Business context and reporting period
Willis Group Holdings plc filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2015. The company provides insurance and reinsurance brokerage, risk management, and consulting services worldwide. Its reporting segments are Willis GB, Willis Capital, Wholesale and Reinsurance (CWR), Willis North America, and Willis International. The filing identifies a pending all-stock merger of equals with Towers Watson; the registrant had not yet adopted the Willis Towers Watson name.
Financial performance and liquidity
| Metric | Three months ended September 30, 2015 | Nine months ended September 30, 2015 |
|---|---|---|
| Total revenue | $846 million; up 4.2% year over year | $2.855 billion; up 0.4% |
| Operating income and margin | $27 million; 3.2% margin, versus $34 million and 4.2% | $425 million; 14.9% margin, versus $508 million and 17.9% |
| Net income attributable to Willis | $117 million, versus a $7 million loss | $397 million, versus $286 million |
| Diluted EPS | $0.64, versus a $0.04 loss | $2.18, versus $1.57 |
| Cash from operating activities | Management reported $106 million, down $23 million year over year | $113 million, versus $281 million |
Underlying and organic measures are non-GAAP and exclude specified items; they are not directly comparable to reported GAAP results. For Q3, organic revenue grew 3.6%, organic operating income rose 38.5% to $72 million, and organic operating margin increased to 9.3% from 6.9%. For the nine months, organic revenue grew 2.8%, organic operating income rose 12.7% to $552 million, and organic operating margin increased to 20.5% from 18.7%.
At September 30, cash and cash equivalents were $466 million, down from $635 million at year-end 2014. Total debt was $2.571 billion, including $323 million current debt, compared with $2.309 billion at year-end. Total equity was $2.486 billion; the reported capitalization ratio was 51.8%, versus 53.8%. Management said liquidity, including undrawn revolving facilities, was sufficient for expected needs over the next 12 months, including planned Gras Savoye funding and debt repayment. Fiduciary assets and liabilities were each $10.509 billion on the balance sheet and are not available for corporate use. The filing separately reports $2.5 billion of fiduciary funds held, compared with $1.9 billion at year-end.
Material changes versus prior comparable periods
- Q3 GAAP revenue rose, but operating income and margin fell; expenses increased 5.3% to $819 million. For the nine months, revenue was nearly flat while operating income and margin declined.
- Foreign exchange significantly reduced reported revenue: $48 million adverse in Q3 and $176 million for the first nine months. Acquisitions and disposals and organic growth partly offset the impact.
- Operating cash flow fell $168 million for the nine-month period. Management cited higher incentive payments, greater UK pension contributions, working-capital needs, and timing of collections.
- Cash used in investing increased to $348 million, including $293 million net acquisition payments and $100 million of fixed-asset additions. Financing provided $94 million, including $420 million of revolving-credit draws.
- Willis CWR and International delivered positive organic commission and fee growth in Q3; North America was flat and GB declined 0.7%. Segment margins weakened year over year in CWR, North America, and International for the nine-month period.
Outlook, management commentary, risks, and unusual items
- Merger: The proposed Towers Watson all-stock merger was valued at approximately $18 billion based on June 29, 2015 closing prices. Closing was then expected by December 31, 2015, subject to regulatory and shareholder approvals and other conditions. Management anticipated the combination would broaden advisory, broking, and solutions capabilities; completion and anticipated benefits were uncertain.
- Acquisitions: Willis acquired an 85% interest in Miller Insurance Services and completed several smaller acquisitions. It also agreed to acquire the remaining 70% of Gras Savoye for approximately €550 million (about $592 million), including repayment of third-party debt, subject to regulatory approval. After quarter-end, Willis announced sale of a 16.9% Miller interest to BB&T and acquired PMI Health Group.
- Operational Improvement Program: The multiyear program targets completion by year-end 2017. Management raised expected cumulative savings through completion to $490 million and annual savings by the end of 2017 to $325 million; expected total restructuring charges rose to approximately $440 million. The company recorded $93 million of restructuring costs in the first nine months and reported $63 million of savings for that period. Savings and costs are estimates and may vary.
- Tax item: Q3 and nine-month GAAP results included a $110 million tax benefit from a partial release of the U.S. deferred-tax valuation allowance. The reported nine-month effective tax rate was negative 11%; management said the underlying rate was 22% for the nine months. The remaining U.S. valuation allowance, excluding state separate taxes, was $61 million.
- Market and execution risks: Management described continued softening in primary insurance and reinsurance rates, excess capacity, competitive pricing, and pressure on underwriting margins, with potential for quarterly volatility. Other stated risks include merger and acquisition approvals and integration, foreign-exchange movements, debt and credit ratings, pension funding, litigation and errors-and-omissions claims, and retaining employees and clients.
- Contingencies: Willis faces Stanford-related litigation, including claims seeking substantial damages, and merger-related shareholder litigation seeking to enjoin the transaction. Management said it did not expect known claims to have a material adverse effect overall, but acknowledged that adverse outcomes could materially affect particular periods. The filing does not provide a clear estimate of reasonably possible losses for these matters.
- Shareholder returns: The company suspended its share repurchase program on June 30, pending the merger; it had repurchased approximately 1.71 million shares for $82 million during 2015. It declared a Q4 dividend of $0.31 per share.
Most important facts an investor should verify
- Whether the Towers Watson merger and Gras Savoye acquisition closed, on what terms, and with what financing and integration costs.
- Whether organic revenue growth, the Operational Improvement Program’s stated savings, and the projected restructuring charges were achieved.
- Whether operating cash generation recovered after the sharp year-over-year decline and how incentive, pension, and working-capital outflows evolved.
- The sustainability of earnings excluding the $110 million valuation-allowance release, disposal gains, restructuring costs, and merger-related expenses.
- Debt maturities, revolving-facility usage, liquidity after planned transactions, and the outcome of significant legal proceedings.