Business Context and Reporting Period
This Form 10-Q covers Aon Corporation for the quarterly period ended September 30, 1999. The company operates primarily in three segments: Insurance Brokerage and Other Services, Consulting, and Insurance Underwriting. The financial statements reflect a three-for-two stock split effective May 17, 1999. The results are unaudited but include normal recurring adjustments.
Key Financial Metrics
| Metric (in millions) | Q3 1999 | Q3 1998 | 9 Months 1999 | 9 Months 1998 |
|---|---|---|---|---|
| Total Revenue | $1,770 | $1,607 | $5,192 | $4,791 |
| Net Income | $138 | $124 | $339 | $402 |
| Net Income Available to Common | $137 | $123 | $337 | $400 |
| Diluted EPS | $0.52 | $0.47 | $1.28 | $1.54 |
| Operating Cash Flow (9mo) | $478 (vs $707 prior year) | |||
| Total Assets | $21,113 (as of Sept 30, 1999) | |||
| Total Liabilities | $17,107 (as of Sept 30, 1999) | |||
| Stockholders' Equity | $3,156 (as of Sept 30, 1999) | |||
| Short-term Borrowings | $1,129 (as of Sept 30, 1999) | |||
| Notes Payable | $817 (as of Sept 30, 1999) |
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 10% in Q3 1999 and 8% for the nine-month period compared to 1998. Brokerage commissions and fees rose 10% in both periods, driven by acquisitions and internal growth.
- Profitability: While Q3 net income increased 11% year-over-year, nine-month net income decreased 16% ($339M vs $402M). This decline is primarily attributed to $163 million in pre-tax special charges recorded in Q1 1999 related to restructuring and pension misselling.
- Excluding Special Charges: Management notes that excluding the Q1 special charges, income before income tax for the nine months increased 10% compared to the prior year.
- Cash Flow: Operating cash flow for the nine months decreased $229 million to $478 million. Management attributes this to the timing of special charge payments, acquisition-related valuation adjustments, and the branding campaign.
- Debt and Liquidity: Short-term borrowings increased by $285 million and notes payable by $237 million compared to year-end 1998, largely to finance acquisitions. The company issued $250 million of 6.9% debt securities in Q2 1999.
Guidance, Outlook, and Risks
- Outlook: Management anticipates continued positive cash flow and adequate liquidity to meet debt service and dividend obligations. Cost savings from Q1 restructuring are projected to be approximately $50 million annually.
- Year 2000 (Y2K) Readiness: Aon reports that Y2K remediation efforts were substantially completed by Q3 1999. Projected total costs are $70 million, with $60 million already incurred. Four small business units remain on a "watch list" for final testing in Q4 1999.
- Contingencies and Litigation:
- IRS Dispute: The IRS proposed tax adjustments of approximately $94 million (plus interest) for years 1990-1993 regarding retro-rated extended warranty contracts. Aon is contesting this vigorously.
- Allianz Lawsuit: Aon is a defendant in a lawsuit filed by Allianz Life Insurance regarding reinsurance placements. Aon believes it has meritorious defenses and does not expect a material adverse effect on financial position.
- Pension Misselling: Special charges of $43 million were recorded in Q1 for redress payments to UK customers regarding private pension plans. Remaining payments are anticipated by early 2001.
- Accounting Changes: Aon has not yet adopted SFAS No. 133 (Derivatives and Hedging), which is required for fiscal quarters beginning after June 15, 2000. The impact on earnings is currently undetermined.
Investor Verification Checklist
- Special Charges Impact: Verify the specific breakdown of the $163 million Q1 special charges and the remaining liability for pension redress payments and restructuring.
- Y2K Exposure: Confirm the status of the four business units on the "watch list" and the potential operational impact of third-party Y2K failures.
- IRS Dispute Resolution: Monitor the administrative appeal regarding the $94 million proposed tax adjustment on extended warranty contracts.
- Acquisition Integration: Assess the financial contribution of recent acquisitions (e.g., Nikols Sedgwick) to the reported revenue growth.
- Investment Portfolio: Review the composition of the $6.5 billion investment portfolio, noting the 0.6% allocation to non-income producing assets and the impact of unrealized losses on equity.