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AON PLC – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
EXECUTIVE SUMMARY OF FIRST QUARTER 2023 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 2023 financial results.
•Revenue increased$201 million , or 5% to$3.9 billion compared to the prior year period reflecting organic revenue growth of 7% and a 1% favorable impact from fiduciary investment income, partially offset by a 3% unfavorable impact from foreign currency translation. •Total operating expenses in the first quarter increased 4% to$2.4 billion compared to the prior year period due primarily to an increase in expense associated with 7% organic revenue growth and investments in long-term growth, partially offset by a$67 million favorable impact from foreign currency translation. •Operating margin increased to 38.1% from 37.2% in the prior year period. The increase was driven by an increase in operating expenses as listed above and organic revenue growth of 7%.
•Due to the factors set forth above, Net income increased
million
•Diluted earnings per share was
year period.
•Cash flows provided by operations for the first three months of 2023 decreased$20 million , or 4%, to$443 million compared to the prior year period, primarily due to higher cash tax payments, 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 2023: •Organic revenue growth is a non-GAAP measure defined under the caption "Review of Consolidated Results - Organic Revenue Growth." Organic revenue growth was 7% for the first quarter of 2023, 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 38.7% for the first quarter of 2023 compared to 38.0% in the prior year period. The increase in adjusted operating margin primarily reflects organic revenue growth, partially offset by increased expenses 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$5.17 per share for the first quarter of 2023, compared to$4.83 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 2023 by$73 million from the prior year period, to$367 million , reflecting a decrease in cash flows from operations and by a$53 million increase in capital expenditures.
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE
For many companies, the management of ESG risks and opportunities has become increasingly important, and ESG-related challenges, such as extreme weather events, supply chain disruptions, cyber events, regulatory changes, ongoing public health impacts, and the increased focus on workforce resilience in various work environments, continue to create volatility and uncertainty for our clients.Aon offers a wide range of risk assessment, consulting and advisory solutions, many of which are significant parts of our core business offerings, designed to address and manage ESG issues for clients, and to enable our clients to create more sustainable value. We view ESG risks as a valuable opportunity forAon to work together as one firm to address client needs and improve our impact on ESG matters. 24
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REVIEW OF CONSOLIDATED RESULTS
Summary of Results
Our consolidated results are as follows (in millions):
Three Months Ended
2023 2022 Revenue Total revenue$ 3,871 $ 3,670 Expenses Compensation and benefits 1,792 1,767 Information technology 139 123 Premises 75 72 Depreciation of fixed assets 38 38 Amortization and impairment of intangible assets 25 28 Other general expense 329 275 Total operating expenses 2,398 2,303 Operating income 1,473 1,367 Interest income 5 3 Interest expense (111) (91) Other income (expense) (25) 25 Income before income taxes 1,342 1,304 Income tax expense 263 256 Net income 1,079 1,048 Less: Net income attributable to noncontrolling interests 29 25 Net income attributable to Aon shareholders$ 1,050 $ 1,023 Diluted net income per share attributable toAon shareholders
$ 5.07
Weighted average ordinary shares outstanding - diluted 207.1 216.4 Revenue Total revenue increased$201 million , or 5%, to$3,871 million , compared to the prior year period, with organic revenue growth of 7%, driven by ongoing strong retention, net new business generation, and management of the renewal book portfolio, and a 1% favorable impact from fiduciary investment income, partially offset by a 3% unfavorable impact from foreign currency translation.Commercial Risk Solutions organic revenue growth of 6% reflects strong growth across most major geographies driven by strong retention, net new business generation, and management of the renewal book portfolio. Growth in retail brokerage was highlighted by double-digit growth in EMEA,Latin America , and the Pacific driven by continued strength in core P&C.U.S. retail brokerage grew modestly after growing double-digits in the prior year period and reflecting the impact of the external M&A and IPO markets on M&A services. Results also reflect strong growth globally in the affinity business across both consumer and business solutions, including growth in the travel and events practice and Digital Client Solutions. On average globally, exposures and pricing were positive, resulting in a modestly positive market impact. Reinsurance Solutions organic revenue growth of 9% reflects strong growth in treaty, driven by strong retention and continued net new business generation, as well as double-digit growth in both theStrategy and Technology Group and facultative placements. Market impact was modestly positive on results in the quarter. The majority of revenue in our treaty portfolio is recurring in nature and is recorded in connection with the major renewal periods that take place throughout the first half of the year.Health Solutions organic revenue growth of 8% reflects growth globally in core health and benefits brokerage, driven by strong retention, net new business generation, and management of the renewal book portfolio. Strength in the core was highlighted by double-digit growth inAsia Pacific ,U.K. , andLatin America . Results also reflect double-digit growth in Human Capital, driven by data and advisory solutions. 25 -------------------------------------------------------------------------------- Wealth Solutions organic revenue growth of 6% reflects growth in Retirement, driven by higher advisory demand and project-related work related to pension de-risking and ongoing impacts of regulatory changes. In Investments, a decrease in AUM-based delegated investment management revenue due to equity market and interest rate movements was partially offset by higher advisory demand and project-related work.
Compensation and Benefits
Compensation and benefits expense increased$25 million , or 1%, compared to the prior year period due primarily to an increase in expense associated with 7% organic revenue growth, partially offset by a$55 million favorable impact from foreign currency translation. Information Technology Information technology expenses, which represent costs associated with supporting and maintaining our infrastructure, increased$16 million , or 13%, compared to the prior year period due primarily to ongoing investments inAon Business Services-enabled technology platforms to drive long-term growth and continued investment in core infrastructure and security.
Premises
Premises expenses, which represent the cost of occupying offices in various
locations throughout the world, increased
quarter of 2023 compared to the prior year period.
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 was flat in the first quarter of 2023 compared to the prior year period.
Amortization and Impairment of Intangible Assets
Amortization and impairment of intangible assets primarily relates to finite-lived customer-related and contract-based assets as well as technology and other assets. Amortization and impairment of intangible assets decreased$3 million , or 11%, compared to the prior year period.
Other General Expense
Other general expense in the first quarter of 2023 increased$54 million , or 20%, compared to the prior year period due primarily to an increase in expense associated with 7% organic revenue growth, including an increase in business travel expense, especially compared to the prior year period as business travel was suppressed by COVID-19. Interest Income Interest income represents income, net of expense, 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 2023, interest income increased$2 million to$5 million compared to the prior year period. Interest Expense Interest expense, which represents the cost of our debt obligations, increased$20 million to$111 million compared to the prior year period, reflecting an increase in total debt and higher interest rates.
Other Income (Expense)
Other expense was$25 million for the first quarter of 2023, compared to Other income of$25 million for the first quarter of 2022. Other expense for the first quarter of 2023 primarily reflects the unfavorable impact of exchange rates on the remeasurement of assets and liabilities in non-functional currencies and non-cash net periodic pension cost. 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 2023 was$1,342 million , a 3% increase from$1,304 million in the first quarter of 2022. Income Taxes
The effective tax rate on Net income was 19.6% for the first quarters of 2023
and 2022.
26 -------------------------------------------------------------------------------- For the three months endedMarch 31, 2023 andMarch 31, 2022 , the tax rate was primarily driven by the geographical distribution of income and certain discrete items, primarily the favorable impact of share-based payments.
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, adjusted net income attributable toAon shareholders, adjusted net income per share, other income (expense), as adjusted, adjusted effective tax rate, 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 certain 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 2023 2022 % Change Impact (1) (2)
Divestitures & Other (3) Revenue Commercial Risk Solutions$ 1,778 $ 1,719 3 % (3) % 2 % (2) % 6 % Reinsurance Solutions 1,077 976 10 (2) 2 1 9 Health Solutions 671 638 5 (3) - - 8 Wealth Solutions 350 345 1 (4) - (1) 6 Eliminations (5) (8) N/A N/A N/A N/A N/A Total revenue$ 3,871 $ 3,670 5 % (3) % 1 % - % 7 % (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, 2023 and 2022, was$52 million and$2 million , respectively. (3)Organic revenue growth includes the impact of certain intercompany activity and excludes the impact of changes in foreign exchange rates, fiduciary investment income, acquisitions, divestitures, transfers between revenue lines, and gains or losses on derivatives accounted for as hedges.
Adjusted Operating Margin
We use adjusted operating margin as a non-GAAP measure of our core operating performance. Adjusted operating margin excludes the impact of certain items, as listed below, because management does not believe these expenses are the best indicators of our core operating performance. This supplemental information related to adjusted operating margin represents a measure not in accordance withU.S. GAAP and should be viewed in addition to, not instead of, our Condensed Consolidated Financial Statements. 27 --------------------------------------------------------------------------------
A reconciliation of this non-GAAP measure to the reported operating margin is as
follows (in millions, except percentages):
Three Months Ended
2023 2022 Revenue$ 3,871 $ 3,670 Operating income - as reported$ 1,473 $ 1,367 Amortization and impairment of intangible assets 25 28 Operating income - as adjusted$ 1,498 $ 1,395 Operating margin - as reported 38.1 % 37.2 % Operating margin - as adjusted 38.7 % 38.0 %
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 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 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, 2023 Non-GAAP U.S. GAAP Adjustments Adjusted Operating income$ 1,473 $ 25$ 1,498 Interest income 5 - 5 Interest expense (111) - (111) Other income (expense) (25) - (25) Income before income taxes 1,342 25 1,367 Income tax expense (1) 263 5 268 Net income 1,079 20 1,099 Less: Net income attributable to noncontrolling interests 29 - 29 Net income attributable to Aon shareholders$ 1,050 $ 20$ 1,070
Diluted net income per share attributable to
$ 0.10 $ 5.17 Weighted average ordinary shares outstanding - diluted 207.1 - 207.1 Effective tax rates (1) 19.6 % 19.6 % 28
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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 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 %
(1)Adjusted items are generally taxed at the estimated annual effective tax
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
2023
2022
Cash provided by operating activities $ 443$ 463 Capital expenditures (76) (23) Free cash flow $ 367$ 440
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$0.14 on net income per diluted share during the three months endedMarch 31, 2023 if prior year period results were translated at current period 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 2021 results were translated at 2022 rates. Currency fluctuations had an unfavorable impact of$0.14 on adjusted diluted earnings per share during the three months endedMarch 31, 2023 if prior year period results were translated at current period foreign exchange rates. Currency fluctuations had an unfavorable impact of$0.19 on adjusted diluted earnings per share during the three months endedMarch 31, 2022 if 2021 results were translated at 2022 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. 29 --------------------------------------------------------------------------------
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. 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$7.1 billion and$6.4 billion atMarch 31, 2023 andDecember 31, 2022 , respectively, and fiduciary receivables of$9.6 billion and$9.5 billion atMarch 31, 2023 andDecember 31, 2022 , 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, 2023 , 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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