WILLIS TOWERS WATSON PLC annual report, FY2016

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Willis Towers Watson plc — 2016 Form 10-K

Reporting period: Fiscal year ended December 31, 2016. The company is a global advisory, insurance broking and solutions business, organized into Human Capital and Benefits, Corporate Risk and Broking, Investment, Risk and Reinsurance, and Exchange Solutions.

Business context and comparability

Willis and Towers Watson merged on January 4, 2016; 2016 results include the combined business, while reported 2015 results largely reflect Legacy Willis. The merger, Gras Savoye acquisition and resulting purchase-accounting charges materially limit direct year-over-year comparisons. Management therefore also presents unaudited pro forma comparisons, which exclude certain merger benefits and costs and are not forecasts.

Financial performance

  • Revenue: $7.887 billion, versus $3.829 billion reported in 2015. On a pro forma basis, revenue rose 5% from $7.492 billion: foreign currency reduced growth by 3%, acquisitions added 7%, and organic growth was 1%. Adjusted revenue growth was 6% reported, or 9% constant currency and 2% organic, including an adjustment for merger-related deferred revenue.
  • Operating profit: GAAP operating income was $551 million (7% of revenue), versus $427 million (11%) in 2015. Against pro forma 2015 operating income of $765 million, 2016 was lower by $214 million, primarily reflecting higher restructuring and integration costs. Non-GAAP adjusted operating income was $1.620 billion versus $1.511 billion pro forma; adjusted EBITDA was $1.771 billion versus $1.682 billion.
  • Net income and EPS: Net income attributable to WTW was $420 million, up from $373 million reported in 2015; diluted EPS was $3.04 versus $5.41. The share count more than doubled with merger consideration, making per-share comparisons especially sensitive to the merger. Adjusted diluted EPS was $7.96; this is a non-GAAP measure.
  • Fourth quarter: Revenue was $1.927 billion, operating income $88 million, and net income attributable to WTW $142 million; diluted EPS was $1.03. The company corrected its prior earnings-release figures after recording a $103 million income-tax benefit. It said the correction was immaterial to previously filed 2016 quarterly statements and did not change adjusted EPS or the 2017 outlook.
  • Cash flow and investment: Cash from operating activities was $920 million, versus $243 million in 2015. Free cash flow, a company-defined non-GAAP measure subtracting $218 million of fixed-asset and internal-use software additions, was $702 million versus $97 million. Total fixed-asset and software spending was $303 million.
  • Liquidity and debt: Cash and cash equivalents were $870 million; total debt was $3.865 billion, including $508 million current debt. The company reported $557 million available under its $800 million revolving facility and $420 million available for securities-underwriting regulatory purposes. It said liquidity was sufficient for the next 12 months and reported compliance with financial covenants. Fiduciary funds of $2.5 billion are not available for corporate use.
  • Capital returns: WTW repurchased 3.17 million shares for $396 million in 2016 and paid $199 million in dividends. A quarterly dividend of $0.53 per share was approved for payment in April 2017.

Material changes and management commentary

  • Reported revenue growth principally reflects the merger and acquisitions, not comparable organic expansion. Pro forma organic growth was modest at 1% (2% adjusted for deferred revenue purchase accounting).
  • Segment revenue shares in 2016 were approximately 41% HCB, 32% CRB, 19% IRR and 8% Exchange Solutions. Exchange Solutions grew commissions and fees 35% pro forma, while IRR commissions and fees declined 1% pro forma, including a 4% organic decline.
  • The merger increased goodwill to $10.413 billion and net intangible assets to $4.368 billion; 2016 amortization expense was $591 million. No goodwill or intangible impairment was recorded.
  • Management’s strategy is to integrate the businesses, grow through a unified global platform and distribution, and realize cost synergies. The filing identifies execution, client and talent retention, and integration costs as significant uncertainties.

Outlook, risks and contingencies

  • Outlook: Management expected Exchange Solutions revenue growth to moderate to around 10% in 2017 as retiree enrollment stabilized, while active-exchange growth was expected to remain strong. The filing does not provide a clear consolidated 2017 revenue or earnings forecast in the text provided.
  • Restructuring: The Operational Improvement Program was expected to deliver $325 million of annual savings beginning in 2018; management expected another $130 million of restructuring charges in 2017, bringing cumulative charges to about $440 million. A separate 2016 program eliminated about 450 positions and was expected to generate annualized savings of about $80 million.
  • Market and regulatory risks: Soft insurance pricing can pressure commissions and margins; other key exposures include foreign-exchange movements and Brexit uncertainty, healthcare policy changes affecting Exchange Solutions, cybersecurity and data privacy, regulatory compliance, and competition.
  • Pensions and obligations: Pension assumptions and market movements can materially change obligations and funding needs. The company projected $128 million of 2017 qualified-plan contributions and $60 million of direct benefit payments.
  • Litigation: The Stanford-related settlement calls for a $120 million payment, subject to final court approval and bar orders; the court reserved decision after a January 2017 hearing. Other matters, including City of Houston, Meriter and CalPERS litigation, had no reasonably estimable loss range disclosed. The filing states adverse outcomes could affect a particular period.
  • Other unusual item: The $103 million tax benefit was recorded in the fourth quarter after correction of the earnings-release figures. Management stated the adjustment did not affect prior-year statements or the 2017 outlook.

Important facts for investors to verify

  • Track organic and constant-currency growth against merger-inclusive and pro forma comparisons, especially the performance of HCB and IRR.
  • Verify delivery and timing of the stated operational savings, associated restructuring costs, and integration progress.
  • Confirm final approval and payment terms of the Stanford settlement, and monitor developments in other significant litigation.
  • Assess debt maturities, refinancing needs, pension funding and the availability of cash held in regulated or fiduciary accounts.
  • Review the tax-benefit correction and subsequent quarterly reporting, and distinguish GAAP results from management’s non-GAAP adjusted measures.