Aon Corporation 2010 Second-Quarter Form 10-Q
Reporting period: Three and six months ended June 30, 2010. The filing identifies the registrant as Aon Corporation, notwithstanding the request metadata’s “Aon Plc.” Figures are in U.S. dollars and millions unless otherwise noted. Statements are unaudited.
Business context and results
Aon operates Risk and Insurance Brokerage Services and Consulting. Management described a challenging recessionary environment, soft insurance pricing, reduced client exposure units and spending, and weakness in certain sectors. Revenue growth was supported by acquisitions and foreign exchange, while organic revenue remained under pressure.
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Total revenue | $1,898 | $1,882 | $3,802 | $3,728 |
| Operating income | $268 | $220 | $541 | $586 |
| Income from continuing operations attributable to Aon stockholders | $179 | $147 | $357 | $377 |
| Net income attributable to Aon stockholders | $153 | $149 | $331 | $429 |
| Diluted EPS from continuing operations | $0.63 | $0.50 | $1.27 | $1.29 |
| Total diluted EPS | $0.54 | $0.51 | $1.18 | $1.47 |
Reported revenue increased 1% in Q2 and 2% for the half. Organic revenue declined 1% and 2%, respectively. Q2 diluted EPS from continuing operations, adjusted for restructuring charges and a pension adjustment, was $0.81; the corresponding six-month figure was $1.65. These are non-GAAP measures.
Margins, segments and material period changes
- Consolidated GAAP operating margin was 14.1% in Q2 versus 11.7% a year earlier; for the first half it was 14.2% versus 15.7%. Adjusted margins were 18.3% for both periods in 2010.
- Risk and Insurance Brokerage Services revenue was $1,587 in Q2 and $3,174 for the half; operating income was $305 and $562, respectively. Q2 operating margin improved to 19.2% from 12.7%, while the half-year margin rose to 17.7% from 16.8%. Management cited lower restructuring costs and savings, partly offset by organic revenue declines and lower fiduciary investment income.
- Consulting revenue was $317 in Q2 and $639 for the half; operating income was $45 and $94. Q2 operating margin increased to 14.2% from 13.7%, but the half-year margin fell to 14.7% from 18.2%, reflecting higher compensation and restructuring costs and a prior-year pension curtailment gain.
- Fiduciary investment income fell to $15 in Q2 from $19 and to $28 for the half from $44, primarily reflecting lower interest rates.
- Operating expenses fell 2% in Q2 to $1,630, but rose 4% for the half to $3,261. The six-month comparison includes a prior-year $83 pension curtailment gain and a 2010 pension expense correction.
Cash flow, liquidity and debt
- Six-month operating cash flow was $872, including a $633 increase in funds held on behalf of clients. Excluding those client funds, operating cash flow was $239, versus negative $16 in 2009. Client fiduciary assets are not available for corporate use.
- Investing cash flow was negative $776, including a $633 use related to client funds; financing cash flow was negative $103. Cash increased $43 to $260. Cash and short-term investments totaled $734 at June 30, of which $79 was restricted.
- Total debt was approximately $2.0 billion: $370 of short-term and current debt and $1,601 of long-term debt. Debt as a percentage of Aon shareholder capital was 26.6%, versus 27.2% at year-end 2009. A $362 Canadian-dollar debt maturity due in April 2011 was reclassified as current.
- Working capital was $1.4 billion. Aon reported $1.2 billion of committed credit facilities available at quarter-end and compliance with its credit covenants. Fiduciary assets of $12.2 billion had an equal corresponding liability and should not be treated as liquidity.
- Cash dividends were $0.15 per share in Q2. Aon repurchased 2.4 million shares for $100 during the first half.
Outlook, unusual items and risks
- Management expected a full-year 2010 underlying tax rate of approximately 28% and planned approximately $278 of pension contributions in 2010; $140 had been contributed by June 30.
- The Aon Benfield restructuring was expected to cost about $155 in total, with a further $30 expected in future earnings and activity continuing into 2011. Management estimated 2010 savings of $90–$100 and 2011 savings of $122, before potential reinvestment. The substantially complete 2007 plan was expected to deliver annualized savings of about $536 by year-end 2010; achievement was not assured.
- Aon recorded a non-cash $49 pretax pension expense in Q2 to correct an error in U.S. pension expense calculations dating from 1999. Management concluded the prior-period error was not material and did not restate prior periods. The adjustment did not affect the plan’s funded status.
- A July 2010 agreement to acquire Hewitt was a subsequent event, not a completed transaction at quarter-end. The deal was valued at approximately $4.9 billion based on Aon’s July 9 share price and was expected to close in mid-November, subject to approvals and other conditions. Aon expected to incur about $2.5 billion of additional debt; projected combined debt was approximately $4.5 billion. Management anticipated GAAP EPS accretion in 2012 and adjusted EPS accretion in 2011, based on preliminary estimates.
- Moody’s changed Aon’s debt outlook to negative in July, citing the proposed Hewitt financing and reduced financial flexibility. Aon warned that ratings downgrades could raise borrowing costs or constrain capital-market access.
- Q2 discontinued operations included an after-tax loss of $26, principally reflecting the Buckner settlement. Aon agreed to pay $47.75 on Resource Life’s behalf, including a $37.75 pretax expense recorded in the quarter and first half, subject to court approval and other settlement terms.
- Other disclosed exposures include ongoing SEC and DOJ anti-corruption investigations, other litigation and E&O claims, and client fiduciary-related claims. Management said current accruals and available insurance led it to conclude these matters were not expected to materially affect consolidated financial position, but adverse resolutions could materially affect results or cash flows in a particular period.
- Key business risks include continued weak economic conditions, soft insurance pricing and exposure levels, lower short-term interest rates, foreign-exchange movements, pension funding needs, restructuring execution, and Hewitt transaction financing, integration, client retention and approval risks.
Important facts for investors to verify
- Whether organic revenue trends and insurance pricing improve, particularly in retail and reinsurance brokerage, and whether Consulting growth sustains margins.
- Actual restructuring costs, timing and realized savings against management’s targets.
- The Hewitt transaction’s final financing, approvals, closing, integration costs, debt levels and realized earnings contribution; the stated accretion expectations were preliminary.
- The timing and outcome of the Buckner settlement approval, SEC/DOJ investigations and other material legal or regulatory matters.
- Debt maturity and refinancing plans, credit ratings and outlook, covenant headroom, and the availability of corporate liquidity excluding fiduciary funds.
- The effects of the pension expense correction, future pension contributions and any further changes in plan assumptions or funding requirements.