Willis Towers Watson PLC Q3 FY2020 Earnings Call

Good morning. Welcome to Willis Towers Watson's Third Quarter 2020 Earnings Conference Call. Please refer to willistowerswatson.com 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 Willis Towers Watson's 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.

Okay. Thank you. Good morning, everyone, and thank you for joining us on our third quarter 2020 earnings call. Joining me today is Mike Burwell, our Chief Financial Officer. In the third quarter, we continued to navigate through challenging economic conditions. Nevertheless, I'm pleased with our financial performance. While our revenues continue to be impacted by the pandemic and the lockdown, particularly in our discretionary lines of business, our overall performance reflects the durability and resilience of our business model. In many of our core businesses we continue to experience new business generation, strong client retention rates and increased operating leverage. We continue to reduce our controllable spending and improve our liquidity through prudent cash flow management. As we navigate through the COVID-19 lockdown and the resulting economic conditions, the well-being of our colleagues, clients and communities remains at the forefront. It has been an arduous but transformative year. With great changes come new opportunities for growth, which is why we continue to be excited about the proposed Aon and Willis Towers Watson combination. COVID-19 has highlighted deficiencies in the way the world approaches people, risk and capital issues, and we believe our combination with Aon will allow us to more proactively support our clients in developing solutions to problems that are inadequately managed today. COVID-19 has shown the world that the widespread cost of extreme events far exceeds the upfront cost of prudent preparatory measures. Climate risk is one such area where we see protection gaps and building greater resilience is critical. Similar to the COVID-19 pandemic, climate change will challenge many countries with the potential for profound socioeconomic destruction, highlighting the critical need for more efficient, risk-informed investment decision making to help save lives and economies from the foreseeable shocks in the years and decades ahead.

Thanks, John, and good morning to everyone. Thanks to all of you for joining us. I'd like to extend my gratitude to our colleagues for another solid quarter as well as thank our clients for their continued support and trust in us through this challenging environment. I'm proud of our leadership, our colleagues and our overall resiliency demonstrated by our businesses.

Thanks, Mike. And now we'll take your questions.

And your first question comes from the line of Paul Newsome with Piper Sandler.

So obviously, the theme today with brokers is that the excellent margin control that everyone's had. Any thoughts as we get into the next quarter or beyond about if you'll have to increase the spending just because hopefully things are getting a little bit back to normal again?

Yes. I think we expect that situation is going to evolve and change during, say, 2021, but we really don't know exactly how it's going to evolve. We know it's going to be different than it is today, but we don't think it's going to go back to where it was prior to COVID-19. To the extent we have some more expenses, say travel and entertainment, we'll only undertake them when they're justified by generating the extra revenue. So while we expect expenses to increase, we're going to try to do that only where we also have the corresponding revenue increases.

Great. And completely different question. Obviously, we're looking at a changing political environment with the ACA possibly being affected by a court ruling. Any thoughts on that business and the outlook, just given the changing regulatory environment?

I think what we would say is we think that the services that we provide — particularly the services we provide in benefits design and administration that let employees and individuals take control of their benefits and their health care — is a theme that you see around the world. Whatever way politicians or the particular methods they use for providing health care, they want individuals to be in charge of their own health care and take responsibility for it. So we feel pretty good about the services we provide.

Our next question comes from the line of Elyse Greenspan with Wells Fargo.

My first question on CRB, you guys pointed to a one-off sale in North America, and I think you gave the impact of Great Britain, the one-off item there that the GB piece would have been up 2%. What would all of CRB have done in the quarter if we adjust for the one-time in North America and Great Britain?

Yes, Elyse, we would have been flat overall to a slight increase. That's really where we would have been for the quarter. When we look at the quarter overall and the year-to-date results, we feel like we're operating pretty favorably in comparison to the market.

Okay. Great. And then wholesale, I think I heard you say that was down 12% within IRR. I know you've disclosed potential sale of Miller. I'm not sure if that had an impact or if we could get a little more color on what you saw within wholesale. Is anything there kind of one-time to Q3? How should we think about the trajectory of that business from here?

When we look at Miller overall — thank you for the question, Elyse — one of the things that happens with Miller is that they insure a lot of events, in particular sporting events, and obviously many of those haven't transpired or are being put on hold. That is what we really saw driving the reduction in revenue growth for the quarter. We continue to evaluate strategic alternatives for Miller. Miller has been a very strong and performing business for us, but that's the direct reason for the decline in Miller for the quarter.

Is the sporting event impact more pronounced in Q3 than other quarters, or would that be even throughout the year?

No, it's a little bit more in the third quarter.

Okay. And then my last question on the tax rate: you pointed to a U.K. statutory change that led to an elevation in the quarter. Is there any impact on your go-forward tax rate?

Yes. The U.K. raised their statutory rate by 2%. It had approximately an $11 million impact on our tax calculation for the quarter in terms of setting up deferred tax liabilities. It had a $0.08 impact on our results for the quarter. For the year, it will have a slight impact, roughly on the order of 1% for the year.

Okay, and then if I can just squeeze one more in. The free cash flow is $1 billion year-to-date. That had obviously been a major focus of Willis Towers Watson. You pulled guidance at the start of COVID like most others, but that was your free cash flow target for the year. You hit that one quarter ahead of time. Anything specific to the free cash flow conversion for the past couple of quarters, or has it just been blocking and tackling with payables and receivables that really drove that conversion up?

Thank you for pointing that out, Elyse. It's really the effort by our colleagues. Our colleagues have worked extremely hard. As a leadership team we've been focused on how we manage our relationships with clients and doing the right things in the face of the pandemic, but equally focused on having the right terms and collecting our cash appropriately, while also paying appropriately. All those things factored into our continued focus. We're proud of where we sit through the third quarter, and we'll look to continue to deliver as we move forward in the fourth quarter.

Your next question comes from the line of Greg Peters with Raymond James.

My first question would be an update on the merger. Can you talk about the role of the U.K. regulator in your merger process, especially in the context of Brexit? And do you still anticipate minimal disposals?

Thanks for the question. We can't comment on any specific approvals obtained or still outstanding. There are several global antitrust filings required in connection with the proposed transaction, and the specific process varies by jurisdiction. We are planning to submit all of our antitrust filings in required jurisdictions, and we're still expecting to have all clearances in the first half of 2021.

Got it. The second question: looking at the consolidated income statement, other operating expenses are down, reflecting tight control over travel and entertainment. But salary and benefits as a percentage of revenue inched up — I think it was about 64.5% last year and above 66% this year. Can you walk us through why salary and benefits as a percentage of revenue is running higher in Q3 this year than Q3 last year, on a consolidated and maybe segment basis?

Thank you, Greg. In terms of salary and benefits, bringing the right talent on board is important for each of our businesses. In particular, when you look at the growth in our Benefits, Delivery & Administration segment, we've added more talent. We also consider our overall incentive compensation accruals on a year-over-year basis. It is a function of people and our drive. Reducing headcount is a decision of last resort; our colleagues have come together to drive cost benefits. Yes, the line is up slightly compared to the prior year, but we've been able to offset many other costs. We continue to manage that line as best we can.

I'll just add that we're looking to get incentive compensation for this year around the same as last year, although quarterly accruals can vary. We did accrue more this quarter than the same quarter last year. We also have headwinds from stock compensation as we record charges when the stock price goes up.

Got it. Just my final question — you mentioned TRANZACT and that you're in the annual enrollment period for that business now. Can you give us an update on how that business looks to grow in the fourth quarter?

It's too early to say anything definitive about the fourth quarter. The enrollment period is just beginning. As we said on prior calls, we're very excited about TRANZACT. We were enthused when we acquired it and folded it into Willis Towers Watson, and we're even more enthused about the business today. We feel good about the long-range prospects and think it's a perfect fit with the rest of the organization.

Your next question comes from the line of Mark Marcon with Baird.

Congrats on the free cash flow. That was really great to see. You're not giving guidance for the fourth quarter, but can you talk across different segments — HCB, CRB, IRR and BDA — what you were seeing as the quarter unfolded in terms of new business development, and how that may potentially impact the fourth quarter and beyond? Also, what will be the impact of disposing Max Matthiessen?

We're not giving guidance because in today's world it's hard to know how things will play from quarter to quarter. Last year's fourth quarter was an extraordinarily good quarter for us, so we face a tough comparable. We're still looking to try to get to about the same results as we had last year.

Mark, I can give some color. For Health, Benefits & Compensation, our retirement business is performing well given the market and continues to serve the marketplace. Talent and Rewards will continue to see discretionary spending; it's performed better than we expected given the comparison to the financial crisis. Health & Benefits had overall 1% growth; we believe it will continue to perform well and is focused on managing costs. TAS had a very large prior-year project that didn't recur this year and that will have some impact into the fourth quarter. Overall margins have been well managed. For CRB, adjusted for the one-offs, we're pleased with year-to-date performance and believe it should perform at market levels. In IRR, we've divested Max Matthiessen; it's a very good business and a good time to divest — the impact will be that it will be out in the fourth quarter. Our reinsurance business grew 7% and is at least comparable to the market. Our ICT business continues to do well, with strong technology sales. Our investment business increased 4% this quarter, with continued expansion in delegated investment services. Wholesale was down primarily due to canceled events, particularly sporting events. BDA is an important focus; as John said, open enrollment means action in the fourth quarter and we're watching that closely. We'll manage costs effectively and spend where appropriate to drive revenue growth; leadership and colleagues are focused on delivering for stakeholders.

I'll add two quick points. First, our Talent and Rewards business has a large percentage of discretionary projects and has performed extraordinarily well, both against peers and relative to downturns in the past. Regarding bulk lump sum activity, we expect a healthy pipeline, but the low interest rate environment creates two opposing forces: some sponsors step back because reduced funded status reduces immediacy, while others see increased ROI for lump sum projects because PBGC premium caps and long-term considerations change. Which force will predominate is unclear, but we still expect a healthy pipeline and potential pickup into 2021.

Great. And then just to make sure I heard correctly, it sounded like there wasn't a huge deterioration month to month through the last quarter in terms of sales activity — generally more stable. Is that a correct interpretation?

Yes, I think that's correct.

And then just Max Matthiessen, what's the revenue impact going to be on a quarterly basis, on an annualized basis, in terms of taking them out?

Mike, do you have that number?

Max Matthiessen is roughly about $25 million in revenue per quarter.

And then while you're looking at that, just to go back to Greg's question, do you sense there's any more regulatory challenge or less regulatory challenge with regards to the Aon merger than previously anticipated, or is it basically in line?

I would say there's nothing that has been a big surprise in terms of what we've seen from regulators. When we put the combination together, we felt there were good arguments for why it made sense and why it should proceed without restrictions, but what matters is what regulators think. We've been working with them, submitting information, and we haven't been asked for anything surprising. We've been working cooperatively and are on our schedule.

Our next question comes from the line of Mark Hughes with Truist.

In the impact of climate change and the efforts you're making to deal with that, what do you think it means for your business in terms of growth opportunities if there's more losses, more risks and more volatility? How do you think about that?

A lot of the climate work we've been doing has evolved out of the capabilities we have in our regular client work. We've been working with clients on risk management and insurance for things like hurricanes that can be impacted by climate change. We also work on initiatives like the Coalition for Climate Resilient Investment, which is not primarily revenue-generating work but is an important contribution we are well-positioned to provide. In the long run, climate change will impact almost every part of our business: it will affect the severity of long-tail and extreme events, and we'll have to help model that, help clients with risk mitigation and build resilience. We're working with financial institutions to evaluate loan portfolios for climate exposure, and our investment consulting operations help pension plans and other investors consider climate in their investments. We've had about a 15-year track record in this area. In Talent and Rewards, we'll help integrate climate metrics into executive compensation. We see climate impacting the broad range of our businesses.

And your final question comes from the line of Sean Reitenbach with KBW.

This might be similar to past questions: thinking about HCB, you mentioned clients have to rethink talent, rewards and such. Is that project flow starting to show up already, or is that projected demand that will contribute to growth in 2021 as the economic environment stabilizes?

When I discussed bulk lump sum activity, I noted reasons it could increase and reasons it might be tamped down. For Talent & Rewards, those are reasons why we think it might increase, but it's not like we're seeing a lot of that yet.

Okay. And thinking about the reinsurance and insurance rate environment in conversations with clients, what are the discussions about the rate environment? Are you preparing them for multiple renewals of high rate increases? I know one industry CEO mentioned the industry still hasn't seen a real response from reinsurers, so that could further provide momentum and a longer duration of this hardening market.

We discuss the pricing environment and what's out there with our clients. Of course we aim to do a better job for them than others. So they probably have a little bit less of a rate increase than they otherwise would, but we help them understand and prepare for the environment.

And there are no further questions. I would now like to turn the call back over to Mr. John Haley, Willis Towers Watson's Chief Executive Officer. Please go ahead.

Okay. Thanks very much, everyone, for joining us on this call, and we look forward to updating you in February on the full year's results. Have a good day.

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