Willis Towers Watson PLC (WTW) 2014 Q3 法說會逐字稿

Welcome and thank you all for standing by.

(Operator Instructions)

This call is being recorded.

If you have any objections, you may disconnect at this point.

Now we'll turn the meeting over to the Director of Investor Relations, Mr. Peter Poillon.

Sir, you may begin.

Thank you.

Welcome to our Third-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 a slide presentation to which we will 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 result, 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.

These 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 a 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 press release and slides associated with this call.

I'll now turn the call over to Dominic.

Welcome and thank you for joining our quarterly conference call.

With me today are John Greene, our 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 have had a chance to read the news release that we put out last night announcing our third-quarter earnings.

On this call, John and I will give our prepared remarks; and then we will move to Q & A. To begin, I'd like to provide some comments on this quarters results, primarily on our organic commissions and fees growth and our underlying expense growth.

Through the first half of 2014, we had grown our commissions and fees organically by 4.3%.

This quarter, growth for the group slowed to 2.5%, which is disappointing as it is below our first-half results.

It is important, however, to get below this headline number to see that the decline is isolated in a few areas, and that many of our regions and practices continue to grow well.

For example, a theme you will hear across segments is weaker construction practice revenues this quarter.

This is a result of timing of projects and the fact that last year's quarter had some significant project revenues that have impacted the current comparison.

Looking at revenues.

On a segment-by-segment basis, Willis International lead the way, contributing 6.3%.

Willis North America added 3.4%.

Willis Global, where most of the negative factors were at play, came in very slightly down at 0.4%.

Now let me provide a little more detail on each of the segments in turn.

First, Willis International.

Our international operations grew 6.3% in the quarter, bringing our core organic growth rate year to date to 6.5%.

Once again, this is a really strong result from this segment.

Latin America and Eastern Europe grew double digits, while Western Europe saw mid single-digit growth in the quarter.

Asia was about flat, as growth in China and Global Wealth Solutions was offset by a decline in Hong Kong.

Now, if you think about economic growth rates around the globe, it is clear that Willis International's organic growth has outpaced the nominal economic growth of many of the geographies in which it operates.

That includes both Western Europe and many of the emerging markets.

We believe that this is evidence of our strong market position in those international markets and our strategic initiatives to actively invest in the fastest-growing markets and take share in developed markets.

On to Willis North America, which continues to generate solid new business while maintaining strong retention levels.

As I said, we delivered 3.4% organic growth in North America.

We saw mid single-digit organic growth across several of our geographic regions, with the Midwest and Atlantic leading the way.

Rates in general in North America continue to moderate with, of course, variances across different products and lines of business.

We've recently published our Marketplace Realities report for those interested in a deep dive into our view of 2015 rates in North America.

It is available on our website.

Looking at our results by practice, importantly, North America's largest practice, human capital, grew mid single digits.

Now, while I'm discussing human capital, let me provide a brief update on our healthcare exchange strategy, which includes our own exchange offering, the Willis Advantage.

I believe when we last updated you, we had 16 current and committed exchange clients in total.

We now have 31, and that includes Willis in North America.

The pipeline remains strong, more than 700 prospects in various stages of discussions.

So we remain optimistic about the growth opportunity of this important business.

Our second largest practice in North America, construction, as I mentioned earlier, was down mid-single digits in the quarter, as a number of projects in the prior-year quarter did not recur,.

That is simply the nature of this project-oriented business.

Quarter to quarter, results can be uneven.

Importantly, year to date, this practice is up mid-single digits, so it continues to be a growing practice.

Now on to Willis Global, which is comprised of Willis Re, Willis Insurance UK, Facultative, Risk, and Willis Capital Markets & Advisory.

Global's organic commissions and fees decreased by 0.4% in the quarter.

This result reflected a blend of differing results across its major component of businesses.

Willis Re grew low single digits in a seasonally small quarter by continuing to innovatively serve our clients and win new business.

This was achieved against the backdrop of perhaps the most competitive market conditions the reinsurance industry has seen in more than a decade.

Within the reinsurance business, North America grew strongly, supported by new business wins; and International grew modestly.

However, the prevailing market conditions took their toll on the specialties reinsurance division, which was down modestly in the quarter.

Moving on to Willis Insurance UK, which combines our UK retail unit and global specialty businesses.

Willis Insurance UK declined mid-single digits in the quarter with the majority of the weakness isolated in the specialty construction business, which was up against a very difficult comparison due to large project revenues recorded in last year's quarter that did not recur.

Meanwhile, natural resources saw strong growth.

And transportation grew low single digits as aerospace saw some rate improvement.

The UK retail business was up modestly year over year.

This business continues to be in turnaround mode, but has been steadily improving.

So to conclude our revenues, as you can see, the majority of our business continued to grow well in the quarter.

But our overall growth rate of 2.5% was pulled down by some specific issues in the specialty division of Willis Re and in selected specialty businesses.

With that, let me turn to expenses.

I want to make a few brief observations about expenses.

And then John will provide the appropriate level of details in his remarks.

We told you last quarter when we reported underlying expense growth of 6.1%, that we expected the rate of expense growth to decline over second half of the year as the rate of increase in headcount slowed and our expense management initiatives took hold.

In that context, our underlying expense growth in the current quarter was 4.1%, an improvement relative to the first half of the year.

Two points of importance I would like to make about our expense growth rate.

First, to date, we have received very little benefit in our expenses from our operational improvement program.

Therefore, we achieved this expense growth moderation through our expense management initiatives that we briefly discussed last quarter.

Second, as we are achieving this moderation expense growth, we continue to invest in talent, in value-added areas, and in our higher growth markets to drive future growth.

We are demonstrating progress in our expense growth rate.

But to be clear, we obviously will not be pleased with any level of overall expense growth that exceeds our overall revenue growth.

John will discuss the financial results of operations in greater detail.

He will also provide an update on our operational improvement program, which is off to a good start.

And we are pleased with the progress we are making.

When he is finished, I'll come back to wrap up and discuss our inorganic growth before we turn to Q&A.

With that, I'll hand it to John.

Thank you, Dominic.

I'll be working off the third-quarter slide deck posted on our website, starting at slide 3. This is a walk through showing the major earnings components in terms of both reported and underlying EPS from the third quarter 2013 through to third quarter 2014.

From 3Q 2013, reported on the left-hand side, we adjust for $0.34 related to the debt extinguishment charge to give us an underlying 3Q 2013 EPS of $0.19.

Moving across the slide, you can see increased commissions and fees for 3Q 2014 had a $0.09 positive impact.

And increased expenses had a $0.13 negative impact.

The net of those items, the $0.04 reduction, represents the Company's underlying business performance.

Continuing across, you can see a net $0.01 negative impact from several items: higher quarter-over-quarter interest expense and a higher tax rate, partially offset by better results in our associate lines and an increase from the non-controlling interest line.

The net impact of these gets us a third-quarter underlying EPS of $0.14 per share.

Let me remind you that we defined underlying as reported, excluding non-operating items and the impact of foreign exchange movements.

So to get from underlying EPS to reported, we have $0.10 of adverse movements in foreign currency and $0.08 of cost from the operational improvement program.

Drilling down into foreign exchange, we saw about $24 million of unfavorable movement.

That breaks out as $3 million in commissions and fees and $7 million in operating expenses, which gives us a total of $10 million of foreign exchange translation impacts or $0.04 per share.

Of that, the most significant year-over-year currency movement for us was the relative strengthening of the pound against the dollar.

We also had $14 million, or $0.06 per share, of unfavorable foreign currency impacts to our other income line, which is below operating income.

This was primarily a change in foreign currency gains and losses on revaluation of our non-functional currency assets and liabilities.

The operational improvement charge in the quarter amounted to $17 million.

You can find that breakdown of the charge by segment and expense category in the press release.

I would note, that we've achieved savings of about $2 million from the program in the third quarter, primarily from headcount reductions.

Let's turn to slide 4 on underlying EBITDA and net cash flow from operations.

You'll recall that we view underlying EBITDA as a decent proxy for cash flow.

You can see from this slide that underlying EBITDA was $636 million, down about $10 million year to date, which is a reduction of less than 2%.

Our net cash flows from operations over the first nine months of the year were down $85 million over the same period last year.

The decrease was driven primarily by the non-recurrence of the close out of derivative contracts in the third quarter last year, plus increased cash payments this year from our long-term incentive plans.

Slide 5 shows our reported and organic commission and fee growth by segment.

I would add three things to what Dominic said.

First, there is no impact on our international results from the China revenue recognition issue from the fourth quarter of last year.

Second, overall reported growth in our international segment was lower than organic growth due to the negative impact of foreign exchange movements.

This was partially offset by acquired revenues, primarily Charles Monat.

Third, North America's reported commission and fee growth was below organic growth because of the sale of some small, slower-growth businesses.

We expect to close on the sale of a few more small offices in North America in the fourth quarter.

Moving on to the total expense walk on slide 6. From the left, we adjust the prior year reported balance for $7 million of adverse foreign currency movements experienced in the current quarter and $1 million of fees related to the debt extinguishment costs that we incurred within other operating expenses in the third quarter last year.

As a side note, we also paid a $65 million tender premium related to the refi; but that flowed through interest expense on a net basis in last year's results.

So that gets us to an underlying amount of $731 million of total expenses in last year's quarter.

Moving across, underlying expenses grew by $30 million or 4.1%.

Salaries and benefits accounted for $22 million of the growth; other operating expenses, $7 million; and the last $1 million from depreciation and amortization.

That gets you to $761 million of total underlying operating expenses in the current quarter.

When you add in the $17 million charge related to the operational improvement program, you get to the reported total expense of $778 million for 3Q 2014.

Slide 7 provides more details on salaries and benefits.

So the primary driver of salary and benefit expense growth over the past several quarters has been our investment in new talent.

We told you last quarter that the growth in our salary and benefits line item would decline over the remainder of the year as a result of a slowdown in net headcount additions in 2014.

In the second quarter of 2014, S&B increased 6.3% year over year.

This quarter, the rate of growth declined to 4%.

FTEs are up 2% since September 2013.

So increased headcount accounted for about half of the S&B growth.

The remainder was largely due to salary increases, which are essentially in line with inflation.

Headcount growth through the first nine months of 2014 was 1.7%.

More than half of the growth is in our low cost operations in Mumbai.

To be clear, the increase is not part of our operational improvement program, but rather part of the move to low-cost operations that we had been implementing before we announced the program.

As we have said, the program, in large part, involves a significant acceleration of movements already well underway for many years, building on the skills and experience we have developed over those years.

Turning to slide 8. Let me give you input on some of the non-operating line items.

Other income and expenses, which is below operating income, includes the revaluation foreign currency laws.

This is a $14 million year-over-year change.

The primary currency drivers of this change were movements in the Venezuelan bolivar, the euro, and the pound sterling against the US dollar.

Taxes in the quarter were impacted by a $4 million adjustment, reflecting an increased proportion of US earnings relative to the UK.

As you know, the US corporate tax rate is almost double that of the UK's.

Our associate line showed improvement in the quarter driven by Gras Savoye.

Let's turn to the balance sheet and uses of cash at slide 9. As you can see, we ended the third quarter with $656 million of cash, up over $30 million from a year ago.

The decreased cash balance, relative to the year end, was driven primarily by the share buyback program and increased cash dividends.

This was partially offset by the non-recurrence of the third-quarter 2013 tender premium paid on our debt refinancing.

Regarding our uses of cash, I would highlight that we repurchased almost 2 million shares of stock for about $82 million during the quarter.

Earlier this month we completed our announced buyback program, having repurchased a little over 5 million shares, in total, at a cost of about $213 million.

CapEx is up a little due to investments in systems and infrastructures; dividends are 9% higher; and we have been more active in M&A, including the Charles Monat acquisition that closed in the second quarter.

Let's turn to slide 10, the update on the operational improvement program we promised back in April.

You've read in our press release that we have updated our estimated savings based on the actions we are taking in 2014 or will take in 2015.

We've also provided saving of our projected spend.

Starting with the updated savings, we are now estimating that we will achieve savings of at least $8 million on actions we have taken in 2014.

That's $3 million ahead of our original estimate.

The majority of the savings flowing through this year are from headcount reductions, primarily in our UK operations.

For 2015, we are now estimating at least $60 million of in-year savings.

That's $15 million ahead of the original estimate.

Our 2014 and 2015 actions will result in an estimated $120 million of annualized savings by the end of the program.

That is 40% of our $300 million estimated total annual savings.

We still expect program cost savings of $135 million in 2016 and $235 million in 2017.

That's unchanged from our original estimate.

Turning to the cost side, we expect to spend about $40 million in 2014.

Some of that, of course, was preparatory work.

We expect to spend about $130 million in 2015.

That gives us about $170 million of the total $410 million we anticipate on spending over the life of the program.

The remaining $240 million will be spent in 2016 and 2017.

Let me note that spend, as we've defined the term here, is total operation improvement program related payments for items that will flow directly through our income statement, or for items that are capitalized and run through depreciation over time.

So it's a combination of expense and CapEx.

We've made a good start to the program.

To help you track our progress, we'll provide you with three metrics indexed in March of this year.

They are the ratio of FTEs in higher-cost geographies to lower-cost near-shore and offshore centers, which stood at a ratio of 80/20, plus the square footage of real estate per FTEs and desks per FTEs, both indexed to 100.

We believe these metrics will be helpful to you in measuring our progress on middle-office and back-office transition and real estate efficiencies.

With that, I'll hand it back over to Dominic.

Thank you, John.

I'd like to conclude with an update on our M&A activity.

Last quarter, we told you about the investment we made in our human capital and benefits capabilities in the Nordics, specifically, our acquisition of a controlling stake in Max Matthiessen in Sweden.

That transaction closed earlier this month.

And we're delighted to welcome the Max Matthiessen team into our worldwide human capital and benefits practice.

Additionally, we're pleased to have announced the acquisition of SurePoint Reinsurance Advisors.

That will meaningfully expand our capabilities in the accident and health reinsurance market in North America.

We also acquired a range of Irish pension and financial advisory businesses from IFG, which nicely complement our global human capital and benefits practice.

Finally, we announced last week that Willis is in advanced, exclusive talks with Miller Insurance Services LLP to take a majority interest in that leading independent specialist program.

Under the proposed transaction, we would combine wholesale businesses to trade under the Miller brand.

When we are able to, we will update you on the progress of these discussions.

Let me leave you with these thoughts about three planks of our strategy.

First, I'm convinced that our strategy to grow revenues organically through our global presence by connecting Willis together to deliver better solutions for our clients and through innovation will continue to drive new business and increase our share of wallet from existing clients.

Despite some isolated negative items this quarter, we exhibited good organic growth in most of the business.

Second, our measured acquisition strategy that is focused on high-quality, specialized firms with leading market positions is proceeding well.

We believe this strategy will further increase our growth rate and support our organic positioning.

Third, you are starting to see the results of our disciplined approach to controlling expense growth and the early encouraging actions from our operational improvement program.

Together, these three items of organic growth, focused M&A, and expense management give all of us at Willis great confidence that we are heading in the right direction to achieve earnings growth, margin expansion, and improved cash flow.

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

Yes, sir, thank you.

(Operator Instructions)

The first question comes from the line of Cliff Gallant of Nomura.

Good morning.

Thank you for your comments about the organic growth slowing in the quarter and I wanted to just clarify.

What is the outlook for Willis Insurance in the UK in the fourth quarter?

Should we continue to expect a little under performance there, offsetting the areas of strength?

Well, let me -- I'm going to have, obviously, Steve Hearn, who oversees Willis Insurance UK, which is part of Global.

Obviously with the proviso, as you know, we don't provide quarter-to-quarter earnings of revenue or cost-specific guidance, but with that let me have Steve just give a sense of how we're doing.

Thanks, Dominic.

Thanks for the question.

I'll remind you, of course, that our UK insurance business is a sum of its parts.

We have some, as we pointed out in the script, some businesses that have performed well in Q3, and in fact have performed well throughout the year for us, and some businesses that continue to drive significant growth for the organization.

We had some challenges.

As we declared, UK Retail has been a challenge for us for a period of time, some years.

That's something we've all been working on very hard over the course of this year in terms of a turnaround program for our UK retail business.

As I said, we continued to drive strong growth in many parts of the organization.

Within it, as well, are our global specialty operations, which continue to be market-leading businesses.

We're very proud of our position as market leader with some strong margin contribution and profit from those businesses.

I'm afraid I can't get to the specifics, as Dominic said, of giving some guidance around what will happen in Q4.

Okay.

As a follow up on the US construction, you discussed how the year-to-date number was up mid single digit.

I just wanted to clarify, that's what you see as the trend, not the decline you saw in the third quarter?

I'm going to hand it over to Todd Jones to talk about US construction.

But clearly, I think we've tried to indicate to you that we're obviously looking -- when we think about our revenues generically, we're looking at how they have been performing during the course of the year as much as what happened in this particular quarter.

Todd, why don't you talk about construction in the US?

Yes, I think Dominic said it well that if you look at how the businesses performed quarter over quarter and then year to date, obviously, our Q2 performance, which was mid teens, was a bit of an outlier in terms of growth.

The expectation is the business continues to perform well.

We continue to see a tremendous amount of activity on both the project space and the surety side, and our expectations is we're going to continue to perform in that space, as we have year to date.

Okay, thank you.

Thank you.

The next question comes from the line of Jay Gelb of Barclays.

Sir, your line is open.

Thank you.

I realize the third quarter is seasonally a light quarter for revenue, but we're just trying to get a handle on when we might see some stabilization in that adjusted pretax margin?

I know third quarter may not be the best indicator of that, but as earnings estimates keep coming down, I think that will be a headwind on the stock, so any insight you can help us with there would be helpful initially?

Thanks.

Again, I'm not going to give you specific guidance.

Obviously the thing you have to analyze is the sense of revenue momentum on an ongoing basis versus where we see cost momentum.

I think where you're starting to see the cost momentum, cost growth come down, both pre the operational improvement program, which hasn't really kicked in yet.

We will see an acceleration of the impact of the operational improvement program.

Obviously, our plan is to continue to have strong organic growth, to supplement that with M&A growth, and to see the combination of our normal expense management, which you start to see the impact of, combined with the operational improvement program to see the crossover and the increase in margin expansion.

Those were the points I made at the end of my remarks.

We can see all the ingredients for that happening.

That's helpful.

Do you think that crossover point, do you think that's 2015 or 2016?

Again, I hope it's as soon as we can possibly make it.

You're going to have to analyze what you'd see the numbers going through in terms of our revenue momentum and the deceleration of our organic expense growth and how that's going to play out.

John took you through, for instance, the trend lines in our salary and benefits over the last few quarters, and you can see that has actually been flat, and the impact of our operational improvement program.

So, we would obviously expect those trends continued, but we will be able to see performance improve in good time.

Okay.

Then, on a separate topic.

With the potential use of free cash for the Miller deal, what impact, if any, does that have on the potential acquisition of the remainder of Gras Savoye in 2015?

Very good question.

We remain very confident of our ability to fund both a Miller transaction and Gras Savoye through our normal cash on hand and debt capacity.

Thank you.

Thank you.

The next question comes from the line of Michael Nannizzi of Goldman Sachs.

Sir, your line is open.

Thank you.

The one slide on the operational expense program, you talked about savings being better than the April announcement, or at least the trajectory of them.

Is there any difference to the costs that you outlined or that you expected when you originally outlined the plan versus now?

In other words, are you investing more now than you anticipated back in April?

Thanks.

Well we didn't give you the details back then, if you'll remember, of how we expected to phase our expense growth.

Yes, I know.

I think you can naturally expect that in our ability to accelerate savings, of course, that doesn't mean you're going to see slight acceleration of expenses.

Let's talk about what are in the expenses.

Expenses are parallel running costs, some redundancy costs, some specific system investments you might make to simplify a process, and obviously, building out of capability to absorb more people in lower-cost locations.

You've got to have somewhere for them to sit, for instance.

Obviously, as we have accelerated our expectations of where our savings will come, we obviously will incur, for obvious reasons, costs a bit earlier.

Got it, okay.

I'm just curious just going a little bit deeper operationally.

What sort of actions are you taking to make sure that the program doesn't negatively impact morale in the areas that you're looking to retain folks?

A very good question, and so all the leaders of this program, all the people heavily involved in it, are focused on a number of metrics.

Obviously, a critical issue of our staff morale is actually how is this affecting client service.

So, as we advance every single project, we are also measuring client service metrics to make sure that as we make changes, not only are clients well informed to understand what we're doing, because at the end of the day we actually want client service metrics to go up.

We are, first of all, very firmly focusing on client service as much as cost improvement as we do this.

Secondly, you should understand this is a program which is highly involving everybody whose doing the change.

These programs are not from some outside element doing the change.

These are Willis-driven programs with people heavily involved in the operational improvements.

So that is the process we're going through.

Got it.

Then just on that, have you also incorporated into your expectation, when you talk about declining year-over-year increase in expenses?

Any potential for higher retention costs, or to the extent that that becomes a tool that you utilize to manage retention?

Or is that just not something that you anticipate being an issue?

Thanks.

We have to, obviously in the cost of the program, include, first of all, parallel running.

If we have to run -- let's say we have a new process taking place in Mumbai, which was taking place in a city in a developed market, we're going to run those two processes in parallel for a period of time to make sure they are bedded down, client services in place, etc.

Secondly, we obviously watch very carefully, make sure that we can retain key people during that process.

As you would expect, we would have the normal approach to retention payments, et cetera, as necessary to make sure that key people, while we're making that transition, are incented to stay.

Dominic, if I could add?

In the 410 there was specific allowance for retention awards.

Okay, got it.

Thank you.

The next question comes from the line of Josh Shanker of Deutsche Bank.

Sir, your line is open.

Yes, good morning, everyone.

First question, I guess, for John.

Trying to understand slide 3, the EPS crawl.

When we are in the third quarter of 2015 crawling forward from this quarter into that earnings quarter, what is the underlying EPS number you start with?

Is it $0.06?

Is it $0.14?

I'm trying to understand.

There was no foreign currency movements between 3Q 2013 and 3Q 2014.

How does that compare when 3Q 2014 becomes history, what will the EPS number be recorded as that it relates to Q3 2015 earnings?

The way we do this is we take the actual results in the current year and the prior year is effectively re-based for the currency that we're seeing.

That difference between the current year and the, I'll say, the re-based will be a FX adjustment reflected on the earnings walk on page 3.

So in 3Q 2015 looking back on 3Q 2014, the underlying EPS number will be $0.06 per share?

No, it will depend on what actually happens to the rates in the period.

I'm talking about the historical number, not the new number.

There will be no currency rates at that point, like ex-currency it was $0.06 per share, and that will be the basis for which you measure performance in 3Q 2015?

Yes, so what we will do is that foreign currency movement effectively re-bases to the prior year.

Then, you're on a constant currency throughout the walk from one period to the next.

If you'd like, we're happy to take this offline and walk you through the exact mechanics, but it's your standard constant-currency analysis.

Okay.

I'm just I guess I'm trying to get the number right in my model what the EPS will be recorded for posterity.

The other question, last quarter I asked the question whether or not margins had bottomed, and Dominic's answer was probably not, let's wait until the end of 2014.

Listening to your answer to Jay's question, margins will bottom as soon as they can, but maybe you're taking a timeline away?

Look, I'm never going to give very, very specific timing on any particular quarter's annual cost performance in advance for the reason we don't give guidance.

I think you just have to look, as I said in answer to the question earlier, is at the trend line in our revenues, in this year, and what you see based upon our expense actions prior to the operational improvement program.

We have given you a lot of information on that in terms of how its decelerating and what's happening to S&B costs quarter to quarter, and how that there for is trending and how we see the operational improvement program flowing through.

We are very confident that we're doing all the right things to have those lines cross and have been very clear we will not be happy until we're regularly producing revenue growth which is more than cost growth.

We think we're taking all the right actions to have that crossover happen as soon as possible.

That makes perfect sense.

Is the business in as good of a shape today as you thought it would be one year ago?

I think in many ways it's in even better shape.

Let me go through the elements of that.

The fundamental drivers of organic growth of our strategy, which is pinned around connecting Willis together, so that we can deliver, around the world, our specialty capabilities through our multiple channels to our clients in a coordinated way, is well advanced.

We've made great strides in that.

We are seeing good momentum in new business wins, pipelines are strong, we're very happy with the way that's developing.

Our expense growth management, we deliberately made investments for that strategy.

I've just described to you in the second half of 2013.

We knew that was going to be a pig-in-the-python problem in terms of cost comparisons during 2014, and we said that to you.

We said that we thought we would see expense growth decline during the course of 2014 as we implemented expense management activity post that investment.

You are seeing that take place, and we are confident about that.

We also have, meanwhile, continued to be able to invest in the talent to drive that organic revenue growth, so we're confident about that.

The operational improvement program, which we only announced in April, is ahead of where we thought it would be and is getting traction, and we are confident of it delivering ahead of the schedule we laid out in April.

Finally, we very explicitly laid out an M&A strategy focused on specialty situations, which have strong franchises, high-quality firms, that we would not be going after just volume, just bulking up but instead we'll be going after very specific transactions where we could engage in exclusive conversations to bring those very talented organizations as part of the Willis family.

We are very pleased at the progress we've made on that and are highly excited about how it's going to play through in 2015.

Actually, if you ask how do I feel about the health of Willis now compared to a year ago?

I feel very good.

Thank you for the answers, and good luck in 2015.

Thank you.

Thank you.

The next question comes from the line of Vinay Misquith of Evercore.

Your line is open.

Hi, good morning.

Part of the organic growth, it appears that a lot of the slowdown this quarter was because of one-time issues because of the construction practice.

Is my understanding of that correct?

Yes, what we highlighted that -- if you look at the detail behind the headline of 2.5% organic growth, you can see that North America continued to grow along the trend line its been on.

International had growth, again, of over 6%.

We had very specific issues, a number of them, coincidentally, in construction.

Your interpretation is correct.

I'm just looking toward to the fourth quarter.

Do we have any bad comps fourth quarter this year versus fourth quarter last year?

As we said to you last year, we did have, again, a very strong construction quarter in the fourth quarter of 2013, so that will just be a tough comp.

Again, we remain optimistic about the trend line in the majority of our businesses.

Sure.

Then on the expense savings, I believe that is about $8 million of the expense savings on the operational improvement program.

Has that already flowed through earnings this year, or do you expect that in the fourth quarter?

No, I think we laid out we had a very, very small number in the third quarter, so the majority of that number will, obviously, flow into the fourth quarter.

Okay.

The $60 million for next year, how much do you expect to flow down to the bottom line and how much do you expect to reinvest in the business?

We've said, overall, that we think the majority of the savings we get will flow to the bottom line.

I think the way to think about this is the different component parts that drive our expenses.

Let me hand it over to John to help you think about that.

Thank you, Dominic.

If you think about our cost base, it's subject to inflation somewhere between 2% and 3% based on the geographic mix, so that naturally wants to increase the expense base.

We have the operational improvement program, the savings that we're talking about here, coming through as an offset to some of that inflation.

Then, there will be select investments to continue to be able to drive positive operating margin growth.

We're going to do that, but we're going to be very specific in making sure that we get definitive pay backs on that.

You can do the math based on what I just described there.

Really good progress and the operational improvement program.

Inflation, 2% to 3% is what we're seeing based on the geographic mix, and selective investments, we said that majority of the operational improvement program would fall through.

Sure.

One last numbers question, and I apologize for so many questions.

On the other expense line, I believe you said $14 million of that was for the foreign exchange, but the reported number was $9 million.

What is the difference between the two?

The $14 million is revaluation FX, and there was translation FX about $10 million, so there's a difference between the two.

The revaluation FX, basically takes a look at non-monetary assets and liabilities and takes the year-over-year change in the FX rate, does a revalue and that creates a P&L debit or credit, charge or income.

This quarter, what we saw when we compared to third-quarter 2013, we saw weakening of the euro, the Venezuelan bolivar and the pound sterling versus third-quarter 2013, where we saw strengthening in the euro and the pound as you'll recall.

So, that difference created the year-over-year P&L charge of $14 million that we talked about in my script.

Thank you.

Is that helpful?

Yes, thank you.

Thank you.

The next question comes from the line of Kai Pan of Morgan Stanley.

Thank you and good morning.

The first quick question on the restructuring cost.

Thank you for the break down.

But you mentioned earlier about the total cost 70% probably attributable to people and 30% to system.

Is that same proportional throughout the years for your restructuring cost?

Broadly, yes.

Okay.

Secondly, on the margin question.

If you were thinking about -- because the economics slowing down, whatever, macro issues, that your organic growth staying at like, let's say, 2% to 3%-ish range, will the cost of the operational improvement program enough for the savings to drive some margin expansion through there or is it difficult even with the ongoing improvements in operations?

I think we tried to be very clear and clarify this issue of what the impact of the operational improvement program as it plays through.

If we were to see organic growth rates, nominal organic growth rates of the businesses, so the numbers that you see, so the equivalent of the over 4% we've seen year to date.

If we were to see that number at the lower end of our single-digit range, much lower than that 4% number, the operational improvement program, we believe, underpins our ability to achieve our margin expansion number.

If we see more robust growth at the middle or higher end of what we're seeing of our mid single digits, obviously the operational improvement program enables us to expand margin over time more than that 70 basis points.

That's the explanation we've given and that's how we see it.

Okay, that's great.

Then lastly, on the -- just curious about your thoughts about capital management priorities, especially between now you've been very focused on the acquisition just versus like share buybacks.

I just wonder what your thought behind like doing acquisitions or return to shareholders?

I think our position remains where it has been.

We continue to focus on our capital management as follows.

Obviously, we have to fund CapEx, et cetera, as we drive the business.

Next, we want to be able to grow our dividend as our earnings grow.

Third, we want to immunize the balance sheet or the numbers share count for option exercises and employee option exercises, so we did that in 2014.

We have a program we announced.

Then, we have M&A.

That's how we are thinking about our program, and obviously managing accordingly.

So actually the buyback is just to neutralize the share creation after the head of acquisitions?

Since you finished your program, $200 million, is there going to be another one just to offset ongoing the issuance?

We will examine what's happening to the option exercises this year, and then look at what's happening on the outlook and make an announcement accordingly.

Thank you so much for all of the answers.

Thank you.

The next question comes from the line of Bob Glasspiegel of Janney Capital.

Sir, your line is open.

Good afternoon, Willis.

I got some numbers questions, and I apologize.

Dominic, if we go back to your original five-year plan to grow revenue 70 bps faster than expenses, the math works out to about 250 basis point margin improvement from your 21.6% base of 2012.

You lost 160 bps of ground last year and you're 100 bps behind the eight ball this year, so that puts you 260 bps behind, which gives you 500 to get in the next three plus years.

The optimist in me says that, wow, they haven't updated that plan.

Dominic must still have confidence that it's achievable.

The realist in me says that, with the economic environment a little less good than we thought it might be a couple years ago and currency a little bit in your face and rates slowing, to try to get 500 bps of margin improvement in three plus years seems like it's a formidable task.

Who's right, the optimist or the realist?

We'll see, Bob, won't we?

I'm, obviously, not going to answer that question.

I'm going to go back to what I said earlier, which is that we have a very strong operational improvement program we put in place which can deliver very significant cost benefits.

You're right to say that our ability to drive our margin expansion and, most importantly of all, the number, as you know you.

You and I have talked about a number of times and I'm really focused on, which is cash flow generation.

That's the real number we should be focused on.

Our ability to do that is obviously dependent as well on how well revenues grow, which to some degree is impacted by the economic outlook.

I would reiterate what I said earlier today, which is, please do not drive a direct correlation between economic performance of the global economy and our ability to grow organic revenues.

There is some correlation, of course.

Of course there is, but we have shown, I think quite successfully over prolonged periods of time, that in a number of our markets we are able to outgrow nominal GDP because either we're taking share or because actually the underlying growth of brokerage of property and casualty insurance or healthcare in the commercial space is growing much faster than the underlying economy.

Yes, of course we're affected by economic outlook, but it's not a one-to-one type ratio.

I do take solace that you haven't adjusted your 2013 plans, so to me that does convey confidence that you think you're on track.

Just another question, then.

How does your incentive comp plan tie to your results?

Your cash payments were higher this year than before because of, I assume, history not anything related to this year or next year results.

If margins aren't expanding, is there a cushion in maybe that number sort of declining perspectively?

First of all, you're right, that what we referred to this year we referred to an old plan.

You should be very confident, and it's all available, is that the two key drivers of incentive compensation, which is our annual bonus plans and our long-term incentive plans, are directly tied to the performance of revenue growth and EBITDA growth in the annual plan, on the long term plan, multi-year revenue growth and EBIT growth over time.

So, yes, you're right.

Our incentive programs are absolutely aligned with the things that drive cash flow generation.

Is that a potential positive in Q4 as you true-up or has that been trued-up to the year in your accounting?

We'll true-up as best we can as we go.

Okay?

So don't look for that as a potential headwind and tailwind in the fourth quarter, is your answer?

No, I wouldn't do that, no.

We try and do our best to true-up as we go.

Okay, thank you.

Thank you.

The next question comes from the line of Thomas Mitchell of Miller Tabak.

Sir, your line is open.

Yes, I'm a little bit curious.

I understand that the Venezuelan bolivar may not be very hedgeable, but it would seem that your other currency exposures are hedgeable.

Is it just terribly expensive to go into the market and hedge for currencies or have you just generally decided to live with the ups and downs?

Good question, so we've actually spent some time looking at it.

There's the translation that is running through the P&L, so revenue and expense, not the other income or expense line.

That piece has to do with the structural mismatch in the UK in terms of about 60% of the revenue comes in in dollars, the cost base is sterling.

We've looked at that and it's impossible to get a cost effective hedge that would also hedge for the movements in the currency.

It's a really, really hard thing to do.

We've talked to a number of bankers who have had some ideas about it, but nothing that we viewed as something that we could implement.

In terms of the revaluation FX, our program there is -- basically, what we try to do is ensure that functional currency cost and functional currency revenue are matched, thereby having a natural hedge.

If there is a change in the underlying FX rate period over period, we deem that largely the non-cash.

So we haven't gone through to try to hedge that.

That's, actually, one of the reasons why we have broken out the underlying the way we've done that.

Alright, okay, that helps very much, thank you.

The other question I have is a little bit more conceptual.

It's about something that we all think we understand.

The construction business has stops and starts.

It's sensitive to different things.

It's probably different in the UK than it is in the US.

In general, there must be some sort of leading indicators that you have that give you an idea of whether projects are going to be started or they are going to be delayed and how big they are and how much coverage they need when.

I mean, what is the timing of this sort of thing?

You have to wait until somebody breaks ground to assume that you now have a coverage initiated?

I'm going to have Steve talk about that.

I think it is worth, of course, remembering that within construction there is lower ticket items going through on an ongoing basis.

Then of course, these big projects, which can affect the quarter-to-quarter numbers.

Do you want to talk more about the latter, Steve?

Yes, you're absolutely right, Dominic.

It is very much both and to your question, or your question was, is there a difference between UK and North America?

Emphatically, there is.

The coverage is different, and in fact the market, the provider, the capacity are often different, as well.

I should say as well, construction is strength.

It's been an issue for us, as we called, in terms of some specifics around Q3.

We are a significant leader, both in the UK and in North America, in terms of construction business, and for both of those activities.

In fact, around the world from our UK business, this is a large and profitable activity for us.

As Dominic describes, it's made up of lots of different things.

There's the continual pipeline of smaller projects, which we have significant share of and continue to come through very effectively for us.

It is typically the larger projects that drive the lumpiness that you see in our performance, both positively and negatively.

The lead time can be significant.

Even, in some cases, these are vast projects, billions of dollars of TIV initial asset value in some cases.

Those are very complex in terms of the way they're financed, very complex in terms of the way they are tendered, often multiple suppliers involved and often multiple brokers engaged in terms of providing the coverage and advice around those.

Again, buried in your question, if you'll excuse the pun, it is literally when the shovel or spade goes into the ground that we know we have a contract in place and insurable risk on many of these projects, you're right.

Well thank you very much.

That's very clear.

Thank you.

The next question comes from the line of Meyer Shields of KBW.

Sir, your line is open.

Great, thank you, good morning.

If I can keep beating on the construction issue?

Are there seasonal quarters where construction is a bigger or smaller portion of your overall business?

The answer to that is, no.

Again, as I said, because there are these very significant contracts and we are particularly strong in that area, it really is about when a contract is awarded and construction begins.

That doesn't tie around, unlike other parts of the insurance world, doesn't tie around traditional renewal dates, so the seasonal renewal dates that you see in other parts of our business.

It is when the contract is awarded.

The more run of the mill business, maybe you'd see more standard business as usual, if you'd like, you'd maybe see an element of that, but no it's not skewed, certainly in the UK and international world's, and I believe that's the case in North America as well.

Okay, that's helpful.

I think it's a question for John, but I'm not sure.

You had some impressive slowdown in organic expense growth from 6.1% to 4.1%.

When we consider the variable expenses associated with some of the business, though, if organic revenue growth would have been at 4.5% range, can you give us a sense of what organic expense growth would have been?

I'll first cut at that.

That is not the driver here.

We might have had slightly more incentive compensation because profits would have been better, but it's not -- I think the thing that's very important.

We do not believe that the slowdown in our revenue growth is because we have been slowing expense growth.

We've highlighted for you specific things that have gone on in specific businesses.

Meanwhile, International has been growing over 6% and North America over 3% etc.

We might have, as I said, had some, because of better performance.

The earlier question about accruing bonuses, we might have had slightly higher bonus accrual.

John, do you want to --?

The only thing I would add is, when we looked at the second quarter, the year-over-year quarter-over-quarter headcount change was about an increase of 4% in the second-quarter 2014 versus second-quarter 2013.

So that, we put on some inflation on there, and it gets you up to that 6% plus number we talked about.

In the September results, what we're seeing is headcount increase, versus September last year of only 2%, so that really explains the delta in the cost.

Okay, so the increase -- and I appreciate what you were saying about the incentive compensation, Dominic.

I'm asking more about the fundamental producer compensation?

That wouldn't have been very much different --

Same thing.

Okay.

In fact, your North American producer compensation, because we had a perfectly good quarter in North America, running at perfectly normal levels.

Great.

That's very helpful, thanks so much.

Thank you.

The next question comes from the line of Brian Meredith of UBS.

Sir, your line is open.

Yes, thanks.

Just a couple quick questions here.

First, I was wondering if we could drill down a little bit more on free cash flow?

I was wondering if you could talk about what was the actual dollar figure of the non-recurring derivatives close outs last year versus this year?

So we can just get a better run rate of what free cash flow looks like right now?

Or is this the right number to think about?

Is there anything else going on there?

Lastly, pension, any updated thoughts on what pension contributions look like next year?

Okay.

I'll be happy to take that.

There were three hedging activities that ended up coming through and creating a year-over-year difference.

There was a treasury lock last year, 2013, that drew about $20 million into the P&L.

There was an interest rate swap in 2013 that was about $15 million of cash.

Then, in the current year, related to the Max Matthiessen acquisition, there was another swap that ended up creating about a $15 million delta negative to cash.

So, you sum those up and you have got about a $50 million quarter-over-quarter issue.

We also had, in the quarter, some working capital changes.

It seems a significant portion of that, the working capital piece, had to do with the reclassification of some businesses to assets held for sale, which is other assets, which the goodwill and intangibles were long-term assets that will move up to short-term.

That creates a working capital effective increase that drives the cash flow number, at least in terms of what you're looking at.

It's really not a cash item.

Matter of fact, the exit of the business will create some positive cash flow for the fourth quarter.

Pension.

Pension, thank you, Dominic.

In terms of pension, year to date, we are under prior year, so we've contributed about $25 million this year versus $48 million in the third quarter last year.

What we expect for the year is year-over-year pension contributions will probably be down about $20 million.

Year over year, okay.

Any thoughts on 2015 at this point, given where interest rates are?

No.

Not at this point.

Then, just one last one here.

Just curious, I know you can't give any details with respect to Miller as far as the financial implications and stuff like that, but what about your strategic rationale behind the transaction?

Wondered if you could give us a little bit of why?

I'm going to turn to Steve for this, because, obviously, it affects particularly our London businesses and our position in that market.

Sure, and, Dominic, keep me straight not to get in to any detail in terms of the transaction itself, because it's a difficult question to answer without doing that.

Miller, I think people would recognize as the preeminent independent wholesaler in the London market, a company that's operating for over 100 years under the Miller brand, with a very strong wholesale content.

As we declared when we announced that we were in exclusive conversations around this acquisition, with also some businesses that we'd move into Willis, the treaty reinsurance business by example.

We have strong credential in wholesale business in Willis and a long history in wholesale.

In fact, if you track back only to a couple of decades ago, Willis was fundamentally a wholesale broker itself, until that time when it set off its retail capability internationally and in North America.

To this day we have significant wholesale capability within our existing London operation.

We felt strategically that it made sense, particularly given the connecting Willis strategy of deepening our connections across the organization around the world.

We recognize the difference around wholesale and this provides a fantastic vehicle, if we're able to conclude this deal, that will allow us to operate, in fact, both models, the connected Willis organization playing with the strengths of our specialty businesses and the London market wholesale operation through the Miller brand.

Great, thank you.

Thank you.

No questions at this time.

(Operator Instructions)

Alright, given that there are no more questions, let me just close this out here, because we're beyond time.

I'll just some brief closing remarks.

First of all let, me reiterate, there have clearly been several unusual events this quarter.

Of course, it's fair to say that this is the toughest reinsurance market, for example, for over a decade.

We feel we're making progress in our efforts on expense management as this quarter's outcome in expense growth illustrates.

We're really encouraged by the results we're seeing in the operational improvement program and what we can see that will achieve in 2015.

We still have a long way to go on this, but so far so good and we won't be distracted from our goals that we've laid out.

Looking further out, of course, economic growth in many major markets as everyone comments, and people have asked on this call, remains uneven.

We, of course, are duly cautious, but our revenue performance year to\ date underscores the value of Willis' business model and the power of our portfolio and our confidence into the future.

Thanks very much.

Thank you.

That concludes today's conference.

Thank you all for joining.

You may now disconnect.