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 the following fundamental disciplines: advertising, CRM,which as described below includes CRM Consumer Experience and CRM Execution & Support, public relations and healthcare. 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. Our fundamental business principle is that our clients’ specific marketing requirements are the central focus of how we structure our service offerings and allocate our resources. This client-centric business model requires that multiple agencies within Omnicom collaborate in formal and informal virtual client networks utilizing our key client matrix organization structure. This collaboration allows us to cut across our internal organizational structures to execute our clients’ marketing requirements in a consistent and comprehensive manner. 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 2017, our largest client represented 3.0% of revenue and our 100 largest clients, which represent many of the world's major marketers, comprised approximately 51% of revenue. Our clients operate in virtually every sector of the global economy with no one industry comprising more than 14% of our revenue in 2017. 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 2017 our revenue decreased $143.3 million, or 0.9%, compared to 2016. Changes in foreign exchange rates negatively impacted revenue in the first six months of 2017. Beginning in the third quarter of 2017, the Euro and a number of other foreign currencies strengthened against the U.S. Dollar. As a result, changes in foreign exchange rates for 2017 had a marginal effect on our revenue. In 2017, changes in foreign exchange rates increased revenue by $42.9 million, or 0.3%. Acquisition revenue, net of disposition revenue, reduced revenue $647.3 million, or 4.2%, primarily reflecting the sale of our specialty print media and organic growth increased revenue $461.1 million, or 3.0%.
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 2017, our agencies in North America continued their modest growth as activity in the United States varied across our service disciplines and growth slowed in the second half of the year relative to the first half. Our businesses in the United Kingdom, or the U.K., and Europe had solid performance. However, while improving in 2017, the continuing uncertain economic and political conditions in the European Union, or the EU, have been further complicated by the official notification from the U.K. to the European Council to withdraw from the EU. In Brazil, unstable economic and political conditions contributed to the continuing volatility in the market and our agencies experienced negative growth. Most of our businesses in Asia continue their modest 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. As clients increase their demands for marketing effectiveness and efficiency, they have made it a practice to consolidate their business within one service provider in the pursuit of a single engagement covering all consumer touch points. We have structured our business around these trends. We believe that our key client matrix organization structure approach to collaboration and integration of our services and solutions have provided a competitive advantage to our business in the past and we expect this to continue over the medium and long term. In addition, during 2017, we continued the process of forming practice areas within our global network structure to bring together agencies operating in common disciplines to leverage existing resources and to create, in close coordination with our key client matrix organization, additional custom client solutions. We expect to complete this process in 2018.
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 2018 revenue to increase modestly and over the long term to be 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 disciplines and business platforms, expand our operations in 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 underperforming businesses 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 exchange rate changes, 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.
The change in revenue in 2017 across our principal regional markets were: North America decreased 5.3%, Europe increased 5.7%, Latin America increased 16.8% and Asia Pacific increased 0.9%. In North America, modest growth in the United States and Canada was offset by the disposition of our specialty print media business in the second quarter. In Europe, growth in substantially all markets and the strengthening of the Euro against the U.S. Dollar was partially offset by the weakening of the British Pound against the U.S. Dollar. The increase in revenue in Latin America was a result of our acquisition activity in Colombia, growth in Mexico and the strengthening of the Brazilian Real against the U.S. Dollar, which was substantially offset by the continued economic weakness in Brazil and negative performance in that market. In Asia Pacific, growth in most countries in the region, especially Australia, India, Japan and Singapore, was partially offset by disposition activity.
In an effort to monitor the changing needs of our clients and to better capture the expanded scope of our services, in the fourth quarter of 2017, we realigned our service disciplines. As a result, our CRM discipline was grouped into two separate categories: CRM Consumer Experience, which includes Omnicom Precision Marketing Group’s digital / direct marketing agencies, as well as our branding agencies, shopper marketing agencies and our experiential marketing agencies; and, CRM Execution & Support, which includes field marketing, sales support, merchandising and point of sale, as well as other specialized marketing and custom communications services. Also, we realigned and renamed our former specialty communications discipline so that it now exclusively includes agencies offering healthcare marketing and communications services.
The change in revenue in 2017 compared to 2016, in our service disciplines was: advertising decreased 0.6%, CRM Consumer Experience decreased 3.2%, CRM Execution & Support decreased 1.6%, public relations increased 0.1% and healthcare increased 3.3%. The decrease in advertising primarily reflects the sale of our specialty print media business in April 2017.
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 for 2017 decreased 1.4% compared to 2016. Salary and service costs, which tend to fluctuate with changes in revenue, decreased $190.9 million, or 1.7%, in 2017 compared to 2016. Occupancy and other costs, which are less directly linked to changes in revenue than salary and service costs, increased $1.5 million, or 0.1%, in 2017 compared to 2016. Operating profit increased $50.8 million year-over-year. As a result, operating margin increased year-over-year to 13.5% from 13.0%. Earnings before interest, taxes and amortization of intangible assets, or EBITA margin, in 2017 was 14.2%, as compared to 13.8% in 2016.
Net interest expense increased $7.7 million year-over-year to $174.8 million in 2017. Interest expense increased $14.8 million to $224.5 million in 2017. Interest income increased $7.1 million to $49.7 million in 2017 compared to 2016.
On December 22, 2017, the Tax Act was enacted into law. The Tax Act reduced the U.S. federal statutory income tax rate to 21% from 35% for tax years beginning after December 31, 2017 and made several changes to existing tax law that affect our tax assets and liabilities related to previously reported taxable income. The significant changes require that we record tax expense on the accumulated earnings of our foreign subsidiaries and adjust our previously reported deferred tax positions to reflect the impact of the revised statutory federal rate as of the enactment date. In December 2017, the SEC issued Staff Accounting Bulletin 118, or SAB 118, which provides guidance on accounting for the impact of the Tax Act. SAB 118 provides that provisional amounts should be recognized in our financial statements where accounting for certain effects of the Tax Act are not complete and a reasonable estimate of the effects of the Tax Act can be made. Accordingly, at December 31, 2017, we have estimated the effect of the Tax Act and recorded a net increase to income tax expense of $106.3 million. Our estimate is based on our understanding of the Tax Act and currently available guidance. We expect to revise this estimate in future periods as further information becomes available. See Note 10 to the consolidated financial statements for additional information.
Our effective tax rate for 2017 was 36.9% compared to 32.6% for 2016. The increase is attributable to the estimated impact of the Tax Act of $106.3 million partially offset by the recognition of an excess tax benefit from share-based compensation of $20.8 million resulting from the adoption of FASB ASU 2016-09 (see Note 1 to the consolidated financial statements). ASU 2016-09 requires that beginning in 2017 excess tax benefits and deficiencies arising from share-based compensation be recognized in results of operations in the period when the restricted stock awards vest or stock options are exercised. In prior years, excess tax benefits and deficiencies from share-based compensation were recorded in additional paid-in capital. The effect of the Tax Act on income tax expense for 2017 is presented below in Results of Operations 2017 Compared to 2016. While we are still evaluating the impact of the Tax Act on our 2018 annual effective tax rate, we expect the Tax Act to reduce our effective tax rate between 3.5% and 4.5%, which excludes the impact of tax benefits or deficiencies on share-based compensation. At this point, we can not predict the 2018 impact from share-based compensation because it is subject to changes in our share price.
Net income - Omnicom Group Inc. for 2017 decreased $60.2 million, or 5.2%, to $1,088.4 million from $1,148.6 million in 2016. The year-over-year decrease is due to the impact of the Tax Act of $106.3 million, which is partially offset by the after tax increase from the factors described above. Diluted net income per share - Omnicom Group Inc. decreased 2.7% to $4.65 in 2017, compared to $4.78 in 2016. The impact of the Tax Act reduced diluted net income per share - Omnicom Group Inc. $0.45. In addition, 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, stock option exercises and employee stock purchase plan improved diluted net income per share - Omnicom Group Inc in 2017 compared to 2016. The effect of the Tax Act on net income - Omnicom Group Inc. and diluted net income per share - Omnicom Group Inc. is presented below in Results of Operations 2017 Compared to 2016.
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, for a more complete understanding of the critical accounting policies discussed below.
Estimates
We prepare our financial statements in conformity with U.S. GAAP and are required 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 2017, we completed four 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 the goodwill impairment test. Although not required, we performed 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 global 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 key client matrix organization structure 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 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 virtual client network 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, 2017 and 2016 were:
| June 30, | |||
| 2017 | 2016 | ||
| Long-Term Growth Rate | 4% | 4% | |
| WACC | 9.6% - 10.3% | 9.7% - 10.3% |
Long-term growth rate represents our estimate of the long-term growth rate for our industry and the markets 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 3.6% and 3.5%, respectively. We considered this history when determining the long-term growth rates used in our annual impairment test at June 30, 2017. 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, 2017, we used an estimated long-term growth rate of 4%.
When performing the annual impairment test as of June 30, 2017 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 2017. In the first half of 2017, we experienced an increase in our revenue of 3.9%, which excluded our net disposition activity 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 the first half of 2017, 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
Based on the results of our impairment test, we concluded that our goodwill at June 30, 2017 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 the goodwill impairment test was approximately 72%. 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, 2017 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 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 significant. 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 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 condition.
Subsequent to the annual impairment test at June 30, 2017 and considering our operating performance in the second half of the year, 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. Our principal source of revenue is derived from fees for services on a rate per hour or per project 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, which includes CRM Consumer Experience and CRM Execution & Support, public relations and healthcare. 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 service 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 in accordance with contractual requirements 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.
Effective January 1, 2018, we will adopt FASB ASC Topic 606, Revenue from Contracts with Customers, or ASC 606. As a result, we will change our revenue recognition accounting policy as described below. ASC 606 will be applied using the modified retrospective method, where the cumulative effect of the initial application is recognized as an adjustment to opening retained earnings at January 1, 2018 and is not expected to have a material impact on our financial position. ASC 606 provides a five-step model where revenue is recognized when the customer obtains control of the promised goods or services in an amount that reflects the consideration that we expect to receive in exchange for those goods or services. The adoption of ASC 606 will not have a material impact on how we recognize revenue for fixed fee or retainer based arrangements. Clients typically receive the benefit of our services as we perform. We will continue to recognize revenue over time using inputs or outputs to measure our progress. Revenue for commission based arrangements will continue to be recognized at a point-in-time. ASC 606 also includes additional disclosure requirements.
For certain of our businesses, the adoption of ASC 606 will result in a change in our accounting policy for certain third-party out-of-pocket costs, which are incurred in connection with our services and are billed to clients. The inclusion of third-party out-of-pocket costs in revenue depends on whether we act as a principal or agent in the client arrangement. Under ASC 606, the principal versus agent assessment is based on whether we control the specified goods or services before they are transferred to the customer. As a result of the adoption of ASC 606, certain third-party costs are no longer included in revenue and cost of services. In 2017, these third-party out-of-pocket costs were approximately $150 million. This change will reduce reported revenue and will have no impact on operating profit.
In addition, performance incentives that can increase revenue if we meet certain quantitative or qualitative objectives in delivering our services will be treated as variable consideration. Performance incentives were recognized in revenue when specific quantitative goals were achieved, or when our performance against qualitative goals was acknowledged by the client. Under ASC 606, variable consideration is estimated and included in total consideration at contract inception based on either the expected value method or the most likely method. These estimates are based on historical award experience, anticipated performance and our best judgment at the time. This change will have offsetting effects in each period and the net effect will not be material to our results of operations or financial position.
Income Taxes
On December 22, 2017, the Tax Act was enacted into law. In accordance with the guidance provided in SEC Staff Accounting Bulletin 118, at December 31, 2017, we made a reasonable estimate of the effect of the Tax Act on our results of operations and, as a result, we recorded a net increase to income tax expense of $106.3 million. We expect to revise this estimate in future periods as further information becomes available. See Note 10 to the consolidated financial statements for additional information.
NEW ACCOUNTING STANDARDS
See Note 20 for information on the adoption of new accounting standards and accounting standards not yet adopted.
RESULTS OF OPERATIONS - 2017 Compared to 2016 (in millions):
| 2017 | 2016 | ||||||
| Revenue | $ | 15,273.6 | $ | 15,416.9 | |||
| Operating Expenses: | |||||||
| Salary and service costs | 11,249.7 | 11,440.6 | |||||
| Occupancy and other costs | 1,232.1 | 1,230.6 | |||||
| Cost of services | 12,481.8 | 12,671.2 | |||||
| Selling, general and administrative expenses | 450.0 | 443.9 | |||||
| Depreciation and amortization | 282.1 | 292.9 | |||||
| 13,213.9 | 13,408.0 | ||||||
| Operating Profit | 2,059.7 | 2,008.9 | |||||
| Operating Margin - % | 13.5 | % | 13.0 | % | |||
| Interest Expense | 224.5 | 209.7 | |||||
| Interest Income | 49.7 | 42.6 | |||||
| Income Before Income Taxes and Income From Equity Method Investments | 1,884.9 | 1,841.8 | |||||
| Income Tax Expense | 696.2 | 600.5 | |||||
| Income From Equity Method Investments | 3.5 | 5.4 | |||||
| Net Income | 1,192.2 | 1,246.7 | |||||
| Net Income Attributed To Noncontrolling Interests | 103.8 | 98.1 | |||||
| Net Income - Omnicom Group Inc. | $ | 1,088.4 | $ | 1,148.6 |
As discussed below, in 2017 the Tax Act reduced Net income - Omnicom Group Inc. by $106.3 million and diluted Net income per share - Omnicom Group Inc. by $0.45. See Note 10 to the consolidated financial statements for additional information.
Non-GAAP Financial Measures
We use EBITA and EBITA Margin as additional operating performance measures that exclude the non-cash amortization expense of intangible assets, which primarily consists of amortization of intangible assets arising from acquisitions. We define EBITA as earnings before interest, taxes and amortization of intangible assets, and EBITA Margin as EBITA divided by revenue. EBITA and EBITA Margin are non-GAAP financial measures. We believe that EBITA and EBITA Margin are useful measures for investors to evaluate the performance of our business.
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.
The following table reconciles the U.S. GAAP financial measure of Net Income - Omnicom Group Inc. to EBITA and EBITA Margin for the for the periods presented (in millions):
| 2017 | 2016 | ||||||
| Net Income - Omnicom Group Inc. | $ | 1,088.4 | $ | 1,148.6 | |||
| Net Income Attributed To Noncontrolling Interests | 103.8 | 98.1 | |||||
| Net Income | 1,192.2 | 1,246.7 | |||||
| Income From Equity Method Investments | 3.5 | 5.4 | |||||
| Income Tax Expense | 696.2 | 600.5 | |||||
| Income Before Income Taxes and Income From Equity Method Investments | 1,884.9 | 1,841.8 | |||||
| Interest Expense | 224.5 | 209.7 | |||||
| Interest Income | 49.7 | 42.6 | |||||
| Operating Profit | 2,059.7 | 2,008.9 | |||||
| Add back: Amortization of intangible assets | 113.8 | 115.2 | |||||
| Earnings before interest, taxes and amortization of intangible assets (“EBITA”) | $ | 2,173.5 | $ | 2,124.1 | |||
| Revenue | $ | 15,273.6 | $ | 15,416.9 | |||
| EBITA | $ | 2,173.5 | $ | 2,124.1 | |||
| EBITA Margin - % | 14.2 | % | 13.8 | % |
Revenue
In 2017, revenue decreased $143.3 million to $15,273.6 million from $15,416.9 million in 2016. Changes in foreign exchange rates increased revenue by $42.9 million, or 0.3%. Acquisition revenue, net of disposition revenue, reduced revenue $647.3 million, or 4.2%, reflecting the disposition of certain non-strategic businesses in the past year, and organic growth increased revenue $461.1 million, or 3.0%. The reduction in revenue in 2017 resulting from our acquisition and disposition activity arose principally from the sale in the second quarter of our specialty print media business, which operated in North America.
Changes in foreign exchange rates negatively impacted revenue in the first six months of 2017. Beginning in the third quarter of 2017, the Euro and a number of foreign currencies strengthened against the U.S. Dollar. As a result, changes in foreign exchange rates for 2017 had a marginal effect on our revenue. The increase in revenue from changes in foreign exchange rates primarily resulted from the strengthening of the Euro, Brazilian Real, Australian Dollar and Russian Ruble against the U.S. Dollar, mostly offset by the weakening of the British Pound against the U.S. Dollar,
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, 2016 | $ | 15,416.9 | $ | 8,627.8 | $ | 6,789.1 | ||||||||||||||
| Components of revenue change: | ||||||||||||||||||||
| Foreign exchange rate impact | 42.9 | 0.3 | % | — | — | % | 42.9 | 0.6 | % | |||||||||||
| Acquisition revenue, net of disposition revenue | (647.3 | ) | (4.2 | )% | (474.4 | ) | (5.5 | )% | (172.9 | ) | (2.5 | )% | ||||||||
| Organic growth | 461.1 | 3.0 | % | 43.5 | 0.5 | % | 417.6 | 6.1 | % | |||||||||||
| December 31, 2017 | $ | 15,273.6 | (0.9 | )% | $ | 8,196.9 | (5.0 | )% | $ | 7,076.7 | 4.2 | % |
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 $15,230.7 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 ($15,273.6 million less $15,230.7 million for the Total column). |
| • | Acquisition revenue is calculated as if the acquisition occurred twelve months prior to the acquisition date by aggregating the comparable prior period revenue of acquisitions through the acquisition date. As a result, acquisition revenue excludes the positive or negative difference between our current period revenue subsequent to the acquisition date and the comparable prior period revenue and the positive or negative growth after the acquisition is attributed to organic growth. Disposition revenue is calculated as if the disposition occurred twelve months prior to the disposition date by aggregating the comparable prior period revenue of dispositions through the disposition date. The acquisition revenue and disposition revenue amounts are netted in the table. |
| • | Organic growth is calculated by subtracting the foreign exchange rate impact, and the acquisition revenue, net of disposition revenue 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 ($15,416.9 million for the Total column). |
Changes in the value of foreign currencies against the U.S. Dollar affect our results of operations and financial position. For the most part, because the revenue and expense of our foreign operations are both denominated in the same local currency, the economic impact on operating margin is minimized. Assuming exchange rates at February 12, 2018 remain unchanged, we estimate the impact of changes in foreign exchange rates to increase 2018 revenue by approximately 2%.
Revenue for 2017 and the percentage change in revenue and organic growth from 2016 in our principal regional markets were (in millions):
| 2017 | 2016 | $ Change | % Change | % Organic Growth | |||||||||||||
| Americas: | |||||||||||||||||
| North America | $ | 8,686.0 | $ | 9,174.0 | $ | (488.0 | ) | (5.3 | )% | 0.6 | % | ||||||
| Latin America | 494.8 | 423.6 | 71.2 | 16.8 | % | 0.6 | % | ||||||||||
| EMEA: | |||||||||||||||||
| Europe | 4,127.9 | 3,904.2 | 223.7 | 5.7 | % | 7.0 | % | ||||||||||
| Middle East and Africa | 314.6 | 278.9 | 35.7 | 12.8 | % | 12.5 | % | ||||||||||
| Asia Pacific | 1,650.3 | 1,636.2 | 14.1 | 0.9 | % | 5.8 | % | ||||||||||
| $ | 15,273.6 | $ | 15,416.9 | $ | (143.3 | ) | (0.9 | )% | 3.0 | % |
Our primary markets in Europe comprise the U.K. and the Euro Zone. In 2017, the U.K. comprised 9.1% of revenue and the Euro Zone and the other European countries together comprised 17.9% of revenue. In 2017, revenue, including the impact of foreign exchange rates, decreased 0.9% in the U.K. and increased 9.4% in the Euro Zone and the other European countries.
In North America, modest growth in the United States and Canada was offset by the disposition of our specialty print media business in the second quarter. In Europe, growth in substantially all markets and the strengthening of the Euro against the U.S. Dollar was partially offset by the weakening of the British Pound against the U.S. Dollar. The increase in revenue in Latin America was a result of our acquisition activity in Colombia, growth in Mexico and the strengthening of the Brazilian Real against the U.S. Dollar, which was substantially offset by the continued economic weakness in Brazil and negative performance in that market. In Asia Pacific, growth in most countries in the region, especially Australia, India, Japan and Singapore, was partially offset by disposition activity.
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 2017 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% of revenue in 2017 and 2016. Our ten largest and 100 largest clients represented 19.6% and 50.5% of revenue in 2017, respectively, and 18.3% and 52.4% of revenue in 2016, 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, branding, content marketing, corporate social responsibility consulting, crisis communications, custom publishing, data analytics, database management,
digital / direct marketing, digital transformation, entertainment marketing, experiential marketing, field marketing, financial/corporate business-to-business advertising, graphic arts/digital imaging, healthcare marketing and communications, instore design, interactive marketing, investor relations, marketing research, media planning and buying, merchandising and point of sale, mobile marketing, multi-cultural marketing, non-profit marketing, organizational communications, package design, product placement, promotional marketing, public affairs, public relations, retail marketing, sales support, search engine marketing, shopper marketing, social media marketing and sports and event marketing.
In an effort to monitor the changing needs of our clients and to better capture the expanded scope of our services, in the fourth quarter of 2017, we realigned our service disciplines. As a result, our CRM discipline was grouped into two separate categories: CRM Consumer Experience, which includes Omnicom Precision Marketing Group’s digital / direct marketing agencies, as well as our branding agencies, shopper marketing agencies and our experiential marketing agencies; and, CRM Execution & Support, which includes field marketing, sales support, merchandising and point of sale, as well as other specialized marketing and custom communications services. Also, we realigned and renamed our former specialty communications discipline so that it now exclusively includes agencies offering healthcare marketing and communications services.
Revenue for 2017 and 2016 and the change in revenue and organic growth from 2016 by discipline were (in millions):
| Year Ended December 31, | |||||||||||||||||||||||
| 2017 | 2016 | 2017 vs. 2016 | |||||||||||||||||||||
| $ | % of Revenue | $ | % of Revenue | $ Change | % Change | % Organic Growth | |||||||||||||||||
| Advertising | $ | 8,142.5 | 53.3 | % | $ | 8,194.5 | 53.2 | % | $ | (52.0 | ) | (0.6 | )% | 3.9 | % | ||||||||
| CRM Consumer Experience | 2,664.3 | 17.5 | % | 2,751.1 | 17.8 | % | (86.8 | ) | (3.2 | )% | 0.8 | % | |||||||||||
| CRM Execution & Support | 2,155.6 | 14.1 | % | 2,191.4 | 14.2 | % | (35.8 | ) | (1.6 | )% | 4.0 | % | |||||||||||
| Public Relations | 1,376.6 | 9.0 | % | 1,374.8 | 8.9 | % | 1.8 | 0.1 | % | 0.3 | % | ||||||||||||
| Healthcare | 934.6 | 6.1 | % | 905.1 | 5.9 | % | 29.5 | 3.3 | % | 2.8 | % | ||||||||||||
| $ | 15,273.6 | $ | 15,416.9 | $ | (143.3 | ) | (0.9 | )% | 3.0 | % |
We provide services to clients that operate in various industry sectors. Revenue by sector for 2017 and 2016 was:
| 2017 | 2016 | ||||
| Food and Beverage | 13 | % | 13 | % | |
| Consumer Products | 10 | % | 10 | % | |
| Pharmaceuticals and Health Care | 12 | % | 12 | % | |
| Financial Services | 7 | % | 7 | % | |
| Technology | 9 | % | 9 | % | |
| Auto | 10 | % | 8 | % | |
| Travel and Entertainment | 6 | % | 7 | % | |
| Telecommunications | 5 | % | 5 | % | |
| Retail | 6 | % | 6 | % | |
| Other | 22 | % | 23 | % |
Operating Expenses
Operating expenses for 2017 compared to 2016 were (in millions):
| Year Ended December 31, | ||||||||||||||||||||
| 2017 | 2016 | 2017 vs. 2016 | ||||||||||||||||||
| $ | % of Revenue | $ | % of Revenue | $ Change | % Change | |||||||||||||||
| Revenue | $ | 15,273.6 | $ | 15,416.9 | $ | (143.3 | ) | (0.9 | )% | |||||||||||
| Operating Expenses: | ||||||||||||||||||||
| Salary and service costs | 11,249.7 | 73.7 | % | 11,440.6 | 74.2 | % | (190.9 | ) | (1.7 | )% | ||||||||||
| Occupancy and other costs | 1,232.1 | 8.1 | % | 1,230.6 | 8.0 | % | 1.5 | 0.1 | % | |||||||||||
| Cost of services | 12,481.8 | 12,671.2 | (189.4 | ) | ||||||||||||||||
| Selling, general and administrative expenses | 450.0 | 2.9 | % | 443.9 | 2.9 | % | 6.1 | 1.4 | % | |||||||||||
| Depreciation and amortization | 282.1 | 1.8 | % | 292.9 | 1.9 | % | (10.8 | ) | (3.7 | )% | ||||||||||
| 13,213.9 | 86.5 | % | 13,408.0 | 87.0 | % | (194.1 | ) | (1.4 | )% | |||||||||||
| Operating Profit | $ | 2,059.7 | 13.5 | % | $ | 2,008.9 | 13.0 | % | $ | 50.8 | 2.5 | % |
Operating expenses decreased $194.1 million, or 1.4%, in 2017 compared to 2016. Salary and service costs, which tend to fluctuate with changes in revenue, decreased $190.9 million, or 1.7%, in 2017 compared to 2016. Occupancy and other costs, which are less directly linked to changes in revenue than salary and service costs, increased $1.5 million, or 0.1%, in 2017 compared to 2016. SG&A expenses increased $6.1 million year-over-year primarily related to professional fees. Operating profit increased $50.8 million year-over-year. As a result, operating margin increased year-over-year to 13.5% from 13.0% and EBITA margin increased year-over-year to 14.2% from 13.8%.
Net Interest Expense
Net interest expense increased $7.7 million year-over-year to $174.8 million in 2017. Interest expense increased $14.8 million to $224.5 million in 2017, primarily due to a reduced benefit from the fixed-to-floating interest rate swaps resulting from higher rates on the floating rate leg and higher interest expense on commercial paper. Our long-term debt portfolio at December 31, 2017, after taking into consideration our outstanding interest rate swaps, was approximately 75% fixed rate obligations and 25% floating rate obligations and was unchanged from December 31, 2016. A discussion of our interest rate swaps is included in Note 6 to the consolidated financial statements. In 2017, interest income increased $7.1 million compared to the prior year, resulting from higher interest earned on the cash held by our international treasury centers.
Income Taxes
Our effective tax rate for 2017 was 36.9% compared to 32.6% for 2016. The increase is attributable to the estimated impact of the Tax Act of $106.3 million partially offset by the recognition of an excess tax benefit from share-based compensation of $20.8 million resulting from the adoption of FASB ASU 2016-09 (see Note 1 to the consolidated financial statements). ASU 2016-09 requires that beginning in 2017 excess tax benefits and deficiencies arising from share-based compensation be recognized in results of operations in the period when the restricted stock awards vest or stock options are exercised. In prior years, excess tax benefits and deficiencies from share-based compensation were recorded in additional paid-in capital. The effect of the Tax Act on income tax expense for 2017 is presented below in Results of Operations 2017 Compared to 2016. While we are still evaluating the impact of the Tax Act on our 2018 annual effective tax rate, we expect the Tax Act to reduce our effective tax rate between 3.5% and 4.5%, which excludes the impact of tax benefits or deficiencies on share-based compensation. At this point, we can not predict the 2018 impact from share-based compensation because it is subject to changes in our share price.
Net Income Per Share - Omnicom Group Inc.
Net income - Omnicom Group Inc. for 2017 decreased $60.2 million, or 5.2%, to $1,088.4 million from $1,148.6 million in 2016. The year-over-year decrease is due to the impact of the Tax Act of $106.3 million, which is partially offset by the after tax increase from the factors described above. Diluted net income per share - Omnicom Group Inc. decreased 2.7% to $4.65 in 2017, compared to $4.78 in 2016. The impact of the Tax Act reduced diluted net income per share - Omnicom Group Inc. $0.45. In addition, 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, stock option exercises and employee stock purchase plan improved diluted net income per share - Omnicom Group Inc in 2017 compared to 2016.
Effect of the Tax Act
The following table presents the effect of the Tax Act on income tax expense, net income - Omnicom Group Inc. and diluted earnings per share Omnicom Group Inc. (in millions):
| 2017 As Reported | Effect of Tax Act | 2017 Excluding Effect of Tax Act | |||||||||
| Income before income taxes and income from equity method investments | $ | 1,884.9 | $ | — | $ | 1,884.9 | |||||
| Income tax expense | $ | 696.2 | $ | 106.3 | $ | 589.9 | |||||
| Effective tax rate | 36.9 | % | 31.3 | % | |||||||
| Net income - Omnicom Group Inc. | $ | 1,088.4 | (106.3 | ) | $ | 1,194.7 | |||||
| Diluted net income per share - Omnicom Group Inc. | $ | 4.65 | $ | (0.45 | ) | $ | 5.10 |
Excluding the effect of the Tax Act from income tax expense, net income Omnicom Group Inc. and diluted net income per share Omnicom Group Inc. are Non-GAAP measures. We believe that these measures help investors understand the effect of the Tax Act on our reported results.
RESULTS OF OPERATIONS - 2016 Compared to 2015 (in millions):
| 2016 | 2015 | ||||||
| Revenue | $ | 15,416.9 | $ | 15,134.4 | |||
| Operating Expenses: | |||||||
| Salary and service costs | 11,440.6 | 11,248.7 | |||||
| Occupancy and other costs | 1,230.6 | 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 | % | |||
| 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 |
Non-GAAP Financial Measures
We use EBITA and EBITA Margin as additional operating performance measures that exclude the non-cash amortization expense of intangible assets, which primarily consists of amortization of intangible assets arising from acquisitions. We define EBITA as earnings before interest, taxes and amortization of intangible assets, and EBITA Margin as EBITA divided by revenue. EBITA and EBITA Margin are non-GAAP financial measures. We believe that EBITA and EBITA Margin are useful measures for investors to evaluate the performance of our business.
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.
The following table reconciles the U.S. GAAP financial measure of Net Income - Omnicom Group Inc. to EBITA and EBITA Margin for the for the periods presented (in millions):
| 2016 | 2015 | ||||||
| Net Income - Omnicom Group Inc. | $ | 1,148.6 | $ | 1,093.9 | |||
| Net Income Attributed To Noncontrolling Interests | 98.1 | 109.5 | |||||
| Net Income | 1,246.7 | 1,203.4 | |||||
| Income From Equity Method Investments | 5.4 | 8.4 | |||||
| Income Tax Expense | 600.5 | 583.6 | |||||
| Income Before Income Taxes and Income From Equity Method Investments | 1,841.8 | 1,778.6 | |||||
| Interest Expense | 209.7 | 181.1 | |||||
| Interest Income | 42.6 | 39.6 | |||||
| Operating Profit | 2,008.9 | 1,920.1 | |||||
| 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 | |||
| Revenue | $ | 15,416.9 | $ | 15,134.4 | |||
| EBITA | $ | 2,124.1 | $ | 2,029.4 | |||
| EBITA Margin - % | 13.8 | % | 13.4 | % |
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, acquisition revenue net of disposition revenue, increased revenue by $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 | )% | |||||||||
| Acquisition revenue, net of disposition revenue | 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). |
| • | Acquisition revenue is calculated as if the acquisition occurred twelve months prior to the acquisition date by aggregating the comparable prior period revenue of acquisitions through the acquisition date. As a result, acquisition revenue excludes the positive or negative difference between our current period revenue subsequent to the acquisition date and the comparable prior period revenue and the positive or negative growth after the acquisition is attributed to organic growth. Disposition revenue is calculated as if the disposition occurred twelve months prior to the disposition date by aggregating the comparable prior period revenue of dispositions through the disposition date. The acquisition revenue and disposition revenue amounts are netted in the table. |
| • | Organic growth is calculated by subtracting the foreign exchange rate impact, and the acquisition revenue, net of disposition revenue 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.
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.
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 | $ | 8,194.7 | 53.2 | % | $ | 7,824.5 | 51.7 | % | $ | 370.2 | 4.7 | % | 5.9 | % | |||||||||
| CRM Consumer Experience | 2,750.9 | 17.8 | % | 2,772.5 | 18.3 | % | (21.6 | ) | (0.8 | )% | 1.8 | % | |||||||||||
| CRM Execution & Support | 2,191.4 | 14.2 | % | 2,359.7 | 15.6 | % | (168.3 | ) | (7.1 | )% | (3.4 | )% | |||||||||||
| Public Relations | 1,374.8 | 8.9 | % | 1,329.1 | 8.8 | % | 45.7 | 3.4 | % | 2.8 | % | ||||||||||||
| Healthcare | 905.1 | 5.9 | % | 848.6 | 5.6 | % | 56.5 | 6.7 | % | 7.6 | % | ||||||||||||
| $ | 15,416.9 | $ | 15,134.4 | $ | 282.5 | 1.9 | % | 3.5 | % |
We provide services to clients that operate in various 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 | 11,440.6 | 74.2 | % | 11,248.7 | 74.3 | % | 191.9 | 1.7 | % | |||||||||||
| Occupancy and other costs | 1,230.6 | 8.0 | % | 1,242.7 | 8.2 | % | (12.1 | ) | (1.0 | )% | ||||||||||
| Cost of services | 12,671.2 | 12,491.4 | ||||||||||||||||||
| 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 $191.9 million, or 1.7%, in 2016 compared to 2015. Occupancy and other costs, which are less directly linked to changes in revenue than salary and service costs, decreased $12.1 million, or 1.0%, 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 year-over-year to $167.1 million in 2016. Interest expense increased $28.6 million to $209.7 million in 2016, primarily resulting from the reduced benefit of the fixed-to-floating interest rate swap on the 2022 Notes. In January 2016, we settled the interest rate swap on the 2022 Notes and 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%. Concurrent with the issuance of $1.4 billion principal amount of 3.60% Notes due 2026 in April 2016, we entered into a $500 million fixed-to-floating interest rate swap on the notes. Our long-term debt portfolio at December 31, 2016, after taking into consideration our outstanding interest rate swaps, 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 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 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.
LIQUIDITY AND CAPITAL RESOURCES
Cash Sources and Requirements
Our primary liquidity sources are our operating cash flow, cash and cash equivalents and short-term investments. Additional liquidity sources include our credit facilities and commercial paper program, and access to the capital markets. At December 31, 2017, we have a $2.5 billion revolving credit facility, or Credit Facility, expiring on July 31, 2021, uncommitted domestic and international credit lines aggregating $1.2 billion and the ability to issue up to $2 billion of commercial paper. Our liquidity funds 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 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 for the next twelve months.
Cash and cash equivalents increased $793.8 million from December 31, 2016. The components of the increase were:
| Sources | |||||||
| Cash flow from operations | $ | 2,023.9 | |||||
| Less: Increase in operating capital | (348.5 | ) | |||||
| Principal cash sources | 1,675.4 | ||||||
| Uses | |||||||
| Capital expenditures | $ | (156.0 | ) | ||||
| Dividends paid to common shareholders | (515.2 | ) | |||||
| Dividends paid to noncontrolling interest shareholders | (101.7 | ) | |||||
| Acquisition payments, including payment of contingent purchase price obligations and acquisition of additional noncontrolling interests, net of cash acquired | (84.8 | ) | |||||
| Repurchases of common stock, net of proceeds from stock plans | (557.7 | ) | |||||
| Principal cash uses | (1,415.4 | ) | |||||
| Principal cash sources in excess of principal cash uses | 260.0 | ||||||
| Foreign exchange rate changes | 227.9 | ||||||
| Financing activities and other | (42.6 | ) | |||||
| Increase in operating capital | 348.5 | ||||||
| Increase in cash and cash equivalents | $ | 793.8 |
Principal cash sources and 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 a policy 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, 2017, our foreign subsidiaries held approximately $937 million of our total cash and cash equivalents of $3.8 billion. The majority of the cash is available to us, net of any foreign withholding taxes payable upon repatriation to the United States. See Note 10 to the consolidated financial statements for additional information.
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, 2017 decreased $798.2 million as compared to December 31, 2016. The decrease in net debt is due to an increase in cash and cash equivalents and short-term investments of $773.6 million primarily arising from an increase in operating capital of $348.5 million, an increase in principal cash sources in excess of principal cash uses of $260.0 million and the favorable impact of foreign exchange rate changes on cash and cash equivalents of $227.9 million.
The components of net debt at December 31, 2017 and 2016 were (in millions):
| 2017 | 2016 | ||||||
| Short-term debt | $ | 11.8 | $ | 28.7 | |||
| Long-term debt, including current portion | 4,912.9 | 4,920.6 | |||||
| Total debt | 4,924.7 | 4,949.3 | |||||
| Cash and cash equivalents and short-term investments | 3,796.4 | 3,022.8 | |||||
| Net debt | $ | 1,128.3 | $ | 1,926.5 |
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, 2017, the total principal amount of our fixed rate senior notes was $4.9 billion and the total notional amount of the outstanding fixed-to-floating interest rate swaps was $1.25 billion. The interest rate swaps have the economic effect of converting our long-term 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.
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, 2017, we were in compliance with these covenants as our Leverage Ratio was 2.1 times and our Interest Coverage Ratio was 10.4 times. The Credit Facility does not limit our ability to declare or pay dividends or repurchase our common stock.
At December 31, 2017, 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 credit ratings are downgraded.
Credit Markets and Availability of Credit
We typically fund our day-to-day liquidity by issuing commercial paper. Additional liquidity sources include our Credit Facility or the uncommitted credit lines. At December 31, 2017, 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, 2017 was (dollars in millions):
| 2017 | 2016 | 2015 | |||||||||
| Average amount outstanding during the year | $ | 902.3 | $ | 861.3 | $ | 964.8 | |||||
| Maximum amount outstanding during the year | $ | 1,769.8 | $ | 1,608.9 | $ | 1,720.7 | |||||
| Average days outstanding | 13.0 | 11.2 | 13.2 | ||||||||
| Weighted average interest rate | 1.29 | % | 0.70 | % | 0.46 | % |
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, 2017 were (in millions):
| Obligation Due | |||||||||||||||||||
| Total Obligation | 2018 | 2019 - 2020 | 2021 - 2022 | After 2022 | |||||||||||||||
| Long-term debt: | |||||||||||||||||||
| Principal | $ | 4,900.0 | $ | — | $ | 1,500.0 | $ | 1,250.0 | $ | 2,150.0 | |||||||||
| Interest | 966.2 | 198.8 | 335.4 | 216.0 | 216.0 | ||||||||||||||
| Lease obligations | 1,805.1 | 347.3 | 498.1 | 332.6 | 627.1 | ||||||||||||||
| Contingent purchase price obligations | 215.6 | 92.6 | 47.2 | 75.8 | — | ||||||||||||||
| Transition tax liability on accumulated foreign earnings | 102.9 | 8.2 | 16.5 | 16.5 | 61.7 | ||||||||||||||
| Deferred tax liability - convertible debt | 41.4 | 41.4 | — | — | — | ||||||||||||||
| Defined benefit pension plans benefit obligation | 277.0 | 9.7 | 23.1 | 32.9 | 211.3 | ||||||||||||||
| Postemployment arrangements benefit obligation | 127.7 | 9.3 | 14.0 | 12.6 | 91.8 | ||||||||||||||
| Uncertain tax positions | 173.7 | 24.3 | 44.7 | 65.7 | 39.0 | ||||||||||||||
| $ | 8,609.6 | $ | 731.6 | $ | 2,479.0 | $ | 2,002.1 | $ | 3,396.9 |
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 Tax Act includes a transition tax on accumulated foreign earnings. After taking into consideration available foreign tax credits and other items, we recorded a net cash liability of $102.9 million. We will elect to pay the liability over an eight-year period. See Note 10 to the consolidated financial statements for additional information.
The unfunded benefit obligation for our defined benefit pension plans and liability for our postemployment arrangements was $324.4 million at December 31, 2017. In 2017, we contributed $8.3 million to our defined benefit pension plans and paid $8.8 million in benefits for our postemployment arrangements. We do not expect these payments to increase significantly in 2018.
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, 2017 were (in millions):
| Commitment Expires | |||||||||||||||||||
| Total Commitment | 2018 | 2019 - 2020 | 2021 - 2022 | After 2022 | |||||||||||||||
| Standby letters of credit | $ | 5.3 | $ | 2.2 | $ | — | $ | 2.0 | $ | 1.1 | |||||||||
| Guarantees | 130.3 | 62.7 | 60.5 | 2.9 | 4.2 | ||||||||||||||
| $ | 135.6 | $ | 64.9 | $ | 60.5 | $ | 4.9 | $ | 5.3 |
At December 31, 2017, there were no significant off-balance sheet arrangements.
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