Aon plc — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015. Aon provides insurance and reinsurance brokerage and human-resources consulting and administration through Risk Solutions and HR Solutions. Financial amounts below are in U.S. dollars; dollar figures are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenue | $2,805 | $2,919 | $5,652 | $5,866 |
| Operating income | $277 | $445 | $718 | $914 |
| Operating margin | 9.9% | 15.2% | 12.7% | 15.6% |
| Net income attributable to Aon shareholders | $178 | $304 | $506 | $629 |
| Diluted earnings per share | $0.62 | $1.01 | $1.76 | $2.07 |
| Cash provided by operating activities | — | $365 | $333 |
- Reported revenue declined 4% in both the quarter and first half. Management attributed the decrease principally to a 7% unfavorable foreign-exchange impact, partly offset by 2% organic growth and 1% net acquisition contribution.
- Q2 Risk Solutions revenue was $1,833, down from $1,948; HR Solutions revenue was $979, versus $982. For the first half, Risk Solutions generated $3,728 and HR Solutions $1,949.
- Q2 GAAP operating income fell 38% and net income attributable to Aon fell 41%. First-half operating income declined 21% and attributable net income declined 20%.
- Management reported adjusted Q2 diluted EPS of $1.31, versus $1.25; first-half adjusted diluted EPS was $2.67, versus $2.53. These are non-GAAP measures that exclude intangible amortization and legacy litigation costs.
- First-half free cash flow, defined by Aon as operating cash flow less capital expenditures, was $223, up from $218. Capital expenditures were $142, compared with $115.
Liquidity, debt and capital allocation
- At June 30, cash and cash equivalents were $367 and short-term investments were $484. Of the combined $851, $117 was restricted. Client fiduciary assets are matched by fiduciary liabilities and are not available for corporate use.
- Total debt was approximately $6.1 billion, up $479 from year-end 2014. Debt-to-total-capital attributable to Aon shareholders was 48.6%, compared with 45.9% at year-end. Long-term debt carrying value was $4,824; its disclosed fair value was $5,060.
- Aon issued $600 of 4.750% senior notes due 2045 in May for general corporate purposes. It replaced an expiring European facility with a $900 multi-currency facility due 2020. Together with its $400 facility due 2017, $1.3 billion of committed facilities was available, with no borrowings under either facility at quarter-end; Aon reported covenant compliance.
- First-half financing included $550 of share repurchases and $156 of shareholder dividends. The quarterly dividend was increased 20%, from $0.25 to $0.30 per share. Aon had $5.1 billion of authorized repurchase capacity remaining at June 30.
- Management said operating cash flow and available credit were expected to meet foreseeable liquidity needs, including debt service, capital expenditures, pension contributions, restructuring, repurchases and dividends. It expected approximately $116 of pension contributions in the remainder of 2015.
Changes, management commentary and risks
- A $176 legacy-litigation expense was the principal reported operating-cost headwind in Q2 and the first half. Aon said the Q2 margin decline also reflected spending to support future growth. Excluding intangible amortization and litigation, Q2 adjusted operating margin was 19.0%, versus 18.2% a year earlier.
- Risk Solutions Q2 GAAP operating margin fell to 15.2% from 21.4%; HR Solutions fell to 4.0% from 7.0%. Management cited litigation expense in Risk Solutions and growth-related spending in HR Solutions.
- Business headwinds included adverse currency movements, economic weakness in continental Europe, soft insurance pricing, and unfavorable reinsurance market conditions. HR Solutions also faced benefits-administration price compression. Management noted solid retail brokerage growth and organic growth in HR consulting and outsourcing.
- Q2 effective tax rate was 12.2%, versus 17.5%; first-half rate was 16.8%, versus 18.3%. Aon attributed the lower 2015 rates to geographic income mix, the effect of a legacy legal settlement on U.S. income, and discrete items.
- In May, Aon agreed to pay $150 to settle the Northrop-related insurance placement lawsuit and paid the amount in June. Separately, the filing estimates reasonably possible losses for specified legal matters, above amounts accrued, at $0 to $0.3 billion before insurance. Management believes the matters will not materially adversely affect consolidated financial position, but says an unfavorable outcome could materially affect results or cash flows in a particular period.
- Other disclosed claims include Opry Mills, Philips, IRU, Gleeds and Lyttelton Port Company. Aon describes its defenses in several matters as meritorious. An arbitration panel rejected all AXA claims in June 2015.
- Key risks include foreign-exchange and interest-rate movements, economic and insurance-market conditions, pension funding, debt and credit ratings, litigation and errors-and-omissions claims, regulation, cybersecurity and technology, and acquisition integration. Aon uses derivatives to manage exposures and stated it does not use them for speculation.
- No specific full-year revenue or earnings guidance is provided in the supplied filing text. Aon cautions that interim results are not necessarily indicative of full-year results. It reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether organic growth can continue to offset currency headwinds and weakness in reinsurance, European markets and pricing.
- The recurring earnings and cash-flow impact of the $176 legacy-litigation charge, including the $150 Northrop settlement and remaining legal exposures.
- Debt trajectory, refinancing costs, credit ratings, covenant headroom and the balance between repurchases, dividends and investment needs.
- Whether adjusted margins and adjusted EPS remain resilient, and how the company’s non-GAAP adjustments reconcile to GAAP results.
- Progress on expected pension contributions and the potential effects of market, currency and interest-rate changes on pension obligations and liquidity.