MRSH

Business Context and Reporting Period

Company: Marsh & McLennan Companies, Inc. (MMC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 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 restructuring, the implementation of a new business model following a settlement with the New York Attorney General (NYAG), and the sale of MMC Capital.

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability Decline: Operating income for the six months ended June 30, 2005, dropped 59% to $578 million compared to $1.405 billion in the prior year. Net income fell 64% to $300 million.
• Revenue Composition: While total operating revenue increased slightly (1% year-to-date), underlying revenue declined 9%. This was driven by a $340 million drop in market services revenue (contingent commissions) in the Risk and Insurance Services segment, offset by the full-year impact of the Kroll acquisition in Risk Consulting & Technology.
• Expense Increases: Operating expenses rose 18% year-to-date, primarily due to $198 million in restructuring costs, $58 million in employee retention costs, and incremental regulatory compliance costs.
• Cash Flow Reversal: Operating cash flow swung from a generation of $769 million in the first half of 2004 to a usage of $377 million in the first half of 2005. This was driven by lower net income and significant cash payments for the NYAG settlement fund ($255 million paid in Q2) and Putnam restitution.
• Segment Performance:
  • Risk & Insurance: Operating income fell 76% (6 months) due to the elimination of market services revenue and restructuring charges.
  • Investment Management (Putnam): Revenue declined 12% due to lower assets under management ($195 billion at June 30, 2005 vs. $213 billion in 2004), though operating income improved due to reduced regulatory settlement costs compared to 2004.

Guidance, Outlook, Risks, and Contingencies

• Restructuring Outlook: MMC expects to incur an additional $148 million in restructuring charges related to the 2005 plan over the remainder of 2005 and early 2006. Annualized savings of approximately $375 million are expected once the plan is fully implemented.
• Business Model Transition: Marsh is implementing a new business model requiring full disclosure of compensation. Revenue from higher retail commissions is expected to begin affecting results in 2006. There is uncertainty regarding the collection of $170 million in accrued market services revenue earned prior to October 2004.
• Legal and Regulatory Risks:
  • NYAG Settlement: A $850 million fund was established to compensate policyholders. Payments are scheduled over four years.
  • Litigation: Numerous class actions and derivative suits are pending regarding market services agreements, market-timing at Putnam, and securities fraud. Management states it is not possible to reasonably estimate the range of possible loss for many of these matters.
  • Putnam Matters: Ongoing investigations by the SEC and Department of Labor regarding market-timing and plan expense reimbursements. A $30 million charge was recorded for estimated costs related to transfer agent service fee calculations.
• Accounting Changes: MMC intends to adopt SFAS 123(R) effective July 1, 2005. This is expected to result in expenses of approximately $80 million for the remainder of 2005 and $120 million in 2006, significantly impacting reported net income.
• Capital Markets: Credit ratings were lowered to Baa2/BBB with negative outlooks. MMC is in the final stages of refinancing its corporate headquarters to extend terms and lock in rates.

Investor Verification Checklist

• Collection of Accrued Revenue: Verify the collectability of the $170 million in accrued market services revenue from pre-October 2004 placements.
• Restructuring Execution: Monitor the realization of the projected $375 million in annualized savings against the $148 million in remaining charges.
• Legal Exposure: Track developments in the NYAG-related class actions and Putnam market-timing litigation, as management has stated losses are not reasonably estimable.
• Putnam Assets Under Management (AUM): Assess the impact of continued net redemptions ($16.8 billion in H1 2005) on future fee revenue.
• Stock-Based Compensation Impact: Evaluate the effect of the July 1, 2005 adoption of SFAS 123(R) on future earnings per share.