Willis Towers Watson PLC (WTW) 2014 Q2 法說會逐字稿

(Operator Instructions) The conference is being recorded.

I'd like to introduce your speaker, Mr. Peter Poillon.

Thank you.

Welcome to our second-quarter 2014 earnings conference call, which is being hosted by Dominic Casserley, Chief Executive Officer of Willis Group Holdings.

A webcast replay of the call, along with the slide presentation to which we'll be referring, can be accessed through our website.

If you have any questions after the call, my direct line is plus 1-212-915-8084.

Please note that we may make certain statements relating to future results which are forward-looking statements as that term is defined by the Private Securities Litigation Reform Act of 1995.

Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or those estimated or anticipated.

The statements reflect our opinions only as of today's date and we undertake no obligation to revise or publicly update them in light of new information or future events.

Please refer to our SEC filings, including our annual report on Form 10-K for the year ended December 31, 2013, and subsequent filings, as well as our earnings press release for more detailed discussion of the risk factors that may affect our results.

Copies may be obtained from the SEC or by visiting the investor relations section of our website.

Also, please note that certain financial measures we use on the call are expressed on a non-GAAP basis.

Our GAAP results and GAAP to non-GAAP reconciliation can be found in our earnings press release and slides associated with this call.

I'll now to the call over to Dominic.

Welcome and thank you for joining our quarterly conference call.

With me today are John Greene, our new Chief Financial Officer; Steve Hearn, our Deputy CEO and Head of Willis Global; Tim Wright, Head of Willis International; and Todd Jones, Head of Willis North America.

By now you've had a chance to read the news release that we put out last night, announcing our second quarter earnings.

John and I will give our prepared remarks and then we'll move to Q&A.

Now, before we dig into the details, I'd like to make three important points in relation to this quarter's results.

Those being, first, on our organic revenue growth; second, on our expense growth; and third, on our earnings.

First, let me turn to organic growth.

Our 4.5% organic growth in fees and commissions is a 30-basis points enhancement over our strong organic growth in the first quarter of this year.

This, for us, highlights our diversified strength across geographies, sectors, and business lines and is testament to the resilience of the model we have built and that we continue to build.

And let's be clear, this is not a one-off; we have delivered mid-single digit organic growth over the last seven quarters.

Second, let me turn to expenses.

We have made significant investments for growth in the business since the end of the second quarter of 2013; in particular, in new hires.

And that is a combination of revenue-producing talent in high growth markets and in growing businesses like Global Wealth Solutions in Asia and Human Capital and benefits, globally.

Now around three quarters of that hiring was in the third and fourth quarters of last year.

So that means, in terms of the year-on-year view, the investments we made in the second half of [23] has made comparisons to 23 numbers challenging in the first and second quarters of this year.

Let me be clear: since then, the pace of hiring has moderated, with global headcount up about 1% in the first six months of 2014 and further, a little more than 1/3 of that increased headcount of 1% in 2014 has been in our lower cost Mumbai operations.

So while we will continue to invest selectively in talent, we are expecting salary and benefit expense growth, excluding acquisitions, to moderate during the second half of the year.

Now nonetheless, as explained in our earnings release, a $0.04 decline in business performance on goods top line growth is not where we want to be.

It does not reflect our ability to drive organic growth, achieve a positive spread between revenue growth and expense growth, and most importantly, improve cash flow generation; all to the benefit of our shareholders.

We obviously have not achieved desired positive spread on an underlying basis thus far in 2014 and we know the reasons.

Those investments in headcount to grow our business and improve our client service and risk management capabilities that I talked about, underperformance in Willis UK retail, and increasingly more difficult marketing conditions that, frankly, today everyone associated with the reinsurance industry.

But we are confident in our ability to meet and exceed our goals over the medium-term and we are taking concrete steps to achieve them.

Let me discuss some of our cost steps.

First, we have a number of initiatives that are not part of our operational improvement program, but that we believe will nevertheless deliver cost savings in 2014.

We are reducing headcount growth for the remainder of the year.

We have revamped our product approval process to bring more cost discipline and our finance transformation project will begin to show cost results this year.

Turning to the operation improvement program, the program is fully underway and will deliver some cost savings in 2014 and begin to deliver substantial savings in 2015.

As part of that program, we have launched, in the third quarter, a redundancy program in the UK that will eliminate 200 roles by the end of this year.

We have also started rationalizing our IT systems in our real estate portfolio, which will deliver cost savings across the group.

And we are well into the planning process for moving more than 3,500 support roles to lower-cost locations.

Taken together, these initiatives show our resolve to meet or exceed our stated goals and we remain committed to them.

So, those were my points on organic revenue growth and our expense growth.

Now to my third point, which is on our earnings.

As I mentioned earlier, business performance was modestly down, $0.04 per share, driven largely by that expense differential year-on-year, but reported earnings are much more substantially down this quarter, as a result of $0.01 from the operation improvement program and $0.28 of non-cash and non-operating adjustments, including a temporarily higher tax rate due to phasing effects.

Now, we have detailed them all in the release and John will run through them shortly in his section.

In this context, it is important to focus on underlying business performance, which is how we look at it and manage the business day to day.

And as we noted in our earnings release, despite the rise in expenses from our 2013 investments, our underlying EBITDA, at decent proxy for cash flow, is flat relative to the prior year.

So the business continues to generate strong cash flow.

With those three thoughts established, I will provide some more specific color on performance this quarter.

Total revenue of $935 million is up 5.1% from the prior year.

In terms of the 4.5% organic revenue growth I opened with, Willis International led the way contributing 5.6%, Willis North America added 4.8%, and Willis Global came in at 3.4%.

You've also seen us laying the foundation this quarter for future growth in fast-growing markets.

You saw us extending our debt from reach in Asia with the completion of the Charles Monat acquisition and you also saw us investing in growing areas in more developed territories.

The recently announced Max Mathiessen transaction will give us the leading human capital footprint in advanced pension management and makes us the leading risk advisor and broker in the Nordics.

And we've also done a better job of connecting Willis, delivering more of the power of the whole firm to clients and contributing to our revenue momentum.

In North America, in the UK, in Asia, and Latin America, we have specific cases of new business wins because Willis is able to bring the whole team to solve the client's risk issues.

To give just one example of this, our Canadian energy teams recently introduced a client to our mining teams in London and globally, where the client has operations.

The outcome was more integrated service for the client and a tenfold increase in our revenues.

There is far more we can and are doing to connect Willis this way.

Onto expenses, I've already given you the context.

On an underlying basis, total expenses were up 6.1% compared to the second quarter of last year and headcount was the primary driver of the growth.

Total headcount increased about 4% quarter-over-quarter, but about 3% of that came in the second half of last year.

As I said earlier, headcount is up mildly, about 1% over the first six months of the year.

So clearly, headcount growth is moderating and this should feed through to salary and benefits expense growth over the remainder of the year.

This is especially true as 1/3 of that headcount increase in 2014 is in our lower-cost Mumbai operation.

I should note that this expected decline in headcount growth is independent of the impact of the operational improvement program that will add a further momentum to cost controls in future quarters.

Now, briefly, on that program, the $3 million charge that we took in the second quarter is indicative of how early we are in terms of implementation.

Rest assured, we are making good progress laying the foundations for a significant transformation of our business.

I mentioned earlier the 200 role reduction in the UK as an early step.

As part of our third quarter call, we will be providing information on the expected phasing of the charges related to the program.

I am looking forward to reporting to you in the future on realized savings and actual charges in the relevant period and sharing with you data on the core underlying drivers of operational change, including the ratio of staff in higher cost to lower cost locations and how we are changing the number of seats per employee and average square footage per employee.

Turning to the segments, I've already made the point on strength across the business.

Let me now provide some detailed segment performance commentary.

First, North America: overall, North America continues to generate strong new business and solid retention levels.

We saw growth across most regions led by strong results in the Northeast and Atlantic regions.

We saw good growth across a number of lines.

Once again, our two largest North American practices, Construction and Human Capital, both grew in the quarter, with the Construction practice up mid-single digits, largely from project business, including two key wins: the Port Authority of New York and the MTA of New York.

The Human Capital practice was up low single-digits and we continue to make great progress in our pipeline of prospects and new business wins.

Rates in North America were generally level during the quarter, with slight variations across products.

While property rates have continued to come down, we've seen some rate increases in other products such as casualty and executive risk.

Turning to our international operations, that grew 5.6% in the quarter with most of the growth coming from emerging and developing markets.

In Western Europe, we saw very modest overall growth, but with strong results in the Iberia region and in Norway.

Given the weak general economic conditions across the region, we are pleased to continue to show growth largely through market share gain.

In Eastern Europe, we recorded high single-digit growth, primarily driven by strong performances in Russia and in Poland.

Latin America delivered mid-teens growth, led by strong growth in Brazil.

Asia also had a very good quarter with strong results from our Global Wealth Solutions business in Hong Kong.

New Zealand recorded mid-single digit growth, while Australia was about flat.

Now, on to Willis Global: this segment comprises Willis Re, Willis Insurance UK, Facultative, Risk, and Willis Capital Markets and Advisory.

Willis Global reported organic growth of 3.4% in the quarter, reflecting the blend of different results across its component businesses.

The reinsurance business grew modestly in the face of a declining rate environment.

Significant new business wins and very strong retention rates countered the impact of deteriorating market rates.

In Willis Re North America, this enabled us to show slight growth.

In Willis Re Specialties and Willis Re International, the level of rate deterioration, together with some timing fluctuations, was significant enough to generate declines.

But given rate declines, continued caution from clients, and extending cover despite much cheaper pricing and a difficult second quarter 2013 comparison, we believe achieving modest growth to this quarter is certainly a satisfactory result.

For an in-depth update on rates in the reinsurance market, I refer you to our July 1 Willis Re First View publication, available on our website.

Now moving onto Willis Insurance UK, which combines our Willis UK retail unit and our global specialty businesses.

Willis Insurance UK grew mid-single digits despite continued weakness from the Willis UK retail unit.

Among the specialties businesses that put up strong growth were Construction and Property and Casualty, which recorded strong double-digit growth, reflecting the successful completion of a number of large projects.

Our UK retail business was down low single-digits.

This business continues in turnaround mode.

As we noted last quarter, the performance challenges, including rate pressure and a weakening in our insolvency business have hit the business.

We have seen mild improvements in the second quarter, but more work is required.

Let me conclude with some brief commentary on one other subject, that being market-derived income or MDI.

At our investor conference last July, I discussed Willis' view of MDI, noting how MDI takes many forms and how we would evaluate whether we would accept a given form of MDI on a case-by-case basis.

I mentioned that Willis would only consider taking a form of MDI if it does not conflict with our client's best interests and if we can do so transparently and in line with its applicable regulations.

These principles remain in place.

After a review of the last year, we believe that, with adequate controls in place, it may be possible to accept MDI in the form of contingent commissions.

We are, therefore, no longer ruling out contingent commissions on our P&C business and other lines of insurance.

Like any other MDI, we will evaluate any proposed contingent commission arrangement against our control framework and will only accept such arrangements when appropriate.

I should note, however, that we do not expect contingent commissions to be a material source of revenue in 2014.

Now, I'll turn over to John to discuss the financial results of operations in greater detail and then I'll come back to wrap up before we turn to Q&A.

Thank you, Dominic.

Let me begin by saying how excited I am to be part of the Willis team.

It's a strong business with great leaders.

I look forward to working with the team and all of you over the coming months and years.

So, let's get straight to it.

I'll be working largely off the second quarter slide deck posted on our website, starting with slide 3. Slide 3 breaks out the several components in terms of both reported and underlying EPS from the second quarter 2013 through to the second quarter 2014.

This is the kind of presentation format you can expect going forward.

I think it's particularly useful this quarter in separating out the non-cash, non-operating impacts that Dominic referenced.

So, starting with last year's reported and adjusted EPS of $0.59 on the left and moving left to right across the slide, you can see increased commissions and fees had a $0.17 positive impact, but increased expenses had a $0.21 negative impact.

Dominic noted earlier, differences between comparable periods is largely driven by headcount investments.

As Dominic also emphasized, the net of those items, a $0.04 reduction, represents the Company's business performance.

Continuing across, you can see a $0.01 negative impact from the increase in our share count and the change in the underlying tax rate negatively impacted our earnings by $0.05.

I will drill down on taxes shortly.

The net impact of those items gets us to our second quarter underlying EPS of $0.49.

We define underlying as reported excluding certain items and the impact of foreign exchange movements.

As a more general point, you'll see from the release that we have taken the opportunity to simplify to just two consistent bases, reported and underlying with a link to organic performance.

I think that gives you the complete and clear picture and is consistent with how we look at and manage the business.

So continuing to the right of underlying EPS, we have the non-cash, non-operating adjustments, which fairly reduce reported EPS; $0.12 from the increase in the valuation allowance on deferred tax assets, $0.07 from Venezuela devaluation, $0.03 from adverse movements in foreign currency, $0.01 from the initial cost of the operational improvement program.

Drilling down, there are two main non-cash, non-operating items that are driving those earnings differences over and above the $0.04 related to business performance.

First, tax expense: there are two pieces to this, and second, the Venezuelan devaluation.

Regarding the tax valuation allowance, you may recall, that during the fourth quarter of 2012, Willis recorded a valuation allowance of approximately $110 million against the net US deferred tax assets.

During the second quarter this year, the Company concluded a clean IRS audit on our tax returns through the period ended December 2011.

That led us to release certain provisions held for years under audit, which ironically, then required us to adjust the valuation allowance.

The second item principally relates to the phasing of the charge.

Previously, US tax expense was straight lined, 25% in each quarter.

Given that the US generally earns most of its income for the year in the first two quarters, the straight line method produced a lower effective tax rate in the first quarter.

The new method results in a better matching of income and expenses but requires a catch-up adjustment in the second quarter to bring the tax expense in line with the US taxable income in the first half of the year.

The result was an additional tax charge of approximately $13 million in the quarter.

This means that there will be about $13 million less tax expense recognized in the third and fourth quarters as the projected annual US tax percent has not changed.

Now the other item, Venezuela devaluation.

The Venezuelan economy is considered hyperinflationary, so each quarter end, in accordance with US GAAP, we revalue our local currency monetary assets and liabilities to US dollars based on the available exchange mechanisms.

Late in the first quarter, the Venezuelan government introduced a new auction rate.

After a thorough review, we deemed this new rate to be more appropriate to revalue our Venezuelan assets and liabilities, resulting in charge of about $13 million in the quarter.

Now, to slide 4, turning to underlying EBITDA.

As you've likely heard Dominic say in the past, we view EBITDA as a decent proxy for cash flows.

For this quarter, especially, it is a useful measure because it excludes the impact of the Venezuelan devaluation and the tax adjustments I just discussed.

You see on this slide the measure is flat year-over-year, despite our investments in personnel, the challenging rate environment, and ongoing work to turnaround the UK retail operation.

Slide 5 shows our reported and organic revenue by segment.

Dominic has discussed the segment performance, so the only thing that I'll point out here is that the North America organic growth at 4.8% was actually higher than the reported growth of 4%.

The difference between reported and organic was caused by the sale of some small slow growth businesses.

We executed the sales in order to redeploy capital to higher growth opportunities.

Moving onto the expense walk on slide 6, as we've shown here on the slide, we are adjusting the prior year balance for $16 million of adverse foreign exchange movements experienced in the quarter.

That gets us to a re-based amount of $739 million.

Underlying expenses grew by $45 million or 6.1%.

This is comprised of a $34 million increase in salary and benefits, a $10 million increase in other operating expenses, and a $1 million increase in depreciation and amortization.

Then, adding the $3 million charge related to the operational improvement program in the quarter, you get to the reported amount of $787 million for the current quarter.

So as Dominic noted, headcount has been a particularly big investment since the end of the second quarter 2013.

Slide 7 drills down on salaries and benefits.

You can see that, after adjusting the prior year for the current quarter's adverse movements in foreign exchange, underlying salaries and benefits grew by 6.3%.

The increase is broadly split between investments for growth of approximately 4% and the annual salary reviews in line with roughly inflation.

Total Willis FTEs are up 4% since June 2013, but only up by 1% for the first six months of the year.

As Dominic said, a little more than 1/3 of the headcount growth in 2014 comes from our operations in low-cost Mumbai.

On to the balance sheet and cash flows, as shown on slide 8, we ended the first quarter with $709 million of cash, down $87 million from year-end, but up over $200 million from a year ago.

The increased cash balances, relative to prior year, was driven primarily by the Company's operating performance, but also the benefit of employee stock options exercised since June 2013, net of share repurchases this far in 2014.

Debt outstanding at quarter-end was $2.3 billion, down slightly from year-end last year.

Cash flows from operations over the first six months of the year are up $15 million over the same period last year, primarily due to a reduction in defined-benefit pension contributions and the non-recurrence of cash outflows related to certain settlements and the 2013 expense reduction initiative.

The increases were partially offset by higher cash outflows related to salary and benefits.

I would also note, during the quarter, we repurchased almost 2 million shares of stock for about $83 million.

From about the last week of February, when we started buying back shares, and through June 30, we repurchased almost 2.9 million shares at a total cost of about $120 million.

Employee option exercises added about $50 million to the cash balances in the quarter.

Finally, we have not drawn down on our revolver in the first six months of the year.

This is the first time this has been the case since 2007.

That's my summary on the financials.

I look forward to meeting more of you over the coming months.

With that, I'll turn the call back over to Dominic.

Thank you, John.

So briefly, summing up and returning to the three points I opened with.

First, our strong organic growth in the face of challenging market conditions underscores our diversified strength across geographies, sectors, and business lines.

Second, we are focused on expenses and we see the prospect of the core driver of that expense growth, headcount increases excluding acquisitions, moderating in the second half of the year.

Third, there are significant non-cash, non-operating adjustments in the reported and underlying headline numbers this quarter, but there's ample evidence across the half for the ongoing cash-generative power of this business.

With that, operator, may we please begin the Q&A session?

(Operator Instructions)

Paul Newsome, Sandler O'Neill.

Hello.

Good morning, thanks for the call.

I was hoping you could talk a little bit about cash usage this quarter and perhaps in the future, as we look out towards -- it looks like you're making a little bit more in acquisitions then maybe I would've thought of before and you did draw down a little bit of cash in the quarter.

Can you just talk about sort of how we should think about your cash usage prospectively?

Are these operational charges going to be used in cash as well?

Sure.

Thanks very much for the question.

I think our approach to usage of cash remains where it was when we outlined it in the investor conference back in July last year, about a year ago.

We said then that we saw four usages for our cash.

They were around, obviously, investments in the business over and above normal CapEx, if for some reason we had unusual CapEx.

We haven't seen that.

Secondly, would be obviously M&A opportunities and I'll come back to that because that was a specific part of your question.

Third, would be dividend increases and fourth would be share repurchase.

We've been active on all three of the last three of those.

Let me talk about M&A.

Our approach to M&A remains the same.

We regard our business as fundamentally a people business and that what we are buying is the talents and capabilities of people and the market franchises they have.

Therefore, it is absolutely crucial to us in any M&A transaction that we have plenty of time to get to know the individuals on the other side of the table, if you like, to make sure that they truly want to become part of Willis and that they want to become part of Willis and that they think they can outgrow their performance when they were standalone.

So if you look at both the Charles Monat acquisition and the Max Mathiessen acquisition, those were both situations where we spent a very large amount of time in exclusive discussions with those institutions and with all the people involved to make sure that everyone understood why one plus one would equal three.

And so we spend a lot of time on that sort of process when we're thinking about acquisitions.

I think it's fair to say, that Willis has become an institution, given the care that, as people are coming to understand, we take in doing acquisitions and our approach to integrating and advancing the careers of people who join us.

People have come to understand that Willis is an interesting destination to think about taking their institution if they decide to sell.

And so I have to say that the pipeline of opportunities we have in M&A is rich and we're excited about it, but we are looking very carefully.

We have very, very strict financial criteria, based upon cash flow returns we see out of any acquisition.

And we are obviously focused on growth and that has led, as we talked earlier, to us actually disposing of some businesses that we thought would not provide enough growth.

So yes, you are right, part of the cash drawdown you saw this quarter was the payment for Charles Monat, as we actually close that.

Obviously, we plan to, hope to be closing Max Mathiessen in the second half of the year and that, again, will be either cash or we may well issue some debt to fund part of that transaction.

But we're very comfortable that, if we take this very deliberate focus on only closing transactions with institutions where we really see the people aligned and we can do one plus one, that will work.

But we've also been using cash for two other purposes, we increased our dividend 7% this year as part of our commitment, in the July investor conference, to gradually grow our dividend as a return to investors.

And we are still in the process of completing our $200 million share repurchase program that we announced and that has also been usage of cash.

Terrific.

My other question is this: I'd like your opinion on whether or not you think there is a natural lag between organic growth and new hires.

In the past, places like Gallagher, for example, have talked a lot about how they felt like if they went through a period of hiring, they didn't see that organic growth in the first year.

It was always sort of a year lag or more.

Sometimes the benefit of organic growth never showed up, sometimes it did.

So I think there's some room to debate.

But as we're looking at your Company, you obviously made a significant push last year.

Should we be looking -- as outsiders be looking for that benefit of organic growth in 2015 or do you think it's already kind of there, embedded in the early benefits you saw this quarter?

That's a very good question, Paul, and I think this has come up before.

I think our view is that the returns on hiring people can be quite disparate.

There are some individuals who we have hired who have very rapidly generated revenues in relation to their ability out in the marketplace and you get a very quick return.

Some people, it can take longer.

What I can assure you is, we wouldn't have made the sort of investments we made in the second half of 2013 on the basis that this was sort of a quick win and then it would fizzle away.

We are trying to build, and are in the process of building, a very strong, sustainable foundation to drive organic revenue growth on a continuous basis.

So those hires were not sort of trying to push revenues just in 2014, they were a part of an important build-out in certain of our businesses to drive medium-term growth as well.

So I think the answer to your question is, some people, it's very quick, some people, it can be first or well into the second year before you really see the revenue momentum come in.

Great, thank you very much.

Thomas Mitchell, Miller Tabak.

Following up on the last question, historically, there seem to have been cycles where, from time to time, the large insurance brokers tend to compete for top producer kind of talent.

I'm wondering if the current environment, where there's quite a few headwinds on rates, there are some headwinds in terms of relatively slow GDP growth in many parts of the world, whether or not it also is becoming more expensive to keep your top producers and/or is more difficult to twist producers away from other firms?

Tom, that's a very good question because that is a clear risk.

One of the dynamics you definitely see in this business is in a slower growth environment, as you say, when people try and say, how am I then going to get growth?

They try and reach for it for a basically (technical difficulty).

We are very cognizant of that risk.

So when you look at where we have been investing and building and where we've been adding our headcount, a lot of it has been, as we said before, in the emerging markets, where we have actually seen, where we think there is natural growth and where actually Willis has a very, very strong competitive proposition.

So we've been adding our capabilities there; in Asia, Latin America, for instance.

Secondly, you've seen us continue, even in this soft environment, to take market share in reinsurance and we do see opportunities, most obviously as we take market share in North America in Willis Re, to take -- and basically, we're having people wanting to join us because of the momentum we have.

But we are very sensitive to the challenge of a sort of tit-for-tat hiring process because of a depressed environment is actually not a winning proposition for us, we believe.

So we are being very cognizant of that risk.

Secondly, I know that you have said in the past that you were using your share repurchase program pretty much to immunize the impact of stock option exercises.

Is there a clear point or is there a plan for there to be a clear point at which the share count, year-over-year, actually begins to reduce or shrink?

Yes, Thomas, you're absolutely right, that we announced our share repurchase plan specifically with the plan of immunizing count share growth and that remains our position.

I think that goes back actually to Paul's question, the first question we had, around uses of cash.

We are constantly, as I said before, making trade-offs in terms of where we see value creation opportunities, between dividend increases, M&A, and share repurchases.

We've decided that the right place for us to settle for the moment on share purchases is to immunize, but as we see different on different M&A opportunities et cetera, again, all looked at on a very tough cash in/cash out basis and again, only doing them where we believe the people want to join us and be part of a growing organization.

If, for some reason, those opportunities slowed, we would obviously revisit that policy because, as we pointed out, this is a cash generative business and we constantly have to be very sensitive to how we're using that cash.

Thank you very much.

Bob Glasspiegel, Janney Capital.

Good morning.

I'm on Paul and Tom's wavelength, so I have just follow-up questions on their questions on cash flow and buyback.

My cash flow question is, it's up 11% year-to-date, but most of the cash flow generation is in the second half.

With EBITDA flat, I would suspect the cash flow will normalize to EBITDA with pension maybe being the one offset.

Any sort of thoughts on how we should think about modeling what the cash flow for the year should be?

How big is the pension decline year-over-year in the first half, John, that you referred to?

I'm just going to set this up by saying, Bob, as you know and as we've said a couple of times, we believe the best medium to proxy for thinking about the cash flow generative capabilities of this business and a decent proxy is EBITDA because you do get balance sheet items moving around.

But I will turn it over to John just to take you through the specifics on some of those balance sheet items in the pension payment.

John.

Thank you Dominic.

Bob, there's a couple things on cash that I've noticed since I came into the business.

The first thing was that there's not a formal working capital management program in Willis and we're certainly going to introduce one, which I think can do two things: we can help improve the turns on the receivables and then also, we're going to look at payable terms and see what that will do.

But get to your specific question on pensions, the difference between 2013 and 2014 was roughly $20 million to $23 million, so a net decrease in the contributions from pensions.

Was there more of that in the second half or was that just tilted to first half?

We're not sure.

It depends on how the pension funding is going to shake out and if we continue to do some analysis on that.

I would take the $23 million and then leave it there for now.

Okay.

Just following up on Tom's immunization of buyback, with the stock price down and Management not meeting the plans that you've established, is it possible that stock option grants will be less than you thought or is that more a 2015 issue?

You're going to be buying back more shares than you modeled, so it seems like you could do a little bit better than immunize share buyback but maybe I'm missing something, share grants.

No, Bob, I think we cannot predict exactly how many stock options will be exercised by our employees.

We know the number that's out there, but we can't predict exactly how many will actually be exercised in any one particular period.

So, we'll see.

I'm certainly not going to, either, react to your stock price comment, we'll see how that all resolves.

But the point I think we would make is we are still focused on immunization.

That is our policy.

We will see, as option execution takes place, we'll see how we then need to respond by uses of cash.

Just to be clear, I was talking about the stock price being down year-to-date, as of yesterday's close, so you should be able to buy a little bit more shares than you were budgeting with $200 million.

Yes, that could well be.

Because, as you saw, you're correct to point out, year-to-date, we have not fully immunized.

We had a $0.01 hit to earnings per share relating to [creep].

You're right, we're still in the process of getting to the immunization that we're aiming for.

Thank you.

Josh Shanker, Deutsche Bank.

Good morning, everyone.

Dominic, in your prepared remarks, you said there were difficult comps in the first half of this year because of the hiring that took place in the second half of this year.

Could we argue that the trailing 12 months margin is a good place to start normalized Willis margins before the impact of the restructuring in the next couple of years?

Josh, thank you for your question.

No, we do think, actually, the comps that we've seen in the last six months, we always knew, as we went through this investment, they were going to be challenging and they've turned out to be.

Given what we hope will happen with headcount growth and with expense growth as a result between the rest of the year, we'll see where our margin settles out.

So I would give us a little time before you decide what the underlying margin is.

Then, of course, you're right to point to the operational improvement program and we will be giving you -- obviously you will see what our reported results are, but we will, obviously, be giving you the adjusted or underlying results so you can see how business performs and how, therefore, the margin performs that will emerge when we're no longer taking charges.

It is obviously the aim of the program to drive our performance cash flow up and thereby, one of the means will be that the margin will go up.

That is our expectation.

Makes sense.

Makes sense.

The press release in your prepared remarks seem to be moving people away from what used to be called adjusted operating income or adjusted operating margin towards what you're calling underlying operating margin, which excludes the effects of ForEx.

I think that makes sense.

I was wondering if you intend to give investors the historical ForEx information so they can calculate that themselves historically?

Yes.

Maybe turn it over to John.

Yes, that's a good question.

I think that's a reasonable expectation, so Peter and I will get together and see if we can work out a schedule in terms of FX and get it out on our website or through some other communication mechanism.

Excellent.

Finally, given the non-operating or non-cash flow charges during the quarter, outside of the operational improvement program, do you have any insight into non-cash, non-operating type charges that might be hitting the P&L over the next six months?

Yes, we don't forecast these things, obviously.

What I would say is that, as I've come in here and worked over the past two months, we've worked through the balance sheet and income statement and there's nothing out there that's glaring, but I reserve the right to change my mind if circumstances change.

You're welcome to that privilege.

Good luck for the remainder (laughter).

Vinay Misquith, Evercore.

Hi.

Good morning.

The first question is on the foreign exchange.

I believe this quarter was negatively hurt by some foreign exchange year-over-year.

Would that also impact the second half of the year in terms of expenses?

Yes.

I'll give the largest pressure point on the FX and it's honestly a structural mismatch between UK pound expenses and billings that are coming in in US dollars.

Again, if I had a crystal ball on what the pound/dollar exchange rate would do, I probably wouldn't be the CFO for this business, I might be retired by now.

But if the pound remains where it is, we're going to have continued pressure on that.

Sure.

It seems that it was about $15 million or $16 million or maybe it was $11 million from the expense perspective, so would that stay relatively flat per quarter for the next couple of quarters if the exchange rates stay where they are right now?

Yes, it's hard to say.

If every single exchange rate remained the same and our revenue base was the same and our expense base was the same, those numbers would be the same.

But there's a lot of assumptions in there, right?

We know we're in a seasonal business, which will impact, certainly, the revenue, the expense base less.

I'd use some judgment on that, but overall, when we're looking at currencies, what we do in terms of modeling out is we assume the current period is what will be going forward and then that fluctuation is dealt with as part of the underlying results.

Clearly, part of the issue here has been the run up of sterling from the $1.50s to about $1.70.

If everything stays the same, quarter by quarter that will gradually unwind, so if a year from now we're still at $1.70, we will suddenly no longer have that differential.

Sure.

Fair enough.

Yes, because just looking at the year-over-year for the second half, I think then we might have to adjust the expenses slightly higher should foreign exchange remain the same right now.

Okay.

The second point was on the expense growth, you mentioned hires happened in the second half of last year.

When can we start to see the year-over-year comps get better?

Or maybe the easy way to put it would be first quarter, your head count was up 4%, so looking at the third quarter and fourth quarter, how would you say the year-over-year headcount would be moving?

We do not give quarter-by-quarter forward guidance.

What we try to signal to you very clearly, is the following: is that headcount -- there's two points, headcount year-to-date is up 1%, and 1/3 of that headcount increase is in our lower-cost Mumbai operations.

Secondly, you've heard our determination about headcount growth for the rest of the year, but I'm not going to give you a pinpoint number as to what that will be.

But you can hear, in our voice I hope, our determination on this topic.

And so, we expect as a result, during the course of the second half, to see that differential decline.

Okay, that's helpful.

Just a numbers question, if I may, the Venezuelan tax charge, where was that on the financial statement?

Was it part of the $787 million of expenses?

No, it was in other income.

Okay, that's helpful.

Thank you.

Cliff Gallant, Nomura.

Thank you.

Just one quick one was, could you please repeat the comments you made about the tax rate in the second half of the year?

I wasn't sure if there was a -- what the -- if you'd just clarify what that was?

My second question was more just about the M&A environment.

You commented briefly in your prepared remarks, but how does the pipeline there look?

Particularly, could you comment on Gras Savoye and any updates there?

You go first on tax.

Cliff, what happened is we took a look at how the US taxes through the expense was being charged or essentially the phasing throughout the quarters in both 2013 and 2014.

What we found was that the tax expense was charged 25% in each of the quarters.

Each quarter, we historically took 25% of the total year tax expense and charged it in that particular quarter, regardless of what the pretax numbers were.

Upon review, what we decided to do was have the tax expense match the pretax profit that was being generated in the particular quarter, so what we had to do is basically pull in tax expense into the first half that would've been higher in the second half, only because we used a straight line methodology.

So that difference was $13 million and essentially, it took tax out of the second half of the year when our earnings will be lower and put it into the first half of the year.

When I say earnings will be lower, I'm speaking of the seasonality nature of the business, not providing any guidance in terms of what we think will happen.

On M&A and our pipeline -- and then I'm going to turn it over to Tim Wright to talk about both the performance of Gras Savoye and then a little bit about where we are the process.

On our pipeline, I would reiterate what I said that, first of all, everyone on this call should be assured that we look at any transaction we might take very, very carefully.

The Charles Monat and Max Mathiessen discussions went on for a very long time and were exclusive in both cases so that we could get very close to those organizations.

We have basically been extremely wary of auction-type events.

There have been a couple of very high profile auction transactions outside the United States and we basically were not excited about those situations.

We could not see how we could create value when there was just a line of people outside the door.

The pipeline is, as I said, one we're interested in, but we have very, very tough criteria and we are very clear that one plus one must equal three.

Let me now turn over to Tim, just to give us a bit of an update on Gras Savoye.

Thank you, Dominic, and hi, Cliff.

First of all on performance of Gras Savoye, as you've seen through our associate line, we had an improvement there of about $2 million year-on-year and that was in great passed down to better performance in Gras Savoye.

You know we have said previously that this year we anticipate our associate lines to contributing between $10 million and $15 million overall for the full year, which would compare with zero for last year and that difference is driven by the growth in the underlying businesses, but particularly Gras Savoye, where last year, we had a negative impact from the charges associated with their operational improvement program.

We're starting to see the benefits of that program and while we don't provide financial performance information on Gras Savoye, I can tell you that we will see an improvement in the cost position reflecting that process last year and we see good revenue momentum.

That's the performance side of Gras Savoye.

In terms of where we are in our consideration, nothing has changed from what we have said previously.

As you know, we have the option to purchase the remaining 70% of Gras Savoye and that option is exercisable at the end of April next year.

I think, as we've also said, we will apply the criteria that Dominic has described on many occasions.

It's worth noting that there are a number of very attractive features to Gras Savoye.

It passed many of our tests.

First of all, to Dominic's earlier point, we know them very well.

We have worked closely with them for many years.

That's unusual in an acquisition situation.

They are a leader in the French market, which by the way, is also home to a large number of French multi-nationals.

They have great emerging markets, exposure particularly in Africa and the Middle East, they have about 1/3 of their business is employee benefits or Human Capital benefits.

But, as we have said, as we go through the final phase of [future], we will make our assessment applying the very strict criteria.

But the relationship is good and the progress is positive.

Thank you.

Mark Hughes, SunTrust.

Yes, thank you.

The underlying inflation or increase in salaries and benefits at 6% really not much more than your growth in headcount.

As you see that headcount decelerate, will that kind of underlying inflation be similar, just 2% or 3%.

Yes, I think we said in our announcement, Mark, that the inflation rate was about 2% in the numbers.

Obviously, we think and we look at that very carefully, that is not the number we just give: oh, yes, it's going to be 2%, right, and that reflects differentials in some markets.

Obviously, in some of the Latin America markets, you've got much higher rates of inflation, in some markets, obviously, you have close to deflation, so that's just an average number and we are not giving away 2%, let me assure you.

Obviously, we would assume that as our headcount growth declines, the total cost or growth rate of overall headcount will also decline.

Just to close the circle, assuming you're able to sustain this organic growth trend that you've had and you lap the expense buildup last year, there's every reason to assume that you ought to be able to see the salary and benefit ratio improve year-over-year as we get into, say, the fourth quarter?

As you know, we do not give guidance, but you can certainly construct the maps that way.

And then a final question, the Human Capital business was low single-digits this quarter.

I think it was more like mid-single digits last quarter.

Anything to that?

First of all, that reference to Human Capital is to our Human Capital business in North America, right, and we should be aware, particularly post the acquisition of Max Mathiessen, North America will be, at this point, about a half our global Human Capital business, but the reference we had was to our North American Human Capital business and let me turn to Todd Jones to give some commentary on that.

Mark, the second quarter for the North American Human Capital business is not a huge quarter for us, so we were happy with the growth.

I think notably, and we've talked about this in past calls, our exchange platform, the number of prospects in the business we continue to draw to Willis based on the position, we're excited about where that business is heading and think it's a key feature to the growth in North America.

Thank you.

Adam Klauber, William Blair.

Good morning.

Thanks.

I've got more of a long-term strategic question.

When I think about the competitive landscape, we have the global brokers and the middle market brokers.

The global brokers, clearly, run the larger businesses, deal with more complex clients, have more infrastructure.

The middle market brokers tend to have more of a focus on sales and tend to be a light infrastructure.

Willis has historically done both and really balanced both sides of the coin.

But, in a sense, they've, I think, had a facade more like a global broker, but the infrastructure more of a regional broker and that resulted in margins that were actually more like middle market brokers than global brokers.

I apologize about the long-winded question, but I guess, strategically, how do you see the organization?

More as a global broker, as a middle market broker?

How do you picture the margin longer term?

More like a global broker or more like a middle market broker?

Thanks.

That's a good question, Adam.

First of all, just to reorient you just a little bit.

Willis' history, you would absolutely say, would be as a global broker and it is the build-out of our position in North America that has tended to make people, particularly sitting here, see Willis more as having a heavier middle market orientation than the global footprint would tell you.

Our approach is the following: we are absolutely a global broker in the Willis Re space and in our approach to the corporate space, larger, not the middle market.

Our entire connecting Willis initiative is about bringing together our specialty capabilities and our large corporate and upper middle market retail capabilities to do a better and better job of winning market share in that space.

When it comes to the middle market, we have a selective approach as to which markets we will dive deep into on the middle market basis.

We are very excited about our middle market platform in North America.

It continues to perform very strongly and is obviously an integral part to the growth we have seen in North America, as is our large corporate performance in North America.

In other markets around the world, we decide whether to compete in the middle market at all, whether to compete in the middle market directly, or whether to do so by a network of arrangements with other local brokers where we bring to bear our global capabilities.

We are selective in thinking through how to pursue the middle market.

Now, as it comes to margin, I'm going to take you back again to what we are focused on.

I want to keep reiterating this.

We are focused on growing cash flow.

We are focused on growing cash flow, which is the mixture of revenue growth and margin performance.

I don't think -- I think about where are we going to rest versus a middle market broker or a large corporate broker.

What I focus on and the whole team is focused on is growing cash flow, which means we have to drive top line growth and of course, we have to improve our margins over time.

Where we settle versus the others are not, I think, that interested or what I think you should understand is how we think about our business in terms of the global approach in Willis Re and in the large corporate and other middle market space and the selective approach on the middle market elsewhere.

Thanks.

That's very helpful.

Arash Soleimani, KBW.

Thank you.

Couple quick ones.

In terms of the comment you made on contingent commissions, I know you said that it wouldn't be impactful in 2014, but looking beyond 2014, is that something that would be at all material or would it be pretty small?

The answer, Arash, of course, is that we don't fully know.

We're only beginning down this path and I would reiterate what we said, that this is part of an overall approach to market-derived income.

We shouldn't just single down on contingent commissions.

We're just starting the process of engaging with some of our carrier friends on this issue.

I think it is clear, I want to be clear, that we don't think there's any material impact in 2014.

These contracts, if we end up signing them, have a lag effect, often, to them, so I would say the impact in 2015 would be less than any impact in 2016, most probably.

Obviously, should we find these arrangements possible to put in place, they are attractive economically because most of those revenues fall straight to the bottom line and the quantum we will see as we negotiate those arrangements.

Thanks.

Lastly, I know we've seen some mixed results from your competitors in terms of reinsurance.

I know you mentioned that you were able to get some positive organic growth there.

I'm just wondering, within your business, what are the things that you were able to do to drive that in the environment?

Let me turn it over to Steve Hearn to talk about Willis Re.

Thank you, Dominic, and thanks for the question.

Yes, our reinsurance business has continued to perform well and at the half year, outperforming our two immediate competitors in terms of growth rate.

Going on, there's some things that are going on in the reinsurance sector, some significant change, and we talked about some of it before.

The impact of so-called new capital into that segment is obviously significant and nothing has abated the pace of the new capital, as far as I'm concerned.

We've definitely have become an interesting new asset class for many new investors in the segment.

The debate continues as to whether that's temporary or something far more fundamental and I'm very much of the latter opinion, that it's driven by macroeconomics and pricing and no more than that.

I think one of the answers to your questions is Willis Re have done a good job in embracing the opportunities that come from that factor, representing, obviously, that in terms of opportunity for our clients and for that matter, for our shareholders through the growth that they've driven.

To my mind, there's no debate that's having an impact on the rating environment.

Market dynamics also look at the way our clients are considering what they risk transfer and what they retain in terms of risk.

Some do take the opportunity to buy more when prices are down, to buy different coverages, et cetera.

Others are retaining much more risk themselves than they have, at least in the recent past.

Again, the way we've gone about that, the way I've seen our reinsurance business go about that, is either of those scenarios still requires the advice of experts.

You still need actuarial support, cap modeling, et cetera and we've embraced the changes in the dynamics of the market and I think, taking good advantage of it.

We've seen a continuing performance, as Dominic said in his prepared remarks, around retention rate and new business rate in our reinsurance business.

Again, I think it's in the way that they've gone about embracing the change in the marketplace and as you quite rightly say, we performed well against our competitors over the half year.

Thank you.

If I could actually just jump back to my first question, is it accurate to say that, because Willis wasn't accepting, you know, contingents in the past, were your base commissions higher than competitors who were accepting contingent commissions?

If so, would that just mean that once you accept them, it's not something that would necessarily boost revenue, it would just cause some of the revenues to be higher-margin?

Is that sort of the right way to think of it?

Good question.

Let me have Steve take a go at that.

Yes, I'll take a go at it.

I think it's a great question.

I think it actually lies with Dominic's earlier answer, which was we don't actually know of the impact of what's going to happen here.

There's no question that how we generate revenues from the placement of our clients' business is a myriad of different things that are going on; obviously, straight commissions, there are incremental commissions, fees, MBI more generally.

I think this is going to take us some time to get into negotiations with the carriers in terms of where the opportunities are for us to benefit from this, remembering that first and foremost is our responsibility and duty to our client and making sure that we're providing optimum outcome for them.

New business penetration, renewal retentions, providing optimum outcome for clients and, yes, of course, how do we earn out of doing that will be what we focus on moving forward.

Great.

Thank you so much for the answers.

Kai Pan, Morgan Stanley.

Thank you.

Most of my questions have been answered.

Just last one on the tax rate.

Seems like you are changing from uniform dollar tax payments to a more sort of even distributed tax rate depending -- than the dollar amounts were, depending on the pretax income of each quarter.

So is that the right way to think about it?

Secondly, in the past, you have guided -- like 2013, you said the full-year tax rate would run about 23%.

Is that still a valid underlying tax rate going forward?

Thanks.

Okay.

Yes, thanks for the question.

Let me just back up a little bit and talk about the two components driving the tax rate here.

And one of the components was that deferred tax valuation allowance of $21 million and then the other one was phasing of the tax expense, which pulled in $13 million into the first half.

That $13 million doesn't change the total year tax rate, it's just a phasing bit.

The way I think about the tax rate is it's generated by a mix of business from across the world where we have different tax rates in each jurisdiction.

We do know that the US has one of the highest corporate tax rates in the geographies we operate in, so as more business is generated in North America, that would generate incremental tax expense for the Corporation.

I think what you're looking for is how to think about the tax rate going forward and the best advice I could give you is, if you take a look at our year-to-date tax rate, remove the two, I'll say, chunky items that we highlighted, that will give you a rate.

Thank you so much.

Brian Meredith, UBS.

Yes, thanks.

A couple questions here for you.

First, I understand what's going on with the S&B.

If you could just chat a little bit or drill down a little bit on what's going on with other operating expenses?

I know there's initiatives and stuff that you've got going on right now.

When are those initiatives going to kind of slow down and come down and what are kind of the magnitude of those as we look forward?

I'm going to hand it over to John in a second, but I think there is a generic point here we should acknowledge.

Though on paper, something like 75% of our costs are S&B, roughly, we think that they drive more of our expenses directly, as well.

Some of the growth you see in our other operating expenses is actually linked to headcount growth.

For instance, as we hire more people out in the client space serving clients, which is what we're trying to do to drive our revenue growth, there is some correlation to travel and expense growth as well.

I didn't know if maybe for consultants and stuff were within that numbers as well.

Let me have John just talk about that.

Underlying under operating expense is up about 6% for the quarter and there's a number of factors driving that.

There's three or four main items there; so there is professional services, we did incur a high level of professional services related to the Max Mathiessen acquisition that we announced, so that was a, I would say, relatively chunky item for the quarter and our new business development activities were higher, as supported by the growth rate that we've seen here.

That added a couple of million dollars there.

But I would say, from an overall standpoint, in terms of how we're thinking about managing expenses, we do have a good infrastructure in place in order to manage expenses.

What I think we're going to focus on going forward here, probably more discreetly, is delegations of authorities and also, making sure we're making, I'll say, the best decision possible for every single dollar we spend and I think that will result in a positive outcome for the Company and shareholders.

Great.

Just one other quick question.

Can you remind us what runs through that other income expense line item?

If you back out the Venezuelan item, it looked like there was a fair amount of income coming through that line.

Yes, that's a good question.

There was some FX revaluation coming through there and gains on disposals.

Gains on disposals.

So we shouldn't necessarily think of the other income line as kind of a recurring item?

What I would do is I would look at the historical trend on that and there's typically, from what I've seen, a credit and we had a substantial charge go through related to Venezuela.

Okay.

Thank you.

Thank you.

At this time, I'm showing no further questions.

I'll turn the call back over to the speakers.

Thank you very much for everybody's attention and joining our call.

We really appreciate your interest in our Company and the great questions we come and we get from you.

We look forward to talking to you again at the end of the third quarter.

Thank you very much.

Thank you.

This does conclude today's conference.

We thank you for your participation.

At this time, you may disconnect your lines.