Marsh & McLennan Companies, Inc. — Q3 2016 Form 10-Q
Reporting period and business: Quarter and nine months ended September 30, 2016. The global professional services firm operates Risk and Insurance Services (Marsh and Guy Carpenter) and Consulting (Mercer and Oliver Wyman Group). Amounts below are in U.S. dollars; financial statement amounts are in millions except per-share data.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $3,135 | $3,115 | $9,847 | $9,555 |
| Operating income | $572 | $461 | $2,031 | $1,825 |
| Income from continuing operations | $384 | $329 | $1,354 | $1,256 |
| Net income attributable to the Company | $379 | $323 | $1,332 | $1,224 |
| Diluted EPS, continuing operations | $0.73 | $0.60 | $2.54 | $2.27 |
| Operating margin | 18.2% | 14.8% | 20.6% | 19.1% |
- Revenue growth: Q3 reported and underlying revenue each grew 1%; nine-month reported and underlying revenue each grew 3%. Foreign currency reduced reported revenue growth by 1 percentage point in Q3 and 2 points year to date.
- Segments: Q3 Risk and Insurance Services revenue was $1,632, up 3% reported and 2% underlying; operating income rose to $315 from $225, and margin expanded to 19.2% from 14.2%. Consulting revenue was $1,513, down 2% reported and flat underlying; operating income increased to $308 from $285, with margin of 20.4% versus 18.5%.
- Cash flow: Nine-month operating cash flow was $1,112, versus $989 in 2015. Capital expenditures were $174, versus $249. Cash and cash equivalents increased to $1,388 from $1,374 at year-end 2015.
- Debt and liquidity: Short- and long-term debt totaled $4,756, compared with $4,414 at December 31, 2015; cash was $1,388. The $1.5 billion revolving credit facility and $150 million uncommitted bank line had no borrowings outstanding. The company reported senior ratings of A- (S&P) and Baa1 (Moody’s), both with stable outlooks.
Material changes and notable items
- Q3 operating income increased 24%, reflecting 1% revenue growth and a 3% decline in operating expenses. Management attributed lower expenses mainly to reduced incentive compensation, pension expense and acquisition-related contingent consideration costs.
- Nine-month operating income grew 11%. Expenses rose 1%, reflecting higher salaries and amortization, partly offset by lower pension and contingent consideration costs.
- Q3 Consulting results included a 10% reported revenue decline at Oliver Wyman Group (9% underlying). Management cited comparison with strong prior-year Financial Services growth and uncertainty around Brexit. Mercer underlying revenue grew 3% in Q3, with Talent and Investments each up 7%.
- Investment income was less than $1 in Q3 2016 versus $34 in Q3 2015; the nine-month period recorded a $2 loss versus $39 income. The prior-year comparison benefited from investment gains.
- In Q2 2016, new Indian regulations led Marsh to deconsolidate Marsh India and account for its interest under the equity method. A net pretax gain of approximately $12 was recognized in nine-month revenue.
- The company repurchased approximately 10 million shares for $625 in the first nine months, versus 23.4 million shares for $1.3 billion in 2015. It paid $504 in dividends and had approximately $530 million of repurchase authorization remaining at September 30.
Outlook, risks and contingencies
- The filing provides no formal earnings or revenue guidance. Management expected the pension-plan change described below to have no significant effect on Q4 2016 pension expense.
- In October 2016, the company amended U.S. defined benefit plans to end future benefit accruals after December 31, 2016, and added a 4% automatic employer contribution to defined contribution plans for most U.S. employees beginning January 1, 2017. Eligible employees may receive total employer contributions of up to 7% of eligible base pay.
- Management cited exposure to foreign exchange, interest rates, market conditions, tax changes, pension obligations, cybersecurity and business continuity, competition, employee retention, regulation, and professional-liability claims. A 10% move in major currencies against the U.S. dollar was estimated to change net operating income by approximately $57. The company estimated that, if September 30 exchange rates held through year-end, currency translation would reduce full-year income by approximately $1.
- Claims, lawsuits and regulatory matters arise in the ordinary course, including errors-and-omissions claims. The company said it could not reasonably estimate possible losses for developing matters; adverse determinations could materially affect future results, financial condition or cash flows. It also disclosed historical guarantees connected with insurance businesses and limited indemnities related to Kroll matters.
- Unrecognized tax benefits were $67 at September 30; up to approximately $6 could be resolved within 12 months. The company also disclosed approximately $1.8 billion of net pension liabilities for underfunded plans, excluded from its contractual-obligations table because timing and amount depend on future events.
- Foreign currency translation reduced equity by $374 in the first nine months. Management noted the company’s significant international operations and that fiduciary funds are segregated and unavailable for corporate use.
Important facts for investors to verify
- Whether underlying revenue growth and margin gains continue, particularly in Risk and Insurance Services and Mercer, and whether Oliver Wyman recovers from Q3 weakness.
- How much Q3 and year-to-date earnings improvement reflects sustainable operating performance versus lower incentive compensation, pension expense, acquisition-related charges and prior-year investment gains.
- Debt maturities, cash generation and capital returns, including repurchases, dividends and remaining authorization.
- Future pension funding needs and the financial effects of the U.S. plan changes, including the estimated $58 of remaining 2016 contributions disclosed for U.S. and non-U.S. plans.
- Developments in litigation, regulatory matters, tax audits, contingent acquisition consideration and the Alexander Forbes investment, whose market value was approximately $208 versus a $266 carrying value; management concluded it was not impaired at September 30.