MARSH & MCLENNAN COMPANIES, INC. quarterly report, Q2 FY2013

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Business context and reporting period

Marsh & McLennan Companies, Inc. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2013. The global professional services firm operates through Risk and Insurance Services (Marsh and Guy Carpenter) and Consulting (Mercer and Oliver Wyman Group).

Financial performance and position

  • Second-quarter revenue: $3.088 billion, up 2% reported and 3% underlying year over year. Operating income was $577 million, up 11%; net income attributable to the Company was $388 million versus $329 million. Diluted EPS attributable to the Company was $0.69 versus $0.59.
  • First-half revenue: $6.214 billion, up 2% reported and 2% underlying. Operating income was $1.184 billion versus $1.045 billion; net income attributable to the Company was $801 million versus $676 million. Diluted EPS was $1.44 versus $1.22.
  • Margins: Consolidated operating margin was approximately 18.7% in Q2 versus 17.1% a year earlier, and 19.1% for the first half versus 17.2%. Risk and Insurance Services’ Q2 margin was 24.9% versus 23.8%; Consulting’s was 14.5% versus 13.1%.
  • Segment trends: Q2 Risk and Insurance Services revenue rose 3% underlying, with operating income up 8%. Consulting revenue rose 2% underlying; Mercer grew 4%, while Oliver Wyman declined 4%. First-half Consulting underlying revenue rose 1%, as Mercer growth of 3% was partly offset by a 6% Oliver Wyman decline.
  • Cash flow: First-half operating cash flow was negative $163 million, compared with positive $66 million in 2012. Investing cash outflow was $194 million and financing cash outflow was $592 million. Capital expenditures were $192 million. Cash and cash equivalents fell to $1.230 billion from $2.301 billion at year-end 2012.
  • Debt and liquidity: June 30 total debt was $2.713 billion, including $10 million short-term and $2.703 billion long-term, compared with $2.918 billion at year-end. The $1.0 billion revolving credit facility was undrawn; the company had $50 million outstanding under a term loan. Current assets were $5.214 billion and current liabilities $2.964 billion. Fiduciary assets are restricted and unavailable for corporate use.
  • Capital returns and pension: The company repurchased $250 million of shares in the first half and paid $255 million in dividends. It contributed $473 million to defined-benefit plans during the first half, including discretionary U.K. and Canadian contributions of $250 million and $70 million.
  • Tax: The effective tax rate was 28.9% in Q2 versus 29.8%, and 29.5% for the first half versus 30.0%. Gross unrecognized tax benefits were $120 million at June 30.

Material changes versus the prior comparable period

  • Operating income increased faster than revenue, alongside flat consolidated operating expenses. Management attributed improved Q2 operating income to revenue growth and slightly lower expenses.
  • Risk and Insurance Services and Consulting both reported higher operating income and margins. Consulting expense reductions, including lower incentive compensation, supported results.
  • First-half operating cash flow deteriorated from a $66 million inflow to a $163 million outflow. The filing cites working-capital timing and pension contributions; cash usage included substantial increases in other assets and payments of accrued compensation and benefits.
  • First-half investment income increased to $44 million from $24 million. Q2 investment income was $23 million versus $4 million; 2013 included $21 million in previously deferred Trident III performance fees no longer subject to clawback.
  • The company repurchased more shares than in the first half of 2012 ($250 million versus $100 million) and authorized up to $1 billion of additional repurchases in May.

Outlook, risks, contingencies, and unusual items

  • The filing provides no specific revenue, earnings, or EPS guidance. Management said it expected approximately $175 million of additional non-qualified U.S. and non-U.S. pension contributions in the remainder of 2013, including approximately $100 million to U.K. plans; it did not expect contributions to the U.S. tax-qualified plan through the end of 2014.
  • Management identified exposure to errors-and-omissions claims, regulatory and legal proceedings, acquisition integration and contingent consideration, pension funding, competition, foreign exchange, interest rates, cybersecurity, business continuity, and tax-law changes. The company could not estimate the possible loss range for certain pending matters; adverse outcomes could materially affect future results, financial condition, or cash flows.
  • Recorded errors-and-omissions liabilities were $440 million at June 30. The filing describes pending policyholder lawsuits and other legal matters, as well as indemnities and legacy insurance guarantees; where losses are not probable and estimable, liabilities may not be recorded.
  • First-half restructuring costs were $13 million. Two acquisitions were completed in the first half for total consideration of $109 million; a subsequent Oliver Wyman acquisition was reported at approximately $30 million.
  • Foreign currency translation reduced first-half other comprehensive income by $340 million after tax. Management estimated that a 10% movement in major currencies against the U.S. dollar, sustained for a year, could change annual net operating income by approximately $50 million.

Important facts for investors to verify

  1. Whether underlying revenue growth, particularly at Mercer and in Risk and Insurance Services, continues and offsets weakness at Oliver Wyman.
  2. Whether operating cash flow improves after the first-half working-capital outflows and substantial pension contributions.
  3. The timing and amount of further pension contributions, and the outcome of the U.K. plan funding valuation expected to inform 2014 funding.
  4. Developments in litigation, regulatory matters, indemnities, and errors-and-omissions claims for which potential losses are not currently estimable.
  5. The sustainability of investment income and timing of recognition of the remaining $32 million in deferred Trident III performance fees, which is subject to investment realization and clawback conditions.
  6. Use of the remaining share-repurchase authorization and the effect of capital returns on cash and debt.