Welcome. Thank you for standing by. At this time, all participants are in a listen-only mode. During the question and answer session, please press star one on your touch-tone phone. Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I will turn the meeting over to Mr. Peter Polion. You may begin.
Thank you. Welcome to our fourth quarter 2012 earnings conference call and webcast. Our call today is hosted by Dominic Casserley, Willis Group Holdings Chief Executive Officer. A webcast replay of the call, along with a slide presentation to which we'll be referring on this call, can be accessed through the Events and Presentations page in the investor relations section of our website. If you have any questions after the call, my direct line is 212-915-8084. As we begin our call, let me remind you 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.
These statements reflect our opinions only as of today's date. 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, 2011, and for the year ended December 31, 2012, which we expect to file by the end of February, 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. 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. I'll now turn the call over to Dominic.
Welcome. Thank you for joining our call to discuss Willis' fourth quarter and full year 2012 results. It's a new year and obviously a different voice on this side of the line. I'm honored to be here with you, sharing important information about our company, serving our investors, and working along with my colleagues to grow the value of Willis. In the weeks and months ahead, I look forward to more communication with you and meeting you in person. I should say at the outset that from the very start, Joe Plumeri has been terrific in transition. He greeted me with great warmth and has worked tirelessly to arm me with a wealth of knowledge and experience from his 12 years at the helm. I'm very grateful for that. While my voice is new, there is a strong sense of continuity on this call.
The people you've come to know on these calls are all here. By my side is Michael Neborak, our Chief Financial Officer, who will provide commentary on our results after my introductory remarks. Also here are Steve Hearn, our Deputy CEO and Head of Willis Global, Tim Wright, our Head of Willis International, and Vic Krauze, our Head of Willis North America. Steve, Tim, and Vic are all ready to answer your questions after Mike and I offer introductory remarks. As today is my first turn before this microphone, it's worth spending a moment sharing what you should expect from me on these calls. My interest is in building total shareholder value for Willis and building interest among the investment community for buying more shares.
We will always lay out for you in a clear and transparent way what you need to know about the performance of Willis and its main constituent parts. With that as context, today, we will provide you with an overview of our results for the past quarter and the past year while highlighting the items, both positive and negative, that we believe most warrant your attention. While our prepared remarks will be brief, our intent is to provide the balance of our time together today for a healthy exchange of questions and answers. Let me start with the overview of our results. Our adjusted earnings per diluted share for the fourth quarter were $0.45 per share. That figure is, of course, net of the goodwill and remuneration charges that we announced in December and the deferred tax asset valuation allowance we announced in our earnings release yesterday.
All of these charges came about as a result of the steps we took to pave our way forward. Mike will add more color on those charges in a few minutes. For the full year 2012, adjusted earnings per share were $2.58. It goes without saying that we, as a management team, view this figure as a disappointment. It represents a decline in group performance from the prior year, and as such, is a result that we will work to reverse in the months and quarters ahead. However, as the management team stated a number of times during 2012, Willis faced a series of obstacles that skewed comparisons to 2011. With the fourth quarter results in hand, it is important to recall Joe's optimism expressed on his last call that certain metrics were pointing towards improving revenue growth.
Today's results bear out that optimism, particularly in terms of the group's organic revenue growth, which came in at 7.5%. This number is the highest rate of growth for Willis since the third quarter of 2006. Importantly, each of our three segments, Willis North America, Willis International, and Willis Global, contributed to the success. Let's spend a few minutes looking in some detail at each of the segments. First, Willis North America. We are pleased that North America achieved 5% organic growth in the quarter. We recognize that the 5% appears somewhat inflated when it is compared to the prior year period, which included a reversal of improperly recorded 2011 revenues that we disclosed previously.
That said, if you exclude the prior year reversal, organic growth still came in at a little over 3%, which is better than we have done in North America since the second quarter of 2007. While we know it's premature to celebrate, we do believe it's a strong indication that the segment has turned a corner, moving beyond a number of operational challenges that Vic and the North American team have been grappling with. One metric that adds to our confidence is new business growth across the segment, which came in at a very strong level of 15%. In fact, that measure improved every quarter during 2012. Another metric that bears close scrutiny is our retention level. Our retention level for North America at the end of the quarter was 90%.
This is up compared to the prior year period. For the year, the retention level for North America was solid at 91%. These good numbers were not just isolated in one geographic region. For the first time in many years, every geographic region in the segment showed growth in the quarter with the Northeast, Canada, and Mexico leading the way. Looking not at regions, but instead at our practices, there was also good news. For the second consecutive quarter, construction showed improvement, a reflection certainly of the stabilizing situation in the U.S. economy. Organic revenue of construction this quarter grew at 3%, an improvement over the 1% growth reported last quarter. Importantly, for the first time in many quarters, we saw growth in the surety area of this group, which we take as a promising sign.
Taking a look at the operations of the North America segment, Vic and his team managed to increase our producer headcount by 3% on a net basis in 2012. Vic talked about the importance of producer headcount at a previous call. This increase follows a number of years of decline. It is an important turnaround. We know that producers that have just come on board won't have an immediate impact on revenue growth, but having a growing base of expert people putting Willis front and center with new prospects is a leading indicator of further improvements ahead. In my initial meetings with leaders across North America, there's a definite excitement from our success in having added new talent to our experienced corps of producers. For the full year 2012, North America's organic growth was 0.6%. Again, we're not content with that achievement. Negative 0.6%.
Again, we're not content with that achievement. It is respectable when considered in the context of the difficult comparisons the segment faced in the first half of the year. I've spent a lot of time with Vic since October, discussing both the challenges and the opportunity facing his segment. In the fourth quarter, we got a strong sense of the opportunities Vic has been describing. Let's now move to Willis International. Willis International's organic revenue growth was a very solid 7.4% in the fourth quarter. This is a welcome result considering the economic conditions in many of the parts of the world that we serve. As in North America, our retention level in International at the end of the fourth quarter came in at a strong level of 92%.
The other metric that we use to gauge our progress, new business growth, was also very good for International as a whole, coming in at 13%. Moving from the whole to the parts, let's spend a few minutes looking at Willis International region by region. In the U.K., our business achieved mid-single digit growth in the fourth quarter and was about flat for the year. The U.K. business had been trending in the right direction throughout 2012, improving each quarter. We have just announced the hiring of David Martin, a new leader for our U.K. business, who brings substantial experience from the broker and carrier side, and our business in the U.K. is poised to continue its progress. In Western Europe, the region continued its consistent record of growth despite the difficult economic conditions.
Western Europe grew organic revenues mid-single digits, with particularly strong performances in Denmark, Sweden, and Italy. As in the U.K., we have just announced Alberto Gallego, a new leader for Willis in the region, an internal promotion for the executive who has contributed greatly over the years to our success in Iberia. Again, this adds to the sense of new opportunity for Willis, built on continuity and the excellent track record we've had in Spain. In Latin America, we are seeing the fruits of a historically high-performing region for Willis that benefited additionally from its new leader, Luis Morais, taking up his post in late 2011. In the fourth quarter of 2012, Latin America continued its momentum, growing double digits with particularly strong growth in Argentina and Brazil. In Asia, we were up low single digits.
Within Asia, China grew modestly in the quarter, finishing the year as a whole with growth in the low double digits. In Japan, the changes we made earlier in the year, appointing Dean Enomoto as our new Retail CEO, contributed to a very strong result for our business there. Across the region, we are poised to maximize opportunity for Willis now that Adam Garrard, our former head of Willis in Europe, is established in Singapore as our new Regional CEO. I had a chance to spend time with Adam in Asia recently and came away very impressed by our prospects. In Australasia, we did not achieve growth and have taken action that helped to stabilize our revenues there.
Among the steps we took was to have Roger Wilkinson, a longstanding Willis executive, who has helped to grow our business enormously over the years across Asia, to relocate to Sydney and take over our business in Australasia. For the full year, International achieved 4.9% organic revenue growth, which is a testament to the strategy and focus of Tim Wright and his team. While Tim would be the first to say there's still considerable room for improvement, we're excited by our opportunities for growth across the globe. Let's now move to Willis Global. Willis Global, as you know, comprises our reinsurance division, the Global Specialties division, Willis, Faber & Dumas, and Willis Capital Markets.
While Willis North America and Willis International each brought welcome improvements in their performance in the last quarter of 2012, Willis Global proved to be the growth engine for the group, delivering 11.6% organic growth over the fourth quarter of 2011. Clearly, to achieve that type of growth across the Willis Global segment, certain businesses within the segment had to put up some outstanding figures. During the quarter, Willis, Faber & Dumas achieved low double-digit organic growth. This was driven by robust new business, including major project wins. Reinsurance grew high single digits in what is a seasonally small quarter for that business. Within Willis Re, North America was up double digits, while specialty reinsurers increased mid-single digits. Willis Re found rates during the quarter to be broadly flat.
For those interested in a broad rate discussion for reinsurance at the 1/1 renewal period, our 1st View report, published on January 1st of this year, is available on our website. It is a comprehensive and useful analysis of the reinsurance marketplace and worth a look. Another part of Willis Global Specialties, was up mid-single digits, delivering good growth from new business. Within Global Specs, Construction, FINEX, Financial Solutions, and Marine all grew nicely in the quarter, partly offset by the ongoing challenging rate and market environment in aerospace. Finally, Willis Capital Markets, in an active fourth quarter, recorded $12 million of commission and fees, compared to $2 million in the year ago quarter. As was discussed on our prior call, the robust activity and the fees generated came from a number of capital market transactions that had been delayed throughout 2012.
All in all, while I'm very happy to have Steve Hearn by my side as Deputy Chief Executive Officer, it's also great to have him wearing his other hat as CEO of Willis Global. Steve and his team have done an excellent job through the year, retaining our clients, winning new business, and securing a number of major deals that have kept the results solid and translated into strong 6.1% organic growth for the full year. You should know that Steve and I, along with our colleagues on the Willis Operating Committee, have been very busy these past few weeks, taking the initial steps that will allow us to maintain our competitive edge and position ourselves for further growth in the quarters ahead. Before turning the call over to Mike, I'd like to discuss one additional item that you saw in our earnings release.
This had to do with a charge we will be taking in the first quarter of 2013, following our initial review of the organization. We have identified a number of positions that can be eliminated and leases we can exit. The charge, which we will expect will amount to approximately $35 million-$45 million, will deliver expected annual savings of approximately $35 million-$40 million, most of which is from headcount reduction. With that, I will turn it over to Mike to discuss the rest of the financial results. I'll return later with some final comments before turning it over to you for questions.
Thank you, Dominic, and good day, everyone. Over the course of the next few minutes, as I review the numbers, all comparisons that I'll make are to Q4 2011, unless otherwise stated. During these few minutes of prepared remarks, I'll be referring to the slide presentation that we've posted on our website. I'll give you a few seconds to pull that up. Okay. As Dominic noted, our fourth quarter performance reflected solid organic revenue growth and strong cash flow from operations. Let's start on slide three of the deck. It shows balance sheet and cash flow highlights. You can see that we ended 2012 with $500 million in cash. That's up $64 million from year-end 2011. Total debt outstanding at year-end for Willis was $2.35 billion, down slightly from last year. Effective capital allocation is an important area of focus.
During 2012, we generated $524 million of cash from operations, an increase of $85 million, or 19%, over 2011. It's important to keep in mind that the 2012 figure is after contributing approximately $140 million to our pension plans. It's worth laying out the math so that's very clear. From the $524 million of cash flow, subtract $185 million for dividends paid, $135 million for capital expenditures, and $15 million for debt repayment. When you do that, you're left with approximately $190 million. From that figure, we repurchased $100 million of common stock and spent $69 million on acquisitions. After all that is done, it leaves a small amount of cash generated during 2012 carried forward. Let me turn to the summary financial results for the quarter as shown on slide four. Please note that I started with the balance sheet and cash flow for a reason.
While we recorded a GAAP loss in the quarter amounting to $804 million, or $4.65 per share, the charges that we took during the quarter had no impact on cash. We are very pleased that the cash balance grew and that the cash generated from operations improved nicely during the year. Our adjusted earnings per share were $0.45, or flat compared to the prior year quarter. These results reflected improved organic growth across all of our segments, muted by higher salaries and benefits, and a higher effective tax rate. I'll discuss expenses and the higher effective tax rate in a moment. Importantly, we grew adjusted operating margin by 40 basis points. Foreign currency rate changes increased EPS by $0.01. Certain items that were excluded from adjusted EPS are highlighted on slide five.
These items include the non-cash charges for North America goodwill impairment and a change in our remuneration policy, where we eliminated the retention feature of our annual incentive program. Those two items were included in the 8-K we filed back in December. Additionally, we established a valuation allowance against our North America deferred tax asset. That item requires some explanation, so please bear with me for a minute. The U.S. GAAP accounting rules around deferred tax asset valuation allowances are very prescriptive. The charges we took in the fourth quarter, when combined with the operational review charges we took in 2011, caused a cumulative loss in the North America segment during the three-year period going back to 2010. The three-year cumulative loss, in effect, triggered the requirement to record a valuation allowance, which increased the tax provision by $113 million. Here are the key takeaways.
First, the allowance relates solely to our North America operations and is directly associated with recording the sizable goodwill impairment, as well as North America's proportionate share of the charges related to the change in our remuneration policy. Second, the allowance is not indicative of our optimism towards the prospects of our North America business. Finally, as North America records net income in future years, we expect the tax allowance will reverse. Let me talk about expenses, which are highlighted on slides five through nine. On slide five, you see our total expenses. On an adjusted basis, which excludes the large charges, total expenses increased 5.9% to $705 million. On an underlying basis, meaning excluding foreign exchange, our total adjusted expenses grew 6.5% in the quarter and 4.7% for the full year. The next few slides show the growth by major cost category.
On slide six, you see details of our salary and benefits expense, which is the largest component of our expense base. Underlying growth in S&B for the quarter was 8.6%. The drivers of this growth were three things in particular. First, there was a difficult comparison with fourth quarter 2011, as that quarter benefited most from the 2011 operational review. Second, there was an increase of approximately 400 FTEs during 2012. Third, there were annual salary increases. For the full year 2012, underlying S&B growth was 5.4%. The purpose of slide seven is to put the change in our remuneration policy into perspective. This is very important. In 2013, we are accruing cash bonuses. As shown on this slide, if accrued bonuses had replaced retention amortization expense beginning January 1st, 2012, our S&B expense would have been $48 million higher.
That is simply due to the change in accounting for the award. It's important for you to understand that the dollar amount and the timing of the award do not differ under the new policy relative to the old policy. As you're thinking about this, you should evaluate this change as essentially cash neutral. Importantly, you should use the higher salaries and benefit expense figure of $2.071 billion shown on slide seven as the baseline when modeling S&B expense for 2013. Please turn to slide eight, where the impact of the higher S&B expense is expressed as a quarterly reduction to our adjusted EPS as disclosed. In summary, if we had accrued bonuses throughout 2012, salary and benefits expense would've been $48 million higher, and adjusted EPS would've been $0.20 lower.
As our largest expense, the growth in S&B is clearly a focus for us, particularly as we continue to grow our business in 2013. Dominic mentioned earlier that we will be incurring a first quarter charge in the range of $35 million-$45 million, primarily for headcount reductions. That charge is expected to help curtail the growth in this line. In fact, we expect the action will result in savings of approximately $20 million-$25 million in 2013 and annual savings of approximately $25 million-$30 million. The savings in 2013 will begin in the second quarter. Slide nine shows our other operating expenses. On an underlying basis, again, meaning excluding foreign exchange, other operating expenses grew a modest 0.6% in the quarter and 3.3% for the full year. Let me spend a moment on depreciation and amortization expense.
On past calls, we've commented about our ongoing investments in technology and systems. As those systems go live, depreciation expense will increase. For 2013, we expect depreciation to be approximately $18 million higher than in 2012. Partially offsetting this increase is a scheduled decline of $5 million in our amortization expense. Now on to slide 10, which shows our adjusted operating margin. Adjusted operating margin for Willis improved 40 basis points from 18.7% in Q4 2011 to 19.1% this quarter. Obviously, the biggest factor in that improvement was the significant growth in revenues. This was offset by increased salary and benefits expense and declining investment income. You might ask, with 40 basis points of margin expansion, why were our earnings flat year-over-year? The answer is taxes. As noted earlier, the effective tax rate on our fourth quarter adjusted earnings was higher than expected.
In fact, it was 33%, which compares to our more normalized 24%-25% range. The high effective tax rate was driven by adjustments related to prior periods that were booked in the current quarter. These adjustments increased the tax provision by approximately $11 million, which equates to $0.06 per share. For 2013, our effective tax rate should be approximately 25%, but could fluctuate depending on the geographic mix of taxable income. Finally, let me comment on the associates line, which is primarily Gras Savoye. For the quarter, that line recorded a net loss of $7 million, which compares to a net loss of $11 million in the comparable prior period. For 2013, we expect that the associates line will continue to lag as Gras Savoye completes its operational review.
As such, we expect the associates line to decline $6 million-$8 million in 2013 compared to 2012, with a normal predominance of income recorded in the first quarter, then net losses throughout the remainder of the year. With that, thank you, and I'll turn the call back to Dominic.
Thank you, Mike. Before we take your questions, I'll conclude our preliminary remarks by saying this. Back in October, like many of you, I listened to the Willis third quarter conference call and heard Willis management state optimistically that they expected better revenue growth in the future. Joe Plumeri, the management team, and all our staff delivered on that expectation in the fourth quarter. I have been in my position of CEO officially for a little over five weeks. During that time, Steve and I have been meeting with our business heads, producers, operational managers, finance leaders, and others who've been very constructive and candid about both the potential and challenges of the business. I've been very impressed with the depth of knowledge and experience throughout this organization.
It adds to the level of excitement for the future of Willis that I expressed last October when I was announced as Joe's successor. We will continue to use the next few months analyzing our operations and understanding where and how we can operate more productively and efficiently. My background and experience within the insurance and financial services industry, and my sense of where growth opportunities lie around the globe, leads me to believe that Willis has room for growth and improvement over the coming years. Of course, we are ever mindful of the changing and challenging economic conditions in many of the countries in which we operate that could challenge our growth. I know that many of you might want me to comment today on my overall strategy for Willis or new initiatives for the company, we are not yet prepared to share those plans.
As you can see from the charge we plan to take this quarter, Steve and I will not stand still. As we implement initial changes and manage the flow and process of our business over the first two quarters of 2013, our new strategy will begin to take shape. We will look forward to discussing our plans with you in detail at an investor day in New York that we will host in early August or early September, and I hope to see many of you there in person. Thank you. We will now be happy to take your questions.
Thank you. We will now begin the question and answer session. If you would like to ask a question, please press star one. You will be prompted to record your name. To withdraw your request, press star two. Once again, to ask a question, please press star one. Our first question comes from Jay Gelb of Barclays. You may ask your question.
Thanks, good morning. Dominic, congratulations on your new role.
Thank you very much, Jay. I look forward to talking to you about that in more detail in person.
Thank you. With regard to the organic revenue growth of 7.5% in Q4, clearly, there's a huge increase versus the prior quarters. There were called out a few one-time items in there. I think we're all trying to get a sense of
the sustainability of that pace of growth overall, or what you feel a more normalized overall organic revenue growth pace might be?
Well, Jay, as you know, we don't give guidance on our major revenue and cost items. I will tell you this, we are obviously all very pleased and excited by what we saw in the fourth quarter. We believe that many elements of the strengths of Willis came through. At the same time, if I was thinking about the full year and just took the fourth quarter numbers and tried to extrapolate them across the whole year, I think that might be a brave thing to do. That's as much as I think I'm going to say on that.
With regard to the actions you took immediately in terms of arresting the growth in salary and benefits, it seems that even in year one, Willis might be positioned on an adjusted basis to improve the operating margin. When I say that takes into account adjusting for the $48 million of increase in the S&B line in 2012. If we use, I think, an adjusted margin of around 20% for full year 2012, is Willis in a position to expand margins?
Jay, look, clearly that will be the result. You and I can do the math as well together of how our revenues and costs develop over the course of the year. What I will tell you is the following. We absolutely believe that long-term value creation for Willis will be the result of the actions we take to serve our clients better and grow revenues and the discipline we show at the same time controlling our costs. We are quietly confident about the revenue momentum in the business without, as I say, getting overexcited about it. We have shown, I think, from day one that we are focused on the fact that our costs must be kept within a reasonable corridor at the same time.
Clearly, we believe that value creation for Willis, one of the key elements of it must be a combination of revenue growth and margin expansion, and we are focused on achieving that.
Understood. Thanks so much.
Great.
Our next question comes from Greg Locraft of Morgan Stanley. You may ask your question.
Good morning. Thanks, and also congrats, Dominic, on the new role.
Thanks, Greg.
I think what a lot of us are wrestling with is what is the base EPS from which you're going to build the plan, and then it sounds as if you don't want to yet talk about the components of the plan, and I guess in a way, it seems we're going to get that in August. Is that sort of the message?
Let's answer that in two parts. On when the plan will emerge in all its detail, that is right. You should focus on the Investor Day, which will either be in early August or early September, depending on logistics and dates and things. Please do not take that to mean we're going to be sitting around doing nothing until then. You will see actions emerge, steps being taken, as you saw already on this earnings announcement. The whole plan we will lay out then. As for the earnings base, let me hand you back to Mike to go over that again.
Yes, Greg. What we are presenting there in the slide on page eight is $2.38 as the base going forward into 2013. If you do the math in terms of that additional $48 million that's referred to on slide seven, that takes our margin down to a little bit greater than 20%. Those are where we're looking at the base in terms of growing this business going forward into 2013 and later.
Okay, that's great. Dominic, over the next couple of quarters, it sounds like you'll be hard at work on the plan that's coming at us later this year. What are the top three things you're going to spend your time really digging into the next couple of quarters?
Greg, one of the great excitements about Willis, we should all understand, is one of its great strengths is it has a truly fantastic global platform. The things we obviously have to be focused on is how to take advantage of that global platform. Secondly, all the great specialty and expert capabilities we have across the world to serve our clients even more effectively than we do today. I think the way in which we serve our clients and deliver value to them, which will end up delivering value to shareholders, is an absolute critical thing we will be focused on. We will obviously be secondly focused on how do we do that in a way which delivers growth. We are absolutely convinced that the underlying need to create shareholder value will be driven by our ability to grow this business.
We'll be very much focused on how do we grow this business. Thirdly, in response to Jay's earlier question, of course, how do we do so in a way that maintains very positive margins and thereby grows cash flow? That's how we'll be thinking about it.
Okay, great. Nice job with the team on the organic in the quarter.
Great.
Paul Newsome, Sandler O'Neill, you may ask your question.
I just want to make sure we're clear. This is going to be a step-by-step process as far as strategy is concerned. We should be very aware of the possibility of further restructuring announcements between now and the formal layout in either August or September. Is that right?
Paul, I think what you should think about is that over the next few months, we will be developing our strategy. As I said, it's focused on growth because we think that's the key driver of shareholder value creation, as long as we maintain and gradually grow our margins at the same time. When you think about how that strategy might evolve, I would as much be thinking about how Willis be thinking about where to invest, what are the growth opportunities which will drive the top line, as much as I'd be thinking about restructuring, which is usually associated with a very large cost reduction. We may be doing one or the other, but bear in mind that growth has to be part of the plan.
That's terrific. I also want to make sure that I've just got some rough numbers here in my head right. As I'm looking at your organic growth, which obviously was quite terrific in the fourth quarter. If I make an adjustment for the year-over-year benefit of the Capital Markets business and the adjustment for the revenue reversal that happened year-over-year, I'm coming up with a number that's sort of a couple points less on organic growth, still extraordinarily strong. Am I directionally in the right idea to think about that that way?
Yes, Paul, this is Michael Neborak here. I think that's correct. We started at 7.5. If you exclude the fourth quarter reversal of revenues that we took in 2011, that goes down to 6.75%. If you excluded half of the Willis Capital Markets revenues in the quarter, that would go down to 6%. I think in that area there, you're looking at something that's without some of these items that perhaps were a little bit exaggerated in the quarter for good reasons.
Terrific. Thank you for the call, looking forward to all the new things at Willis. Thanks.
Great.
Our next question comes from Bob Glasspiegel of Janney Montgomery Scott. You may ask your question.
Good morning. I've got a couple of big picture questions that you can take any direction you want, Dominic. Coming from a consultant background, you've experienced a lot of and seen a lot of companies like Willis firsthand. Now that you've been there a short period of time, what are the strengths of Willis that you see, and what are the areas of weakness that need to be upgraded? The second question is, how long of a honeymoon period do you think you need before we can judge your results on being you're running the company versus what you inherited?
Well, I'm going to answer the second part of that question first. I think there is no honeymoon period in the world any longer, and we're all responsible from day one. I take no credit for these fourth quarter results, which are a huge credit to Joe and the management team and all the staff of Willis that were in place during that fourth quarter. As you know, I did not come on board until the beginning of January. I think in the world we live in today, honeymoons don't last very long at all. We're moving this thing forward. We're responsible for quarter by quarter. I think we've just been saying that if you are waiting for the big strategy plan, that's not going to come until after into August or maybe early September.
Let's be clear, we're responsible for delivering each quarter up to that period and beyond.
Strengths.
Strengths and weaknesses. Yes. I think I've touched on these a bit, but let me reiterate some of them. We are very lucky through history and through the work of our predecessors, and many still here today, to have a wonderful global platform. I strongly believe that a global platform differentiates us in the eyes of many of our clients. What is special about Willis in that context is our ability to play as a global team. We really do fly under one flag, and Joe gets enormous credit. One of his great legacies in years to come of what he left at this company, as well as many other things, is his focus on the one flag. The way in which we play with clients and with markets is a fantastic strength of the firm.
Another great strength is, therefore, our ability to attract, retain, and develop the skills of wonderful talent. In a world where, which is basically a people business, that is a great strength. I think the fact that Willis has the platform, the scale, and the level of specialty and expertise is a great strength for us and differentiates us from many others. If you were to think about challenges, the challenges are all of you because you are demanding, and you want us to deliver consistent returns and growing returns over time. We have to make sure that we do that, and we have to be focused on that. Clearly, as there's been no secret that no one's tried to hide, we had a legacy of challenges in North America as a result of both the state of the economy and the HRH integration.
I think what you are seeing, which Vic had been signaling throughout 2012, and we have now seen in the fourth quarter, that we have seen a turnaround of that, and North America is now going to be a great strength of this company. I see the world pretty much like that.
Thank you, Greg, Jay, Paul, and I and the rest are cream puffs. You'll have no problem with us.
Our next question comes from Joshua Shanker of Deutsche Bank. Your line is open.
I hope I don't ruin the parade and be the non-cream puff. You're happy to talk about Willis's strengths. I know you're not going to unveil the plan right now, but from your view right now, what are Willis's weaknesses?
I think I tried to touch on them a bit, Josh. The weaknesses are the ones that face any broker/advisory firm is what we are, which is we live in a very competitive world, and we have to win our business every day, and we can't live on yesterday. We have a great talent offering, but it's a competitive talent world, and we have to make sure we're as strong as possible in it. This business globally is moving more and more to depend on analytics. We like to talk about the analytical broker around here. In that world, the competition to develop the next insight, the next great capability, the next great offering, and to retain the analytical talent you need is fierce. We have had a recent, a wonderful pipeline of new products and services we've brought to the marketplace.
In any knowledge business like that, the life cycle can be quite short. Our challenge is to continue to invest and build new products and capabilities. Unless we're able to do so, over time, you fall behind. What I see at Willis is a great desire and interest to continue the product innovation we've shown over the last 18 months, 24 months. If we were to slow, let me tell you, we would soon see that in the marketplace. I think the ways of thinking about this is not to say Willis must have some enormous specific challenge, just to say this is a very competitive market, and we need to be on our toes all the time.
You don't think there's any technological disadvantages between you and your competitors?
Nothing that at the moment gets me very excited. No.
Okay.
We always constantly have to invest and play in what we're doing. Did you have a specific point you were trying to make there?
Well, one thing which obviously the question of WillPLACE, how competitive it can be with GRIP and MarshConnect? This is a question that we don't know yet from our end, but we hope that's correct. Maybe you have some thoughts on that issue.
I'm partly confident, but let me turn over to Steve Hearn, Deputy CEO and Head of Willis Global, to talk more about that.
Yeah, sure. Thanks, Dominic. Hi, Josh. The WillPLACE technology and placement more generally sits from a management structural perspective within Global, has a report line through to me. I'm familiar with our competitors' propositions, and I guess it wouldn't be appropriate to get into the specifics of where I think some of their developments have been misplaced, but maybe to reference where I think we've done perhaps a better job. Our model has been built around the client, which I've said previously on previous earnings calls. That is a very client-centric model that we've created with WillPLACE. It isn't just about the relationship between us as an intermediary and the carriers with whom we place the business.
It's actually about the client and our relationship with that client in terms of the sales proposition to them and how we articulate their needs within the context of the carriers that are available to place the business with and getting a better match. I think over time, that will deliver to us increased sales penetration, and we're seeing early stages of that, and also should improve our already higher retention rates across our business. I think WillPLACE we feel is a very significant strategic importance to Willis now, and that continues to be our view moving forward. I would see that continue to be a significant part of our platform as we move forward.
Thank you. Finally, in your headcount reduction plan, is anyone in the 200 jobs, have these been announced yet to anyone, or is this going to begin going forwards from here?
Begin going forwards from here.
Okay. Well, thank you very much and the best of luck to all of you.
Michael Nannizzi at Goldman Sachs, you may ask your question.
Thanks. Yeah, I guess one question, just looking at peers and you guys is, a lot of other folks are deploying capital significantly, either via buybacks or M&A. Can you talk about your ability to do either or both of those in a larger way? Maybe more broadly, how should we think about these cash flow uses? I know Mike kind of laid it out up front, but M&A pension, CapEx, and how soon will buybacks legitimately be on the table? One follow-up. Thanks.
Dominic here. The way to think about that, I think, is if you look at the $500 million plus of cash flow we had in 2012, it was roughly divided 50/50 between returns to shareholders and investing in the business, broadly, rough numbers. Obviously, we are very sensitive to the fact that what we're really doing there is investing for long-term shareholder value growth or delivering immediate returns. We have to get that balance right. We are going to be very focused on, as I've said, we believe that the sustainable value creation of Willis must be based on long-term growth. We will be focused on that, as well as on delivering short-term value to shareholders, as we signaled with our dividend increase.
If I think about 2013, I think we are going to be a bit more focused on investing for growth in 2013. We have the potential, when necessary and when we think it is the right thing to do, to return more to shareholders through share repurchases.
Is leverage a factor in that consideration at this point for you?
Well, as you know, of the three global brokers, we are the most highly leveraged. We just need to be cognizant of maintaining very strong credit rating. We have to operate within that envelope. When we're thinking about acquisitions, when we're thinking about returns to shareholders, we're not going to do anything which violates our credit position in the marketplace.
Great, thanks. I did see there was an 8-K that looked like a financial metric change from or to organic growth and organic EBITDA. Does that mean, I guess, does that kind of follow that point that you're going to be more focused on the notional number, not the per-share number, and kind of more on the operating side from that perspective?
We believe that long-term shareholder value is driven by cash flow generation, and so we're focused on revenue growth and organic EBITDA growth, which obviously therefore drives us to keep an eye on margin at the same time. What you're seeing there is just reference to one of our incentive plans.
Right.
We have other incentive plans which will reflect some of the other elements that you are talking about. Right? We will not be losing sight of the individual shareholder and earnings per share issues.
Got it. Great. Thank you very much.
Tom Mitchell of Miller Tabak, you may ask your question.
Thank you. I just wanted to go back for a second to the question of the salary and benefits costs that would have been $48 million higher if the cash bonus had been accrued through 2012. I just wanted to double-check on that. Would it be reasonable to assume that would have been about $12 million in the fourth quarter?
You could, if you wanted to spread it evenly. I think on slide number eight, we basically based on how the numbers fall, $0.07. It'd be a little bit more than $16 million in the fourth quarter.
Oh, okay. I'm sorry. I wasn't looking at the slide. The second question is more, I know you're focused on both the cost and revenues, but if we look at sort of the normalized run rate of revenue growth in the fourth quarter at around, let's say, 5.5%-6%, then try to think about not so much what is the normalized rate of cost, but if you were able to sustain, let's say, a 5% growth rate in revenues, and that's organic growth, what underlying growth in costs would you think is an appropriate way to look at it from this point going forward?
Tom, as we've said, again, we don't provide guidance on our major elements. What I can tell you is the following. Repeat what I said before. We are very clear that the drivers of shareholder value here have to be sustainable revenue growth and growing our costs a little bit less than that each year, so that you get a combination of growth and some margin expansion along the way. We absolutely recognize that. You should see in our actions in the first quarter around the charge that we understand that fully. We will be focused on this issue very closely in the coming quarters and years to make sure that for you, we deliver sustainable revenue growth and we manage our costs appropriately.
I appreciate that. I think my underlying concern is that Willis has had in the past, has come through with a series of restructuring charges, each of which was followed by a reduction in the expected cost basis. There was rarely a period of relief where the cost of the restructuring charges disappeared and the benefits of the cost savings clearly came through. I have a concern that we may be entering another new period of repeated charges with adjusted earnings looking terrific, but the adjusted going back may be more challenging than that adjusted number.
Tom, I understand your concern. There's not much I can do about it looking backwards. Going forward, I want you to very much focus on what we believe are the true drivers of shareholder value here. Out of cash flow comes our ability to invest for the future and deliver short-term returns, immediate returns to investors. That is something we're going to be very much focused on going forward. We will be managing this business exactly the way I described. I assure you, for instance, in the charge we have taken in the first quarter, or when we eventually take it, we will be tracking very carefully that the costs we have taken a charge from actually exit the business in a timely fashion and do not get backfilled left, right, and center or something.
That's what we will be working on. Now, we may decide to take some of those cost savings and invest some of them in what we believe are high-return future investments. We will be very focused on making sure the costs we are taking actually exit the business.
Good. Thank you very much.
Our next question comes from Raymond Iardella of Macquarie. Your line is open.
Thank you very much. Maybe just a more strategy question for you, Dominic. First, thinking about in the past, the commentary from Joe was there wasn't an expense problem. It was more of a growth problem at Willis. Clearly, fourth quarter results showed some improvement on the growth side. With the charge and you taking a fresh look at the business, what are you seeing, I guess, differently than maybe what the prior management team or prior CEO was seeing?
I'm not going to comment on what Joe saw or did not see. All I can tell you is he delivered over a long period of time, terrific performance of this company. What I'm focused on is exactly what I've been saying, which is I want us to grow this business steadily based upon our franchises around the world because we are able to deliver distinctive value to our clients and thereby win new business and retain our existing client base. We will be focused in parallel in making sure that over time, our costs expand at a slightly slower pace so that you get the combination of revenue growth and some margin expansion. That's going to be the focus going forward. Will that happen every single quarter? I can't tell you, but the pattern we want to produce is exactly the one I described.
We, as a management team, understand that extremely clearly and need to make the right trade-offs and decisions to deliver that.
Okay. Then maybe for Vic, since we haven't heard him on the call this time. Maybe thinking about the growth in Willis North America, I know employee benefits is a big part of that business. Maybe can you talk, was there any benefit from contingent commissions? Then maybe secondly, Dominic, get any update on your opinion on contingent commissions, or maybe it's premature as well.
Thank you, Ray. This is Vic. Appreciate it. The short answer is no. In the fourth quarter, contingents or any type of income like that did not help the quarter. Anything we receive on the employee benefits side would be in the first quarter of 2013.
On the general issue, the way I think about this is actually more broadly thinking about market-derived income, of which contingent commissions are a part, and there are many elements of MDI. Our position has been very clearly that we think that whatever we do in this space has to be in the interest of our clients and has to be completely transparent. That posture, I think, is a sustainable and appropriate one for us to take, and we will continue to take it. That applies across the whole area of MDI, and I think it is a sustainable and the right position, which aligns us with the clients and is clear to one and all.
You have seen that we had a position a few years ago that we took no contingent commissions, then because of changes in the marketplace and competitive issues, we took the decision to take them in employee benefits in North America. As Vic said, we will probably see some revenue from that in 2013. More broadly, we will continue to keep this under review, again, in the context of what is right for our clients and what is transparent, because we believe that posture is best for our shareholders. That posture is best for our shareholders. It is a sustainable position in the marketplace. We will continue to keep this under review to make sure we are serving our clients right and doing best by our shareholders for the long term.
Okay. I appreciate that response, Dominic. One more if I can squeeze it in. In terms of headcount, just broadly speaking, the change in compensation, the bonus payout. Has that helped you guys in increasing the talent in the organization in the first couple of months of 2013?
Well, I'll turn to any of my colleagues who want to add, I think it's too early to tell, generally. I think it's fair to say that the change has been welcomed in the company. The retention program we had was absolutely appropriate in past periods. It was perceived to be a good way of rewarding talent. We came to the conclusion that a change would be in the best interest of the business, that's why we made the change. I think it has been well received. I think it's too early to tell whether it has made a difference in recruiting or anything. Steve, do you want to add anything to that?
No. I can probably give a bit of perspective. I think the working hypothesis should be that it should make it easier for us to attract talent. Not that we haven't attracted talent, obviously over recent years with the previous
Reward structure and the issue around retention. It should be an enabler, should make it easy. We're weeks into having that tool available to us, so I think Dominic's right. There's no impact yet.
Okay. Thanks so much for your answers, and best of luck.
Thanks.
Our next question comes from Meyer Shields of Stifel Nicolaus. Your line is open.
Thanks. Good morning, everyone. Dominic, the 200 people or 200 headcount reduction, is that basically focused in a single unit, or is it spread more broadly?
It's spread broadly.
Okay. Are you seeing any indications of another slowdown in the U.S., maybe driven by consumer spending? Do things seem like the momentum for last year is continuing?
Vic, why don't you take that question?
Happy to. We have not really seen any signs of a slowdown yet that's evidenced itself in the business. It's a longer-term sort of view we would have to take on that. I can read the news like everyone else and surmise what might happen, but frankly, our new business activity is picking up, and our pipelines are getting stronger. Until that changes, I'm going to retain my optimism.
Good. Glad to hear it. Mike, two quick numbers questions if I can. Corporate expense still at about $25 million a quarter. For Gras Savoye, should we expect the decline in income to be spread evenly over 2013?
Well, to answer your first question, your assumption is correct in the corporate expense. As you know, as I mentioned, we typically, in the associates line, which is predominantly Gras Savoye, in the first quarter, it's very positive. That positive will get reduced down versus the same quarter in 2012. Then the losses in the quarters 2, 3, and 4 will get a little bit higher. It will be spread more or less evenly throughout the year, as best we can tell at this point.
Okay, fantastic. Good luck. Thanks so much.
Our next question comes from Mark Hughes of SunTrust. Your line is open.
Thank you, good morning. The goal of a sustainable revenue growth and then cost increases or cost leveraging, would you anticipate that you'd be able to achieve that, say, in North America, in the international business by the end of this year? Or will that be a longer process?
Well, I think Vic and Tim should comment on that, I think it is our view that all our segments should be contributing on that basis, That's what we're working towards. Vic, why don't you go first, Tim, you can talk about international.
I think that from a North American perspective, we should be able to contribute. While there were some challenges in 2012, as I look at this business going forward, if we grow our revenues, we will always intend to grow our expenses at a lower level. We managed to grow our producer headcount last year, but we did not increase our S&B. We take a pretty disciplined view of the business and plan on continuing that. Tim?
Thank you. I think it's a different story around the world, but the conclusion is the same. As I said before, in international, we have opportunities to grow actually in most markets, reversing those businesses that have experienced decline or low growth, taking share in markets which are low growth markets, such as continental Europe, which we've shown in the fourth quarter and this year, and more than making the most of growth in emerging markets. That revenue dynamic is reflected also in the costs, creating opportunities for a positive spread as Dominic described. In different ways, in different parts of the world, the same conclusion.
Right. Rates in North America, how sustainable do you think the recent trend has been? Seems like a mid-single digit according to the broader surveys. Do you think that is sustained here in 2013?
This is Vic, I think that they will be sustained. I think based on what we're seeing that any increase in rates has flattened out. The trend is not going up. I don't expect any major changes in rate from the past couple of quarters as I look forward.
Thank you.
Our last question comes from Ron Bodman of Capital Returns. Your line is open.
Hi, good morning. Thanks a lot. Vic, you made a comment. I'm sorry, not Vic. Dominic, you made a comment regarding North America and Vic's business. I think it was in the Q&A, basically, and I'm sort of putting words in your mouth, but it was something close to North America has improved. It's sort of turned around, and it's going to be positive or improving from here. I'm wondering if, assuming I'm in sort of in the ballpark of what I think I heard you say, Vic, could you expand on that, please?
Well, that's a little tough, isn't it? Let me repeat what I said.
Thanks
Vic's set up to answer it appropriately rather than having words put in his mouth. It is clear from what you have seen Vic report and say during 2012, and what we've reported today, that a number of indicators in North America are now turning the right way. We have growth in producers. We have positive organic revenue growth, and many of the forward-looking indicators are very positive. Okay? That is all very good. The pipelines that Vic has kept a very close eye on are looking strong. That is all good. As we go through our strategic review, we are going to be looking at all our businesses around the world, all our businesses around the world to make sure they can contribute fully to growth and margin expansion. That includes our businesses in Taiwan, and it includes our businesses in North America.
The base in North America is clearly heading in the right direction, which is great news. With that, let me hand over to Vic for his commentary.
Thanks, Dominic. All I can do is go back to what we actually started in 2011 and really try to drive through 2012, which is what I believe drives this business, and that's pipelines, that's recruiting, and that's retention of our clients. Those are our leading indicators. We seem to be improving in each one of those. While we can't give guidance, all I can say is I feel like we are on the right path.
Thank you very much.
At this time, we have no further questions.
Thank you very much, everybody. Thank you very much for your interest in Willis and taking part in this call. We look forward to meeting many of you in person, and of course, preparing for that investor day I talked about in August. Thank you very much.