Aon Plc quarterly report, Q3 FY2017

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Aon plc — Form 10-Q Summary

Reporting period: Quarter and nine months ended September 30, 2017. Amounts are in U.S. dollars unless otherwise noted. Aon reports one continuing-operations segment across five revenue lines: Commercial Risk, Reinsurance, Retirement, Health, and Data & Analytic Services.

Financial results

  • Revenue: Third-quarter revenue was $2.340 billion, up 6% year over year, reflecting 2% organic growth, 3% from acquisitions net of divestitures, and 1% favorable currency. Nine-month revenue was $7.089 billion, up 5%, including 3% organic growth.
  • Revenue-line organic growth: Q3: Commercial Risk -1%, Reinsurance 7%, Retirement 5%, Health 2%, and Data & Analytic Services 3%. Nine-month growth was 1%, 5%, 3%, 7%, and 4%, respectively.
  • Profit and EPS: Q3 continuing-operations net income was $196 million versus $284 million; net income attributable to Aon shareholders was $185 million versus $319 million, and diluted EPS was $0.72 versus $1.18. Nine-month continuing-operations income was $418 million versus $869 million; Aon-attributable net income was $1.245 billion versus $944 million, and diluted EPS was $4.74 versus $3.48. The nine-month comparison includes a gain on the divestiture.
  • Margins: Reported operating margin was 11.3% in Q3 versus 16.7%, and 6.9% for nine months versus 17.4%. Adjusted operating margin, a non-GAAP measure, was 20.3% versus 18.6% in Q3 and 21.7% versus 20.0% for nine months.
  • Adjusted earnings: Adjusted diluted EPS from continuing operations, a non-GAAP measure, was $1.29 for Q3 versus $1.09 and $4.19 for nine months versus $3.59.
  • Cash flow: Nine-month operating cash flow was $353 million, including $289 million from continuing operations; continuing-operations free cash flow was $164 million, down 84% from $1.045 billion. Management cited higher cash taxes, largely related to the divestiture, and restructuring payments as key pressures.
  • Liquidity and debt: Cash and cash equivalents plus short-term investments totaled $2.389 billion at September 30, up from $716 million at year-end, primarily due to divestiture proceeds. Working capital was $1.793 billion. Total debt was approximately $5.967 billion, down $238 million from year-end; the reported debt-to-EBITDA ratio was 2.6x versus 2.9x a year earlier. Aon had no borrowings under its $900 million committed facility and reported covenant compliance. Client fiduciary assets are matched by fiduciary liabilities and are not available for general corporate use.

Material changes and unusual items

  • Aon sold its benefits administration and business process outsourcing business on May 1, 2017, for $4.3 billion cash at closing, subject to customary adjustments, plus up to $500 million of deferred consideration. Cash proceeds after adjustments and before taxes were $4.2 billion. The business is presented as discontinued operations.
  • The nine-month results include an $803 million after-tax gain on sale. Aon also recorded a $380 million non-cash impairment of related tradenames and accelerated amortization as it moves to a unified Aon brand. These items materially affect period comparisons.
  • Q3 operating expenses rose $242 million year over year; nine-month expenses rose $1.015 billion. Drivers included restructuring charges, the tradename impairment and amortization, acquisition-related costs, and regulatory and compliance costs. Aon cited savings from restructuring and other operational improvements as offsets.
  • The nine-month effective tax rate on continuing operations was negative 49.8%, reflecting principally the non-cash tradename impairment tax benefit and share-based compensation accounting benefits; Q3’s rate was 2.0%. These rates are not necessarily representative of ongoing tax expense.
  • Aon repurchased $1.9 billion of shares in the first nine months and paid $274 million in dividends. The quarterly dividend paid per share was $0.36, versus $0.33 a year earlier.

Outlook, management commentary, and risks

  • Aon expects restructuring activity and related expenses to continue through 2019. The plan is estimated to cost $750 million in total; $401 million had been incurred through September 30. The company had eliminated 2,125 positions and expects 2,400–2,850 eliminations overall. Management estimates approximately $400 million of annualized savings by the end of 2019; actual costs, timing, and savings may differ.
  • Management stated that operating cash flow, cash reserves, and available borrowing capacity should meet foreseeable liquidity needs. It expected 2017 operating cash generation to support debt service, capital spending, pension obligations, repurchases, and dividends. A new $400 million credit facility was entered into in October 2017.
  • Risks include execution of the restructuring and divestiture separation, potential loss of up to $500 million in deferred sale consideration, currency and interest-rate movements, debt ratings and access to financing, pension funding, and regulatory, cyber, operational, and litigation exposures.
  • Legal matters include significant errors-and-omissions claims and an aviation and aerospace broking competition investigation by European and other authorities. Aon could not estimate the investigation’s ultimate impact. For described matters where loss is estimable, the reasonably possible additional loss range was $0–$300 million, excluding insurance and amounts already accrued. Aon also disclosed ongoing U.K. regulatory reviews concerning systems and controls.
  • Sale-related guarantees include maximum undiscounted potential payments of $104 million for lease commitments and $395 million for performance obligations, with estimated fair values of $25 million and $4 million, respectively. No payments had been made under these guarantees through the reporting date.

Important facts for investors to verify

  • Progress toward restructuring’s estimated $750 million cost, role reductions, and targeted annualized savings of $400 million.
  • Whether organic growth and adjusted-margin improvement persist, particularly given Q3 Commercial Risk’s 1% organic decline and the strong reported-versus-adjusted margin gap.
  • Cash conversion, tax payments, and the extent to which the unusually low nine-month cash flow reflects timing or recurring demands.
  • Collection and conditions attached to the deferred divestiture consideration, plus performance of ongoing commercial arrangements with the buyer.
  • Developments in the disclosed litigation, competition investigation, and U.K. regulatory reviews, including any change in loss estimates or accruals.
  • Future debt, pension funding, and shareholder-return needs; fiduciary assets should not be treated as corporate liquidity.