Business context and reporting period
Willis Group Holdings plc, an Ireland-incorporated insurance and reinsurance broker and risk-management adviser, filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2014. The filing predates the company’s later name, Willis Towers Watson. Unless otherwise noted, figures are in U.S. dollars; financial amounts are in millions.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $935 | $890 | $2,032 | $1,941 |
| Operating income | $148 | $167 | $474 | $448 |
| Operating margin | 15.8% | 18.8% | 23.3% | 23.1% |
| Net income attributable to Willis | $47 | $105 | $293 | $324 |
| Diluted EPS | $0.26 | $0.59 | $1.61 | $1.83 |
| Operating cash flow | Not separately provided | Not separately provided | $152 | $137 |
Commissions and fees were $930 in Q2, up 5.1% reported and 4.5% organically; for the first half they were $2,020, up 4.6% reported and 4.3% organically. Underlying operating income, a company-defined non-GAAP measure, was $151 in Q2 versus $156, with a 16.1% underlying margin versus 17.4%. First-half underlying operating income was $477 versus $479, and underlying margin was 23.5% versus 24.6%.
First-half investing cash outflow was $82 and financing cash outflow was $155, resulting in an $85 decrease in cash before a $3 adverse foreign-exchange effect. Cash and cash equivalents were $708 at June 30, down from $796 at year-end 2013. Total debt was $2,317 ($15 current and $2,302 long-term), compared with $2,326 at year-end; reported equity was $2,444. The capitalization ratio declined to 48.7% from 51.2%. The company reported $800 of undrawn capacity on its principal revolving facility and no draws on its revolving facilities at quarter-end. Fiduciary assets and liabilities were each $9,983 and are not available for general corporate use.
Material changes versus prior comparable periods
- Q2 revenue increased 5.1%, but operating income fell 11.4% and attributable net income fell 55.2%. First-half operating income rose 5.8%, while attributable net income declined 9.6%.
- Q2 operating margin contracted 300 basis points. Management cited higher compensation and operating costs, investment in growth and increased corporate-function costs; Q2 salaries and benefits rose 8.7%.
- Q2 tax expense rose to $59 from $29, including a $21 increase in the U.S. deferred-tax valuation allowance and a $13 charge from updating the timing of the estimated annual tax charge. The reported Q2 tax rate was 54%, versus 21% a year earlier.
- Other expense included a $14 charge from Venezuelan currency devaluation, partly offset by foreign-exchange gains and disposal gains. Interest expense rose to $35 from $32 in Q2.
- First-half operating cash flow improved by $15, while financing cash outflow increased to $155 from $50, principally reflecting share repurchases and dividends.
Outlook, management commentary, risks and contingencies
- Management described the outlook as challenging amid global economic uncertainty and softening insurance and reinsurance rates, while noting improving conditions in some U.S. and European markets. The filing does not provide full-year revenue or earnings guidance.
- The multiyear Operational Improvement Program, expected to finish by the end of 2017, targets approximately $420 of cumulative savings through 2017 and approximately $300 of annual savings from 2018. Estimated cumulative charges are approximately $410. Management cautioned that savings, charges and timing may vary; $3 of costs were recognized in the first half.
- Management expected 2014 associate earnings of $10–$15, versus no profit in 2013, primarily reflecting Gras Savoye; actual results may differ because Willis does not control its associates.
- Expected 2014 pension contributions were approximately $84 to the UK plan, $30 to the U.S. plan and $9 to other plans, in addition to approximately $12 of UK salary-sacrifice contributions. UK funding terms were due for negotiation in 2014.
- The company said it believed liquidity was sufficient for the next 12 months and that its leverage and interest-coverage ratios remained within revolving-credit covenants. It also intended to repurchase up to $200 of shares during 2014; $117 was spent in the first half, and approximately $30 more was spent after quarter-end through August 1.
- Willis disclosed multiple Stanford-related lawsuits, including claims seeking damages exceeding $1 billion in certain actions. It disputes the allegations and intends to defend itself; outcomes and potential payments could not be predicted. Management did not expect known claims to have a material adverse effect on financial condition, results or liquidity, while acknowledging possible effects on individual periods.
- Other risks include insurance-market pricing and premium levels, foreign-exchange movements, debt management, pension funding, regulatory scrutiny, litigation and errors-and-omissions claims. The filing newly highlighted possible regulatory or other scrutiny of market-derived income and related conflicts of interest.
- The company adopted new tax-benefit presentation guidance in 2014, reducing deferred tax assets and other non-current liabilities by $21. It was assessing the impact of the new revenue-recognition standard, effective for its 2017 fiscal year.
Important facts for investors to verify
- Whether organic growth and segment trends persist, particularly given softening reinsurance rates and uneven UK retail performance.
- Whether the $21 valuation-allowance increase and elevated tax rate affect subsequent periods, and whether the reported tax-rate timing adjustment is fully understood.
- Progress, realized savings, restructuring charges and execution risks under the Operational Improvement Program.
- Actual pension contributions and the outcome of UK pension-funding negotiations, alongside cash available after dividends and buybacks.
- Developments in the Stanford litigation, Venezuelan currency exposure and market-derived-income regulatory risk.