Business context and reporting period
Willis Towers Watson plc (WTW) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. WTW is a global advisory, insurance broking, consulting, technology and employee-benefits solutions company. The January 4, 2016 Towers Watson merger substantially changed the scale and composition of the business; the 2015 reported results do not include Towers Watson for comparable periods. WTW also completed its Gras Savoye acquisition in December 2015 and acquired Miller in May 2015.
WTW reorganized reporting into four integrated segments: Human Capital and Benefits (HCB), Corporate Risk and Broking (CRB), Investment, Risk and Reinsurance (IRR), and Exchange Solutions (ES). Management cautions that interim results are not necessarily indicative of full-year results.
Financial results and key metrics
| Metric | Three months ended September 30, 2016 | Nine months ended September 30, 2016 |
|---|---|---|
| Total revenue | $1.777 billion | $5.960 billion |
| Income from operations | $1 million | $463 million |
| Net income (loss) attributable to WTW | $(32) million | $278 million |
| Diluted earnings (loss) per share | $(0.23) | $2.00 |
| Operating margin | Approximately 0.1% | Approximately 7.8% |
For comparison, 2015 reported revenue was $846 million for the quarter and $2.855 billion for the nine months; reported WTW-attributable net income was $117 million and $397 million, respectively. These reported comparisons are not like-for-like because Towers Watson was not included in 2015 reported results. On management’s pro forma combined-company basis, revenue increased 2% for the quarter and 7% for the nine months; organic revenue growth was 1% in both periods. Pro forma diluted EPS was $1.51 for the 2015 quarter and $4.12 for the 2015 nine-month period.
Reported revenue growth was primarily acquisition-driven. In the third quarter, HCB revenue was $747 million, CRB $554 million, IRR $299 million and ES $161 million. On a pro forma basis, IRR revenue declined 9% in the quarter, while ES increased 25%. Nine-month pro forma organic revenue growth was strongest in ES; IRR organic revenue declined 4%.
Third-quarter costs included $157 million of amortization, $49 million of restructuring costs and $36 million of integration expenses. Nine-month amounts were $443 million, $115 million and $117 million, respectively. Company-defined adjusted operating income was $243 million for the quarter and $1.246 billion for the nine months; adjusted diluted EPS was $1.04 and $6.03, respectively. These non-GAAP measures exclude specified items and should be considered alongside GAAP results.
Operating cash flow was $608 million for the nine months, versus $113 million in 2015. Company-defined free cash flow was $457 million, versus $13 million. Investing cash flow was positive $283 million, including $476 million of cash acquired in the merger; financing cash flow was negative $646 million. Cash and cash equivalents were $767 million at September 30, 2016, versus $532 million at December 31, 2015.
Total debt was $3.786 billion ($519 million current and $3.267 billion long-term), up from $3.266 billion at year-end 2015. Cash less total debt was approximately negative $3.019 billion. WTW reported $710 million undrawn on its $800 million revolving facility and $420 million available under other facilities. It reported compliance with financial covenants. Current assets and liabilities include $11.604 billion of fiduciary assets and an equal amount of fiduciary liabilities; these client-related balances are generally unavailable for corporate purposes.
Material changes, outlook and risks
- Merger and comparability: The merger added substantial revenue, goodwill and intangible assets. At September 30, goodwill was $10.483 billion and net intangible assets were $4.589 billion. Merger-related amortization and integration costs weighed on GAAP operating results. WTW’s pro forma comparisons are illustrative and exclude anticipated synergies and costs to achieve them.
- Management outlook: WTW said it believed available cash, operating cash flow and undrawn facilities were sufficient for the next 12 months, including investment, debt service, dividends and contemplated repurchases. No specific consolidated earnings or revenue guidance was provided in the supplied filing text.
- Efficiency programs: The Legacy Willis Operational Improvement Program is expected to finish by the end of 2017. Management targeted $325 million of annual savings by then and reported $259 million cumulative savings to date. It expected approximately $180 million of additional restructuring costs through the end of 2017. A separate Business Restructure Program was expected to finish by year-end 2016, with $23 million of additional costs anticipated.
- Stanford litigation: WTW recorded a $120 million provision, including a $50 million increase in the first quarter of 2016, for a proposed settlement requiring a one-time $120 million payment. The settlement and broad bar orders remained subject to court approval; final approval was scheduled for January 20, 2017. The filing warns the ultimate resolution may differ from the provision.
- Other contingencies: WTW could not estimate a reasonably possible loss range for several matters, including Towers Watson appraisal proceedings, the City of Houston pension-actuary suit, Meriter Health Services claims and the CalPERS long-term-care litigation. The filing states that adverse outcomes could affect results or cash flows in particular periods.
- Market and operating risks: Management cited insurance-market conditions, weaker activity in parts of IRR, foreign-exchange exposure and uncertainty following the U.K. Brexit vote. WTW said it then expected Brexit’s effect to be neutral to slightly positive over the next couple of years, while noting uncertainty and potential regulatory, currency and economic impacts. It also highlighted cybersecurity, data privacy, integration, competition and talent-retention risks.
- Other notable items: Foreign-currency translation reduced reported revenue by $25 million in the quarter and $73 million in the nine months. The board approved a $0.48-per-share quarterly dividend in October, payable in January 2017. WTW repurchased $222 million of shares during the nine months and said it intended to repurchase up to $78 million more during the remainder of 2016, subject to conditions.
Important facts for investors to verify
- Review the merger pro forma and organic-growth calculations to distinguish acquisition-driven growth from underlying performance.
- Track integration spending, restructuring charges, realized savings and whether management achieves the stated savings timetable.
- Monitor the Stanford settlement’s final approval, bar orders and any change to the recorded provision; review developments in other unquantified litigation.
- Assess debt maturities, refinancing needs, covenant headroom and the availability of undrawn credit, while excluding fiduciary balances from corporate liquidity.
- Evaluate the recurring cash conversion behind reported operating cash flow and company-defined free cash flow, including capitalized software spending.
- Monitor currency exposure, Brexit-related developments, pension funding and the effect of acquired intangible amortization on reported earnings.