Willis Towers Watson PLC Q2 FY2021 Earnings Call

Good morning. Welcome to Willis Towers Watson's Second Quarter 2021 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. 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 the most recent Form 10-K and in other Willis Towers Watson’s SEC filings.

Thank you. Good morning, everyone, and thank you for joining us on our second quarter 2021 earnings call. Joining me today is Mike Burwell, our Chief Financial Officer. Today, we'll review our results for the second quarter of 2021. Let me start by thanking our 45,000 plus colleagues for their resilience, their commitment, and their focus on serving clients with excellence. At Willis Towers Watson, our colleagues have persisted through an unprecedented global pandemic while simultaneously preparing for a proposed integration and for potential divestitures. What our teams have accomplished is nothing short of extraordinary. We're now moving forward with clarity. Today, I'm going to share some observations on the termination of our proposed business combination agreement with Aon. But I really want to focus on our strong second quarter results, an excellent return to shareholders. In Q2, our team delivered outstanding results with organic revenue increasing by 8% compared to the second quarter of 2020. All our business segments contributed meaningfully to this result. Our adjusted operating margin improved by 390 basis points. This translates into 48% adjusted EPS growth rate in Q2 and 30% free cash flow improvement when normalized for one-time items. Our 6% organic revenue growth for the first half reflects mid single-digit or greater organic growth in three of our four segments. Turning now to the termination of our proposed business combination with Aon. We recently announced our mutual agreement to move forward independently. On behalf of Willis Towers Watson, I'd like to thank our counterparts at Aon for their professionalism over the past 16 plus months since we announced the transaction. I again would also like to thank our Willis Towers Watson colleagues for all of their efforts, as well as our clients for their continued support throughout this process. The proposed combination had significant regulatory momentum. A notable exception was the United States, where the parties reached an impasse with the Department of Justice. In the end, working closely with Aon, we decided to terminate our agreement. We're confident this is the right decision for Willis Towers Watson, for our colleagues, for our clients and for all of our stakeholders, including our shareholders. Aon has already paid the $1 billion termination fee.

Thanks, John; and good morning to everyone. Thanks to all of you for joining us. First, I'd like to extend my appreciation to all our colleagues. We’ve asked a lot of our teams and our colleagues over the past 16 months, and they have continued to deliver. They remain committed to our vision and upholding our values. They went above and beyond to support our company, our clients and one another. I'm extremely grateful for their patience, commitment and resilience. We delivered continued progress for both the quarter and year-to-date period, including 8% revenue growth in Q2. Through the first half of the year, we translated strong organic revenue growth into excellent operating income growth and almost doubled earnings per share, demonstrating the resilience of the Willis Towers Watson business model. We continue to expect mid-single-digit revenue growth for the full year 2021. I would note that our reported revenue included the favorable impact from changes in FX rates driven by a weaker U.S. dollar versus most currencies. Our strong revenue growth and ongoing operational discipline, as well as sound cost management, contributed to adjusted operating income margin growth of 390 basis points in Q2 and 240 basis points through the first half of the year. It should be noted the growth in our margins was driven by the speed of revenue growth, which outpaced our expense growth. While we made investments in people, operations and technology to enable long-term growth in the first half, we expect to increase these investments during the second half of the year. We also anticipate some resumption of travel and entertainment costs over the second half of the year as well, though we anticipate continued leverage of technology to conduct much of our business remotely, enabling us to sustain our improved efficiency and reduced carbon footprint. Looking forward, we expect to deliver margin expansion for the full year 2021 and over the long term. Moving back to the results for the second quarter. We've translated strong operating income into adjusted EPS growth of 48% in Q2 and 23% year-to-date. Foreign currency changes had a favorable impact to revenue of $87 million or 4% in Q2 versus the prior year and no impact to diluted earnings per share. If currency were to remain stable at today's rates we'd expect a modest tailwind to adjusted diluted earnings per share for the full year. As John mentioned, Willis Towers Watson mutually agreed to terminate our business combination agreement and move forward independently. In accordance with the business combination agreement, Aon has paid the $1 billion termination fee. Free cash flow increased 30% year-to-date when adjusted for the $185 million for the previously announced StanCorp and Willis Towers Watson merger settlements, and higher incentive comp and benefit related items of $249 million. We expect — we continue to expect to drive free cash flow growth over the long term, building on our efforts over the past couple of years. We expect our CapEx expenditures to increase in the second half of the year as we invest in technology to grow our business. Given our outlook for long-term free cash flow growth, we see share repurchases as the highest return on capital opportunity for capital allocation. As John noted, we plan to implement an accelerated share repurchase strategy of $500 million additional to our normal share repurchase plans. We look to execute as much as practical in fiscal year 2021, and we also raised our dividend by 13%. Now turning to our balance sheet and debt capacity. We had $2.2 billion of cash on our balance sheet at the end of the quarter. We plan to pay off $450 million of debt outstanding in August 2021. We have no borrowings outstanding under our $1.25 billion credit facility. We remain confident in the strength of our balance sheet and manage liquidity risk through a well laddered debt maturity profile. Considering our June 30 balance sheet, we have plenty of additional debt capacity for discretionary use in the second half of the year. Over the long term, we expect to return to our past practice of growing debt and EBITDA gross. It should be noted that free cash flow generation in the second half of the year is seasonally strong, stronger than in the first half of the year, and we will look to allocate cash for our best use based on return on capital. In summary, we ended the second quarter in a very strong position as we delivered strong top-line and bottom-line results. While the termination of our combination with Aon was not the outcome we originally intended, the opportunity for Willis Towers Watson as a standalone business is strong and exciting. We believe our disciplined approach to return on capital combined with our continued improved cash flow delivery and increased debt capacity provides flexibility to improve shareholder value creation over the long term. It should be noted our U.S. GAAP tax rate for the second quarter was 33.8% versus 42.2% in the prior year. Adjusted tax rate for the second quarter was 19.3% versus 22.2% in the prior year. The current year quarter effective tax rate includes $14 million deferred tax expense related to the enacted UK statutory tax rate change; the prior year effective tax rate was higher due to additional expense recognized in connection with the temporary provisions of the CARES Act. We anticipate our annual effective adjusted tax rate will be between 20% and 21% for the full year. We're very pleased with the second quarter results and their direct reflection of our incredibly talented colleagues, and an unwavering commitment to client service. Our second quarter results were very encouraging. We have momentum, we have solid financial results, a strong balance sheet and an excellent team, which gives me confidence in our ability to continue driving value for all our stakeholders. And now I'll turn the call back to you, John.

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

Thank you. The floor is now open for questions. And your first question is from Greg Peters of Raymond James.

Good morning. The first question will focus on retention. And John, I know you said that your client retention remained strong through the second quarter, but you also did highlight that there were some departures on the employee side. And I was wondering if you could give us some more color behind that? In the past, you've talked about retention as a percentage of the total employee base. Obviously, I think most of your investors are concerned about these departures and its impact on future organic revenue results. So any color you can add here will be helpful.

Yes. So thanks very much for that question, Greg. When we look at our overall attrition over the last 16 months or so, that attrition is within the normal historical bands we have now. We've seen our attrition go up a little bit more in the second quarter than we did before, and that's something we've seen companies across the board experience. The biggest issue we've had is not so much the attrition rate itself—although we have lost some valuable colleagues, let me be clear about that—but it was harder to hire new people and to onboard them while we were in the process of the merger because of the uncertainty of exactly how they would fit into the new organization. I think what we're going to be doing now is going out aggressively, recruiting and looking to replace some of the talent we've lost.

Can you just—as a follow-up to that, John, can you give us a sense within HCB, if you lost some healthcare brokers, can you give us a sense within CRB where the losses have been, whether it's Western Europe or North America, IRR—just some additional color there, so we can sort of use it to help build out our projections going forward?

So, hey Greg, this is Mike. As you might imagine, one of the biggest places we've lost talent has been in some of our corporate areas overall in the business, with the anticipation of the business combination. As John mentioned, we have lost some teams, but when you compare across HCB, CRB or IRR, our turnover isn't materially different than what we saw back in 2019. We have had some reinsurance teams that were lost in places like Australia. We're highlighting it because it's in the context of the M&A window, but this is a normal process that had been happening and may have slightly accelerated recently, as John mentioned. When I look at the numbers in terms of pure overall turnover, they're not that different from where we were in 2019.

I mean, to give you a sense—the turnovers are generally in the 10%, maybe 11% range. I think BDA, because of the nature of that business, is the one outlier where we have relatively high turnover rates.

But we hired people up for the seasonal fourth quarter, and then they go away.

Yes. Makes sense. And then the other related area, your retention bonuses. I think Aon came out on their call and they expressed their intent to pay the retention bonuses to their employees. What's your view on retention bonuses for your producers going forward?

So our view is that employee retention is something that we are managing constantly, not just during deals. We have various incentives that are embedded within our employees' compensation structure. The retention awards for the business combination were communicated in connection with the proposed combination to address specific risks and contingencies that could arise from that transaction. Since the transaction is no longer pending, we don't think those incentives are necessarily the ones we should have in place. That doesn't mean we won't put other ones in place; we will make sure we manage retention on an ongoing basis.

Yes, I would expect that. I guess my last question—I'm sorry, but I had to hammer the retention thing—would just be, Mike, I think in your comments you called out the benefit of T&E and certainly in your response reduced corporate expenses. When I think about just the overall expense structure going forward, is it fair to say that you're going to be making investments in this business, so the expense side of the house may start to increase relative to what we saw in the second quarter?

Yes. I think that's a fair statement, Greg. But I would also point to the comment I made, which is that we're focused on continued annual improvement and we anticipate margin improvement for the year. We'll look at those investments in terms of the run rate of the company. If we're making specific investments, we'll call them out. Our intent is to continue to drive margin improvement and margin expansion.

And maybe just as a quick addition to that, Greg. As Mike referenced in his comments, we're very excited about the growth prospects. We will be making investments in the business, but those are investments that we expect to generate revenue too. We're looking at both organic and inorganic opportunities and have a lot of enthusiasm around some of the prospects we see.

Got it. Thanks for the answers. Good luck in the future.

Thanks.

Thank you. Your next question is from Elyse Greenspan of Wells Fargo.

Hi, thanks. Good morning. My first question, John, in your prepared remarks you addressed that you're planning to retire which was kind of planned in conjunction with the Aon merger as well. I understand that your contract runs through the end of this year. So is there desire to put someone in place in advance of that timeframe? Is there the potential to extend your contract? And can you just tell us whether both internal and external candidates would be considered for your role? Also, on the leverage side, your leverage is now below 2x EBITDA, and you have some debt that's coming due shortly. So I'm trying to get a sense—are you willing to go up to 2.5x EBITDA? If you do add to debt, could additional share repurchases be considered for that additional capital in addition to looking to pursue growth?

Yes. Thanks very much, Elyse. My contract runs through the end of the year and I think the intention would be not to extend that, but to identify a successor and have that successor named before that time. I'll be working with the board on that; the board has a very thorough process and considers everything. This is not new; we've been doing this for a lot of years and we're not starting from square one here.

So Elyse, thanks for the question. When we think about leverage, at times we have gone up toward the higher end of our historical range, but we've always had a commitment to get it down below a certain range. Historically we've been comfortable around low-to-mid single-digit leverage targets, and that gives us plenty of capacity to think about investments both organically and inorganically, which we're excited about. We have lots of opportunities; it's a matter of deploying capital to the best return. As we think about capital allocation, we'll continue to look at share repurchases as an important element, along with dividends and inorganic or organic growth, in a balanced way going forward.

Okay, great. And then, on the revenue guidance, I think you said for the full year you guys would be at mid-single-digit. Was that total revenue or organic, or was that meant to be both? Also, you were at 8% for Q2 and 6% for the half year. Are you expecting a slowdown in the second half, given some of the retention stuff, or is it more conservatism given economic uncertainty as you think about going from 8% to what seems to be maybe 6% in the back half of the year?

It's meant to be organic for the full year. The pattern of our quarters is that Q1 and Q4 tend to be our largest quarters, with Q4 being the largest. Q3 tends to be a lighter quarter. I think you might have used the word conservative; it's our best estimate given current visibility. We thought that guidance would be helpful.

Okay. Thanks for the color.

Thank you. Your next question is from Paul Newsome of Piper Sandler.

Good morning. I'm curious if there is a lot of difference between the organic growth that you saw by account size, as opposed to segment, basically across the broking as well as the healthcare businesses? Was there more improvement in the larger account space or middle market or about the same?

It's about the same. We really saw it about the same across account sizes.

And perhaps you could talk a little bit about the pricing environment and what sort of tailwind that helped you within the broking side a little bit more?

We publish our Marketplace Realities twice a year, generally in April and October, where we include our view of the marketplace in terms of pricing. It continues to be a hard market; we continue to see a pricing tailwind with continued increases, with cyber being up almost 50% based on quoted prices. Our role is to do the best thing for our clients—manage those risks, help them understand the risks and price them appropriately. Property has been up, general liability has been up, casualty has been up, and we've seen some moderation in workers' comp and D&O, but overall across the board we're seeing pricing tailwinds reflected in the business.

Were there any notable geographic concentrations for the organic growth?

No, it was pretty balanced across the board. We didn't see any particular geography that we'd call out. We saw growth across all four segments and across geographies. Frankly, the business is running very strong; we're proud of the second quarter results.

And I think where there were some differences across the geographies, I did call them out when I went through the segment review.

Thank you. Your next question is from Shlomo Rosenbaum of Stifel.

Hi, good morning, and thank you for taking my questions. John, when you have a merger like this that you're anticipating, a lot of times companies go ahead and delay certain initiatives in anticipation of a joint strategy post-close. With Willis Towers Watson going out on its own more, what items might have been placed on ice that will now be revisited, or what are some strategies you'll be pursuing that you might not have been pursuing beforehand now that the company is on its own? Specific areas you could talk about—acceleration of investments into specific areas or verticals—any color would be helpful.

Thanks very much for that question, Shlomo. We clearly had some initiatives that we slowed in anticipation of the combination. Our leaders are going through and reviewing those now, and they're across all of our businesses—CRB, IRR, HCB—so we're looking at them and prioritizing them. At our Investor Day we'll present a comprehensive plan about how we're attacking them and taking them forward. There are initiatives we've continued to pursue during these 16 months—for example, our leadership on climate change, which we think is important both from the perspective of the work we're doing and because it will be a meaningful business for us going forward.

Okay. And then the company posted very strong growth—8%—clearly off a weaker 2Q comp. If we're looking at the underlying momentum in the business, would you say it feels like mid-single-digits as you guided for the year, or can you give some color around what a normalized year-over-year number might look like?

We've been talking for a couple of years about the overall market growing at about mid single-digits, and we're growing at least as fast as the overall market. If we look at it today, we feel slightly more bullish than mid single-digits, so we see at least mid single-digit growth for the longer run.

Thank you. In the interest of time, we do ask that you please limit yourself to one question and one follow-up. And your next question is from Suneet Kamath of Citi.

Great. Thanks. Back on retention, quick one: are there any agreements in place between you and Aon regarding recruiting and hiring each other's talent?

There are not. I mean, I think there are limitations on the use of confidential information that we've exchanged, but that's basically it.

Okay. And then in the CRB business, I think in the press release you talked about growth tied to settlements and book of business sales. Can you give us a sense of how much that contributed to the growth in the quarter? Is that normal course or one-time in nature?

We have business sales, and that's an ongoing feature of the business we're in. We had some last year and we had some this year; we probably had a little more this year than in prior years, but it's not something we break out separately.

Thank you. Next question is from Mark Hughes of Truist.

Yes. Thank you. Good morning. Mike, one would be a good way to approach other income—it was $74 million this quarter. What's a good proxy for future quarters?

Yes. I mean, I think this quarter is probably a reasonable representation of what you'd expect or think about. There obviously can be some slight ups and downs, but I think it's a reasonable proxy to consider.

Okay. And then John, the Willis Re decision at this time—could you expand a little bit more on your thinking about why and anything else that might fall into that category?

We have great appreciation for the Willis Re business, for our colleagues and the work they've been doing. We thought that coming off the termination of the deal with Aon was an appropriate time to consider strategic alternatives for Willis Re. That's the only business we're looking at in that way right now.

Thank you. Next question is from Ryan Tunis of Autonomous Research.

Hey, thanks. Quick one for Mike, on free cash flow. What are you thinking you'll be able to do for the full year of 2021 after we got through the second quarter?

Ryan, we have not given specific free cash flow guidance and do not intend to at this time given the uncertainties around COVID variants and the macro environment. I do believe we will continue to improve from what we've delivered previously—as you've seen, roughly 30% year-to-date improvement—and if you look at a run-rate basis for the first half, that's consistent with where we've been over the last couple of years. We're focused on free cash flow and proud of the progress. There's a lot of focus inside the organization on how important cash is for reinvesting in the business, buying back shares and other uses. We'll continue to work on improving it.

Thanks. And then it seems like there's a little bit of a mixed message on investing versus buybacks. You're saying you want to invest organically and inorganically, but you're divesting Willis Re. On the other hand, the buyback could clearly be bigger than it is. Thinking about the decision to sell Willis Re, what are you thinking about in terms of revenue replacement options? Could we see a larger share repurchase program?

We have an Investor Day coming up on September 9 and intend to provide more specifics about our growth plans. As we've said in our remarks, we see a lot of growth opportunities across our businesses—broking, consulting, BDA—and we'll prioritize them. If we don't find acquisitions or investments that are attractive, we will likely do more share repurchases. We'll be guided by what's best for shareholders in terms of financing growth.

Thank you. Our next question is from Mark Marcon of Baird.

Good morning. Thanks for taking my questions. Regarding margin outlook for the second half of the year, how should we think about that vis-à-vis some replacement hiring? Related to replacement hiring, generally speaking, when we take a look at the top leadership team within Willis Towers Watson and perhaps the layer or two below, how should we think about retention going forward? Obviously there were some agreements that were put in place to hold things together through the merger which are no longer relevant. So how should we think about that as we look through until the successor is named?

One of the things we've seen is incredible performance during the 16 months while we were in the combination period. That performance is driven by our colleagues, particularly our leaders and the broad leadership group at Willis Towers Watson, which has been outstanding. We have incredibly deep talent in the organization and we'll make sure we do the appropriate things to retain and motivate them. We're moving forward with a lot of confidence.

Great. Will you highlight that to a greater extent on September 9? And how should we think about the margin outlook over the next six months to the extent you can elaborate?

I think we will highlight some of that on September 9. We're proud of the margin expansion we've seen over the last couple of years and we think we can continue it. We recognize that some features like travel and entertainment expenses were suppressed; as those resume, we'll be careful to increase those costs only where they drive revenue. We feel good about continuing to drive margin expansion over the longer term.

Thank you. Our next question comes from Meyer Shields of KBW.

Thanks. First question for John: can you talk about how you came up with $1 billion as the share repurchase? I'm asking that because of how much cash is on the balance sheet.

If you think about the share repurchases we've done in the past, they've bounced around somewhat year-to-year, but if you look at what we would have been expected to do during the 16-month period, that's about $1 billion. It's effectively a catch-up to where we would have been under normal circumstances.

Okay. The second question, I know we've been talking about retention a lot, but it really is top of mind for investors. Is there any way of guiding or ballparking the impact on revenue growth either in the second quarter or maybe over the next 12 months from the people that you've lost?

No, we haven't broken it down to that level. If you look at what Mike said about mid-single-digit growth guidance, that gives you the net of everything. We haven't provided a finer breakdown.

Thank you. Your next question is from Brian Meredith of UBS.

Thanks. Two questions. First, Mike, I recall a couple of years ago you talked about the need to integrate systems to drive meaningful margin improvement in the CRB business. Where are you in that process and did the Aon merger agreement put a halt on some of that integration?

The teams continue to invest in systems and technology as appropriate and we've continued to do that. Most of CRB is supported by two core systems, and we've continued to invest in those systems that are core to our brokering capabilities and operations. Adam and the team are focused on driving efficiency and effectiveness, and you see that reflected in their results.

Great. My second question: I'm curious about the sale of Max Matthiessen and the sale of Miller—was that driven by the merger and are there certain things you might want to rebuild in that area now that the deal is terminated?

No, actually both Miller and Max Matthiessen were started before we announced the merger. We did slow some things during the merger window, and we'll address those on September 9 and reinvigorate initiatives we had, but nothing major like whole businesses that we'd want to rebuild specifically because of the termination.

Your next question is from Phil Stefano of Deutsche Bank.

Good morning. On the margin conversation, most investors focus on adjusted EBITDA margin, but you most recently gave guidance on adjusted operating margin. Which of these is more important and where should we focus our margin thoughts looking forward?

We tend to focus on operating margins overall in the business, so that's an appropriate spot for you to focus on as well. Depreciation and amortization are in EBITDA, but operating margin is the focal point.

My follow-up: There are strategic actions that could be announced over the next couple of months—the potential for share repurchases, whether to lever up the debt, the strategic review for Willis Re. How should we think about the timeline for all these things, given you don't have a new CEO in place and presumably the new CEO would need to be involved in strategic decisions?

We're working on a review of opportunities across all businesses—both those deferred and those newly identified in the last 16 months. It's a broad-based effort across our leadership, and it will have buy-in from the whole leadership team. We expect the work to be up and ready for the new CEO to execute on; we'll present more on our plans at the Investor Day on September 9.

Thank you. We have no further questions at this time. I will hand the call back over for any additional or closing remarks.

Okay. Thanks very much, everyone for joining us on today's call. We look forward to seeing you on September 9, when we'll be discussing the company's growth plans at our Investor Day in New York City.

Thank you. This does conclude today's conference call. You may now disconnect.