Willis Towers Watson plc — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Amounts are U.S. dollars; financial figures are in millions unless noted. WTW is a global advisory, broking and solutions company. Results are unaudited and reflect the January 1, 2018 adoption of ASC 606, which materially changed the timing of some revenue and expense recognition. Comparative 2017 results were not restated.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $1,990 | $1,953 | $4,282 | $4,272 |
| Income from operations | $63 | $61 | $322 | $462 |
| Income before income taxes | $74 | $49 | $338 | $447 |
| Net income attributable to WTW | $58 | $33 | $273 | $377 |
| Diluted EPS | $0.44 | $0.24 | $2.05 | $2.75 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $395 | $319 |
- Reported operating margin was approximately 3.2% in Q2 and 7.5% for the first half; attributable net margin was approximately 2.9% and 6.4%, respectively.
- Reported revenue increased 2% in Q2 and was approximately flat for the first half. Management reported organic revenue growth of 3% and 4%, respectively, excluding currency, acquisitions and disposals, and ASC 606 effects.
- ASC 606 reduced 2018 revenue by $32 million in Q2 and $291 million in the first half versus the prior accounting basis; it reduced operating income by $30 million and $309 million, and attributable net income by $24 million and $250 million, respectively. On a basis without ASC 606, first-half revenue was $4,573 million and operating income was $631 million, versus $4,272 million and $462 million in 2017. These are company-provided supplemental comparisons, not restated GAAP results.
- Q2 adjusted operating income was $258 million as reported, or $288 million without ASC 606, versus $300 million in Q2 2017. First-half adjusted operating income was $701 million as reported, or $1,010 million without ASC 606, versus $919 million in 2017. These are non-GAAP measures.
- Q2 segment revenue and operating income/(loss): HCB $780 million/$149 million; CRB $674 million/$97 million; IRR $385 million/$89 million; BDA $119 million/$(31) million. BDA’s reported decline and loss were substantially affected by ASC 606’s shift of Medicare broking revenue toward the fourth quarter.
Cash, debt and liquidity
- Six-month free cash flow was $254 million as reported ($278 million without ASC 606), compared with $200 million in 2017. Operating cash flow improved to $395 million from $319 million, primarily due to customer collections. Investing cash outflow was $153 million; financing cash outflow was $335 million.
- Cash and cash equivalents were $911 million at June 30, 2018, down from $1,030 million at year-end 2017. Cash reduction reflected capital spending, dividends and share repurchases, partly offset by operating cash flow. Some cash is held for regulatory capital requirements; fiduciary funds are not available for corporate use.
- Total debt was $4,674 million, including $85 million current and $4,589 million long-term, up from $4,535 million at year-end. Net debt, calculated as total debt less cash, was approximately $3,763 million. The capitalization ratio was 31.4%, versus 30.9% at year-end. WTW reported compliance with all financial covenants; $85 million of term-loan repayments were scheduled over the next 12 months.
- $165 million remained available under the $1.25 billion revolving credit facility at June 30. Management believed available liquidity was sufficient for the next 12 months. The balance sheet includes matching fiduciary assets and liabilities of $14,126 million, which substantially inflate current asset and liability totals and should not be treated as ordinary operating liquidity.
- WTW repurchased 1.77 million shares for $269 million in the first half. Approximately $0.7 billion remained under repurchase authority. Cash dividends paid were $149 million; the quarterly dividend was raised to $0.60 per share, paid July 16, 2018. Expected remaining 2018 fixed-asset and internal-software spending was approximately $110 million.
Changes, outlook and management commentary
- ASC 606 shifted Medicare broking revenue recognition toward policy placement, concentrating more revenue in Q4; it also changed recognition for certain health and benefits, affinity and proportional treaty reinsurance broking arrangements. This materially affects period-to-period and quarterly comparisons.
- Management cited organic growth across segments, including retirement consulting, benefits advisory and marketplace placements, CRB new business and renewals, and IRR sales. Talent and Rewards demand weakened in parts of North America and Great Britain. First- and fourth-quarter revenue typically runs higher because of broking seasonality.
- Management did not provide a specific full-year revenue or earnings forecast in the supplied filing text. It expected approximately $110 million of additional 2018 capital expenditures and pension contributions for the remainder of the year of $50 million to U.S. plans, $42 million to U.K. plans and $6 million to other plans.
- Other notable items included a $20 million non-cash U.K. pension settlement expense; favorable foreign-exchange activity contributed to higher other income. Merger-related transaction and integration expenses remained significant at $55 million in Q2 and $98 million for the first half, though lower than the prior-year periods.
Risks, contingencies and controls
- The $120 million Stanford litigation settlement remains conditional on final resolution of appeals and approval of bar orders; WTW stated it would not pay until appeals were resolved in its favor and no further appeal remained. The filing identifies appeal risk and gives no estimable loss range for related unresolved matters.
- The City of Houston litigation was dismissed with prejudice after a $40 million settlement, paid in April 2018. The $9.75 million CalPERS-related class settlement was paid in June 2018.
- European Commission proceedings concerning alleged information exchange and coordination in aviation and aerospace broking remained open; the company could not estimate potential loss. The FCA said it would not take enforcement action against Willis Limited on related broking regulatory matters. A U.K. competition investigation of investment consulting and an FCA London wholesale insurance market study were also ongoing.
- WTW noted risks from Brexit, sanctions and possible counter-sanctions, competition and regulation, litigation, cyber and data-security incidents, currency movements, pension obligations, indebtedness, integration execution and changes in demand. The company’s U.S. Tax Reform accounting remained incomplete; transition-tax estimates and other provisional tax amounts could change.
- Disclosure controls and procedures were concluded effective as of June 30, 2018; no material change in internal control over financial reporting was reported during the quarter.
Important facts for investors to verify
- Assess underlying operating trends using ASC 606-adjusted and organic comparisons, while distinguishing them from GAAP results and considering the Q4 revenue concentration.
- Track BDA performance and whether the Medicare broking revenue timing shift affects later reported periods as expected.
- Monitor debt, revolving-credit availability, scheduled repayments, share repurchases, dividends and cash available after regulatory and fiduciary restrictions.
- Follow the Stanford settlement appeals and the status and potential outcomes of the European Commission and U.K. competition matters.
- Review subsequent updates to U.S. Tax Reform estimates, pension contributions and other non-GAAP adjustments.