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AON > SEC Filings for AON > Form 10-K on 18-Feb-2014All Recent SEC Filings

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Form 10-K for AON PLC


18-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
EXECUTIVE SUMMARY OF 2013 FINANCIAL RESULTS
During 2013, we continued to face certain headwinds impacting our business. In our Risk Solutions segment, these headwinds included economic weakness in continental Europe and a significant decline in investment income due to lower short-term interest rates globally. In our HR Solutions segment, these headwinds included price compression in our benefits administration business and competitive pressures across continental Europe. The following is a summary of our 2013 financial results:
Revenue increased $301 million, or 3%, compared to the prior year to $11.8 billion in 2013 due primarily to solid organic revenue growth of 3% in the Risk Solutions segment and 3% in the HR Solutions segment, and a 1% increase in commissions and fees resulting from acquisitions, net of divestitures, partially offset by a 1% unfavorable impact from foreign currency translation. The increase in revenue was driven by strong management of the renewal book portfolio and strong new business growth across our Retail business, as well as solid growth in our Reinsurance business, and new client wins in our HR Solutions segment with notable growth in heath care exchanges.

         Operating expenses increased $226 million, or 2%, compared to the prior
          year to $10.1 billion in 2013 due primarily to an increase in expense
          associated with organic revenue growth of 3%, an increase in
          restructuring charges of $76 million and $20 million of legacy,
          non-recurring claims handling charges, partially offset by lower
          intangible asset amortization expenses of $28 million, a decrease in
          headquarters relocation costs of $19 million, benefits achieved from
          the restructuring plans and a $43.5 million favorable impact from
          settlement of a non-recurring, one-time legal matter.



         Operating margin increased to 14.1% in 2013 from 13.9% in 2012. The
          increase in operating margin from the prior year is primarily related
          to organic revenue growth of 3%, decreased intangible asset
          amortization, and benefits achieved from the restructuring plans. Risk
          Solutions operating margin increased to 19.8% in 2013 from 19.6% in
          2012. HR Solutions operating margin increased to 7.8% in 2013 from 7.4%
          in 2012.



         Net income attributable to Aon shareholders was $1.1 billion, an
          increase of $120 million, or 12%, from $993 million in 2012. Diluted
          earnings per share increased to $3.53 in 2013 from $2.99 in 2012.



         Cash flows provided by operating activities was $1.6 billion in 2013,
          an increase of $214 million, or 15%, from $1.4 billion in 2012, due
          primarily to growth in net income, strong working capital performance,
          and a decrease in pension contributions, partially offset by an
          increase in cash paid for taxes. Cash flow from operations in 2013 was
          also favorably impacted by the $43.5 million settlement of a
          non-recurring, one-time legal matter.

We focus on four key non-GAAP metrics that we communicate to shareholders: grow organically, expand adjusted margins, increase adjusted diluted earnings per share, and increase free cash flow. The following is our measure of performance against these four metrics for 2013:

         Organic revenue growth, a non-GAAP measure as defined under the caption
          "Review of Consolidated Results - Organic Revenue," was 3% in 2013.
          Organic revenue growth was driven by solid growth across our businesses
          in both Risk and HR Solutions. In Risk Solutions, organic revenue
          growth was driven by strong management of the renewal book portfolio
          and strong new business growth across our Retail Business, as well as
          growth in treaty placements in Reinsurance. In HR Solutions, organic
          growth was driven by new client wins in outsourcing, primarily health
          care exchanges, and solid growth across consulting.



         Adjusted operating margin, a non-GAAP measure as defined under the
          caption "Review of Consolidated Results - Adjusted Operating Margin,"
          was 19.0% for Aon overall, 22.5% for the Risk Solutions segment, and
          16.7% for the HR Solutions segment in 2013. In 2012, adjusted operating
          margin was 18.6% for Aon overall, 21.7% for the Risk Solutions segment,
          and 16.6% for the HR Solutions segment. The increase in adjusted
          operating margin for the Risk Solutions segment reflects solid organic
          revenue growth and restructuring savings, partially offset by an
          unfavorable impact from foreign currency translation and a decline in
          fiduciary investment income. The increase in adjusted operating margin
          for the HR Solutions segment reflects solid organic revenue growth and
          restructuring savings, partially offset by continued investment in
          long-term growth opportunities.



         Adjusted diluted earnings per share from net income attributable to
          Aon's shareholders, a non-GAAP measure as defined under the caption
          "Review of Consolidated Results - Adjusted Diluted Earnings per Share,"
          was $4.89


per share in 2013, an increase of $0.68 per share, or 16%, from $4.21 per share in 2012. The increase demonstrates solid operational performance and effective capital management despite a difficult business environment, as well as the impact of $1.1 billion of share repurchases during 2013.

         Free cash flow, a non-GAAP measure as defined under the caption "Review
          of Consolidated Results - Free Cash Flow," was $1.4 billion in 2013, an
          increase of $254 million, or 22%, from $1.2 billion in 2012. The
          increase in free cash flow from the prior year was driven by strong
          cash flow from operations of $1.6 billion in 2013 and a 15%, or $40
          million, decrease in capital expenditures.

During 2013, we continued to execute against the strategic goals of the Redomestication. We believe the Redomestication will continue to strengthen our long term strategy by:
Enabling Risk Solutions to deliver superior value to our clients by executing our Aon Broking strategy;

         Expanding the HR Solutions portfolio penetration, especially within
          consulting, which already has a significant presence in the U.K. and
          EMEA;

Enhancing our Risk Solutions' relationship with, and integration into, London markets;

         Increasing our connection to emerging markets, accelerating our ability
          to grow there, and further aligning our strategy with underwriters and
          carriers who are also targeting these high growth markets;

Strengthening our international brand awareness and positioning as a global firm;

         Advancing our talent strategy through better development, retention and
          acquisition of professional talent, with a special focus on London's
          insurance talent;



         Optimizing our fiscal planning and capital allocation and reducing our
          global tax rate in a manner that provides us with the increased
          financial flexibility to properly invest in our growth.

REVIEW OF CONSOLIDATED RESULTS
General
In our discussion of operating results, we sometimes refer to certain non-GAAP supplemental information derived from consolidated financial information specifically related to organic revenue growth, adjusted operating margin, adjusted diluted earnings per share, free cash flow, and the impact of foreign exchange rate fluctuations on operating results. Organic Revenue
We use supplemental information related to organic revenue to help us and our investors evaluate business growth from existing operations. Organic revenue is a non-GAAP measure and excludes the impact of foreign exchange rate changes, acquisitions, divestitures, transfers between business units, fiduciary investment income, reimbursable expenses, and certain unusual items. Supplemental information related to organic revenue growth represents a measure not in accordance with U.S. GAAP, and should be viewed in addition to, not instead of, our Consolidated Financial Statements and Notes thereto. Industry peers provide similar supplemental information about their revenue performance, although they may not make identical adjustments. Reconciliation of this non-GAAP measure, organic revenue growth percentages to the reported Commissions, fees and other revenue growth percentages, has been provided in the "Review by Segment" caption, below.
Adjusted Operating Margin
We use adjusted operating margin as a non-GAAP measure of core operating performance of our Risk Solutions and HR Solutions segments. Adjusted operating margin excludes the impact of certain items, including restructuring charges, intangible asset amortization and headquarters relocation costs. This supplemental information related to adjusted operating margin represents a measure not in accordance with U.S. GAAP, and should be viewed in addition to, not instead of, our Consolidated Financial Statements and Notes thereto.


A reconciliation of this non-GAAP measure to the reported operating margin is as follows (in millions):

                                  Total          Risk            HR
Year Ended December 31, 2013     Aon (1)      Solutions      Solutions
Revenue - U.S. GAAP             $ 11,815     $    7,789     $    4,057
Operating income - U.S. GAAP    $  1,671     $    1,540     $      318
Restructuring charges                174             94             80
Intangible asset amortization        395            115            280
Headquarters relocation costs          5              -              -
Operating income - as adjusted  $  2,245     $    1,749     $      678
Operating margins - U.S. GAAP       14.1 %         19.8 %          7.8 %
Operating margins - as adjusted     19.0 %         22.5 %         16.7 %


                                  Total          Risk            HR
Year Ended December 31, 2012     Aon (1)      Solutions      Solutions
Revenue - U.S. GAAP             $ 11,514     $    7,632     $    3,925
Operating income - U.S. GAAP    $  1,596     $    1,493     $      289
Restructuring charges                101             35             66
Intangible asset amortization        423            126            297
Headquarters relocation costs         24              -              -
Operating income - as adjusted  $  2,144     $    1,654     $      652
Operating margins - U.S. GAAP       13.9 %         19.6 %          7.4 %
Operating margins - as adjusted     18.6 %         21.7 %         16.6 %


                                                 Total          Risk            HR
Year Ended December 31, 2011                    Aon (1)      Solutions      Solutions
Revenue - U.S. GAAP                            $ 11,287     $    7,537     $    3,781
Operating income - U.S. GAAP                   $  1,596     $    1,413     $      336
Restructuring charges                               113             65             48
Legacy receivables write-off                         18             18              -
Intangible asset amortization                       362            129            233
Transaction related costs - UK reincorporation        3              -              -
Hewitt related costs                                 47              -             47
Operating income - as adjusted                 $  2,139     $    1,625     $      664
Operating margins - U.S. GAAP                      14.1 %         18.7 %          8.9 %
Operating margins - as adjusted                    19.0 %         21.6 %         17.6 %

(1) Includes unallocated expenses and the elimination of inter-segment revenue.

Adjusted Diluted Earnings per Share
We also use adjusted diluted earnings per share as a non-GAAP measure of our core operating performance. Adjusted diluted earnings per share excludes the impact of restructuring charges, intangible asset amortization, headquarters relocation costs, Hewitt related costs, and other unusual items, along with related income taxes. This supplemental information related to adjusted diluted earnings per share represents a measure not in accordance with U.S. GAAP and should be viewed in addition to, not instead of, our Consolidated Financial Statements and Notes thereto.


Reconciliations of this non-GAAP measure to the reported diluted earnings per share are as follows (in millions except per share data):

Year Ended December 31, 2013                       U.S. GAAP       Adjustments      As Adjusted
Operating income                                 $     1,671     $         574     $     2,245
Interest income                                            9                 -               9
Interest expense                                        (210 )               -            (210 )
Other income                                              68                 -              68
Income before income taxes                             1,538               574           2,112
Income taxes                                             390               146             536
Net income                                             1,148               428           1,576
Less: Net income attributable to noncontrolling
interests                                                 35                 -              35
Net income attributable to Aon shareholders      $     1,113     $         428     $     1,541
Diluted earnings per share                       $      3.53     $        1.36     $      4.89
Weighted average common shares outstanding -
diluted                                                315.4             315.4           315.4


Year Ended December 31, 2012                       U.S. GAAP       Adjustments      As Adjusted
Operating income                                 $     1,596     $         548     $     2,144
Interest income                                           10                 -              10
Interest expense                                        (228 )               -            (228 )
Other income                                               2                 2               4
Income before income taxes                             1,380               550           1,930
Income taxes                                             360               144             504
Net income                                             1,020               406           1,426
Less: Net income attributable to noncontrolling
interests                                                 27                 -              27
Net income attributable to Aon shareholders      $       993     $         406     $     1,399
Diluted earnings per share                       $      2.99     $        1.22     $      4.21
Weighted average common shares outstanding -
diluted                                                332.6             332.6           332.6


Year Ended December 31, 2011                       U.S. GAAP       Adjustments      As Adjusted
Operating income                                 $     1,596     $         543     $     2,139
Interest income                                           18                 -              18
Interest expense                                        (245 )               -            (245 )
Other income                                              19                19              38
Income before income taxes                             1,388               562           1,950
Income taxes                                             378               153             531
Net income                                             1,010               409           1,419
Less: Net income attributable to noncontrolling
interests                                                 31                 -              31
Net income attributable to Aon shareholders      $       979     $         409     $     1,388
Diluted earnings per share                       $      2.87     $        1.20     $      4.07
Weighted average common shares outstanding -
diluted                                                340.9             340.9           340.9

Free Cash Flow
We use free cash flow, defined as cash flow provided by operations minus capital expenditures, as a non-GAAP measure of our core operating performance. This supplemental information related to free cash flow represents a measure not in accordance with U.S. GAAP and should be viewed in addition to, not instead of, our Consolidated Financial Statements and Notes thereto. The use of this non-GAAP measure does not imply or represent the residual cash flow for discretionary expenditures.


Reconciliations of this non-GAAP measure to Cash flow provided by operations are as follows (in millions):

Years Ended December 31,                     2013        2012        2011
Cash flow provided by operations-U.S. GAAP $ 1,633     $ 1,419     $ 1,018
Less: Capital expenditures                    (229 )      (269 )      (241 )
Free cash flow                             $ 1,404     $ 1,150     $   777

Impact of Foreign Exchange Rate Fluctuations Because we conduct business in more than 120 countries, foreign exchange rate fluctuations have a significant 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, to give financial statement users meaningful information about our operations, we have provided an illustration of the impact of foreign currency exchange rates on our financial results. The methodology used to calculate this impact isolates the impact of the change in currencies between periods by translating last year's revenue, expenses and net income, using current year's foreign exchange rates. Using this illustrative methodology, currency fluctuations had an unfavorable impact of $0.03, $0.06, and favorable impact of $0.04 during the years ended December 31, 2013, 2012, and 2011, respectively, on adjusted net income per diluted share, when we translate prior year results at current year end foreign exchange rates. These translations are performed for comparative and illustrative purposes only and do not impact the accounting policy or practices for amounts included in the Consolidated Financial Statements.
Summary of Results
Our consolidated results of operations follow (in millions):

Years ended December 31,                                     2013         2012         2011
Revenue:
Commissions, fees and other                               $ 11,787     $ 11,476     $ 11,235
Fiduciary investment income                                     28           38           52
Total revenue                                               11,815       11,514       11,287
Expenses:
Compensation and benefits                                    6,945        6,709        6,567
Other general expenses                                       3,199        3,209        3,124
Total operating expenses                                    10,144        9,918        9,691
Operating income                                             1,671        1,596        1,596
Interest income                                                  9           10           18
Interest expense                                              (210 )       (228 )       (245 )
Other income                                                    68            2           19
Income before income taxes                                   1,538        1,380        1,388
Income taxes                                                   390          360          378
Net income                                                   1,148        1,020        1,010
Less: Net income attributable to noncontrolling interests       35           27           31
Net income attributable to Aon shareholders               $  1,113     $    993     $    979


Consolidated Results for 2013 Compared to 2012
Revenue

Revenue increased by $301 million, or 3%, to $11.8 billion in 2013, compared to $11.5 billion in 2012. The increase was driven by organic revenue growth of 3% in the Risk Solutions segment and 3% in the HR Solutions segment. Organic growth in the Risk Solutions segment was driven by solid growth across both Retail and Reinsurance. Strong growth in Latin America, solid new business growth in U.S. Retail and strong management of the renewal book portfolio across the region drove organic revenue growth in the Americas. International organic revenue growth was driven by strong growth in Asia, emerging markets and New Zealand. Reinsurance organic growth was driven by growth in international treaty placements. Organic growth in the HR Solutions segment was driven by strong growth in health care exchanges, growth in investment and compensation consulting and strong growth in health care exchanges, modest growth in benefits administration and HR BPO, partially offset by a modest decline in actuarial services in retirement consulting.


Compensation and Benefits
Compensation and benefits increased $236 million, or 4%, compared to 2012. The increase was driven by an increase in expense associated with 3% organic revenue growth, partially offset by the impact of realization of benefits from restructuring initiatives.
Other General Expenses
Other general expenses remained flat in 2013 compared to 2012 due largely to a decrease in intangible amortization of $28 million, decreased costs related to the headquarters relocation of $19 million, a $43.5 million favorable impact from settlement of a non-recurring one-time legal matter and restructuring savings, partially offset by a $76 million increase in formal restructuring costs and $20 million of legacy, non-recurring claims handling charges. Interest Income
Interest income represents income earned on operating cash balances and other income-producing investments. It does not include interest earned on funds held on behalf of clients. Interest income decreased $1 million, or 10%, from 2012, due to lower average interest rates globally and lower average cash balances. Interest Expense
Interest expense, which represents the cost of our worldwide debt obligations, decreased $18 million, or 8%, from 2012. The decrease in interest expense reflects a decline in the average rate on total debt outstanding. Other Income
Other income increased $66 million from $2 million in 2012 to $68 million in 2013. Other income in 2013 includes $28 million in gains on investments, equity earnings of $20 million, foreign exchange gains of $13 million, and $10 million in gains on disposal of businesses, partially offset by a $10 million loss from derivatives. Other income in 2012 includes equity earnings of $13 million and $7 million in gains on investments, partially offset by foreign exchange losses of $19 million.
Income before Income Taxes
Income before income taxes was $1.5 billion in 2013, an increase of $158 million, or 11%, from $1.4 billion in 2012. Income Taxes
The effective tax rate on net income was 25.4% in 2013 and 26.1% in 2012. The 2013 rate reflects certain discrete tax adjustments and changes in the geographic distribution of income. The 2012 rate reflects the release of a valuation allowance relating to foreign tax credits and net operating losses, partially offset by the impact of a U.K. tax rate change. The effective tax rate is expected to decrease over time.
Net Income
Net income increased to $1.1 billion ($3.53 diluted net income per share) in 2013, compared to $1.0 billion ($2.99 diluted net income per share) in 2012. Consolidated Results for 2012 Compared to 2011 Revenue
Revenue increased by $227 million, or 2%, to $11.5 billion in 2012, compared to $11.3 billion in 2011. The increase was driven by organic revenue growth of 4% for both the Risk Solutions and HR Solutions segments. Organic growth in the Risk Solutions segment was driven by solid growth across all regions, including strong new business growth for U.S. retail and continued management of the renewal book portfolio in the Americas. International organic revenue growth was driven by strong growth in Asia and in emerging markets, as well as modest growth in continental Europe. Reinsurance organic growth was driven by strong growth across global treaty, driven by favorable pricing in the near-term and new business growth, partially offset by a significant decline in capital market transactions and advisory business. Organic growth in the HR Solutions segment was driven by growth in investment consulting, pension administration services, talent and rewards, and communications consulting, as well as new client wins in HR BPO, partially offset by a modest decline in benefits administration.


Compensation and Benefits
Compensation and benefits increased $142 million, or 2%, compared to 2011. The increase was driven by 4% organic revenue growth, partially offset by the impact of realization of benefits from restructuring initiatives. Other General Expenses
Other general expenses increased by $85 million, or 3%, in 2012 compared to 2011. The increase was due largely to an increase in intangible amortization of $61 million and increased costs related to the headquarters relocation of $21 million. These increased costs were partially offset by lower restructuring charges of $12 million and restructuring savings. Interest Income
Interest income represents income earned on operating cash balances and other income-producing investments. It does not include interest earned on funds held on behalf of clients. Interest income decreased $8 million, or 44%, from 2011, due to lower average interest rates globally. Interest Expense
Interest expense, which represents the cost of our worldwide debt obligations, decreased $17 million, or 7%, from 2011. The decrease was due primarily to lower average debt outstanding during the year, as well as the use of commercial paper to meet short-term working capital needs. Other Income
Other income in 2012 of $2 million decreased $17 million from 2011. The decrease in income was the result of foreign exchange gains (losses) that were $26 million of additional loss in 2012 and an $11 million decrease in gains related to long-term investments, partially offset by $6 million of additional income from equity method investments and $19 million loss on extinguishment of debt in 2011.
Income before Income Taxes
Income before income taxes was $1.4 billion, flat compared to $1.4 billion in 2011.
Income Taxes
The effective tax rate on income was 26.1% in 2012 and 27.3% in 2011. The 2012 rate reflects the release of a valuation allowance relating to foreign tax credits and net operating losses, partially offset by the impact of a U.K. tax rate change. The 2011 rate reflects the release of a valuation allowance relating to foreign tax credits offset partially by net unfavorable deferred tax . . .

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