AON PLC – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
EXECUTIVE SUMMARY OF FIRST QUARTER 2022 FINANCIAL RESULTS
Aon plc is a leading global professional services firm providing a broad range of risk, health, and wealth solutions. Through our experience, global reach, and comprehensive analytics, we are better able to help clients meet rapidly changing, increasingly complex, and interconnected challenges. We are committed to accelerating innovation to address unmet and evolving client needs, so that our clients are better informed, better advised, and able to make better decisions to protect and grow their business. Management is focused on strengtheningAon and uniting the firm with one portfolio of capability enabled by data and analytics and one operating model to deliver additional insight, connectivity, and efficiency.
Financial Results
The following is a summary of our first quarter of 2022 financial results.
•Revenue increased$145 million , or 4%, to$3.7 billion compared to the prior year period due primarily to organic revenue growth of 8%, partially offset by a 3% unfavorable impact if prior year period results were translated at current period foreign exchange rates ("foreign currency translation") and a 1% unfavorable impact from acquisitions, divestitures, and other. •Operating expenses were$2.3 billion , an increase of$23 million from the prior year period. The increase was due primarily to an increase in expense associated with 8% organic revenue growth and investments in long-term growth, partially offset by a$43 million favorable impact from foreign currency translation and a decrease in transaction costs incurred in the prior year period of$35 million .
•Operating margin increased to 37.2% from 35.3% in the prior year period. The
increase was driven by organic revenue growth of 8%, partially offset by an
increase in operating expenses as listed above.
•Due to the factors set forth above, Net income increased
million
•Diluted earnings per share was
year period.
•Cash flows provided by operating activities was$463 million , a decrease of$98 million from the prior year period, primarily due to higher incentive compensation payments following strong performance in 2021, partially offset by strong operating income growth. We focus on four key metrics not presented in accordance withU.S. GAAP that we communicate to shareholders: organic revenue growth, adjusted operating margin, adjusted diluted earnings per share, and free cash flow. These non-GAAP metrics should be viewed in addition to, not instead of, our Condensed Consolidated Financial Statements. The following is our measure of performance against these four metrics for the first quarter of 2022: •Organic revenue growth is a non-GAAP measure defined under the caption "Review of Consolidated Results - Organic Revenue Growth." Organic revenue growth was 8% for the first quarter of 2022, driven by ongoing strong retention and net new business generation. •Adjusted operating margin, a non-GAAP measure defined under the caption "Review of Consolidated Results - Adjusted Operating Margin," was 38.0% for the first quarter of 2022 compared to 37.4% in the prior year period. The increase in adjusted operating margin primarily reflects strong organic revenue growth, partially offset by expense growth and investments in long-term growth. •Adjusted diluted earnings per share, a non-GAAP measure defined under the caption "Review of Consolidated Results - Adjusted Diluted Earnings per Share," was$4.83 per share for the first quarter of 2022, compared to$4.28 per share for the respective prior year period. •Free cash flow, a non-GAAP measure defined under the caption "Review of Consolidated Results - Free Cash Flow," decreased in the first three months of 2022 by$92 million from the prior year period, to$440 million , reflecting a decrease in cash flows from operations, partially offset by a$6 million decrease in capital expenditures.
COVID-19 PANDEMIC
The outbreak of the coronavirus, which causes COVID-19, was declared by theWorld Health Organization to be a pandemic and has impacted almost all countries, in varying degrees, creating significant public health concerns, and significant volatility, uncertainty, and economic disruption in every region in which we operate. The COVID-19 pandemic has resulted, and may continue to result, in significant economic disruption and volatility, although much progress has been made in the development and distribution of vaccines, contributing to overall improved economic conditions globally. We continue to closely monitor the situation and its impacts on our business, liquidity, and capital planning initiatives. We continue to be fully operational and to reoccupy certain offices, where deemed appropriate and in compliance with governmental restrictions 26 -------------------------------------------------------------------------------- considering the impact on health and safety of our colleagues, their families, and our clients. We continue to deploy business continuity protocols and our Smart Working strategy to facilitate remote working capabilities to ensure the health and safety of our colleagues, to deliver results on behalf of clients, and to comply with public health and travel guidelines and restrictions. As the situation continues to evolve, the scale and duration of disruption cannot be predicted, and it is not possible to quantify or estimate the full impact that COVID-19 will have on our business. While we continue to focus on managing our cash flow to meet liquidity needs, our results of operations may be adversely affected. However, for the three months endedMarch 31, 2022 the impacts of COVID-19 on our business results have lessened and we have seen overall strength across the firm. We continue to monitor the situation closely.
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE
For many companies, the management of ESG risks and opportunities has become increasingly important.Aon offers a wide range of consulting and advisory solutions designed to address and manage ESG issues for clients. We view ESG risks as presenting an important opportunity to help clients and improve our impact on ESG matters. RUSSIAN WAR INUKRAINE The Russian war inUkraine , initiated onFebruary 24, 2022 , has resulted in certain sanctions being imposed by jurisdictions in which we operate, including theU.S. , the E.U., and theU.K. , onRussia and certain Russian companies and individuals. The Company's operations inRussia andUkraine represent an immaterial portion of the Company's global operations and the war has not had a material impact on the Company's global operations as ofMarch 31 2022 .
The Company continues to monitor the potential impacts on the business and the
ancillary impacts that the military conflict could have on other global
operations.
27 --------------------------------------------------------------------------------
REVIEW OF CONSOLIDATED RESULTS
Summary of Results
Our consolidated results are as follows (in millions):
Three Months Ended
2022 2021 Revenue Total revenue$ 3,670 $ 3,525 Expenses Compensation and benefits 1,767 1,719 Information technology 123 114 Premises 72 77 Depreciation of fixed assets 38 41 Amortization and impairment of intangible assets 28 40 Other general expense 275 289 Total operating expenses 2,303 2,280 Operating income 1,367 1,245 Interest income 3 3 Interest expense (91) (79) Other income (expense) 25 (2) Income before income taxes 1,304 1,167 Income tax expense 256 234 Net income 1,048 933 Less: Net income attributable to noncontrolling interests 25 20 Net income attributable to Aon shareholders$ 1,023 $ 913 Diluted net income per share attributable toAon shareholders
$ 4.73
Weighted average ordinary shares outstanding - diluted 216.4 228.1 Revenue Total revenue increased$145 million , or 4%, in the first quarter of 2022 compared to the first quarter of 2021. This increase reflects organic revenue growth of 8%, partially offset by a 3% unfavorable impact from foreign currency translation and a 1% unfavorable impact from acquisitions, divestitures, and other.Commercial Risk Solutions revenue increased$79 million , or 5%, to$1.7 billion in the first quarter of 2022, compared to$1.6 billion in the first quarter of 2021. Organic revenue growth was 9% in the first quarter of 2022, driven by growth across every major geography, reflecting strong retention, new business generation, and management of the renewal book portfolio. Strength in retail brokerage was highlighted by double-digit growth in theU.S. ,Canada ,Asia , and the Pacific, driven by continued strength in core P&C, as well as strong growth in construction and project-related work. Results also reflect solid growth globally in the affinity business across both consumer and business solutions, including growth in the travel and events practice. On average globally, exposures and pricing were modestly positive, resulting in a modestly positive market impact. Reinsurance Solutions revenue increased$54 million , or 6%, to$976 million in the first quarter of 2022, compared to$922 million in the first quarter of 2021. Organic revenue growth was 7% in the first quarter of 2022, driven by strong growth in treaty, reflecting strong retention and continued net new business generation, as well as strong growth in facultative placements and double-digit growth in capital markets transactions. Market impact was modestly positive on results in the quarter.Health Solutions revenue increased$23 million , or 4%, to$638 million in the first quarter of 2022, compared to$615 million in the first quarter of 2021. Organic revenue growth was 8% in the first quarter of 2022, driven by strong growth globally in core health and benefits brokerage, reflecting strong retention and management of the renewal book portfolio. Strength in health and benefits brokerage included solid growth in project-related work, driven by advisory work related to wellbeing and resilience. Results also reflect double-digit growth in Consumer Benefit Solutions and double-digit growth in Human Capital, driven by rewards and advisory solutions. 28 -------------------------------------------------------------------------------- Wealth Solutions revenue decreased$10 million , or 3%, to$345 million in the first quarter of 2022, compared to$355 million in the first quarter of 2021. Organic revenue growth was flat overall in the first quarter of 2022. Retirement was flat, reflecting modest growth in the core portion of the business, partially offset by a modest decline in project-related work. Investments grew modestly driven by new business generation and project-related work.
Compensation and Benefits
Compensation and benefits expenses increased$48 million , or 3%, in the first quarter of 2022 compared to the first quarter of 2021. This increase was primarily driven by an increase in expense associated with 8% organic revenue growth, partially offset by a$37 million favorable impact from foreign currency translation. Information Technology Information technology expenses, which represent costs associated with supporting and maintaining our infrastructure, increased$9 million , or 8%, in the first quarter of 2022 compared to the first quarter of 2021. This increase was primarily driven by an increase in expense associated with 8% organic revenue growth, partially offset by a$2 million favorable impact from foreign currency translation. Premises
Premises expenses, which represent the cost of occupying offices in various
locations throughout the world, decreased
quarter of 2022 compared to the first quarter of 2021. This decrease was
primarily driven by a reduction in rent expense associated with our Smart
Working strategy, which gives colleagues flexibility in where they work.
Depreciation of Fixed Assets
Depreciation of fixed assets primarily relates to software, leasehold improvements, furniture, fixtures, and equipment, computer equipment, buildings, and automobiles. Depreciation of fixed assets decreased$3 million , or 7%, in the first quarter of 2022 compared to the first quarter of 2021 due primarily to a$1 million favorable impact from foreign currency translation.
Amortization and Impairment of Intangible Assets
Amortization and impairment of intangible assets primarily relates to finite-lived tradenames and customer-related, contract-based, and technology assets. Amortization and impairment of intangible assets decreased$12 million , or 30%, in the first quarter of 2022 compared to the first quarter of 2021.
Other General Expense
Other general expense in the first quarter of 2022 decreased$14 million , or 5%, compared to the first quarter of 2021 due primarily to a decrease in transaction costs incurred in the prior year period of$35 million , partially offset by an increase in expense associated with 8% organic revenue growth and an increase in travel and entertainment expense.
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. During the first quarter of 2022, Interest income was$3 million , and flat compared to the first quarter of 2021.
Interest Expense
Interest expense, which represents the cost of our debt obligations, was$91 million for the first quarter of 2022, an increase of$12 million , or 15%, from the first quarter of 2021. The increase was driven primarily by higher outstanding term debt.
Other Income (Expense)
Other income was$25 million for the first quarter of 2022, compared to Other expense of$2 million for the first quarter of 2021. Other income for the first quarter of 2022 primarily reflects a gain from the sale of a business in Wealth Solutions. Income before Income Taxes Due to the factors discussed above, Income before income taxes for the first quarter of 2022 was$1,304 million , a 12% increase from$1,167 million in the first quarter of 2021. Income Taxes
The effective tax rates on Net income were 19.6% and 20.1% for the first quarter
of 2022 and 2021, respectively.
29 -------------------------------------------------------------------------------- For the three months endedMarch 31, 2022 andMarch 31, 2021 , the tax rate was primarily driven by the geographical distribution of income and certain discrete items.
Net Income Attributable to
Net income attributable to
increased to
Non-GAAP Metrics
In our discussion of consolidated 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. Management believes that these measures are important to make meaningful period-to-period comparisons and that this supplemental information is helpful to investors. Management also uses these measures to assess operating performance and performance for compensation. This non-GAAP supplemental information should be viewed in addition to, not instead of, our Condensed Consolidated Financial Statements.
Organic Revenue Growth
We use supplemental information related to organic revenue growth to help us and our investors evaluate business growth from existing operations. Organic revenue growth is a non-GAAP measure that includes the impact of intercompany activity and excludes the impact of changes in foreign exchange rates, fiduciary investment income, acquisitions, divestitures, transfers between revenue lines, and gains or losses on derivatives accounted for as hedges. This supplemental information related to organic revenue growth represents a measure not in accordance withU.S. GAAP and should be viewed in addition to, not instead of, our Condensed Consolidated Financial Statements. Industry peers provide similar supplemental information about their revenue performance, although they may not make identical adjustments. A reconciliation of this non-GAAP measure to the reported Total revenue is as follows (in millions, except percentages): Three Months Ended March 31, Less: Fiduciary Organic Less: Currency Investment Income Less: Acquisitions, Revenue Growth 2022 2021 % Change Impact (1) (2)
Divestitures & Other (3) Revenue Commercial Risk Solutions$ 1,719 $ 1,640 5 % (3) % - % (1) % 9 % Reinsurance Solutions 976 922 6 (2) - 1 7 Health Solutions 638 615 4 (3) - (1) 8 Wealth Solutions 345 355 (3) (2) - (1) - Eliminations (8) (7) N/A N/A N/A N/A N/A Total revenue$ 3,670 $ 3,525 4 % (3) % - % (1) % 8 % (1)Currency impact represents the effect on prior year period results if they were translated at current period foreign exchange rates. (2)Fiduciary investment income for the three months endedMarch 31, 2022 and 2021 was$2 million in each period. (3)Organic revenue growth includes the impact of intercompany activity and excludes the impact of changes in foreign exchange rates, fiduciary investment income, acquisitions, divestitures, transfers between revenue lines, and gains or losses on derivatives accounted for as hedges.
Adjusted Operating Margin
We use adjusted operating margin as a non-GAAP measure of our core operating performance. Adjusted operating margin excludes the impact of certain items, as listed below, because management does not believe these expenses are the best indicators of our core operating performance. This supplemental information related to adjusted operating margin represents a measure not in accordance withU.S. GAAP and should be viewed in addition to, not instead of, our Condensed Consolidated Financial Statements. 30 --------------------------------------------------------------------------------
A reconciliation of this non-GAAP measure to the reported operating margin is as
follows (in millions, except percentages):
Three Months Ended
2022 2021 Revenue$ 3,670 $ 3,525 Operating income - as reported$ 1,367 $ 1,245 Amortization and impairment of intangible assets 28 40
Transaction costs and other charges related to the combination
and resulting termination (1)
- 35 Operating income - as adjusted$ 1,395 $ 1,320 Operating margin - as reported 37.2 % 35.3 % Operating margin - as adjusted 38.0 % 37.4 % (1)As part of the terminated combination with WTW, certain transaction costs were incurred by the Company in the first quarter of 2021. These costs may include advisory, legal, accounting, valuation, and other professional or consulting fees related to the combination, including planned divestitures that have been terminated, as well as certain compensation expenses and expenses related to further steps on ourAon United operating model as a result of the termination.
Adjusted Diluted Earnings per Share
We use adjusted diluted earnings per share as a non-GAAP measure of our core operating performance. Adjusted diluted earnings per share excludes the items identified above, along with pension settlements and related income taxes, because management does not believe these expenses are representative of our core earnings. This supplemental information related to adjusted diluted earnings per share represents a measure not in accordance withU.S. GAAP and should be viewed in addition to, not instead of, our Condensed Consolidated Financial Statements. A reconciliation of this non-GAAP measure to reported diluted earnings per share is as follows (in millions, except per share data and percentages): Three Months Ended March 31, 2022 Non-GAAP U.S. GAAP Adjustments Adjusted Operating income$ 1,367 $ 28$ 1,395 Interest income 3 - 3 Interest expense (91) - (91) Other income (expense) 25 - 25 Income before income taxes 1,304 28 1,332 Income tax expense (1) 256 6 262 Net income 1,048 22 1,070 Less: Net income attributable to noncontrolling interests 25 - 25 Net income attributable to Aon shareholders$ 1,023 $ 22$ 1,045
Diluted net income per share attributable to
$ 0.10 $ 4.83 Weighted average ordinary shares outstanding - diluted 216.4 - 216.4 Effective tax rates (1) 19.6 % 19.7 % 31
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Three Months Ended March 31, 2021 Non-GAAP U.S. GAAP Adjustments Adjusted Operating income$ 1,245 $ 75$ 1,320 Interest income 3 - 3 Interest expense (79) - (79) Other income (expense) (2) - (2) Income before income taxes 1,167 75 1,242 Income tax expense (1) 234 11 245 Net income 933 64 997 Less: Net income attributable to noncontrolling interests 20 - 20 Net income attributable to Aon shareholders$ 913 $ 64$ 977
Diluted net income per share attributable to
$ 0.28 $ 4.28 Weighted average ordinary shares outstanding - diluted 228.1 - 228.1 Effective tax rates (1) 20.1 % 19.7 % (1)Adjusted items are generally taxed at the estimated annual effective tax rate, except for the applicable tax impact associated with certain transaction costs and other charges related to the combination and resulting termination, which are adjusted at the related jurisdictional rate.
Free Cash Flow
We use free cash flow, defined as cash flow provided by operations less capital expenditures, as a non-GAAP measure of our core operating performance and cash-generating capabilities of our business operations. This supplemental information related to free cash flow represents a measure not in accordance withU.S. GAAP and should be viewed in addition to, not instead of, our Condensed Consolidated Financial Statements. The use of this non-GAAP measure does not imply or represent the residual cash flow for discretionary expenditures. A reconciliation of this non-GAAP measure to the reported Cash provided by operating activities is as follows (in millions): Three Months Ended
2022
2021
Cash provided by operating activities $ 463$ 561 Capital expenditures (23) (29) Free cash flow $ 440$ 532
Impact of Foreign Exchange Rate Fluctuations
Because we conduct business in over 120 countries and sovereignties, foreign exchange rate fluctuations may have a significant impact on our business. 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 the prior year quarter's revenue, expenses, and net income using the current quarter's foreign exchange rates. Currency fluctuations had an unfavorable impact of$0.19 on net income per diluted share during the three months endedMarch 31, 2022 if prior year period results were translated at current period foreign exchange rates. Currency fluctuations had a favorable impact of$0.17 on net income per diluted share during the three months endedMarch 31, 2021 , respectively, if 2020 results were translated at 2021 rates. Currency fluctuations had an unfavorable impact of$0.19 on adjusted net income per diluted share during the three months endedMarch 31, 2022 if prior year period results were translated at current period foreign exchange rates. Currency fluctuations had a favorable impact of$0.18 on adjusted net income per diluted share during the three months endedMarch 31, 2021 , respectively, if 2020 results were translated at 2021 rates. These translations are performed for comparative and illustrative purposes only and do not impact the accounting policies or practices for amounts included in our Condensed Consolidated Financial Statements. 32 --------------------------------------------------------------------------------
LIQUIDITY AND FINANCIAL CONDITION
Liquidity
Executive Summary
We believe that our balance sheet and strong cash flow provide us with adequate liquidity. Our primary sources of liquidity in the near-term include cash flows provided by operations and available cash reserves; primary sources of liquidity in the long-term include cash flows provided by operations, debt capacity available under our credit facilities and capital markets. Our primary uses of liquidity are operating expenses and investments, capital expenditures, acquisitions, share repurchases, pension obligations, and shareholder dividends. We believe that cash flows from operations, available credit facilities, available cash reserves, and the capital markets will be sufficient to meet our liquidity needs, including principal and interest payments on debt obligations, capital expenditures, pension contributions, and anticipated working capital requirements in the next twelve months and over the long-term. Although there continues to be uncertainties around future economic conditions due to COVID-19, we have largely returned to normal levels of liquidity and will continue to monitor our needs as economic conditions change. Cash on our balance sheet includes funds available for general corporate purposes, as well as amounts restricted as to their use. Funds held on behalf of clients in a fiduciary capacity are segregated and shown together with uncollected insurance premiums in Fiduciary assets in our Condensed Consolidated Statements of Financial Position, with a corresponding amount in Fiduciary liabilities. In our capacity as an insurance broker or agent, we collect premiums from insureds and, after deducting our commission, remit the premiums to the respective insurance underwriters. We also collect claims or refunds from underwriters on behalf of insureds, which are then returned to the insureds. Unremitted insurance premiums and claims are held by us in a fiduciary capacity. The levels of funds held on behalf of clients and liabilities can fluctuate significantly depending on when we collect the premiums, claims, and refunds, make payments to underwriters and insureds, and collect funds from clients and make payments on their behalf, and upon the impact of foreign currency movements. Funds held on behalf of clients, because of their nature, are generally invested in very liquid securities with highly rated, credit-worthy financial institutions. Fiduciary assets include funds held on behalf of clients comprised of cash and cash equivalents of$6.7 billion and$6.1 billion atMarch 31, 2022 andDecember 31, 2021 , respectively, and fiduciary receivables of$8.6 billion and$8.3 billion atMarch 31, 2022 andDecember 31, 2021 , respectively. While we earn investment income on the funds held in cash and money market funds, the funds cannot be used for general corporate purposes. We maintain multicurrency cash pools with third-party banks in which variousAon entities participate. IndividualAon entities are permitted to overdraw on their individual accounts provided the overall global balance does not fall below zero. AtMarch 31, 2022 , non-U.S. cash balances of one or more entities may have been negative; however, the overall balance was positive.
The following table summarizes our Cash and cash equivalents, Short-term
investments, and Fiduciary assets as of
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