Willis Towers Watson PLC (WTW) 2002 Q2 法說會逐字稿

Good morning and welcome to the second quarter earnings conference call.

All parties will be on listen-only mode until the question-and- answer session of the conference.

Investor relations is recording today's call.

If you have objections, you may disconnect.

I would like to introduce Mr. Carry Colero(phonetic).

You may begin when ready.

Thank you and good morning.

Welcome to our second quarter earnings conference call and webcast.

On the call today are Joe Plumeri, Willis chairman and CEO, and Tom Colraine, our chief financial officer.

This teleconference will be available starting at 10:30 this morning eastern-standard time and ending at 5 p.m. on August 13th.

For access please call 800-944-3659, within the U.S.

Or 402-998-1746 outside the U.S.

If you have questions after the call, you may call me at 212-837-0880. Let me remind you, we may make certain statements relating to future results which are forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995.

Such statements of subject to risk and uncertainties that could cause actual results to differ materially from those anticipated.

Additional information concerning risk factors that could cause such a difference can be found in the company's documents filed with the SEC from time to time. Let me introduce Joe Plumeri.

Good morning, everybody.

Let me make a comment or two with regard to the quarter.

The best way to do it is straight forward.

In that, our model, which as you all know, is a model that simply concentrates on growing the sales culture and growing revenues with tremendous expense discipline, don't waste money and bring revenue to bottom line, build our pipeline with new accounts to where we think we can to hold on to accounts, expand our margins through very diligent, irrespective of the times that we were going through whether hard or soft markets and simply execute.

We spend a great deal of time talking about execution on a day in and day out basis.

So, I think that that model, which is the model that we have built almost now for couple of years, continues to get executed.

I think that the second quarter is again a manifestation of simply executing on that very simple model. The quarter, operating cash earnings on cash basis was 35 cents, up 94% from last year.

Our operating cash earnings rose 136%, to $59 million in the quarter.

Our organic growth was up 18%in the quarter, which is a record for Willis.

That gives us 10 successive quarters of year-over-year growth in operating cash earnings and revenue.

Our operating margin, which we spend a great deal talking about in the company.

We talk about our margins not only being a manifestation of how well we run the company, but also the amount of cash flow it generates for us to pay down debt and invest in our business, whatever the case may be.

With 26% in the quarter, that is up from 18% a year ago, or 800 basis points increase over last year. Our EBITDA margin was 28% in the quarter, which is another record for Willis in the quarter.

Up from 23% last year of 500 basis point differential.

We continue to talk about our vision, which is to be the very best global broker in the world and deliver those resources locally so that we have a global reach and global accessibility, but yet deliver to clients locally by the relationships that we have with them.

We want to be a pure broker.

We don't underwrite.

When we look at margins and things we are doing, we are not distracted by anything other than what we do, and that is to deliver product and services as good as we possibly can and as efficiently as we possibly can.

Everyone of our businesses contributed to this great quarter. One of the nice things about the momentum we have is the fact that we are attracting very good talent to our company.

One of the drivers in any sales organization is the number of people who are selling for you, the number of people who produce or are faced with the clients.

We increase that by 130 sales associates in the first half of the year, which in addition to the 230 that we recruited last year, obviously has helped in contributing to our very, very positive revenue growth.

I might also add parenthetically, that as we are talking about the amount of increased people who are joining us, that at the same time, we have been able to keep our non-productive staff headcount increased to less than 1% in a year-over-year basis, which goes to the issue of being able to watch our expenses and to continue to expand our margins and spend our money where it is most productive on a year-over- year basis. Let me just talk about the revenue in general, if I can.

As you know, one of our headlines in our model is to grow sales culture, one that will give us the opportunity not only to thrive in hard markets, but someday the markets will be soft, whenever that will be.

We want to be able to continue to grow our revenue when that happens, as well.

The way you do that is to build a culture that is very, very scientific, very focused on the amount of new accounts we are opening constantly.

Because if your pipelines, which are monitored closely at Willis, are growing and they are long, you add predictability to a business that by and large is unpredictable.

The predictability comes from our ability to be able to understand our closed rates, understand our gestation periods and as that pipeline gets longer, you have the ability to predict and control your destiny.

We spend a lot of time doing that. We put those into effect basically at the beginning of this year.

I don't think they have fully manifested themselves yet.

We did that, as well, with our compensation program.

So, the organic growth up 18% in the second quarter was up over 12% a year ago and 17% the first quarter.

So, we are growing very, very nicely year-over-year, but also on a quarter-to-quarter basis.

But, still, not having the full results, I think, of our pipelines and seeing how the pipelines can result in even better revenue growth.

Our reported revenues grew 22% to $411 million. These revenues obviously are cyclical, just to remind you.

The first is the highest and then the fourth, then the second and then the third.

About half of revenue growth came from new business and the other half came from the updraft in the rates, which has been pretty consistent.

Our new launch business ratio is still about 2-to-1.

We are opening 2 accounts for every 1 we are losing.

We are pleased as we track that and are tracking closely. 95% of our revenue comes from commissions and fees.

Only 5% come from contingencies, investment income and that sort of stuff.

Again, in our driver to be a pure broker and not rely on other types of things we can control, but the things we can control is our revenue growth through pure organic sales. About 70% of revenue still comes from commission. 30% comes from fees.

I think obviously that provides us with leverage in this pricing environment.

The mirement continues to present challenges.

Limits, terms, conditions, pricing are all obviously very, very difficult as this hard market continues.

We like the opportunity because as a pure broker, the way you differentiate yourself in times are difficult and prices are like this, is it gives us a opportunity to shine.

We preach that all the time and talk to our people about that because that is the time to do better than the other people who are trying to vie for our clients or prospect business. I might also tell you, that as we are growing this culture and as we are sophisticating our processes, we intend to continue to invest in the parts of the business that will stand us in good stead over time, which means recruiting becomes, as I said, a big driver for those people who would like to join us and get excite body our model and what we are doing.

Obviously we will continue to do that as much as we possibly can.

Our training program, which is - we have invested heavily in and will continue to invest heavily in, will also continue to take shape in the second half of this year. Obviously, our IP spending, which not only on software programs, but on global platform, to create better service for our clients on a worldwide basis, is another investment we are going to be continuing to make, which will manifest itself in the second half of this year.

So, our growth strategy continues by investing in our business as we continue to grow our model and try to not waste money where we don't need to use it and spend money where we invest in our business.

Just a review Of our various operations.

North American operations continues to grow and to show good results as it relates to us continuing to turn that into a sales culture.

Reported revenues were $140 million.

Organic revenue growth accelerated to 15% in the second quarter, up from 12% the first quarter and 5% a year ago.

So, progress continues.

We are very happy with the way North America is going.

The sales culture is attacking hold and driving our middle market business, especially practices, construction, benefits, health care, environmental, are all continuing to do well and growing. Just a comment about the market in the U.S., it is obviously the hard market continues throughout the North American region.

U.S. middle market, I guess experienced 20 to 30% increase in rates.

The highest of which was bno premium, that has risen 50% for the companies that have very good claim experience.

That is topical today.

Our global businesses, the U.K.-based businesses serving global companies, continues to do extremely well, reported revenues are $216 million.

Organic revenue growth of 17% in the quarter, another strong quarter by our specialty lines, aerospace, marine, property and casualty, reinsurance, just right across the board.

Obviously that is benefiting from the hard market, as well.

Increased rates, higher deductibles, coverage restrictions, reduced capacities, all the things you are well aware of now.

Because those businesses are very varied, you are looking at increases anywhere between 10 and 200% and in aviation it could be more. Good margins, expenses and great shape as it relates to global.

Couldn't be happier with them.

Those are the most seasoned businesses.

For seasoned businesses, they continue to grow.

International, which is one of the areas along with North America, I had mentioned in one of my calls I thought had leverage in this business because between the two they make up about 50% of our revenue.

Those revenues were up $55 million organic growth of 26% in the growth.

Great performance in Europe and northern hemisphere, especially Australia and northern American.

As of January 1, we brought controlling interest in a German associate, Jaspers Wuppesahl, who have revenues of $50 million.

The hard market continues across the globe, but we are very happy with the progress in our international area, as well. So, I guess to sum it up, all things are firing across the globe.

Let me talk about expenses, which is a big deal here.

We watch them, as you know, closely for the quarter.

The reported general and administrative expenses rose (inaudible) percent, but on organic growth percent it was 9%, which primarily is a reflection of higher incentive compensation, which goes with the - now that all of our pay is variable, as you have extraordinary increase necessary revenue, your incentive compensation will be accrued at a very, very high rate.

It also shows the impact of hiring the producers. So, I think that is good spend, if you will.

The gna expenses, healthy spread, as you have heard me talk about between revenue and expense increases.

That is difference between 9% increase in expenses and 18% increase in growth organically.

That is 9.

A good 30 to 40% of the 9 came from the incentive compensation and hiring of people.

You can see the expense controls we have in for embedded costs.

Embedded costs are things like travel and temporaries and entertainment and those kinds of things you do everyday that you have to watch.

I will tell you, those costs are down from a year ago, which was down considerably from the year before that. So, we are very proud of that.

Again, as I said, we are trying to take some of the money and invest it even more in the things we talked about.

Gna expense was 72% of revenue, that is down from 77% a year ago.

Salary and benefits were 51% of revenues, versus 52% a year ago.

Our controllable expenses, as outlined, was 6% increase, which is in line with revenue growth.

The controllable - if you look at it this way, take your controllable expenses, which was everything, except the incentives, the gna minus the incentives.

There was a spread between the 18% revenue growth and the 6% increase in controllable expenses, which includes recruits of 12%.

This is - we watch that spread all the time. The - nothing much more to say about the expenses that I haven't, other than the fact that we obviously watch them.

It is part of our culture here.

But, we are making the investments that I mentioned and will make them in the second half of this year in recruiting, training and it.

As far as capitalization liquidity is concerned, at the end of the quarter, long-term debt was $677 million, down $232 million or 26% in one year. Our debt to total capitalization is down to 44%.

Yesterday S and P raised our debt ratings and revised outlook for Willis to stable.

In the first half of 2002, we repaid $110 million of debt with excess cash flow generated by the business.

While, again, that is the result of the margins.

Our next mandatory debt payment is not due until November, 2005.

So, the ratios are leverage ratio [K-EBT] to last 12 months EBITDA was 1 and a half times the quarter end, half of what it was a year ago.

Our coverage ratio last 12 months EBITDA to interest expense was 6.2 times at quarter end, more than twice what it was a year ago. Cash held in treasury about $70 million at the end of the quarter.

It gives us a lot of room to do a lot of the kinds of things that we need to do, whether acquisition opportunities, whatever the case may be.

We feel we are in good shape as it relates to that.

As you know and as we have done traditionally now, it seems, that the better we do we trigger these non-cash charges, which comes from old options that KKR gave when they bought the company.

That have to do with performance and time.

The non-cash charge and we are doing it again this quarter, which is a good thing.

The non-cash charge for performance stock options was $78 million in the quarter, 65 million after tax or 44 cents per diluted share. $70 million of the charge resulted in rise in the stock price during the second quarter to 32 none from 24 70. As you know, these options are triggered by our company performing and secondly, as the higher our stock goes, thankfully, the more it costs us.

Interesting conundrum.

We have reported 76% of the charge since the third quarter of last year, with remaining to be recognized through 2004.

Just want to conclude by saying that I still think we are working in progress.

We have a lot to do, but have a clear vision.

Everybody in the company understands it.

We want to be the best broker in the world.

That is what we are focusing on doing.

We don't want to underwrite or do the other kinds of other things.

We want to be good at our craft so that everybody in the company is all going in the same direction.

While obviously we are in a hard market, and the wind is at our back, we want to do intelligent things and be cautious and be able to grow a business and a platform that will endure and grow over time. We will be very, very glad to answer any questions that you have at this time. 00:36:59

Thank you.

To ask a question, press * 1 on your phone.

You will be announced prior to asking your question.

To ask a question, press * 1 on your phone.

If you need to withdraw your question, press * 2.

I will wait a moment.

First question from John Balkine from Fox-Pitt Kelton.

Good morning, guys.

Just a quick question on headcount hires.

I want to drill down on large corporate business, which I know you are planning on building over time.

Of the producer build, how much is focused on middle market business and how much is focused on the large corporate area, which is traditionally margin Aon's business?

How is that going from account growth standpoint?

Couple of things.

We think we can grow all markets, middle market and large account, which we call Willis Resolutions across the board.

We don't look at one focus more than another.

The Willis Resolution business in New York and in London are two places where I think we got a lot of leverage.

We simply don't have the business Marsh and McLennan and Aon have.

That gives us leverage and we have been opening a lot of accounts.

I think that our recruiting effort, especially in New York, has paid big rewards over the course of the last year or so.

I can only tell you that business is growing at a greater clip than 20%. What is interesting to note about that, that is fee business, John, as you know.

Not commissioned business.

There is no rate involvement there.

That is all fees.

So, we are very pleased with the way that is going and think it will create a lot of leverage for us in the future.

Just one quick follow-up.

Is the compensation competition increasing over the course of the last year as you go after people from some of the competitors or how does the environment look from that standpoint?

The environment is obviously competitive.

I don't think we have felt that our compensation has been challenged because of competition.

What I find is that as people are talking to us and are willing in a lot of cases to join us, it gets heated as it relates to people willing to pay to keep them. I think without getting into the gory details, John, which I don't want to.

That is just not something we are going to engage in.

But, I found that to be heating up, if you will, in the last 6 months.

Sounds good.

Appreciate you.

Our next question comes from Venay Socky from Morgan Stanley.

Good morning.

Couple of questions for you, Joe.

One, you mentioned in your commentary on the revenue front you haven't hit all cylinders in terms of getting the sales culture where you want to be.

Could you drill down on that and give us data points at what we are looking for over the next six months?

Any progress in acquiring associates or other acquisitions out there?

As far as the sales culture is concerned, you know, when I got here I remember talking to a lot of you about this.

There was no tracking mechanisms.

You can't build a sales culture unless you know how you are doing t. is like an athlete looking at stats.

Stats tell you how you are doing.

We had no stats here.

That is really drilled down into the culture.

Every team and every producer, we look at them weekly.

That is the pipeline.

Again, I get to this issue, which is very important, of predictability and recurrability.

I think the way you do that, if you have pipelines, which means new account prospects and you know the conversion rate and gestation period to convert it, you can predict business over time. When things get soft and there is less rate help, if you will, pipelines get longer, people are paid on them, if you will.

You can have sustainable growth business over a long period of time, which I think the business hasn't done, if history is correct.

So, I am only suggesting we put this in at the beginning of the year.

These things don't happen overnight.

One full gestation period hasn't happened yet.

I am confident that as we go along, it will show itself.

We are two-one, new accounts lost.

We tracked this down to really almost teams.

Pretty sophisticated stuff.

So, that is what I said, who knows what the future will bear.

I feel confident with these tracking systems in place that it will be good.

Of course, you step up your recruiting effort, which is not something that occurred in the past at the company. It requires investment of money, but that is something else we are doing.

We are training, which trains in the model, which is to say one individual has a relationship with the client and then, coupled with the pipelines and so forth, that hasn't kicked in totally yet.

The training basically just began.

That investment will continue.

Then, the it, which supports all of this.

You know, I can tell you that relative to that, you can draw your own conclusions, but we spend a lot of time with that.

As it relates to acquisitions, yeah, I mean, we are - as I said in the past, there are three ways to grow, organic growth, acquisitions, recruits number two and acquisitions number three, in that order.

We have mechanism to do all three things. We have talked to a lot of people just to say hello and make sure they know who we are.

I don't know how active we will be, it depends a lot upon price.

I can only tell you in a lot of these cases, that I have seen, the prices are a little bit heavy and maybe a little bit higher than maybe we want to go.

Who knows.

We will be very prudent, but we are definitely talking to a lot of people just to say hello and introduce ourselves and make sure they know Willis is here and Willis is interested in growing.

Just one final question.

It seems like you had great growth in North America and international on a sequential basis.

The global side seemed to slow down from 19 to 17%.

Is there anything to make of that?

No, I think that is just timing.

That is all.

I am pleased across the board.

Just a timing issue.

In a couple of cases, you might have found a placement here or there that drifted into one quarter or another.

Not at all.

I am ecstatic.

Great.

Thank you very much.

Our next question comes from Joanne Smith, UBS Warburg.

Good morning.

I had a couple of questions.

Could you update the July renewals and talk about what you are seeing in terms of pricing and in terms of broadening out the rate increases we are seeing?

That is what we are hearing from underwriters.

Also, on the net investment income line, could you address why net investment income was so strong?

Other brokers are reporting lower investment income because of the environment.

And then I will have a follow-up.

I will answer the first one by rates and let my friend, Tom Colraine, talk about the interest income. The rates are continuing to harden, as you know.

We found renewal process to be continue to be difficult in terms of we got everything placed, maybe a few stragglers here and there.

Continuing to harden with nothing that suggests any directional change with regard to rates. When I say difficulty, obviously it used to take a couple of weeks and a couple of markets to do these things.

It now takes longer and with more markets.

They are all getting done.

Directionally, it appears that rates are going higher.

As it relates to percentages, it depends on different lines.

Pno continues to go up dramatically.

You are looking at 15, 20 25% increases that we saw in the July renewals without any suggestion that that will change, certainly in the foreseeable future.

Tom, you want to talk about interest income?

We have (inaudible) comprehensive (inaudible).

So as interest rates in the market fall and rise, we have a cushion for the mark ultimately and will take it.

It has moved considerably, more than other brokers hedged in that area.

Also for improvement, we are (inaudible), we are doing a better job of getting money in faster.

We repay money in terms of keeping with terms of trade.

We are doing a better job of getting money hedged from the clients as quickly as we should.

Lastly, could you comment on the tax rate?

Looks like this is the second quarter in a row, the tax has been around 36%.

Is that what we should use in models going forward?

Yeah, that is a good rate.

Something around 76%, including non-cash charges, etcetera.

It is about right.

Great.

Thank you very much.

Our next question comes from Adam Kalbarg, Parker Carnia(phonetic) Securities.

Good morning.

How are you?

Question surrounding the margin.

Margins have come up nicely from last year substantial improvement.

Obviously, as it gets higher, it gets tougher to get further improvement.

You know, as we go on to the next couple of quarters, are we going to see webbing of the margin or is there continued expansion potential?

Well, I suggested without targets, as you know, because people ask me about targets all the time.

I always say we could do better.

I will always continue to say we can do better and we have.

I suspect that we will and I think that we get up in the morning here and that is our number one goal, to expand margins.

The only thing I can temper that with is what I said before.

We plan to continue to make investments in training, it and recruits.

So, you got to temper the market expansion by those kinds of investments. But, we get up every morning to expand our margin.

Thank you.

Our next question comes from Hugh Warren, J.P. Morgan.

Good morning, everybody.

Looks like you guys are doing phenomenal.

That is all we can ask for.

Two quick questions for Joe and one for Tom.

If we look at the sales associates, you brought on 130 year to date.

What kind of arrangements are they brought on?

Are they locked out of the market for sometime?

Is there a lag before they can become productive because of non-competes?

We don't as a policy hire people who just have books and haven't grown the books.

We, as a policy, just hire people who have the ability to grow their books.

Therefore, as you know, they can come here and open new accounts while they can't obviously bring their accounts over from whence they came.

So, we only hire people who can open new accounts, therefore, they are productive.

Secondly, the kinds of transactions we make, we don't make expensive, up-front transaction.

A lot is performance- oriented and thirdly and very important point.

We don't give guarantees.

That is very important. We don't do that.

Can upon so, I feel very good about the kind of people we hire and because of the kind of transaction we do, they are the kind of people who want to be at Willis, rather than go from company to company.

So, I feel comfortable with our policy regarding that.

If we look at the 130 or so you hired, how many of those are experienced producers, roughly?

I don't need to know if it is 67.

Are you hiring younger people, people -

Most of that, they are seasoned producers who have been in the business and have business.

Okay.

And if you look at on a more macro level, what is going on from the revenue side, we are starting to see obviously back offices are getting more important.

I think you fixed a lot of problems in the back office.

How scalable is the model from here?

We are seeing other brokers starting to ramp-up non-production sides of the shop.

Can you speak to that?

Yeah.

One of the things in our model in the service area, we have as you recall, just to refresh everybody's memory, operations used to be in each business unit.

That no longer exists.

They are consolidated under global operations.

It had nothing to do with operations.

IT and Global operations are one.

They both report to Janet Collick(phonetic), the chief administrative officer.

That is under one roof.

People are working together and our service metrics and standards are now tracked.

It was never tracked before. I can tell you how long it takes to do this or that.

And when you are building the IT platform we are building, which is a global platform, as it relates to claims and accounting, on top of everybody going in the same direction, in three different processing centers around the world, I feel comfortable that not only could we do a better job with service in an industry relatively speaking that didn't pay a lot of attention to it.

Secondly, upon that platform, can be a bigger platform.

Which, over time, as we have stated, we would love to be able to grow our business.

So, that becomes a very important component.

Okay.

But, I mean for the near term, with obviously what we are seeing in the number of new business applications you are putting up, you don't see a jump in wholesale needs from a back-office standpoint?

Needs in terms of -

Bodies or space?

No, not at all. one is IT driven, the better the it and the better the process, the better we control that aspect, obviously.

Tom, the one question for you.

Can you give us - I don't know if the balance sheet is finalized, ending equity for the quarter?

I don't have that.

As Joe said, debt was 44%.

I just emphasize, it is really not important number.

It was reduced by non-cash performance option charge.

It is hard for me to see the relevance of it.

Okay.

Very good.

Thank you very much.

Our next question comes from Kim Loga, with J.P. Morgan.

The debt that you paid down in the quarter, was that term loans or do did you buy back loans?

In the quarter, term loans.

Great.

Thank you.

Our next question comes form Peter Monacho, Tutor investment corp.

Good morning.

Given the very strong cash generation capabilities of the company, what do you see as the optimal capitalization going forward or a little bit in the future?

It is tough to say.

I mean, I don't know what optimal means, it depends on what you want to do.

I can only say we are generating cash, as you can see.

And putting this in great position to be able to exercise our strategy.

We are able to help ourselves grow organically and make investments in the kinds of things we do to increase sales capability.

Obviously it helps us recruit.

Thirdly, puts us in a position to make acquisitions if we think they make sense strategically and economically.

I don't know because we are in a cash-flow business, Peter, that doesn't require the kind of cash that it did when I was in the securities business.

With securities on the desk and market to market and everything.

I don't know what optimal is, but for what we are doing right now and for what I think we are going to be doing, it is quite comfortable. We have been paying down our debt.

We look everyday at the dollar and see what is the best way and the best use of this dollar.

We are in a comfortable position.

But, I never thought of that from an optimal point of view because it - the business doesn't lend itself - we need so much to be able to operate.

In your prepared remarks, you seem to hint a little bit at acquisitions getting a little more difficult because price expectations of the sellers might be higher.

If you are comfortable with the level of debt that the company carries and if the acquisition opportunities do get a little more challenging and few and far between, have you thought further about how you would deploy the cash you generate?

Yeah.

Right now what we have been doing, Peter, is we have been paying down debt in the absence of anything that we find more attractive than that, we are going to pay down debt.

Or, as you have heard me say, continue to make the investment in the IT platform, make the investment in the training, make the investment in recruits and spend that money wisely from an investment point of view.

Yeah, I would say you could - if the environment continues to be pricey, or doesn't make sense or whatever you want to call it, we will continue to do the same thing, which is to take the margins and cash we have been able to generate and follow our strategy.

Thanks.

Once again, to ask a question, please press * 1 on your phone.

There are no further questions, Mr. Plumeri.

I will turn back to you.

We appreciate everybody's time and attention.

Thank you and have a nice day.

Thank you.

This ends today's 00:58:35 conference call.

You may now disconnect.