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| AOC > SEC Filings for AOC > Form 10-Q on 8-May-2009 | All Recent SEC Filings |
8-May-2009
Quarterly Report
The outline for our Management's Discussion and Analysis is as follows:
EXECUTIVE SUMMARY
REVIEW OF CONSOLIDATED RESULTS
General
Consolidated Results
REVIEW BY SEGMENT
General
Risk and Insurance Brokerage Services
Consulting
Unallocated Income and Expense
FINANCIAL CONDITION AND LIQUIDITY
Cash Flows
Financial Condition
Borrowings
Stockholders' Equity
Restructuring Initiatives
Off Balance Sheet Arrangements
CRITICAL ACCOUNTING POLICIES
INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS
EXECUTIVE SUMMARY
The current global economic recession is providing significant headwind for our business. We continue to operate in a soft insurance pricing market, as property and casualty rates continue to decline, although at a somewhat slower pace. In addition to pricing declines, we are seeing a volume impact driven by the current economic environment, which places pressure on our business in three primary ways:
† Declining insurable risks due to decreasing asset values, including property values, shipment volume, payroll and number of active employees,
† Client cost-driven behavior, where clients are actively looking to reduce spending in order to meet budget reductions and increase risk retention, as a result of prioritizing their total spending, and
† Sector specific weakness, including financial services, construction, private equity, and mergers and acquisitions, all of which have been particularly impacted by the current recession.
Despite this difficult market environment, we grew the business organically and took further steps to streamline our product portfolio around our core businesses while reducing capital requirements.
Organic revenue growth in first quarter 2009 was 1%, with growth of 1% in our Risk and Insurance Brokerage Services segment and growth of 2% in our Consulting segment. See our discussion below for more details regarding organic revenue growth.
Our consolidated pretax margins from continuing operations improved from 13.5% in 2008 to 18.5% in 2009. The improvement is mainly attributable to a $83 million pension curtailment gain related to the decision to cease crediting future benefits relating to salary and service in our U.S. defined benefit pension plan, the positive impact of Benfield and other acquisitions, lower restructuring costs, and organic revenue growth, which more than offset lower investment income and the unfavorable impact of foreign currency translation.
The following is a summary of our first quarter 2009 financial results:
† Revenue decreased $51 million or 3% overall, as the negative effect of foreign exchange translation was only partially offset by the impact of Benfield and other acquisitions and organic revenue growth.
† Operating expenses decreased 9% in 2009 due primarily to favorable foreign exchange translation and the pension curtailment gain, partially offset by the impact of Benfield and other acquisitions.
† Income from continuing operations increased $53 million in 2009 to $235 million.
† Diluted earnings per share from continuing operations attributable to Aon's stockholders was $0.80 in 2009, an increase of 45% from 2008's $0.55 per share.
REVIEW OF CONSOLIDATED RESULTS
General
In our discussion of operating results, we sometimes refer to supplemental information derived from our consolidated financial information.
We use supplemental information related to organic revenue growth to help us and our investors evaluate business growth from existing operations. Organic revenue growth excludes the impact of foreign exchange rate changes, acquisitions, divestitures, transfers between business units, investment income, reimbursable expenses, and unusual items.
Supplemental organic revenue growth represents a non-GAAP measure and should be viewed in addition to, not instead of, our condensed consolidated statements of income. Industry peers provide similar supplemental information about their revenue performance, although they may not make identical adjustments.
Because we conduct business in over 120 countries, foreign exchange rate fluctuations have an impact on our business. In comparison to the U.S. dollar, foreign exchange rate movements may be significant and may distort true period-to-period comparisons of changes in revenue or pretax income. Therefore, we have:
† isolated the impact of the change in currencies between periods by providing percentage changes on a comparable currency basis for revenue, and have disclosed the impact on expenses and earnings per share, and
† provided this form of reporting to give financial statement users more meaningful information about our operations.
Some tables in the segment discussions reconcile organic revenue growth percentages to the reported commissions, fees and other revenue growth percentages for the segments and sub-segments. We disclose separately:
† the impact of foreign currency, and
† the impact from acquisitions, divestitures, transfers of business units, reimbursable expenses, and unusual items, which represent the most significant reconciling items.
Consolidated Results
The consolidated results of continuing operations follow (in millions):
First Quarter Ended
March 31,
(millions) 2009 2008
Revenue:
Commissions, fees and other $ 1,822 $ 1,848
Investment income 32 57
Total revenue 1,854 1,905
Expenses:
Compensation and benefits 1,014 1,154
Other general expenses 397 414
Depreciation and amortization 60 50
Total operating expenses 1,471 1,618
383 287
Interest expense 29 33
Other expense (income) 11 (4 )
Income from continuing operations before income taxes $ 343 $ 258
Pretax margin - continuing operations 18.5 % 13.5 %
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Revenue
Commissions, fees and otherdecreased by $26 million or 1% driven by a $190 million negative impact from foreign currency translation, which more than offset the addition of Benfield's revenues and overall organic growth of 1%.
Investment income decreased $25 million due to lower interest rates and the negative impact of foreign currency translation.
Expenses
Compensation and benefits decreased $140 million or 12%. Driving the decrease is a $132 million favorable impact from foreign currency translation and a $83 million pension curtailment gain related to the decision to cease crediting future benefits relating to salary and service in our U.S. defined benefit pension plans. In addition, we incurred lower incentive costs and $9 million of lower restructuring charges. Partially offsetting these items were higher expenses reflecting the inclusion of Benfield's operations in our results, along with higher pension expense, which was principally driven by declines in equity assets and a lower U.S. discount rate.
Other general expenses decreased $17 million or 4%. The decrease was driven by $47 million in favorable foreign currency translation and lower costs related to the FCPA and anti-corruption reviews and related compliance initiatives, partially offset by Benfield's cost of operations.
Depreciation and amortization expense increased $10 million or 20%, resulting primarily from amortization of intangibles related to the Benfield merger.
Interest expense decreased $4 million reflecting the impact of lower interest rates and favorable foreign exchange translation.
Other expense of $11 million for the current quarter primarily reflects costs related to the integration of Benfield. In 2008, we recorded $4 million of income, which was mostly due to a gain on the sale of land in the U.K.
Income from Continuing Operations Before Income Taxes
Income from continuing operations before income taxes for the first quarter 2009 increased $85 million or 33% to $343 million. The improvement is mainly attributable to the $83 million pension curtailment gain, the positive impact of Benfield and other acquisitions, lower restructuring costs, and organic revenue growth, which more than offset lower investment income and the unfavorable impact of foreign currency translation.
Income Taxes
The effective tax rate for continuing operations was 31.5% for first quarter 2009 compared to 29.5% for first quarter 2008. The rates for both periods were favorably impacted by the benefit of statutory rate reductions in key operating jurisdictions in 2008 and the projected geographic distribution of earnings in both years. The increase from 2008 was driven by a noncash deferred tax expense on the U.S. pension curtailment gain. The underlying tax rate for continuing operations is approximately 29% for 2009.
Income from Continuing Operations
Income from continuing operations for first quarter 2009 and 2008 was $235 million and $182 million, respectively. Basic and diluted income per share in the first quarter 2009 was $0.81 and $0.80, respectively, versus $0.57 and $0.55 in 2008, respectively. Currency fluctuations negatively impacted income from continuing operations in 2009 by $0.02 per diluted share when we translate last year's statement of income at this year's foreign exchange rates. 2008's income from continuing operations was positively impacted by $0.08 per diluted share. Our basic and diluted per share calculations were favorably impacted this year by lower shares outstanding as a result of shares acquired last year as part of our share repurchase program.
Discontinued Operations
First quarter income from discontinued operations was $50 million ($0.18 and $0.17 per basic and diluted share, respectively) for 2009 versus income of $41 million for 2008 ($0.13 for both basic and diluted share). Results for 2009 primarily reflect the gain on the sale of AIS, a curtailment gain on the post-retirement benefit plan related to the CICA disposal and residual tax settlements related to our AWG disposal. Our results for 2008 principally reflect first quarter operating results from our AIS, CICA, and Sterling businesses.
REVIEW BY SEGMENT
General
We classify our businesses into two operating segments: Risk and Insurance Brokerage Services and Consulting.
Segment revenue includes investment income generated by invested assets of that segment, as well as the impact of related derivatives. Our Risk and Insurance Brokerage Services and Consulting businesses invest funds held on behalf of clients and operating funds in short-term obligations.
The following table and commentary provide selected financial information on the operating segments (in millions):
First Quarter Ended
March 31,
2009 2008
Commissions, fees and other revenue: (1)
Risk and Insurance Brokerage Services $ 1,520 $ 1,515
Consulting 308 342
Investment income:
Risk and Insurance Brokerage Services $ 30 $ 51
Consulting 1 1
Income before income taxes:
Risk and Insurance Brokerage Services $ 328 $ 243
Consulting 70 63
Pretax Margins:
Risk and Insurance Brokerage Services 21.2 % 15.5 %
Consulting 22.7 % 18.4 %
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Risk and Insurance Brokerage Services
Aon is a leader in many sectors of the insurance industry. Aon was ranked in 2008 by Business Insurance as the world's largest insurance broker, by A.M. Best as the number one global insurance brokerage based on brokerage revenues, and voted the best insurance intermediary and best reinsurance intermediary by the readers of Business Insurance.
In 2008, we experienced a soft market in many business lines/segments and in many geographic areas. In a "soft market," premium rates flatten or decrease, along with commission revenues, due to increased competition for market share among insurance carriers or increased underwriting capacity. Prices fell throughout the year, although the rate of decline slowed toward the end of the year. In the first quarter 2009, we continued to see a soft market in our retail business. In reinsurance, pricing overall was flat to up slightly, with firmer pricing primarily in the U.S. property catastrophe areas. Changes in premiums have a direct and potentially material impact on the insurance brokerage industry, as commission revenues are generally based on a percentage of the premiums paid by insureds.
We are facing increasingly difficult conditions as a result of unprecedented disruptions in the global economy, the repricing of credit risk and the deterioration of the financial markets. Continued volatility and further deterioration in the credit markets may reduce our customers' demand for our brokerage and reinsurance services and products, which could hurt our operational results and financial condition. In addition, overall capacity in the industry could decrease if a significant insurer either fails or withdraws from writing insurance coverages that we offer our clients. This failure could reduce our revenues and profitability, since we would no longer have access to certain lines and types of insurance.
Risk and Insurance Brokerage Services generated approximately 83% of Aon's total operating segment revenues for first quarter 2009. Revenues are generated primarily through:
† fees paid by clients,
† commissions and fees paid by insurance and reinsurance companies, and
† interest income on funds held on behalf of clients.
Our revenues vary from quarter to quarter throughout the year as a result of:
† the timing of our clients' policy renewals, † the net effect of new and lost business, † the timing of services provided to our clients, and † the income we earn on investments, which is heavily influenced by short-term interest rates. |
Revenue
This table shows Risk and Insurance Brokerage Services commissions, fees and
other revenue (in millions):
First Quarter Ended March 31,
Less:
Less: Acquisitions, Organic
Percent Currency Divestitures, Revenue
2009 2008 Change Impact & Other Growth
Americas $ 477 $ 493 (3 )% (5 )% - % 2 %
United Kingdom 116 150 (23 ) (19 ) 1 (5 )
Europe, Middle East & Africa 448 510 (12 ) (12 ) - -
Asia Pacific 84 106 (21 ) (18 ) (1 ) (2 )
Reinsurance 395 256 54 (8 ) 61 1
Total $ 1,520 $ 1,515 - % (10 )% 9 % 1 %
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† The 3% decline in Americas revenue is driven by unfavorable foreign currency translation. Organic revenue growth is 2%, reflecting strong growth in Latin America as well as growth in our Canadian and Affinity operations. This growth was tempered by soft market conditions in our U.S. retail operations, as well as overall economic weakness, especially in the construction and private equity sectors.
† U.K. revenue declined 23% due to unfavorable foreign currency translation and a 5% decline in organic revenue, reflecting soft market conditions as well as lower new business.
† Europe, Middle East & Africa revenue decreased 12%, reflecting unfavorable foreign currency translation. Organic growth was unchanged as strong growth in emerging markets was offset by weak economic conditions in continental Europe.
† Asia Pacific revenue declined 21%, driven by unfavorable foreign currency translation and 2% organic decline, reflecting the impact of economic weakness in Asia, the impact from exiting certain businesses in Japan, and political unrest in Thailand, partially offset by strong growth in New Zealand.
† Reinsurance revenue increased 54% due to the impact of the Benfield and Gallagher Re acquisitions in 2008 and 1% organic revenue growth, driven primarily by growth in global treaty placements, partially offset by unfavorable foreign currency translation.
Income Before Income Taxes
First quarter 2009 income before income taxes, increased $85 million to $328 million. In 2009, pretax margins in this segment were 21.2%, up 570 basis points from 15.5% in 2008. Contributing to the increased margins and pretax income were organic revenue growth of 1%, along with:
† $58 million gain from the pension curtailment, † $13 million in lower costs related to anti-corruption and compliance initiatives, † lower restructuring costs, and † lower incentive expenses. |
These improvements were partially offset by:
† $21 million lower investment income, † $10 million in Benfield integration costs, † $10 million impact of unfavorable foreign exchange rates, and † $5 million gain on sale of land in 2008. |
Consulting
Aon Consulting is one of the world's largest integrated human capital consulting organizations. Our Consulting segment:
† provides a broad range of consulting services and outsourcing, and
† generated 17% of Aon's total operating segment revenue for first quarter 2009.
The recent disruption in the global credit markets and the deterioration of the financial markets has created significant uncertainty in the marketplace. A severe and/or prolonged economic downturn could hurt our clients' financial condition and the levels of business activities in the industries and geographies where we operate. While we believe that the majority of our practices are well positioned to manage through this time, these challenges may reduce demand for some of our services or depress pricing of those services and have an adverse effect on our new business and results of operations.
Consulting Services are provided in four practice areas:
1. Health and Benefits advises clients about how to structure, fund, and administer employee benefit programs that attract, retain, and motivate employees. Benefits consulting includes health and welfare, executive benefits, workforce strategies and productivity, absence management, benefits administration, data-driven health, compliance, employee commitment, investment advisory and elective benefits services.
2. Retirement professionals specialize in global actuarial services, defined contribution consulting, investment consulting, tax and ERISA consulting, and pension administration.
3. Compensation focuses on compensatory advisory/counsel including:
compensation planning design, executive reward strategies, salary survey and
benchmarking, market share studies and sales force effectiveness, with special
expertise in the financial services and technology industries.
4. Strategic Human Capital delivers advice to complex global organizations on talent, change and organizational effectiveness issues, including talent strategy and acquisition, executive on-boarding, performance management, leadership assessment and development, communication strategy, workforce training and change management.
Outsourcing, which offers employment processing, performance improvement, benefits administration and other employment-related services.
Revenue
This table shows Consulting commissions, fees and other revenue (in millions):
First Quarter Ended March 31,
Less:
Less: Acquisitions, Organic
Percent Currency Divestitures, Revenue
2009 2008 Change Impact & Other Growth
Consulting Services $ 263 $ 288 (9 )% (10 )% (1 )% 2 %
Outsourcing 45 54 (17 ) (13 ) - (4 )
Total $ 308 $ 342 (10 )% (10 )% (2 )% 2 %
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† Consulting Services commissions, fees and other revenue decreased $25 million or 9% due to unfavorable foreign currency translation. Organic revenue growth was 2%, reflecting growth in health and benefits consulting, partially offset by a decline in human capital consulting, including a significant decline in compensation consulting.
† Outsourcing revenue decreased $9 million due to unfavorable foreign currency translation and a 4% decline in organic revenue, reflecting the termination of our contract with AT&T, partially offset by modest growth in benefits outsourcing.
Income Before Income Taxes
First quarter 2009 pretax income increased 11% to $70 million, compared to $63 million in 2008. 2009 pretax margins in this segment were 22.7%, an increase of 430 basis points from 18.4% in 2008. The pretax income and margin improvement was principally driven by the $21 million gain from the pension curtailment and 2% organic revenue growth in Consulting Services. These improvements were partially offset by $6 million unfavorable impact of foreign currency translation.
Unallocated Income and Expense
Unallocated income consists primarily of investment income, including gain or loss on investment disposals and other-than-temporary impairment losses, if any, which is not otherwise reflected in the operating segments. We include invested assets and related investment income not directly required to support the risk and insurance brokerage services and consulting businesses.
Unallocated investment income was $1 million for first quarter 2009, a decrease of $4 million over 2008, and was driven by:
† $2 million decrease from our PEPS I investment, † lower interest rates, and † the unfavorable impact of foreign currency translation. |
Unallocated expenses include corporate governance costs not allocated to the operating segments. These expenses increased to $27 million from $20 million in 2008, driven by:
† higher pension expense, and
† increased corporate staff expenses.
The higher costs were partially offset by a $4 million gain from the pension curtailment.
Interest expense, which represents the cost of our worldwide debt obligations, decreased $4 million in 2009 to $29 million, primarily due to lower interest rates and the favorable impact of foreign currency translation.
FINANCIAL CONDITION AND LIQUIDITY
Cash Flows
Cash flows from operating activities
Cash flows from operating activities were $553 million for the three months ended March 31, 2009, compared to $516 million for the three months ended March 31, 2008. The operating cash flows depend on the timing of receipts and payments related to revenues, incentive compensation, other operating expenses, income taxes and funds held on behalf of clients.
Gains from disposal of businesses were $92 million in 2009, principally the sale of our AIS business, which resulted in an $86 million gain. There were no gains or losses from the disposal of businesses in 2008.
Amortization of intangible assets was $23 million in 2009 compared to $14 million in 2008. The increase in amortization reflects the purchase of Benfield, and the associated intangible assets, in late 2008.
Stock compensation expense was $40 million in 2009 and $82 million in 2008. The decrease between years was due primarily to an acceleration of expense in 2008 due to modification of stock awards and options related to the sale of CICA, reduction of expense associated with the conversion of our stock administration system to a new service provider, and a reduction of expense related to performance-based incentives.
In our Risk and Insurance Brokerage Services segment, we typically hold funds on behalf of clients as a result of premiums received from clients and claims due to clients that are in transit to insurers. These funds held on behalf of clients are generally invested in interest bearing premium trust accounts and can fluctuate significantly depending on when we collect cash from our clients and when premiums are remitted to the insurance carriers. Aon earns interest on these accounts, which is permitted under applicable laws and regulations. However, the principal is segregated and not available for general operating expenses. During 2009, the net change in the premium trust accounts was $512 million.
Net receivables reflect changes in brokerage commission and fees, consulting work in progress, premium finance notes and other items. These types of receivables fluctuate based on when invoices are billed and cash collected.
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