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 2016, our largest client represented 3.0% of revenue and our 100 largest clients, which represent many of the world's major marketers, comprised approximately 52% of revenue. Our business is spread across a number of industry sectors with no one industry comprising more than 14% of our revenue in 2016. 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 2016 our revenue increased $282.5 million, or 1.9%, compared to 2015. Beginning in the fourth quarter of 2014 and continuing throughout 2015, substantially all foreign currencies weakened against the U.S. Dollar. In 2016, while the strength of the U.S. Dollar moderated against a number of currencies, the British Pound weakened substantially against the U.S. Dollar. In 2016, changes in foreign exchange rates reduced revenue by $283.8 million, or 1.9%, acquisitions, net of dispositions, increased revenue $38.2 million, or 0.3%, and organic growth increased revenue $528.1 million, or 3.5%.
Global economic conditions have a direct impact on our business and financial performance. Adverse global or regional economic conditions pose 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 2016, the United States continued its modest economic growth. Uncertain economic and political conditions in the Euro Zone have resulted in uneven growth across the region and have been further complicated by the vote in 2016 in the United Kingdom, or U.K., to exit the European Union. In Brazil, unstable economic and political conditions contributed to the continuing downward economic trend that began in the second quarter of 2015. The major economies of Asia had modest economic growth consistent with recent periods. The economic and fiscal issues facing countries in Europe and Latin America continue to cause economic uncertainty in those regions; 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 2017 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 high-growth and emerging markets and enhance our capabilities to leverage new technologies that are being used by marketers today. In addition, we continually evaluate our portfolio of businesses to identify non-strategic or under performing business for disposition.
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 and marketing discipline, the impact from foreign currency fluctuations, growth from acquisitions and growth from our largest clients. Operating expenses are comprised of: cost of services, selling, general and administrative, or SG&A, expenses and depreciation and amortization.
In 2016, revenue increased 1.9% compared to 2015. Changes in foreign exchange rates reduced revenue 1.9%, acquisitions, net of dispositions, increased revenue 0.3% and organic growth increased revenue 3.5%. Across our principal regional markets, the changes in revenue were: North America increased 1.6%, Europe decreased 1.0%, Latin America increased 28.4% and Asia Pacific increased 4.1%. In North America, moderate growth in the United States and strong growth in Canada was partially offset by the weakening of the Canadian Dollar against the U.S. Dollar. In Europe, growth in the U.K., Spain, Russia and Italy was offset by the weakening of the British Pound and Russian Ruble against the U.S. Dollar and negative performance in the Netherlands. The increase in revenue in Latin America was a result of our acquisition activity in Brazil, which was partially offset by the weakening of most currencies in the region against the U.S. Dollar, especially the Brazilian Real. In Asia Pacific, growth in the major economies in the region was also partially offset by the weakening of most currencies in the region against the U.S. Dollar. The change in revenue in 2016 compared to 2015, including the negative impact of currency changes, in our four fundamental disciplines was: advertising increased 4.7%, CRM decreased 3.6%, public relations increased 3.4% and specialty communications increased 3.9%.
We measure cost of services in two distinct categories: salary and service costs and occupancy and other costs. As a service business, salary and service costs make up the vast majority of our operating expenses and substantially all these costs comprise the essential components directly linked to the delivery of our services. Salary and service costs include employee compensation and benefits, freelance labor and direct service costs, which include third-party supplier costs and client-related travel costs. Occupancy and other costs consist of the indirect costs related to the delivery of our services, including office rent and other occupancy costs, equipment rent, technology costs, general office expenses and other expenses.
SG&A expenses primarily consist of third-party marketing costs, professional fees and compensation and benefits and occupancy and other costs of our corporate and executive offices, which includes group-wide finance and accounting, treasury, legal and governance, human resource oversight and similar costs.
Operating expenses increased 1.5% in 2016 compared to 2015. Salary and service costs, which tend to fluctuate with changes in revenue, increased $204.5 million, or 1.8%, in 2016 compared to 2015. Occupancy and other costs, which are less directly linked to changes in revenue than salary and service costs, decreased $24.7 million, or 2.0%, in 2016 compared to 2015. Operating margin in 2016 was 13.0%, as compared to 12.7% in 2015. Earnings before interest, taxes and amortization of intangible assets, or EBITA, margin in 2016 was 13.8%, as compared to 13.4% in 2015.
Net interest expense for 2016 increased $25.6 million to $167.1 million from $141.5 million in 2015. Interest expense
increased $28.6 million to $209.7 million in 2016, primarily resulting from the reduced benefit of the $1 billion fixed-to-floating interest rate swap on the 3.625% Senior Notes due 2022, or 2022 Notes. In January 2016, we settled the interest rate swap on the 2022 Notes. By settling the swap, we were able to lock interest savings over the remaining term of the 2022 Notes by reducing the effective rate to 2.7% from 3.5%. On April 6, 2016, we issued $1.4 billion principal amount of 3.60% Senior Notes due April 15, 2026, or 2026 Notes, and a portion of the proceeds were used to retire the $1.0 billion 5.9% Senior Notes due 2016, or 2016 Notes, at maturity. Concurrent with the issuance of the 2026 Notes, we entered into a $500 million fixed-to-floating interest rate swap on the 2026 Notes. At December 31, 2016, our debt portfolio was approximately 75% fixed rate obligations and 25% floating rate obligations as compared to 61% fixed rate and 39% floating rate at December 31, 2015 and, as a result, in 2016 there was less floating rate benefit from the interest rate swaps. Interest income increased $3.0 million to $42.6 million in 2016 compared to 2015, as a result of higher cash balances in our international treasury centers available for investment.
Our effective tax rate for 2016 was 32.6% compared to 32.8% for 2015.
Net income - Omnicom Group Inc. for 2016 increased $54.7 million, or 5.0%, to $1,148.6 million from $1,093.9 million in 2015. The year-over-year increase is due to the factors described above. Diluted net income per common share - Omnicom Group Inc. increased 8.4% to $4.78 in 2016, compared to $4.41 in 2015 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 restricted stock awards and 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 amounts reported 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 evaluation 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 2016, we completed 5 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 assets we acquire are intangible assets primarily consisting of the know-how of the personnel, which is treated as part of goodwill and under U.S. GAAP is not required to be valued separately. For each acquisition, we undertake a detailed review to identify other intangible assets that are required to be valued separately. 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. Under FASB ASC Topic 350, Intangibles - Goodwill and Other, 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. 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. 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 occupancy and other 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, 2016 and 2015 were:
| June 30, | |||
| 2016 | 2015 | ||
| Long-Term Growth Rate | 4% | 4% | |
| WACC | 9.7% - 10.3% | 10.1% -10.7% |
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 4.0% and 3.6%, respectively. We considered this history when determining the long-term growth rates used in our annual impairment test at June 30, 2016. 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, which are similar across our reporting units. For our annual test as of June 30, 2016, we used an estimated long-term growth rate of 4%.
When performing the annual impairment test as of June 30, 2016 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 2016. In the first half of 2016, we experienced an increase in our revenue of 3.6%, which excluded 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 2016, weakness in most Latin American economies we operate in have 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
Based on the results of the Step 1 impairment test, we concluded that our goodwill at June 30, 2016 was not impaired, because the fair value of each reporting unit 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 77%. 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, 2016 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, 2016, 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. Our primary client arrangements include: fixed fee contracts where revenue is recognized based on the level of effort completed to date, retainer agreements where revenue is recognized on a straight-line basis over the contract period, and media commissions where revenue is recognized when the media is run. 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. 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 in certain international markets may be 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 ASU 2014-09, Revenue from Contracts with Customers (“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. 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. We plan to apply ASU 2014-09 on January 1, 2018. Presently, we are not yet in a position to conclude on the transition method we will choose. 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. 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 of revenue recognition for certain contract incentives compared to the current method. Additionally, in certain of our businesses we record revenue as a principal and include certain third-party pass-through and out-of-pocket costs, which are billed to clients in connection with our services, in revenue. In March 2016, the FASB issued further guidance on principal versus agent considerations. We are currently evaluating the impact of the principal versus agent guidance on our revenue and cost of services; however, we do not expect the change, if any, to have a material effect on our results of operations.
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 have assumed that substantially all the PRSUs will vest.
Share-based compensation expense of $93.4 million, $99.4 million and $93.5 million in 2016, 2015 and 2014, respectively, primarily resulted from restricted stock awards. Information about our stock award plans can be found in Note 9 to the consolidated financial statements.
NEW ACCOUNTING STANDARDS
See Note 20 for information on the adoption of new accounting standards and accounting standards not yet adopted.
RESULTS OF OPERATIONS - 2016 Compared to 2015 (in millions):
| 2016 | 2015 | ||||||
| Revenue | $ | 15,416.9 | $ | 15,134.4 | |||
| Operating Expenses: | |||||||
| Salary and service costs | 11,453.2 | 11,248.7 | |||||
| Occupancy and other costs | 1,218.0 | 1,242.7 | |||||
| Cost of services | 12,671.2 | 12,491.4 | |||||
| Selling, general and administrative expenses | 443.9 | 431.8 | |||||
| Depreciation and amortization | 292.9 | 291.1 | |||||
| 13,408.0 | 13,214.3 | ||||||
| Operating Profit | 2,008.9 | 1,920.1 | |||||
| Operating Margin - % | 13.0 | % | 12.7 | % | |||
| Add back: Amortization of intangible assets | 115.2 | 109.3 | |||||
| Earnings before interest, taxes and amortization of intangible assets (“EBITA”) | 2,124.1 | 2,029.4 | |||||
| EBITA Margin - % | 13.8 | % | 13.4 | % | |||
| Deduct: Amortization of intangible assets | 115.2 | 109.3 | |||||
| Operating Profit | 2,008.9 | 1,920.1 | |||||
| Interest Expense | 209.7 | 181.1 | |||||
| Interest Income | 42.6 | 39.6 | |||||
| Income Before Income Taxes and Income From Equity Method Investments | 1,841.8 | 1,778.6 | |||||
| Income Tax Expense | 600.5 | 583.6 | |||||
| Income From Equity Method Investments | 5.4 | 8.4 | |||||
| Net Income | 1,246.7 | 1,203.4 | |||||
| Net Income Attributed To Noncontrolling Interests | 98.1 | 109.5 | |||||
| Net Income - Omnicom Group Inc. | $ | 1,148.6 | $ | 1,093.9 |
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 intangible assets, primarily consisting of intangible assets related to acquired businesses. The table above reconciles EBITA and EBITA Margin to the U.S. GAAP financial measures for the periods presented. We believe that EBITA and EBITA Margin are useful measures for investors 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 2016, revenue increased $282.5 million to $15,416.9 million from $15,134.4 million in 2015. Changes in foreign exchange rates reduced revenue $283.8 million, acquisitions, net of dispositions, increased revenue $38.2 million and organic growth increased revenue $528.1 million.
The components of revenue change in the United States (“Domestic”) and the remainder of the world (“International”) were (in millions):
| Total | Domestic | International | ||||||||||||||||||
| $ | % | $ | % | $ | % | |||||||||||||||
| December 31, 2015 | $ | 15,134.4 | $ | 8,526.7 | $ | 6,607.7 | ||||||||||||||
| Components of revenue change: | ||||||||||||||||||||
| Foreign exchange impact | (283.8 | ) | (1.9 | )% | — | — | % | (283.8 | ) | (4.3 | )% | |||||||||
| Acquisitions, net of dispositions | 38.2 | 0.3 | % | (56.9 | ) | (0.7 | )% | 95.1 | 1.4 | % | ||||||||||
| Organic growth | 528.1 | 3.5 | % | 158.0 | 1.9 | % | 370.1 | 5.6 | % | |||||||||||
| December 31, 2016 | $ | 15,416.9 | 1.9 | % | $ | 8,627.8 | 1.2 | % | $ | 6,789.1 | 2.7 | % |
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 $15,700.7 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 ($15,416.9 million less $15,700.7 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 ($15,134.4 million for the Total column). |
In 2016, changes in foreign exchange rates continued to negatively impact revenue but at a more moderate rate as compared to 2015. The impact of foreign exchange rates in 2016 reduced revenue by 1.9%, or $283.8 million. While a number of currencies weakened against the U.S. Dollar, including the Australian Dollar, Brazilian Real, Canadian Dollar and Russian Ruble, the most significant impact resulted from the weakening of the British Pound.
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 6, 2017 remain unchanged, we expect the impact of changes in foreign exchange rates to reduce 2017 revenue by approximately 1.25%.
Revenue and organic growth for 2016 and the change in revenue from 2015 in our principal regional markets were (in millions):
| 2016 | 2015 | $ Change | % Change | % Organic Growth | |||||||||||||
| Americas: | |||||||||||||||||
| North America | $ | 9,174.0 | $ | 9,029.2 | $ | 144.8 | 1.6 | % | 2.4 | % | |||||||
| Latin America | 423.6 | 329.8 | 93.8 | 28.4 | % | (0.8 | )% | ||||||||||
| EMEA: | |||||||||||||||||
| Europe | 3,904.2 | 3,942.9 | (38.7 | ) | (1.0 | )% | 4.3 | % | |||||||||
| Middle East and Africa | 278.9 | 260.6 | 18.3 | 7.0 | % | 11.7 | % | ||||||||||
| Asia Pacific | 1,636.2 | 1,571.9 | 64.3 | 4.1 | % | 6.9 | % | ||||||||||
| $ | 15,416.9 | $ | 15,134.4 | $ | 282.5 | 1.9 | % | 3.5 | % |
Our primary markets in Europe comprise the U.K. and the Euro Zone. In 2016, the U.K. comprised 9.1% of revenue and the Euro Zone and the other European countries together comprised 16.2% of revenue. In 2016, revenue decreased 6.8% in the U.K. and increased 2.6% in the Euro Zone and the other European countries.
In North America, moderate growth in the United States and strong growth in Canada was partially offset by the weakening of the Canadian Dollar against the U.S. Dollar. In Europe, growth in the U.K., Spain, Russia and Italy was offset by the weakening of the British Pound and Russian Ruble against the U.S. Dollar and negative performance in the Netherlands. The increase in revenue in Latin America was a result of our acquisition activity in Brazil, which was partially offset by the weakening of most currencies in the region against the U.S. Dollar, especially the Brazilian Real. The continuing uncertainty in the economic and political climate in Brazil resulted in organic revenue declines that partially offset the growth from our acquisition and also overshadowed strong growth in Mexico. In Asia Pacific, growth in the major economies in the region was also partially offset by the weakening of most currencies in the region against the U.S. Dollar.
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 2016 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 3.0% and 2.7% of revenue in 2016 and 2015, respectively. Our ten largest and 100 largest clients represented 18.3% and 52.4% of revenue in 2016, respectively, and 17.9% and 52.3% of revenue in 2015, 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 2016 and 2015 and the change in revenue and organic growth from 2015 by discipline were (in millions):
| Year Ended December 31, | |||||||||||||||||||||||
| 2016 | 2015 | 2016 vs. 2015 | |||||||||||||||||||||
| $ | % of Revenue | $ | % of Revenue | $ Change | % Change | % Organic Growth | |||||||||||||||||
| Advertising | $ | 8,194.5 | 53.2 | % | $ | 7,824.5 | 51.7 | % | $ | 370.0 | 4.7 | % | 5.9 | % | |||||||||
| CRM | 4,738.3 | 30.7 | % | 4,913.1 | 32.5 | % | (174.8 | ) | (3.6 | )% | (0.3 | )% | |||||||||||
| Public relations | 1,374.8 | 8.9 | % | 1,329.1 | 8.8 | % | 45.7 | 3.4 | % | 2.8 | % | ||||||||||||
| Specialty communications | 1,109.3 | 7.2 | % | 1,067.7 | 7.0 | % | 41.6 | 3.9 | % | 4.6 | % | ||||||||||||
| $ | 15,416.9 | $ | 15,134.4 | $ | 282.5 | 1.9 | % | 3.5 | % |
We provide services to clients that operate in a number of industry sectors. Revenue by sector for 2016 and 2015 was:
| 2016 | 2015 | |||||
| Food and Beverage | 13 | % | 13 | % | ||
| Consumer Products | 10 | % | 10 | % | ||
| Pharmaceuticals and Health Care | 12 | % | 11 | % | ||
| Financial Services | 7 | % | 7 | % | ||
| Technology | 9 | % | 10 | % | ||
| Auto | 8 | % | 8 | % | ||
| Travel and Entertainment | 7 | % | 6 | % | ||
| Telecommunications | 5 | % | 5 | % | ||
| Retail | 6 | % | 6 | % | ||
| Other | 23 | % | 24 | % |
Operating Expenses
Operating expenses for 2016 compared to 2015 were (in millions):
| Year Ended December 31, | ||||||||||||||||||||
| 2016 | 2015 | 2016 vs. 2015 | ||||||||||||||||||
| $ | % of Revenue | $ | % of Revenue | $ Change | % Change | |||||||||||||||
| Revenue | $ | 15,416.9 | $ | 15,134.4 | $ | 282.5 | 1.9 | % | ||||||||||||
| Operating Expenses: | ||||||||||||||||||||
| Salary and service costs | 11,453.2 | 74.3 | % | 11,248.7 | 74.3 | % | 204.5 | 1.8 | % | |||||||||||
| Occupancy and other costs | 1,218.0 | 7.9 | % | 1,242.7 | 8.2 | % | (24.7 | ) | (2.0 | )% | ||||||||||
| Cost of services | 12,671.2 | 12,491.4 | 179.8 | |||||||||||||||||
| Selling, general and administrative expenses | 443.9 | 2.9 | % | 431.8 | 2.9 | % | 12.1 | 2.8 | % | |||||||||||
| Depreciation and amortization | 292.9 | 1.9 | % | 291.1 | 1.9 | % | 1.8 | 0.6 | % | |||||||||||
| 13,408.0 | 87.0 | % | 13,214.3 | 87.3 | % | 193.7 | 1.5 | % | ||||||||||||
| Operating Profit | $ | 2,008.9 | 13.0 | % | $ | 1,920.1 | 12.7 | % | $ | 88.8 | 4.6 | % |
Operating expenses increased 1.5% in 2016 compared to 2015. Salary and service costs, which tend to fluctuate with changes in revenue, increased $204.5 million, or 1.8%, in 2016 compared to 2015. Occupancy and other costs, which are less directly linked to changes in revenue than salary and service costs, decreased $24.7 million, or 2.0%, in 2016 compared to 2015, principally resulting from our ongoing efforts to leverage scale and enhance efficiency. SG&A expenses increased $12.1 million year-over-year primarily related to professional fees incurred in connection with our acquisition activities. As a result, operating margin in 2016 increased to 13.0% from 12.7% in 2015 and EBITA margin increased year-over-year to 13.8% from 13.4%.
Net Interest Expense
Net interest expense increased $25.6 million to $167.1 million in 2016 from $141.5 million in 2015. Interest expense increased $28.6 million to $209.7 million in 2016, primarily resulting from the reduced benefit of the $1 billion fixed-to-floating interest rate swap on the 2022 Notes. In January 2016, we settled the interest rate swap on the 2022 Notes. By settling the swap, we were able to lock interest savings over the remaining term of the 2022 Notes by reducing the effective rate to 2.7% from 3.5%. On April 6, 2016, we issued $1.4 billion principal amount of 2026 Notes and a portion of the proceeds were used to retire the 2016 Notes at maturity. Concurrent with the issuance of the 2026 Notes, we entered into a $500 million fixed-to-floating interest rate swap on the 2026 Notes. At December 31, 2016, our debt portfolio was approximately 75% fixed rate obligations and 25% floating rate obligations as compared to 61% fixed rate and 39% floating rate at December 31, 2015 and, as a result, in 2016 there was less floating rate benefit from the interest rate swaps. A discussion of our interest rate swaps is included in Note 6 to the consolidated financial statements. Interest income increased $3.0 million in 2016 compared to the prior year, as a result of higher cash balances in our international treasury centers available for investment.
Income Taxes
Our effective tax rate for 2016 was 32.6% compared to 32.8% for 2015.
Net Income Per Common Share - Omnicom Group Inc.
Net income - Omnicom Group Inc. increased $54.7 million, or 5.0%, to $1,148.6 million in 2016 from $1,093.9 million in 2015. The year-over-year increase is due to the factors described above. Diluted net income per common share - Omnicom Group Inc. increased 8.4% to $4.78 in 2016, compared to $4.41 in 2015 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 restricted stock awards and stock option exercises and shares issued under our employee stock purchase plan.
RESULTS OF OPERATIONS - 2015 Compared to 2014 (in millions):
| 2015 | 2014 | ||||||
| Revenue | $ | 15,134.4 | $ | 15,317.8 | |||
| Operating Expenses: | |||||||
| Salary and service costs | 11,248.7 | 11,245.5 | |||||
| Occupancy and other costs | 1,242.7 | 1,356.6 | |||||
| Cost of services | 12,491.4 | 12,602.1 | |||||
| Selling, general and administrative expenses | 431.8 | 477.2 | |||||
| Depreciation and amortization | 291.1 | 294.4 | |||||
| 13,214.3 | 13,373.7 | ||||||
| Operating Profit | 1,920.1 | 1,944.1 | |||||
| Operating Margin - % | 12.7 | % | 12.7 | % | |||
| Add back: Amortization of intangible assets | 109.3 | 107.1 | |||||
| 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 Profit | 1,920.1 | 1,944.1 | |||||
| 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 intangible assets, primarily consisting of intangible assets related to acquired businesses. The table above reconciles EBITA and EBITA Margin to the U.S. GAAP financial measures for the periods presented. We believe that EBITA and EBITA Margin are useful measures for investors 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 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 by $14.6 million and organic growth increased revenue $810.8 million.
The components of 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). |
In 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.
Revenue and organic growth for 2015 and the change in revenue from 2014 in our principal regional markets were (in millions):
| 2015 | 2014 | $ Change | % Change | % Organic Growth | |||||||||||||
| Americas: | |||||||||||||||||
| North America | $ | 9,029.2 | $ | 8,672.0 | $ | 357.2 | 4.1 | % | 5.4 | % | |||||||
| Latin America | 329.8 | 439.7 | (109.9 | ) | (25.0 | )% | (3.3 | )% | |||||||||
| EMEA: | |||||||||||||||||
| Europe | 3,942.9 | 4,346.4 | (403.5 | ) | (9.3 | )% | 4.9 | % | |||||||||
| Middle East and Africa | 260.6 | 256.1 | 4.5 | 1.7 | % | 6.8 | % | ||||||||||
| Asia Pacific | 1,571.9 | 1,603.6 | (31.7 | ) | (2.0 | )% | 7.9 | % | |||||||||
| $ | 15,134.4 | $ | 15,317.8 | $ | (183.4 | ) | (1.2 | )% | 5.3 | % |
Our primary markets in Europe comprise the U.K. and the Euro Zone. In 2015, the U.K. comprised 10.0% of revenue and the Euro Zone and the other European countries together comprised 16.1% of revenue. In 2015, revenue increased 0.2% in the U.K. and decreased 14.3% in the Euro Zone and the 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 decline in economic conditions that began in 2015. 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 our 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.
Revenue for 2015 and 2014 and the 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 | $ | 7,824.5 | 51.7 | % | $ | 7,710.7 | 50.4 | % | $ | 113.8 | 1.5 | % | 9.0 | % | |||||||||
| CRM | 4,913.1 | 32.5 | % | 5,178.9 | 33.8 | % | (265.8 | ) | (5.1 | )% | 2.4 | % | |||||||||||
| Public relations | 1,329.1 | 8.8 | % | 1,370.6 | 8.9 | % | (41.5 | ) | (3.0 | )% | (2.2 | )% | |||||||||||
| Specialty communications | 1,067.7 | 7.0 | % | 1,057.6 | 6.9 | % | 10.1 | 1.0 | % | 2.4 | % | ||||||||||||
| $ | 15,134.4 | $ | 15,317.8 | $ | (183.4 | ) | (1.2 | )% | 5.3 | % |
We provide services to clients that operate in a number of industry sectors. Revenue by sector for 2015 and 2014 was:
| 2015 | 2014 | |||||
| Food and Beverage | 13 | % | 13 | % | ||
| Consumer Products | 10 | % | 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 | 24 | % | 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 Revenue | $ Change | % Change | |||||||||||||||
| Revenue | $ | 15,134.4 | $ | 15,317.8 | $ | (183.4 | ) | (1.2 | )% | |||||||||||
| Operating Expenses: | ||||||||||||||||||||
| Salary and service costs | 11,248.7 | 74.3 | % | 11,245.5 | 73.4 | % | 3.2 | — | % | |||||||||||
| Occupancy and other costs | 1,242.7 | 8.2 | % | 1,356.6 | 8.9 | % | (113.9 | ) | (8.4 | )% | ||||||||||
| Cost of services | 12,491.4 | 12,602.1 | ||||||||||||||||||
| Selling, general and administrative expenses | 431.8 | 2.9 | % | 477.2 | 3.1 | % | (45.4 | ) | (9.5 | )% | ||||||||||
| Depreciation and amortization | 291.1 | 1.9 | % | 294.4 | 1.9 | % | (3.3 | ) | (1.1 | )% | ||||||||||
| 13,214.3 | 87.3 | % | 13,373.7 | 87.3 | % | (159.4 | ) | (1.2 | )% | |||||||||||
| Operating Profit | $ | 1,920.1 | 12.7 | % | $ | 1,944.1 | 12.7 | % | $ | (24.0 | ) | (1.2 | )% |
Operating expenses decreased $159.4 million in 2015 compared to 2014. Salary and service costs, which tend to fluctuate with changes in revenue, increased $3.2 million in 2015 compared to 2014 reflecting growth in revenue and increases related to changes in the mix of our business during the period. Occupancy and other costs, which are less directly linked to changes in revenue than salary and service costs, decreased $113.9 million in 2015 compared to 2014, reflecting the continuing effort by our agencies to reduce operating costs. SG&A expenses decreased $45.4 million year-over-year primarily related to a reduction in professional fees. As a result, operating margin and EBITA margin were unchanged year-over-year at 12.7% and 13.4%, respectively.
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 swap on the 2022 Notes to $1 billion. Additionally, we entered into a $750 million fixed-to-floating interest rate swap on the 2024 Notes.
Income Taxes
Our effective tax rate was 32.8% and was in line with the prior year, which included the recognition of an income tax benefit of approximately $11 million related to expenses incurred in connection with a proposed merger with Publicis Groupe S.A., or Publicis. The merger was terminated in May 2014.
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 in net income - Omnicom Group Inc. 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 restricted stock awards and stock option exercises and shares issued under our employee stock purchase plan. Excluding the net effect of the proposed merger with Publicis, which included 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.
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 and short-term investments, additional liquidity sources include a $2.5 billion revolving credit facility, or Credit Facility, uncommitted domestic and international credit lines, the ability to issue up to $2 billion of commercial paper 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, 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. As a result, we typically 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, and our discretionary spending through 2017. Our cash and cash equivalents and short-term investments, access to the commercial paper market, Credit Facility, uncommitted credit lines and access to the capital markets provide additional sources of liquidity.
Cash and cash equivalents increased $397.0 million from December 31, 2015. The components of the increase were:
| Sources | |||||||
| Cash flow from operations | $ | 1,931.2 | |||||
| Less: Increase in operating capital | (323.0 | ) | |||||
| Principal cash sources | 1,608.2 | ||||||
| Uses | |||||||
| Capital expenditures | $ | (165.5 | ) | ||||
| Dividends paid to common shareholders | (505.4 | ) | |||||
| Dividends paid to shareholders of noncontrolling interests | (87.2 | ) | |||||
| Acquisition payments, including payment of contingent purchase price obligations and acquisition of additional noncontrolling interests, net of cash acquired | (499.3 | ) | |||||
| Repurchases of common stock, net of proceeds from stock plans and tax benefits | (554.2 | ) | |||||
| Principal cash uses | (1,811.6 | ) | |||||
| Principal cash uses in excess of principal cash sources | (203.4 | ) | |||||
| Foreign exchange rate changes | (75.5 | ) | |||||
| Financing activities and other | 352.9 | ||||||
| Increase in operating capital | 323.0 | ||||||
| Increase in cash and cash equivalents | $ | 397.0 |
Principal cash sources and principal cash uses amounts are Non-GAAP liquidity 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 consolidated 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 liquidity measures should not be considered in isolation from, or as a substitute for, financial information presented in compliance with U.S. GAAP. Non-GAAP liquidity 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 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 imbalances. 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.
At December 31, 2016, our foreign subsidiaries held approximately $899 million of our total cash and cash equivalents of $3.0 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.
Our net debt position, which we define as total debt, including short-term debt, less cash and cash equivalents and short-term investments, at December 31, 2016 decreased $24.6 million as compared to December 31, 2015. Cash and cash equivalents and short-term investments increased $403.1 million, which was substantially offset by a net increase in our senior notes and short-term debt.
The components of net debt at December 31, 2016 and 2015 were (in millions):
| 2016 | 2015 | ||||||
| Short-term debt | $ | 28.7 | $ | 5.2 | |||
| Long-term debt, including current portion | 4,920.6 | 4,565.6 | |||||
| Total debt | 4,949.3 | 4,570.8 | |||||
| Cash and cash equivalents and short-term investments | (3,022.8 | ) | (2,619.7 | ) | |||
| Net debt | $ | 1,926.5 | $ | 1,951.1 |
Net debt is a Non-GAAP liquidity measure. This presentation, together with the comparable U.S. GAAP liquidity measures, reflects one of the key metrics used by us to assess our cash management. Non-GAAP liquidity measures should not be considered in isolation from, or as a substitute for, financial information presented in compliance with U.S. GAAP. Non-GAAP liquidity measures as reported by us may not be comparable to similarly titled amounts reported by other companies.
Debt Instruments and Related Covenants
At December 31, 2016, our short-term liquidity sources include the $2.5 billion Credit Facility, expiring on July 31, 2021, domestic and international uncommitted credit lines aggregating $1.1 billion and the ability to 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, 2016, we were in compliance with these covenants as our Leverage Ratio was 2.2 times and our Interest Coverage Ratio was 11.0 times. The Credit Facility does not limit our ability to declare or pay dividends or repurchase our common stock.
On April 6, 2016, we issued $1.4 billion principal amount of 2026 Notes and a portion of the proceeds were used to retire the 2016 Notes, at maturity. Concurrent with the issuance of the 2026 Notes, we entered into a $500 million fixed-to-floating interest rate swap on the 2026 Notes.
At December 31, 2016, the total principal amount of our fixed rate senior notes was $4.9 billion and the total amount of the fixed-to-floating interest rate swaps was $1.25 billion. The interest rate swaps have the economic effect of converting our debt portfolio to approximately 75% fixed rate obligations and 25% floating rate obligations. A discussion of our interest rate swaps is included in Note 6 to the consolidated financial statements.
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.
Credit Markets and Availability of Credit
We typically fund our day-to-day liquidity by issuing commercial paper. As an additional source of liquidity, we may borrow under the Credit Facility or the uncommitted credit lines. At December 31, 2016, 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, 2016 was (dollars in millions):
| 2016 | 2015 | 2014 | |||||||||
| Average amount outstanding during the year | $ | 861.3 | $ | 964.8 | $ | 909.0 | |||||
| Maximum amount outstanding during the year | $ | 1,608.9 | $ | 1,720.7 | $ | 1,795.8 | |||||
| Average days outstanding | 11.2 | 13.2 | 20.3 | ||||||||
| Weighted average interest rate | 0.70 | % | 0.46 | % | 0.29 | % |
At December 31, 2016, our long-term and short-term debt was rated BBB+ and A2 by S&P and Baa1 and P2 by Moody's. Our access to the commercial paper market and the cost of these borrowings are affected by our credit ratings and market conditions. Our 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, 2016 were (in millions):
| Obligation Due | |||||||||||||||||||
| Total Obligation | 2017 | 2018 - 2019 | 2020 - 2021 | After 2021 | |||||||||||||||
| Long-term debt: | |||||||||||||||||||
| Principal | $ | 4,900.1 | $ | 0.1 | $ | 500.0 | $ | 1,000.0 | $ | 3,400.0 | |||||||||
| Interest | 1,165.0 | 198.8 | 383.4 | 274.0 | 308.8 | ||||||||||||||
| Lease obligations | 1,639.0 | 320.9 | 460.9 | 305.0 | 552.2 | ||||||||||||||
| Deferred tax liability - convertible debt | 132.3 | 65.8 | 66.5 | — | — | ||||||||||||||
| Contingent purchase price obligations | 386.1 | 190.8 | 111.1 | 84.2 | — | ||||||||||||||
| Defined benefit pension plans benefit obligation | 251.1 | 9.0 | 18.5 | 27.8 | 195.8 | ||||||||||||||
| Postemployment arrangements benefit obligation | 120.3 | 8.1 | 15.1 | 11.3 | 85.8 | ||||||||||||||
| Uncertain tax positions | 116.9 | 22.8 | 43.7 | 50.4 | — | ||||||||||||||
| $ | 8,710.8 | $ | 816.3 | $ | 1,599.2 | $ | 1,752.7 | $ | 4,542.6 |
Certain acquisitions include an initial payment at closing and provide for future additional contingent purchase price payments (earn-outs) that 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 unfunded benefit obligation for our defined benefit pension plans and liability for our postemployment arrangements was $302.8 million at December 31, 2016. In 2016, we contributed $6.6 million to our defined benefit pension plans and paid $9.2 million in benefits for our postemployment arrangements. We do not expect these payments to increase significantly in 2017.
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, 2016 were (in millions):
| Commitment Expires | |||||||||||||||||||
| Total Commitment | 2017 | 2018 - 2019 | 2020 - 2021 | After 2021 | |||||||||||||||
| Standby letters of credit | $ | 5.5 | $ | 3.5 | $ | 2.0 | $ | — | $ | — | |||||||||
| Guarantees | 87.8 | 73.3 | 6.9 | 2.5 | 5.1 | ||||||||||||||
| $ | 93.3 | $ | 76.8 | $ | 8.9 | $ | 2.5 | $ | 5.1 |
At December 31, 2016, there were no significant off-balance sheet arrangements.
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