filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
EXECUTIVE SUMMARY
We are a strategic holding company providing advertising, marketing and corporate communications services to clients through our branded networks and agencies around the world. On a global, pan-regional and local basis, our networks and agencies provide a comprehensive range of services in four fundamental disciplines: advertising, CRM, public relations and specialty communications. Our business model was built and continues to evolve around our clients. While our networks and agencies operate under different names and frame their ideas in different disciplines, we organize our services around our clients. The fundamental premise of our business is that our clients’ specific requirements should be the central focus in how we deliver our services and allocate our resources. This client-centric business model requires that multiple agencies collaborate in formal and informal virtual networks that cut across internal organizational structures to deliver consistent brand messages for a specific client and execute against each of our clients’ specific marketing requirements. We continually seek to grow our business with our existing clients by maintaining our client-centric approach, as well as expanding our existing business relationships into new markets and with new clients. In addition, we pursue selective acquisitions of complementary companies with strong entrepreneurial management teams that typically currently serve or have the ability to serve our existing client base.
As a leading global advertising, marketing and corporate communications company, we operate in all major markets and have a large and diverse client base. In 2015, our largest client accounted for 2.7% of our revenue and our 100 largest clients accounted for approximately 52% of our revenue. Our business is spread across a significant number of industry sectors with no one industry comprising more than 13% of our revenue in 2015. Although our revenue is generally balanced between the United States and international markets and we have a large and diverse client base, we are not immune to general economic downturns.
As described in more detail below, in 2015 our revenue decreased $183.4 million, or 1.2%, compared to 2014. Beginning in the fourth quarter of 2014 and continuing throughout 2015, substantially all foreign currencies weakened against the U.S. Dollar. Changes in foreign exchange rates reduced revenue by $1.0 billion or 6.6%, acquisitions, net of dispositions increased revenue $14.6 million or 0.1% and organic growth increased revenue $810.8 million or 5.3%.
Global economic conditions have a direct impact on our business and financial performance. In particular, a contraction in global or regional economic conditions poses a risk that our clients may reduce, postpone or cancel spending on advertising, marketing and corporate communications services which would reduce the demand for our services. In 2015, the United States experienced modest economic growth and the major economies of Asia continued their moderate expansion. Economic conditions in the Euro Zone remain unsettled and economic conditions in Brazil continued a downward trend that began in the second quarter of 2015. The economic and fiscal issues facing certain countries in the Euro Zone continue to cause economic uncertainty in that market; however, the impact on our business varies by country. We will continue to monitor economic conditions closely, as well as client revenue levels and other factors and, in response to reductions in our client revenue, if necessary, we will take actions available to us to align our cost structure and manage our working capital. There can be no assurance whether, or to what extent, our efforts to mitigate any impact of future adverse economic conditions, reductions in client revenue, changes in client creditworthiness and other developments will be effective.
Certain business trends have had a positive impact on our business and industry. These trends include clients increasingly expanding the focus of their brand strategies from national markets to pan-regional and global markets and integrating traditional and non-traditional marketing channels, as well as utilizing new communications technologies and emerging digital platforms. Additionally, in an effort to gain greater efficiency and effectiveness from their total marketing expenditures, clients continue to require greater coordination of marketing activities. We believe these trends have benefited our business in the past and over the medium and long term will continue to provide a competitive advantage to us.
In the near term, barring unforeseen events and excluding the impact of changes in foreign exchange rates, as a result of continued improvement in operating performance by many of our agencies and new business activities, we expect our 2016 revenue to increase modestly in excess of the weighted average nominal GDP growth in our major markets. We expect to continue to identify acquisition opportunities intended to build upon the core capabilities of our strategic business platforms, expand our operations in the emerging markets and enhance our capabilities to leverage new technologies that are being used by marketers today.
Given our size and breadth, we manage our business by monitoring several financial indicators. The key indicators that we focus on are revenue and operating expenses. We analyze revenue growth by reviewing the components and mix of the growth, including growth by principal regional market, growth by marketing discipline, impact from foreign currency fluctuations, growth from acquisitions and growth from our largest clients.
In 2015, our revenue decreased 1.2% compared to 2014. Changes in foreign exchange rates reduced revenue 6.6%, acquisitions, net of dispositions increased revenue 0.1% and organic growth increased revenue 5.3%. Across our principal regional markets, the changes in revenue were: North America increased 4.1%, Europe decreased 9.3%, Latin America decreased 25% and Asia Pacific decreased 2%. In North America, moderate growth in the United States and Canada was partially offset by the weakening of the Canadian Dollar against the U.S. Dollar. In Europe, growth in the U.K., Germany and Spain was offset by the weakening of all major European currencies against the U.S. Dollar and negative performance in The Netherlands and France. The decrease in revenue in Latin America was a result of the weakening of all currencies in the region and negative performance in Chile and Brazil, which offset strong growth in Mexico. In Brazil, the decline resulted from a difficult comparison to the prior year period, which included additional client spending related to the World Cup primarily in the second quarter of 2014 and a recent decline in economic conditions. In Asia Pacific, strong growth in the major economies in the region was offset by the weakening of the currencies in the region. The change in revenue in 2015 compared to 2014, including the negative impact of currency changes, in our four fundamental disciplines was: advertising increased 1.8%, CRM decreased 5.6%, public relations decreased 2.3% and specialty communications increased 0.8%.
We measure operating expenses in two distinct cost categories: salary and service costs and office and general expenses. Salary and service costs consist of employee compensation, including freelance labor, and related costs and direct service costs. Office and general expenses consist of rent and occupancy costs, technology costs, depreciation and amortization and other overhead expenses. Each of our agencies requires professionals with the skill sets that are common across our disciplines. At the core of the skill sets is the ability to understand a client’s brand or product and its selling proposition and the ability to develop a unique message to communicate the value of the brand or product to the client’s target audience. The facility requirements of our agencies are similar across geographic regions and disciplines, and their technology requirements are generally limited to personal computers, servers and off-the-shelf software.
Similar to revenue, operating expenses decreased in 2015 compared to 2014 as a result of the weakening of substantially all foreign currencies against the U.S. Dollar. Salary and service costs, which normally tend to fluctuate with changes in revenue, increased $11.9 million, or 0.1%, in 2015 compared to 2014, primarily reflecting increases related to changes in the mix of our business during the period. Office and general expenses, which are less directly linked to changes in revenue than salary and service costs, decreased $171.3 million, or 8.5%, in 2015 compared to 2014.
Operating margins and earnings before interest, taxes and amortization of intangible assets, or EBITA, margins were unchanged year-over-year at 12.7% and 13.4%, respectively.
Net interest expense for 2015 increased $7.4 million to $141.5 million from $134.1 million in 2014. Interest expense
increased $3.9 million to $181.1 million in 2015, primarily resulting from the interest expense on the $750 million principal amount of the 3.65% Senior Notes due 2024, or 2024 Notes, issued in October 2014, partially offset by the benefit of the interest rate swaps on the 3.625% Senior Notes due 2022, or 2022 Notes, and the 4.45% Senior Notes due 2020, or 2020 Notes. Interest income decreased $3.5 million to $39.6 million in 2015 resulting from lower interest earned on cash balances in our international treasury centers and the negative impact of changes in foreign exchange rates.
Our effective tax rate was unchanged at 32.8%. Income tax expense for 2014 reflects the recognition of an income tax benefit of approximately $11 million, related to expenses incurred in prior periods in connection with the proposed merger with Publicis, which was terminated on May 8, 2014. Prior to the termination of the merger, the majority of the merger costs, which were incurred in 2013, were capitalized for income tax purposes and the related tax benefits were not recorded. Because the proposed merger was terminated, the merger costs were no longer required to be capitalized for income tax purposes. Excluding the income tax effect of the merger expenses, income tax expense for 2014 would have been $604.5 million.The decrease in the effective tax rate in 2015 from the effective tax rate in 2014, excluding the income tax benefit related to the proposed merger, is primarily due to a legal entity restructuring of our European operations. As a result of the reorganization, a certain portion of the foreign earnings in the affected countries is subject to lower effective tax rates.
Net income - Omnicom Group Inc. for 2015 decreased $10.1 million, or 0.9%, to $1,093.9 million from $1,104.0 million in 2014. The year-over-year decrease is due to the factors described above. Diluted net income per common share - Omnicom Group Inc. increased 4.0% to $4.41 in 2015, compared to $4.24 in 2014 due to the factors described above, as well as the impact of the reduction in our weighted average common shares outstanding resulting from repurchases of our common stock, net of shares issued for stock option exercises and shares issued under our employee stock purchase plan.
CRITICAL ACCOUNTING POLICIES
The following summary of our critical accounting policies provides a better understanding of our financial statements and the related discussion in this MD&A. We believe that the following policies may involve a higher degree of judgment and complexity in their application than most of our accounting policies and represent the critical accounting policies used in the preparation of our financial statements. Readers are encouraged to consider this summary together with our financial statements and the related notes, including Note 2, Significant Accounting Policies, for a more complete understanding of the critical accounting policies discussed below.
Estimates
Our financial statements are prepared in conformity with U.S. GAAP and require us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses in the consolidated financial statements and accompanying notes. We use a fair value approach in testing goodwill for impairment and when evaluating our equity method and cost method investments to determine if an other-than-temporary impairment has occurred. Actual results could differ from those estimates and assumptions.
Acquisitions and Goodwill
We have made and expect to continue to make selective acquisitions. The valuation of potential acquisitions is based on various factors, including specialized know-how, reputation, geographic coverage, competitive position and service offerings of the target businesses, as well as our experience and judgment.
Business combinations are accounted for using the acquisition method. The assets acquired, including identified intangible assets, liabilities assumed and any noncontrolling interest in the acquired business are recorded at their acquisition date fair values. In circumstances where control is obtained and less than 100% of a business is acquired, goodwill is recorded as if 100% were acquired. Acquisition-related costs, including advisory, legal, accounting, valuation and other costs are expensed as incurred. Certain acquisitions include an initial payment at closing and provide for future additional contingent purchase price payments (earn-outs), which are recorded as a liability at the acquisition date fair value. Subsequent changes in the fair value of the liability are recorded in results of operations. The results of operations of acquired businesses are included in results of operations from the acquisition date. In 2015, we completed 8 acquisitions of new subsidiaries.
Our acquisition strategy is focused on acquiring the expertise of an assembled workforce in order to continue to build upon the core capabilities of our various strategic business platforms and agency brands through the expansion of their geographic reach or their service capabilities to better serve our clients. Additional key factors we consider include the competitive position and specialized know-how of the acquisition targets. Accordingly, as is typical in most service businesses, a substantial portion of the intangible asset value we acquire is the know-how of the people, which is treated as part of goodwill and is not valued separately. For each acquisition, we undertake a detailed review to identify other intangible assets and a valuation is performed for all such identified assets. A significant portion of the identifiable intangible assets acquired is derived from customer relationships, including the related customer contracts, as well as trade names. In valuing these identified intangible assets, we typically use an income approach and consider comparable market participant measurements.
We evaluate goodwill for impairment at least annually at the end of the second quarter of the year and whenever events or circumstances indicate the carrying value may not be recoverable. We identified our regional reporting units as components of our operating segments, which are our five agency networks. The regional reporting units of each agency network are responsible for the agencies in their region. They report to the segment managers and facilitate the administrative and logistical requirements of our client-centric strategy for delivering services to clients in their regions. We have concluded that for each of our operating segments, their regional reporting units have similar economic characteristics and should be aggregated for purposes of testing goodwill for impairment at the operating segment level. Our conclusion was based on a detailed analysis of the aggregation criteria set forth in FASB ASC Topic 280, Segment Reporting, and the guidance set forth in FASB ASC Topic 350, Intangibles - Goodwill and Other. Consistent with our fundamental business strategy, the agencies within our regional reporting units serve similar clients in similar industries, and in many cases the same clients. In addition, the agencies within our regional reporting units have similar economic characteristics. The main economic components of each agency are employee compensation and related costs and direct service costs and office and general costs, which include rent and occupancy costs, technology costs that are generally limited to personal computers, servers and off-the-shelf software and other overhead expenses. Finally, the expected benefits of our acquisitions are typically shared by multiple agencies in various regions as they work together to integrate the acquired agency into our client service strategy.
Goodwill Impairment Review - Estimates and Assumptions
We use the following valuation methodologies to determine the fair value of our reporting units: (1) the income approach, which utilizes discounted expected future cash flows, (2) comparative market participant multiples for EBITDA (earnings before interest, taxes, depreciation and amortization) and (3) when available, consideration of recent and similar acquisition transactions.
In applying the income approach, we use estimates to derive the discounted expected cash flows (“DCF”) for each reporting unit that serves as the basis of our valuation. These estimates and assumptions include revenue growth and operating margin, EBITDA, tax rates, capital expenditures, weighted average cost of capital and related discount rates and expected long-term cash flow growth rates. All of these estimates and assumptions are affected by conditions specific to our businesses, economic conditions related to the industry we operate in, as well as conditions in the global economy. The assumptions that have the most significant effect on our valuations derived using a DCF methodology are: (1) the expected long-term growth rate of our reporting units' cash flows and (2) the weighted average cost of capital (“WACC”).
The assumptions used for the long-term growth rate and WACC in our evaluations as of June 30, 2015 and 2014 were:
| June 30, | |||
| 2015 | 2014 | ||
| Long-Term Growth Rate | 4% | 4% | |
| WACC | 10.1% - 10.7% | 9.9% - 10.6% |
Long-term growth rate represents our estimate of the long-term growth rate for our industry and the markets of the global economy we operate in. For the past ten years, the average historical revenue growth rate of our reporting units and the Average Nominal GDP growth of the countries comprising the major markets that account for substantially all of our revenue was approximately 4.8% and 4.0%, respectively. We considered this history when determining the long-term growth rates used in our annual impairment test at June 30, 2015. We believe marketing expenditures over the long term have a high correlation to GDP. We also believe based on our historical performance, that our long-term growth rate will exceed Average Nominal GDP growth in the markets we operate in. For our annual test as of June 30, 2015, we used an estimated long-term growth rate of 4% for our reporting units.
When performing the annual impairment test as of June 30, 2015 and estimating the future cash flows of our reporting units, we considered the current macroeconomic environment, as well as industry and market specific conditions at mid-year 2015. In the first half of 2015, we experienced an increase in our revenue of 5.2%, which excludes growth from acquisitions and the impact from changes in foreign exchange rates. Economic conditions in the Euro Zone are unsettled and the continuing fiscal issues faced by many countries in the European Union has caused economic difficulty in certain of our Euro Zone markets. During 2015, weakness in most Latin American economies we operate in has the potential to affect our near-term performance in that region. We considered the effect of these conditions in our annual impairment test.
The WACC is comprised of: (1) a risk-free rate of return, (2) a business risk index ascribed to us and to companies in our industry comparable to our reporting units based on a market derived variable that measures the volatility of the share price of equity securities relative to the volatility of the overall equity market, (3) an equity risk premium that is based on the rate of return on equity of publicly traded companies with business characteristics comparable to our reporting units and (4) a current after-tax market rate of return on debt of companies with business characteristics similar to our reporting units, each weighted by the relative market value percentages of our equity and debt.
Our five reporting units vary in size with respect to revenue and the amount of debt allocated to them. These differences drive variations in fair value among our reporting units. In addition, these differences as well as differences in book value, including goodwill, cause variations in the amount by which fair value exceeds book value among the reporting units. The reporting unit goodwill balances and debt vary by reporting unit primarily because our three legacy agency networks were acquired at the formation of Omnicom and were accounted for as a pooling of interests that did not result in any additional debt or goodwill being recorded. The remaining two agency networks were built through a combination of internal growth and acquisitions that were accounted for using the acquisition method and as a result, they have a relatively higher amount of goodwill and debt.
Goodwill Impairment Review - Conclusion
Under U.S. GAAP, we have the option of either assessing qualitative factors to determine whether it is more-likely-than-not that the carrying value of our reporting units exceeds their respective fair value or proceeding directly to Step 1 of the goodwill impairment test. Although not required, we performed Step 1 of the annual impairment test and compared the fair value of each of our reporting units to its respective carrying value, including goodwill. Based on the results of our impairment test, we concluded that our goodwill at June 30, 2015 was not impaired, because the fair value of each of our reporting units was substantially in excess of its respective net book value. The minimum decline in fair value that one of our reporting units would need to experience in order to fail Step 1 of the goodwill impairment test was approximately 74%. Notwithstanding our belief that the assumptions we used for WACC and long-term growth rate in our impairment testing are reasonable, we performed a sensitivity analysis for each of our reporting units. The results of this sensitivity analysis on our impairment test as of June 30, 2015 revealed that if the WACC increased by 1% and/or the long-term growth rate decreased by 1%, the fair value of each of our reporting units would continue to be substantially in excess of its respective net book value and would pass Step 1 of the impairment test.
We will continue to perform our impairment test at the end of the second quarter of each year unless events or circumstances trigger the need for an interim impairment test. The estimates used in our goodwill impairment test do not constitute forecasts or projections of future results of operations, but rather are estimates and assumptions based on historical results and assessments of macroeconomic factors affecting our reporting units as of the valuation date. We believe that our estimates and assumptions are reasonable, but they are subject to change from period to period. Actual results of operations and other factors will likely differ from the estimates used in our discounted cash flow valuation and it is possible that differences could be material. A change in the estimates we use could result in a decline in the estimated fair value of one or more of our reporting units from the amounts derived as of our latest valuation and could cause us to fail Step 1 of our goodwill impairment test if the estimated fair value for the reporting unit is less than the carrying value of the net assets of the reporting unit, including its goodwill. A large decline in estimated fair value of a reporting unit could result in a non-cash impairment charge and may have an adverse effect on our results of operations and financial position.
Subsequent to the annual impairment test at June 30, 2015, there were no events or circumstances that triggered the need for an interim impairment test. Additional information about acquisitions and goodwill appears in Notes 2, 4 and 5 to the consolidated financial statements.
Revenue Recognition
We recognize revenue in accordance with FASB ASC Topic 605, Revenue Recognition, and applicable SEC Staff Accounting Bulletins. Substantially all of our revenue is derived from fees for services based on a rate per hour or equivalent basis. Revenue is realized when the service is performed in accordance with the client arrangement and upon the completion of the earnings process. Prior to recognizing revenue, persuasive evidence of an arrangement must exist, the sales price must be fixed or determinable, delivery, performance and acceptance must be in accordance with the client arrangement and collection must be reasonably assured. These principles are the foundation of our revenue recognition policy and apply to all client arrangements in each of our service disciplines: advertising, CRM, public relations and specialty communications. Certain of our businesses earn a portion of their revenue as commissions based upon performance in accordance with client arrangements.
Because the services that we provide across each of our disciplines are similar and delivered to clients in similar ways, all of the key elements in revenue recognition apply to client arrangements in each of our four disciplines.
In the majority of our businesses, we act as an agent and record revenue equal to the net amount retained when the fee or commission is earned. Although, in certain markets, we may bear credit risk with respect to these activities, the arrangements with our clients are such that we act as an agent on their behalf. In these cases, costs incurred with third-party suppliers are excluded from our revenue. In certain arrangements, we act as principal and we contract directly with third-party suppliers and media providers and production companies and we are the primary obligor. In these circumstances, revenue is recorded at the gross amount billed since revenue has been earned for the sale of goods or services.
Some of our client arrangements include performance incentive provisions designed to link a portion of our revenue to our performance relative to quantitative and qualitative goals. We recognize performance incentives in revenue when the specific quantitative goals are achieved, or when our performance against qualitative goals is determined by the client. We may receive rebates or credits from certain vendors based on transactions entered into on behalf of clients. These rebates or credits are remitted to the clients or retained by us based on the terms of the client contract or local law. Amounts passed on to clients are recorded as a liability and amounts retained by us are recorded as revenue when earned.
In May 2014, the FASB issued FASB ASU 2014-09, Revenue from Contracts with Customers, or ASU 2014-09, which will replace all existing revenue recognition guidance under U.S. GAAP. On July 9, 2015, the FASB approved a one year deferral of the effective date of ASU 2014-09 to all annual and interim periods beginning after December 15, 2017, with early application permitted only for annual and interim periods beginning after December 31, 2016. ASU 2014-09 provides for one of two methods of transition: retrospective application to each prior period presented; or, recognition of the cumulative effect of retrospective application of the new standard as of the beginning of the period of initial application. Presently, we are not yet in a position to conclude on the application date or the transition method we will choose. While our implementation effort is ongoing, based on our initial assessment the impact of the application of the new standard will likely result in a change in the timing of our revenue recognition for performance incentives received from clients and the recognition of certain reimbursable out-of-pocket costs as revenue. Performance incentives are currently recognized in revenue when specific quantitative goals are achieved, or when our performance against qualitative goals is determined by the client. Under the new standard, we will be required to estimate the amount of the incentive that will be earned at the inception of the contract and recognize the incentive over the term of the contract. While performance incentives are not material to our revenue, this will result in an acceleration in revenue recognition for certain contract incentives compared to the current method. Certain incidental costs that are reimbursed by our clients and are currently required to be recorded in revenue will likely not be recorded as revenue under the new standard. We expect this will result in less revenue and related cost recorded in our results of operations. While, we have not yet completed our assessment, we do not expect this change to have a material impact to our revenue and it will not result in any change to operating income.
Additional information about our revenue recognition policy appears in Note 2 to the consolidated financial statements.
Share-Based Compensation
The majority of our incentive based share awards represent restricted stock awards and performance restricted stock awards, or PRSUs. Share-based compensation for these awards is determined and fixed on the grant date using the closing price of our common stock and we assume that substantially all the PRSUs will vest.
Share-based compensation expense of $99.4 million, $93.5 million and $86.3 million, in 2015, 2014 and 2013, respectively, was primarily attributed to restricted stock awards. Information about our specific awards and stock plans can be found in Note 9 to the consolidated financial statements.
NEW ACCOUNTING STANDARDS
See Note 2 to the consolidated financial statements for a description of accounting standards that were adopted in 2015 and our significant accounting policies and Note 20 for a discussion of accounting standards not yet implemented.
RESULTS OF OPERATIONS - 2015 Compared to 2014 (in millions):
| 2015 | 2014 | ||||||
| Revenue | $ | 15,134.4 | $ | 15,317.8 | |||
| Operating Expenses: | |||||||
| Salary and service costs | 11,361.9 | 11,350.0 | |||||
| Office and general expenses | 1,852.4 | 2,023.7 | |||||
| Total Operating Expenses | 13,214.3 | 13,373.7 | |||||
| Add back: Amortization of intangible assets | 109.3 | 107.1 | |||||
| 13,105.0 | 13,266.6 | ||||||
| Earnings before interest, taxes and amortization of intangible assets (“EBITA”) | 2,029.4 | 2,051.2 | |||||
| EBITA Margin - % | 13.4 | % | 13.4 | % | |||
| Deduct: Amortization of intangible assets | 109.3 | 107.1 | |||||
| Operating Income | 1,920.1 | 1,944.1 | |||||
| Operating Margin - % | 12.7 | % | 12.7 | % | |||
| Interest Expense | 181.1 | 177.2 | |||||
| Interest Income | 39.6 | 43.1 | |||||
| Income Before Income Taxes and Income From Equity Method Investments | 1,778.6 | 1,810.0 | |||||
| Income Tax Expense | 583.6 | 593.1 | |||||
| Income From Equity Method Investments | 8.4 | 16.2 | |||||
| Net Income | 1,203.4 | 1,233.1 | |||||
| Net Income Attributed To Noncontrolling Interests | 109.5 | 129.1 | |||||
| Net Income - Omnicom Group Inc. | $ | 1,093.9 | $ | 1,104.0 |
EBITA, which we define as earnings before interest, taxes and amortization of intangible assets, and EBITA Margin, which we define as EBITA divided by Revenue, are Non-GAAP financial measures. We use EBITA and EBITA Margin as additional operating performance measures, which exclude the non-cash amortization expense of acquired intangible assets. The table above reconciles EBITA and EBITA Margin to the U.S. GAAP financial measure of Operating Income for the periods presented. We believe that EBITA and EBITA Margin are useful measures to evaluate the performance of our businesses. Non-GAAP financial measures should not be considered in isolation from or as a substitute for financial information presented in compliance with U.S. GAAP. Non-GAAP financial measures reported by us may not be comparable to similarly titled amounts reported by other companies.
Revenue
In 2015, revenue decreased $183.4 million, or 1.2%, to $15,134.4 million from $15,317.8 million in 2014. Changes in foreign exchange rates reduced revenue $1.0 billion, acquisitions net of dispositions increased revenue $14.6 million and organic growth increased revenue $810.8 million.
The components of 2015 revenue change in the United States (“Domestic”) and the remainder of the world (“International”) were (in millions):
| Total | Domestic | International | ||||||||||||||||||
| $ | % | $ | % | $ | % | |||||||||||||||
| December 31, 2014 | $ | 15,317.8 | $ | 8,185.9 | $ | 7,131.9 | ||||||||||||||
| Components of revenue change: | ||||||||||||||||||||
| Foreign exchange impact | (1,008.8 | ) | (6.6 | )% | — | — | % | (1,008.8 | ) | (14.1 | )% | |||||||||
| Acquisitions, net of dispositions | 14.6 | 0.1 | % | (37.0 | ) | (0.5 | )% | 51.6 | 0.7 | % | ||||||||||
| Organic growth | 810.8 | 5.3 | % | 377.8 | 4.6 | % | 433.0 | 6.1 | % | |||||||||||
| December 31, 2015 | $ | 15,134.4 | (1.2 | )% | $ | 8,526.7 | 4.2 | % | $ | 6,607.7 | (7.4 | )% |
The components and percentages are calculated as follows:
| • | The foreign exchange impact is calculated by translating the current period’s local currency revenue using the prior period average exchange rates to derive current period constant currency revenue (in this case $16,143.2 million for the Total column). The foreign exchange impact is the difference between the current period revenue in U.S. Dollars and the current period constant currency revenue ($15,134.4 million less $16,143.2 million for the Total column). |
| • | Acquisitions, net of dispositions is calculated by aggregating the prior period revenue of the acquired businesses, less the prior period revenue of any business that was disposed of in the current period. |
| • | Organic growth is calculated by subtracting both the foreign exchange and acquisition components from total revenue growth. |
| • | The percentage change is calculated by dividing the individual component amount by the prior period revenue base of that component ($15,317.8 million for the Total column). |
For the year ended December 31, 2015, changes in foreign exchange rates reduced revenue by 6.6%, or $1.0 billion, compared to 2014. Substantially all currencies have weakened against the U.S. Dollar, with the most significant impacts resulting from the weakening of the Euro and British Pound, as well as the Australian Dollar, Brazilian Real, Canadian Dollar and Russian Ruble.
Our results of operations are subject to risk from the translation to U.S. Dollars of the revenue and expenses of our foreign operations, which are generally denominated in their local currency. However, for the most part, because the revenue and expenses of our foreign operations are denominated in the same currency, the economic impact on operating margin is minimized. Assuming exchange rates at February 8, 2016 remain unchanged, we expect the impact of changes in foreign exchange rates to reduce 2016 revenue by approximately 2.0%.
Revenue for 2015 and the percentage change in revenue and organic growth from 2014 in our principal regional markets were (in millions):
| $ | % Change | % Organic Growth | |||||||
| Americas: | |||||||||
| North America | $ | 9,029.2 | 4.1 | % | 5.4 | % | |||
| Latin America | 329.8 | (25.0 | )% | (3.3 | )% | ||||
| EMEA: | |||||||||
| Europe | 3,942.9 | (9.3 | )% | 4.9 | % | ||||
| Middle East and Africa | 260.6 | 1.7 | % | 6.8 | % | ||||
| Asia Pacific | 1,571.9 | (2.0 | )% | 7.9 | % | ||||
| $ | 15,134.4 | (1.2 | )% | 5.3 | % |
Europe comprises the U.K. and the Euro currency countries, and other European countries that have not adopted the European Union Monetary standard. In 2015, the percentage of revenue attributed to the U.K. and to the Euro currency and other European countries was 10.0% and 16.1%, respectively. In 2015, revenue increased 0.2% in the U.K. and revenue decreased 14.3% in the Euro currency and other European countries.
In North America, moderate growth in the United States and Canada was partially offset by the weakening of the Canadian Dollar against the U.S. Dollar. In Europe, growth in the U.K., Germany and Spain was offset by the weakening of all major European currencies against the U.S. Dollar and negative performance in The Netherlands and France. The decrease in revenue in Latin America was a result of the weakening of all currencies in the region and negative performance in Chile and Brazil, which offset strong growth in Mexico. In Brazil, the decline resulted from a difficult comparison to the prior year period, which included additional client spending related to the World Cup primarily in the second quarter of 2014, and a recent decline in economic conditions. In Asia Pacific, strong growth in the major economies in the region was offset by the weakening of the currencies in the region.
In the normal course of business, our agencies both gain and lose business from clients each year due to a variety of factors. The net change in 2015 was an overall gain in new business. Under our client-centric approach, we seek to broaden our relationships with all of our clients. Our largest client represented 2.7% and 2.6% of revenue in 2015 and 2014, respectively. Our ten largest and 100 largest clients represented 17.9% and 52.3% of revenue in 2015, respectively and 18.1% and 50.4% of revenue in 2014, respectively.
Driven by our clients’ continuous demand for more effective and efficient marketing activities, we strive to provide an extensive range of advertising, marketing and corporate communications services through various client-centric networks that are organized to meet specific client objectives. These services include advertising, brand consultancy, content marketing, corporate social responsibility consulting, crisis communications, custom publishing, data analytics, database management,
direct marketing, entertainment marketing, environmental design, experiential marketing, field marketing, financial/corporate business-to-business advertising, graphic arts/digital imaging, healthcare communications, instore design, interactive marketing, investor relations, marketing research, media planning and buying, mobile marketing, multi-cultural marketing, non-profit marketing, organizational communications, outsource sales support, package design, product placement, promotional marketing, public affairs, public relations, reputation consulting, retail marketing, search engine marketing, social media marketing and sports and event marketing. In an effort to monitor the changing needs of our clients and to further expand the scope of our services to key clients, we monitor revenue across a broad range of disciplines and group them into the following four categories: advertising, CRM, public relations and specialty communications.
Revenue for 2015 and 2014 and the percentage change in revenue and organic growth from 2014 by discipline were (in millions):
| Year Ended December 31, | |||||||||||||||||||||||
| 2015 | 2014 | 2015 vs. 2014 | |||||||||||||||||||||
| $ | % of Revenue | $ | % of Revenue | $ Change | % Change | % Organic Growth | |||||||||||||||||
| Advertising | $ | 7,730.2 | 51.1 | % | $ | 7,593.5 | 49.6 | % | $ | 136.7 | 1.8 | % | 9.3 | % | |||||||||
| CRM | 4,958.2 | 32.7 | % | 5,254.4 | 34.3 | % | (296.2 | ) | (5.6 | )% | 1.9 | % | |||||||||||
| Public relations | 1,361.0 | 9.0 | % | 1,393.7 | 9.1 | % | (32.7 | ) | (2.3 | )% | (1.4 | )% | |||||||||||
| Specialty communications | 1,085.0 | 7.2 | % | 1,076.2 | 7.0 | % | 8.8 | 0.8 | % | 2.2 | % | ||||||||||||
| $ | 15,134.4 | $ | 15,317.8 | $ | (183.4 | ) | (1.2 | )% | 5.3 | % |
We operate in a number of industry sectors. The percentage of revenue by industry sector for 2015 and 2014 was:
| 2015 | 2014 | |||||
| Food and Beverage | 13 | % | 13 | % | ||
| Consumer Products | 9 | % | 9 | % | ||
| Pharmaceuticals and Health Care | 11 | % | 10 | % | ||
| Financial Services | 7 | % | 7 | % | ||
| Technology | 10 | % | 9 | % | ||
| Auto | 8 | % | 8 | % | ||
| Travel and Entertainment | 6 | % | 6 | % | ||
| Telecommunications | 5 | % | 5 | % | ||
| Retail | 6 | % | 7 | % | ||
| Other | 25 | % | 26 | % |
Operating Expenses
Operating expenses for 2015 compared to 2014 were (in millions):
| Year Ended December 31, | ||||||||||||||||||||||||||
| 2015 | 2014 | 2015 vs. 2014 | ||||||||||||||||||||||||
| $ | % of Revenue | % of Total Operating Expenses | $ | % of Revenue | % of Total Operating Expenses | $ Change | % Change | |||||||||||||||||||
| Revenue | $ | 15,134.4 | $ | 15,317.8 | $ | (183.4 | ) | (1.2 | )% | |||||||||||||||||
| Operating Expenses: | ||||||||||||||||||||||||||
| Salary and service costs | 11,361.9 | 75.1 | % | 86.0 | % | 11,350.0 | 74.1 | % | 84.9 | % | 11.9 | 0.1 | % | |||||||||||||
| Office and general expenses | 1,852.4 | 12.2 | % | 14.0 | % | 2,023.7 | 13.2 | % | 15.1 | % | (171.3 | ) | (8.5 | )% | ||||||||||||
| Operating Expenses | 13,214.3 | 87.3 | % | 13,373.7 | 87.3 | % | (159.4 | ) | (1.2 | )% | ||||||||||||||||
| Operating Income | $ | 1,920.1 | 12.7 | % | $ | 1,944.1 | 12.7 | % | $ | (24.0 | ) | (1.2 | )% |
Similar to revenue, operating expenses decreased in 2015 compared to 2014 as a result of the weakening of substantially all foreign currencies against the U.S. Dollar. Salary and service costs, which normally tend to fluctuate with changes in revenue, increased $11.9 million in 2015 compared to 2014, primarily reflecting increases related to changes in the mix of our business during the period. Office and general expenses, which are less directly linked to changes in revenue than salary and service costs, decreased $171.3 million in 2015 compared to 2014, reflecting the continuing effort by our agencies to reduce operating costs.
Operating margins and EBITA margins were unchanged year-over-year at 12.7% and 13.4%, respectively. In 2014, we incurred $8.8 million of expenses in connection with the proposed merger with Publicis, which were primarily comprised of professional fees. On May 8, 2014, the proposed merger was terminated.
Net Interest Expense
Net interest expense increased $7.4 million to $141.5 million in 2015 from $134.1 million in 2014. Interest expense increased $3.9 million to $181.1 million in 2015, primarily resulting from the interest expense on the 2024 Notes, issued in October 2014, partially offset by the benefit of the interest rate swaps on the 2022 Notes and 2020 Notes. Interest income decreased $3.5 million to $39.6 million in 2015 resulting from lower interest earned on cash balances in our international treasury centers and the negative impact of changes in foreign exchange rates.
In October 2015, we terminated the swap on the 2020 Notes and reduced the notional amount of the swap on the 2022 Notes to $1 billion. Additionally, we entered into a fixed-to-floating interest rate swap on the $750 million principal amount of the 2024 Notes. On January 19, 2016, we terminated the remaining $1.0 billion notional amount of the swap on the 2022 Notes.
Income Taxes
Our effective tax rate was unchanged at 32.8%. Income tax expense for 2014 reflects the recognition of an income tax benefit of approximately $11 million related to previously incurred expenses for the proposed merger with Publicis. On May 8, 2014, the proposed merger was terminated. Prior to the termination of the merger, the majority of the merger costs, which were incurred in 2013, were capitalized for income tax purposes and the related tax benefits were not recorded. Because the merger was terminated, the merger costs were no longer required to be capitalized for income tax purposes. Excluding the income tax benefit of $11 million related to the proposed merger, income tax expense for 2014 would have been $604.5 million. The decrease in the effective tax rate for 2015 from the effective tax rate for 2014 excluding the income tax benefit related to the proposed merger, is primarily due to a legal entity restructuring of our European operations. As a result of the reorganization, a certain portion of the foreign earnings in the affected countries is subject to lower effective tax rates.
Net Income Per Common Share - Omnicom Group Inc.
Net income - Omnicom Group Inc. decreased $10.1 million, or 0.9%, to $1,093.9 million in 2015 from $1,104.0 million in 2014. The year-over-year decrease is due to the factors described above. Diluted net income per common share - Omnicom Group Inc. increased 4.0% to $4.41 in 2015, compared to $4.24 in 2014 due to the factors described above, as well as the impact of the reduction in our weighted average common shares outstanding resulting from repurchases of our common stock, stock option exercises and shares issued under our employee stock purchase plan. Excluding the net effect of the merger, which includes the income tax benefit of approximately $11 million, net income - Omnicom Group Inc. and diluted net income per common share - Omnicom Group Inc. for 2014 were $1,101.4 million and $4.23, respectively.
RESULTS OF OPERATIONS - 2014 Compared to 2013 (in millions):
| 2014 | 2013 | ||||||
| Revenue | $ | 15,317.8 | $ | 14,584.5 | |||
| Operating Expenses: | |||||||
| Salary and service costs | 11,350.0 | 10,724.4 | |||||
| Office and general expenses | 2,023.7 | 2,034.8 | |||||
| Total Operating Expenses | 13,373.7 | 12,759.2 | |||||
| Add back: Amortization of intangible assets | 107.1 | 100.8 | |||||
| 13,266.6 | 12,658.4 | ||||||
| Earnings before interest, taxes and amortization of intangible assets (“EBITA”) | 2,051.2 | 1,926.1 | |||||
| EBITA Margin - % | 13.4 | % | 13.2 | % | |||
| Deduct: Amortization of intangible assets | 107.1 | 100.8 | |||||
| Operating Income | 1,944.1 | 1,825.3 | |||||
| Operating Margin - % | 12.7 | % | 12.5 | % | |||
| Interest Expense | 177.2 | 197.2 | |||||
| Interest Income | 43.1 | 32.8 | |||||
| Income Before Income Taxes and Income From Equity Method Investments. | 1,810.0 | 1,660.9 | |||||
| Income Tax Expense | 593.1 | 565.2 | |||||
| Income From Equity Method Investments | 16.2 | 15.9 | |||||
| Net Income | 1,233.1 | 1,111.6 | |||||
| Net Income Attributed To Noncontrolling Interests | 129.1 | 120.5 | |||||
| Net Income - Omnicom Group Inc. | $ | 1,104.0 | $ | 991.1 |
In 2014 and 2013, we incurred $8.8 million and $41.4 million of expenses in connection with the proposed merger with Publicis, which were primarily comprised of professional fees. On May 8, 2014, the proposed merger was terminated. Excluding the merger expenses, operating income and operating margin for 2014 and 2013 were $1,952.9 million and 12.7% and $1,866.7 million and 12.8%, respectively, and EBITA and EBITA margin for 2014 and 2013 were $2,060.0 million and 13.4% and $1,967.5 million and 13.5%, respectively. Excluding the income tax effect of the merger expenses of $11.4 million in 2014 and $6.5 million in 2013, income tax expense was $604.5 million in 2014 and $571.7 million in 2013. Excluding the after-tax effect of the merger expenses, net income - Omnicom Group Inc. was $1,101.4 million in 2014 and $1,026.0 million in 2013.
EBITA, which we define as earnings before interest, taxes and amortization of intangible assets, and EBITA Margin, which we define as EBITA divided by Revenue, are Non-GAAP financial measures. We use EBITA and EBITA Margin as additional operating performance measures, which exclude the non-cash amortization expense of acquired intangible assets. The table above reconciles EBITA and EBITA Margin to the U.S. GAAP financial measure of Operating Income for the periods presented. We believe that EBITA and EBITA Margin are useful measures to evaluate the performance of our businesses. Non-GAAP financial measures should not be considered in isolation from or as a substitute for financial information presented in compliance with U.S. GAAP. Non-GAAP financial measures reported by us may not be comparable to similarly titled amounts reported by other companies.
Revenue
In 2014, revenue increased $733.3 million, or 5.0%, to $15,317.8 million from $14,584.5 million in 2013. Changes in foreign exchange rates reduced revenue $112.6 million, acquisitions net of dispositions increased revenue by $19.0 million and organic growth increased revenue $826.9 million.
The components of 2014 revenue change in the United States (“Domestic”) and the remainder of the world (“International”) were (in millions):
| Total | Domestic | International | ||||||||||||||||||
| $ | % | $ | % | $ | % | |||||||||||||||
| December 31, 2013 | $ | 14,584.5 | $ | 7,569.7 | $ | 7,014.8 | ||||||||||||||
| Components of revenue change: | ||||||||||||||||||||
| Foreign exchange impact | (112.6 | ) | (0.8 | )% | — | — | % | (112.6 | ) | (1.6 | )% | |||||||||
| Acquisitions, net of dispositions | 19.0 | 0.1 | % | (48.4 | ) | (0.6 | )% | 67.4 | 1.0 | % | ||||||||||
| Organic growth | 826.9 | 5.7 | % | 664.6 | 8.8 | % | 162.3 | 2.3 | % | |||||||||||
| December 31, 2014 | $ | 15,317.8 | 5.0 | % | $ | 8,185.9 | 8.1 | % | $ | 7,131.9 | 1.7 | % |
The components and percentages are calculated as follows:
| • | The foreign exchange impact is calculated by translating the current period’s local currency revenue using the prior period average exchange rates to derive current period constant currency revenue (in this case $15,430.4 million for the Total column). The foreign exchange impact is the difference between the current period revenue in U.S. Dollars and the current period constant currency revenue ($15,317.8 million less $15,430.4 million for the Total column). |
| • | Acquisitions, net of dispositions is calculated by aggregating the prior period revenue of the acquired businesses, less the prior period revenue of any business that was disposed of in the current period. |
| • | Organic growth is calculated by subtracting both the foreign exchange and acquisition components from total revenue growth. |
| • | The percentage change is calculated by dividing the individual component amount by the prior period revenue base of that component ($14,584.5 million for the Total column). |
For the year ended December 31, 2014, changes in foreign exchange rates reduced revenue by 0.8%, or $112.6 million, compared to 2013. The most significant impacts resulted from the weakening of several currencies, including the Australian Dollar, Brazilian Real, Canadian Dollar, Japanese Yen, Russian Ruble and South African Rand, against the U.S. Dollar. This was partially offset by the strengthening of the British Pound against the U.S. Dollar.
Revenue for 2014 and the percentage change in revenue and organic growth from 2013 in our principal regional markets were (in millions):
| $ | % Change | % Organic Growth | |||||||
| Americas: | |||||||||
| North America | $ | 8,672.0 | 6.3 | % | 7.3 | % | |||
| Latin America | 439.7 | 0.5 | % | 5.7 | % | ||||
| EMEA: | |||||||||
| Europe | 4,346.4 | 4.3 | % | 2.6 | % | ||||
| Middle East and Africa | 256.1 | 7.2 | % | 10.1 | % | ||||
| Asia Pacific | 1,603.6 | 1.5 | % | 4.6 | % | ||||
| $ | 15,317.8 | 5.0 | % | 5.7 | % |
Europe comprises the U.K. and the Euro currency countries, and other European countries that have not adopted the European Union Monetary standard. In 2014, the percentage of revenue attributed to the U.K. and to the Euro currency and other European countries was 9.8% and 18.5%, respectively. In 2014, revenue increased 13.1% in the U.K. and revenue increased 0.1% in the Euro currency and other European countries.
In the normal course of business, our agencies both gain and lose business from clients each year due to a variety of factors. The net change in 2014 was an overall gain in new business. Under our client-centric approach, we seek to broaden our relationships with all of our clients. Our largest client represented 2.6% and 2.7% of our revenue in 2014 and 2013, respectively. Our ten largest and 100 largest clients represented 18.1% and 50.4% of revenue in 2014, respectively, and 19.1% and 51.3% of revenue in 2013, respectively.
Revenue for 2014 and 2013 and the percentage change in revenue and organic growth from 2013 by discipline were (in millions):
| Year Ended December 31, | |||||||||||||||||||||||
| 2014 | 2013 | 2014 vs. 2013 | |||||||||||||||||||||
| $ | % of Revenue | $ | % of Revenue | $ Change | % Change | % Organic Growth | |||||||||||||||||
| Advertising | $ | 7,593.5 | 49.6 | % | $ | 7,026.1 | 48.2 | % | $ | 567.4 | 8.1 | % | 9.1 | % | |||||||||
| CRM | 5,254.4 | 34.3 | % | 5,166.6 | 35.4 | % | 87.8 | 1.7 | % | 1.9 | % | ||||||||||||
| Public relations | 1,393.7 | 9.1 | % | 1,327.4 | 9.1 | % | 66.3 | 5.0 | % | 4.1 | % | ||||||||||||
| Specialty communications | 1,076.2 | 7.0 | % | 1,064.4 | 7.3 | % | 11.8 | 1.1 | % | 3.1 | % | ||||||||||||
| $ | 15,317.8 | $ | 14,584.5 | $ | 733.3 | 5.0 | % | 5.7 | % |
We operate in a number of industry sectors. The percentage of revenue by industry sector for 2014 and 2013 was:
| 2014 | 2013 | |||||
| Food and Beverage | 13 | % | 13 | % | ||
| Consumer Products | 9 | % | 10 | % | ||
| Pharmaceuticals and Health Care | 10 | % | 10 | % | ||
| Financial Services | 7 | % | 7 | % | ||
| Technology | 9 | % | 10 | % | ||
| Auto | 8 | % | 8 | % | ||
| Travel and Entertainment | 6 | % | 5 | % | ||
| Telecommunications | 5 | % | 6 | % | ||
| Retail | 7 | % | 6 | % | ||
| Other | 26 | % | 25 | % |
Operating Expenses
Operating expenses for 2014 compared to 2013 were (in millions):
| Year Ended December 31, | ||||||||||||||||||||||||||
| 2014 | 2013 | 2014 vs. 2013 | ||||||||||||||||||||||||
| $ | % of Revenue | % of Total Operating Expenses | $ | % of Revenue | % of Total Operating Expenses | $ Change | % Change | |||||||||||||||||||
| Revenue | $ | 15,317.8 | $ | 14,584.5 | $ | 733.3 | 5.0 | % | ||||||||||||||||||
| Operating Expenses: | ||||||||||||||||||||||||||
| Salary and service costs | 11,350.0 | 74.1 | % | 84.9 | % | 10,724.4 | 73.5 | % | 84.1 | % | 625.6 | 5.8 | % | |||||||||||||
| Office and general expenses | 2,023.7 | 13.2 | % | 15.1 | % | 2,034.8 | 14.0 | % | 15.9 | % | (11.1 | ) | (0.5 | )% | ||||||||||||
| Operating Expenses | 13,373.7 | 87.3 | % | 12,759.2 | 87.5 | % | 614.5 | 4.8 | % | |||||||||||||||||
| Operating Income | $ | 1,944.1 | 12.7 | % | $ | 1,825.3 | 12.5 | % | $ | 118.8 | 6.5 | % |
Salary and service costs, which tend to fluctuate with changes in revenue, increased $625.6 million in 2014 compared to 2013 reflecting growth in revenue and increases related to changes in the mix of our business during the period, including increased use of freelance labor. Office and general expenses, which are less directly linked to changes in revenue than salary and service costs, decreased $11.1 million in 2014 compared to 2013.
In 2014 and 2013, we incurred $8.8 million and $41.4 million, respectively, of expenses in connection with the proposed merger with Publicis, which were primarily comprised of professional fees. On May 8, 2014, the proposed merger was terminated.
Operating margins in 2014 increased to 12.7% from 12.5% in 2013 and EBITA margins in 2014 increased to 13.4% from 13.2% in 2013. Excluding the merger expenses from both years, operating income and operating margins for 2014 and 2013 were $1,952.9 million and 12.7% and $1,866.7 million and 12.8%, respectively, and EBITA and EBITA margins for 2014 and 2013 were $2,060.0 million and 13.4% and $1,967.5 million and 13.5%, respectively.
Net Interest Expense
Net interest expense decreased $30.3 million to $134.1 million in 2014 from $164.4 million in 2013. In October 2014, we issued $750 million principal amount of the 2024 Notes and in September 2014, we entered into a fixed-to-floating interest rate swap on the 2020 Notes. In 2014, the benefit from the swap on the 2020 Notes substantially offset the interest expense on the 2024 Notes. Interest expense for 2014 decreased $20.0 million to $177.2 million, primarily resulting from the benefit from the swap on the 2022 Notes, entered into in May 2014. The interest rate swaps have the economic effect of converting the 2022 Notes and the 2020 Notes from fixed rate obligations to floating rate obligations. Interest income increased $10.3 million to $43.1 million in 2014 resulting from our cash management efforts and interest earned on cash balances in our international treasury centers.
Income Taxes
Our effective tax rate decreased to 32.8% in 2014 from 34.0% in 2013. Income taxes for 2014 and 2013 reflect the recognition of an income tax benefit of $11.4 million and $6.5 million, respectively, related to expenses incurred in connection with the proposed merger with Publicis. Prior to the termination of the proposed merger on May 8, 2014, the majority of the merger costs were capitalized for income tax purposes and the related tax benefits were not recorded. Because the proposed merger was terminated, the merger costs were no longer required to be capitalized for income tax purposes. Excluding the income tax effect of the merger expenses from both years, income tax expense for 2014 and 2013 would have been $604.5 million and $571.7 million, respectively.
Net Income Per Common Share - Omnicom Group Inc.
Net income - Omnicom Group Inc. increased $112.9 million, or 11.4%, to $1,104.0 million in 2014 from $991.1 million in 2013. The year-over-year decrease in net income - Omnicom Group Inc. is due to the factors described above. Diluted net income per common share - Omnicom Group Inc. increased 14.3% to $4.24 in 2014, compared to $3.71 in 2013 due to the factors described above, as well as the impact of the reduction in our weighted average common shares outstanding resulting from repurchases of our common stock, net of shares issued for the conversion of the Convertible Notes due 2032, or 2032 notes, stock option exercises and shares issued under our employee stock purchase plan. In the second quarter of 2014, following the termination of the proposed merger with Publicis, we resumed repurchases of our common stock. Excluding the after-tax effect of the merger expenses from both years, net income - Omnicom Group Inc. for 2014 and 2013 was $1,101.4 million and $1,026.0 million, respectively, and diluted net income per common share - Omnicom Group Inc. was $4.23 and $3.84, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Cash Sources and Requirements
Our primary source of liquidity is operating cash flow. In addition to our cash and cash equivalents, additional liquidity sources include access to the commercial paper market, our $2.5 billion revolving credit facility, or Credit Facility, uncommitted domestic and international credit lines and access to the capital markets. These sources of liquidity fund our non-discretionary cash requirements and our discretionary spending.
Working capital is our principal non-discretionary funding requirement. In addition, we have contractual obligations related to our senior notes, including the repayment of the $1 billion 5.9% Senior Notes due April 15, 2016, or 2016 Notes, recurring business operations, primarily related to lease obligations, and contingent purchase price obligations (earn-outs) from prior acquisitions. Our principal discretionary cash spending includes dividend payments to common shareholders, capital expenditures, strategic acquisitions and repurchases of our common stock. We have a short-term borrowing requirement normally peaking during the second quarter of the year primarily due to the timing of payments for incentive compensation, income taxes and contingent purchase price obligations.
Based on past performance and current expectations, we believe that our operating cash flow will be sufficient to meet our non-discretionary cash requirements, excluding the repayment of the 2016 Notes, and our discretionary spending through 2016. Our cash and cash equivalents, access to the commercial paper market, Credit Facility, uncommitted credit lines and access to the capital markets provide additional sources of liquidity, as well as providing funding for the repayment of the 2016 Notes.
Our cash and cash equivalents increased $217.1 million to $2.6 billion at December 31, 2015, from $2.4 billion at December 31, 2014. The components of the increase for 2015 are (in millions):
| Sources | ||||||||
| Cash flow from operations | $ | 2,172.3 | ||||||
| Deduct increase in operating capital | (557.6 | ) | ||||||
| Principal cash sources | 1,614.7 | |||||||
| Uses | ||||||||
| Capital expenditures | $ | (202.7 | ) | |||||
| Dividends paid to common shareholders | (496.7 | ) | ||||||
| Dividends paid to shareholders of noncontrolling interests | (129.4 | ) | ||||||
| Acquisition payments, including payment of contingent purchase price obligations and acquisition of additional noncontrolling interests, net of cash acquired | (149.6 | ) | ||||||
| Repurchases of common stock, net of proceeds from stock plans and tax benefits. | (680.2 | ) | ||||||
| Principal cash uses | (1,658.6 | ) | ||||||
| Principal cash uses in excess of principal cash sources | (43.9 | ) | ||||||
| Foreign exchange rate changes | (262.6 | ) | ||||||
| Financing activities and other | (34.0 | ) | ||||||
| Increase in operating capital | 557.6 | |||||||
| Increase in cash and cash equivalents | $ | 217.1 |
Principal cash sources and principal cash uses amounts are Non-GAAP financial measures. These amounts exclude changes in working capital and other investing and financing activities, including commercial paper issuances and redemptions used to fund working capital changes. This presentation reflects the metrics used by us to assess our sources and uses of cash and was derived from our statement of cash flows. We believe that this presentation is meaningful to understand the primary sources and uses of our cash flow and the effect on our cash and cash equivalents. Non-GAAP financial measures should not be considered in isolation from, or as a substitute for, financial information presented in compliance with U.S. GAAP. Non-GAAP financial measures as reported by us may not be comparable to similarly titled amounts reported by other companies. Additional information regarding our cash flows can be found in our consolidated financial statements.
Cash Management
Our regional treasury centers in North America, Europe and Asia, which are structured as wholly owned finance subsidiaries, manage our cash and liquidity. Each day, operations with excess funds invest these funds with their regional treasury center. Likewise, operations that require funds borrow from their regional treasury center. The treasury centers aggregate the net position which is either invested with or borrowed from third parties. To the extent that our treasury centers require liquidity, they have the ability to issue up to a total of $2 billion of U.S. Dollar-denominated commercial paper or borrow under the Credit Facility or the uncommitted credit lines. This process enables us to manage our debt more efficiently and utilize our cash more effectively, as well as manage our risk to foreign exchange rate changes. In countries where we either do not conduct treasury operations or it is not feasible for one of our treasury centers to fund net borrowing requirements on an intercompany basis, we arrange for local currency uncommitted credit lines.
We have policies governing counterparty credit risk with financial institutions that hold our cash and cash equivalents and we have deposit limits for each institution. In countries where we conduct treasury operations, generally the counterparties are either branches or subsidiaries of institutions that are party to the Credit Facility. These institutions generally have credit ratings equal to or better than our credit ratings. In countries where we do not conduct treasury operations, all cash and cash equivalents are held by counterparties that meet specific minimum credit standards.
Our net debt position, which we define as total debt outstanding less cash and cash equivalents and short-term investments, decreased $208.3 million at December 31, 2015, as compared to December 31, 2014, primarily due to an increase in cash and cash equivalents and short-term investments resulting from an increase in operating capital of $557.6 million, partially offset by a decrease in foreign cash balances of $262.6 million from the translation of local currencies to U.S. Dollars and principal cash uses in excess of principal cash sources of $43.9 million, as described above. The components of net debt at December 31, 2015 and 2014 were (in millions):
| 2015 | 2014 | ||||||
| Debt: | |||||||
| Short-term debt | $ | 5.2 | $ | 7.2 | |||
| 5.9% Senior Notes due 2016 | 1,000.0 | 1,000.0 | |||||
| 6.25% Senior Notes due 2019 | 500.0 | 500.0 | |||||
| 4.45% Senior Notes due 2020 | 1,000.0 | 1,000.0 | |||||
| 3.625% Senior Notes due 2022 | 1,250.0 | 1,250.0 | |||||
| 3.65% Senior Notes due 2024 | 750.0 | 750.0 | |||||
| Other debt | 0.3 | 0.5 | |||||
| Unamortized premium (discount) on senior notes, net | 10.1 | 11.1 | |||||
| Debt issuance costs | (16.9 | ) | (20.5 | ) | |||
| Adjustment to carrying value for interest rate swaps | 72.1 | 51.4 | |||||
| Total debt | 4,570.8 | 4,549.7 | |||||
| Cash and cash equivalents and short-term investments | (2,619.7 | ) | (2,390.3 | ) | |||
| Net debt | $ | 1,951.1 | $ | 2,159.4 |
Net debt is a Non-GAAP financial measure. This presentation, together with the comparable U.S. GAAP measures, reflects one of the key metrics we use to assess our cash management performance. Non-GAAP financial measures should not be considered in isolation from, or as a substitute for, financial information presented in compliance with US GAAP. Non-GAAP financial measures as reported by us may not be comparable to similarly titled amounts reported by other companies.
At December 31, 2015, our foreign subsidiaries held approximately $1.4 billion of our total cash and cash equivalents of $2.6 billion. The majority of the cash is available to us, net of any taxes payable upon repatriation to the United States. Changes in international tax rules or changes in U.S. tax rules and regulations covering international operations and foreign tax credits may affect our future reported financial results or the way we conduct our business.
Debt Instruments and Related Covenants
At December 31, 2015, as a source of short-term financing, we have a $2.5 billion Credit Facility, which expires on July 31, 2020, domestic and international uncommitted credit lines aggregating $1.2 billion and we can issue up to $2 billion of commercial paper.
The Credit Facility contains financial covenants that require us to maintain a Leverage Ratio of consolidated indebtedness to consolidated EBITDA of no more than 3 times for the most recently ended 12-month period (EBITDA is defined as earnings before interest, taxes, depreciation and amortization) and an Interest Coverage Ratio of consolidated EBITDA to interest expense of at least 5 times for the most recently ended 12-month period. At December 31, 2015, we were in compliance with these covenants as our Leverage Ratio was 2.1 times and our Interest Coverage Ratio was 12.2 times. The Credit Facility does not limit our ability to declare or pay dividends or repurchase our common stock.
Omnicom and its wholly owned finance subsidiary Omnicom Capital Inc., or OCI, are co-obligors under all the senior notes. The senior notes are a joint and several liability of us and OCI and we unconditionally guarantee OCI’s obligations with respect to the senior notes. OCI provides funding for our operations by incurring debt and lending the proceeds to our operating subsidiaries. OCI’s assets consist of cash and cash equivalents and intercompany loans made to our operating subsidiaries and the related interest receivable. There are no restrictions on the ability of OCI or us to obtain funds from our subsidiaries through dividends, loans or advances. Our senior notes are senior unsecured obligations that rank equal in right of payment with all existing and future unsecured senior indebtedness.
On March 26, 2015, in connection with the maturity of our 2016 Notes, we entered into a $1.0 billion forward-starting interest rate swap. The swap mitigates the risk of changes in the semi-annual interest payments from inception to May 2, 2016, the contractual termination date of the swap, and effectively locks in the fixed interest rate, excluding the effect of our credit spread, on any refinancing at 2.32%. In October 2015, we terminated the interest rate swap on the 2020 Notes and reduced the notional amount of the interest rate swap on the 2022 Notes to $1.0 billion. Additionally, in October 2015, we entered into a fixed-to-floating interest rate swap on the $750 million principal amount of our 2024 Notes. On January 19, 2016, we terminated the remaining $1.0 billion notional amount of the swap on the 2022 Notes. A complete discussion of our interest rate swaps is included in Note 6 to the consolidated financial statements.
Credit Markets and Availability of Credit
We typically fund our day-to-day liquidity by issuing commercial paper. As an additional source of funding, we may borrow under the Credit Facility or the uncommitted credit lines. At December 31, 2015, there were no outstanding commercial paper issuances or borrowings under the Credit Facility or the uncommitted credit lines.
Commercial paper activity for the three years ended December 31, 2015 was (dollars in millions):
| 2015 | 2014 | 2013 | |||||||||
| Average amount outstanding during the year | $ | 964.8 | $ | 909.0 | $ | 471.7 | |||||
| Maximum amount outstanding during the year | $ | 1,720.7 | $ | 1,795.8 | $ | 1,027.5 | |||||
| Total issuances during the year | $ | 26,615.5 | $ | 18,539.9 | $ | 11,786.9 | |||||
| Average days outstanding | 13.2 | 20.3 | 14.6 | ||||||||
| Weighted average interest rate | 0.46 | % | 0.29 | % | 0.33 | % |
Our access to the commercial paper market and the cost of these borrowings are affected by our credit ratings and market conditions. S&P rates our long-term and short-term debt BBB+ and A2, respectively, and Moody’s rates our long-term and short-term debt Baa1 and P2, respectively. Our outstanding senior notes and Credit Facility do not contain provisions that require acceleration of cash payments in the event our debt credit ratings are downgraded.
We expect to continue funding our day-to-day liquidity by issuing commercial paper. However, disruptions in the credit markets may lead to periods of illiquidity in the commercial paper market and higher credit spreads. To mitigate any future disruption in the credit markets and to fund our liquidity we may borrow under the Credit Facility or access the capital markets if favorable conditions exist. We will continue to monitor closely our liquidity and conditions in the credit markets. We cannot predict with any certainty the impact on us of any future disruptions in the credit markets. In such circumstances, we may need to obtain additional financing to fund our day-to-day working capital requirements. Such additional financing may not be available on favorable terms, or at all.
Contractual Obligations and Other Commercial Commitments
In the normal course of business we enter into numerous contractual and commercial undertakings. The following tables should be read in conjunction with our consolidated financial statements.
Contractual obligations at December 31, 2015 were (in millions):
| Obligation Due | |||||||||||||||||||
| Total Obligation | 2016 | 2017 - 2018 | 2019 - 2020 | After 2020 | |||||||||||||||
| Long-term debt: | |||||||||||||||||||
| Principal | $ | 4,500.3 | $ | 1,000.3 | $ | — | $ | 1,500.0 | $ | 2,000.0 | |||||||||
| Interest | 862.5 | 165.6 | 296.9 | 234.6 | 165.4 | ||||||||||||||
| Lease obligations | 1,444.3 | 323.4 | 420.9 | 277.8 | 422.2 | ||||||||||||||
| Deferred tax liability - convertible debt | 197.3 | 65.8 | 131.5 | — | — | ||||||||||||||
| Contingent purchase price obligations | 322.0 | 81.5 | 214.8 | 25.7 | — | ||||||||||||||
| Defined benefit pension plans benefit obligation | 234.8 | 8.5 | 17.7 | 22.0 | 186.6 | ||||||||||||||
| Postemployment arrangements benefit obligation | 115.9 | 9.3 | 16.4 | 12.0 | 78.2 | ||||||||||||||
| Uncertain tax positions | 113.0 | 18.7 | 28.3 | 66.0 | — | ||||||||||||||
| $ | 7,790.1 | $ | 1,673.1 | $ | 1,126.5 | 2,138.1 | $ | 2,852.4 |
Certain acquisitions include an initial payment at closing and provide for future additional contingent purchase price payments (earn-outs), which are recorded as a liability at the acquisition date fair value. Subsequent changes in the fair value of the liability are recorded in our results of operations.
The unfunded benefit obligation for our defined benefit pension plans and liability for our postemployment arrangements was $281.8 million at December 31, 2015. In 2015, we contributed $4.2 million to our defined benefit pension plans and paid $8.7 million in benefits for our postemployment arrangements. We do not expect these payments to increase significantly in 2016.
The liability for uncertain tax positions is subject to uncertainty as to when or if the liability will be paid. We have assigned the liability to the periods presented based on our judgment as to when these liabilities will be resolved by the appropriate taxing authorities.
Commercial commitments at December 31, 2015 were (in millions):
| Commitment Expires | |||||||||||||||||||
| Total Commitment | 2016 | 2017 - 2018 | 2019 - 2020 | After 2020 | |||||||||||||||
| Standby letters of credit | $ | 7.8 | $ | 6.4 | $ | 0.8 | $ | — | $ | 0.6 | |||||||||
| Guarantees | 93.4 | 62.2 | 26.0 | 2.6 | 2.6 | ||||||||||||||
| $ | 101.2 | $ | 68.6 | $ | 26.8 | $ | 2.6 | $ | 3.2 |
At December 31, 2015, there were no significant off-balance sheet arrangements.
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