Willis Towers Watson plc — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; unaudited. Amounts are in U.S. dollars. WTW is a global advisory, broking and solutions company operating across Human Capital and Benefits, Corporate Risk and Broking, Investment, Risk and Reinsurance, and Benefits Delivery and Administration. Results are seasonal, with commissions and fees generally higher in the first and fourth quarters.
Financial performance and position
- Revenue: Q3 revenue was $1.852 billion, up 4% from $1.777 billion; nine-month revenue was $6.124 billion, up 3% reported and 4% at constant currency. Nine-month organic growth was 4%.
- Profit and EPS: Q3 net loss attributable to WTW was $54 million, or $0.40 per diluted share, versus a $32 million loss, or $0.23 per share, a year earlier. Nine-month attributable net income rose to $323 million from $278 million; diluted EPS was $2.36 versus $2.00.
- Operating results and margins: Q3 GAAP operating income was $41 million versus $1 million; nine-month operating income was $628 million versus $463 million. Adjusted operating income, a non-GAAP measure, was $287 million for Q3 and $1.331 billion year to date, compared with $243 million and $1.246 billion, respectively. Approximate adjusted operating margins were 15.5% for Q3 and 21.7% year to date in 2017.
- Cash flow: Nine-month operating cash flow was $515 million, down from $621 million; free cash flow, as defined by the company, was $317 million versus $470 million. Investing used $262 million, and financing used $246 million. Cash at period-end was $912 million, compared with $870 million at year-end 2016.
- Debt and liquidity: Total debt was $4.578 billion, up from $3.865 billion at year-end; cash less total debt was approximately $3.666 billion. The $1.25 billion revolving facility had $329 million available to draw. WTW said it expected to have sufficient liquidity for the next 12 months and reported compliance with financial covenants. Fiduciary funds are restricted and unavailable for corporate purposes.
- Other balance-sheet metrics: Total assets were $32.272 billion and shareholders’ equity was $9.915 billion. Fiduciary assets and matching liabilities were each $12.206 billion. The company declared a quarterly dividend of $0.53 per share.
Changes versus comparable periods
- Q3 revenue growth was broad-based; BDA commissions and fees increased 11%, CRB 5%, IRR 3%, and HCB 2% year over year. Year-to-date BDA commissions and fees grew 12%.
- Q3 GAAP net loss widened by $22 million despite higher revenue, reflecting increased transaction and integration costs, income tax expense, and other expense. The quarter included $74 million of transaction and integration expenses and a $10 million loss on disposal of the Global Wealth Solutions business.
- Nine-month adjusted operating income increased 7%, supported by revenue growth and lower salaries and benefits from integration and restructuring savings. However, operating cash flow and free cash flow declined, chiefly due to working-capital movements, higher capital spending, and higher discretionary compensation payments.
- Total debt rose by $713 million from year-end, while the capitalization ratio increased to 31.6% from 27.7%. The company issued $650 million of 3.6% senior notes due 2024 and refinanced debt, including repayment of 2017 notes.
Outlook, commentary, risks and unusual items
- WTW did not provide a consolidated full-year revenue or earnings forecast in the supplied filing text. Management said BDA revenue growth was expected to slow to around 10% in 2017 as retiree enrollments stabilize, while Group Marketplace growth was expected to remain strong.
- The Operational Improvement Program was expected to incur about $130 million of restructuring costs in 2017, its final year, bringing cumulative charges to approximately $440 million. Nine-month 2017 restructuring costs were $85 million.
- A $211 million settlement resolved the Merger-related appraisal demands in September 2017; related Towers Watson shares were canceled. Separately, the $120 million Stanford litigation settlement had court approval but remained subject to appeals; WTW said it would not pay until appeals were resolved in its favor and no further appeal remained.
- Other material legal and regulatory matters include the City of Houston pension-actuary lawsuit, with the company unable to estimate a reasonably possible loss; the CalPERS long-term-care matter, with a proposed $9.75 million settlement awaiting final approval; and European aviation-broking and U.K. investment-consulting investigations, for which loss estimates were unavailable. WTW disputed the allegations in the litigation.
- Management identified risks including soft insurance markets, competition, integration and restructuring execution, foreign exchange and Brexit uncertainty, litigation and regulatory outcomes, pension exposures, and cybersecurity or data breaches. The company stated disclosure controls were effective; U.K. and Irish operations underwent a material system migration during the quarter, with controls updated for the implementation.
- WTW planned to adopt the new revenue standard on January 1, 2018 using the modified retrospective method. It expected accelerated recognition for Retiree Medicare Exchange commissions and changes to deferred-cost accounting; the full financial effect was still under assessment.
Most important facts for investors to verify
- Whether the Stanford settlement appeals are resolved and the $120 million payment and required bar orders become final.
- The ultimate exposure and resolution of the City of Houston case and the aviation-broking and investment-consulting investigations.
- Whether Q3’s GAAP loss and elevated integration costs are temporary, and how non-GAAP adjustments reconcile to reported results.
- The drivers of lower operating and free cash flow, and the company’s capacity to fund debt service, dividends, repurchases and restructuring commitments.
- The realized growth and margin trajectory in BDA and other segments, including the expected 2017 BDA slowdown and the 2018 revenue-recognition transition.