Aon Plc quarterly report, Q2 FY2014

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Aon plc — Q2 2014 Form 10-Q

Business context and reporting period. Aon provides insurance and reinsurance brokerage and risk advisory services through Risk Solutions, and human capital, benefits, consulting and outsourcing services through HR Solutions. This unaudited filing covers the three and six months ended June 30, 2014; comparisons are with the corresponding 2013 periods. Amounts below are in U.S. dollars unless noted.

Key financial results

  • Q2 revenue: $2.919 billion, up 1% year over year. Organic revenue growth was 2%, versus 3% in Q2 2013. Risk Solutions revenue was $1.948 billion; HR Solutions was $982 million.
  • Q2 operating results: Operating income was $445 million, up from $382 million; operating margin was 15.2%, versus 13.2%. Adjusted operating margin, a non-GAAP measure, was 18.2%, versus 18.5%.
  • Q2 earnings: Net income attributable to Aon shareholders was $304 million, up 26%; diluted GAAP EPS was $1.01, versus $0.76. Adjusted diluted EPS was $1.25, versus $1.11.
  • First-half results: Revenue was $5.866 billion, up 1%; operating income was $914 million, versus $792 million, and operating margin was 15.6%, versus 13.6%. Shareholder net income was $629 million, versus $502 million; diluted EPS was $2.07, versus $1.58. Adjusted diluted EPS was $2.53, versus $2.23.
  • Cash flow: First-half operating cash flow was $333 million, down from $387 million. Capital expenditures were $115 million, yielding free cash flow of $218 million, versus $265 million; free cash flow is non-GAAP.
  • Balance sheet and liquidity: At June 30, cash and cash equivalents plus short-term investments totaled $726 million, including $161 million restricted. Total debt was approximately $6.0 billion, up $1.6 billion from year-end 2013; debt was 43.6% of capital attributable to Aon shareholders, versus 35.0%. Aon reported $1.3 billion of committed credit facilities, all available, and compliance with facility covenants. Fiduciary assets and matching liabilities were $12.786 billion and are not available for corporate use.
  • Capital returns: Aon repurchased 14.6 million shares for $1.25 billion in the first half and paid $128 million in shareholder dividends. Q2 dividends were $0.25 per share.

Material changes and drivers

  • Expense reductions, restructuring savings and lower intangible amortization supported higher operating income and GAAP margins. No Aon Hewitt restructuring charges were recorded in the first half of 2014, compared with $79 million in the first half of 2013.
  • Risk Solutions’ Q2 organic growth reflected retail brokerage strength, partly offset by a 4% decline in reinsurance brokerage revenue. HR Solutions benefited from investment consulting and outsourcing growth; its results also reflected restructuring savings and increased spending to develop the healthcare exchanges business.
  • The effective tax rate fell to 17.5% in Q2 and 18.3% for the first half, from 26.4% and 26.2%, respectively. Management attributed the reduction to the geographic distribution of income and discrete items.
  • Interest expense increased to $65 million for Q2 and $123 million for the first half, primarily reflecting higher debt. Currency translation and continental European economic weakness weighed on results; management estimated an unfavorable $0.04-per-share currency impact on adjusted diluted EPS for both Q2 and the first half.

Outlook, risks and unusual items

  • No specific full-year revenue or earnings guidance is provided. Management said expected operating cash flow should cover debt service, contractual obligations, capital spending, restructuring costs, pension funding, repurchases and dividends; available credit facilities can address timing needs.
  • Aon expected approximately $159 million of additional pension contributions in the remainder of 2014. Planned full-year contributions were $183 million to U.K. plans, $173 million to U.S. plans and $29 million to other significant international plans.
  • Management warned that potential unfavorable discrete tax adjustments in the second half could make the full-year effective tax rate higher than the first-half rate.
  • Business pressures include soft insurance pricing, economic weakness in continental Europe, adverse reinsurance market conditions, HR benefits-administration price compression, foreign exchange movements, competition and client demand. Aon also cited pension funding, credit ratings, litigation, regulation, cyber and operational disruption, and acquisition integration among relevant risks.
  • Legal matters include substantial client claims. The filing estimates a reasonably possible loss range of $0 to $0.7 billion, beyond amounts accrued and before insurance. Named matters include claims by Northrop, Opry Mills, Philips, Mazeikiu Nafta, IRU and AXA; Aon said it believes it has defenses and intends to defend itself. Management believes the matters will not have a material adverse effect on consolidated financial position, while acknowledging that adverse outcomes could materially affect a particular period’s results or cash flows.
  • Aon deposited $723 million with a trustee on June 30 to repay a July 2014 euro bond, but continued to recognize the debt at quarter-end; the trustee paid bondholders on July 1. During May, Aon issued $800 million of U.S.-dollar notes and €500 million of 2.875% notes due 2026. It acquired National Flood Services on July 15, after quarter-end.

Important facts for investors to verify

  • Whether organic growth and margin improvement persist, particularly in retail brokerage, reinsurance and HR Solutions, and how much depends on cost savings.
  • Debt maturity and refinancing details, leverage, borrowing costs, credit ratings and covenant headroom; confirm the July bond repayment and subsequent commercial paper balance.
  • Cash conversion and working-capital trends: operating cash flow and free cash flow declined despite higher earnings.
  • The sustainability of the unusually low first-half tax rate and any second-half discrete tax adjustments.
  • Developments, insurance coverage and potential accruals for the disclosed legal claims and other contingencies.
  • Integration and financial impact of acquisitions, including the post-quarter National Flood Services transaction, and the returns from substantial share repurchases.