Gregory C. Case - Aon Plc Christa Davies - Aon Plc.

David Anthony Styblo - Jefferies LLC Sarah E. DeWitt - JPMorgan Securities LLC Adam Klauber - William Blair & Co. LLC Quentin McMillan - Keefe, Bruyette & Woods, Inc. Kai Pan - Morgan Stanley & Co. LLC Charles Joseph Sebaski - BMO Capital Markets (United States) Josh D. Shanker - Deutsche Bank Securities, Inc..

Good morning. And thanks for holding. Welcome to Aon Plc's Third Quarter 2016 Earnings Conference Call. At this time, all parties will be in a listen-only mode until the question-and-answer portion of today's call. If anyone has an objection, you may disconnect your line at this time.

I would also like to remind all parties that this call is being recorded. And that it is 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 third quarter 2016 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 Plc. Sir, you may begin..

Thank you and good morning, everyone. Welcome to our third quarter 2016 conference call. Joining me today is our CFO, Christa Davies. I would note that there are slides available on our website for you to follow along with our commentary today.

And consistent with previous quarters, I'd like to cover two areas before turning the call over to Christa for further financial review. First is our performance against key metrics we communicate to shareholders. And second is overall organic growth performance, including continued areas of strategic investment across Aon.

On the first topic, our performance versus key metrics; each quarter, we measure our performance against the key metrics we focus on achieving over the course of the year; grow organically, expand margins, increase earnings per share, and deliver free cash flow growth. Turning to slide three.

In the third quarter organic revenue growth was 4%, including growth across every major business, highlighted by 5% growth in both the Americas Retail Brokerage and Outsourcing businesses. Operating margin increased 10 basis points, reflecting modest improvement in Risk Solutions.

EPS increased 4% to $1.29, primarily reflecting effective capital management and underlying operational improvements. And finally, free cash flow for the nine months is up 24%, reflecting strong cash flow from operations and a decline in capital expenditures.

Overall, we continued to strengthen the firm with positive performance across each of our key metrics for both the third quarter and the first nine months of 2016, highlighted by solid organic revenue growth across both Risk Solutions and HR Solutions and strong double-digit growth in free cash flow. Turning to slide four.

On the second topic of growth and investment, I want to spend the next few minutes discussing the quarter for both of our segments. In Risk Solutions, organic revenue growth was 3% compared to 1% in the prior-year quarter, driven by improved growth across all major businesses.

As we've discussed previously, we're driving a set of initiatives to maximize return on invested capital and making strategic investments that are strengthening underlying performance and positioning our Risk Solutions segment for long-term growth and improved operating leverage with management of our renewal book portfolio through a proactive client partnership we call Aon Client Promise, which is driving retention rates of more than 90% on average across Retail Brokerage, including record retention rates of 94% in the U.S.

and EMEA. New business generation of roughly $265 million in the third quarter across Retail Brokerage, including double-digit growth in Latin America, Affinity and EMEA and another consecutive quarter of record new business in U.S.

Retail, 22 consecutive quarters of positive net new business in core treaty reinsurance, increased operating leverage from our significant investments in innovative technology and data and analytics, including Aon Inpoint, a growing business where we help carriers to become more competitive, effective and operationally efficient by integrating our market-leading data and analytics with strategic consulting and access to Aon's unmatched expertise.

This includes the Risk Insight Platform, which now captures 3.3 million trades and nearly $165 billion of bound premium, as well as our reinsurer dashboard, ReView. Another example is our Aon broking initiative to better match client need with insurer appetite for risk.

And finally, we're expanding our content and global footprint through tuck-in acquisitions that increase scale in emerging markets and expand capability.

For example, we recently announced the addition of Stroz Friedberg, a global leader in cyber security, bringing together two of the world's most highly skilled teams focused on cyber risk mitigation.

This investment extends Aon's leading position in cyber risk brokerage and creates a comprehensive cyber advisory group, allowing Aon's clients to have access to the most advanced thinking and solutions in the industry.

Reflecting on our individual businesses within Risk Solutions, in the Americas, organic revenue growth was 5% compared to 4% in the prior-year quarter. Exposures continue to be positive across the region, while the impact from pricing was negative, resulting in relatively stable market impact overall. We saw solid growth across all regions, U.S.

Retail, Latin America and Canada, including growth across all businesses, Property-Casualty, Health and Benefits and Affinity. Results were highlighted by double-digit growth in Affinity's Consumer Solutions Group and strong growth in U.S. Retail, driven by record new business generation and retention.

In international, organic revenue growth was 2% compared to 1% in the prior-year quarter. The impact from pricing remains modestly negative on average driven by fragile market conditions in various countries across Europe and Asia and continued pricing pressure in the Pacific region, while exposures are modestly improving.

Similar to the Americas, we saw growth across every major region, including EMEA, Asia and the Pacific. Results were highlighted by continued strength in New Zealand, record retention in EMEA and solid growth in Asia.

In Continental Europe, we continue to see signs of improving growth, reflecting Aon's strength in client leadership across the region despite a macroeconomic environment that remains challenged in various countries. In Reinsurance, organic revenue growth was 1% compared to minus 4% in the prior-year quarter.

This marks the fourth consecutive quarter of positive growth in Reinsurance, further validating our previous guidance of an expected return to modest growth in 2016. Results in the quarter were primarily driven by continued net new business generation in treaty and growth in facultative placements.

Results were partially offset by an unfavorable market impact globally. As highlighted in our prior discussions, pricing continues to moderate, ceding (7:03) demand continues to increase and capital is being deployed to new markets, including U.S. mortgage credit risk, life and annuity risk, and other emerging risks such as cyber liability.

We believe new opportunities for growth, combined with Aon's industry-leading data and analytics and integrated capital solutions, have positioned our Reinsurance business for long-term growth.

Turning to HR Solutions, organic revenue growth was 4% overall with solid growth across high demand areas where we continue to invest in innovative solutions and client serving capabilities.

These investments reflect Aon Hewitt's leadership and in-depth understanding of market trends, including solutions to help plan sponsors both manage pension risk and drive better retirement outcomes for their employees.

A strong area of growth has been delegated investment consulting, where assets under management have grown from $10 billion to almost $90 billion in five years. We expect continued global growth in this area as sponsors are faced with regulatory changes and increasingly complex global markets.

Continuing investments to strengthen our industry-leading portfolio of health solutions, covering the full range of benefit strategies, client size, and funding choices, including our suite of private healthcare exchanges. We view health as a substantial long-term opportunity.

We are the industry leader in managing unique company or employee population needs today and our superior advisory capabilities allow us to help clients evolve when their needs change and priorities shift and as the healthcare landscape continues to evolve.

We also continue to invest in software-as-a-service models in our HR BPO business, where growth in new clients and conversion of existing clients is driving strong demands, as well as the expansion of our capabilities to include financial implementations.

And finally, we're investing in data analytics in our health, retirement investment and talent rewards businesses to provide superior advice to drive better outcomes for our clients and our clients' employees. Turning to the individual businesses within HR Solutions.

In Consulting Services, organic revenue growth was 3%, similar to the prior-year quarter. Results primarily reflect continued growth in retirement consulting, driven by demand for delegated investment consulting services, as an increasing amount of clients find significant value in Aon's ability to provide advice and manage their retirement assets.

We saw growth in communications consulting, where clients are proactively preparing their employees in advance of annual enrollment season as well certain project-related work. Results in the quarter also include solid growth in our compensation consulting practice. In Outsourcing, organic revenue growth was 5%, similar to the prior-year quarter.

Results reflect strong growth in HR BPO, driven by new client wins in cloud-based solutions. And we saw strong growth in our health exchange business for off-cycle enrollments and certain project-related work. Results in the quarter were partially offset by an anticipated modest decline in benefits administration.

Overall, in HR Solutions, we are firmly on track for improved organic revenue growth in both businesses for the second half of the year, driven by continued growth in high demand areas where we've been investing, combined with seasonal strength in the fourth quarter.

In summary, our performance marks another quarter of progress, reflecting strong organic revenue growth across both segments, effective capital management and substantial free cash flow generation towards our near-term goal of $2.4 billion for the full year 2017.

Looking forward, we expect a strong finish to the year, as we head into our seasonally strongest quarter with continued long-term growth driven by our unmatched level of investment in advisory and analytic capabilities across our portfolio. With that said, I'm now pleased to turn the call over to Christa for further financial review.

Christa?.

Thank you so much, Greg, and good morning, everyone. As Greg noted, our results reflect solid organic revenue growth across both segments, substantial free cash flow generation and effective capital management, highlighted by $300 million of share repurchase in the quarter and more than $1 billion of share repurchase year-to-date.

Now, let me turn to the financial results for the quarter on page six of the presentation. Our core EPS performance excluding certain items increased 4% to $1.29 per share for the third quarter compared to $1.24 in the prior-year quarter.

Certain items that were adjusted for in the core EPS performance and highlighted in the schedules on page 12 of the press release include non-cash intangible asset amortization. Also included in the results was a $0.01 per share favorable impact related to foreign currency translation due primarily to the U.S. dollar strength against the pound.

If currency to remain stable at today's rates, we would expect foreign currency translation to have a modest positive impact in the fourth quarter. Now let me talk about each of the segments on the next slide.

In our Risk Solutions segment, organic growth was 3%, operating margin increased 10 basis points to 20.9% and operating income increased 2% compared to the prior-year quarter. Reported results are in line with our previous guidance of modest operating income growth in the third quarter.

Operating margin improvement of 10 basis points reflects solid organic revenue growth and an 80 basis points favorable impact from foreign currency translation, partially offset by an unfavorable impact from the timing of certain compensation expenses and a minus 50 basis point unfavorable impact from higher E&O expense in the quarter.

For the first nine months, operating margin improved 60 basis points and operating income increased 3%. Anticipating a strong performance in the fourth quarter, we are fully on track to deliver improved operating income growth and further margin expansion for the full year, reflecting continued progress towards our long-term target of 26%.

Turning to the HR Solutions segment, organic revenue growth was 4%, operating margin decreased 30 basis points to 17.1%, and operating income decreased 4% compared to the prior-year quarter. Operating income results include a $7 million or minus 70 basis points of legacy IT contract costs incurred in the quarter.

This impact as well as an anticipated minus 70 basis point unfavorable impact related to previous portfolio repositioning activities and a minus 20 basis point unfavorable impact from foreign currency more than offset solid organic growth in the quarter.

For the first nine months, operating margin decreased 70 basis points and operating income decreased 8%.

As discussed previously, we continue to take steps to reduce certain costs that remained after the disposition of two businesses in the last 12 months as well as optimize our global cost structure in areas such as IT, real estate, and global procurement.

Combined with an expected strong performance in the fourth quarter, we are fully on track for continued margin expansion towards our long-term operating margin target of 22%. Now let me discuss a few of the line items outside of the operating segments on slide 9. Unallocated expenses were $42 million compared to $45 million in the prior-year quarter.

Interest income was $1 million compared to $3 million in the prior-year quarter. Interest expense decreased $2 million to $70 million due to a decline in costs related to certain derivative hedging programs which have now expired. Other income in both the current and prior-year quarters included gains on certain long-term investments.

Going forward, we expect a run rate of approximately $45 million per quarter of unallocated expense, $3 million per quarter of interest income and $70 million per quarter of interest expense. Turning to taxes.

The adjusted effective tax rate on net income from continuing operations excluding the applicable tax impact associated with non-cash pension settlements in the first half of the year increased to 18.2% compared to 16% in the prior-year quarter.

Changes in the geographic distribution of income and certain favorable discrete tax adjustments impacted the adjusted effective tax rate in the current quarter. The prior-year quarter adjusted effective tax rate excluded the applicable tax impact associated with expenses related to legacy litigation.

Lastly, average diluted shares outstanding decreased 5% to 269.6 million in the third quarter compared to 283.8 million in the prior-year quarter as we effectively allocate capital. The company repurchased 2.7 million Class A ordinary shares for approximately $300 million in the third quarter.

The company has $3 billion of remaining authorization under its share repurchase program. Actual shares outstanding on September 30 were 263.5 million and there are approximately 6 million additional dilutive equivalents.

Estimated Q4 2016 beginning dilutive share count is approximately 269 million, subject to share price movements, share issuance and share repurchase. Now let me turn to the next slide to highlight our solid balance sheet and strong cash flow growth on slide 10. At September 30, 2016 cash and short-term investments increased to $946 million.

Total debt outstanding was approximately $6.2 billion and total debt to EBITDA on a GAAP basis was 2.4 times, similar to the prior quarter.

Cash flow from operations for the first nine months increased 14% or $180 million to $1.5 billion, driven by lower pension contributions and increase in net income, working capital improvements and lower cash taxes.

Free cash flow, as defined by cash flow from operations less CapEx, increased 24% or $252 million to $1.3 billion, reflecting strong growth in cash flow from operations and a $72 million decrease in CapEx. Looking forward, we expect to deliver strong double-digit free cash flow growth for the full-year 2016.

Reflecting further progress towards our near-term goal of $2.4 billion of free cash flow for the full-year 2017. Turning to the next slide to discuss our significant increases in free cash flow. We value the firm based on free cash flow and allocate capital to maximize free cash flow returns.

Free cash flow of $2.4 billion for the full-year 2017 is not our end goal, as we expect to deliver sustainable strong free cash flow growth on an annual basis beyond 2017. There are four primary areas that we expect to contribute to our near-term goal of delivering $2.4 billion for the full-year 2017.

The first is continued operational performance, driven by organic revenue growth and margin expansion. The second is working capital improvements, as we focus on closing the gap between receivables and payables.

We've made substantial progress in this area over the last five years with further opportunity to increase free cash flow by over $500 million. Third is declining uses of cash, of pension contributions, CapEx and restructuring, which we expect to free up more than $105 million of annual free cash flow between the end of 2015 and 2017.

And fourth, lower cash tax payments, reflecting a lower effective tax rate. Turning to our pension plans. We've taken significant steps to reduce the volatility and liability of our plans. In the first half of 2016, we completed two transactions to materially de-risk our pension liabilities in the U.K.

And we'll continue to actively manage de-risking opportunities as they make financial sense. Further, we currently expect pension contributions to decline by approximately $44 million to $150 million in 2016 and expect non-cash pension income on an underlying basis to be a modest benefit in 2016 versus 2015.

In summary, we delivered solid organic revenue growth, overall operating margin improvement, despite certain anticipated headwinds in the quarter and continued to deliver double-digit free cash flow growth. For the first nine months, results reflect positive performance across each of our key metrics heading into our seasonally strongest quarter.

With a strong finish to the year, we are well on track in 2016 to deliver meaningful progress towards our near-term goal of $2.4 billion in free cash flow for the full year 2017. With that, I'd like to turn the call back over to the operator for questions..

Thank you. Our first question is from Mr. Dave Styblo from Jefferies. Your line is open..

Hey there. Good morning, guys..

Hey, Dave..

Thanks for taking the questions.

I just want to talk about just the rest of the year here, as we go in I know you're feeling good about the momentum, and fourth quarter is typically your seasonally strongest, I'm wondering if you could talk a little bit about the visibility or maybe a percent of the pipeline that you already know for revenue that you have in hand versus maybe what's left to do and then I don't think I heard you guys talk much about the exchange outlook for next year.

I know you've got Starbucks under your belt, what are the other moving parts, any customer losses or other wins to flag there for growth in 2017?.

big companies, medium-size companies, small companies and a complete suite of efforts to the table. And for us on the health side, we're very excited about it. This is a double-digit growth opportunity for us. We're already achieving but we see more potential going forward, with substantial margin improvement potential as well.

So we feel good about the momentum for the fourth quarter and into 2017..

Okay.

Can you talk – maybe just put some numbers around the exchange growth enrollment for this year going into 2017?.

So here is what I would say, as we think about the exchange piece and we step back. For us – and I'll just be very direct – this is an incredibly positive outcome for us with great momentum, but we continue to be confused/interested in all the confusion in the market. The numbers are really not apples-to-apples in any way, shape or form.

So for us the enrollment numbers really aren't as relevant at this point anymore. We've got so many off-cycle enrollments now on the horizon of project related revenue, which is much more substantial than ever before, and this really ends up being a platform for us.

We're seeing things like elective benefits, whether it's life, home, long-term disability, short-term disability, it's a very, very positive set of developments for us. And if you looked at it as a business, again, less about enrollment, about the business overall, this is double-digit revenue growth on exchanges for us.

We moved to profitability last year. It's going to obviously be stronger this year. But I'd say from a macro standpoint, I mean, look at where we are in the exchanges. This is strong and steady growth. We've done the largest active, the largest retiree. You mentioned Starbucks, we don't mention our clients, but we were very privileged.

Starbucks has a well-earned reputation for defining excellence in employee value proposition and we help them deliver on that through our exchange. So we're very excited about what that means overall. So, for us, this is just an exceptionally strong platform for us and I would say our pipeline is as strong as it's ever been.

So there's no waning, there's no backing up, there's no deferring, it's as strong as it's ever been. Having said that, Dave, I still want to emphasize, and we've been saying this from the beginning, this is not a change in direction.

The exchanges are an exceptionally strong solution for a subset of our clients, but it's really part of the overall health platform, which we feel very, very strong about..

Sure. I get that. That's great. The free cash flow, I want to come back to that. I know you guys are trending really well this year.

Is there anything to look for in the fourth quarter? It seems like you're going to be pretty darn close to the $2.4 billion goal this year, and want to know if you could help us – help remind us if there were any unusual puts or takes throughout the year-to-date numbers as we bridge into next year?.

Dave, there's nothing particularly unusual this year. I would note last year we had an extraordinary legal legacy litigation settlement of about $140 million. But we feel really good about the free cash flow growth for the full year 2016. We're on track for double-digit growth in free cash flow this year.

And we're well on track to the $2.4 billion in free cash flow in 2017. So we feel really good about the growth in cash flow. And we feel equally good about the way in which we're deploying that cash on a really disciplined return on capital basis.

And so, we continue to see share repurchase as the highest return on capital opportunity across Aon, it really sets the bar, but we're equally – we've actually done over $0.5 billion of M&A year-to-date and we feel really good about the opportunities, like cyber, like elective benefits, which are huge growth opportunities for us.

And so, we're very excited about the deployment of the cash, as much as we are about the growth in free cash flow itself..

Okay, great. And just my last one real quick is on the HR Solutions. I think you guys had previously in the last quarter talked about income growth being flat year-over-year for this quarter. Obviously, it was down about 4%. I'm wondering, what changed there that caused the deviation from what you guys thought it would be.

Is it perhaps the – I think you guys had flagged the legacy IT contract cost coming...?.

Yeah. I think that was simply it, Dave, there was $7 million of IT contracts that were legacy and that was really it. And then, look, FX was a slight negative too, but I mean, I think we were largely in line. And it was really just that IT item..

Okay.

And is that totally put to bed at this point or can that continue to dribble on?.

It actually creates slight upside going forward..

All right. Thanks for the questions..

Thank you. Our next question is from Sarah DeWitt from JPMorgan. Your line is open..

Hi. Good morning. In Risk Solutions organic growth, I was surprised it didn't slow this quarter, given you had said there would be some revenue shifting from the third quarter into the fourth quarter.

Can you just quantify that and should we expect some tailwind in the fourth quarter from timing?.

Yes. So, Sarah, we absolutely said that. And we do believe that Q4 will be – it is always our seasonally strongest quarter, and it will remain so. So we absolutely expect that revenue – and there was a small movement of clients from Q3 to Q4, really lining up buying patterns, Sarah, with the annual calendar year. And so we expect that trend to continue.

What I think you saw in the third quarter was continued strong retention and continued strong new business. And so we feel really good about Q3 and we feel exceptionally good about Q4..

Okay. Great.

And then how do you think about the buyback in the fourth quarter in light of the acquisition that you just made?.

Yeah. So as I said, we've got extremely strong free cash flow for the full year, Sarah, double-digit free cash flow on track for the $2.4 billion next year. As we think about deployment of that cash, share repurchase is the highest return on capital item. And so we continue to deploy cash on a return on capital basis.

And for us to invest in M&A, the return on capital of that M&A has to be better than buyback. And we've seen some opportunities this year, which are in extraordinarily attractive areas, such as cyber and elective benefits. And we fully expect to continue buyback in Q4..

Okay.

But could you quantify the Stroz acquisition, and would that slow the buyback at all?.

Sarah, we don't – we're not revealing the purchase price on Stroz and we don't give guidance on share repurchase..

Okay. Thanks for the answers..

Thank you. Our next question is from Adam Klauber from William Blair. Your line is open..

Thanks. Good morning..

Hey, Adam..

Some questions around the Stroz deal. You already had a cyber consulting operation.

So could you talk about what the differences are between your existing operation and Stroz? And then when you put them together, what can you do different or better with these organizations together?.

Yeah. We really are excited about the addition of Stroz Friedberg in addition to some exceptional talent we brought in on the topic of cyber. And let me describe kind of the rationale behind it. First of all, our clients tell us every day cyber is becoming an increasingly important concern for them, important risk for them.

And if you think about what insurance has been able to do in the context of that risk, we've roughly placed together, the entire industry about, call it $2 billion, a little over $2 billion in premium and, Adam, that's good, that's terrific but think about the $2 billion in premium in the context of $400 billion in client reported losses.

And so for us, we've only tapped the surface and started really delivering on the needs of our clients.

And if you ask yourself – and by the way in the context of that, as you described – appreciate you describing it, we have an awesome capability, the best in the industry, leading position, exceptional capability in the context of what insurance does. What we've essentially said is we've got to do more for our clients.

We've got to take the capability we've got and build on it, and the way you build on it, is not to bring more insurance expertise in, but bring more cyber expertise in and really help insurers and capital understand how to quantify and deal with cyber risk in a way in which you would actually open up more capital.

So instead of $2 million in premium against $400 billion in reported losses. We could do much, much better than that. And Stroz Friedberg is simply the preeminent platform in the world in our view around how to do that.

So this is a firm that's publicly reported, has covered and helped remediate, understand, identify and deal with some of the most sophisticated complex cyber challenges in the world today. Imagine combining that capability with what we have from a capital and insurance side.

That's going to open up just tremendous opportunities we believe to bring better solutions to our clients in a much more comprehensive way, which is why we're very excited to bring these assets together and I can tell you, we've had incredible client reaction. They see this logic immediately.

They see the opportunity to take what is a very distributed risk in cyber because it attacks you from everywhere.

They know it requires an integrated solution and this is now the first time they're going to get a chance to put some of those pieces together and this is really a role the risk manager can play to take a broader view across the organization to help their CIOs and CSOs do this in a more effective way.

So, for us, this is terrific and for Stroz Friedberg, who are excited to be able to actually take the capability they deliver to clients every day and back that up with capital. So if you think about it, it really is a net-net new creation of opportunity for our clients and in doing so a net new for Aon..

Thanks.

And will that be reported in the Risk Solutions business?.

Yes, it will..

Okay.

And then one more question on the HR BPO, how is the pipeline – I mean that business has been doing very well, grown nicely, how is the pipeline going into 2017 and are you doing any work on the financial side of the house?.

First of all, it's going exceptionally well.

Again, the business colleagues have done a terrific job in really building out and driving it, I think we're describing it as (31:22) the work we do on the HR, implementations in the cloud and we are the leader in that, biggest in Workday in the US, biggest in the UK, reinforced by capability we brought into the firm.

And then as you described, even a bigger opportunity is what's going on in the finance side. And Aon in particular is leading the pack on that as well, not just in implementation, but we're doing it for us as well. So just like everything else we've done on behalf of our clients is something Aon participates in.

So we're very excited about the possibilities for our clients in this category and the pipeline is exceptionally strong..

And just on that, is there any seasonality to that when the revenue hits from that business?.

Not really. It comes in over time. Again, it's driven by client need..

Okay. Thanks a lot..

Thank you. Our next question is from Quentin McMillan from KBW. Your line is open..

Good morning. Thanks very much, guys. Christa, I wanted to touch on a free cash flow comment that you made in your prepared remarks. You said you have a further opportunity to increase free cash flow by over $500 million from working capital from procurement and from accounts payable.

So you guys increased by about $100 million on both receivables and accounts payable in this quarter, which is obviously pretty strong numbers.

Just wondering, that $500 million, maybe what's the runway, how long will that take? And in addition you also talked about lower cash tax payments, do you believe that there is opportunity to go below the 19% and maybe where can that go over time?.

Sure. So, Quentin, I think, on the first question on working capital, what we would say is, we really think about it as days sales outstanding, so the days it takes to collect cash from clients and days payables, which is the days that it takes – we collect cash or we pay suppliers.

And right now we are – we run negative working capital and we believe for a professional services firm that being working capital neutral is the right goal. And in fact, in some of our leading countries we're actually working capital positive. So we certainly see it's more than achievable.

And so, to get from where we are today to working capital neutral is a little over $500 million in free cash flow. So we feel really good about the ability to collect a further $500 million of working capital. It will take multiple years. It will take eight years to 10 years to get there because it's not some Big Bang effort.

It's continued improvements in process, it's continued improvements in contract terms, a number of our contract terms are annual or multi-year agreements and so it will absolutely take a long period of time to get there. So I don't want to overplay the amount you're going to get in any one year. So that's on the working capital.

And then the other thing I think I would note is, as you look at our working capital you can see the improvements in receivables. If you divide receivables by revenue, trailing 12 months, from Q3 last 12 months, you can see we actually improved DSO on an externally reported basis by two days. And so we continue to make progress.

And I'll tell you that on BPO, we improved by four days. You can't see that externally, but we are continuing to make improvements on both fronts. And then in terms of the opportunity on the tax side, what I would say is we really feel good about the sustainability of our 19% effective tax rate. We do run a global capital pool.

We do see statutory rates around the world declining, particularly in the U.K. And we have a growing business in emerging markets, which happen to have lower tax rates.

And so we feel really good, therefore, about the sustainability of the 19% and, therefore, opportunity to have improvements in cash taxes, as cash taxes catch up to the lower effective tax rate..

Great. Thank you so much. And then just one follow-up question.

Moving back to HR BPO, can you help us just understand what the size of that business is, where the margins are currently and what the kind of cloud-based solutions implementation could do for margins over whether it be 2017 or even over the next few years?.

Sure. So it's about a $500 million business today, and we feel really good about the progress in cloud. If you rewound five years, we had 30-plus clients who had on-premises BPO. And today it's in the mid-teens with every one of those clients moving from on premises to cloud with us. And so it is a fantastic value proposition for clients to do this.

On average, clients are saving 30% of costs in moving to the cloud. And they get a much more effective solution, and so we do see the majority of our clients moving that way. And we expect that to continue. In terms of the margin profile of the business, today, it is a low-single-digit margin business.

And it's moving to a mid-teens margin business over time. And so we do see that opportunity, primarily driven by that cloud growth, which is enormous. And as Greg described, I really just described the cloud opportunity in HR.

And there is a cloud opportunity, which we're increasingly seeing as very happy HR customers actually want to move to cloud financials as well, to actually bring together and get the same value proposition they got in HR in financials..

Great. Thanks very much, guys..

Thank you. Our next question is from Kai Pan from Morgan Stanley. Your line is open..

Thank you and good morning. Christa, I just want to clarify one number. You mentioned like you did $500 million of merger amortization year-to-date. But in the cash flow for the first nine months is about $200 million.

I just wonder if that number or figure is correct or is that including the fourth quarter's acquisitions as well?.

It's including Stroz Friedberg..

Okay.

And how material is Stroz to – in terms of revenue as well as margin for 2017?.

Yeah, we haven't given that number. What I can say is that we will report about $6 million of deal cost related to that cyber acquisition in Q4..

Thank you. Okay great. And then stepping back, if you look at margin, relatively stable year-over-year, but the revenue growth is pretty strong.

I just wonder, is that you investing more in the business, that could held back a little bit about the margin expansion, or do you think it's just one quarter thing and you will continue to see meaningful margin expansion if the growth rate remains strong?.

Yeah. So, I would say, Q3 was exactly in line with our expectations. We did guide essentially to flat and if you look at year-to-date, we've got margin expansion and we're heading into our strongest quarter of the year, Q4, which we feel really good about, therefore, we're on track for substantial margin expansion in the full year..

I would encourage you, as you think about Q3, it was always our weakest quarter. We think about this from an annual standpoint; I think Christa captures it very well. We're on track in 2016, exactly where we had hoped to be..

Okay. That's great. Lastly, on Brexit and what's the impact you have seen when talking with your clients in both the London market as well as your consulting side.

Is there any sign of slowing down or temporary slowing down of management consulting projects?.

I would say, Kai, in many respects the uncertainty around Brexit for us as an advisor to clients on risk, retirement and health, has actually increased in terms of helping them understand that, deal with that set of uncertainties and we think that's going to persist for a period of time.

So, for us, we're helping clients actually sort through a very complicated situation and that will continue for the foreseeable future..

What about London market?.

Same in the London market. I'm really describing the global mindset. What I just described could be doubled or tripled in the London market because that's actually where the intensity is greatest.

Clients are thinking for example, if I've got retirement plans that cut across the Continent, how do I deal with those? If I've got health plans that cut across, how do you deal with those? And then on the risk side, how do you manage complexity across markets that are going to change and emerge a bit.

So, for us, it's an opportunity to advise clients and advise markets on how to think about this overall. So net-net, when we think about the impact to places like Lloyd's, a very important market in the world, we continue to see them be very strong.

We continue to see them work to adapt to what the new world will be, and there is lots of levers they can pull to adapt and do that..

Great. Thank you so much for all the answers..

Sure..

Thank you. Our next question is from Mr. Charles Sebaski from BMO Capital Markets. Your line is open..

Yeah, good afternoon. Thank you. Just a follow-up on the M&A that you guys have done so far. I guess I'm just trying to rectify the transactions with the, I guess, dispositions being greater than, just the negative revenue reported in the acquisition/disposition.

Would we expect that to go positive relative to these deals next year or why these – are there more dispositions to come that offset the acquisitions...?.

Just to set the framework, Charles, so to think back to commentary we've had on these calls for literally going back almost 10 years. Everything we do is built off a foundation that Christa has set up and applied across the firm around return on invested capital.

And what are the ways we can actually apply capital in a way to serve our clients most effectively. And you've seen us do that over the years. And if you step back over the last 10 years, we've deployed probably, call it, $15 billion in capital of which, call it, roughly half, a little more than that, buyback, roughly half is on some acquisitions.

So net-net, this is obviously a very positive story and will continue to be a very positive story for us.

Within that context you'll see us continuously try to look for ways to optimize return on invested capital on behalf of clients, strengthen the firm, double down in areas that we can grow and build capability in the areas of risk, retirement, health, talent, et cetera, communications. So you see us doing that.

That will drive everything we do, it's also why in that context you hear Christa describe and I describe, the team describe, buyback sets the benchmark for that. And then against that, we make acquisitions that are accretive against that benchmark.

And that really has been the formulation and foundation of exactly everything we've done and we'll continue do that. And we're less worried about kind of, a quarter plus or minus or a year plus or minus, we're worried about and focused on, in fact, maniacally focused on how we build this for Aon over time..

And the other thing I'd say, Charles, is the disposition costs do go away in Q1, 2017 because you've then lapped the significant dispositions. Obviously, you've got lost operating income, you've got stranded costs like half floor of real estate or half a server leftover.

And I think just to dimensionalize the impact of disposition year-to-date, we've lost $141 million of revenue, we've lost $10 million of PTI (42:16), so that gives you a sense of year-to-date impact. But we will lap that in Q1 next year. And then, obviously, as Greg described, we are actually acquiring great talent and capability on the M&A side.

And you'll see that continue to grow..

Okay. On the margin side for Risk, you talked about in the quarter that there was an 80 bp benefit from foreign currency translation. I'm curious if you could let us know what is that on a nine month basis.

The 23.4% adjusted margin for Risk, what's the embedded FX benefit in that number?.

Hang on. Just trying to find that number for you..

And I guess....

20 basis points – 50 basis points, sorry..

But for the year overall, when you think about FX and the impact on our business, as we think about FX overall – again, we reflect back in terms of less about the quarter and less about the nine months – I think, it's got a marginal impact on margins overall for the year in terms of where we are across the board. We use that number..

Okay.

And I guess this is just a general thought on 2017, I guess, my question is, a good problem to have – and not maybe a problem – but at record retention and record new business in Risk, does that set up a comparable challenge in 2017 for organic growth? Knowing that if you're at 94% retentions and your ceiling is at 100%, does it just create – an excellent result, makes a tough year-over-year comp going into next year or you just don't – the things that are transpiring don't set up like that?.

We don't see it that way, Charles, as you might expect. In fact, in many respects, what we've done is invest very, very heavily to increase operating leverage in the business, make the acquisitions Christa described to strengthen our position.

It frankly gives us the ability to create net new demand on behalf of clients and substantially increase growth trajectory. You've actually seen it, if you think about our performance in the third quarter. What this is a reflection of is certainly not the insurance environment.

It's really a reflection of our ability to create net new demand and help clients succeed. So if you think about it, our view is – think about some the three or four areas that we look to, to grow, obviously, there is all the traditional areas around property, casualty, D&O.

And we've made this multi-year investment to increase operating leverage in something called Aon Client Promise. This is not just talk. This is very real mechanics on how we interact and support clients every day. That's what's resulted in record new retention. That's resulted in record new business. So I emphasize record new business.

And yet we're still relatively small when you think about the opportunity to build market share globally. So we've got a capability to build market share and compete globally in a way that we think is actually quite extraordinary, and that's called a tradition.

In addition to that, we have capabilities into areas outside the core that we're investing heavily in. Call it, a couple of examples, in Affinity and Health and Benefits, these are two areas reported up through our Risk business that are $1 billion-plus businesses growing well above mid-single-digit with opportunities for margin expansion.

So this is now a second full category completely outside anything that we've just described. And then, finally, very exciting for us is we've made substantial investments in data and analytics.

We believe more than anyone else and you see that coming out – a manifestation of real things about clients, I mean, Aon Client Treaty is simply the single biggest transaction in the history Lloyd's. We've got thousands of clients now taking advantage of that. It's incredibly impactful for them. Aon Inpoint, 45 plus carriers onboard work with that.

Aon Review, what we did in U.S. mortgage, we literally are creating a $10 billion business out of – just net new. So in many respects, Charles, we would describe what we have come to as a set of opportunities to accelerate our ability to grow in the current environment, irrespective of what happens over in the insurance environment.

So, for us, we're excited about the progress and we have real confidence that 2017, 2018 will bring more opportunity. And the final thing I would say about it is this idea of operating leverage. We're not just putting on net new revenue.

This is revenue that we believe has operational leverage, different than the revenue we put on three years or four years ago. And how we've actually brought it on board, which means we've got margin opportunities which are substantial..

Thank you very much for all the color..

Thank you. And our last question is from Mr. Josh Shanker from Deutsche Bank. Your line is open..

Yes, thank you very much for fitting me in. I just wanted to go through the 270 basis point items in the HR Solutions I guess, one is, you're closing some offices and you're shutting down a server.

Is that a reserve set up for the full cost or did you spend all that in the third quarter and, two, can we expect there are other items like this as you, for the long-term plan for higher margins, are there more of these restructuring type items to come?.

Yes, so, on the IT cost, this was related to a legacy IT contact. It was a one-time expense and it will not be repeated. And then the other $7 million item is really related to dispositions and it's really the stranded costs that remain in that business. As I described, half a floor or half sever and we're continuing to reduce those costs over time..

And that's the point, are there other initiatives that might come up that are similar to this over the foreseeable future that have a long-term margin expanding goal but short-term might be a headwind?.

Yes, I mean, I guess I would say absolutely, Josh, because as we think about return on capital for the firm, are we going to make investments that we think drive higher return longer-term, you bet, we are. I mean, you saw that in M&A, in the cyber example Greg described.

You see it organically in the kinds of things we're investing in in Health and Benefits and Affinity. And so you will continue to see that occur where we see the return on capital being substantially attractive for Aon..

And then on Chuck's question, obviously the fourth quarter is the strongest quarter. He was talking about the favorable tailwind from currency translation. Given the higher revenue base for the quarter, is that going to be – should we think about, 80 basis points is a significant amount. You amortize that over a larger revenue base.

It's a big, big benefit to the quarter, or is 80 basis points really just a unique thing for 3Q?.

Yeah. I wouldn't over rotate on the 80 basis points. I would say, most of the countries in which we operate we have local revenue and local expense and you're translating back to U.S. dollars. And the U.S. dollar has been strong. And so I think what you saw in Q3 was an unusual situation with the pound.

And so I just – I would not over rotate on the 80 basis point number..

Okay. Thank you very much..

Thank you..

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

Thanks very much. And appreciate everybody being on the call today. Thanks very much..

That concludes today's conference. Thank you for participating. You may now disconnect..