Willis Group Holdings plc — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. The filing’s registrant is Willis Group Holdings plc; the supplied company label, Willis Towers Watson plc, is not the name shown on this 2012 filing. Unless indicated otherwise, dollar amounts are in millions.
Business context and financial performance
Willis provides insurance and reinsurance brokerage, risk management and consulting services. Its reporting segments are Global, North America and International. Revenue is primarily commissions and fees, which are affected by insurance pricing, client exposures, retention and foreign exchange.
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total revenue | $842 | $861 | $1,855 | $1,868 |
| Commissions and fees | $837 | $852 | $1,842 | $1,851 |
| Operating income | $179 | $156 | $496 | $395 |
| Operating margin | 21.3% | 18.1% | 26.7% | 21.1% |
| Adjusted operating margin | 20.7% | 21.5% | 27.2% | 27.7% |
| Net income attributable to Willis shareholders | $108 | $85 | $333 | $119 |
| Diluted EPS from continuing operations | $0.61 | $0.48 | $1.89 | $0.68 |
| Adjusted diluted EPS from continuing operations | $0.59 | $0.61 | $1.91 | $1.89 |
Second-quarter organic commissions and fees grew 2% overall: Global grew 7%, International 2%, and North America declined 3%. Excluding Loan Protector, North America organic fees declined 2%. First-half organic growth was also 2% overall, with Global up 6%, International up 3%, and North America down 3% (down 1% excluding Loan Protector).
Q2 adjusted net income was $104 and adjusted diluted EPS was $0.59, down from $107 and $0.61 a year earlier. For the first half, adjusted net income was $337 versus $331 and adjusted diluted EPS was $1.91 versus $1.89. Adjusted figures exclude specified items and are non-GAAP measures.
Cash flow, balance sheet and capital
- First-half cash flow: Continuing operating activities provided $158, versus $126 in 2011. Investing activities used $66, versus $52. Financing activities used $120, versus $81. Cash decreased $28 to $407 at June 30.
- Debt: Total debt was $2,411, including $2,397 long-term debt and $14 current debt, compared with $2,369 at December 31, 2011. The company had $50 drawn on its $500 revolving facility and reported $450 of remaining revolver availability. Debt included $2,050 of fixed-rate senior notes and a $295 term loan.
- Liquidity: Management said available liquidity was sufficient for at least the next 12 months. Cash was $407. Fiduciary assets and corresponding liabilities were each $10,962; fiduciary funds are generally unavailable for corporate purposes.
- Capital returns: First-half dividends paid were $93; declared dividends were $0.27 per share for Q2. The company repurchased approximately 1.58 million shares in the first half for about $56, and reported approximately $76 spent on 2.13 million shares by August 3.
- Equity and leverage: Total equity was $2,711 at June 30, versus $2,517 at year-end. The reported capitalization ratio was 47.3%, down from 48.8%.
Material changes and management commentary
- Reported revenue slipped 2% in Q2 and 1% for the first half. Foreign exchange reduced commissions and fees by 4% in Q2 and 2% in the first half; organic growth partly offset the effect.
- Operating income rose as expenses fell, but reported improvement reflects prior-year costs that did not recur, including 2011 Operational Review charges and an $11 FSA settlement. Adjusted margin declined 80 basis points in Q2 and 50 basis points for the first half.
- North America and International segment margins weakened. Management cited Loan Protector’s contraction, lower insured exposures, retention-award amortization and investment in growth initiatives. Global performance was comparatively stronger.
- Management described market conditions as challenging and generally soft, with firmer rates in some catastrophe-exposed and other lines. It said a broad-based market turn was unlikely absent significant catastrophe losses or industry capital impairment. It also highlighted Eurozone economic and sovereign-debt risks.
Outlook, risks and unusual items
- No consolidated revenue, earnings or EPS guidance is provided. Management estimated 2012 depreciation expense of about $83 and intangible amortization of about $60; it expected the associates line to be down $6–$7 from 2011, with estimated Q3 losses of $1–$2 and Q4 losses of $5–$6.
- The company identified about $40 of cumulative commission and fee overstatement from 2005–2011 in a stand-alone North American unit. It concluded the misstatement was not material to previously issued periods, recorded charges of $22 in Q4 2011 and $13 in Q1 2012, and recorded a $5 insurance recovery in Q2 2012. The internal investigation was complete; the company said no client or carrier funds were misappropriated and controls had been enhanced.
- The FSA had imposed a £7 million ($11 million) fine in 2011 for deficiencies in controls over overseas third-party payments. The company continued a review of relevant payments and said it did not expect material fines or sanctions, while noting no assurance was possible.
- Stanford-related litigation remained unresolved, including claims seeking substantial damages; the company disputed the allegations. A petition for Supreme Court review was filed in July 2012 after an appellate reversal and remand. The contingent-compensation class settlement was approved, but one class member appealed.
- The UK pension contribution schedule was revised. Expected 2012 contributions were about $92 for the UK plan, $40 for the US plan and $12 for international plans. Additional UK contributions may depend on EBITDA and shareholder returns, subject to specified terms and caps.
- Other key risks include insurance-market softness and catastrophe exposure, currency and interest-rate movements, significant debt and refinancing constraints, pension obligations, client and employee retention, regulatory and legal matters, and potential goodwill impairment. Management reported disclosure controls effective and no material change in internal control apart from enhancements related to the commission overstatement.
Important facts for investors to verify
- Whether organic growth and segment profitability improve, particularly in North America and International, and how much Loan Protector continues to affect results.
- The adjusted-to-GAAP reconciliations and the extent to which reported profit growth reflects nonrecurring prior-year charges, foreign exchange or other adjustments.
- Progress and financial consequences of the commission-overstatement matter, insurance recovery and strengthened controls.
- Developments in Stanford litigation, the European Commission coinsurance inquiry and any further regulatory review or sanctions.
- Debt maturities, revolver availability, pension funding requirements, and the cash impact of buybacks and dividends; fiduciary balances should not be treated as corporate liquidity.
- Actual 2012 depreciation, amortization and associate results against management’s estimates, and the effect of continued soft markets and Eurozone conditions.