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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 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 use our client-centric approach to grow our business by expanding our service offerings to existing clients, moving into new markets and obtaining new clients. In addition, we pursue selective acquisitions of complementary companies with strong entrepreneurial management teams that typically currently serve or could serve our existing clients.
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 2018, 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 2018. 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 2018, revenue increased $16.6 million, or 0.1%, compared to 2017. Changes in foreign exchange rates increased revenue $85.1 million, or 0.6%, acquisition revenue, net of disposition revenue, reduced revenue $326.6 million, or 2.1%, reflecting the disposition of certain non-strategic businesses, and organic growth increased revenue $404.2 million, or 2.6%. In addition, the impact of the adoption of ASC 606 (see Note 1 to the consolidated financial statements) reduced revenue by $146.1 million, or 1.0%.
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. Revenue is typically lower in the first and third quarters and higher in the second and fourth quarters, reflecting client spending patterns during the year and additional project work that usually occurs in the fourth quarter. Additionally, certain global events targeted by major marketers for advertising expenditures, such as the FIFA World Cup and the Olympics, and certain national events, such as the U.S. election process, may affect our revenue period-over-period in certain businesses. Typically, these events do not have a significant impact on our revenue in any period. In 2018, our agencies in North America continued their modest growth with uneven performance across our service disciplines. In Europe, while mixed by country, most of our businesses had strong growth, however, the continuing uncertain economic and political conditions in the E.U., have been complicated by the status of Brexit. In Brazil, unstable economic and political conditions contributed to the continuing volatility in the market. Most of our businesses in Asia-Pacific had positive growth consistent with recent periods. The economic and fiscal issues facing the countries we operate in can cause economic uncertainty and volatility; however, the impact on our business varies by country. We 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, in 2018, we completed the process of forming practice areas within our global network structure to bring together agencies operating in common disciplines. This action leverages existing resources and, in close coordination with our key client matrix organization, enhances the development of custom client solutions.
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, among others, 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, in-store 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 the near term, barring unforeseen events and excluding the impact of changes in foreign exchange rates, because of continued improvement in operating performance by many of our agencies and new business activities, we expect our organic revenue to increase modestly for 2019 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.
We continually evaluate our portfolio of businesses to identify areas for investment and acquisition opportunities, as well as to identify non-strategic or underperforming businesses for disposition. During the third quarter of 2018, we disposed of certain businesses, primarily in our CRM Execution & Support discipline, and recorded a net gain of $178.4 million primarily related to the sale of Sellbytel, our European-based outsourced sales, service and support company. Also, during the third quarter, we took certain repositioning actions in an effort to continue to improve our strategic position and achieve operating efficiencies, and we recorded charges of $149.4 million for incremental severance, office lease consolidation and termination, asset write-offs, and other charges. We expect the reduction to our earnings for the disposition activity to be substantially offset by savings achieved from the operating efficiencies and cost reductions, as well as any incremental earnings from new acquisition activity, and we expect a net reduction to revenue of approximately 3% to 3.5% in the first half of 2019 and 2.5% for the full year.
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, net of dispositions and growth from our largest clients. Operating expenses are comprised of cost of services, selling, general and administrative expenses, or SG&A, and depreciation and amortization.
In 2018, our revenue increased 0.1% compared to 2017. Changes in foreign exchange rates increased revenue 0.6%, acquisition revenue, net of disposition revenue, reduced revenue 2.1%, and organic growth increased revenue 2.6%. Across our principal regional markets, the changes in revenue were: North America decreased 2.8%, Europe increased 6.0%, Asia-Pacific increased 3.6% and Latin America decreased 7.5%. In North America, modest growth in the United States was offset by a decrease in revenue primarily resulting from the impact of the adoption of ASC 606, the disposition of our specialty print media business in the second quarter of 2017 and negative performance in Canada. Organic revenue growth in the United States was led by our CRM Consumer Experience, healthcare, advertising and media and public relations businesses, and was partially offset by a decrease in our CRM Execution & Support discipline. The revenue increase in Europe resulted from strong organic revenue in the region, particularly in France, Spain and the Czech Republic, modest organic revenue growth in the U.K., and the strengthening of the Euro and the British Pound against the U.S. Dollar in the first half of the year, which was partially offset by disposition activity and negative performance in Germany. The decrease in revenue in Latin America was primarily a result of the weakening of the Brazilian Real against the U.S. Dollar. In Asia-Pacific, organic growth in most countries in the region, especially Australia, China, New Zealand and India, was partially offset by disposition activity. The change in revenue in 2018 compared to 2017, in our four fundamental disciplines was: Advertising increased 1.3%, CRM Consumer Experience increased 0.2%, CRM Execution & Support decreased 11.0%, Public Relations increased 1.7% and Healthcare increased 12.7%.
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 a significant portion 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, which increased slightly year-over-year, 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, which include the net gain from the disposition of subsidiaries and the repositioning charges, as described above (see Note 13 to the consolidated financial statements), decreased $33.1 million, in 2018 compared to 2017. Salary and service costs, which tend to fluctuate with changes in revenue, increased $78.9 million, or 0.7%, in 2018 compared to 2017. The year-over-year increase primarily reflects the incremental severance and other charges of $73.7 million incurred in connection with the repositioning actions taken in the third quarter of 2018. Occupancy and other costs, which are less directly linked to changes in revenue than salary and service costs, increased $68.8 million, or 5.5%, in 2018 compared to 2017. The year-over-year change reflects a decrease of $4.7 million, which was offset by $73.5 million of repositioning charges primarily related to office lease consolidation and termination actions taken in the third quarter of 2018. Operating margin increased year-over-year to 14.0% from 13.6% and EBITA margin increased year-over-year to 14.6% from 14.4%. The net gain on disposition of subsidiaries and repositioning expenses, increased operating profit and operating margin year-over year by $29.0 million and 0.2%, respectively.
Net interest expense increased $10.3 million to $209.2 million in 2018 compared to 2017. Interest expense on debt increased $17.4 million to $241.9 million in 2018. Interest income in 2018 increased $7.5 million, compared to the prior year.
Our effective tax rate for 2018, decreased period-over-period to 25.6% from 36.9% in 2017. The decrease was primarily attributable to the reduction of the U.S. federal statutory income tax rate to 21% from 35% resulting from the Tax Act which was enacted in December 2017. Additionally, income tax expense for 2018 reflects the following: a reduction of approximately $19 million, primarily as a result of the successful resolution of foreign tax claims, a reduction of $25.0 million related to the net income tax effect of the net gain on disposition of subsidiaries and repositioning actions (see Note 13 to the consolidated financial statements) and additional income tax expense of $28.9 million, reflecting the finalization of the provisional estimate of the effect of the Tax Act recorded in the fourth quarter of 2017 (see Note 11 to the consolidated financial statements).
Net income - Omnicom Group Inc. in 2018 increased, due to the factors described above, $238.0 million, or 21.9%, to $1,326.4 million from $1,088.4 million in 2017. The net gain on disposition of subsidiaries and repositioning actions, after the allocable share of $6.9 million to noncontrolling interests, and the additional income tax expense from the finalization of the provisional estimate of the effect of the Tax Act, increased net income - Omnicom Group Inc. $18.2 million. Diluted net income per share - Omnicom Group Inc. increased 25.4% to $5.83 in 2018, compared to $4.65 in 2017, 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, stock option exercises and the employee stock purchase plan. The net gain on disposition of subsidiaries and repositioning actions net of the additional income tax expense from the finalization of the provisional estimate of the effect of the Tax Act, increased diluted net income per share - Omnicom Group Inc. $0.08.
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 2018, we completed six 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”) for each reporting unit.
The assumptions used for the long-term growth rate and WACC in our evaluations as of June 30, 2018 and 2017 were:
| June 30, | |||
| 2018 | 2017 | ||
| Long-Term Growth Rate | 4% | 4% | |
| WACC | 10.5% - 11.1% | 9.6% - 10.3% |
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 3.2% and 3.4%, respectively. We considered this history when determining the long-term growth rates used in our annual impairment test at June 30, 2018. We believe marketing expenditures over the long term have a high correlation to GDP. Based on our historical performance, we also believe 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, 2018, we used an estimated long-term growth rate of 4%.
When performing the annual impairment test as of June 30, 2018 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 2018. In the first half of 2018, our revenue increased 2.2%, which excluded our net disposition activity and the impact from changes in foreign exchange rates. While our businesses in Europe had improved performance, the continuing uncertain economic and political conditions in the E.U. have been further complicated by the United Kingdom's ongoing negotiations with the European Council to withdraw from the E.U. During the first half of 2018, weakness in certain 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, 2018 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 60%. 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, 2018 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, 2018 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, 5 and 6 to the consolidated financial statements.
Revenue Recognition
Effective January 1, 2018, we adopted ASC 606 (see Note 1 to the consolidated financial statements). As described below, in accordance with ASC 606 we changed certain aspects of our revenue recognition accounting policy. ASC 606 was applied using the modified retrospective method, where the cumulative effect of the initial application was recognized as an adjustment to opening retained earnings at January 1, 2018. Therefore, comparative prior periods have not been adjusted and continue to be reported under FASB ASC Topic 605, Revenue Recognition.
Under ASC 606, revenue is recognized when a customer obtains control of promised goods or services (the performance obligation) in an amount that reflects the consideration we expect to receive in exchange for those goods or services (the transaction price). We measure revenue by estimating the transaction price based on the consideration specified in the client arrangement. Revenue is recognized as the performance obligations are satisfied. Our revenue is primarily derived from the planning and execution of advertising communications and marketing services in the following fundamental disciplines: Advertising, which includes creative advertising services and strategic media planning and buying services, Customer Relationship Management or CRM, which includes CRM Consumer Experience and CRM Execution & Support, Public Relations and Healthcare Advertising. Our client contracts are primarily fees for service on a rate per hour or per project basis. Revenue is recorded net of sales, use and value added taxes.
Performance Obligations
In substantially all our disciplines, the performance obligation is to provide advisory and consulting services at an agreed-upon level of effort to accomplish the specified engagement. Our client contracts are comprised of diverse arrangements involving fees based on any one or a combination of the following: an agreed fee or rate per hour for the level of effort expended by our employees; commissions based on the client’s spending for media purchased from third parties; qualitative or quantitative incentive provisions specified in the contract; and reimbursement for third-party costs that we are required to include in revenue when we control the vendor services related to these costs and we act as principal. The transaction price of a contract is allocated to each distinct performance obligation based on its relative stand-alone selling price and is recognized as revenue when, or as, the customer receives the benefit of the performance obligation. Clients typically receive and consume the benefit of our services as they are performed. Substantially all our client contracts provide that we are compensated for services performed to date and allow for cancellation by either party on short notice, typically 90 days, without penalty.
Generally, our short-term contracts, which normally take 30 to 90 days to complete, are performed by a single agency and consist of a single performance obligation. As a result, we do not consider the underlying services as separate or distinct performance obligations because our services are highly interrelated, occur in close proximity, and the integration of the various components of a marketing message is essential to overall service. In certain of our long-term client contracts, which have a term of up to one year, the performance obligation is a stand-ready obligation, because we provide a constant level of similar services over the term of the contract. In other long-term contracts, when our services are not a stand-ready obligation, we consider our services distinct performance obligations and allocate the transaction price to each separate performance obligation based on its stand-alone selling price, including contracts for strategic media planning and buying services, which are considered to be multiple performance obligations, and we allocate the transaction price to each distinct service based on the staffing plan and the stand-alone selling price. In substantially all of our creative services contracts we have distinct performance obligations for our services, including certain creative services contracts where we act as an agent and arrange, at the client’s direction, for third-parties to perform studio production efforts.
Revenue Recognition Methods
A substantial portion of our revenue is recognized over time, as the services are performed, because the client receives and consumes the benefit of our performance throughout the contract period, or we create an asset with no alternative use and are contractually entitled to payment for our performance to date in the event the client terminates the contract for convenience. For these over time client contracts, other than when we have a stand-ready obligation to perform services, revenue is recognized over time using input measures that correspond to the level of staff effort expended to satisfy the performance obligation on a rate per hour or equivalent basis. For client contracts when we have a stand-ready obligation to perform services on an ongoing basis over the life of the contract, typically for periods up to one year, where the scope of these arrangements is broad and there are no significant gaps in performing the services, we recognize revenue using a time-based measure resulting in a straight-line revenue recognition. From time to time, there may be changes in the client service requirements during the term of a contract and the changes could be significant. These changes are typically negotiated as new contracts covering the additional requirements and the associated costs, as well as additional fees for the incremental work to be performed.
To a lesser extent, for certain other contracts where our performance obligations are satisfied in phases, we recognize revenue over time using certain output measures based on the measurement of the value transferred to the customer, including milestones achieved. Where the transaction price or a portion of the transaction price is derived from commissions based on a percentage of purchased media from third parties, the performance obligation is not satisfied until the media is run and we have an enforceable contract providing a right to payment. Accordingly, revenue for commissions is recognized at a point in time, typically when the media is run, including when it is not subject to cancellation by the client or media vendor.
Principal vs. Agent
In substantially all our businesses, we incur third-party costs on behalf of clients, including direct costs and incidental, or out- of-pocket costs. Third-party direct costs incurred in connection with the creation and delivery of advertising or marketing communication services include, among others: purchased media, studio production services, specialized talent, including artists and other freelance labor, event marketing supplies, materials and services, promotional items, market research and third-party data and other related expenditures. Out-of-pocket costs include, among others: transportation, hotel, meals and telecommunication charges incurred by us in the course of providing our services. Billings related to out-of-pocket costs are included in revenue since we control the goods or services prior to delivery to the client.
However, the inclusion of billings related to third-party direct costs in revenue depends on whether we act as a principal or as an agent in the client arrangement. In most of our businesses, including Advertising, which also includes studio production efforts and media planning and buying services, Public Relations, Healthcare Advertising and most of our CRM Consumer Experience businesses, we act as an agent and arrange, at the client's direction, for third parties to perform certain services. In these cases, we do not control the goods or services prior to the transfer to the client. As a result, revenue is recorded net of these costs, equal to the amount retained for our fee or commission.
In certain businesses we may act as principal when contracting for third-party services on behalf of our clients. In our events business and most of our CRM Execution & Support businesses, including field marketing and certain specialty marketing businesses, we act as principal because we control the specified goods or services before they are transferred to the client and we are responsible for providing the specified goods or services, or we are responsible for directing and integrating third-party vendors to fulfill our performance obligation at the agreed upon contractual price. In such arrangements, we also take pricing risk under the terms of the client contract. In certain specialty media buying business, we act as principal when we control the buying process for the purchase of the media and contract directly with the media vendor. In these arrangements, we assume the pricing risk under the terms of the client contract. When we act as principal, we include billable amounts related to third-party costs in the transaction price and record revenue over time at the gross amount billed, including out-of-pocket costs, consistent with the manner that we recognize revenue for the underlying services contract. However, in media buying contracts where we act as principal, we recognize revenue at a point in time, typically when the media is run, including when it is not subject to cancellation by the client or media vendor.
Variable Consideration
Some of our client arrangements include variable consideration provisions, which include performance incentives, tiered commission structures and vendor rebates in certain markets outside of the United States. Variable consideration is estimated and included in total consideration at contract inception based on either the expected value method or the most likely outcome method. These estimates are based on historical award experience, anticipated performance and other factors known at the time. Performance incentives are typically recognized in revenue over time. Variable consideration for our media businesses in certain international markets includes rebate revenue and is recognized when it is probable that the media will be run, including when it is not subject to cancellation by the client. In addition, when we receive rebates or credits from vendors for transactions entered into on behalf of clients, they are remitted to the clients in accordance with contractual requirements or retained by us based on the terms of the client contract or local law. Amounts passed on to clients are recorded as a liability and amounts retained by us are recorded as revenue when earned, which is typically when the media is run.
NEW ACCOUNTING STANDARDS
See Note 22 to the consolidated financial statements for information on the adoption of new accounting standards and accounting standards not yet adopted.
RESULTS OF OPERATIONS
Accounting Changes
Effective January 1, 2018, we adopted ASC 606 (see Note 1 to the consolidated financial statements). As described below, in accordance with ASC 606 we changed certain aspects of our revenue recognition accounting policy. ASC 606 was applied using the modified retrospective method, where the cumulative effect of the initial application was recognized as an adjustment to opening retained earnings at January 1, 2018. Therefore, comparative prior periods have not been adjusted and continue to be reported under FASB ASC Topic 605, Revenue Recognition, or ASC 605.
Upon adoption of ASC 606, our accounting policy for certain third-party out-of-pocket costs, which are incurred in connection with our services and are billed to clients, was required to be changed. In addition, our policy for performance incentives (variable consideration) included in certain client contracts was required to be changed. 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. This change was the principal adjustment to our reported revenue and operating expenses included in the table below. However, the change had no impact on operating profit.
In addition, performance incentives included in certain client contracts can increase revenue if we meet certain quantitative or qualitative objectives in delivering our services. Under ASC 606, performance incentives are now treated as variable consideration. Prior to the adoption of ASC 606, performance incentives were recognized in revenue under ASC 605 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 outcome method. These estimates are based on historical award experience, anticipated performance and our best judgment at the time. As a result of this change, we recorded a cumulative effect adjustment to increase opening retained earnings at January 1, 2018 by $19.5 million, to reflect the transition requirements of ASC 606. The effect of this change on our financial position and cash flows was not material.
The impact of the adoption of ASC 606 on revenue, operating expenses and operating profit for the year ended December 31, 2018 was (in millions):
| As Reported | Adjustments | Amounts without the Adoption of ASC 606 | |||||||||
| Revenue | $ | 15,290.2 | $ | 146.1 | $ | 15,436.3 | |||||
| Operating Expenses | 13,156.7 | 139.5 | 13,296.2 | ||||||||
| Operating Profit | 2,133.5 | 6.6 | 2,140.1 |
The impact of the adoption of ASC 606 on net income - Omnicom Group Inc., diluted net income per share - Omnicom Group Inc. and the consolidated financial statements was not material.
RESULTS OF OPERATIONS - 2018 Compared to 2017 (in millions):
| 2018 | 2017 | ||||||
| Revenue | $ | 15,290.2 | $ | 15,273.6 | |||
| Operating Expenses: | |||||||
| Salary and service costs | 11,306.1 | 11,227.2 | |||||
| Occupancy and other costs | 1,309.6 | 1,240.8 | |||||
| Net gain on disposition of subsidiaries | (178.4 | ) | — | ||||
| Cost of services | 12,437.3 | 12,468.0 | |||||
| Selling, general and administrative expenses | 455.4 | 439.7 | |||||
| Depreciation and amortization | 264.0 | 282.1 | |||||
| 13,156.7 | 13,189.8 | ||||||
| Operating Profit | 2,133.5 | 2,083.8 | |||||
| Operating Margin - % | 14.0 | % | 13.6 | % | |||
| Interest Expense | 266.4 | 248.6 | |||||
| Interest Income | 57.2 | 49.7 | |||||
| Income Before Income Taxes and Income From Equity Method Investments | 1,924.3 | 1,884.9 | |||||
| Income Tax Expense | 492.7 | 696.2 | |||||
| Income From Equity Method Investments | 8.9 | 3.5 | |||||
| Net Income | 1,440.5 | 1,192.2 | |||||
| Net Income Attributed To Noncontrolling Interests | 114.1 | 103.8 | |||||
| Net Income - Omnicom Group Inc. | $ | 1,326.4 | $ | 1,088.4 |
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):
| 2018 | 2017 | ||||||
| Net Income - Omnicom Group Inc. | $ | 1,326.4 | $ | 1,088.4 | |||
| Net Income Attributed To Noncontrolling Interests | 114.1 | 103.8 | |||||
| Net Income | 1,440.5 | 1,192.2 | |||||
| Income From Equity Method Investments | 8.9 | 3.5 | |||||
| Income Tax Expense | 492.7 | 696.2 | |||||
| Income Before Income Taxes and Income From Equity Method Investments | 1,924.3 | 1,884.9 | |||||
| Interest Expense | 266.4 | 248.6 | |||||
| Interest Income | 57.2 | 49.7 | |||||
| Operating Profit | 2,133.5 | 2,083.8 | |||||
| Add back: Amortization of intangible assets | 102.5 | 113.8 | |||||
| Earnings before interest, taxes and amortization of intangible assets (“EBITA”) | $ | 2,236.0 | $ | 2,197.6 | |||
| Revenue | $ | 15,290.2 | $ | 15,273.6 | |||
| EBITA | $ | 2,236.0 | $ | 2,197.6 | |||
| EBITA Margin - % | 14.6 | % | 14.4 | % |
Revenue
In 2018, revenue increased $16.6 million, or 0.1%, to $15,290.2 million from $15,273.6 million in 2017. Changes in foreign exchange rates increased revenue $85.1 million, acquisition revenue, net of disposition revenue, reduced revenue $326.6 million, and organic growth increased revenue $404.2 million.
The impact of changes in foreign exchange rates increased revenue 0.6%, or $85.1 million, primarily resulting from the strengthening of the Euro and British Pound, against the U.S. Dollar, partially offset by the weakening of the Brazilian Real, Russian Ruble and Australian Dollar 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, 2017 | $ | 15,273.6 | $ | 8,196.9 | $ | 7,076.7 | ||||||||||||||
| Components of revenue change: | ||||||||||||||||||||
| Foreign exchange rate impact | 85.1 | 0.6 | % | — | — | % | 85.1 | 1.2 | % | |||||||||||
| Acquisition revenue, net of disposition revenue | (326.6 | ) | (2.1 | )% | (108.7 | ) | (1.3 | )% | (217.9 | ) | (3.1 | )% | ||||||||
| Organic growth | 404.2 | 2.6 | % | 58.0 | 0.7 | % | 346.2 | 4.9 | % | |||||||||||
| Impact of adoption of ASC 606 | (146.1 | ) | (1.0 | )% | (146.4 | ) | (1.8 | )% | 0.3 | — | % | |||||||||
| December 31, 2018 | $ | 15,290.2 | 0.1 | % | $ | 7,999.8 | (2.4 | )% | $ | 7,290.4 | 3.0 | % |
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 $15,205.1 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 ($15,290.2 million less $15,205.1 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, excluding the impact of the adoption of ASC 606. |
| • | The impact of the adoption of ASC 606 is discussed above in the “Accounting Changes” section. |
| • | The percentage change is calculated by dividing the individual component amount by the prior period revenue base of that component ($15,273.6 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 11, 2019 remain unchanged, we estimate the impact of changes in foreign exchange rates to reduce revenue in the first half of 2019 by approximately 2.5% to 3% and 1.5% for the full year.
Revenue and organic growth, expressed as a percentage and excluding the impact of ASC 606, in our principal regional markets were (in millions):
| 2018 | 2017 | $ Change | % Organic Growth | |||||||||||
| Americas: | ||||||||||||||
| North America | $ | 8,442.5 | $ | 8,686.0 | $ | (243.5 | ) | 0.4 | % | |||||
| Latin America | 457.5 | 494.8 | (37.3 | ) | 2.0 | % | ||||||||
| EMEA: | ||||||||||||||
| Europe | 4,375.4 | 4,127.9 | 247.5 | 5.7 | % | |||||||||
| Middle East and Africa | 304.4 | 314.6 | (10.2 | ) | (2.9 | )% | ||||||||
| Asia-Pacific | 1,710.4 | 1,650.3 | 60.1 | 7.9 | % | |||||||||
| $ | 15,290.2 | $ | 15,273.6 | $ | 16.6 | 2.6 | % |
In Europe, our primary markets are the U.K. and the Euro Zone. Revenue for 2018 in the U.K., which represents 9.5% of total revenue, increased 4.3%, and revenue in the Euro Zone and the other European countries, which together comprised 19.1% of total revenue, increased 6.9%.
In North America, modest growth in the United States was offset by a decrease in revenue primarily resulting from the impact of the adoption of ASC 606, the disposition of our specialty print media business in the second quarter of 2017 and negative performance in Canada. Organic revenue growth in the United States was led by our CRM Consumer Experience, healthcare, advertising and media and public relations businesses, and was partially offset by a decrease in our CRM Execution & Support discipline. The revenue increase in Europe resulted from strong organic revenue in the region, particularly in France, Spain and the Czech Republic, modest organic revenue growth in the U.K., and the strengthening of the Euro and the British Pound against the U.S. Dollar in the first half of the year, which was partially offset by disposition activity and negative performance in Germany. The decrease in revenue in Latin America was primarily a result of the weakening of the Brazilian Real against the U.S. Dollar. In Asia-Pacific, organic growth in most countries in the region, especially Australia, China, New Zealand and India, 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 2018 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 2018 and 2017. Our ten largest and 100 largest clients represented 19.1% and 50.7% of revenue in 2018, respectively, and 19.6% and 50.5% of revenue in 2017, respectively.
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 categories: advertising, CRM, which includes CRM Consumer Experience and CRM Execution & Support, public relations and healthcare.
Revenue for 2018 and 2017 and the change in revenue and organic growth from 2017 by discipline were (in millions):
| Year Ended December 31, | ||||||||||||||||||||
| 2018 | 2017 | 2018 vs. 2017 | ||||||||||||||||||
| $ | % of Revenue | $ | % of Revenue | $ Change | % Organic Growth | |||||||||||||||
| Advertising | $ | 8,281.0 | 54.2 | % | $ | 8,175.9 | 53.6 | % | $ | 105.1 | 2.9 | % | ||||||||
| CRM Consumer Experience | 2,620.7 | 17.1 | % | 2,615.9 | 17.1 | % | 4.8 | 5.9 | % | |||||||||||
| CRM Execution & Support | 1,900.5 | 12.4 | % | 2,135.8 | 14.0 | % | (235.3 | ) | (2.7 | )% | ||||||||||
| Public Relations | 1,435.1 | 9.4 | % | 1,411.4 | 9.2 | % | 23.7 | 1.8 | % | |||||||||||
| Healthcare | 1,052.9 | 6.9 | % | 934.6 | 6.1 | % | 118.3 | 4.5 | % | |||||||||||
| $ | 15,290.2 | $ | 15,273.6 | $ | 16.6 | 2.6 | % |
We provide services to clients that operate in various industry sectors. Revenue by sector for 2018 and 2017 was:
| 2018 | 2017 | ||||
| Food and Beverage | 13 | % | 13 | % | |
| Consumer Products | 9 | % | 10 | % | |
| Pharmaceuticals and Health Care | 13 | % | 12 | % | |
| Financial Services | 8 | % | 8 | % | |
| Technology | 8 | % | 9 | % | |
| Auto | 10 | % | 10 | % | |
| Travel and Entertainment | 7 | % | 7 | % | |
| Telecommunications | 5 | % | 5 | % | |
| Retail | 6 | % | 6 | % | |
| Other | 21 | % | 20 | % |
Operating Expenses
Operating expenses for 2018 compared to 2017 were (in millions):
| Year Ended December 31, | ||||||||||||||||||||
| 2018 | 2017 | 2018 vs. 2017 | ||||||||||||||||||
| $ | % of Revenue | $ | % of Revenue | $ Change | % Change | |||||||||||||||
| Revenue | $ | 15,290.2 | $ | 15,273.6 | $ | 16.6 | 0.1 | % | ||||||||||||
| Operating Expenses: | ||||||||||||||||||||
| Salary and service costs | 11,306.1 | 73.9 | % | 11,227.2 | 73.5 | % | 78.9 | 0.7 | % | |||||||||||
| Occupancy and other costs | 1,309.6 | 8.6 | % | 1,240.8 | 8.1 | % | 68.8 | 5.5 | % | |||||||||||
| Net gain on disposition of subsidiaries | (178.4 | ) | (1.2 | )% | — | — | % | (178.4 | ) | |||||||||||
| Cost of services | 12,437.3 | 12,468.0 | (30.7 | ) | ||||||||||||||||
| Selling, general and administrative expenses | 455.4 | 3.0 | % | 439.7 | 2.9 | % | 15.7 | 3.6 | % | |||||||||||
| Depreciation and amortization | 264.0 | 1.7 | % | 282.1 | 1.8 | % | (18.1 | ) | (6.4 | )% | ||||||||||
| 13,156.7 | 86.0 | % | 13,189.8 | 86.4 | % | (33.1 | ) | (0.3 | )% | |||||||||||
| Operating Profit | $ | 2,133.5 | 14.0 | % | $ | 2,083.8 | 13.6 | % | $ | 49.7 | 2.4 | % |
In the third quarter of 2018, we disposed of certain businesses, primarily in our CRM Execution & Support discipline, and recorded a net gain of $178.4 million. Also, during the third quarter, we took certain repositioning actions in an effort to continue to improve our strategic position and achieve operating efficiencies, and we recorded charges of $149.4 million for incremental severance, office lease consolidation and termination, asset write-offs and other charges. The impact of the repositioning actions and net gain on sale of subsidiaries on operating expenses for 2018 was (dollars in millions):
| Increase (Decrease) | |||||||||||
| Repositioning Actions | Net Gain on Disposition of Subsidiaries | Total | |||||||||
| Salary and service costs | $ | 73.7 | $ | — | $ | 73.7 | |||||
| Occupancy and other costs | 73.5 | — | 73.5 | ||||||||
| Net gain on disposition of subsidiaries | — | (178.4 | ) | (178.4 | ) | ||||||
| Cost of services | 147.2 | (178.4 | ) | (31.2 | ) | ||||||
| Selling, general and administrative expenses | 2.2 | — | 2.2 | ||||||||
| Depreciation and amortization | — | — | — | ||||||||
| $ | 149.4 | $ | (178.4 | ) | $ | (29.0 | ) |
Operating expenses, which include the net gain from the disposition of subsidiaries and the repositioning charges, as described above (see Note 13 to the consolidated financial statements), decreased $33.1 million, in 2018 compared to 2017. Salary and service costs, which tend to fluctuate with changes in revenue, increased $78.9 million, or 0.7%, in 2018 compared to 2017. The year-over-year increase primarily reflects the incremental severance and other charges of $73.7 million incurred in connection with the repositioning actions taken in the third quarter of 2018. Occupancy and other costs, which are less directly linked to changes in revenue than salary and service costs, increased $68.8 million, or 5.5%, in 2018 compared to 2017. The year-over-year change reflects a decrease of $4.7 million, which was offset by $73.5 million of repositioning charges primarily related to office lease consolidation and termination actions taken in the third quarter of 2018. Operating margin increased year-over-year to 14.0% from 13.6% and EBITA margin increased year-over-year to 14.6% from 14.4%. The net gain on disposition of subsidiaries and repositioning expenses, increased operating profit and operating margin year-over year by $29.0 million and 0.2%, respectively.
Net Interest Expense
Net interest expense increased $10.3 million year-over-year to $209.2 million in 2018. Interest expense on debt increased $17.4 million to $241.9 million in 2018, primarily due to a reduced benefit from the fixed-to-floating interest rate swaps resulting from higher rates on the floating rate leg. Our long-term debt portfolio at December 31, 2018, 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, 2017. A discussion of our interest rate swaps is included in Note 7 to the consolidated financial statements. Interest income in 2018 increased $7.5 million year-over-year to $57.2 million due to higher interest earned on the cash held by our international treasury centers.
Income Taxes
Our effective tax rate for 2018 decreased year-over-year to 25.6% from 36.9% in 2017. The decrease was primarily attributable to the reduction of the U.S. federal statutory income tax rate to 21% from 35% resulting from the Tax Act. Income tax expense in 2018 was reduced by approximately $19 million, primarily as a result of the successful resolution of foreign tax claims and $7.4 million related to the excess tax benefits from share-based compensation.
Additionally, income tax expense for 2018 reflects the following items recorded in the third quarter of 2018 (in millions):
| Increase (Decrease) | |||||||
| Income Before Income Taxes | Income Tax Expense | ||||||
| Net gain on disposition of subsidiaries | $ | 178.4 | $ | 11.0 | |||
| Repositioning actions | (149.4 | ) | (36.0 | ) | |||
| Adjustment to provisional effect of the Tax Act | — | 28.9 | |||||
| $ | 29.0 | $ | 3.9 |
The net gain resulting from the net disposition of subsidiaries reflects favorable local tax rates applied to certain non-U.S. gains. The tax benefit on the repositioning actions was calculated based on the jurisdictions where the charges were incurred and reflects the likelihood that we will be unable to obtain a tax benefit for all charges incurred. Further, in 2018 we recorded additional income tax expense of $28.9 million reflecting the finalization of the provisional estimate of the effect of the Tax Act recorded in the fourth quarter of 2017 (see Note 11 to the consolidated financial statements).
Net Income Per Share - Omnicom Group Inc.
Net income - Omnicom Group Inc. in 2018 increased, due to the factors described above, $238.0 million, or 21.9%, to $1,326.4 million from $1,088.4 million in 2017. The net gain on disposition of subsidiaries and repositioning actions, after the allocable share of $6.9 million to noncontrolling interests, and the additional income tax expense from the finalization of the provisional estimate of the effect of the Tax Act, increased net income - Omnicom Group Inc. $18.2 million. Diluted net income per share - Omnicom Group Inc. increased 25.4% to $5.83 in 2018, compared to $4.65 in 2017, 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, stock option exercises and the employee stock purchase plan. The net gain on disposition of subsidiaries and repositioning actions net of the additional income tax expense from the finalization of the provisional estimate of the effect of the Tax Act, increased diluted net income per share - Omnicom Group Inc. $0.08.
RESULTS OF OPERATIONS - 2017 Compared to 2016 (in millions):
| 2017 | 2016 | ||||||
| Revenue | $ | 15,273.6 | $ | 15,416.9 | |||
| Operating Expenses: | |||||||
| Salary and service costs | 11,227.2 | 11,419.0 | |||||
| Occupancy and other costs | 1,240.8 | 1,230.6 | |||||
| Cost of services | 12,468.0 | 12,649.6 | |||||
| Selling, general and administrative expenses | 439.7 | 443.9 | |||||
| Depreciation and amortization | 282.1 | 292.9 | |||||
| 13,189.8 | 13,386.4 | ||||||
| Operating Profit | 2,083.8 | 2,030.5 | |||||
| Operating Margin - % | 13.6 | % | 13.2 | % | |||
| Interest Expense | 248.6 | 231.3 | |||||
| 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.
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 | 248.6 | 231.3 | |||||
| Interest Income | 49.7 | 42.6 | |||||
| Operating Profit | 2,083.8 | 2,030.5 | |||||
| Add back: Amortization of intangible assets | 113.8 | 115.2 | |||||
| Earnings before interest, taxes and amortization of intangible assets (“EBITA”) | $ | 2,197.6 | $ | 2,145.7 | |||
| Revenue | $ | 15,273.6 | $ | 15,416.9 | |||
| EBITA | $ | 2,197.6 | $ | 2,145.7 | |||
| EBITA Margin - % | 14.4 | % | 13.9 | % |
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 $42.9 million, acquisition revenue net of disposition revenue, decreased revenue $647.3 million and organic growth increased revenue $461.1 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, 2016 | $ | 15,416.9 | $ | 8,627.8 | $ | 6,789.1 | ||||||||||||||
| Components of revenue change: | ||||||||||||||||||||
| Foreign exchange 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 | 6.2 | % | |||||||||||
| 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). |
In 2017, changes in foreign exchange rates continued to negatively impact revenue but at a more moderate rate as compared to 2016. The impact of foreign exchange rates in 2017 increased revenue by 0.3%, or $42.9 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 2017 and the change in revenue from 2016 in our principal regional markets were (in millions):
| 2017 | 2016 | $ Change | % Organic Growth | |||||||||||
| Americas: | ||||||||||||||
| North America | $ | 8,686.0 | $ | 9,174.0 | $ | (488.0 | ) | 0.6 | % | |||||
| Latin America | 494.8 | 423.6 | 71.2 | 0.6 | % | |||||||||
| EMEA: | ||||||||||||||
| Europe | 4,127.9 | 3,904.2 | 223.7 | 7.0 | % | |||||||||
| Middle East and Africa | 314.6 | 278.9 | 35.7 | 12.5 | % | |||||||||
| Asia-Pacific | 1,650.3 | 1,636.2 | 14.1 | 5.8 | % | |||||||||
| $ | 15,273.6 | $ | 15,416.9 | $ | (143.3 | ) | 3.0 | % |
In Europe, our primary markets are the U.K. and the Euro Zone. Revenue for 2017 in the U.K., which represents 9.1% of total revenue, decreased 0.9%, and revenue in the Euro Zone and the other European countries, which together represent 17.9% of total revenue, increased 9.4%.
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 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% and 3.0% of revenue in 2017 and 2016, respectively. 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.
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 | % Organic Growth | |||||||||||||||
| Advertising | $ | 8,175.9 | 53.6 | % | $ | 8,233.3 | 53.4 | % | $ | (57.4 | ) | 3.9 | % | |||||||
| CRM Consumer Experience | 2,615.9 | 17.1 | % | 2,698.9 | 17.5 | % | (83.0 | ) | 0.9 | % | ||||||||||
| CRM Execution & Support | 2,135.8 | 14.0 | % | 2,173.8 | 14.1 | % | (38.0 | ) | 4.0 | % | ||||||||||
| Public Relations | 1,411.4 | 9.2 | % | 1,405.8 | 9.1 | % | 5.6 | 0.5 | % | |||||||||||
| Healthcare | 934.6 | 6.1 | % | 905.1 | 5.9 | % | 29.5 | 2.8 | % | |||||||||||
| $ | 15,273.6 | $ | 15,416.9 | $ | (143.3 | ) | 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 | 8 | % | 7 | % | ||
| Technology | 9 | % | 9 | % | ||
| Auto | 10 | % | 8 | % | ||
| Travel and Entertainment | 7 | % | 7 | % | ||
| Telecommunications | 5 | % | 5 | % | ||
| Retail | 6 | % | 6 | % | ||
| Other | 20 | % | 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 | 11,227.2 | 73.5 | % | 11,419.0 | 74.1 | % | (191.8 | ) | (1.7 | )% | ||||||||||
| Occupancy and other costs | 1,240.8 | 8.1 | % | 1,230.6 | 8.0 | % | 10.2 | 0.8 | % | |||||||||||
| Cost of services | 12,468.0 | 12,649.6 | ||||||||||||||||||
| Selling, general and administrative expenses | 439.7 | 2.9 | % | 443.9 | 2.9 | % | (4.2 | ) | (0.9 | )% | ||||||||||
| Depreciation and amortization | 282.1 | 1.8 | % | 292.9 | 1.9 | % | (10.8 | ) | (3.7 | )% | ||||||||||
| 13,189.8 | 86.4 | % | 13,386.4 | 86.8 | % | (196.6 | ) | (1.5 | )% | |||||||||||
| Operating Profit | $ | 2,083.8 | 13.6 | % | $ | 2,030.5 | 13.2 | % | $ | 53.3 | 2.6 | % |
Operating expenses decreased $196.6 million, or 1.5% in 2017 compared to 2016. Salary and service costs, which tend to fluctuate with changes in revenue, decreased $191.8 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 $10.2 million, or 0.8%, in 2017 compared to 2016, principally resulting from our ongoing efforts to leverage scale and enhance efficiency. SG&A expenses decreased $4.2 million year-over-year primarily related to professional fees incurred in connection with our acquisition activities. As a result, operating margin in 2017 increased to 13.6% from 13.2% in 2016 and EBITA margin increased year-over-year to 14.4% from 13.9%.
Net Interest Expense
Net interest expense increased $10.2 million year-over-year to $198.9 million in 2017. Interest expense on debt 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% and was unchanged from December 31, 2016. A discussion of our interest rate swaps is included in Note 7 to the consolidated financial statements. Interest income in 2017 increased $7.1 million year-over-year to $49.7 million due to higher interest earned on 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, which 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.
Net Income Per Share - Omnicom Group Inc.
Net income - Omnicom Group Inc. decreased $60.2 million, or 5.2%, to $1,088.4 million in 2017 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 and stock option exercises and shares issued under our 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.
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, 2018, we have a $2.5 billion revolving credit facility, or Credit Facility, expiring on July 31, 2021, uncommitted credit lines aggregating $1.2 billion and the ability to issue up to $2 billion of commercial paper. Borrowings under the Credit Facility may be in U.S. Dollars, British Pounds or Euro. 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. Our short-term borrowing requirements normally peak in the second quarter of the year due to the timing of payments for incentive compensation, income taxes and contingent purchase price obligations. In addition, our $500 million 6.25% Senior Notes due 2019 mature on July 15, 2019 and are classified as current. 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 decreased $143.6 million from December 31, 2017. The components of the decrease were:
| Sources | |||||||
| Cash flow from operations | $ | 1,722.3 | |||||
| Less: Increase in operating capital | (80.5 | ) | |||||
| Principal cash sources | 1,641.8 | ||||||
| Uses | |||||||
| Capital expenditures | $ | (195.7 | ) | ||||
| Dividends paid to common shareholders | (548.5 | ) | |||||
| Dividends paid to noncontrolling interest shareholders | (134.9 | ) | |||||
| Acquisition payments, including payment of contingent purchase price obligations and acquisition of additional noncontrolling interests, net of cash acquired | (477.1 | ) | |||||
| Repurchases of common stock, net of proceeds from stock plans | (568.3 | ) | |||||
| Principal cash uses | (1,924.5 | ) | |||||
| Principal cash sources in excess of principal cash uses | (282.7 | ) | |||||
| Foreign exchange rate changes | (203.0 | ) | |||||
| Investing activities and other | 261.6 | ||||||
| Increase in operating capital | 80.5 | ||||||
| Decrease in cash and cash equivalents | $ | (143.6 | ) |
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, 2018, our foreign subsidiaries held approximately $962 million of our total cash and cash equivalents of $3.7 billion. Most of the cash is available to us, net of any foreign withholding taxes payable upon repatriation to the United States.
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, 2018 increased $105.6 million as compared to December 31, 2017. The increase in net debt is due to a decrease in cash and cash equivalents and short-term investments of $138.5 million primarily arising from the unfavorable impact of foreign exchange rate changes on cash and cash equivalents of $203.0 million, partially offset by an increase in operating capital of $80.5 million.
The components of net debt at December 31, 2018 and 2017 were (in millions):
| 2018 | 2017 | ||||||
| Short-term debt | $ | 8.1 | $ | 11.8 | |||
| Long-term debt, including current portion | 4,883.7 | 4,912.9 | |||||
| Total debt | 4,891.8 | 4,924.7 | |||||
| Cash and cash equivalents and short-term investments | 3,657.9 | 3,796.4 | |||||
| Net debt | $ | 1,233.9 | $ | 1,128.3 |
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, 2018, 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 7 to the consolidated financial statements.
Omnicom Group Inc., or OGI, 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 OGI and OCI, and OGI unconditionally guarantees 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 OGI or OCI to obtain funds from our subsidiaries through dividends, loans or advances. The 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, 2018, we were in compliance with these covenants as our Leverage Ratio was 2.1 times and our Interest Coverage Ratio was 9.9 times. The Credit Facility does not limit our ability to declare or pay dividends or repurchase our common stock.
At December 31, 2018, 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, 2018, there were no outstanding commercial paper issuances or borrowings under the Credit Facility or material borrowings under the uncommitted credit lines.
Commercial paper activity for the three years ended December 31, 2018 was (dollars in millions):
| 2018 | 2017 | 2016 | |||||||||
| Average amount outstanding during the year | $ | 411.7 | $ | 902.3 | $ | 861.3 | |||||
| Maximum amount outstanding during the year | $ | 1,218.7 | $ | 1,769.8 | $ | 1,608.9 | |||||
| Average days outstanding | 5.7 | 13.0 | 11.2 | ||||||||
| Weighted average interest rate | 2.19 | % | 1.29 | % | 0.70 | % |
While we expect to continue funding our day-to-day liquidity by issuing commercial paper, we may draw on our Credit Facility. 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, 2018 were (in millions):
| Obligation Due | |||||||||||||||||||
| Total Obligation | 2019 | 2020 - 2021 | 2022 - 2023 | After 2023 | |||||||||||||||
| Long-term debt: | |||||||||||||||||||
| Principal | $ | 4,900.0 | $ | 500.0 | $ | 1,000.0 | $ | 1,250.0 | $ | 2,150.0 | |||||||||
| Interest | 767.4 | 184.5 | 274.0 | 170.7 | 138.2 | ||||||||||||||
| Lease obligations | 1,953.6 | 364.7 | 565.6 | 357.0 | 666.3 | ||||||||||||||
| Contingent purchase price obligations | 146.5 | 65.4 | 72.3 | 8.8 | — | ||||||||||||||
| Transition tax liability on accumulated foreign earnings | 139.1 | 15.1 | 23.6 | 33.9 | 66.5 | ||||||||||||||
| Defined benefit pension plans benefit obligation | 258.4 | 8.9 | 26.1 | 32.7 | 190.7 | ||||||||||||||
| Postemployment arrangements benefit obligation | 126.5 | 7.8 | 14.8 | 15.0 | 88.9 | ||||||||||||||
| Uncertain tax positions | 182.8 | 25.6 | 47.2 | 71.9 | 38.1 | ||||||||||||||
| $ | 8,474.3 | $ | 1,172.0 | $ | 2,023.6 | $ | 1,940.0 | $ | 3,338.7 |
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 included a transition tax on accumulated foreign earnings, which is payable through 2025. See Note 11 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 $327.5 million at December 31, 2018. In 2018, we contributed $8.0 million to our defined benefit pension plans and paid $8.1 million in benefits for our postemployment arrangements. We do not expect these payments to increase significantly in 2019.
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.
See Note 16 to the consolidated financial statements for a description of our lease commitments, which comprise a significant component of our occupancy and other costs. See Note 22 to the consolidated financial statements for a discussion of the impact of the adoption of FASB Accounting Standards Codification Topic 842, Leases.
Commercial commitments at December 31, 2018 were (in millions):
| Commitment Expires | |||||||||||||||||||
| Total Commitment | 2019 | 2020 - 2021 | 2022 - 2023 | After 2023 | |||||||||||||||
| Standby letters of credit | $ | 4.6 | $ | 1.0 | $ | — | $ | 2.5 | $ | 1.1 | |||||||||
| Guarantees | 115.3 | 87.5 | 16.5 | 6.7 | 4.6 | ||||||||||||||
| $ | 119.9 | $ | 88.5 | $ | 16.5 | $ | 9.2 | $ | 5.7 |
At December 31, 2018, there were no significant off-balance sheet arrangements.
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