Aon plc — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Aon is a global professional services firm providing risk, retirement, and health solutions. Unless otherwise noted, figures are in U.S. dollars; financial statement amounts are in millions.
Financial performance and position
| Metric | Q1 2018 | Q1 2017 or prior balance date |
|---|---|---|
| Revenue | $3,090 | $2,381 |
| Operating income / reported operating margin | $799 / 25.9% | $335 / 14.1% |
| Adjusted operating margin (non-GAAP) | 31.8% | 21.9% |
| Continuing operations net income | $604 | $265 |
| Net income attributable to Aon shareholders | $594 | $291 |
| Diluted EPS, continuing operations | $2.35 | $0.94 |
| Adjusted diluted EPS (non-GAAP) | $2.97 | $1.45 |
| Cash provided by operating activities, continuing operations | $140 | $182 |
| Free cash flow (non-GAAP) | $95 | $148 |
| Cash and short-term investments | $715 | $1,285 at Dec. 31, 2017 |
| Total debt | Approximately $6.1 billion | Approximately $6.0 billion at Dec. 31, 2017 |
| Total assets / total liabilities | $27,847 / $22,462 | $26,088 / $21,440 at Dec. 31, 2017 |
Reported revenue rose 30%, but the company attributed 17 percentage points of the increase to adopting ASC 606, 5 points to foreign currency, 5 points to acquisitions net of divestitures, and 3% to organic growth. ASC 606 increased Q1 2018 reported revenue by $413 million and continuing-operations net income by $265 million, or $1.06 per diluted share; prior periods were not restated. Without ASC 606, Q1 2018 revenue would have been $2,677 million. Thus, reported year-over-year growth and earnings are not directly comparable with the prior period.
Organic revenue growth was 4% in Commercial Risk Solutions, 6% in Reinsurance Solutions, flat in Retirement Solutions and Health Solutions, and 1% in Data & Analytic Services. Management cited broad-based strength in Commercial Risk and Reinsurance, while Retirement and Health were held back by softer project-related work and timing effects.
The reported operating margin improvement also reflects accounting and expense items. Management said adoption of ASC 606 increased the reported margin by 860 basis points. Adjusted operating income excludes amortization and impairment of intangible assets and restructuring costs.
Cash, debt, and liquidity
- Operating cash flow from continuing operations declined $42 million year over year; management attributed the decrease primarily to higher cash restructuring payments. Free cash flow fell 36%, to $95 million, including $45 million of capital expenditures.
- Investing activities provided $346 million, primarily reflecting $415 million of net sales of non-fiduciary short-term investments. Financing activities used $663 million, including $569 million for share repurchases and $89 million for dividends. Cash and cash equivalents ended the quarter at $597 million.
- Cash and short-term investments totaled $715 million, of which $102 million was restricted. Fiduciary assets of $10.7 billion are matched by fiduciary liabilities and are not available for general corporate purposes.
- Debt was approximately $6.1 billion, including $399 million of commercial paper outstanding. A $291 million Canadian-dollar senior note matured and was repaid during the quarter. Aon had no borrowings under its $1.3 billion committed credit facilities and reported compliance with their covenants.
- Management stated that operating cash flow, cash reserves, credit facilities, and capital-market access should be sufficient to meet foreseeable liquidity needs. Working capital was $1.457 billion, up $535 million from year-end.
Material changes, outlook, and notable items
- Restructuring: Q1 restructuring and related expenses were $74 million; cumulative costs since inception were $571 million. Aon estimates total plan costs of approximately $1.025 billion through 2019, expects annualized savings of approximately $450 million by end-2019, and expects 4,200–4,800 role eliminations. It had eliminated 3,123 positions by March 31.
- Tax: The effective tax rate on continuing operations was 15.9%, compared with 0.1% in Q1 2017. The prior-period rate was unusually low. Aon was still evaluating provisional accounting for U.S. tax reform and expected to finalize estimates by year-end 2018.
- Shareholder returns: Aon repurchased 3.9 million shares for approximately $550 million at an average price of $140.94 and paid $0.36 per share in dividends. The remaining authorized repurchase amount was approximately $4.9 billion.
- Other unusual items: Q1 included $54 million of accelerated tradename amortization and a $7 million non-cash U.K. pension settlement charge. The quarter’s $6 million of discontinued-operations income included an $8 million after-tax gain on sale; Q1 2017 discontinued-operations income was $40 million.
- Legal and regulatory matters: Aon disclosed significant errors-and-omissions and other claims. For described matters where loss was estimable, reasonably possible losses in excess of recorded accruals were estimated at $0–$300 million, excluding insurance. Large claims include Opry Mills, Lyttelton Port, Christchurch City Council, and the Gleeds pension fund matter. Aon also faces competition investigations involving aviation and aerospace broking, plus U.K. market reviews; the company could not estimate their ultimate impact.
- Guarantees: In connection with the divested business, Aon had maximum potential payments of $97 million under lease guarantees and $206 million under performance guarantees; estimated fair values were $22 million and $1 million, respectively.
- Market and execution risks: The filing highlights foreign-exchange and interest-rate exposure, pension funding, debt and rating risks, tax uncertainty, litigation and regulatory matters, cybersecurity and technology risks, and the ability to realize restructuring savings. Management noted that U.S. dollar currency movements benefited comparative Q1 diluted EPS by $0.16.
- Formal outlook: The filing does not provide specific revenue or EPS guidance. Management expects cash generation to support debt service, capital expenditures, acquisitions, repurchases, and dividends, and expects restructuring activity to continue through 2019.
Most important facts for investors to verify
- Separate underlying operating performance from the substantial ASC 606 timing impact: it added $413 million to reported revenue and $1.06 per diluted share to Q1 continuing-operations earnings.
- Assess whether organic growth, particularly in Commercial Risk and Reinsurance, continues, and whether flat-growth Retirement and Health businesses improve.
- Track cash conversion and working-capital movements: operating cash flow and free cash flow declined despite higher reported earnings.
- Monitor restructuring execution, remaining costs, role reductions, and delivery of the targeted $450 million annualized savings by end-2019.
- Evaluate debt, commercial-paper funding, liquidity available after excluding fiduciary assets, and the scale of buybacks and dividends relative to cash generation.
- Follow resolution and potential financial exposure from the disclosed claims, competition investigations, tax-reform estimates, pension obligations, and divested-business guarantees.