Aon plc — Q3 2015 Form 10-Q
Business context and period. Aon provides insurance and reinsurance brokerage and risk advisory services through Risk Solutions, and human-capital, benefits, consulting and outsourcing services through HR Solutions. This unaudited report covers the quarter and nine months ended September 30, 2015; comparisons are with the corresponding 2014 periods unless stated otherwise. Amounts are in U.S. dollars.
Financial performance and liquidity
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total revenue | $2.742bn | $2.880bn | $8.394bn | $8.746bn |
| Operating income | $413m | $417m | $1.131bn | $1.331bn |
| Operating margin (GAAP) | 15.1% | 14.5% | 13.5% | 15.2% |
| Net income attributable to Aon shareholders | $295m | $309m | $801m | $938m |
| Diluted EPS (GAAP) | $1.04 | $1.04 | $2.80 | $3.11 |
| Operating cash flow | Not separately stated | Not separately stated | $1.075bn | $883m |
| Free cash flow (company-defined, non-GAAP) | Not separately stated | Not separately stated | $850m | $704m |
- Reported revenue declined 5% in Q3 and 4% year to date. Foreign exchange reduced revenue by about 7% in both periods; organic revenue grew 2% in each period.
- Q3 shareholder net income fell 5%, while year-to-date shareholder net income fell 15%. Q3 diluted EPS was flat; year-to-date diluted EPS declined. The Q3 effective tax rate was 14.0%, versus 19.1%, with 2015 benefiting from geographic income mix and discrete items.
- Company-defined adjusted diluted EPS was $1.24 in Q3 versus $1.29, and $3.92 year to date versus $3.82. Adjusted operating margin was 17.9% in Q3 versus 17.6%, and 18.4% year to date versus 18.2%. These are non-GAAP measures and exclude specified items, including intangible amortization and, where applicable, legacy litigation.
- Operating cash flow rose $192m year to date. Free cash flow increased 21%; capital expenditures were $225m, up from $179m. Management attributed stronger operating cash flow to working-capital improvements, lower tax payments and pension contributions, among other factors.
- At September 30, cash and short-term investments totaled $783m, including $107m restricted. Fiduciary assets of $9.956bn are matched by fiduciary liabilities and generally cannot be used for corporate purposes. Working capital was $379m, down $430m from year-end 2014.
- Total debt was approximately $6.1bn, up $544m from year-end; debt was 51.0% of total capital attributable to Aon shareholders, versus 45.9%. Commercial paper outstanding was $810m. Aon reported $1.3bn of committed credit facilities available and no facility borrowings; it was in covenant compliance.
Material changes and management commentary
- Risk Solutions revenue declined 8% in Q3 and 6% year to date, primarily from currency effects; organic growth was 1% and 2%, respectively. Retail brokerage grew organically, while Reinsurance declined, reflecting soft market conditions, repricing of credit risk and weaker demand.
- HR Solutions revenue increased 1% in Q3 and was broadly flat year to date as organic growth was offset by foreign exchange. Organic growth was 5% in Q3 and 4% year to date, with gains across consulting and outsourcing.
- Q3 GAAP operating margin improved, supported by organic growth, expense discipline and currency effects. Year-to-date margin declined, principally because of $176m of legacy-litigation expense and investment in future growth. Q3 other income was $8m versus $35m, which included a $25m business-sale gain in 2014.
- Aon repurchased 11.7m shares for approximately $1.15bn year to date, including 6.3m shares for $600m in Q3. It paid $240m in dividends year to date; the quarterly dividend was increased 20% to $0.30 per share. Debt issuance included $600m of 4.75% senior notes due 2045; $600m of 3.50% notes matured and were repaid.
Outlook, risks and contingencies
- No specific earnings or revenue guidance is provided. Management said operating cash flow and available credit facilities should meet foreseeable liquidity needs, and expected 2015 cash generation to support debt service, capital spending, pension contributions, restructuring, repurchases and dividends. Approximately $56m of pension contributions was expected for the remainder of 2015.
- Management identified adverse currency movements, economic weakness in continental Europe, soft insurance pricing, Reinsurance market impacts and price compression in benefits administration as continuing headwinds. Aon noted that its results are exposed to foreign exchange and interest-rate movements, competition, debt and ratings changes, pension funding needs, regulation, technology and cybersecurity risks, and litigation.
- For specified legal matters, Aon estimated reasonably possible losses beyond amounts accrued at $0 to $300m, excluding insurance coverage. Management believed the matters would not materially adversely affect consolidated financial position, but unfavorable outcomes could materially affect results or cash flows in a particular period.
- Notable claims include the Opry Mills dispute, where a jury awarded $204m against insurers and Aon faces an alternative professional-liability claim; Philips’ pension-related claim, increased to approximately £290m ($440m); and LPC’s New Zealand claim of about NZD184m ($117.5m). Aon said it had defenses and intended to defend these matters. The filing also reports a $150m payment in Q2 to settle legacy litigation with Huntington Ingalls.
- Management cautioned that interim results are not necessarily indicative of full-year results. It also noted that new consolidation guidance was under evaluation and that the impact of the forthcoming revenue-recognition standard could not yet be determined.
Important facts for investors to verify
- How much reported revenue and earnings pressure reflects currency versus underlying growth, particularly in Risk Solutions and Reinsurance.
- The nature, timing and potential financial exposure of the disclosed legal claims, including how the $0–$300m reasonably possible loss range relates to individual matters, accruals and insurance coverage.
- Debt maturities, commercial-paper funding needs, credit-facility availability and the effect of continued repurchases and dividends on leverage and liquidity.
- The sustainability and calculation of adjusted margins, adjusted EPS and free cash flow, including the treatment of litigation costs and other exclusions.
- Whether working-capital cash-flow benefits, pension contributions and foreign-exchange effects persist in subsequent periods; fiduciary funds are not a source of general corporate liquidity.