WILLIS TOWERS WATSON PLC quarterly report, Q2 FY2015

Willis Group Holdings plc — Q2 2015 Form 10-Q

Reporting period: Three and six months ended June 30, 2015. The filing is by Willis Group Holdings plc, not a post-merger “Willis Towers Watson plc”; the Towers Watson merger was pending at the reporting date. Willis brokers insurance and reinsurance and provides risk-management and human-capital consulting services.

Financial performance and liquidity

Metric	Q2 2015	Q2 2014	Six months 2015	Six months 2014
Total revenue	$922m	$935m	$2,009m	$2,032m
Operating income	$105m	$148m	$398m	$474m
Operating margin	11.4%	15.8%	19.8%	23.3%
Net income attributable to Willis	$70m	$47m	$280m	$293m
Diluted EPS	$0.38	$0.26	$1.54	$1.61

Q2 commissions and fees were $917m, down 1.3% reported; organic growth was 1.6%. For the first half, fees were $1,998m, down 1.1% reported, while organic growth was 2.6%. Foreign exchange reduced reported first-half revenue by $128m.
Underlying, non-GAAP operating income was $157m in Q2, up 6.2%, and $481m for the half, up 6.1%. Organic operating margins were 17.8% and 24.9%, respectively. These measures exclude specified items and rebase prior-period currency; they are not GAAP results.
Net cash provided by operating activities was $7m for the first half, versus $152m a year earlier. Investing activities used $248m, including $228m for acquisitions; financing activities provided $104m. Cash fell to $483m from $635m at year-end 2014.
Total debt was $2.520bn, comprising $468m current and $2.052bn long-term, versus $2.309bn at December 31, 2014. The company had drawn $220m on its revolving facility. Shareholders’ equity was $2.393bn; the reported capitalization ratio was 51.3%.
Current assets and liabilities included matching fiduciary balances of $11.006bn each; fiduciary funds are not available for corporate purposes. The filing states liquidity was sufficient for the next 12 months, including planned acquisitions and debt repayment.

Changes versus the prior comparable period

Reported operating margin fell 440 basis points in Q2 and 350 basis points for the first half. Restructuring costs rose to $38m in Q2 and $69m in the first half, from $3m in each prior-year period; Q2 also included $14m of M&A transaction costs.
Despite lower reported operating income, Q2 net income rose to $70m from $47m, supported in part by lower tax expense ($19m versus $59m) and $23m of other income versus $3m of expense. The prior-year quarter included significant U.S. valuation-allowance and tax-methodology charges.
First-half net income declined to $280m from $293m, while first-half operating cash flow dropped to $7m from $152m. Management cited incentive payments, higher UK pension contributions, working-capital growth and timing of collections and tax payments.
By segment, Q2 organic fee growth was strongest in Willis International (7.1%) and Willis North America (2.5%); Willis GB and Willis CWR each declined 2.3%. Reported segment margins were lower year over year across all four segments.

Outlook, management commentary, risks and unusual items

Operational Improvement Program: Expected to finish by end-2017. Management raised expected cumulative savings through completion to $490m and annual savings by end-2017 to $325m; estimated annual savings phasing is $80m in 2015, $150m in 2016 and $250m in 2017. Expected restructuring charges through 2017 were revised to approximately $440m. The company reported $41m cumulative savings through June 2015 and $105m cumulative restructuring charges.
Towers Watson merger: A proposed all-stock merger of equals, with implied equity value of approximately $18bn, was expected to close by December 31, 2015, subject to regulatory and shareholder approvals. The filing identifies completion, integration, employee and client retention, costs, synergies and tax treatment as risks. Merger-related Delaware shareholder suits sought to enjoin the transaction.
Gras Savoye: Willis agreed to acquire the remaining 70% interest for approximately €550m, including repayment of third-party debt, subject to regulatory approval. Management expected to use additional debt to finance the acquisition.
Acquisitions: Willis acquired an 85% interest in Miller Insurance Services, plus Carsa and Evolution Benefits Consulting. First-half acquisition and disposal cash outflow, net of cash acquired, was $228m. Miller’s purchase-price allocation was preliminary.
Insurance market and currency: Management described primary and reinsurance pricing as easing, creating pressure on commissions and margins. Foreign-exchange movements materially reduced reported results; Willis also cited exposure to further Venezuelan bolivar devaluation.
Pensions and taxes: A UK pension salary freeze reduced the plan’s projected benefit obligation by approximately $215m and generated a prior-service gain recorded in other comprehensive income. Willis said a $70m–$100m release of its $164m U.S. deferred-tax valuation allowance was possible, subject to profitability and timing.
Contingencies: Willis faced Stanford-related litigation, including claims seeking substantial damages; it said outcomes could not be predicted and did not expect the matters to have a material adverse effect overall, while acknowledging possible period-specific effects. The filing also disclosed approximately $180m of net new operating and sublease commitments and no other material off-balance-sheet arrangements.

Most important facts for investors to verify

Progress, approvals, closing conditions and any termination or litigation developments for the Towers Watson merger, including potential termination payments.
Actual execution and costs of the improvement program versus the revised savings and charge estimates.
Operating cash generation, incentive and pension cash requirements, and funding for debt maturities and the Gras Savoye acquisition.
Underlying and organic growth calculations alongside GAAP results, including segment trends and the effect of foreign exchange.
Any U.S. deferred-tax valuation-allowance release and developments in the Stanford claims and merger-related lawsuits.