MRSH

Business Context and Reporting Period

Company: Marsh & McLennan Companies, Inc. (MMC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2005
Business Overview: MMC is a professional services firm operating in four segments: Risk and Insurance Services (Marsh), Risk Consulting & Technology (Kroll), Consulting (Mercer), and Investment Management (Putnam). The reporting period reflects significant ongoing restructuring, the implementation of a new business model following regulatory settlements, and the adoption of new accounting standards for stock-based compensation.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Stability: Operating revenue remained flat year-over-year for the nine-month period ($9.176B vs $9.174B). However, underlying revenue declined 7% due to a $361 million drop in market services revenue at Marsh and lower assets under management at Putnam. This was offset by growth in the Risk Consulting segment (driven by the Kroll acquisition) and Consulting segment.
• Profitability Decline: Operating income for the nine months fell 50% to $773 million from $1.533 billion. This decrease is primarily attributed to restructuring charges ($245 million), employee retention costs ($118 million), and incremental regulatory compliance costs.
• Expense Increases: Operating expenses rose 10% year-over-year for the nine-month period. Key drivers included restructuring costs, retention costs, and a $37 million incremental charge for stock-based compensation due to the adoption of SFAS 123(R).
• Cash Flow Contraction: Net cash generated from operations dropped significantly to $109 million from $1.43 billion in the prior year. This was driven by lower net income and significant cash outflows for regulatory settlements (NYAG/NYSID fund) and restructuring payments.
• Debt Refinancing: In September 2005, MMC issued $1.3 billion in new senior notes (5.15% due 2010 and 5.75% due 2015) to repay a $1.3 billion term loan maturing in 2006. Additionally, the company refinanced its headquarters mortgage, replacing a $200 million 9.8% loan with a $475 million 5.7% loan.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Restructuring: MMC expects to incur an additional $95 million in restructuring charges related to the 2005 Plan over the remainder of 2005 and the first half of 2006. Annual savings of approximately $375 million are expected once the plan is fully implemented.
• Business Model Transition: Marsh is transitioning to a new business model eliminating contingent commissions. Management expects new revenue streams from higher retail commissions to begin impacting results in 2006.
• Putnam Assets: Putnam's assets under management declined to $192 billion at quarter-end, down from $209 billion in the prior year, due to net redemptions. Management is focused on reversing net redemption trends.
• Tax Outlook: The effective tax rate for ongoing operations is expected to be 35% for the fourth quarter of 2005.

Risks and Contingencies

• Regulatory Settlements: MMC established an $850 million fund to compensate policyholders as part of the settlement with the New York Attorney General (NYAG) and New York State Insurance Department (NYSID). Approximately $750 million of this fund has been elected by policyholders. The company faces ongoing investigations in 21 other jurisdictions and potential civil actions.
• Litigation: Numerous lawsuits remain pending, including class actions by policyholders alleging antitrust violations and bid-rigging, shareholder derivative suits, and securities class actions related to the NYAG investigation and Putnam's "market-timing" issues.
• Putnam Regulatory Matters: Putnam faces ongoing investigations by the SEC and Department of Labor regarding market-timing, late trading, and plan expense reimbursement agreements. A $35 million charge was recorded for estimated costs related to transfer agent service fee calculations.
• Accounting Changes: The adoption of SFAS 123(R) on July 1, 2005, resulted in a $37 million incremental expense for the nine-month period. Unrecognized compensation costs related to stock options and restricted stock remain significant ($184 million and $253 million, respectively).

Investor Verification Checklist

• Restructuring Progress: Verify the realization of the projected $375 million in annual savings from the 2005 restructuring plan and the timing of the remaining $95 million in expected charges.
• Market Services Revenue: Monitor the collection of accrued market services revenue earned prior to October 1, 2004 ($158 million outstanding as of Sept 30, 2005), as failure to collect could result in future charges.
• Putnam Flows: Track Putnam's ability to reverse net redemptions and stabilize assets under management, which directly impacts Investment Management revenue.
• Regulatory Exposure: Assess the status of the $850 million policyholder fund disbursements and the outcome of ongoing investigations in other states and by federal regulators (SEC, DOL).
• Stock-Based Compensation: Review the impact of SFAS 123(R) on future earnings, noting the $437 million in unrecognized compensation costs related to options and restricted stock awards.