Business context and reporting period
Willis Towers Watson plc (WTW) is a global advisory, insurance broking and solutions company. This unaudited Form 10-Q covers the three and nine months ended September 30, 2020; comparisons are with the corresponding 2019 periods. Amounts below are U.S. dollars.
WTW reports four segments: Human Capital and Benefits (HCB), Corporate Risk and Broking (CRB), Investment, Risk and Reinsurance (IRR), and Benefits Delivery and Administration (BDA).
Financial performance and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $2.009 billion | $1.989 billion | $6.588 billion | $6.349 billion |
| Operating income | $73 million | $107 million | $596 million | $642 million |
| Operating margin | 3.6% | 5.4% | 9.0% | 10.1% |
| Net income attributable to WTW | $121 million | $75 million | $520 million | $500 million |
| Diluted EPS | $0.93 | $0.58 | $3.99 | $3.84 |
Management’s non-GAAP adjusted operating income was $238 million in Q3 (11.8% margin), versus $231 million (11.6%) a year earlier; for nine months it was $1.059 billion (16.1% margin), versus $1.022 billion (16.1%). Adjusted diluted EPS was $1.33 for Q3 and $6.47 for nine months, compared with $1.31 and $6.06, respectively. These non-GAAP measures exclude specified items and are not substitutes for GAAP results.
Revenue grew 1% as reported in Q3, but organic revenue declined 1%; for nine months, reported revenue grew 4% and organic revenue grew 1%. Segment revenue trends were mixed: Q3 HCB declined 1%, CRB was approximately flat, IRR increased 2%, and BDA increased 26% (including TRANZACT). For nine months, HCB declined 1%, CRB grew 1%, IRR grew 3%, and BDA grew 51%, including acquisition effects.
Q3 net income rose primarily because of the Max Matthiessen divestiture gain, despite lower operating income. Other income included an $85 million Q3 gain on disposal; the nine-month gain was $83 million. The nine-month effective tax rate was 27.1%, versus 19.3%, including $38 million of CARES Act-related tax expense. Q3 also included an $11 million deferred tax expense from U.K. statutory tax rate changes.
For the nine months, operating cash flow was $1.206 billion, versus $620 million; company-defined free cash flow was $1.023 billion, versus $445 million. Management attributed the improvement primarily to working capital. Investing cash outflow was $108 million, compared with $1.531 billion, largely reflecting the prior-year TRANZACT acquisition and current-year divestiture proceeds. Financing cash outflow was $334 million, including $259 million of dividends.
At September 30, cash and cash equivalents were $1.647 billion, compared with $887 million at December 31, 2019. Total debt was $5.614 billion, broadly unchanged from $5.617 billion; $973 million was classified as current, including $500 million and $449 million of senior notes due in 2021. The $1.25 billion revolving credit facility was undrawn, and WTW reported compliance with financial covenants. Management said available liquidity was sufficient for expected needs over the next 12 months. Fiduciary assets and matching liabilities were each $15.560 billion; fiduciary funds are generally restricted and are not available for corporate debt service or other corporate purposes.
Material changes, outlook and risks
- COVID-19: Management said the pandemic negatively affected revenue growth, particularly discretionary services, but generally had no material impact on overall results through Q3. WTW expected continued negative effects on revenue and operating results for the remainder of 2020 and beyond, with uncertain duration and severity. Potential effects include delayed client payments, weaker demand, coverage disputes and increased professional liability exposure.
- Aon combination: The proposed transaction provides for 1.08 Aon shares per WTW share. Both shareholder groups approved it on August 26, 2020, but regulatory approvals and other closing conditions remained outstanding, including the U.S. Department of Justice Second Request. The parties expected closing in the first half of 2021; completion and timing were not assured.
- Operating costs and unusual items: Q3 transaction and integration costs were $42 million, primarily related to the proposed Aon combination. Nine-month costs were $65 million. Nine-month depreciation included a $35 million accelerated charge for abandoned internal software. The company recorded a $15 million Q3 litigation provision related to legacy merger litigation.
- Divestiture: WTW sold its majority-owned Swedish subsidiary Max Matthiessen in September for stated consideration of SEK 2.3 billion (approximately $262 million), plus adjustments, and recorded a tax-exempt gain. A SEK 600 million (approximately $68 million) purchaser note is included in non-current assets and is subject to repayment terms.
- Legal and regulatory contingencies: Legacy merger-related securities litigation was class-certified, and plaintiffs indicated class-wide damages of approximately $456 million; defendants disputed the allegations and were pursuing defenses. The Stanford settlement involves a $120 million payment, but WTW said it would not pay until the settlement is no longer subject to appeal; petitions for Supreme Court review were pending. WTW could not estimate reasonably possible losses from aviation broking competition investigations in the E.U. and Brazil. The filing says other litigation outcomes could materially affect particular periods.
- Market and execution risks: Management described modest improvement in insurance pricing, while noting that softer pricing can pressure commissions and margins. Other cited risks include seasonality, foreign exchange, Brexit, LIBOR transition, cybersecurity and remote-work resilience, regulatory change, and the ability to complete and integrate the Aon transaction.
- Capital allocation: WTW paid $259 million of dividends in the first nine months and approved a $0.68-per-share quarterly dividend, paid October 15, 2020. No shares were repurchased during the period, and the board did not expect repurchases for the remainder of 2020 due to transaction-agreement restrictions.
Most important facts for investors to verify
- Whether organic revenue trends, especially discretionary consulting demand, improve or worsen after Q3.
- How much reported earnings and cash generation depend on the Max Matthiessen gain, pension income, working-capital movements and other non-recurring items.
- Near-term refinancing or repayment plans for the $949 million of senior notes due in 2021, alongside the other current debt balance.
- Progress and conditions for Aon regulatory clearance and closing, and related costs or operating restrictions.
- Developments in merger and Stanford litigation, competition investigations, and any changes to recorded provisions or potential exposure.
- Whether cash-flow improvement persists, bearing in mind that fiduciary funds are not freely available for corporate use.