Aon plc — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Unaudited results are reported under U.S. GAAP; amounts are in U.S. dollars unless noted. Aon operates Risk Solutions (insurance and reinsurance brokerage/advisory) and HR Solutions (benefits, consulting and outsourcing).
Key financial results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total revenue | $2.766bn | $2.805bn | $5.558bn | $5.652bn |
| Operating income | $405m | $277m | $855m | $718m |
| GAAP operating margin | 14.6% | 9.9% | 15.4% | 12.7% |
| Net income attributable to Aon shareholders | $272m | $178m | $587m | $506m |
| Diluted GAAP EPS | $1.01 | $0.62 | $2.16 | $1.76 |
| Adjusted diluted EPS (non-GAAP) | $1.39 | $1.31 | $2.75 | $2.67 |
- Revenue and segments: Reported revenue fell about 1% in Q2 and 2% in the first half. Organic revenue growth was 3% in both periods, offset by foreign-exchange headwinds and net divestitures. Q2 Risk Solutions revenue was $1.847bn, up from $1.833bn; HR Solutions revenue was $931m, down from $979m. Segment GAAP operating margins were 20.2% for Risk Solutions and 8.1% for HR Solutions in Q2.
- Cash flow: First-half operating cash flow was $764m, versus $578m a year earlier. Free cash flow, a non-GAAP measure defined as operating cash flow less capital expenditures, was $660m versus $436m. Capital expenditures were $104m.
- Balance sheet and liquidity: At June 30, cash and cash equivalents plus short-term investments totaled $689m, of which $87m was restricted; client fiduciary funds are separate and unavailable for general corporate use. Debt was $6.158bn, up $458m from year-end 2015. The rolling 12-month debt-to-EBITDA ratio was 2.4x, compared with 2.5x a year earlier. Aon reported $1.104bn of working capital and $1.3bn of committed credit facilities available, with no facility borrowings and covenant compliance at quarter-end.
- Shareholder returns: Aon repurchased 7.7m shares for approximately $750m in the first half, but made no repurchases in Q2. First-half dividends paid were $169m; the quarterly dividend paid was $0.33 per share.
Material changes and unusual items
- Profit and GAAP operating margin increased substantially year over year, but comparison is affected by $176m of legacy litigation expense recorded in Q2 2015. Q2 2016 also included a $62m pension settlement charge, principally from a U.K. pension lump-sum settlement.
- Q2 operating expenses declined $167m year over year, mainly reflecting the prior-year litigation charge, divestitures and currency effects, partly offset by the pension charge and costs supporting organic growth. Adjusted operating margin, which excludes specified items including intangible amortization and pension settlements, was 19.3% versus 19.0% in Q2 2015.
- In March 2016, Aon issued $750m of 3.875% senior notes due December 2025; it repaid $500m of 3.125% notes at maturity in May. Commercial paper outstanding was $241m at June 30, versus $50m at year-end 2015.
- First-half acquisitions used $183m net of acquired cash; proceeds from business sales were $103m. First-half other income was $18m, including $41m of disposal gains offset in part by foreign-currency remeasurement and investment losses.
- Other comprehensive loss increased $299m in the first half, primarily from $138m of currency translation losses and $150m of post-retirement benefit losses.
Outlook, commentary and risks
Management cited adverse currency movements and a negative market impact in reinsurance, as well as price compression in benefits administration. It described global insurance pricing as modestly negative on average and characterized the market as soft. Management reported strong retail brokerage growth, modest reinsurance growth and modest consulting growth; HR Solutions outsourcing revenue was pressured by divestitures and benefits-administration declines.
Aon gave no specific full-year revenue or earnings forecast in the supplied filing text. Management said it expects operating cash generation to be sufficient for debt service, capital spending, pension contributions, repurchases and dividends, and considers cash, credit facilities and capital-markets access adequate for foreseeable liquidity needs. It expected approximately $87m of additional pension contributions in the remainder of 2016.
- Legal contingencies: Aon disclosed a reasonably possible loss range of $0 to $300m in excess of amounts accrued, excluding insurance. Matters include Opry Mills, Philips, IRU, Gleeds and Lyttelton Port Company claims. Management said it did not expect the matters, individually or together, to materially adversely affect consolidated financial position, but warned unfavorable outcomes could materially affect results or cash flows in a particular period.
- Other risks: Foreign-exchange and interest-rate movements, weak economic conditions, soft insurance pricing, competitive pressures, pension funding, debt ratings, regulatory and litigation exposure, and operational, cyber and data-security risks. The company uses derivatives to manage exposures and states it does not use them for speculation.
- Tax and accounting: The six-month effective tax rate was 17.5%, versus 16.8%; management cited geographic income mix and discrete items. Aon early adopted the deferred-tax balance-sheet presentation guidance in Q2 2016. It was evaluating the effects of several future accounting standards, including credit losses, leases and revenue recognition.
Investor facts to verify
- Assess whether organic growth can continue to offset currency pressure, divestitures and soft-market pricing, particularly in HR Solutions outsourcing and reinsurance.
- Separate underlying earnings trends from the $176m prior-year litigation expense and the $62m current-year pension settlement charge; review the company’s non-GAAP reconciliations.
- Track debt, commercial-paper usage, interest expense, credit ratings and covenant headroom; distinguish corporate liquidity from fiduciary assets held for clients.
- Review the status and potential exposure of the disclosed legal matters and the $0–$300m reasonably possible loss range beyond accruals.
- Confirm execution against management’s cash-flow and pension-contribution expectations; the filing does not provide specific full-year revenue or EPS guidance.