Aon plc
Q1 2011 Earnings Call Transcript

Published: 29 Apr 2011

[Operator:]

Good morning and thank you for holding. Welcome to Aon Corporation's First Quarter Earnings Conference Call. [Operator Instructions] I would also like to remind all parties that this call is being recorded, and that it's important to note that some of the comments in today's call may constitute certain statements that are forward-looking in nature as defined by the Private Securities Reform Act of 1995. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or those anticipated. Information concerning risk factors that could cause such differences are described in the press release covering our first quarter results, as well as having been posted on our website. Now it is my pleasure to turn the call over to Greg Case, President and CEO of Aon Corporation.

[Greg Case:]

Good morning, everyone, and welcome to our first quarter conference call. Joining me today is our CFO, Christa Davies. To begin, our first quarter results reflect continued momentum and progress as we execute on our strategy to distinctly strengthen and unite Aon around the globe, irrespective of the stock market, economic conditions or other challenges outside our control. Consistent with previous quarters, I'd like to cover 3 areas before turning the call over to Christa for further financial review

[Christa Davies:]

Thanks, Greg, and good morning, everyone. As Greg noted, our first quarter results reflect continued progress to strengthen our industry-leading position and client-serving capabilities across risk and people. We are firmly on track for growth in 2011. Against that, we're managing expenses, delivering savings from our restructuring program and effectively allocating capital as highlighted by the repurchase of $350 million in common stock in the quarter. Now let me turn to the results for the first quarter. Our core EPS performance, excluding certain items, is $0.80 per share for the first quarter, compared to $0.83 in the prior-year quarter, as the inclusion of Hewitt results, including a $61 million increase in intangible amortization expense and a higher effective tax rate offset strong underlying performance and effective capital management. Certain items that were adjusted for in the core EPS performance and highlighted in the schedules on Page 12 include

[Operator:]

[Operator Instructions] Our first question comes from Yaron Kinar, Deutsche Bank.

[Yaron Kinar:]

My first question and I have a follow-up after that. My first question relates to the Risk Solutions segment and the expenses there. So even when I adjust for the FX and the lease termination and despite the 3% improvement in the comp and benefit expenses, the adjusted operating income was still flat year-over-year. So I was hoping to get a little more color on what, I guess, is organic revenue growth related expenses? And maybe how we should think about it going forward?

[Christa Davies:]

Yes. So I think as we look at our Risk Solutions margin, we believe that we have underlying Risk Solutions margin expansion in the quarter after we adjust for the onetime lease termination payment in France, that's 110 basis points and the FX and investment income impact of 70 basis points, that's 180 basis points which if you then adjust for that, it's 30 basis point improvement year-over-year. We do believe that we continue to sort of drive a structural operational improvement in our business which is leading to long-term margin expansion both over the course of the year and towards our long-term 25% margin target.

[Yaron Kinar:]

But wasn't that improvement that you were just talking about, it all came from the compensation expense side and it's pretty much offset by the other expenses in a scalable business, or what I thought was a scalable business.

[Christa Davies:]

Yes, so I mean, I think there are a couple of onetime items in the quarter which are really sort of meaning that we're not getting quite the level of margin expansion we would excluding those onetime items.

[Yaron Kinar:]

Okay. And then on the HR Solutions side, could you maybe talk a little bit about the pension business? Do you see it coming back at some point, maybe to the point where it starts getting like 2%, 4%, 5% organic growth again for a longer period? And do you think that's possible without a regulatory change?

[Greg Case:]

We see a tremendous opportunity across the HR Solutions business from a growth standpoint. And in fact, if you just reflect on sort of the last few years in which what's happened in the U.S. economy and the global economy on that front, the business has actually helped serve quite well. And during that time, we made substantial investments to sort of build for the future long-term growth and we see a number of those items actually coming to pass now as we think about what's going on. When you just think about what's going on in the overall retirement market right now, and what's needed to think about pensions and retirement across an employee base, that demand is going up, not down and we're incredibly well-positioned for that. The same on the healthcare side, when you think about what's happening in the healthcare in the U.S. right now, just as one example, but you can actually talk about it around the world and the demand for advice in the context of reducing healthcare costs is actually going up. So we actually see lots of opportunity for growth across the HR Solutions business, whether it's on the retirement side, the investment advice side, the admin side. So we're very optimistic about how we think that's going to evolve over the next couple of years.

[Operator:]

Next, Brian Meredith, UBS.

[Brian Meredith:]

A couple of questions here. Greg, first one, I was hoping you could chat a little bit more what's going on in the Outsourcing business. We've been hearing from some of the carriers that they're starting to see some exposure growth out of the comp business and I'm just curious why you're not seeing it translate into the Outsourcing business as well.

[Christa Davies:]

Yes. So Brian, I think one of the things we're seeing in our sort of HR Solutions business in Outsourcing in particular is, they're very long-term contracts. And so we absolutely sort of expect long-term growth in that business and as we've said before, with 5 to 7 years sort of average contract length in the HR BPO business, we can see the next 4 years of revenue and EBITDA growth. And so absolutely, we see the structural, sort of forces you're describing. They just take time to flow through given the long-term sort of contract nature in that business.

[Brian Meredith:]

So changes in employment don't have an immediate impact?

[Christa Davies:]

Changes in employment absolutely do. And we have huge potential upside from changes in employment and they do flow through and get trued up on a monthly basis.

[Brian Meredith:]

Okay. So we haven't seen that yet, I guess, is what's happening here?

[Christa Davies:]

Absolutely.

[Greg Case:]

So we expect that, Bryan, on the horizon. And again, that will come through faster than in the U.K. For example, on the risk side, you see rates come through, so that's a much more direct impact.

[Brian Meredith:]

Okay. And then, also just curious on cash flows in the quarter, I mean share buyback was greater than I was expecting. You had some cautionary remarks on cash flows in I think last quarter on kind of the timing. I'm curious why the level of share buyback was great but why was it bigger in this quarter? Should we expect a big slow down coming forward?

[Christa Davies:]

Yes. So I think as we think about sort of share buyback going forward, I'd look at sort of cash and short-term investments on the balance sheet which I would observe post the Canadian debt is down from $1.2 billion at year-end to $900 million x the Canadian debt. And so we have used up excess cash in the quarter. And I would say, going forward, as we think about share buyback, Q4 is more of sort of a good run rate to use than the Q1 number. Because really what we've done there is we've got some excess cash on the balance sheet as well as operating cash flow.

[Greg Case:]

Overall, Bryan, look at our investments on the buyback side, as Christa has described before on the call, reflecting sort of our view on where we are and the opportunity on return on invested capital. And we're just very, very positive on our current position and the opportunity against it and that reflects our investment.

[Operator:]

Next question, Meyer Shields, Stifel, Nicolaus.

[Meyer Shields:]

I just want to follow up on Yaron's question with regard to retirement. Did we see within the U.S., a general trend towards later retirement for whatever reason, skepticism on Social Security or whatever, would that have a negative impact on -- or does that conform with your expectations and what's the estimated long-term impact on insurance and healthcare?

[Greg Case:]

No. In fact, again, back kind of fundamental principles of sort of what's going on across really the overall HR Solutions business in total, whether it's on the retirement or pension side or whether it's on the healthcare side, we actually see demand for advice in that business which is really what we do exceptionally well going up. And in fact, because the costs are going up, the demand for high-quality execution, which is also what we're capable of doing in the Outsourcing businesses, is actually going up. So we are very, very bullish on sort to the fundamental underpinnings of what drives our HR Solutions business, both on the advice side as well as on the execution side. I mean, as an example, I was with a client last week, just talking about their current situation, and look, they're essentially talking about how they can think about supporting their employees for overall retirement and actually delivering on a sort of promises that are helping their employees deliver on a set of commitments that they've really made over time. And our advice in the context of what's going on in the current marketplace is vital to them both in terms of how they actually execute it but also in terms of how they do it in a cost-effective way and that same argument holds true on the health and benefits side.

[Meyer Shields:]

Okay. And a couple of quick modeling questions if I can. When would be the expected share issuance of compensation over the course of the year? And the second would be the ramp up of the $200 million or so in expected too of related savings sort of over the balance of that one.

[Christa Davies:]

Right. So on the share issuance, share issuance in the form of stock compensation has been coming down over the last couple years. We would expect around 8 million shares over the course of 2011. Q1 is always the highest because that's when we issue shares related to our sort of major compensation program. And then your second question, the ramp-up of savings. So we have said that we are on track to deliver $243 million of total savings. That's comprised of restructuring savings plus other non-restructuring savings. You saw $24 million of restructuring savings plus other additional synergies in the quarter. As we complete projects the savings will ramp up during the course of the year to that $243 million total number.

[Greg Case:]

But Meyer, we are fully on track, as Christa described, both in the overall game plan for 2011, as well as I described for the $355 million in 2013. Just the teams have just done a magnificent job coming together and really identifying the projects, getting those behind us and really focusing Aon Hewitt very much on future growth. But on the savings side have just done a terrific, terrific job.

[Meyer Shields:]

No, I understand that and that's helpful. I'm just trying to sort of use the methodology you talked with summing Aon Hewitt's operating income, subtracting the increased amortization and then adding back the savings and then trying to get a handle on the seasonality of the...

[Christa Davies:]

Would you like the -- so the baseline for the numbers in terms of how to think about the starting point and sort of seasonality of our business. So seasonality of our revenue overall, Q4 is our strongest revenue quarter, followed by Q1 and then Q2 and Q3 sort of on the revenue front. If you think about the starting point for the HR Solutions operating income for Q2, if you take the Aon Consulting operating income number of $47 million, you add in the Hewitt operating income number of $105 million from Q2 2010, that gets you to $152 million, Meyer. Then you get subtract the $61 million of amortization expense, that gets you to a $91 million operating income starting point for Q2. And you can do a similar math for Q3 2011, taking the numbers from Q3 2010, Aon Consulting $55 million, Hewitt $115 million, that gets you to $170 million, less the amortization expense of $61 million, gets you to $109 million starting point in operating income for Q3 2011.

[Operator:]

Next question, Dan Farrell, Sterne Agee.

[Dan Farrell:]

You guys, obviously, in the brokerage segment have taken out a lot of expenses over the last few years. And importantly, I think you've been very disciplined in putting some of the savings back into the business. I'm wondering, as those expense savings are ramping down, is there still a need to keep reinvesting? And I then also wonder if we're in an environment that's only modest organic growth, with the margin expansion that we think we might see be a little more muted because of ongoing stuff getting put back into the business.

[Greg Case:]

Look, Dan, I'd take a step back, you're absolutely right. If you think about sort of what we've done over the last number of years, we've literally laid out a game plan and executed as cleanly as we could against our game plan which was to invest in our business, build for long-term organic growth and also do it in a way simultaneously that we build margin over time. And I will just reflect, as you think about your question and some previous questions around the margin front, you think about the track record over the course of the last 5 years. We've increased margin 530 basis points from 15% and change to 20% plus and we have a game plan in place to drive that to 25% as we said before. The 25% really is fundamentally driven by 5 specific areas where we believe there will be real improvement

[Dan Farrell:]

Is there a level of organic that you think you need to achieve the 25%? And I realize there's other headwinds below interest rate environment and other things that could help as well over time, but is there a type of organic level in your mind that you think you have to sort of have on a run rate to get to that point?

[Greg Case:]

There really isn't. Obviously, we're about growing our business and building our business over time. So we're absolutely focused on doing that. But we've reflected on these calls before, we absolutely don't need insurance pricing in the context of growing our business. And again, we've looked at over the last 5 years, we've been able to grow. Most of the years, we've certainly been able to improve margin and we've done that in an environment obviously that's got soft insurance pricing, a very negative economy, low interest rates, et cetera . And we absolutely have the game plan in place to continue to drive and do that. Obviously, growth and some of the external factors can really help accelerate that and can bring the 25% to us much more quickly. But irrespective of what happens on the items outside our control, we intend to get to a 25% margin.

[Operator:]

Next question, Jay Gelb, Barclays Capital.

[Jay Gelb:]

I wanted to touch base on the Reinsurance Brokerage business. You had a nice uptick in organic growth in the first quarter versus 4Q. And I'm trying to understand the implications of the impact on the massive Asia Pacific Reinsurance losses going forward, on what that means for Aon's organic revenue growth, as well as margins. And alongside of that, Aon recently put out a report talking about pretty dampened expectations for the U.S. midyear property Reinsurance renewals, so I was hoping you could expand a bit on that because the reinsurers are talking it up a bit more.

[Greg Case:]

Yes, Jay, absolutely have to talk about it. Really 2 questions in the context of sort of what we're doing there. One as it relates to Aon Benfield and agree with you, our colleagues are doing a great job as we continue to build in that platform we believe is a very unique platform in the world today with Aon Benfield and our position on the treaty side, number one in the world, number one in facultative, number one in the capital markets world, et cetera. And a very strong platform and we're improving in that. I would say in the first quarter, factually, the market had a negative impact on us, it was negative 1% as you think about what we were able to deliver on flat organic growth, market impact was negative 1% and so overall, we haven't seen the impact that you've described. And as we go forward through the year, we expect it to be a lot of the same, obviously we're reacting to the trauma around world, and supporting our clients, but we see more of the same. In the context of your second quarter in the broader pricing environment, look, there's always going to be a lot of discussion. It's obviously an important topic for our clients, critical for our clients. We observe it on 2 sides; one is you think about Q1, literally what happened and then sort of think about what the go forward is going to look like. And we base our observations very much on a couple of things. One is the Aon Benfield team with those great analytics, really, we believe world-class analytics around this as well as what happens and the observations we take on the specific data out of GRIP, the Global Risk Insight Platform. And that’s now got 1 million trades on it, over $50 billion in premiums. So we literally look at that fact-based. And in the context of that, Jay, literally, rates were down 2% to 5% in the first quarter and that's just factually what they were. It impacted our Retail book negatively. It impacted our Reinsurance book as I described before. And on the go forward, what we've essentially said is assuming no new events, capital availability will remain at surplus levels, it just will, and as a result, it's going to continue to support a pretty competitive market. Obviously, we recognize that there a lot of important, very important critical regional events that have occurred around the world. And accordingly, there’s going to be price increase in those areas. And certainly in these affected areas, in some cases, it will be substantial increases. But and we also recognize, by the way, to your point, there's more pressure on the system than ever before around rate declines. But overall, the facts indicate that unless there's another event or series of events, the industry's going to have excess capital and that, that remaining supply, demand imbalance is going to continue to put downward pressure on price. Particularly, in the non-affected areas which happen to be, in this case, much, much larger than the affected areas. In the example, you described on the Reinsurance analysis what our colleagues have done is literally calculate it bottom up literally brick by brick the capital in the industry. And it's roughly $470 billion as of the year-end 2010 which was a 17% increase over 2009. It really is that supply/demand imbalance, Jay, that's led us to basically say, "Look, there's clearly, less slack in the system than maybe there has been for a long time," but we see that supply demand imbalance remaining at a reasonable level. And I would just finally say, our GRIP data suggests that, if you sort of looked at our pipeline over the next 30, 60, 90 days, and it also indicates continued decreases in price. Albeit at a lower level, want to make sure I'm highlighting that. It's a lower level, but not the turns that others have talked about. So hopefully that's helpful.

[Jay Gelb:]

It’s very helpful, Greg. And just on GRIP, are you talking about primary commercial, as well as Reinsurance? Or just...

[Greg Case:]

Well, the GRIP really is primary commercial. So I'm trying to give you 2 perspectives, one on the Reinsurance side, and one on the primary side, given the importance of the topic. And GRIP, literally look at it as 1 million trades, it's not the market, but it literally is our entire market. So and it's pretty extrapolatable to the overall market and it’s the specific data which shows exactly what happened in the first quarter and then it literally has all the indications in it for the foreseeable future.

[Jay Gelb:]

And that $470 billion, you're saying that's dedicated Reinsurance capital globally?

[Greg Case:]

Yes, exactly. The analysis, by the way, happy to send it to you, you can also access it on our website, is we did our level best to identify dedicated Reinsurance capital around the world and that's how we got to the $470 billion.

[Operator:]

Next question, Matt Heimermann, JPMorgan.

[Matthew Heimermann:]

Couple questions, just specifically in HR Solutions on the traditional Consulting side, I'm just curious if you could maybe break down what you're seeing in terms of growth between maybe the less discretionary lines which I would think about being kind of health and benefits actuarial, investment, Consulting and then the discretionary of kind of talent, compensation, leadership?

[Greg Case:]

Well, essentially, we're actually seeing growth across the board but what you do see is the areas that we’re really impacted by the economy, talent, comp, et cetera, those are really beginning to bounce back. We see that as very positive. Things that involved, Matt, discretionary spend during the last few years have really been under pressure. Our colleagues have done a great job in those businesses, but now as the economy has leveled off or even in some cases looks like it might even be coming back a bit, we're seeing real upticks in those businesses. And the others that were actually holding a bit more during the downturn, are doing just fine, but they don't see as much of an uptick.

[Matthew Heimermann:]

Okay. And so as we think about what might happen with growth there, it's more likely we should think about those discretionary areas pulling the growth rate up more so than much of a change in the other areas?

[Greg Case:]

Well, in the other areas, it'll just be more gradual in the other areas. The uptick will be more acute and more positive on the areas that involve discretionary spend, but we're investing to see it in both sides. And we've got, again, great capability on both sides and we see positive movement really on the discretionary and some of the things that were more recurring.

[Matthew Heimermann:]

Okay. And then if we kind of dovetail that same question into Outsourcing with respect to project revenues, is it fair to think about the timeline there maybe being a little bit drawn out than what we might see in some of the discretionary areas in the Consulting side?

[Christa Davies:]

That's right, Matt, because of the long-term nature of the contract. The only thing I would note is, as employment levels increase, they do flow through the Outsourcing contracts with a month lag. And so employment levels have significant upside leverage to that revenue base. The project related sort of revenue year-over-year will stabilize really in Q2.

[Matthew Heimermann:]

Okay, that's helpful. And then just a couple numbers questions, if I could, just, Christa, just the pension expense or benefit in the quarter. And then also, can you just tell us what the common outstanding shares were at the end of the quarter?

[Christa Davies:]

So the pension expense for the year, Matt, it's down slightly in 2010. And it's roughly the same per quarter, is the way I think about it. And then contribution levels on pension, we did say were about $400 million for the year and again roughly equal by quarter. And then common shares outstanding were 330.5 million as at March 31.

[Operator:]

Next question, Dan Johnson, Citadel.

[Dan Johnson:]

You mentioned that in your prepared remarks your outlook on the Reinsurance business. I can't recall the exact word you used, but I didn't think it implied much change from the current level of, I think, we put up a 0 this quarter. Is that characterization correct?

[Greg Case:]

Well, I think, Dan, I would say, we're continuing to build and working to grow that business. But we essentially characterize it as sort of over the next 12 months, sort of roughly positive but we did not dramatically positive.

[Dan Johnson:]

Sure. That sounds like a decent uptick from last quarter where I think it was minus one, but the expectations were for something that looked a little bit more like 2010, which was a minus 3. If all this math is right, what sort of led to, I guess I'll call it, an improvement in the outlook?

[Greg Case:]

Well, listen, getting back, we've been try to pretty measured about this and will always do that as is our practice. We believe we'll see continued improvement here. I wouldn't say it's a dramatic change. It's really sort of roughly the overall same outlook. Again, as we said before, certain aspects of the business on the fact side and on the capital markets side, Cap bond, et cetera, tend to be a bit lumpy so it sometimes a little more positive and little negative and we'll highlight that in the process. But essentially, this is a business in which we think demand is going to continue to increase. The events around the world have actually highlighted that. And it will be reflected in our overall business. But we just see solid progress for 2011.

[Dan Johnson:]

Okay. And then in terms of the Brokerage margins, do you have any visibility on any further sort of one-timers, if you will, like we saw this quarter with the lease termination?

[Greg Case:]

We really don't and I would highlight again, on the lease termination in France, for us, that really for us was just an investment in our colleagues around the world. This is something that in the context of what we're trying to do with Aon united and really bring our global firm together, deliver for our clients in a very local way. Our colleagues in France have just done a remarkable job, Robert Le Blanc, Laurent, Michel, and all the colleagues there have done a great job and really it's an investment we wanted to make to get our business back closer into kind of central Paris. And it's something we talked about for quite some time and we believe that it's is going to help our business long term. And we made the investment. We always do that to strengthen our business and our business lets us make these investments and absorb it and that's exactly what we did in the context of Q1. And we don't see anything more on the horizon, but I wanted you to understand why we did it and the psychology behind it.

[Dan Johnson:]

Yes, understood. And then last quick one on the commission compliance efforts, I forgot exactly which program that falls under, but any update you could add there as to sort of how that has helped profitability versus what you think it could do and sort of maybe what inning we're in I guess in that effort?

[Greg Case:]

Great question. This really relates back to kind of Aon Broking, so if you really think about how we're going to grow our business, we're going to take a number of steps to really bring new clients in and get a greater share of wallet with them, a la what we’re doing on the revenue engine in Client Promise. And then we're also going to work to, in the context of that, as we get them the best deals out there in the world, best terms and conditions, best price, we're also going to work to make sure we get a fair and appropriate kind of yield per dollar of premium placed. And that really is our Aon Broking effort. That's what you're describing. And we're in the early innings of that still. In the 9-inning baseball game, if you want to use that analogy, we're kind of still in the third or fourth inning, early innings, it's beginning to actually have some benefit for us. We're excited about that. We can see how that's going to play out for us over time in a very positive way, but that's really still early innings and but we're quite excited about it. That combination of new clients and again, we had a great, great quarter from a new client, new business standpoint, grew at 11% across the board which is fantastic for us, feel good about that. Very good on the retention side and we think this one you're describing or highlighting, Dan, is a very important one for us as we continue to increase yield per dollar of premium placed.

[Dan Johnson:]

And you see it as a contributor to 2011 profitability or is this more of a 2012 and beyond sort of effort?

[Greg Case:]

No, we see it as having meaningful impact as we get into the second half of 2011 and then really kicking in, in '12 and '13.

[Operator:]

Our last question comes from Scott Scher, Clovis Capital.

[Scott Scher:]

All my questions have been answered.

[Operator:]

I would now like to turn the call back over to Greg Case for closing remarks.

[Greg Case:]

I just wanted to say to all of our investors and partners on the phone, thanks for taking part and we appreciate your support in Aon.

[Operator:]

Thank you. That does conclude today's presentation. You may now disconnect.