How did MMC's earnings change in 2002, and how much of the increase is due to accounting changes?

Net income rose 40% to $1.365 billion, and diluted EPS rose 44% to $2.45. Part of the year-over-year increase reflects 2001 charges of $187 million related to September 11 and a $61 million restructuring charge, plus a $222 million Bipop investment write-down that was reclassified against revenue. In addition, MMC adopted SFAS 142 on January 1, 2002, which eliminated goodwill amortization; 2001 amortization had reduced adjusted earnings by about $131 million. Excluding special items, 2001 diluted EPS was $2.12, so the underlying 2002 growth was about 16%.

Which business drives MMC's results, and what is the outlook for that business?

Risk and Insurance Services (Marsh) generated about 57% of 2002 revenue and about 66% of segment operating income. Management reports that the commercial insurance market has tightened since September 11, with reduced capacity, higher rates and restrictive terms. The 10-K states that the difficult market is expected to continue in 2003, particularly for many liability coverages, though rate increases are moderating in some property lines. Revenue growth in this segment is linked to premium rate levels, so continued rate increases support results, while a softening market would reduce them.

Why did Putnam's results decline, and what could affect them going forward?

Putnam's revenue fell 10% to $2.17 billion because equity markets declined for a third consecutive year, reducing average AUM by 15% to $279 billion. The mutual fund industry also experienced net equity fund redemptions for the first time in 14 years. Putnam's fee revenue depends on AUM levels, so further market declines or continued outflows would reduce revenue. The filing also notes that the termination of key advisory contracts or changes to 12b-1 fees could have a material adverse effect, and that fund trustees regularly review fee structures.

What are the main balance sheet and cash flow considerations?

Long-term debt rose to $2.89 billion from $2.33 billion, reflecting the March 2002 issuance of $750 million of senior notes used to repay commercial paper, and the February 2003 issuance of $500 million of additional senior notes. Operating cash flow was $1.28 billion, down from $1.50 billion in 2001, mainly because of $445 million of accrued income tax payments and higher other asset build-ups, and included $460 million of retirement plan contributions. Financing outflows of $1.0 billion were driven by share repurchases of $1.18 billion and dividends of $593 million. Management states that operating cash flow is sufficient to fund working capital, dividends, capital expenditures and scheduled debt repayments, and the revolving credit facilities total $2.4 billion.

Are there material legal or contingent liabilities investors should be aware of?

MMC faces claims principally alleging errors and omissions in insurance placement and in investment and consulting services, some seeking significant punitive damages. The most notable matter is a UK regulatory review of personal pension plan sales, originating at Sedgwick, under which settlements and related costs of about $525 million had been paid by December 31, 2002, with about $200 million recovered from insurers. Management states that the remaining payments are not expected to be material. The filing also discloses a guarantee related to River Thames Insurance Company that management does not expect to have a material net impact. Management believes that none of these matters will have a material adverse effect on consolidated results or financial position.

MRSH/MMC 10-K FY2002 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 26, 2003. Cited figures are marked; the original filing is the authoritative source.

Marsh & McLennan Companies (MMC) reported a strong 2002 in its 10-K filed March 26, 2003.

Operating revenue rose 6% to $10.44 billion^a, operating income rose 29% to $2.27 billion, and net income grew 40% to $1.365 billion, or $2.45 per diluted share. Much of the improvement reflects the Risk and Insurance Services segment (Marsh), where revenue grew 15% to $5.9 billion and operating income rose 31% to $1.49 billion, aided by a higher volume of business and sharply higher commercial insurance rates after September 11. Management notes that 2002 comparisons are flattered by the 2001 charges and by the cessation of goodwill amortization under SFAS 142, which added roughly $131 million to 2001 expense that is absent in 2002.

The picture is more mixed beneath the headline. Putnam, the investment management segment, saw revenue fall 10% to $2.17 billion^b and average assets under management drop 15% to $279 billion, as three consecutive years of equity market declines produced $10.3 billion of net redemptions. Year-end AUM fell to $251 billion.

Mercer, the consulting segment, grew revenue only 2% to $2.36 billion^c. Pension funding is a notable pressure point: unfunded non-U.S. pension obligations rose to $742 million, and MMC contributed $460 million to retirement plans in 2002. Balance sheet items to watch include $2.9 billion of long-term debt, after $750 million of senior notes were issued in 2002 and a further $500 million in February 2003, and $1.0 billion of share repurchases in 2002 (24.2 million shares).

The filing also discloses the continuing Sedgwick personal pension redress review (about $525 million^d paid to date) and a management view that pending litigation will not be materially adverse. For investors, the filing describes a company whose core brokerage franchise is benefiting from a hard insurance market, while its asset management and consulting businesses remain tied to slower-recovering end markets. Cash generation was solid, with $1.28 billion of operating cash flow, but operating cash flow declined from $1.50 billion in 2001 because of higher income tax payments and larger other asset build-ups.

02—Key points

Key Highlights

Operating revenue rose 6% to $10.44 billion; net income rose 40% to $1.365 billion and diluted EPS rose 44% to $2.45 (2001 EPS was $1.70, or $2.12 excluding special items).
Risk and Insurance Services (Marsh) revenue grew 15% to $5.91 billion and operating income rose 31% to $1.49 billion, with operating margin expanding to 25.2% from 22.1%, driven by net new business and higher commercial premium rates.
Putnam investment management revenue fell 10% to $2.17 billion and operating income fell 4% to $560 million; average AUM dropped 15% to $279 billion and year-end AUM fell to $251 billion, with $10.3 billion of net redemptions.
Mercer consulting revenue rose 2% to $2.36 billion and operating income rose 4% to $326 million, with retirement services (50% of segment revenue) growing 7% on an underlying basis.
Pension funding pressure increased: non-U.S. plan benefit obligations exceeded plan assets by $742 million, U.S. plans were underfunded by $264 million, and MMC contributed $460 million to retirement plans during 2002.
Capital management was active: $1.18 billion of share repurchases (24.2 million shares), a dividend increase to $1.09 per share, a two-for-one stock split in June 2002, and $750 million of new senior notes in 2002 plus $500 million in February 2003.
Risk factors disclosed include the Sedgwick personal pension redress review (about $525 million paid to date, of which about $200 million was recovered from insurers) and a difficult insurance pricing environment expected to persist into 2003, particularly in liability lines.

03—Questions

Frequently Asked Questions

How did MMC's earnings change in 2002, and how much of the increase is due to accounting changes?
Net income rose 40% to $1.365 billion, and diluted EPS rose 44% to $2.45. Part of the year-over-year increase reflects 2001 charges of $187 million related to September 11 and a $61 million restructuring charge, plus a $222 million Bipop investment write-down that was reclassified against revenue. In addition, MMC adopted SFAS 142 on January 1, 2002, which eliminated goodwill amortization; 2001 amortization had reduced adjusted earnings by about $131 million. Excluding special items, 2001 diluted EPS was $2.12, so the underlying 2002 growth was about 16%.
Which business drives MMC's results, and what is the outlook for that business?
Risk and Insurance Services (Marsh) generated about 57% of 2002 revenue and about 66% of segment operating income. Management reports that the commercial insurance market has tightened since September 11, with reduced capacity, higher rates and restrictive terms. The 10-K states that the difficult market is expected to continue in 2003, particularly for many liability coverages, though rate increases are moderating in some property lines. Revenue growth in this segment is linked to premium rate levels, so continued rate increases support results, while a softening market would reduce them.
Why did Putnam's results decline, and what could affect them going forward?
Putnam's revenue fell 10% to $2.17 billion because equity markets declined for a third consecutive year, reducing average AUM by 15% to $279 billion. The mutual fund industry also experienced net equity fund redemptions for the first time in 14 years. Putnam's fee revenue depends on AUM levels, so further market declines or continued outflows would reduce revenue. The filing also notes that the termination of key advisory contracts or changes to 12b-1 fees could have a material adverse effect, and that fund trustees regularly review fee structures.
What are the main balance sheet and cash flow considerations?
Long-term debt rose to $2.89 billion from $2.33 billion, reflecting the March 2002 issuance of $750 million of senior notes used to repay commercial paper, and the February 2003 issuance of $500 million of additional senior notes. Operating cash flow was $1.28 billion, down from $1.50 billion in 2001, mainly because of $445 million of accrued income tax payments and higher other asset build-ups, and included $460 million of retirement plan contributions. Financing outflows of $1.0 billion were driven by share repurchases of $1.18 billion and dividends of $593 million. Management states that operating cash flow is sufficient to fund working capital, dividends, capital expenditures and scheduled debt repayments, and the revolving credit facilities total $2.4 billion.
Are there material legal or contingent liabilities investors should be aware of?
MMC faces claims principally alleging errors and omissions in insurance placement and in investment and consulting services, some seeking significant punitive damages. The most notable matter is a UK regulatory review of personal pension plan sales, originating at Sedgwick, under which settlements and related costs of about $525 million had been paid by December 31, 2002, with about $200 million recovered from insurers. Management states that the remaining payments are not expected to be material. The filing also discloses a guarantee related to River Thames Insurance Company that management does not expect to have a material net impact. Management believes that none of these matters will have a material adverse effect on consolidated results or financial position.

04—Continue

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