Willis Towers Watson plc — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016. Unaudited. Willis completed its merger with Towers Watson on January 4, 2016; reported year-over-year comparisons therefore include a substantially larger combined business and are not directly comparable. Unless otherwise stated, amounts are U.S. dollars.
Business context and financial results
WTW provides insurance broking, risk advisory, benefits and human-capital consulting, technology and exchange services. At quarter-end it reported through eight legacy-company segments, with plans to move to four integrated segments in Q2 2016.
- Revenue: $2.234 billion, up 105% from $1.087 billion reported in Q1 2015, principally reflecting the Towers Watson merger and Gras Savoye and Miller acquisitions. Against pro forma Q1 2015 revenue of $2.012 billion, revenue increased 11%; constant-currency growth was 14%, while organic change was negative 1%. Adjusted revenue, which adds back a purchase-accounting deferred-revenue reduction, was $2.266 billion and organic growth was 1%.
- Profit: Operating income was $326 million, versus $293 million reported a year earlier; GAAP operating margin was approximately 14.6%, versus 27.0%. Against pro forma Q1 2015 operating income of $369 million, it declined 12%. Net income attributable to WTW was $238 million, up from $210 million reported, but down from $251 million pro forma. Diluted EPS was $1.75 versus $3.04 reported and $1.82 pro forma.
- Adjusted measures: Adjusted operating income was $646 million versus $540 million pro forma, and adjusted EBITDA was $671 million versus $579 million pro forma. Adjusted diluted EPS was $3.41 versus $3.49 in Q1 2015. These are non-GAAP measures and should be read with the company’s reconciliations.
- Cash flow: Operating cash flow was $118 million, compared with cash used of $64 million in Q1 2015. Free cash flow, defined by WTW as operating cash flow less fixed-asset and internal-software additions, was $70 million versus negative $81 million. Operating cash flow included significant working-capital outflows, including incentive payments and higher receivables.
- Liquidity: Cash and equivalents were $954 million at March 31, up from $532 million at year-end; cash acquired in the merger was a principal driver. WTW reported $667 million available on its $800 million revolving facility and $420 million available under other facilities. Fiduciary funds are restricted and not available for corporate purposes.
- Debt and balance sheet: Total debt was $3.911 billion, up from $3.266 billion at December 31, 2015; cash less total debt was approximately $2.957 billion. The company issued $1.0 billion of senior notes in March and used proceeds in part to refinance and repay debt. Shareholders’ equity rose to $11.151 billion, largely reflecting shares issued for the merger. WTW stated that it was in compliance with financial covenants.
- Margins and taxes: GAAP income from operations included $161 million of amortization, $52 million of integration expenses, and a $50 million increase to the Stanford litigation provision. The effective tax rate was 6.9%, versus 22.0% reported in Q1 2015, primarily due to the post-merger global mix of income and deductions.
Material changes and segment performance
- Reported revenue more than doubled because Towers Watson was consolidated for the first time; pro forma results provide a more useful, though still illustrative, comparison. Pro forma figures exclude Gras Savoye and Miller and do not reflect merger synergies or the costs to achieve them.
- Exchange Solutions revenue rose 57% pro forma, supported by the 2016 enrollment season; WTW reported about 1.6 million covered lives in OneExchange. Risk and Financial Services revenue fell 8% pro forma, and Talent and Rewards fell 11%, including the effect of a prior-year business sale and lower transaction activity.
- Willis International revenue increased 68% reported, primarily from Gras Savoye; organic performance was affected by a large project cancellation, timing and weakness in Asia. Willis CWR increased 12% reported, driven by Miller, while organic revenue declined. Willis North America rose 3%; Willis GB declined 2%.
- WTW recognized $25 million of restructuring costs in Q1, compared with $31 million in Q1 2015. Goodwill reached $10.477 billion and net intangible assets $5.086 billion, largely from acquisition accounting; Q1 amortization rose sharply versus reported 2015.
Outlook, risks and unusual items
- Management said liquidity was sufficient for the next twelve months, including business investment, integration, scheduled debt payments and contemplated dividends. It also said it may continue to adjust debt financing during 2016 depending on market conditions. The filing gives no specific consolidated revenue or earnings guidance.
- The Legacy Willis operational improvement program is expected to run through 2017. Management forecast up to approximately $150 million of savings in 2016 and $250 million in 2017, with $325 million of annual savings targeted by the end of 2017, excluding merger-related savings. Expected cumulative restructuring charges were approximately $440 million through 2017, including approximately $140 million in 2016. WTW reported $41 million of Q1 savings.
- A $120 million settlement in principle was reached in the Stanford litigation, with a corresponding $50 million Q1 increase to the previously recorded provision. Payment and broad releases depend on definitive documentation, court approval and bar orders; approval is not assured. WTW denied liability and said it would defend the matter if the settlement does not become effective.
- Other proceedings include merger appraisal demands, the City of Houston pension-advice case, British Coal investment-consulting claims and Meriter litigation. WTW could not estimate reasonably possible losses or ranges for several of these matters. The company cautioned that adverse litigation outcomes could affect results or cash flows in particular periods.
- WTW assumed substantial pension obligations in the merger: approximately $4.6 billion of projected benefit obligations and $3.7 billion of plan assets. It anticipated additional U.K. and other-plan contributions during the remainder of 2016; U.S. contributions had not yet been determined.
- After quarter-end, a separate restrictive-covenant matter produced a £28 million ($41 million) settlement payment to WTW, plus £2.75 million ($4 million) for legal fees, received April 28, 2016.
- Key risks include integration execution and realizing expected benefits, competition and insurance-market pricing, foreign exchange, pension funding, litigation, regulation, client retention, and data or systems security. Management reported disclosure controls effective and no material change in internal control over financial reporting during the quarter; acquired businesses were excluded from the stated controls assessment as described in the filing.
Important facts for investors to verify
- Track organic and constant-currency growth against pro forma results, and distinguish acquisition contributions from underlying performance.
- Monitor integration costs, delivery and timing of merger synergies, and whether restructuring savings are achieved net of reinvestment and charges.
- Confirm the Stanford settlement’s final court approval, bar orders, payment timing and tax treatment.
- Review debt maturities and refinancing needs, especially the $620 million one-year term loan due in 2016 and $394 million of senior notes due in 2017; assess liquidity excluding fiduciary funds.
- Assess the effect of acquisition-related amortization, purchase-accounting adjustments and the unusually low Q1 effective tax rate on sustainable earnings and EPS.
- Follow pension funding requirements and developments in appraisal and professional-liability proceedings for which loss estimates were unavailable.