WILLIS TOWERS WATSON PLC quarterly report, Q2 FY2013

Business context and reporting period

Willis Group Holdings plc (the registrant named in this filing; not “Willis Towers Watson plc”) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2013. It provides insurance and reinsurance brokerage, risk management and consulting services through Global, North America and International segments. Unless noted, amounts are in U.S. dollars.

Financial performance and liquidity

• Commissions and fees rose 5.7% in Q2 to $885m and 4.8% for the first half to $1,931m. Organic growth was 6.3% and 5.1%, respectively; foreign currency reduced reported growth by 1.0 and 0.5 percentage points.
• Cash and cash equivalents were $503m at June 30, 2013, including $106m held for regulatory capital requirements; $397m was available for general corporate purposes. Management said liquidity was sufficient for the next 12 months.
• Total debt was $2,343m ($2,326m long-term and $17m short-term/current), versus $2,353m at year-end 2012. Stockholders’ equity was $1,977m; the reported capitalization ratio improved to 54.2% from 58.1%.
• First-half investing cash use was $75m and financing cash use was $50m. Cash increased $12m before a $9m adverse foreign-exchange effect. Dividends paid were $95m; declared dividends were $0.28 per share for Q2.
• Fiduciary assets and matching liabilities were each $9,910m. Fiduciary funds are generally unavailable for corporate purposes and should not be treated as operating liquidity.

Material changes versus prior comparable periods

• Q2 revenue growth did not translate into higher reported earnings: operating income declined $8m and shareholder continuing-operations income declined $2m. Higher expenses more than offset revenue growth; lower taxes partly mitigated the effect.
• First-half operating income fell $38m, while shareholder continuing-operations income fell $8m. Reported operating margin contracted 3.1 percentage points; adjusted margin was 26.0%, down 1.2 points from 27.2%.
• Salary and benefit costs rose 5.8% in Q2 and 9.0% in the first half; other operating expenses rose 20.2% and 9.1%, respectively. Q2 included $7m of one-time VAT charges and higher business-development costs; prior-year Q2 included a $5m insurance recovery.
• First-half results included a $46m Expense Reduction Initiative charge. Excluding specified items, adjusted first-half net income was $362m versus $337m, and adjusted diluted EPS was $2.05 versus $1.91. Q2 adjusted diluted EPS was $0.59 in both years.
• Segment performance was mixed. Q2 Global operating margin rose to 34.6% from 33.2%, and North America to 17.0% from 15.2%; International fell to 10.8% from 16.4%. In the first half, Global and International margins declined, while North America improved.

Outlook, commentary, risks and unusual items

• The filing gives no broad full-year revenue or EPS guidance. Management described the environment as challenging: Q2 reinsurance market sentiment was shifting amid additional capital, with possible rate softening absent significant catastrophe losses; primary-market rate increases persisted in some lines and regions. Management did not expect a pronounced universal market turn absent catastrophe losses or industry capital impairment.
• The $46m organizational review charge covered severance and staff costs, property and systems rationalization, and depreciation; it related to 207 positions. Management expected no further charge, approximately $20m of savings in 2013 and $25m–$30m in annualized savings.
• Management estimated full-year 2013 associate results would be a loss of $1m–$3m, versus $5m profit in 2012, while noting that results are outside its control. The Gras Savoye call-option exercise date was extended to June 2016.
• After quarter-end, the company amended credit facilities on July 23: the revolving facility increased from $500m to $800m and facility maturities were extended to July 23, 2018, with no change to stated interest rates. On July 25 it commenced tender offers for certain senior notes, with aggregate accepted principal capped at $500m, subject to the stated formula.
• Pension funding remains a significant cash commitment. Expected 2013 contributions were approximately $87m to the UK plan, $40m to the U.S. plan and $11m to international and U.S. non-qualified plans.
• Willis faced multiple Stanford Financial Group-related lawsuits, including claims seeking substantial damages. The company disputed the allegations and intended to defend itself; it said outcomes could not be predicted. A U.S. Supreme Court hearing in the Troice matter was scheduled for October 2013. The filing also cited potential additional claims and an August 31, 2013 tolling-agreement expiry.
• Other risks include insurance-market pricing and catastrophe exposure, European economic conditions and currency movements, significant indebtedness, pension obligations, client and employee retention, regulatory matters, and errors-and-omissions claims. Management said current litigation was not expected to materially adversely affect financial condition, results or liquidity, but adverse outcomes could affect particular periods.

Important facts for investors to verify

• Whether commission growth can continue while expense growth moderates and operating margins recover, particularly in International.
• Actual savings delivered from the restructuring and whether any further implementation costs arise.
• Cash generation after incentive payments, pension contributions, dividends and capital spending; confirm the amount of cash available for general corporate use.
• Execution and final economics of the amended credit facilities and senior-note tender offers, including debt maturities, covenant headroom and refinancing effects.
• Developments and potential exposure in Stanford-related litigation and other regulatory or claims matters.
• Actual 2013 associate results and pension contributions compared with management’s estimates.