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WSH > SEC Filings for WSH > Form 10-Q on 7-Nov-2012All Recent SEC Filings

Show all filings for WILLIS GROUP HOLDINGS PLC

Form 10-Q for WILLIS GROUP HOLDINGS PLC


7-Nov-2012

Quarterly Report


Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations

This discussion includes references to non-GAAP financial measures as defined in Regulation G of the rules of the Securities and Exchange Commission ('SEC'). We present such non-GAAP financial measures, specifically, organic growth in commissions and fees, adjusted operating margin, adjusted operating income, adjusted net income from continuing operations and adjusted earnings per diluted share from continuing operations, as we believe such information is of interest to the investment community because it provides additional meaningful methods of evaluating certain aspects of the Company's operating performance from period to period on a basis that may not be otherwise apparent on a GAAP basis. Organic growth in commissions and fees excludes the impact of acquisitions and disposals, period over period movements in foreign exchange, legacy contingent commissions assumed as part of the HRH acquisition, and investment and other income from growth in revenues and commissions and fees. Adjusted operating margin, adjusted net income from continuing operations and adjusted earnings per diluted share from continuing operations are calculated by excluding the impact of certain specified items from operating income, net income from continuing operations, and earnings per diluted share from continuing operations, respectively, the most directly comparable GAAP measures. These financial measures should be viewed in addition to, not in lieu of, the consolidated financial statements for the three and nine months ended September 30, 2012.

This discussion includes forward-looking statements. Please see 'Forward-Looking Statements' for certain cautionary information regarding forward-looking statements and a list of factors that could cause actual results to differ materially from those predicted in those statements.

EXECUTIVE SUMMARY

Business Overview

We provide a broad range of insurance broking, risk management and consulting services to our clients worldwide and organize our business into three segments:
Global, North America and International.

Our Global business provides specialist brokerage and consulting services to clients worldwide arising from specific industries and activities including Aerospace; Energy; Marine; Construction; Financial and Executive Risks; Fine Art, Jewelry and Specie; Special Contingency Risks; and Reinsurance.

North America and International comprise our retail operations and provide services to small, medium and large corporations and the Human Capital practice, our largest product-based practice group, provides health, welfare and human resources consulting and brokerage services.

In our capacity as advisor and insurance broker, we act as an intermediary between our clients and insurance carriers by advising our clients on their risk management requirements, helping clients determine the best means of managing risk, and negotiating and placing insurance with insurance carriers through our global distribution network.

We derive most of our revenues from commissions and fees for brokerage and consulting services and do not determine the insurance premiums on which our commissions are generally based. Commission levels generally follow the same trend as premium levels as they are derived from a percentage of the premiums paid by the insureds. Fluctuations in these premiums charged by the insurance carriers can therefore have a direct and potentially material impact on our results of operations.

Due to the cyclical nature of the insurance market and the impact of other market conditions on insurance premiums, commission revenues may vary widely between accounting periods. A period of low or declining premium rates, generally known as a 'soft' or 'softening' market, generally leads to downward pressure on commission revenues and can have a material adverse impact on our commission revenues and operating margin. A 'hard' or 'firming' market, during which premium rates rise, generally has a favorable impact on our commission revenues and operating margin.

Market Conditions

The years 2005 through 2010 were generally viewed as soft market years across most of our product offerings and our commission revenues and operating margins throughout that period were negatively impacted, although in 2009 the market experienced modest stabilization in the reinsurance market and certain specialty markets.


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Business discussion

Our North America and UK and Irish retail operations were particularly impacted by the weakened economic climate and continued soft market throughout 2009 and 2010 with no material improvement in rates across most sectors in these geographic regions. This resulted in declines in revenues in these operations, particularly amongst our smaller clients who have been especially vulnerable to the economic downturn.

In 2011, we saw some modest increases in catastrophe-exposed property insurance and reinsurance pricing levels driven by significant 2011 catastrophe losses including the Japanese earthquake and tsunami, the New Zealand earthquake, the mid-west US tornadoes and Thailand floods. However, in general, we continued to be negatively impacted by the soft insurance market and challenging economic conditions across other sectors and most geographic regions.

Thus far in 2012, the trend in rates noted in 2011 in catastrophe-exposed regions continues as insurance and reinsurance rates in such regions have firmed or hardened.

There have been recent signs that the unprofitability of certain business lines such as property catastrophe and workers' compensation is slowly firming rates in those lines. However, we believe that, in the absence of a significant catastrophe loss or capital impairment in the industry, a universal turn in market rates is not likely to occur.

The outlook for our business, operating results and financial condition continues to be challenging due to the economic conditions within certain European Union countries, in particular, Greece, Ireland, Italy, Portugal and Spain. If the Eurozone debt crisis continues or further deteriorates, there will likely be a negative effect on our European business as well as the businesses of our European clients. A significant devaluation of the Euro would cause the value of our financial assets that are denominated in Euros to be significantly reduced.

Financial Performance

Consolidated Financial Performance

Results from operations: third quarter 2012

Total revenues of $754 million for third quarter 2012 were $6 million, or 1 percent, lower than in third quarter 2011. Total commissions and fees for third quarter 2012 were $749 million, down from $753 million in the prior year quarter. Foreign currency movements negatively impacted commissions and fees by 3 percent, and organic commissions and fees growth was 2 percent.

Organic growth in commissions and fees was driven by 3 percent growth in our Global operations and 5 percent growth in our International operations while our North America operations reported flat growth compared to third quarter 2011.

Total expenses in third quarter 2012 of $684 million were $14 million, or 2 percent, higher than in third quarter 2011. Foreign currency movements positively impacted total expenses by $21 million or 3 percent.

Excluding the impact of foreign exchange, total expenses were $705 million, $35 million or 5 percent higher than in third quarter 2011. This increase includes the $11 million charge related to a settlement with a former joint venture partner in India; the related $1 million loss from dissolving that joint venture; and the investments made in growth opportunities across key geographic regions, such as Latin America and Asia. The third quarter 2011 included a charge of $15 million relating to the 2011 Operational Review and the $5 million benefit from the release of funds related to potential legal liabilities.

Net income from continuing operations attributable to Willis shareholders was $26 million or $0.15 per diluted share in third quarter 2012 compared to $60 million or $0.34 per diluted share in third quarter 2011. The $34 million decrease reflects the decline in revenues and the increase in total expenses described above as well as the increase on the tax expense and the decline in income from associates. The net tax expense relating to discrete items was $1 million compared to a net tax benefit of $9 million in the third quarter 2011. The change principally relates to a difference in the tax benefit derived from a reduction in the estimated annual effective tax rate for both periods applied to the ordinary income of the prior two quarters. Income from associates was down $12 million having reported a loss of $2 million in third quarter 2012 compared to a $10 million profit in the same period of 2011.


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Willis Group Holdings plc

Foreign currency movements increased earnings by $0.01 per diluted share in third quarter 2012 compared with third quarter 2011.

Results from operations: nine months ended September 30, 2012

Total revenues of $2,609 million for the first nine months 2012 were $19 million, or 1 percent, lower than in the first nine months 2011. Total commissions and fees for the first nine months 2012 were $2,591 million, down from $2,604 million in the first nine months 2011. Foreign currency movements negatively impacted commissions and fees by $53 million, or 2 percent, and organic growth was 2 percent.

Organic growth in commissions and fees was driven by 5 percent growth in our Global operations and 4 percent growth in our International operations, while our North America operations reported a 2 percent decline compared to the first nine months 2011.

Total expenses of $2,043 million in the first nine months 2012 were $100 million, or 5 percent, lower than in the first nine months 2011. Foreign currency movements positively impacted expenses by $66 million or 3 percent.

Excluding the impact of foreign exchange, total expenses were $2,109 million, $34 million or 2 percent lower than the first nine months 2011. The first nine months 2012 expenses included an $11 million charge related to a settlement with a former joint venture partner in India and the related $1 million loss on dissolving that joint venture, a $29 million increase in amortization of cash retention awards, a $13 million write-off of an uncollectible accounts receivable balance together with associated legal fees (see 'Correction of Commissions and Fees Overstatement Relating to 2011 and Prior Periods', below) and the impact of annual salary increases and investment in growth opportunities. The first nine months 2011 included charges of $130 million relating to the 2011 Operational Review, an $11 million regulatory settlement, and the $11 million benefit from release of funds related to potential legal liabilities.

Net income attributable to Willis shareholders from continuing operations was $358 million or $2.03 per diluted share in the first nine months 2012 compared to $179 million or $1.02 per diluted share in the first nine months 2011. The $179 million increase reflects the reduction in total expenses described above. Additionally, the first nine months 2011 results include a $125 million post-tax expense relating to the make-whole amounts on the repurchase and redemption of $500 million of our senior debt and write-off of related unamortized debt issuance costs.

Foreign currency movements increased earnings by $0.05 per diluted share in the first nine months 2012 compared with the first nine months 2011.

Adjusted Operating Income, Adjusted Net Income from Continuing Operations and Adjusted Earnings per Diluted Share from Continuing Operations

Adjusted operating income, adjusted net income from continuing operations and adjusted earnings per diluted share from continuing operations are calculated by excluding the impact of certain items (as detailed below) from operating income, net income from continuing operations, and earnings per diluted share from continuing operations, respectively, the most directly comparable GAAP measures.

The following items are excluded from operating income and net income from continuing operations as applicable:

(i) write-off of uncollectible accounts receivable balance and associated legal fees arising in Chicago due to fraudulent overstatement of commissions and fees;

(ii) costs associated with the 2011 Operational Review;

(iii) significant legal and regulatory settlements which are managed centrally;

(iv) gains and losses on the disposal of operations;

(v) insurance recoveries; and

(vi) make-whole amounts on repurchase and redemption of senior notes and write-off of unamortized debt issuance costs.


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Business discussion

We believe that excluding these items, as applicable, from operating income, net income from continuing operations and earnings per diluted share provides a more complete and consistent comparative analysis of our results of operations. We use these and other measures to establish Group performance targets and evaluate the performance of our operations. The Company also uses both adjusted earnings per diluted share from continuing operations and adjusted operating margin measures to form the basis of establishing and assessing components of compensation.

As set out in the tables below, adjusted operating margin at 10.9 percent in third quarter 2012 was down 290 basis points compared to third quarter 2011, while third quarter 2012 adjusted net income from continuing operations was $38 million, $34 million lower than in third quarter 2011. Adjusted earnings per diluted share from continuing operations was $0.22 in third quarter 2012, compared to $0.41 in third quarter 2011.

Adjusted operating margin at 22.5 percent in the first nine months 2012 was down 120 basis points compared to the first nine months 2011, while for the first nine months 2012 adjusted net income from continuing operations was $375 million, $28 million lower than in the first nine months 2011. Adjusted earnings per diluted share from continuing operations was $2.13 in the first nine months 2012, compared to $2.30 in the first nine months 2011.

A reconciliation of reported operating income, the most directly comparable GAAP measure, to adjusted operating income for the three and nine months ended September 30, is as follows (in millions, except percentages):

                                                 Three months ended                  Nine months ended
                                                   September 30,                       September 30,
                                              2012               2011             2012               2011
Operating income, GAAP basis                $      70         $       90        $     566         $      485
Excluding:
India JV settlement(a)                             11                  -               11                  -
Insurance recovery(b)                               -                  -               (5 )                -
Write-off of uncollectible accounts
receivable balance and legal costs(c)               -                  -               13                  -
2011 Operational Review(d)                          -                 15                -                130
FSA regulatory settlement(e)                        -                  -                -                 11
Net loss/(gain) on disposal of
operations(a)                                       1                  -                1                 (4 )

Adjusted operating income                   $      82         $      105        $     586         $      622

Operating margin, GAAP basis, or
operating income as a percentage of
total revenues                                    9.3 %             11.8 %           21.7 %             18.5 %

Adjusted operating margin, or adjusted
operating income as a percentage of
total revenues                                   10.9 %             13.8 %           22.5 %             23.7 %

(a) $11 million settlement with former partners related to the termination of a joint venture arrangement in India. In addition, a $1 million loss on disposal of operations was recorded related to the termination.

(b) Insurance recovery related to previously disclosed fraudulent activity in Chicago. See 'Correction of Commissions and Fees Overstatement Relating to 2011 and Prior Periods', below.

(c) Write-off of uncollectible accounts receivable balance and associated legal costs relating to periods prior to January 1, 2012. See 'Correction of Commissions and Fees Overstatement Relating to 2011 and Prior Periods', below.

(d) Charge relating to the 2011 Operational Review, including $7 million and $64 million of severance costs for the three and nine months ended September 30, 2011 respectively related to the elimination of approximately 200 and 800 positions in the three and nine months ended September 30, 2011, respectively.

(e) Regulatory settlement with the UK Financial Services Authority (FSA).


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Willis Group Holdings plc

A reconciliation of reported net income from continuing operations and reported earnings per diluted share from continuing operations, the most directly comparable GAAP measures, to adjusted net income from continuing operations and adjusted earnings per diluted share from continuing operations, is as follows (in millions, except per share data):

                                                                                   Per diluted share
                                                 Three months ended               Three  months ended
                                                   September 30,                     September 30,
                                               2012             2011             2012              2011
Net income from continuing operations
attributable to Willis Group Holdings
plc                                          $      26        $      60       $     0.15        $     0.34
Excluding:
India JV settlement, net of tax ($nil,
$nil)(a)                                            11                -             0.06                 -
Net loss on disposal of operations, net
of tax ($nil, $nil)(a)                               1                -             0.01                 -
2011 Operational Review, net of tax
($nil, $4)(d)                                        -               11                -              0.06
Tax adjustment on make-whole amounts on
repurchase and redemption of Senior
Notes and write-off of unamortized debt
issuance costs                                       -                1                -              0.01

Adjusted net income                          $      38        $      72       $     0.22        $     0.41

Diluted shares outstanding, GAAP basis             175              176

                                                                                     Per diluted share
                                                 Nine months ended                   Nine months ended
                                                   September 30,                       September 30,
                                              2012               2011             2012              2011
Net income from continuing operations
attributable to Willis Group Holdings
plc                                         $     358          $     179        $    2.03        $     1.02
Excluding:
India JV settlement, net of tax ($nil,
$nil)(a)                                           11                  -             0.06                 -
Net loss (gain) on disposal of
operations, net of tax ($nil, $nil)(a)              1                 (4 )           0.01             (0.02 )
Insurance recovery, net of tax ($2,
$nil)(b)                                           (3 )                -            (0.02 )               -
Write-off of uncollectible accounts
receivable balance and legal costs, net
of tax ($5, $nil)(c)                                8                  -             0.05                 -
2011 Operational Review, net of tax
($nil, $38)(d)                                      -                 92                -              0.53
FSA regulatory settlement, net of tax
($nil, $nil)(e)                                     -                 11                -              0.06
Make-whole amounts on repurchase and
redemption of Senior Notes and
write-off of unamortized debt issuance
costs, net of tax ($nil, $46)                       -                125                -              0.71

Adjusted net income                         $     375          $     403        $    2.13        $     2.30

Diluted shares outstanding, GAAP basis            176                175

(a) $11 million settlement with former partners related to the termination of a joint venture arrangement in India. In addition, a $1 million loss on disposal of operations was recorded related to the termination.

(b) Insurance recovery related to previously disclosed fraudulent activity in Chicago. See 'Correction of Commissions and Fees Overstatement Relating to 2011 and Prior Periods', below.

(c) Write-off of uncollectible accounts receivable balance and associated legal costs relating to periods prior to January 1, 2012. See 'Correction of Commissions and Fees Overstatement Relating to 2011 and Prior Periods', below.

(d) Charge relating to the 2011 Operational Review, including $7 million and $64 million of severance costs for the three and nine months ended September 30, 2011 respectively related to the elimination of approximately 200 and 800 positions in the three and nine months ended September 30, 2011, respectively.

(e) Regulatory settlement with the UK Financial Services Authority (FSA).


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Business discussion

Correction of Commissions and Fees Overstatement Relating to 2011 and Prior Periods

As previously disclosed, in early 2012 we identified through our internal financial control process and a subsequent internal investigation an uncollectible accounts receivable balance of approximately $40 million in Chicago from the fraudulent overstatement of Commissions and fees from the years 2005 to 2011.

We concluded that the total $40 million of overstatement does not materially affect our previously issued financial statements for any of the prior periods and we corrected the misstatement by recognizing a charge to Other operating expenses to write off the uncollectible receivable (a) of $13 million (including legal expenses) in the first quarter of 2012 and (b) of $22 million in the fourth quarter of 2011. In the fourth quarter 2011 we also reversed a $6 million balance of Commissions and fees which had been recorded during 2011 and $2 million of Salaries and benefits expense representing an over-accrual of production bonuses relating to the overstated revenue. During the second quarter 2012, we have recorded within Other operating expenses a $5 million insurance recovery being an interim settlement from insurers in respect of our claim under Group insurance policies, for compensation paid out in the years 2005 to 2010 on the fraudulently overstated revenues discussed above.

The employees in question, who have been terminated, were not members of Willis executive management nor did they play a significant role in internal control over financial reporting. Based on the results of our investigation, which has now been completed, we do not believe that any client or carrier funds were misappropriated or that any other business units were affected.

We have enhanced our internal controls in relation to the business unit in question, including enhanced procedures over receipt of checks and application of cash, increased segregation of duties between the operating unit and the accounting and settlement function, and additional central sign off on revenue recognition.

Cash Retention Awards

We started making cash retention awards in 2005 to a small number of employees. With the success of the program, we expanded it over time to include more staff and we believe it is a contributing factor to the reduction in employee turnover we have experienced in recent years.

Salaries and benefits do not reflect the unamortized portion of annual cash retention awards made to employees. Employees must repay a proportionate amount of these cash retention awards if they voluntarily leave our employ (other than in the event of redundancy, retirement or permanent disability) within a certain time period, currently three years. We make cash payments to our employees in the year we grant these retention awards and recognize these payments ratably over the period they are subject to repayment, beginning in the quarter in which the award is made.

During third quarter and the first nine months 2012, we made $2 million and $219 million, respectively, of cash retention award payments compared with $2 million and $208 million in the same periods of 2011. Salaries and benefits expense in third quarter and the first nine months 2012 include $49 million and $165 million, respectively, of amortization of cash retention award payments made on or before September 30, 2012, compared with $48 million and $136 million in the same periods of 2011.

Included within the $165 million amortization of cash retention awards in the first nine months 2012 is a $7 million charge for retention waivers. In certain circumstances we may choose to waive repayment of retention awards when an employee leaves the Company. Therefore when we make the retention award payments we book a provision to reflect the anticipated level of waivers.

The remaining increase of $22 million reflects the higher level of cash retention awards paid in 2012 compared to cash retention awards paid in 2009, which were fully amortized in 2011.

As of September 30, 2012, December 31, 2011 and September 30, 2011, we included $258 million, $196 million and $243 million, respectively, within Other current assets and Other non-current assets on the balance sheet, which represented the unamortized portion of cash retention award payments made on or before those dates.


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Willis Group Holdings plc

Pension Expense

We recorded a net pension income on our UK defined benefit pension plan in third quarter and the first nine months 2012 of $1 million and $3 million, respectively, compared with a net charge of $1 million and $5 million in the same periods of 2011. On our US defined benefit pension plan we recorded a net pension charge in third quarter and the first nine months 2012 of $1 million and $2 million respectively, compared with $nil and $nil in the same periods of 2011. On our international defined benefit pension plans, we recorded a net pension charge of $nil and $2 million in third quarter and the first nine months 2012, respectively, compared with $1 million and $3 million in the same periods of 2011.

The UK pension charge was $2 million and $8 million lower in third quarter 2012 and the first nine months 2012, respectively, compared to third quarter 2011 and the first nine months 2011 due to an increased asset return from a higher asset base partly offset by an increase in amortization of prior period losses. The US . . .

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