SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For quarter ended September 30, 1998 Marsh & McLennan Companies, Inc. 1166 Avenue of the Americas New York, New York 10036 (212) 345-5000 Commission file number 1-5998 State of Incorporation: Delaware I.R.S. Employer Identification No. 36-2668272 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X . NO . As of October 31, 1998, there were outstanding 257,302,775 shares of common stock, par value $1.00 per share, of the registrant. INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS This report contains forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. Such statements may include, without limitation, discussions concerning revenue and expense growth, cost savings and efficiencies expected from the integration of Johnson & Higgins and Sedgwick Group plc, Year 2000 remediation and testing of computer systems, market and industry conditions, interest rates, foreign exchange rates, contingencies and matters relating to the operations and income taxes of Marsh & McLennan Companies, Inc. and subsidiaries (the "Company"). Such forward-looking statements are based on available current market and industry materials, experts' reports and opinions, as well as management's expectations concerning future events impacting the Company. Forward-looking statements by their very nature involve risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by any forward-looking statements contained herein include, in the case of the Company's risk and insurance services business, the failure to successfully integrate the insurance services business of Johnson & Higgins and Sedgwick Group plc (including the achievement of synergies and cost reductions), changes in competitive conditions, a decrease in the premium rate levels in the global property and casualty insurance markets, the impact of changes in insurance markets and natural catastrophes; in the case of the Company's investment management business, changes in worldwide and national securities and fixed income markets and; with respect to all of the Company's activities, the failure of the Company and/or its significant business partners to be Year 2000 compliant on a timely basis, changes in general worldwide and national economic conditions, fluctuations in foreign currencies, actions of competitors or regulators, changes in interest rates, developments relating to claims and lawsuits, changes in the tax or accounting treatment of the Company's operations and the impact of tax and other legislation and regulation in the jurisdictions in which the Company operates. PART I, FINANCIAL INFORMATION MARSH & McLENNAN COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share figures) (Unaudited) Three Months Ended Nine Months Ended September 30, September 30, 1998 1997 1998 1997 Revenue $1,719 $1,548 $5,245 $4,383 Expense 1,384 1,299 4,160 3,595 Operating Income 335 249 1,085 788 Interest Income 5 6 17 17 Interest Expense (33) (28) (94) (77) Income Before Income Taxes 307 227 1,008 728 Income Taxes 121 87 398 279 Net Income $ 186 $ 140 $ 610 $ 449 Basic Net Income Per Share (A) (B) $.73 $.55 $2.38 $1.86 Diluted Net Income Per Share (A) (B) $.69 $.54 $2.28 $1.82 Average Number of Shares Outstanding - Basic (A) 256 253 256 241 Average Number of Shares Outstanding - Diluted (A) 263 260 264 247 Dividends Declared (A) $.40 $.33 $1.13 $.96 (A) Amounts in 1997 were restated to reflect the three-for-two stock split in the form of a stock distribution issued on June 26, 1998. (B) Net income per share is computed independently for each of the periods presented. Accordingly, the sum of the quarterly net income per share amounts may not equal the total for the year. MARSH & McLENNAN COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In millions of dollars) (Unaudited) September 30, December 31, 1998 1997 ASSETS Current assets: Cash and cash equivalents (including interest-bearing amounts of $597 at September 30, 1998 and $378 at December 31, 1997) $ 667 $ 424 Receivables- Commissions and fees 1,418 1,296 Advanced premiums and claims 125 95 Other receivables 161 160 1,704 1,551 Less-allowance for doubtful accounts (68) (53) Net receivables 1,636 1,498 Other current assets 543 647 Total current assets 2,846 2,569 Long-term securities 752 720 Fixed assets, net 934 957 (net of accumulated depreciation and amortization of $842 at September 30, 1998 and $798 at December 31, 1997) Intangible assets 2,822 2,417 Other assets 1,374 1,251 $8,728 $7,914 MARSH & McLENNAN COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In millions of dollars) (Unaudited) September 30, December 31, 1998 1997 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term debt $ 480 $ 237 Accrued compensation and employee benefits 650 564 Accounts payable and accrued liabilities 1,130 1,276 Accrued income taxes 354 218 Dividends payable 100 85 Total current liabilities 2,714 2,380 Fiduciary liabilities 2,570 2,282 Less - cash and investments held in a fiduciary capacity (2,570) (2,282) - - Long-term debt 1,280 1,240 Other liabilities 1,157 1,096 Commitments and contingencies - - Stockholders' equity: Preferred stock, $1 par value, authorized 6,000,000 shares, none issued - - Common stock, $1 par value, authorized 400,000,000 shares, issued 260,662,839 shares at September 30, 1998 and 258,586,766 at December 31, 1997 * 261 172 Additional paid-in capital 980 994 Retained earnings 2,294 1,975 Accumulated other comprehensive income 216 167 3,751 3,308 Less - treasury shares, at cost, 3,457,056 shares at September 30, 1998 and 3,661,256 shares at December 31, 1997 * (174) (110) Total stockholders' equity 3,577 3,198 $8,728 $7,914 * Restated to reflect the three-for-two stock split in the form of a stock distribution issued on June 26, 1998. MARSH & McLENNAN COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions of dollars) (Unaudited) Nine Months Ended September 30, 1998 1997 Operating cash flows: Net income $610 $ 449 Gain on sale of business - (10) Depreciation and amortization 181 147 Deferred income taxes 83 (1) Other liabilities 61 12 Prepaid dealer commissions (95) (125) Other, net (10) 1 Net changes in operating working capital other than cash and cash equivalents - Receivables (138) (77) Other current assets 82 (12) Accrued compensation and employee benefits 86 47 Accounts payable and accrued liabilities (146) (39) Accrued income taxes 114 (79) Effect of exchange rate changes 39 (12) Net cash generated from operations 867 301 Financing cash flows: Net increase (decrease) in commercial paper 453 (100) Other borrowings 32 2,175 Other repayments (204) (1,507) Purchase of treasury shares (195) - Issuance of common stock 171 195 Dividends paid (276) (221) Net cash (used for) provided by financing activities (19) 542 Investing cash flows: Additions to fixed assets (216) (159) Proceeds from sale of business, net of cash sold - 29 Acquisitions (373) (568) Other, net (21) - Net cash used for investing activities (610) (698) Effect of exchange rate changes on cash and cash equivalents 5 (10) Increase in cash & cash equivalents 243 135 Cash & cash equivalents at beginning of period 424 300 Cash & cash equivalents at end of period $667 $ 435 MARSH & McLENNAN COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. The consolidated financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company's latest annual report on Form 10-K. The financial information contained herein reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the results of operations for the three and nine-month periods ended September 30, 1998 and 1997. 2. Fiduciary Cash and Liabilities In its capacity as an insurance broker or agent, the Company collects premiums from insureds and, after deducting its commissions, remits the premiums to the respective insurance underwriters; the Company also collects claims or refunds from underwriters on behalf of insureds. Unremitted insurance premiums and claims are held in a fiduciary capacity. Interest income on these fiduciary funds, included in revenue, amounted to $98 million and $84 million for the nine months ended September 30, 1998 and 1997, respectively. Net uncollected premiums and claims and the related payables amounting to $6.1 billion at September 30, 1998 and $5.2 billion at December 31, 1997, are not included in the accompanying Consolidated Balance Sheets. 3. Per Share Data In 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share" which requires the Company to include basic and diluted per share figures on the face of the income statement. Basic net income per share is calculated by dividing net income by the average number of shares of the Company's common stock outstanding. Diluted net income per share is calculated by reducing net income for the potential minority interest associated with unvested shares granted under the Putnam Private Equity Plan. This result is then divided by the average common shares outstanding which have been adjusted for the dilutive effect of potential common shares. The following reconciles net income to net income for diluted earnings per share and basic weighted average common shares outstanding to diluted weighted average common shares outstanding for the three and nine-month periods ended September 30, 1998 and 1997. Three Months Nine Months Ended Ended September 30, September 30, 1998 1997 1998 1997 Net Income $186 $140 $610 $449 Less: Potential Minority Interest associated with Putnam Private Equity Plan (5) - (8) - Net Income for Diluted Earnings per Share $181 $140 $602 $449 Basic Weighted Average Common Shares Outstanding 256 253 256 241 Stock Options 7 7 8 6 Diluted Weighted Average Common Shares Outstanding 263 260 264 247 4. Comprehensive Income Effective January 1, 1998, the Company adopted SFAS No.130, "Reporting Comprehensive Income" which establishes standards for reporting and displaying comprehensive income and its components. Comprehensive income amounted to $659 million and $477 million for the nine months ended September 30, 1998 and 1997, respectively. The difference between net income and comprehensive income for the nine months ended September 30, 1998 was primarily due to foreign currency translation adjustments while the difference for the period ended September 30, 1997 was due to net unrealized securities holding gains, partially offset by foreign currency translation adjustments. 5. Supplemental Disclosure to the Consolidated Statements of Cash Flows The following schedule provides additional information concerning acquisitions: Nine Months Ended September 30, (In millions of dollars) 1998 1997 Purchase acquisitions: Assets acquired, excluding cash $373 $ 2,659 Liabilities assumed - (1,115) Shares issued - (975) Net cash outflow for acquisitions 373 569 Cash acquired in pooling of interests acquisition - (1) $373 $ 568 Interest paid during the nine months ended September 30, 1998 and 1997 was $107 million and $66 million, respectively. Income taxes paid during the nine months ended September 30, 1998 and 1997 were $230 million and $339 million, respectively. 6. Income Taxes The Company has received a Notice of Proposed Adjustment from a field office of the Internal Revenue Service ("IRS") challenging its tax treatment related to 12b-1 fees paid by the Putnam Mutual Funds. The Company believes its tax treatment of these fees is consistent with current industry practice and applicable requirements of the Internal Revenue Code and previously issued IRS technical advice. The field office has referred the Notice to the national office of the IRS for technical advice. Taxing authorities periodically challenge positions taken by the Company on its tax returns. On the basis of present information and advice received from counsel, it is the opinion of the Company's management that any assessments resulting from current tax audits will not have a material adverse effect on the Company's consolidated results of operations or its consolidated financial position. 7. Acquisitions During the third quarter, the Company announced its offer to acquire Sedgwick Group plc ("Sedgwick"), a London-based holding company of one of the world's leading insurance and reinsurance broking and consulting groups, for total cash consideration of pounds sterling 1.25 billion or approximately $2.1 billion. On November 3, 1998, the Company announced that it had received the necessary acceptances of its offer and that all remaining conditions of the merger had been satisfied. Accordingly, on November 3, 1998, this offer became wholly unconditional and the Company became the beneficial owner of approximately 88% of Sedgwick's issued share capital. The offer remains open and the Company intends to acquire the remaining issued share capital pursuant to the offer and/or other applicable statutory procedures under the laws of the United Kingdom. Except to the extent specifically identified herein, the information contained in this Form 10-Q reflects the business and operations of the Company without giving effect to the consummation of the Sedgwick offer. For the year ended December 31, 1997, Sedgwick reported net income amounting to pounds sterling 52.1 million ($85 million) on a U.S. GAAP basis. At December 31, 1997, Sedgwick and its subsidiaries employed approximately 16,000 employees. On June 30, 1998, the Company purchased Kirke-Van Orsdel, Inc., an administrator of insurance and health benefit programs in the U.S. On March 24, 1998, the Company purchased Brockman y Schuh Group, a risk and insurance services and employee benefit consulting firm in Mexico. On March 27, 1997, the Company consummated a business combination with Johnson & Higgins ("J&H"), a privately-held risk and insurance services and employee benefit consulting firm. The following unaudited pro forma summary presents the consolidated results of operations of the Company as if the J&H business combination had occurred on January 1, 1997. The pro forma results are shown for illustrative purposes only and do not purport to be indicative of the results which would have been reported if the business combination had occurred on the date indicated or which may occur in the future. (In millions of dollars, except per share figures) Nine Months Ended September 30, 1997 Revenue $4,688 Net Income 460 Basic Net Income per share 1.84 Diluted Net Income per share 1.79 8. Claims, Lawsuits and Other Contingencies The Company and its subsidiaries are subject to various claims and lawsuits consisting principally of alleged errors and omissions in connection with the placement of insurance or reinsurance and in rendering investment and consulting services. Some of these claims and lawsuits seek damages, including punitive damages, in amounts which could, if assessed, be significant. On November 24, 1997, an action captioned "Aiena et al. vs. Olsen et al" was brought in the United States District Court for the Southern District of New York by certain former directors of J&H, which was acquired by the Company in March 1997, against twenty-four selling shareholders of J&H, as well as J&H itself and the Company. The action essentially challenges the allocation of the consideration paid in connection with the Company's combination with J&H as between the defendants who were directors and shareholders of J&H at the time of the transaction and the plaintiffs who were former directors and shareholders of J&H. The Complaint asserts, among others, claims for breach of fiduciary duty, federal securities law violations, breach of contract, and ERISA violations. Plaintiffs seek compensatory and punitive damages. On or about April 14, 1998, an action captioned "Sempier v. Olsen, et al" was brought in the United States District Court for the District of New Jersey by another former director of J&H against the same defendants named in the Aiena action, including J&H and the Company, in connection with the same transaction. The allegations and claims in the Sempier case are substantially similar to those in the Aiena action. Plaintiff seeks, among other relief, an unspecified amount of compensatory and punitive damages. This action was transferred to the District Court for the Southern District of New York to be heard together with the Aiena action. The defendants made motions to dismiss both the Sempier and Aiena actions. These motions are currently under consideration by the District Court. In 1993, several years prior to the acquisition of J&H, the Equal Employment Opportunity Commission ("EEOC") commenced a lawsuit against J&H in the United States District Court for the Southern District of New York. The action alleges that a mandatory retirement policy for directors then in effect at J&H violated the federal Age Discrimination in Employment Act ("ADEA"). In 1995, the District Court ruled in the EEOC's favor that the J&H mandatory retirement policy violated the ADEA. The Court of Appeals for the Second Circuit affirmed that ruling in 1996. The EEOC seeks to recover damages on behalf of certain former directors and a trial on the matter of damages is presently scheduled for February, 1999. Pursuant to the Stock Purchase Agreement between the Company and J&H and the stockholders of J&H, the Company will bear one-half of all damages and expenses in this action. Certain present and former English subsidiaries of the Company are required by their regulatory body, the Personal Investment Authority, to review transactions with, and advice to, clients in relation to the sale of certain investments. The disclosure and advice in connection with such sales has been called into question by clients or by the Personal Investment Authority on their behalf. Where the review discloses an inappropriate sale, compensation is required to be paid to the client. While the amount of compensation which has been and may be paid, the liability of present subsidiaries of the Company in connection therewith and the extent to which any such liability is covered by insurance remains uncertain, the aggregate amount claimed could be significant. On the basis of present information, available insurance coverage and advice received from counsel, it is the opinion of the Company's management that the disposition or ultimate determination of these claims and lawsuits will not have a material adverse effect on the Company's consolidated results of operations or its consolidated financial position. 9. Common Stock On May 20, 1998, the Company's Board of Directors authorized a three-for-two stock distribution of $1 par value common stock, which was issued on June 26, 1998 to shareholders of record on June 5, 1998. Upon issuance of the shares, paid-in capital was reduced and the common stock account increased by $87 million, the par value of the additional common shares issued. All references to per share amounts have been restated for this stock distribution. 10. New Accounting Pronouncements In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," and in February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." Both statements are effective for fiscal years beginning after December 15, 1997. The Company will adopt the provisions of these standards in conjunction with the preparation of the 1998 Annual Report. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This standard, which establishes new accounting and reporting requirements for derivative instruments, must be adopted in the fiscal year beginning after June 15, 1999. The Company does not expect the adoption of this standard to have a material impact on its operating results or financial position. Marsh & McLennan Companies, Inc. and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations Third Quarter and Nine Months Ended September 30, 1998 General Marsh & McLennan Companies, Inc. and Subsidiaries (the "Company") is a professional services firm providing risk and insurance services, investment management and consulting. More than 39,000 employees worldwide provide analysis, advice and transactional capabilities to clients in over 100 countries. This management's discussion and analysis of financial condition and results of operations contains certain statements relating to future results which are forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. See "Information Concerning Forward-Looking Statements" on page one of this filing. This form 10-Q should be read in conjunction with the Company's latest annual report on Form 10-K. The consolidated results of operations follow: Third Quarter Nine Months (In millions of dollars) 1998 1997 1998 1997 Revenue: Risk and Insurance Services $ 764 $ 707 $2,418 $2,017 Investment Management 568 494 1,713 1,367 Consulting 387 347 1,114 999 1,719 1,548 5,245 4,383 Expense: Compensation and Benefits 860 811 2,577 2,236 Other Operating Expenses 524 488 1,583 1,359 1,384 1,299 4,160 3,595 Operating Income $ 335 $ 249 $1,085 $ 788 Operating Income Margin 19.5% 16.1% 20.7% 18.0% Revenue, derived mainly from commissions and fees, rose 11% from the third quarter of 1997 and grew by 20% for the nine months. This growth was driven principally by increased revenue from the Investment Management segment as average assets under management were substantially higher than the comparable figures in the previous year. Also, the Consulting segment experienced strong revenue growth due to a higher level of services provided in the retirement, global compensation, health care and economic consulting areas. For the nine months, the increases in the Investment Management and Consulting segments were supplemented by an increase in Risk and Insurance Services as the Company's business combination with Johnson & Higgins ("J&H"), which closed on March 27, 1997, was not reflected in the consolidated results of operations for the first quarter of 1997. Excluding acquisitions and dispositions, revenue grew approximately 13% for the first nine months of 1998. Expenses rose 7% in the third quarter of 1998 due, in part, to costs associated with staff growth in the Investment Management and Consulting segments to support a higher volume of business in 1998. For the nine months, the increase in expenses of 16% is partially due to the impact of the J&H transaction. Excluding acquisitions and dispositions, expenses rose 8% for the first nine months of 1998 primarily reflecting costs associated with staff growth and higher incentive compensation levels in the Investment Management segment commensurate with strong operating performance. The translated values of revenue and expense from the Company's international operations are affected by fluctuations in currency exchange rates. However, the net impact of these fluctuations on the Company's results of operations has not been material. Risk and Insurance Services Third Quarter Nine Months (In millions of dollars) 1998 1997 1998 1997 Revenue $764 $707 $2,418 $2,017 Expense 648 606 1,924 1,628 Operating Income $116 $101 $ 494 $ 389 Operating Income Margin 15.2% 14.2% 20.4% 19.3% Revenue Revenue for the Risk and Insurance Services segment increased 8% from the third quarter of 1997. Excluding the impact of the acquisition of Kirke-Van Orsdel, Inc. ("KVI"), a U.S.-based administrator of insurance and health benefit programs, and the net effect of several smaller acquisitions and dispositions, revenue grew 5% in the quarter. Insurance broking revenue, which represented 70% of Risk and Insurance Services, grew 5% in the third quarter of 1998 as net new business development was partially offset by continued premium rate declines in virtually all lines of coverage. The increased level of net new business development was primarily concentrated in the United States and the United Kingdom. Revenue for reinsurance broking grew 5% over the third quarter of 1997 and program management revenue, excluding KVI, rose 8%. For the nine months, revenue for Risk and Insurance Services increased 20% over the same period last year primarily due to the effect of the J&H transaction at the end of the first quarter of 1997. Excluding acquisitions and dispositions, Risk and Insurance Services revenue rose approximately 5% for the nine months, as revenue grew 5% in insurance broking while reinsurance broking rose 6% and program management increased 7%. Expense Risk and Insurance Services expenses increased 7% from the third quarter of 1997. Excluding acquisitions and dispositions, expenses grew 2% reflecting normal salary progressions for continuing staff and higher technology and systems spending offset by the realization of integration related savings. For the nine months, expenses increased 18%, largely attributable to the business combination with J&H, which, as previously noted, was effective as of the end of the first quarter of 1997 resulting in 1998 having one additional quarter of J&H expenses. Excluding acquisitions and dispositions, expenses grew 2% compared with the first nine months of 1997. Investment Management Third Quarter Nine Months (In millions of dollars) 1998 1997 1998 1997 Revenue $568 $494 $1,713 $1,367 Expense 389 368 1,218 1,025 Operating Income $179 $126 $ 495 $ 342 Operating Income Margin 31.5% 25.4% 28.9% 25.0% Revenue Putnam's revenue increased 15% compared with the third quarter of 1997 and 25% for the nine months reflecting excellent growth in the level of assets under management on which management fees are earned. Assets under management aggregated $253 billion at September 30, 1998 compared with $227 billion at September 30, 1997 reflecting $32 billion of mutual fund net new sales and additional investments by institutional accounts offset, in part, by a $6 billion decline resulting from lower equity market levels. Compared with June 30, 1998, assets under management declined $25 billion as a $5 billion cash inflow from net new fund sales and additional institutional investments was more than offset by a $30 billion decline in market value related to a significant drop in equity market levels during the quarter. Expense Putnam's expenses rose 5% in the third quarter of 1998 reflecting the effect of staff growth to support higher volume partially offset by a reduction in variable incentive compensation that fluctuates with overall performance levels. For the nine months, expenses grew 19% due to the effect of staff growth and higher incentive compensation levels commensurate with strong operating performance along with increased service-related costs resulting from the higher level of business activity. Quarter-end and average assets under management for the third quarter are presented below: (In billions of dollars) 1998 1997 Mutual Funds: Domestic Equity $125 $115 Taxable Bond 37 33 Tax-Free Income 17 16 International Equity 12 12 191 176 Institutional Accounts: Fixed Income 25 21 Domestic Equity 25 20 International Equity 12 10 62 51 Quarter-end Assets $253 $227 Average Assets $268 $218 Assets under management are affected by fluctuations in domestic and international stock and bond market prices and by the level of investments and withdrawals for current and new fund shareholders and institutional clients. They are also affected by investment performance, service to clients, the development and marketing of new investment products, the relative attractiveness of the investment style under prevailing market conditions and changes in the investment patterns of clients. Revenue levels are sensitive to all of the factors above, but in particular, to significant changes in stock and bond market valuations. Putnam provides individual and institutional investors with a broad range of equity and fixed income investment products and services, designed to meet varying investment objectives and which affords its clients the opportunity to allocate their investment resources among various alternative investment products as changing worldwide economic and market conditions warrant. At the end of the third quarter in 1998 and 1997, assets held in equity securities represented 69% of assets under management, while investments in fixed income products represented 31% for both periods. Consulting Third Quarter Nine Months (In millions of dollars) 1998 1997 1998 1997 Revenue $387 $347 $1,114 $999 Expense 332 305 973 888 Operating Income $ 55 $ 42 $ 141 $111 Operating Income Margin 14.1% 12.2% 12.7% 11.2% Revenue Consulting revenue increased 12% in 1998 compared with the third quarter of 1997 reflecting net new business and the impact of several small acquisitions partially offset by the transfer of certain business lines as part of a strategic alliance with Automatic Data Processing. Adjusting for the impact of acquisitions and dispositions, revenue increased approximately 14% in the third quarter of 1998. Retirement consulting revenue, which represented 40% of the Consulting segment, grew 12% in the third quarter while revenue rose 25% in the global compensation practice, 35% for economic consulting and 14% in health care consulting due to a higher volume of business in these practice lines. For the first nine months of 1998, Consulting revenue increased 11%. Excluding acquisitions and dispositions, revenue increased approximately 12% for the nine months as retirement consulting grew 11% while revenue increased 21% in the global compensation practice and 19% in economic consulting. Health care consulting and general management consulting grew 8% and 7%, respectively. Expense Consulting expenses increased 9% for the third quarter of 1998 and 10% for the nine months. Excluding acquisitions and dispositions, expenses increased 12% for the third quarter and 10% for the nine months primarily reflecting the effect of staff growth to support new business, higher incentive compensation commensurate with strong operating performance along with normal compensation expense increases. Interest Interest income earned on corporate funds was $5 million in the third quarter of 1998 compared with $6 million in 1997. Interest expense increased to $33 million in the third quarter of 1998 from $28 million in 1997 partially due to incremental debt incurred in connection with the acquisition of KVI at the end of the second quarter of 1998. Interest expense increased to $94 million for the nine months ended September 30, 1998 from $77 million in 1997 as a result of increased bank borrowings used to finance a portion of the acquisition of J&H as well as the assumption of J&H's long-term debt and the acquisition of KVI. Income Taxes The Company's consolidated tax rate was 39.5% of income before income taxes in the third quarter and first nine months of 1998 compared with 38.25% for the comparable periods of 1997. The increase in the 1998 tax rate is largely attributable to the nondeductibility of the goodwill amortization associated with the J&H transaction. The overall tax rates are higher than the U.S. statutory rates primarily because of state and local income taxes. Liquidity and Capital Resources The Company's cash and cash equivalents aggregated $667 million on September 30, 1998, compared with $424 million on December 31, 1997. Cash flow from operations includes the net cash requirements of Putnam's prepaid dealer commissions, which amounted to $95 million for the nine months compared with $125 million during the same period of 1997. The Company's capital expenditures, which amounted to $216 million in the first nine months of 1998 and $159 million during the same period of 1997, were primarily related to computer equipment purchases and the refurbishing and modernizing of office facilities. The other liabilities in the Consolidated Balance Sheets, which totaled $1.2 billion on September 30, 1998 and $1.1 billion on December 31, 1997, include the Company's long-term pension liability, reserves related to the Company's professional liability insurance program, and the postretirement liability for certain health care and life insurance benefits. During the third quarter, the Company announced its offer to acquire Sedgwick Group plc ("Sedgwick"), a London-based holding company of one of the world's leading insurance and reinsurance broking and consulting groups, for total cash consideration of pounds sterling 1.25 billion or approximately $2.1 billion. On November 3, 1998, the Company announced that it had received the necessary acceptances of its offer and that all remaining conditions of the merger had been satisfied. Accordingly, on November 3, 1998, this offer became wholly unconditional and the Company became the beneficial owner of approximately 88% of Sedgwick's issued share capital. The offer remains open and the Company intends to acquire the remaining issued share capital pursuant to the offer and/or other applicable statutory procedures under the laws of the United Kingdom. The Company will initially finance the transaction with commercial paper that will be supported by a committed bank facility comprising 19 banks and led by J. P. Morgan. Other Comprehensive income amounted to $659 million and $477 million for the nine months ended September 30, 1998 and 1997. The difference between net income and comprehensive income for the nine months ended September 30, 1998 was primarily due to foreign currency translation adjustments. In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information," and in February 1998, the FASB issued Statement of Financial Accounting Standards No. 132, "Employers' Disclosure about Pensions and Other Postretirement Benefits." Both statements are effective for fiscal years beginning after December 15, 1997. The Company will adopt the provisions of these standards in conjunction with the preparation of the 1998 Annual Report. In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." This standard, which establishes new accounting and reporting requirements for derivative instruments, must be adopted in the fiscal year beginning after June 15, 1999. The Company does not expect the adoption of this standard to have a material impact on its operating results or financial position. Year 2000 Issue The Company is in the process of updating its computer systems in preparation for the Year 2000. The project, which began in early 1996, is well under way. Steering committees have been established comprising executive level management in each operating segment. The Audit Committee of the Company's Board of Directors is regularly updated on the status of its Year 2000 efforts. In connection with this project, each of the Company's operating segments will complete a four-step process consisting of (1) taking inventory of all technical areas, including hardware, software (application and system), data, third-party services and infrastructure that could potentially be affected by the Year 2000 issue, (2) assessing the scope and severity of the issue, (3) performing necessary remediation and (4) testing/implementation. Each operating segment has already enhanced or replaced a number of systems to handle dates beyond January 1, 2000. At this time, all of the Company's operating segments are in the process of remediation or in the testing/implementation phase of the process for mission critical systems. At Putnam Investments, testing of third party dependencies with sub-custodians, pricing services and other vendors has been identified as a critical component of the Year 2000 evaluation process. In July 1998, Putnam participated in the "Street-wide Test" carried out under the auspices of the Securities Industry Association. Putnam will participate in all future testing, which will include the simulation of a trading cycle from order entry to settlement in a Year 2000 environment. On a cumulative basis, the cost to the Company of achieving Year 2000 compliance has amounted to approximately $35 million through September 30, 1998, of which $17 million was incurred during 1996 and 1997. Such costs do not include expenses incurred in replacing systems and applications in the ordinary course which have the effect of making such systems and applications Year 2000 compliant but which were not incurred for that specific purpose. Costs of modifying computer software for Year 2000 conversion are being charged to expense as they are incurred. Future costs associated with addressing this issue are not expected to have a material adverse impact on the Company's financial position or results of operations. The Company expects that all of its mission critical systems will be Year 2000 compliant by mid-1999. In addition, the Company is continuing its inquiries as to the state of readiness of its clients and vendors. If these third parties are unable to resolve Year 2000 processing issues in a timely manner, a material operating and financial risk could result. A further review of the Year 2000 issues associated with Sedgwick will be performed. Sedgwick has advised the Company that its progress is in line with the Company on this issue. The individual operating units of the Company are currently in the process of developing their contingency plans to address certain exposures relating to the Year 2000 issue. It is anticipated that these plans will be completed during 1999. PART II, OTHER INFORMATION MARSH & McLENNAN COMPANIES, INC. AND SUBSIDIARIES INFORMATION REQUIRED FOR FORM 10-Q QUARTERLY REPORT September 30, 1998 Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. 10.1 Credit Agreement dated as of August 24, 1998 among Marsh & McLennan Companies, Inc., the lenders party thereto and Morgan Guaranty Trust Company of New York, as Administrative Agent. 10.2 First Amendment dated as of September 2, 1998 to the Credit Agreement dated as of August 24, 1998 among Marsh & McLennan Companies, Inc., the lenders party thereto and Morgan Guaranty Trust Company of New York, as Administrative Agent. 27 Financial Data Schedule (b) Reports on Form 8-K. Two reports on Form 8-K dated August 25, 1998 and November 12, 1998 were filed by the registrant in connection with its offer to acquire the entire issued and unissued share capital of Sedgwick Group plc. MARSH & McLENNAN COMPANIES, INC. AND SUBSIDIARIES SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed this 13th day of November, 1998 on its behalf by the undersigned, thereunto duly authorized and in the capacity indicated. MARSH & McLENNAN COMPANIES, INC. /s/ Frank J. Borelli Senior Vice President and Chief Financial Officer