Willis Towers Watson plc — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016; unaudited. WTW provides insurance broking, risk and human-capital consulting, administration, technology and exchange services. The Towers Watson merger closed January 4, 2016, making reported comparisons with 2015 substantially non-comparable; pro forma comparisons are more informative but remain illustrative.
Financial performance and liquidity
- Revenue: Q2 reported revenue was $1.949 billion, up 111% from $922 million; first-half revenue was $4.183 billion, up 108% from $2.009 billion, primarily reflecting the merger and acquisitions. Against pro forma 2015, revenue rose 8% in Q2 and 10% in the first half. Adjusted for purchase-accounting deferred revenue, constant-currency growth was 11% and 13%, respectively, including organic growth of 5% and 2%.
- Profit and margins: Q2 operating income was $136 million versus $105 million; first-half operating income was $462 million versus $398 million. GAAP operating margin was approximately 7.0% in Q2 and 11.0% year to date, down from approximately 11.4% and 19.8% on the reported 2015 bases. Net income attributable to WTW was $72 million in Q2 and $310 million in the first half, versus $70 million and $280 million. Diluted EPS was $0.51 and $2.25, versus $1.01 and $4.06; the 2015 per-share figures were reverse-split adjusted and are not merger pro forma.
- Pro forma adjusted results (non-GAAP): Adjusted operating income was $357 million in Q2 versus $347 million and $1.003 billion for the first half versus $884 million. Adjusted EBITDA was $406 million versus $401 million in Q2 and $1.077 billion versus $979 million for the first half. The filing attributes Q2 improvement in part to a £28 million ($41 million) JLT settlement; this is an unusual item.
- Cash flow: First-half operating cash flow was $427 million versus $7 million; free cash flow, as defined by WTW, was $335 million versus negative $40 million. Operating cash flow included $593 million of incentive payments and $112 million of defined-benefit pension funding; accounts receivable increased $123 million. Investing cash flow was positive $308 million, largely reflecting $476 million of cash acquired in the merger, while capital and internal-use software spending totaled $134 million.
- Balance sheet and liquidity: Cash was $949 million at June 30, up from $532 million at year-end. Total debt was $3.809 billion ($528 million current and $3.281 billion long term), versus $3.266 billion at year-end; approximate net debt was $2.860 billion, excluding fiduciary balances. WTW reported $719 million available on its $800 million revolving facility and $420 million available under other facilities. Management said liquidity should cover the next 12 months’ needs. Fiduciary assets and matching liabilities were each $11.767 billion and are not available for corporate use.
- Other metrics: Total assets were $32.409 billion versus $18.839 billion at year-end, reflecting the merger, including $10.527 billion of goodwill and $4.713 billion of net intangible assets. Shareholders’ equity was $11.050 billion versus $2.229 billion. The reported capitalization ratio was 25.6%, compared with 59.4% at year-end, largely reflecting merger share issuance. The company remained in compliance with financial covenants.
Material changes and business developments
- The January merger issued approximately 69.5 million post-reverse-split shares and was recorded at preliminary consideration of $8.723 billion. The acquisition accounting remains preliminary; acquired Towers Watson contributed $892 million of Q2 revenue and $1.791 billion in the first half.
- WTW reorganized reporting into four segments. In Q2, segment revenue was $765 million for Human Capital and Benefits, $629 million for Corporate Risk and Broking, $399 million for Investment, Risk and Reinsurance, and $155 million for Exchange Solutions. Exchange Solutions growth was notable; Investment, Risk and Reinsurance benefited from the JLT settlement but reported organic weakness in several activities.
- WTW issued $1.0 billion of dollar-denominated senior notes due 2021 and 2026 and €540 million ($609 million) of notes due 2022, using proceeds primarily to repay debt and reduce revolving-facility and term-loan borrowings. Total debt nevertheless exceeded year-end debt.
Outlook, commentary and risks
- No formal full-year revenue or EPS guidance is provided in the supplied filing text. The legacy Willis Operational Improvement Program is expected to finish by the end of 2017; management targets $325 million of annual savings by then, including up to approximately $150 million in 2016 and $250 million in 2017. Expected program restructuring costs are approximately $440 million through 2017, with approximately $140 million expected in 2016. WTW reported $212 million of cumulative savings through June 30, 2016. A separate restructuring program was expected to incur $22 million of additional costs through year-end 2016.
- Management described the second quarter as seasonally weak for some businesses. It said commercial insurance pricing declines were slowing, while ample market capacity remained. Management viewed Brexit’s near-term impact as uncertain but then expected a modest economic impact and a neutral-to-slightly-positive effect on WTW over the next couple of years; the risk-factor disclosure cautions that adverse economic, currency, regulatory, data-transfer or labor effects could be material.
- WTW increased its Stanford litigation provision by $50 million in Q1, bringing the provision to $120 million, following a settlement in principle for a one-time $120 million payment. Settlement effectiveness depends on court approval, final documentation and bar orders; the company disputes liability. Other disclosed matters include appraisal claims related to the merger and professional-negligence claims, including City of Houston, Meriter and CalPERS matters, for which loss estimates were unavailable.
- Acquisition accounting produced substantial goodwill and intangible assets and elevated amortization. WTW estimated $297 million of additional amortization for the remainder of 2016. Foreign-currency translation reduced reported revenue by $14 million in Q2 and $48 million in the first half. The company also disclosed cybersecurity, integration, competition, pension, litigation, leverage and client-retention risks.
- As of August 1, WTW had repurchased $100 million of shares and anticipated a further $200 million, targeting $300 million total by year-end, subject to market conditions and other factors. The board approved a quarterly dividend of $0.48 per share, payable in October 2016.
Investor facts to verify
- Track integration execution and whether merger synergies and the stated operational-improvement savings are realized against restructuring costs.
- Review subsequent purchase-price-allocation updates, goodwill impairment testing and the actual amortization burden.
- Monitor the status and final terms of the Stanford settlement and other litigation with unquantified potential losses.
- Assess cash generation, receivable collections, pension funding, debt maturities and facility availability; exclude fiduciary funds when evaluating usable liquidity.
- Separate organic growth and recurring performance from acquisitions, currency movements, purchase-accounting adjustments and the JLT settlement; confirm the basis of all pro forma and non-GAAP comparisons.
- Evaluate evolving Brexit exposure, especially currency translation, cross-border regulation, data protection and staffing requirements.