Willis Towers Watson PLC Q1 FY2020 Earnings Call

Good morning and welcome to Willis Towers Watson's first quarter 2020 earnings conference call. Please refer to our website for the press release and supplemental information that was issued earlier today. Today's call is being recorded and will be available for the next three months on our website. Some of the comments in today's call may constitute forward-looking statements within the meaning of the Private Securities Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties. Actual results may differ materially from those discussed today and the company undertakes no obligation to update these statements unless required by law. For a more detailed discussion of these and other risk factors, investors should review the forward-looking statements section of the earnings press release issued this morning as well as other disclosures in our most recent Form 10-K and in other Willis Towers Watson SEC filings.

Thank you very much. Good morning everyone and thank you for joining us on our 2020 first quarter earnings call. Joining me today are Mike Burwell, our Chief Financial Officer and Rich Keefe, our Head of Investor Relations. Before we get into our first quarter performance, I want to start by talking about COVID-19 and how we are managing Willis Towers Watson during this global pandemic. First of all, I hope all of you and your families are staying healthy. The safety and well-being of our colleagues has been our primary focus as the COVID-19 crisis escalated and we have mobilized to mitigate the risk to our colleagues. The COVID-19 pandemic did not have a material adverse impact to our financial results for the first quarter of fiscal 2020. However, we expect that the impact of COVID-19 on general economic activity could negatively impact our revenue and results for the remainder of 2020. We are closely monitoring the spread and impact of COVID-19, while adhering to governmental health directives. We have implemented restrictions on business travel, office access, meetings and events. We have thorough business continuity and incident management processes in place, including split team operations for essential workers and work-from-home protocols which are now globally effective. We are communicating frequently with colleagues, clients and critical vendors while meeting our objectives via remote working capabilities, overseen and coordinated by our incident management response team. Before the pandemic, we were already experienced in working virtually and had implemented collaboration technologies and infrastructure for remote working that we believe are effective. Currently, more than 90% of our 45,000 colleagues are working remotely. For example, our top leaders are spread across the globe and we have effectively operated this way as a management team for a number of years. We were able to mobilize quickly to address this situation and the agility of our colleagues is remarkable. I am extremely proud of the way our colleagues have adapted. They continue to demonstrate their resilience and their commitment to support our clients' needs and one another.

Thanks John. I would like to express my gratitude to our 45,000 colleagues for delivering another quarter despite the difficulties we are experiencing as a result of the COVID-19 pandemic. I would also like to thank our clients for their continued support and trust in us. Helping clients solve complex problems is at the heart of everything we do at Willis Towers Watson and we fully intend to continue being a reliable source of strength for the clients we serve around the world as they confront their unique pandemic-related challenges. Our first quarter represented a good start to the year with strong organic revenue growth, robust margin expansion and underlying adjusted EPS growth.

Thanks very much Mike. And now we will take your questions.

Our first question comes from the line of Shlomo Rosenbaum with Stifel. Your line is now open.

Hi. Good morning. Thank you for taking my questions. John, given the pending business combination with Aon, I wanted to ask you to comment on what you are seeing in your business right now versus Aon, which announced broadly reducing salaries in anticipation. Is there a strategy difference or end market difference? Since you are merging with them, what is your take on that versus what is going on internally in your business?

Shlomo, thanks for the question. Even though we are merging and perhaps especially because we are merging, we have to make sure that we manage ourselves as independent competitors during this time running up to the combination. We are not able to collaborate on anything like how we are handling the market, clients, or strategy. We must come to completely independent solutions. It's hard for me to say a lot about what went into Aon's actions. As Mike said, we wanted to take whatever actions we needed and we have been focused on cutting discretionary spending. We want to cut back to the bone and protect our cash flow. If we can do those things successfully, our judgment is they will probably be sufficient. But the fact is we don't know. Whether we have to take stricter action depends on how successful we are with these initiatives and on the pace of COVID-19. Different recovery shapes — V, U, or W — imply different scenarios. We believe we remain agile and ready to react. Our first priority is the safety and well-being of our colleagues. Our second priority is managing the financial health of our business, including making sure we take care of colleagues from a benefits and compensation standpoint. While there are circumstances where we might contemplate reductions like salary actions, we are hoping to avoid them.

Okay. Great. I appreciate that color. One thing on TRANZACT: can you provide what the growth was in the last year-quarter? I know you didn't own them the full year, but to get a sense of how that is growing. And with the improvement year-over-year in operating margin for the BDA segment, is that due to operating leverage, a change in seasonality, or some of the TRANZACT business? Any clarity would be helpful.

Mike, do you want to take us through that?

Yes. Shlomo, thank you for the question. For TRANZACT overall, almost 50% of our revenues for the BDA segment come in the fourth quarter, which encapsulates TRANZACT. Although we are seeing nominal losses in the first quarter, we have been pleased with TRANZACT's performance. We carry expenses in earlier periods. Small changes in last quarter don't impact as much as what we see overall. TRANZACT continues to grow very nicely for us. We had 57% growth and it continues to be very strong. Over the year, again, more than 50% comes in the fourth quarter for the BDA segment with TRANZACT being a big piece of that. We continue to see growth with it and are very pleased with TRANZACT's performance.

Okay. Thank you.

Our next question comes from the line of Mark Marcon with Baird. Your line is now open.

Good morning. Thanks for taking my questions. Glad to hear that everybody is doing well. I have two broad sets of questions. First, can you give us color on how to think about the economic downturn? John, you've been through multiple recessions. This one's deeper. Can you talk segment-by-segment about second half of March and early April impacts, vertical exposure, and how you think those segments will perform? Second, how are associates feeling since the Aon announcement? If COVID ends up being really significant, how could that impact the transaction?

Thanks, Mark. I'll start with how our colleagues around the world are feeling and then ask Mike to cover the details of what we were seeing in March. When we announced the deal on March 9, lockdowns and shelter-in-place measures were beginning in Europe and the U.S. It was not an ideal time to get out and talk to colleagues, but we've been communicating virtually. One thing that was interesting is how quickly colleagues understood what we are trying to do with this combination. Being home and facing uncertainty may have helped some people see the rationale: the aim is not just to get bigger but to get better, to build a firm that is more innovative and able to address new and emerging client needs than either predecessor alone. The COVID-19 environment actually strengthens the case for a firm with broad innovative capability. There is always a period early in a merger when people ask questions about fit, but we have seen a positive embracing of the deal faster than I expected. Greg Case and other senior leaders have been talking to our folks, and we've had sessions with Aon people as well. We are seeing excitement from both sides. We remain convinced about the rationale for this deal and are more excited and more convinced today than we were on announcement day. Regarding recessions, this one is more difficult and harder to predict than prior downturns. The financial crisis was the most recent comparable event and both Willis and Towers Watson managed through it pretty well. We have large recurring revenues — roughly 80% to 85% of our revenues are largely known before the year starts — which helps. This crisis is harder because of its effects on the general economy and the potential for clients to go out of business; those are imponderables that make it more challenging. We saw some impact in Asia in February and March, which affected CRB international results; it is hard to isolate the COVID impact fully. Mike, can you take us through segment-by-segment?

I'll take it through the HCB segment and then provide color by line of business. In retirement, from a risk standpoint, we continue to see a low interest rate environment so bulk lump sum activity may increase. Some sponsors may be hesitant given reduced funding in their plans, but there remain opportunities for bulk lump sum work and liability-driven investment strategies to limit damage to funding levels. In health and benefits, we see revenue opportunities around off-cycle products, bundled solutions and voluntary benefits. Retention rates in some geographies have been steady; clients are not making benefit changes at the top of their list, which helps offset the reduction in new business sales. A challenge is unemployment: with higher unemployment, commission revenue can be impacted. In CRB, we are seeing opportunities in risk analytics services and risk management consulting. Aerospace is under pressure, and hospitality and some finance and fintech areas are seeing lower deal volumes and lower M&A activity, which has an impact. In the IRR segment, reinsurance clients are using reinsurance as protection. Damage to investment portfolios and drops in capital surplus mean many clients may retain current levels of reinsurance purchase. We are continuing to see rate increases, which is a tailwind, though clients will pressure to reduce costs. Regarding TRANZACT in the BDA segment, it has been very strong with continued growth and interest from retiree clients looking at cost savings. Our BDA segment presents opportunities to manage costs, particularly pre- and post-65 through our exchange operations. Overall, that gives a sense of what's happening across our segments.

That's terrific. One quick follow-up: what percentage exposure do you have to the areas that seem most affected — aerospace, hospitality, finance, real estate? How are you thinking about that?

By client, no single client reaches 1% of our revenues. When we look by industry, we don't have high exposure to any particular industry with the exception of insurance and financial services more broadly, but insurance has not been particularly affected by this crisis. So we are not particularly worried about industry concentration effects.

Great. Thank you very much.

Our next question comes from the line of Elyse Greenspan with Wells Fargo. Your line is now open.

Hi. Thanks. Good morning. I understand there's a lot of uncertainty and why you pulled the outlook, but could you give a sense — even a big range or qualitative view — about how organic growth could slow and how much inorganic growth you could see over the next three quarters? Also, is there a lag in some businesses so we might see more slowdown in the third quarter than the second?

Elyse, the reason we pulled guidance is that uncertainty creates a wide range of potential outcomes. We are fortunate not to be concentrated in industries like aviation or hospitality that have seen enormous hits. However, could our revenue decline in the remainder of the year at a double-digit rate versus prior expectations? It's not impossible in extreme scenarios. We do well when economies do well and less well when economies weaken. We did scenario planning, but there are many variables. We do not see ourselves in the most distressed industries. The services we provide are needed in both difficult and good times, so much of the revenue should continue. Regarding lags, talent and rewards in the human capital and benefits area is the most discretionary service we offer. Clients sometimes delay or cancel projects during downturns. So we could see delays that affect the third quarter. At the same time, certain retirement work can see an early uptick in activity because clients are concerned about funded status, contributions and accounting costs, which could mean a pickup in the second quarter and a relatively worse third quarter. The mix across businesses could produce various timing effects; we don't know how large those will be.

I'll emphasize John's point. In HCB, a lot of work is nondiscretionary and recurring. The nonrecurring or discretionary projects are where you see slowdowns. That work is being replaced by COVID-related support work in many cases. Our colleagues are agile and are supporting clients with different solutions. So while discretionary spend is pressured, we are finding ways to help clients and offset some impacts.

Mike is right. The difficulty is whether the COVID-related work outweighs the delayed discretionary projects. We don't yet know the relative size of those movements.

That's helpful. On the BDA segment, the margin did better year-over-year. In your original guidance for 2020, you pointed to TRANZACT as a drag early in the year due to how that business comes online. The BDA segment performed better than expected. Was something different in the quarter, or is this ongoing improvement away from TRANZACT?

They had a good quarter. Last year TRANZACT was only in the year-end period when it is highly profitable; this year we have TRANZACT for the full year and it creates a negative impact in early quarters compared to that seasonal profit. Overall, BDA is a business we expect to be strong across the year.

One last question: have you disclosed transportation and entertainment costs as a percent of expenses? Any context on how much the expense base could benefit from the slowdown in T&E due to COVID and lack of travel?

We have not disclosed T&E as a percentage of expenses. We have guidance in place for colleagues not to travel currently, and as things open we will relax that. We expect our future travel patterns to change; virtual meetings and work-from-home practices will remain features of how we operate, so travel will likely not return to prior levels. For now, travel and entertainment expense has decreased. We have had some increased costs in webhosting and virtual meetings, but it has been a net savings.

Okay. Thank you for the color.

Our next question comes from the line of Greg Peters with Raymond James. Your line is now open.

Good morning. I realize you are limited in commenting on the pending transaction, but do you anticipate any slowdowns with regulatory approvals as a result of COVID? With the stock down and the market movement, can you update us on shareholder feedback? I didn't envision the company being sold at a price below $200 when announced.

On regulatory approvals, regulators are working virtually. They have adapted and become reasonably efficient; at the margin things could be a bit slower, but we don't see an enormous impact. Regarding shareholder feedback, it has been pretty positive. Shareholders see the value of the opportunity and feel good about what we can accomplish as a combined firm. They view this as the next step in our evolution.

My second question: regarding ASC 606, when setting revenue assumptions and accounts receivable you have embedded assumptions around numbers of employees, especially in HCB. With the rise in unemployment, how might ASC 606 assumptions change through the year given the chaos unfolding?

Good question, Greg. We have been evaluating this, but at this stage we do not see a meaningful change to our ASC 606-related assumptions.

Final question: among the corporate world there is a growing sense of social responsibility given rising unemployment. Do you think that will impact synergy objectives over the next year or two because of layoff pledges and related considerations?

We want to avoid having people we don't have work for. Some synergy targets relate to roles; a lot of our targets are also non-people-related costs. We will take the social context into account. Willis Towers Watson has been a company that offers meaningful work and opportunities for colleagues, and we intend the combined firm to be that as well. One positive we have seen is that colleagues recognize the increased opportunities from the combination, and that has generated excitement.

Thank you for your answers.

Our next question comes from the line of David Styblo with Jefferies. Your line is now open.

Hi. Good morning. Thanks. You mentioned 80% to 85% of revenues are known for the year. Can you parse that down so we can understand what types of projects within that might still get pushed out? For example, does that include annual surveys to benchmark employee pay in talent and rewards? What types of projects are higher risk of being pushed out? Also, provide color on the other 15% to 20% that's not known or renewable every year.

Thanks, David. I'll hit the highlights. In HCB, retirement work is often multiyear and recurring — think trust work and plan services — so much of that is recurring. Perhaps 70% recurring and 30% nonrecurring in that line, though mixes vary. Nonrecurring work includes bulk lump sum projects and other specific engagements, and you are seeing some retrenchment there. In CAS and talent and rewards, clients are thinking about workforce management and COVID-19 issues, so while some discretionary spend may slow, we are seeing COVID-related projects replace or shift some of that work. Annual surveys are important to clients and many are multiyear arrangements. In CRB, construction projects, aerospace, hospitality and other sectors are pressured, but insurance needs continue and we are seeing pricing tailwinds in reinsurance and high retention rates in many client relationships. In IRR, reinsurance and investment-related businesses are largely multiyear and clients are maintaining relationships. In BDA, long-term relationships and exchange arrangements are in place. So while 15% to 20% of revenue can be discretionary and subject to timing shifts, we feel reasonably good given the recurring nature of the majority of our revenue and the ways we are adapting to client needs.

Thanks. Second, regarding the transaction with Aon, how do you get comfortable with potential overlap risk on the reinsurance book? How do you characterize that market and how concerned are you about divestitures?

We have sought advice from leading antitrust law firms and feel well-advised. We are comfortable with our ability to bring the firms together within the regulatory framework.

Lastly, on TRANZACT: given COVID, how have you transitioned people to work from home without missing call volume? On demand, if seniors are deciding not to shop as much, have you seen any slowdown? March was strong year-over-year; is a slowdown manifesting into TRANZACT in April?

Gene and his management team in BDA have done an outstanding job reacting to COVID-19 and migrating operations to run virtually. About 90% to 95% of our colleagues are working from home, including TRANZACT. The team migrated the business to run effectively in remote mode and has been focused on serving clients. Their agility has been impressive and we are evaluating what the ongoing business model should be based on this experience.

We have not seen a material decline in senior buying due to COVID-19. Some seniors may be more reluctant, but with more people at home there is also more time to consider these opportunities. We do not foresee senior buying being a major issue and expect BDA to be strong for the remainder of the year.

Great. Thanks.

This concludes today's question-and-answer session. I would now like to turn the call back to John Haley for closing remarks.

Thanks very much everyone for joining us on the call today. Again, I hope you and your families all stay safe and we look forward to updating you with our second quarter results. Goodbye.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.