Willis Towers Watson plc — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Unaudited results; amounts are U.S. dollars unless noted. WTW provides global advisory, broking and benefits services. It reported more than 45,000 employees and clients in over 140 countries.
Financial performance and liquidity
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $2.113bn | $2.048bn | $4.579bn | $4.360bn |
| Income from operations | $163m | $176m | $523m | $535m |
| Net income attributable to WTW | $94m | $138m | $399m | $425m |
| Diluted EPS | $0.72 | $1.06 | $3.07 | $3.26 |
| Operating margin, GAAP | 7.7% | 8.6% | 11.4% | 12.3% |
| Operating cash flow | Not separately presented for the quarter | $685m | $303m | |
| Free cash flow, non-GAAP | Not separately presented for the quarter | $550m | $183m |
Q2 reported revenue rose 3%, but organic revenue was flat after excluding currency and acquisitions/divestitures. For the first half, reported revenue grew 5% and organic revenue grew 2%. Currency translation reduced revenue by $35m in Q2 and $69m year to date. TRANZACT contributed $87m of Q2 and $182m of first-half revenue.
Q2 adjusted operating income, a non-GAAP measure, was $296m versus $299m, with adjusted operating margin of 14.0% versus 14.6%. For the first half, adjusted operating income was $821m versus $791m, and adjusted margin was 17.9% versus 18.1%. Adjusted diluted EPS was $1.80 in Q2 versus $1.78, and $5.14 for the first half versus $4.76. These measures exclude specified items; they are not substitutes for GAAP results.
Segment trends were mixed. Q2 organic growth in Corporate Risk and Broking (CRB) and Investment, Risk and Reinsurance (IRR) was offset by declines in Human Capital and Benefits (HCB) and Benefits Delivery and Administration (BDA). HCB was affected by weaker demand for discretionary work. BDA’s reported growth largely reflected TRANZACT; organic revenue declined 3% in Q2 and 1% in the first half, partly reflecting Individual Marketplace seasonality.
Cash and cash equivalents were $1.087bn at June 30, up from $887m at year-end 2019. The $685m of first-half operating cash flow reflected improved working capital compared with the prior-year period. Capital expenditures and internal-use software additions were $135m; reported free cash flow deducts these expenditures. WTW said it had full availability under its $1.25bn revolving facility and believed liquidity was sufficient for the next 12 months. Fiduciary assets and matching liabilities were each $16.042bn; fiduciary funds are generally restricted and are not available for corporate debt service or other general purposes.
Total debt was $5.593bn, compared with $5.617bn at December 31, 2019; the capitalization ratio was 35.1%, versus 35.4%. Current debt included $500m of 5.750% notes due 2021 and $25m under a collateralized facility. WTW issued $275m of additional 2.950% notes due 2029 in May and used net proceeds primarily to repay term-loan and revolving-credit borrowings. The company reported compliance with financial covenants. It paid $171m in dividends during the first half; its quarterly dividend was $0.68 per share. No shares were repurchased in the first half, and the company did not expect repurchases during the remainder of 2020 under the Aon transaction restrictions.
Material changes and unusual items
- Q2 net income attributable to WTW fell 32% year over year. Management cited higher compensation-related costs and tax expense, partly offset by higher revenue and TRANZACT results. First-half attributable net income declined 6%.
- Q2 salaries and benefits rose 7% to $1.363bn and increased to 65% of revenue from 62%. Other operating expenses declined 6%, primarily due to lower travel and entertainment spending.
- First-half depreciation included a $35m acceleration related to abandoning internally developed software. Depreciation increased to $165m from $113m.
- The Q2 effective tax rate was 42.2%, versus 19.7%; the first-half rate was 26.9%, versus 19.1%. A $35m discrete tax expense related to CARES Act provisions was the primary stated driver. The election under the temporary business-interest rules also accelerated an approximately $40m cash tax benefit, with additional BEAT expense expected during 2020.
- In May, WTW agreed to sell its majority-owned Swedish subsidiary Max Matthiessen for SEK 2.3bn, subject to adjustments, including a SEK 600m seller-financed note. Closing was expected in Q3 2020. The filing does not establish that the sale had closed by the reporting date.
Outlook, risks and contingencies
WTW gave no specific numerical full-year earnings or revenue guidance in the provided filing text. Management expected COVID-19 to negatively affect revenue and operating results for the remainder of 2020 and potentially beyond. It said the pandemic had reduced demand for discretionary and project-based work, could cause delayed client payments, and might also affect demand for insurance and other services. Management noted that impacts could lag developments and that the eventual effect was difficult to predict. The company reported that remote-working arrangements had not significantly affected operations or internal controls as of the filing date.
Management described insurance pricing as modestly but definitely improving overall, while noting that commission revenue remains sensitive to insurance-market cycles, renewals and rates. The business is seasonal, with revenue typically higher in the first and fourth quarters.
The proposed Aon combination, announced March 9, 2020, would give each WTW shareholder 1.08 Aon shares; the companies estimated WTW shareholders would own approximately 37% of the combined company. The transaction required shareholder and regulatory approvals, including a U.S. Department of Justice Second Request and other closing conditions. Shareholder meetings were scheduled for August 26, 2020, and closing was expected in the first half of 2021, subject to conditions. Transaction-related lawsuits were filed alleging proxy-statement omissions or misstatements.
Other material legal exposures include Stanford Financial Group litigation. A $120m settlement and related bar orders remained subject to further appeal, and WTW said it would not pay until no further appeal was available. In a separate legacy-merger securities action, plaintiffs sought class-wide damages of approximately $456m; the company said it could not estimate a reasonably possible loss range. Aviation broking competition investigations in the European Union and Brazil also remained unresolved, with no loss estimate provided. WTW stated that adverse outcomes in litigation or regulatory matters could materially affect particular periods.
Key facts for investors to verify
- Track subsequent quarterly results for evidence of COVID-19 effects on discretionary demand, organic growth, collections and margins.
- Reconcile reported and adjusted performance, including the impact of TRANZACT, the $35m software abandonment, transaction costs and CARES Act tax items.
- Monitor Aon transaction approvals, the DOJ review, litigation and any changes to the expected closing timeline or terms.
- Check the 2021 debt maturities and refinancing plans, credit-facility availability, covenant compliance and cash-flow conversion; exclude fiduciary balances from general liquidity.
- Confirm the closing, final proceeds and seller-note terms for the Max Matthiessen divestiture, and the status of the Stanford settlement and other legal or regulatory matters.