I would say the 2016 rocky start after the merger gave them at least something to point to say, "Hey, this company is kind of what we'd seen before." There's been a change recently. What comfort can investors have that really the ship has been righted and the merger is now at a point where they could feel comfortable with the revenue growth trajectory, the margin expansion? What can you say now, though, to say, "Hey, we are now at a position that you can be comfortable that we're not going to see another rocky road?
Yeah. Good question. I think it starts with the management philosophy of meeting or exceeding expectations is high on John and my priority list in terms of what it is that we set as objectives. I think second is that we're trying to reduce the level of adjustments that we have. I was being a bit of a smart aleck, but in terms of the level of adjustments, we really tried to reduce those down, and it really is depreciation and amortization from the merger. For example, what do I mean by that? In the fourth quarter of last year, we took a charge in HCB and in our IRR business due to some restructuring actions. We didn't adjust those out.
Okay.
They weren't big numbers, but we didn't adjust them out. It's not saying that let's try to reduce between reported and adjusted is really a very small item in terms of how we think about things. I think if you look back to the last three quarters, organic growth has been greater than our competition. We like to believe that that's a very good trend. Now three quarters doesn't make a year, but three quarters in a row and continuing to make those expectations, I think is there. The only thing we think about is trust. How do I make trust is I meet or exceed expectations over time, and that's what we're really trying to do, and that's what we hope we can then help the former Willis shareholders understand that is over time that we can build that trust.
One of the things is retention of clients. The other issue that people talk about is retention of people internally in the company. Some of the discussion when there was a growth kind of rocky start was that maybe you were losing people that are really integral to the business. Can you talk about how many people did you retain that you wanted to retain? There's always some kind of loss of personnel when there's a merger.
Yeah.
There's the part that you want and the part you don't want, I guess focus on the part you didn't want, and where are you today in terms of that?
Yeah. We did lose some people we didn't want to lose at the time of the merger, to be candid about it. We did. What we've been very focused on is the culture in the organization. What we think about is making it a place that we hold people accountable for, but that they feel that they have the right interactions, the right behaviors are important elements to setting the expectations of what we want individuals to be. The level of resumes that we're seeing today, the people that want to join Willis Towers Watson is double from the number we saw back in 2016, both at the producer level and to the organization. Which to me speaks to how strong the culture is that John's built and that I've now become a part of. How did I join the company? Why did I come here?
Was the culture. Was an important element to me in terms of how we're thinking about operating the business. To be honest with you, Shlomo, look, we lost some people in 2016. I don't think they were devastating to the company, but there were some people we lost. I haven't seen that to be the case. I see the culture building. I see it as a pretty exciting proposition, and the level of volume is there, and our producer turnover is less than 10%. It's not like people are exiting the place.
Okay, thanks. One other thing I just wanted to throw out that there's the accounting change between ASC 605 and 606 has had a little bit more of an outsized impact on your company than I've seen with other companies. John, who's the CEO, when the merger came together, his incentive compensation was based on ASC 605, and the world was moving to ASC 606. Because of that change, we're seeing the estimates and essentially the guidance was moved down because of the accounting change. Maybe you could explain to everybody why the investors should really focus on the 605 and why that's indicative this year of the actual performance versus the 606, which is where the accounting standard's going to be going forward.
Yeah, no, that's a really good question, Shlomo. Well, first let's dissect what did 606 mean to Willis Towers Watson.
From an accountant's point of view.
I'll just do a high level. I won't go to the Everybody was at different starting points, which were all GAAP before. Essentially, there were two things that are principally driving our change. Think about our change in revenue is about, I'll use round numbers, $300 million change in the way we report on a ASC 605 versus ASC 606, and that's a revenue number that was less.
Okay.
Why? What we had done in our health and benefits business was we would recognize revenue when we wrote the contracts. The accounting standard says you need to amortize it over the life of that particular contract going forward. It changed that particular piece of the number. The second one is in our BDA business, our benefit delivery and administration business, where we would record it over the life of the contract, and now you have to record it in the fourth quarter. Those two adjustments were the biggest two adjustments that happened without going through all the nuances in the accounting. We're continuing because we had done this merger in 2016 to go back and restate those records. Our competitors were able to go back and restate those numbers.
For us, because of how much technology consulting we do in the business, as well as going back to that purchase accounting, I'm not saying it was impossible, but it was as close to difficult as you could get. The accounting rules allowed us to say, okay, then report ASC 606 and ASC 605. That's indeed what we've done. The analyst community, except for you, and a couple others, had a difficult time going through and understanding what exactly the implications would be of that going forward. In our first-quarter analyst call, we got a lot of questions about our margins. John and I and Ida were looking at each other saying, "Hey, we're feeling pretty good about our numbers." Our organic growth is third quarter in a row. We're greater than our competitors.
We're up 250 basis points in terms of on a ASC 605 basis around our margin. Yet people were not happy with our margin views. We're like, well, because where your model is. Now, look, part of that's us to have to help with that education process as well. This is new ground, and we're all working it together. There was that disconnect between those two. We're running the company on ASC 605. We are reporting and getting people comfortable with ASC 606, and I think it'll take to the first quarter of 2019 to people all be at the same spot and then really have comparables in terms of thinking about it. I think particularly the insurance sell-side analysts have wanted to stay with ASC 606.
I think 605 is quite candidly the way to look at us or at least both in some ways in terms of thinking about it, would be my thoughts.
It normalizes next year, right?
It does.
That's one of the things that I've been also pointing out to people that as it normalizes next year, this is a one-time event, not a next year event. I was going to poll in case. Does anybody have any questions that they wanted? This is your opportunity, CFO of the company. Go ahead. I'll repeat the question, by the way. The question was how much of the profitability is tied to the insurance rate environment, and what do they see the environment going forward in the insurance market?
Good question. Thank you. We have seen a continued decline until this year when I say this year, back to 2017, first part of 2018, in terms of renewal seasons decline in terms of rates. We've seen a flattening or stabilization of it. If I were to say rate impacts, I'd say 0%-1%. It's no different why is because in me sitting as a CFO of Willis Towers Watson, I look at how do I manage our risk profile, and I'm willing to say, what can I take in terms of deductibility or deductibles? Overall, am I willing to take a little bit more risk in terms of thinking about it? It's principally the rate increases have been in the P&C space, principally, or as we think about it, our cat and property with cat has really been the space overall.
I don't see big price in terms of coming back for us. Frankly, when we see the market decline, what we do, some people will look at how do I take on more insurance overall. We have seen areas that cyber's been growing pretty rapidly for us. Obviously with the GDP growth, we've obviously seen companies growing and therefore needing more insurance as well. Hopefully that's responsive to your question.
I guess I'll throw one out over here. One, in terms of the free cash flow of the business, the company is really coming to the end of the merger and the integration and the charges. Based on what was said on the Analyst Day, you're going to really see the free cash flow, frankly, probably double this year from what it was the year before. If you take the guidance out or I guess we won't call it guidance, but the goals out a couple of years, you're talking about a business that could be generating $1.6 billion-$1.8 billion of free cash flow. Number one, are my calculations right?
Number two, if that is right, and with the difference between the share price that the multiples you're trading at and the competitors, why won't you just take advantage of this opportunity, take on a little bit more leverage, buy in the stock at this point?
It's a good question, Shlomo. First is, we want to stay investment grade. In our review with Moody's and S&P, and the Moody's calculation, we've constantly wanted to stay at investment grade overall. We've been really trying to pay down and versus leveraging ourselves up has been trying to get our EBITDA to debt down a little bit comparison to where we've been because we have been spending on these programs overall. We did start a buyback program April 1st. It's running. We'll have required about $400 million shares probably by the end of August based on what we see. We'll continue to go down that particular path. To your question or comment is what we see as a target operating model is 3%-4% organic growth.
We see 2%-3% inorganic growth. We're building behind that as a platform to be able to put acquisitions on, of course, at 3% productivity. If you think about that as a 10% return and we're paying dividends at 20%-25% of stock value, that's another point and a half. We're looking at 10%-12% of the target operating model into your calculations. We're looking at saying over the next three to five years that we should be generating 75%-80% of adjusted EBITDA in terms of free cash flow. Why do we see the private equity firms rolling up brokerage businesses is because where interest rates are. They generate a lot of cash. You should be able to pay down that debt. We're very focused on saying, we see their organic growth rate.
We're seeing new business come into place. We like the culture. We need to deliver on that cash flow number. This year will be the first down payment on that. That's clearly a big focus of the company in terms of delivering against those cash flow numbers.
Do you have wiggle room with what you see that has been one time that you could explain to Moody's and S&P to be able to pull forward some of what you're talking about? Both of them are here today, by the way.
Yeah. Well, they're important partners in terms of helping us go through that process. We do want them to understand what's happening. We have a meeting coming up with them in August, and we will take them through what's going on. We have been trying to reduce, again, the amount of reported versus adjustments. Making sure we reduce the OIP program that was in place, activity that happened last year. At the end of this year, we'll be done with the restructuring actions that we, or integration activities that we had had to be in place. I think the story should be pretty good after three quarters and hopefully after four.
Okay. Is there other questions then? Richard.
The insurance brokerage side, I mean, three quarters of managed
Yep.
What is that attributed to? What about changing the culture? What else is driving?
Just to repeat the question, the question was that the company has outperformed on the insurance brokerage side for the last three quarters its main peers. What can you attribute that to? What's driving that outperformance?
Thank you for the question. What I would say is the market was looking for a third option. Before, and these will be approximate numbers, but MMC at $14 billion, $15 billion in terms of revenue, Aon at $13 billion range before the divestiture of the Hewitt business. You had Willis sitting there at $4 billion overall, and kind of a rocky road in terms of its financial performance. The market looked at it and said, "Are you really a viable player?" Now you're $8.5 billion in revenue, and you bring forth this consulting practice that we've been consulting, and that Towers Watson had been consulting to the banks. We don't call it data analytics, but it's data analytics. We're bringing that insight.
Not only are you credible, but in terms of the market wanting a third option, you've got credibility in terms of scale, size, and you're bringing insight that's different from a data analytics standpoint. That's why we're driving 17% new business growth in the first quarter of 2018, that's indeed what we're seeing. I would also say our cyber position. Cyber has doubled for us in the last 12 months. We believe it'll continue to be a very strong grower for us going forward. Because we have focused on the connection between culture and cyber risk. We teamed with IBM to bring on the backside in terms of technology, but we really had that HR front end that's been really growing for us. Those are the kinds of things that we're seeing happening in the brokerage space.
There's a question over here.
Following the merger of these two very great companies, have there been any change in the approach towards retaining risk on goods when it comes to specialty risk, [audio distortion] , or has the policy just been taken forward from these two companies?
The question is, after the merger of the two companies, has there been a change in the philosophy of the company in terms of retaining risk versus what it had been before?
I would say we're probably a little bit less risky, to tell you the truth, would be my view. I don't mean that in the sense that just John as a CEO is not about he's not afraid of taking risk at all, but it's managing risk. He thinks about what's the overall enterprise risk, how do we manage risk in the company itself, and then where do we place that risk overall. I was hesitating because I wouldn't say we're not afraid to take on risk, but at the same time, we're not going that we continue to be very risky in terms of our approach. It's kind of somewhere in between in terms of how we think about things.
I think it's setting expectations and really trying to meet or exceed those over time, but not setting them that they're ridiculous, and so that there's no way in heck you're ever going to meet them. He doesn't want them slam dunks, but he doesn't want them that they're just far-reaching goals that you'd never get to. Hopefully it gives you some sense of the philosophy. Yeah.
At PwC, you were very active role in shake up the business over there. Now that you've taken the role over there, which areas do you want to bring to the direction?
The question was, at PwC, Mike was very active in shaking up the business, and given what John has done, do you have a chance to shake it up over here as well?
Yeah. I think the answer to that's yes. The opportunities that we see are continued down the technology route. One of the roles I'd had at PwC was to be the transformation leader for the whole organization. In doing that, I'd spent a lot of time with various technology players, whether it was Microsoft, Google, IBM, Apple, et cetera. I had probably spent the better part of 50 weeks in Silicon Valley over the last four years. I think about we're doing a lot in technology, but can we do more, and how do we think about that? I'm bringing part of that to the table. I think, too, is DSO and cash flow. It's about changing a battleship and moving us in a different direction. This focus on cash flow is a key component that I'm driving overall. It's not easy.
I know it's not easy in terms of doing it, I've done it before. I've seen this playbook. When I benchmark us versus others, I see opportunity. Again, I see that overall. I also think how we buy and procure things is something that we can do a bit differently than we've been doing heretofore, as well as thinking about how we continue to refine our back office operations. We continue to move everything to the cloud and cloud platforms. We believe that that's going to create a back office and operating leverage for us going forward. When we think about that 2%-3% inorganic growth that Shlomo and I had talked about, we're looking and saying, well, to drive that 3% productivity, one plus one's got to equal one.
I've got to have operating leverage that I can drive in the back office, and I've been there and done that before. I guess those would be the things that I would share with you.
Okay. Thank you very much, Mike. We appreciate it, and thank you, everyone, for attending.
Thanks, Shlomo.