WILLIS GROUP HOLDINGS LTD - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended June 30, 2004
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-16503

WILLIS GROUP HOLDINGS LIMITED
(Exact name of registrant as specified in its charter)

Bermuda (Jurisdiction of incorporation or organization)		98-0352587 (I.R.S. Employer Identification No.)
c/o Willis Group Limited Ten Trinity Square, London EC3P 3AX, England (Address of principal executive offices) (011) 44-20-7488-8111 (Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý No o

As of July 31, 2004, there were outstanding 158,337,710 shares of common stock, par value $0.000115 per share of the registrant.

WILLIS GROUP HOLDINGS LIMITED

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2004

Table of Contents

			Page
PART I	—	Financial Information
Item 1	—	Financial Statements	2
Item 2	—	Management's Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3	—	Quantitative and Qualitative Disclosures about Market Risk	31
Item 4	—	Controls and Procedures	31
PART II	—	Other Information
Item 2	—	Changes in Securities and Use of Proceeds	32
Item 4	—	Submission of Matters to a Vote of Security Holders	32
Item 6	—	Exhibits and Reports on Form 8-K	33
Signatures			34

INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS

We have included in this document forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that state our intentions, beliefs, expectations or predictions for the future. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or those anticipated, depending on a variety of factors such as general economic conditions in different countries around the world, fluctuations in global equity and fixed income markets, changes in premium rates, the competitive environment and the actual cost of resolution of contingent liabilities. Although we believe that the expectations reflected in forward-looking statements are reasonable we can give no assurance that those expectations will prove to have been correct. All forward-looking statements contained in this document are qualified by reference to this cautionary statement.

PART I—FINANCIAL INFORMATION

Item 1—Financial Statements

WILLIS GROUP HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF OPERATIONS

			Three months ended June 30,						Six months ended June 30,
			2004			2003			2004			2003
			(millions, except per share data) (unaudited)
REVENUES:
	Commissions and fees		$	516		$	472		$	1,164		$	1,012
	Interest income			16			20			33			35

		Total revenues		532			492			1,197			1,047

EXPENSES:
	General and administrative expenses (excluding non-cash compensation)			369			346			786			697
	Non-cash compensation—performance options			4			5			6			13
	Depreciation expense			10			9			21			18
	Amortization of intangible assets			1			—			2			1
	Net gain on disposal of operations			(5	)		(4	)		(5	)		(4	)

		Total expenses		379			356			810			725

OPERATING INCOME				153			136			387			322
	Interest expense			4			13			9			28
	Premium on redemption of subordinated notes			—			—			17			—

INCOME BEFORE INCOME TAXES, EQUITY IN NET INCOME OF ASSOCIATES AND MINORITY INTEREST				149			123			361			294
INCOME TAXES				52			44			124			105

INCOME BEFORE EQUITY IN NET INCOME OF ASSOCIATES AND MINORITY INTEREST				97			79			237			189
EQUITY IN NET INCOME OF ASSOCIATES				—			1			12			11
MINORITY INTEREST				(1	)		—			(5	)		(3	)

NET INCOME			$	96		$	80		$	244		$	197

NET INCOME PER SHARE (Note 5)
	—Basic		$	0.61		$	0.53		$	1.54		$	1.31
	—Diluted		$	0.57		$	0.47		$	1.44		$	1.17

AVERAGE NUMBER OF SHARES OUTSTANDING (Note 5)
	—Basic			158			152			158			150
	—Diluted			169			169			169			169

The accompanying notes are an integral part of these consolidated financial statements.

WILLIS GROUP HOLDINGS LIMITED

CONSOLIDATED BALANCE SHEETS

			June 30, 2004			December 31, 2003
			(millions, except share data)
			(unaudited)
ASSETS
Cash and cash equivalents			$	383		$	364
Fiduciary funds—restricted				1,576			1,502
Short-term investments				65			61
Accounts receivable, net of allowance for doubtful accounts of $32 in 2004 and $32 in 2003				8,474			6,980
Fixed assets, net of accumulated depreciation of $178 in 2004 and $161 in 2003				238			249
Goodwill and other intangible assets, net of accumulated amortization of $123 in 2004 and $121 in 2003				1,430			1,345
Investment in associates				120			118
Deferred tax assets				135			141
Other assets				260			198

TOTAL ASSETS			$	12,681		$	10,958

LIABILITIES AND STOCKHOLDERS' EQUITY
	Accounts payable		$	9,810		$	8,210
	Deferred revenue and accrued expenses			227			327
	Income taxes payable			197			137
	Long-term debt (Note 6)			450			370
	Other liabilities			604			571

		Total liabilities		11,288			9,615

COMMITMENTS AND CONTINGENCIES (Note 7)
MINORITY INTEREST				18			19
STOCKHOLDERS' EQUITY:
	Common shares, $0.000115 par value; Authorised: 4,000,000,000; Issued and outstanding, 158,365,242 shares in 2004 and 159,083,048 shares in 2003			—			—
	Additional paid-in capital			973			1,100
	Retained earnings			552			367
	Accumulated other comprehensive loss (Note 9)			(133	)		(126	)
	Treasury stock, at cost, 740,648 shares in 2004 and 811,370 shares in 2003			(17	)		(17	)

		Total stockholders' equity		1,375			1,324

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY			$	12,681		$	10,958

The accompanying notes are an integral part of these consolidated financial statements.

WILLIS GROUP HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS

				Six months ended June 30,
				2004			2003
				(millions)
				(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
	Net income			$	244		$	197
	Adjustments to reconcile net income to net cash provided by operating activities:
		Depreciation			21			18
		Amortization of intangible assets			2			1
		Provision for doubtful accounts			1			2
		Minority interest			2			—
		Provision for deferred income taxes			14			1
		Subordinated debt redemption expense			17			—
		Non-cash compensation—performance options			6			13
		Other			7			13
	Changes in operating assets and liabilities, net of effects from purchase of subsidiaries:
		Fiduciary funds—restricted			(83	)		(132	)
		Accounts receivable			(1,460	)		(1,831	)
		Accounts payable			1,560			1,926
		Other assets and liabilities			(55	)		31

			Net cash provided by operating activities		276			239

CASH FLOWS FROM INVESTING ACTIVITIES:
		Proceeds on disposal of fixed assets			3			3
		Additions to fixed assets			(24	)		(27	)
		Acquisitions of subsidiaries, net of cash acquired			(67	)		(72	)
		Purchase of short-term investments			(33	)		(23	)
		Proceeds on sale of short-term investments			28			21
		Net cash proceeds from sale of operations			9			8

			Net cash used in investing activities		(84	)		(90	)

CASH FLOWS FROM FINANCING ACTIVITIES:
		Repayments of debt			(370	)		(77	)
		Draw down of term loans			450			—
		Subordinated debt redemption expense			(17	)		—
		Repurchase of shares			(198	)		—
		Proceeds from issue of shares			19			17
		Dividends paid			(56	)		(19	)

			Net cash used in financing activities		(172	)		(79	)

INCREASE IN CASH AND CASH EQUIVALENTS					20			70
Effect of exchange rate changes on cash and cash equivalents					(1	)		5
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR					364			211

CASH AND CASH EQUIVALENTS, END OF PERIOD				$	383		$	286

The accompanying notes are an integral part of these consolidated financial statements.

WILLIS GROUP HOLDINGS LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

1. THE COMPANY AND ITS OPERATIONS

Willis Group Holdings Limited ("Willis Group Holdings") and subsidiaries (collectively, the "Company") provide a broad range of value-added risk management consulting and insurance brokerage services, both directly and indirectly through its associates, to a diverse base of clients internationally. The Company provides specialized risk management advisory and other services on a global basis to clients in various industries, including the construction, aerospace, marine and energy industries. In its capacity as an advisor and insurance broker, the Company acts as an intermediary between clients and insurance carriers by advising clients on risk management requirements, helping clients determine the best means of managing risk, and negotiating and placing insurance risk with insurance carriers through the Company's global distribution network. The Company also provides other value-added services.

2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

The accompanying consolidated financial statements (hereinafter referred to as the "Interim Financial Statements") have been prepared in accordance with accounting principles generally accepted in the United States of America ("US GAAP").

The Interim Financial Statements are unaudited but include all adjustments (consisting of normal recurring adjustments) which the Company's management considers necessary for a fair presentation of the financial position as of such dates and the operating results and cash flows for those periods. Certain information and footnote disclosures normally included in financial statements prepared in accordance with US GAAP have been condensed or omitted. The results of operations for the six month period ended June 30, 2004 may not necessarily be indicative of the operating results that may be incurred for the entire fiscal year.

The December 31, 2003 balance sheet was derived from audited financial statements but does not include all disclosures required by US GAAP. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These Interim Financial Statements should be read in conjunction with the Company's consolidated balance sheets as of December 31, 2003 and 2002, and the related consolidated statements of operations, cash flows and changes in stockholders' equity for each of the three years in the period ended December 31, 2003 included in the Annual Report on Form 10-K filed with the Securities and Exchange Commission.

Stock-based compensation—The Company accounts for its stock option and stock-based compensation plans using the intrinsic-value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"). Accordingly, the Company computes compensation costs for each employee stock option granted as the amount by which the quoted market price of the Company's shares on the date of the grant exceeds the amount the employee must pay to acquire the shares.

Had compensation expense for such plans been determined consistent with the fair value method prescribed by Statement of Financial Accounting Standard ("SFAS") No. 123, Accounting for

Stock-Based Compensation, using the Black-Scholes option-pricing model, the Company's pro forma net income and net income per share would have been:

			Three months ended June 30,						Six months ended June 30,
			2004			2003			2004			2003
			(millions, except per share data)
Net income, as reported			$	96		$	80		$	244		$	197
Add: Non-cash compensation expense—performance options included in reported net income, net of related tax of $(1), $nil, $(1) and $(2)				3			5			5			11
Less: Total stock-based employee compensation expense determined under FAS 123 for all awards, net of related tax of $1, $nil, $2 and $1				(5	)		(2	)		(7	)		(3	)

Net income, pro forma			$	94		$	83		$	242		$	205

Net income per share:
	Basic:
		As reported	$	0.61		$	0.53		$	1.54		$	1.31
		Pro forma	$	0.59		$	0.55		$	1.53		$	1.37
	Diluted:
		As reported	$	0.57		$	0.47		$	1.44		$	1.17
		Pro forma	$	0.56		$	0.49		$	1.44		$	1.21

3. DERIVATIVE FINANCIAL INSTRUMENTS

The financial risks the Company manages through the use of financial instruments are interest rate risk and foreign currency risk. The Company's Board of Directors reviews and agrees on policies for managing each of these risks. The Company has applied SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"), as amended by SFAS 149, in accounting for these financial instruments.

The fair values of both interest rate contracts and foreign currency contracts are recorded in other assets and other liabilities on the balance sheet. For contracts that are effective cash flow hedges as defined by SFAS 133, changes in fair value are recorded as a component of other comprehensive income. Amounts are reclassified from other comprehensive income into earnings when the hedged exposure affects earnings. For contracts that do not qualify for hedge accounting as defined by SFAS 133, changes in fair value are recorded in general and administrative expenses.

The changes in fair value of derivative financial instruments have been recorded as follows:

		Three months ended June 30,						Six months ended June 30,
		2004			2003			2004			2003
		(millions)
General and administrative expenses:
	Interest rate contracts	$	—		$	—		$	—		$	(1	)
	Foreign currency contracts		—			(2	)		—			(2	)
Other Comprehensive Income:
	Interest rate contracts (net of tax of $6, $nil, $6 and $nil)		(15	)		(2	)		(15	)		(1	)
	Foreign currency contracts (net of tax of $1, $(3), $(2) and $nil)		(2	)		8			5			2

4. PENSIONS PLANS

The components of the net periodic benefit cost (income) of the UK and US defined benefit plans are as follows:

			Three months ended June 30,						Six months ended June 30,
UK pension benefits			Three months ended June 30,						Six months ended June 30,
UK pension benefits			2004			2003			2004			2003
			(millions)
Components of net periodic benefit cost (income):
	Service cost		$	11		$	8		$	21		$	15
	Interest cost			19			16			40			33
	Expected return on plan assets			(28	)		(24	)		(56	)		(48	)
	Amortization of unrecognized prior service gain			—			—			(1	)		(1	)

		Net periodic benefit cost (income)	$	2		$	—		$	4		$	(1	)

			Three months ended June 30,						Six months ended June 30,
US pension benefits			Three months ended June 30,						Six months ended June 30,
US pension benefits			2004			2003			2004			2003
			(millions)
Components of net periodic benefit cost:
	Service cost		$	5		$	4		$	10		$	8
	Interest cost			7			7			14			14
	Expected return on plan assets			(7	)		(7	)		(15	)		(14	)
	Amortization of unrecognized actuarial loss			—			1			—			2

		Net periodic benefit cost	$	5		$	5		$	9		$	10

The Company previously disclosed in its financial statements for the year ended December 31, 2003, that it expected to contribute $30 million and $14 million in 2004 to the UK and US defined benefit pension plans, respectively. As of June 30, 2004, $15 million and $4 million of contributions have been made to the UK and US defined benefit pension plans, respectively.

5. NET INCOME PER SHARE

Basic and diluted net income per share is calculated by dividing net income by the average number of shares outstanding during each period. The computation of diluted net income per share reflects the potential dilution that could occur if dilutive securities and other contracts to issue shares were exercised or converted into shares or resulted in the issue of shares that then shared in the net income of the Company.

At June 30, 2004, time-based and performance-based options to purchase 18.7 million and 5.5 million (2003: 18.1 million and 8.5 million) shares, respectively, and 0.5 million restricted shares (2003: 0.4 million), were outstanding. Basic and diluted net income per share are as follows:

	Three months ended June 30,				Six months ended June 30,
	2004		2003		2004		2003
	(millions, except per share data)
Basic average number of shares outstanding		158		152		158		150
Dilutive effect of potentially issuable shares		11		17		11		19

Diluted average number of shares outstanding		169		169		169		169

Basic net income per share	$	0.61	$	0.53	$	1.54