WILLIS TOWERS WATSON PLC quarterly report, Q2 FY2017

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Willis Towers Watson plc — Q2 2017 Form 10-Q

Reporting period: Three and six months ended June 30, 2017. Figures are in U.S. dollars; financial statement amounts are in millions unless stated otherwise. WTW is a global advisory, broking and solutions company operating across Human Capital and Benefits (HCB), Corporate Risk and Broking (CRB), Investment, Risk and Reinsurance (IRR), and Exchange Solutions (ES).

Financial performance and liquidity

  • Q2 revenue: $1.953 billion, up less than 1% reported year over year; up 2% at constant currency. Foreign exchange reduced revenue by $43 million. Q2 commissions and fees were $1.930 billion.
  • First-half revenue: $4.272 billion, up 2% reported and 4% at constant currency; foreign exchange reduced revenue by $93 million. Organic growth was also 4%.
  • Profit and margins: Q2 operating income was $124 million versus $136 million; operating margin was approximately 6.3% versus 7.0%. Net income attributable to WTW was $33 million versus $72 million, and diluted EPS was $0.24 versus $0.51. First-half operating income was $587 million versus $462 million; operating margin was approximately 13.7% versus 11.0%. Attributable net income was $377 million versus $310 million, and diluted EPS was $2.75 versus $2.25.
  • Adjusted measures: Q2 adjusted operating income was $363 million versus $357 million; adjusted EBITDA was $387 million versus $406 million; adjusted diluted EPS was $1.45 versus $1.66. First-half adjusted operating income was $1.044 billion versus $1.003 billion; adjusted EBITDA was $1.095 billion versus $1.077 billion; adjusted diluted EPS was $5.18 versus $5.04. These are non-GAAP measures.
  • Cash flow: First-half operating cash flow was $319 million, down from $436 million. Free cash flow, as defined by WTW, was $200 million versus $344 million. Investing activities used $155 million; financing activities used $196 million. Cash ended the period at $852 million, compared with $870 million at year-end 2016.
  • Debt and liquidity: Total debt was $4.182 billion, up from $3.865 billion at December 31, 2016; net debt was approximately $3.330 billion. WTW reported $722 million available under its $1.25 billion revolving facility and compliance with financial covenants. Management said available liquidity was sufficient for expected needs over the next 12 months. Fiduciary assets and liabilities were each $12.751 billion and are not available for corporate purposes.
  • Capital returns and investment: WTW repurchased $296 million of shares in the first half and paid $137 million in dividends. The quarterly dividend was raised to $0.53 per share. Approximately $837 million remained under the repurchase authority. First-half fixed-asset and internal-software additions were $119 million; the company estimated another approximately $130 million for the remainder of 2017.

Material changes and operating drivers

  • Q2 revenue growth was led by ES, whose commissions and fees increased 15% to $178 million. HCB and CRB commissions and fees declined 2% and were broadly flat, respectively; IRR commissions and fees increased 1%. IRR’s prior-year comparison included a $41 million settlement receipt, contributing to lower reported segment revenue in Q2 2017.
  • For the first half, HCB commissions and fees rose 1%, CRB 1%, IRR 1%, and ES 13%, reported. Management cited strong HCB healthcare consulting demand and increased utilization, solid CRB international business, and ES exchange growth.
  • Q2 attributable earnings fell 54% year over year despite nearly flat revenue. Management cited lower operating income and $30 million of other expense, compared with $6 million of other income in Q2 2016, including foreign-exchange hedging and balance-sheet remeasurement impacts.
  • First-half operating income improved, supported by $89 million of additional revenue and $36 million lower total service costs. Salary and benefit costs fell, reflecting integration and restructuring savings; integration expense increased to $103 million for the half, principally from ERP migration and real-estate consolidation.
  • Operating cash flow and free cash flow declined year over year. Management attributed the decrease primarily to working-capital movements, higher discretionary compensation payments for the 2016 cycle, and higher capital spending.

Outlook, risks and unusual items

  • WTW expected ES revenue growth to moderate to around 10% in 2017 as retiree enrollments stabilized, while active-exchange growth was expected to remain strong. No consolidated full-year revenue or earnings guidance was provided in the supplied filing text.
  • The Operational Improvement Program was expected to generate $130 million of restructuring costs in 2017, its final year, bringing cumulative program charges to approximately $440 million.
  • Management expected interest expense to increase over the rest of 2017, citing the expected increase in the Federal Funds rate. It also described Brexit’s effects as uncertain, while expecting a neutral-to-slightly-positive impact over the next few years. Currency movements, insurance-market conditions, seasonality, competition and integration execution remain relevant business risks.
  • Litigation and regulatory matters: The proposed $120 million Stanford litigation settlement remained subject to court approval and bar orders; approval could fail or be challenged. In the City of Houston actuarial lawsuit, the plaintiff’s expert asserted approximately $430 million of past damages and approximately $400 million of future damages on a present-value basis; WTW disputed the claims and could not estimate a reasonably possible loss. The FCA opened a formal investigation into possible agreements or concerted practices in aviation broking; WTW could not estimate potential loss.
  • WTW accrued a $9.75 million proposed settlement in the CalPERS long-term-care matter, pending court approval. The Meriter matter was settled for an amount not materially above prior accruals; the court dismissed the claims with prejudice on July 27, 2017. These matters and the Stanford settlement should be monitored for subsequent developments.
  • Other notable items include a $5 million Q2 settlement receipt in HCB relating to the loss of a Florida team; a $19 million first-half tax impact from an internal reorganization; and continued Venezuelan currency and foreign-exchange impacts. WTW disclosed that ERP-system migrations materially affected internal controls during the quarter; management said disclosure controls were effective and described ongoing updates to affected internal controls.
  • WTW planned to adopt the new revenue standard on January 1, 2018 using the modified retrospective method. It expected accelerated recognition for certain Retiree Medicare Exchange commissions and changes to deferred-cost accounting; the full financial effect remained under assessment.

Most important facts for investors to verify

  • Whether reported growth translates into sustained organic growth and improved GAAP operating margins, particularly after restructuring, integration and amortization costs.
  • Whether operating cash flow and free cash flow recover, and how working capital, compensation payments and capital expenditures affect conversion of earnings to cash.
  • Debt trajectory, refinancing costs, revolving-facility availability and the capacity to fund dividends and the remaining share-repurchase authorization.
  • Developments and potential exposure in the Stanford, City of Houston, CalPERS and FCA matters, including required approvals and any changes to recorded provisions.
  • Actual 2017 restructuring costs and savings, ERP integration execution and the effects of the 2018 revenue-recognition transition.
  • Whether ES growth moderates as management anticipated, and whether segment trends and currency effects align with the reported and constant-currency results.