================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended: December 31, 2004
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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Commission File Number: 1-10551
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OMNICOM GROUP INC.
(Exact name of registrant as specified in its charter)
New York 13-1514814
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
437 Madison Avenue, New York, NY 10022
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 415-3600
Securities Registered Pursuant to Section 12(b) of the Act:
Name of each Exchange
Title of each class on which Registered
---------------------------- -----------------------
Common Stock, $.15 Par Value New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act: None
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Indicate by check mark if the registrant has (1) filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) been subject to such filing
requirements for the past 90 days. Yes |X| No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulations S-K is not contained herein and will not be contained in the
definitive proxy or information statements incorporated by reference in Part III
of this form 10-K or any amendment to this Form 10-K. Yes [_] No |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2): Yes |X| No [_]
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At February 28, 2005, 184,776,556 shares of Omnicom Common Stock, $.15 par
value, were outstanding; the aggregate market value of the voting stock held by
nonaffiliates as of the last business day of the registrant's most recently
completed second fiscal quarter was $13,707,144,000.
Certain portions of Omnicom's definitive proxy statement relating to its
annual meeting of shareholders scheduled to be held on May 24, 2005 are
incorporated by reference into Part III of this report.
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OMNICOM GROUP INC.
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ANNUAL REPORT ON FORM 10-K FOR
THE YEAR ENDED DECEMBER 31, 2004
TABLE OF CONTENTS
Page
----
PART I
Item 1. Business......................................................... 1
Item 2. Properties....................................................... 3
Item 3. Legal Proceedings................................................ 3
Item 4. Submission of Matters to a Vote of Security Holders.............. 4
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities.......... 5
Item 6. Selected Financial Data.......................................... 5
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 8
Item 7A. Critical Accounting Policies and New Accounting Pronouncements... 16
Item 8. Financial Statements and Supplementary Data...................... 24
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure................................... 24
Item 9A. Controls and Procedures.......................................... 24
Item 9B. Other Information................................................ 24
PART III
Item 10. Directors and Executive Officers of the Registrant............... 25
Item 11. Executive Compensation........................................... *
Item 12. Security Ownership of Certain Beneficial Owners and Management... *
Item 13. Certain Relationships and Related Transactions................... *
Item 14. Principal Accounting Fees and Services........................... *
PART IV
Item 15. Exhibits, Financial Statement Schedules and
Reports on Form 8-K........................................ 26
Index to Financial Statements.................................... 26
Index to Financial Statements Schedules.......................... 26
Exhibit Index.................................................... 26
Signatures................................................................ 29
Management Report on Internal Controls Over Financial Reporting........... F-1
Report of Independent Registered Public Accounting Firm................... F-2
Report of Independent Registered Public Accounting Firm................... F-3
Consolidated Financial Statements......................................... F-4
Notes to Consolidated Financial Statements................................ F-8
- ----------
* The information called for by Items 10, 11, 12, 13 and 14 to the extent
not included in this document, is incorporated herein by reference to the
information to be included under the captions "Election of Directors",
"Stock Ownership", "Director Compensation" and "Executive Compensation" in
Omnicom's definitive proxy statement, which is expected to be filed by
April 22, 2005.
PART I
Introduction
This report is both our 2004 annual report to shareholders and our 2004
annual report on Form 10-K required under federal securities laws.
We are a strategic holding company. We provide professional services to
clients through multiple agencies operating in all major markets around the
world. Our companies provide advertising, marketing and corporate communications
services. For simplicity, however, the terms "Omnicom", "we", "our" and "us"
each refer to Omnicom Group Inc. and our subsidiaries unless the context
indicates otherwise.
Statements of our beliefs or expectations regarding future events are
"forward-looking statements" within the meaning of the federal securities laws.
These statements are subject to various risks and uncertainties, including as a
result of the specific factors identified under the captions "Risks and
Competitive Conditions" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" on pages 2 and 8 and elsewhere in this
report. There can be no assurance that these beliefs or expectations will not
change or be affected by actual future events.
1. Business
Our Business: As a strategic holding company, we are one of the largest
advertising, marketing and corporate communications companies in the world.
Omnicom was formed as a corporation in 1986 by the merger of several leading
advertising, marketing and corporate communications networks. Around that time
and through the 1990s, the proliferation of media channels, especially print and
cable television, effectively fragmented mass audiences. This development made
it increasingly more difficult for marketers to reach their target audiences in
a cost-effective way, and they turned to marketing service providers such as
Omnicom for a customized mix of advertising and marketing communications
services that would make best use of their total marketing expenditures.
Our agencies provide an extensive range of services which we group into
four fundamental disciplines: traditional media advertising; customer
relationship management ("CRM"); public relations and specialty communications.
The services included in these categories are:
advertising
brand consultancy
crisis communications
custom publishing
database management
digital and interactive marketing
direct marketing
directory advertising
entertainment marketing
environmental design
experiential marketing
field marketing
financial / corporate business-to-business advertising
graphic arts
healthcare communications
instore design
investor relations
marketing research
media planning and buying
multi-cultural marketing
non-profit marketing
organizational communications
package design
product placement
promotional marketing
public affairs
public relations
real estate advertising and marketing
recruitment communications
reputation consulting
retail marketing
sports and event marketing
Although the medium used to reach a given client's target audience may be
different across each of these disciplines, the marketing message is developed
in the same way -- and it is delivered in the same way -- through the provision
of consultative services.
Omnicom's business model was built and evolves around its clients. While
our companies operate under different names and frame their ideas in different
disciplines, we organize our services around our clients. The fundamental
premise of our business is that the specific requirements of our clients should
be the central focus in how we structure our business offering and allocate our
resources. As clients increase their demands for marketing effectiveness and
efficiency, they tend to consolidate their business with larger,
multi-disciplinary
1
agencies. Accordingly, our business model demands that multiple agencies within
Omnicom collaborate in formal and virtual networks that cut across internal
organizational structures to execute against our clients' specific marketing
requirements. We believe that this organizational philosophy, and our ability to
execute on it, is what differentiates us from our competition.
Our agency networks and our virtual networks, provide us with the ability
to integrate services across all disciplines. This means that the delivery of
these services can and does take place across agencies, networks and geographies
simultaneously.
Longer term, we believe that our virtual network strategy facilitates
better integration of services required by the demands of the marketplace for
advertising and marketing communications services. Our over-arching strategy for
the business is to continue to use our virtual networks to grow our business
relationships with our clients.
The various components of our business and material factors that affected
us in 2004 are discussed under the caption "Management's Discussion and Analysis
of Financial Conditions and Results of Operations" of this report. None of our
acquisitions in 2004, 2003 or 2002 were material to our consolidated financial
position or results of operations. For information concerning our acquisitions,
see note 2 to our consolidated financial statements.
Geographic Regions: Our total consolidated revenue is about evenly divided
between U.S. and non-U.S. operations. For financial information concerning
domestic and foreign operations and segment reporting, see note 5 to our
consolidated financial statements.
Our Clients: Consistent with the fundamentals of our business strategy,
our agencies serve similar clients, in similar industries, and in many cases the
same clients, across a variety of geographies. Furthermore, in many cases our
agencies or networks serve different product groups within the same clients
served by other of Omnicom's agencies or networks. For example, our largest
client was served by more than 90 of our agencies in 2004 and represented 4.3%
of our 2004 consolidated revenue. No other client accounted for more than 2.8%
of our consolidated 2004 revenue. Each of our top 100 clients were served, on
average, by 23 of our agencies in 2004. Our top 100 clients represented 45.1% of
our 2004 consolidated revenue.
Our Employees: We employed approximately 61,000 people at December 31,
2004. We are not party to any significant collective bargaining agreements. The
skill-sets of our workforce across our agencies and within each discipline are
similar. Common to all is the ability to understand a client's brand, its
selling proposition and the ability to develop a unique message to communicate
the value of the brand to the client's target audience. Recognizing the
importance of this core competency, we have established training and education
programs for our service professionals around this competency. See our
management discussion and analysis beginning on page 8 of this report for a
discussion of the effect of salary and related costs on our historical results
of operations.
Risks and Competitive Conditions: We face the risks normally associated
with global services businesses. The operational and financial performance of
our businesses are typically tied to overall economic and regional market
conditions, competition for client assignments and talented staff, new business
wins and losses and the risks associated with extensive international
operations. We do not believe that our international operations as a whole
present any material foreign exchange risk to our overall business because they
invoice clients and pay expenses in their local currency. However, there are
some risks of doing business abroad, including those of currency fluctuations,
political instability and exchange controls, which do not affect
domestic-focused firms. For financial information on our operations by
geographic area, see note 5 to our consolidated financial statements.
The particular businesses in which we participate are highly competitive.
Typically, the financial and technological barriers to entry are low. Key
competitive considerations for keeping existing business and winning new
business include our ability to develop creative solutions that meet client
needs, the quality and effectiveness of the services we offer, and our ability
to efficiently serve clients, particularly large international clients, on a
broad geographic basis. While many of our client relationships are
long-standing, companies put their advertising, marketing and corporate
communications services business up for competitive review from time to time. To
the extent that we are not able to remain competitive or to keep key clients,
our business and financial results would be adversely affected.
2
Our ability to retain existing clients and to attract new clients may, in
some cases, be limited by clients' policies on, or perceptions of, conflicts of
interest arising out of other client relationships. We maintain multiple
agencies to effectively manage multiple client relationships and avoid potential
conflicts of interests. In addition, an important aspect of our competitiveness
is our ability to retain key personnel. Our continuing ability to attract and
retain these employees may have a material effect on our business and financial
results.
Our revenue is dependent upon the advertising, marketing and corporate
communications requirements of our clients and tends to be lowest in the first
and third quarters of the calendar year as a result of the post-holiday slowdown
in client activity at the beginning of January and a slowdown in client activity
in August primarily as a result of the vacation season. See our management
discussion and analysis in Part II of this report for a discussion of the effect
of market conditions and other factors on our historical results of operations.
Directly or indirectly, government agencies and consumer groups have from
time to time affected or attempted to affect the scope, content and manner of
presentation of advertising, marketing and corporate communications services,
whether through regulations or other governmental action. However, these
attempts have not materially affected our agency networks nor do we expect such
actions to do so in the future.
2. Properties
We maintain office space in many major cities around the world. The office
space requirements of our agencies are similar across geographies and
disciplines and is in suitable and well-maintained condition for our current
operations. This space is primarily used for office and administrative purposes
by our employees in performing professional services. Our principal corporate
offices are at 437 Madison Avenue, New York, New York and One East Weaver
Street, Greenwich, Connecticut. We also maintain executive offices in London,
England.
Our office space is utilized for performing professional services.
Substantially all of our office space is leased from third parties with varying
expiration dates ranging from one to 19 years. Certain of our leases are subject
to rent reviews or contain various escalation clauses and certain of our leases
require our payment of various operating expenses, which may also be subject to
escalation. Leases are denominated in the local currency of the operating
entity. Our consolidated rent expense was $345.3 million in 2004, $335.5 million
in 2003 and $311.3 million in 2002, after reduction for rents received from
subleases of $26.3 million, $17.3 million and $15.5 million, respectively. Our
obligations for future minimum base rents under terms of non-cancelable real
estate leases and other operating leases, which include primarily office
furniture and computer and technology equipment, reduced by rents receivable
from non-cancelable subleases are (in millions):
Net Rent
--------
2005 ................................................... $401.2
2006 ................................................... 335.1
2007 ................................................... 282.1
2008 ................................................... 231.1
2009 ................................................... 206.3
Thereafter.............................................. 884.2
See note 10 to our consolidated financial statements of this report for a
discussion of our lease commitments and our management discussion and analysis
in Part II of this report for the impact of leases on our operating expenses.
3. Legal Proceedings
Beginning on June 13, 2002, several proposed class actions were filed
against us and certain senior executives in the United States District Court for
the Southern District of New York. The actions have since been consolidated
under the caption In re Omnicom Group Inc. Securities Litigation, No. 02-CV4483
(RCC), on behalf of a proposed class of purchasers of our common stock between
February 20, 2001 and June 11, 2002. The consolidated complaint alleges among
other things that our public filings and other public statements during that
period contained false and misleading statements or omitted to state material
information relating to (1) our calculation of the organic growth component of
period-to-period revenue growth, (2) our valuation of certain internet
investments made by our Communicade Group, which we contributed to Seneca
Investments LLC in
3
2001, and (3) the existence and amount of certain contingent future obligations
in respect of acquisitions. The complaint seeks an unspecified amount of
compensatory damages plus costs and attorneys' fees. Defendants have moved to
dismiss the complaint. The court has not yet decided the motion. In addition to
the proceedings described above, a shareholder derivative action was filed on
June 28, 2002 in New York State Court in New York City, by a plaintiff
shareholder, purportedly on the company's behalf. The complaint alleges, among
other things, breaches of fiduciary duty, disclosure failures, abuse of control
and gross mismanagement in connection with the formation of Seneca Investments
LLC by certain of our current and former directors. This case is stayed, pending
a ruling on the motion to dismiss the proposed class action. On February 18,
2005, another shareholder filed an action asserting similar claims. No response
is yet required.
The defendants in these cases expect to defend themselves vigorously.
Currently, we are unable to determine the outcome of these cases and the effect
on our financial position or results of operations. The outcome of any of these
matters is inherently uncertain and may be affected by future events.
Accordingly, we cannot assure investors as to the ultimate effect of these
matters on our financial position or results of operations.
We are also involved from time to time in various routine legal
proceedings in the ordinary course of business. We do not presently expect that
these proceedings will have a material adverse effect on our consolidated
financial position or results of operations.
For additional information concerning our legal proceedings, including the
class action and derivative action described above, see note 14 to our
consolidated financial statements, which is incorporated into this section by
reference.
4. Submission of Matters to a Vote of Security Holders
Our annual shareholders meeting has historically been held in the second
quarter of the year. No matters were submitted to a vote of our shareholders
during the last quarter of 2004.
4
PART II
5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
Our common shares are listed on the New York Stock Exchange under the
symbol "OMC". On February 28, 2005, we had 3,784 holders of record of our common
shares. The table below shows the range of quarterly high and low sales prices
reported on the New York Stock Exchange Composite Tape for our common shares and
the dividends paid per share for these periods.
Dividends Paid
Period High Low Per Share
------ ---- --- --------------
Q1 2003.................. $68.25 $46.50 $0.200
Q2 2003.................. 76.43 53.15 0.200
Q3 2003.................. 81.18 69.61 0.200
Q4 2003.................. 87.60 71.80 0.200
Q1 2004.................. $88.82 $74.65 $0.200
Q2 2004.................. 83.48 75.05 0.225
Q3 2004.................. 76.15 66.43 0.225
Q4 2004.................. 84.95 70.97 0.225
The following table presents information with respect to purchases of
common stock made during the three months ended December 31, 2004, by us or any
of our "affiliated purchasers."
(c) (d)
Total Number Maximum Number of
(a) (b) of Shares Purchased Shares that May
Total Average As Part of Publicly Yet Be Purchased Under
Number of Price Paid Announced Plans Publicly Announced
During the month: Shares Purchased Per Share or Programs Plans or Programs
- ----------------- ---------------- ---------- ---------------------- ----------------------
October 2004 ............... -- $ -- -- --
November 2004 .............. 6,130 82.75 -- --
December 2004 .............. 26,382 84.62 -- --
------ ------ ---- ----
Total ...................... 32,512 $84.26 -- --
====== ====== ==== ====
6. Selected Financial Data
The following selected financial data should be read in conjunction with
our consolidated financial statements and related notes which begin on page F-1,
as well as our management's discussion and analysis which appears in Part II of
this report.
In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation"
("SFAS No. 123"), as amended by SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure, an amendment of FASB Statement No.
123", we elected, effective January 1, 2004, to account for stock-based employee
compensation using the fair value method. As a result, the fair value of
stock-based employee compensation, including unvested employee stock options
issued and outstanding, was recorded as an expense in the current period
utilizing the retroactive restatement method as set forth in SFAS 148.
Accordingly, our results for the prior periods have been restated as if we had
used the fair value method to account for stock-based employee compensation.
5
(Dollars in Millions Except Per Share Amounts)
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For the years ended December 31, 2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
Revenue .................................. $ 9,747.2 $ 8,621.4 $ 7,536.3 $ 6,889.4 $ 6,154.2
Operating Profit ......................... 1,215.4 1,091.9 985.1 889.1 839.5
Income After Income Taxes ................ 782.5 696.1 625.0 495.9 519.4
Net Income ............................... 723.5 631.0 570.5 455.7 475.7
Net Income per common share:
Basic ................................. 3.90 3.37 3.07 2.49 2.72
Diluted ............................... 3.88 3.37 3.07 2.48 2.61
Dividends declared per
common share .......................... 0.900 0.800 0.800 0.775 0.700
(Dollars in Millions Except Per Share Amounts)
----------------------------------------------------------------------------------
As of the year ended December 31: 2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
Cash, cash equivalents and
short-term investments ................ $ 1,739.6 $ 1,548.9 $ 695.9 $ 517.0 $ 576.5
Total assets ............................. 16,002.4 14,620.0 12,056.5 10,686.8 9,899.2
Long-term obligations
Long-term debt ........................ 19.1 197.3 197.9 490.1 1,015.4
Convertible notes ..................... 2,339.3 2,339.3 1,747.0 850.0 230.0
Deferred compensation and
other liabilities .................. 309.1 326.5 293.6 297.0 296.9
As discussed in footnote 1 of the notes to our consolidated financial
statements, as required by statements of Financial Accounting Standards 142 --
"Goodwill and Other Intangibles" ("SFAS 142"), beginning with our 2002 results,
goodwill and other intangible assets that have indefinite lives are not
amortized due to a change in generally accepted accounting principles ("GAAP").
To make our results for the periods prior to 2002 more directly comparable in
the table that follows, we adjusted our historical results for periods prior to
2002 to eliminate goodwill amortization for all periods, as well as a
non-recurring gain on the sale of Razorfish shares in 2000, and the related tax
impacts. As a result of these exclusions, this presentation is a non-GAAP
financial measure. We believe that by excluding the items noted above, the table
below presents selected financial data using amounts that are more comparable
year-to-year and thus more meaningful for purposes of this analysis. In
addition, as a reminder, "Net Income, as reported, GAAP" includes the effect of
our adoption of SFAS No. 123 for all prior periods presented below.
(Dollars in Millions Except Per Share Amounts)
---------------------------------------------------------------------------------
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
Net Income, as adjusted:
Net Income, as reported, GAAP ......... $ 723.5 $ 631.0 $ 570.5 $ 455.7 $ 475.7
Add-back goodwill amortization,
net of income taxes ................ -- -- -- 83.1 76.5
Less: gain on sale of Razorfish
shares, net of income taxes ........ -- -- -- -- (63.8)
---------- ---------- ---------- ---------- ----------
Net Income, excluding goodwill
amortization and Razorfish gain .... $ 723.5 $ 631.0 $ 570.5 $ 538.8 $ 488.4
========== ========== ========== ========== ==========
Basic Net Income per share:
as reported, GAAP .................. $ 3.90 $ 3.37 $ 3.07 $ 2.49 $ 2.72
as adjusted ........................ $ 3.90 $ 3.37 $ 3.07 $ 2.95 $ 2.79
Diluted Net Income per share:
as reported, GAAP .................. $ 3.88 $ 3.37 $ 3.07 $ 2.48 $ 2.61
as adjusted ........................ $ 3.88 $ 3.37 $ 3.07 $ 2.92 $ 2.68
6
The following is a reconciliation of the "as reported" to "as adjusted"
Net Income per share on a basic and diluted basis.
2004 2003 2002 2001 2000
---------- ---------- ---------- ---------- ----------
Basic Net Income per share, as adjusted:
Net Income per common share:
Basic, as reported, GAAP ........... $ 3.90 $ 3.37 $ 3.07 $ 2.49 $ 2.72
Add-back goodwill amortization
per common share,
net of income taxes ................ -- -- -- 0.46 0.44
Less: gain on sale of Razorfish
shares, per common share,
net of income taxes ................ -- -- -- -- (0.37)
---------- ---------- ---------- ---------- ----------
Net Income per common share,
excluding goodwill amortization
and Razorfish gain:
Basic ............................ $ 3.90 $ 3.37 $ 3.07 $ 2.95 $ 2.79
========== ========== ========== ========== ==========
Diluted Net Income per share, as adjusted:
Net Income per common share:
Diluted, as reported, GAAP ......... $ 3.88 $ 3.37 $ 3.07 $ 2.48 $ 2.61
Add-back goodwill amortization
per common share,
net of income taxes ................ -- -- -- 0.44 0.41
Less: gain on sale of Razorfish
shares, per common share,
net of income taxes ................ -- -- -- -- (0.34)
---------- ---------- ---------- ---------- ----------
Net Income per common share,
excluding goodwill amortization
and Razorfish gain:
Diluted .......................... $ 3.88 $ 3.37 $ 3.07 $ 2.92 $ 2.68
========== ========== ========== ========== ==========
7
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations
Executive Summary
We are a strategic holding company. We provide professional services to
clients through multiple agencies around the world. On a global, pan-regional
and local basis, our agencies provide these services in the following
disciplines: traditional media advertising, customer relationship management,
public relations and specialty communications. Our business model was built and
evolves around clients. While our companies operate under different names and
frame their ideas in different disciplines, we organize our services around
clients. The fundamental premise of our business is that clients' specific
requirements should be the central focus in how we structure our business
offering and allocate our resources. This client-centric business model results
in multiple agencies collaborating in formal and informal virtual networks that
cut across internal organizational structures to deliver consistent brand
messages for a specific client and execute against our clients' specific
marketing requirements. We continually seek to grow our business with our
existing clients by maintaining our client-centered approach, as well as
expanding our existing business relationships into new markets and new clients.
In addition, we pursue selective acquisitions of complementary companies with
strong, entrepreneurial management teams that typically either currently serve
or have the ability to serve our existing client base.
Several long-term trends continue to positively affect our business,
including our clients increasingly expanding the focus of their brand strategies
from national markets to pan-regional and global markets. Additionally, in an
effort to gain greater efficiency and effectiveness from their marketing
dollars, clients are increasingly requiring greater coordination of their
traditional advertising and marketing activities and concentrating these
activities with a smaller number of service providers.
Globally, during the past few years, the overall industry has continued to
be affected by geopolitical unrest, lagging economic conditions, lack of
consumer confidence and cautious client spending. All of these factors
contributed to a difficult business environment and industry-wide margin
contraction. During this period we have continued to invest in our businesses
and our personnel, and have taken action to reduce costs at some of our agencies
to deal with the changing economic circumstances.
Although the business environment has been difficult, as a result of the
diversity and balance of our portfolio of companies and service offerings, we
continued to grow our revenues, operating income, net income and earnings per
share. In the United States, revenue growth accelerated to 10.6% in 2004 and on
a constant currency basis, revenue growth for our international business
increased to 6.0%, an improvement over the prior year's revenue growth of 10.2%
and 5.7%, respectively. The slower international growth has been evidenced
mainly in Continental European countries.
As a result of increased incentive compensation costs, increased
professional fees and increased amortization of other intangible assets, our
operating margins were lower in 2004 and in 2003. However, as a result of our
revenue initiatives and cost reduction actions, we have achieved an improvement
in our operating margins in the fourth quarter of 2004, relative to the same
period in the prior year. Our operating margin for the fourth quarter of 2004
was 14.2% versus 14.1% for the fourth quarter of 2003. We are hopeful that
margins will continue to stabilize as a result of our new business initiatives
associated with the positive long-term industry trends described above, combined
with continuing improvements in the U.S. and international economy and the
cost-reduction actions taken in prior periods by our agencies.
Given our size and breadth, we manage the business by monitoring several
financial and non-financial performance indicators. The key indicators that we
review focus on the areas of revenues and operating expenses.
Revenue growth is analyzed by reviewing the components and mix of the
growth, including: growth by major geographic location; growth by major
marketing discipline; growth from currency changes; growth from acquisition and
growth from our largest clients.
In recent years, our revenue has been divided almost evenly between
domestic and international operations. In 2004, our overall revenue growth was
13.1%, of which 4.5% was related to changes in foreign exchange rates and 1.9%
was related to acquired entities. The remainder, 6.7%, was organic growth.
In 2004, traditional media advertising represented about 43% of the total
revenue and grew by 11.4% over the prior year. Customer relationship management
represented about 34% of the total revenue and grew by
8
14.0% over the previous year. Public relations represented about 11% of the
total revenue and grew by 12.0% over the previous year and specialty
communications represented about 12% of total revenue and grew by 17.6% over the
previous year.
We measure operating expenses in two distinct cost categories, salary and
service costs, and office and general expenses. Salary and service costs are
primarily comprised of employee compensation related costs and office and
general expenses are primarily comprised of rent and occupancy costs, technology
related costs and depreciation and amortization. Each of our agencies require
service professionals with a skill set that is common across our disciplines. At
the core is their ability to understand a client's brand and its selling
proposition, and their ability to develop a unique message to communicate the
value of the brand to the client's target audience. The office space
requirements of our agencies are similar across geographies and disciplines, and
their technology requirements are generally limited to personal computers,
servers and off-the-shelf software.
Because we are a service business, we monitor these costs on a percentage
of revenue basis. Salary and service costs tend to fluctuate in conjunction with
changes in revenues, whereas office and general expenses, which are not directly
related to servicing clients, tend to decrease as a percentage of revenue as
revenues increase because a significant portion of these expenses are relatively
fixed in nature. During 2004, salary and service costs increased to 70.2% of
revenue from 68.6% of revenue in 2003 due in part to our efforts to restore
incentive compensation, while office and general expenses declined to 17.3% of
revenue from 18.8% in 2003 as a result of our continuing efforts to better align
these costs with business levels on a location-by-location basis.
Our net income for 2004 increased by 14.7% to $723.5 million from $631.0
million in 2003 and our diluted EPS increased by 15.1% to $3.88 from $3.37.
In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation"
("SFAS No. 123"), as amended by SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure, an amendment of FASB Statement No.
123", we elected, effective January 1, 2004, to account for stock-based employee
compensation using the fair value method. As a result, the fair value of
stock-based employee compensation, including unvested employee stock options
issued and outstanding, was recorded as an expense in the current period
utilizing the retroactive restatement method as set forth in SFAS 148.
Accordingly, our results for all prior periods presented have been restated as
if we had used the fair value method to account for stock-based employee
compensation.
Financial Results from Operations -- 2004 Compared with 2003
(Dollars in millions,
except per share amounts)
Twelve Months Ended December 31, 2004 2003
--------- ---------
Revenue ...................................... $ 9,747.2 $ 8,621.4
Operating expenses:
Salary and service costs .................. 6,846.8 5,911.8
Office and general expenses ............... 1,685.0 1,617.7
--------- ---------
8,531.8 7,529.5
--------- ---------
Operating profit ............................. 1,215.4 1,091.9
Net interest expense:
Interest expense .......................... 51.1 57.9
Interest income ........................... (14.5) (15.1)
--------- ---------
36.6 42.8
--------- ---------
Income before income taxes ................... 1,178.8 1,049.1
Income taxes ................................. 396.3 353.0
--------- ---------
Income after income taxes .................... 782.5 696.1
Equity in earnings of affiliates ............. 17.1 15.1
Minority interests ........................... (76.1) (80.2)
--------- ---------
Net income ................................ $ 723.5 $ 631.0
========= =========
Net Income Per Common Share:
Basic ..................................... $ 3.90 $ 3.37
Diluted ................................... 3.88 3.37
Dividends Declared Per Common Share .......... $ 0.90 $ 0.80
9
The following year-over-year analysis gives further details and insight
into the changes in our financial performance.
Revenue: When comparing performance between years, we discuss non-GAAP
financial measures such as the impact that foreign currency rate changes,
acquisitions/dispositions and organic growth have on reported revenues. As we
derive significant revenue from international operations, changes in foreign
currency rates between the years impact reported results. Reported results are
also impacted by our acquisition and disposition activity and organic growth.
Accordingly, we provide this information to supplement the discussion of changes
in revenue period-to-period.
Our 2004 consolidated worldwide revenue increased 13.1% to $9,747.2
million from $8,621.4 million in 2003. Foreign exchange impacts increased
worldwide revenue by $390.6 million. The effect of acquisitions, net of
disposals, increased 2004 worldwide revenue by $163.9 million. Organic growth
increased worldwide revenue by $571.3 million. The components of total 2004
revenue growth in the U.S. ("domestic") and the remainder of the world
("international") are summarized below ($ in millions):
Total Domestic International
-------------- -------------- --------------
$ % $ % $ %
-------- ---- -------- ---- -------- ----
December 31, 2003 ........ $8,621.4 -- $4,720.9 -- $3,900.5 --
Components of
Revenue Changes:
Foreign exchange impact .. 390.6 4.5% -- -- 390.6 10.0%
Acquisitions ............. 163.9 1.9% 131.9 2.8% 32.0 0.8%
Organic .................. 571.3 6.7% 370.6 7.8% 200.7 5.2%
-------- ---- -------- ---- -------- ----
December 31, 2004 ........ $9,747.2 13.1% $5,223.4 10.6% $4,523.8 16.0%
======== ==== ======== ==== ======== ====
The components and percentages are calculated as follows:
o The foreign exchange impact component shown in the table is
calculated by first converting the current period's local currency
revenue using the average exchange rates from the equivalent prior
period to arrive at a constant currency revenue (in this case
$9,356.6 million for the Total column in the table). The foreign
exchange impact equals the difference between the current period
revenue in U.S. dollars and the current period revenue in constant
currency (in this case $9,747.2 million less $9,356.6 million for
the Total column in the table).
o The acquisition component shown in the table is calculated by
aggregating the applicable prior period revenue of the acquired
businesses. Netted against this number is the revenue of any
business included in the prior period reported revenue that was
disposed of subsequent to the prior period.
o The organic component shown in the table is calculated by
subtracting both the foreign exchange and acquisition revenue
components from total revenue growth.
o The percentage change shown in the table of each component is
calculated by dividing the individual component amount by the prior
period revenue base of that component (in this case $8,621.4 million
for the Total column in the table).
The components of revenue and revenue growth for 2004 compared to 2003, in
our primary geographic markets are summarized below ($ in millions):
$ Revenue % Growth
--------- --------
United States ..................... $5,223.4 10.6%
Euro Markets ...................... 2,058.2 15.0%
United Kingdom .................... 1,085.0 15.2%
Other ............................. 1,380.6 18.1%
-------- ----
Total ............................. $9,747.2 13.1%
======== ====
As indicated, foreign exchange impacts increased our international revenue
by $390.6 million for 2004. The most significant impacts resulted from the
continued strengthening of the Euro and the British Pound
10
against the U.S. dollar, as our operations in these markets represented
approximately 70.0% of our international revenue. Additional geographic
information relating to our business is contained in note 5 to our consolidated
financial statements.
Due to a variety of factors, in the normal course, our agencies both gain
and lose business from clients each year. The net result in 2004, and
historically each year for us as a whole, was an overall gain in new business.
Under our client-centric approach, we seek to broaden our relationships with our
largest clients. Revenue from our single largest client represented 4.3% of
worldwide revenue in 2004 and 4.7% in 2003 and no other client represented more
than 2.8% in 2004 or 2003. Our ten largest and 250 largest clients represented
18.3% and 55.9% of our 2004 worldwide revenue, respectively and 18.7% and 53.8%
of our 2003 worldwide revenue.
Driven by clients' continuous demand for more effective and efficient
branding activities, we strive to provide an extensive range of advertising,
marketing and corporate communications services through various client centric
networks that are organized to meet specific client objectives. These services
include advertising, brand consultancy, crisis communications, custom
publishing, database management, digital and interactive marketing, direct
marketing, directory advertising, entertainment marketing, environmental design,
experiential marketing, field marketing, financial / corporate
business-to-business advertising, graphic arts, healthcare communications,
instore design, investor relations, marketing research, media planning and
buying, multi-cultural marketing, non-profit marketing, organizational
communications, package design, product placement, promotional marketing, public
affairs, public relations, real estate advertising and marketing, recruitment
communications, reputation consulting, retail marketing and sports and event
marketing. In an effort to monitor the changing needs of our clients and to
further expand the scope of our services to key clients, we monitor revenue
across a broad range of disciplines and group them into the following four
categories: traditional media advertising, customer relationship management,
referred to as CRM, public relations and specialty communications as summarized
below.
(Dollars in millions)
-----------------------------------------------------------------
Twelve Months Ended December 31,
2004 2003 2004 vs 2003
------------------ ------------------- -----------------
% of % of $ %
Revenue Revenue Revenue Revenue Growth Growth
------- ------- ------- ------- ------ ------
Traditional media advertising ................ $4,207.5 43.2% $3,775.7 43.8% $ 431.8 11.4%
CRM .......................................... 3,366.1 34.5% 2,953.4 34.2% 412.7 14.0%
Public relations ............................. 1,040.5 10.7% 928.6 10.8% 111.9 12.0%
Specialty communications ..................... 1,133.1 11.6% 963.7 11.2% 169.4 17.6%
-------- -------- --------
$9,747.2 $8,621.4 $1,125.8 13.1%
======== ======== ========
Certain reclassifications have been made to the 2003 amounts in the tables
above to conform the numbers to the 2004 amounts presented.
Operating Expenses: Our 2004 worldwide operating expenses increased
$1,002.3 million, or 13.3%, to $8,531.8 million from $7,529.5 million in 2003,
as shown below.
(Dollars in millions)
------------------------------------------------------------------------------------------
2004 2003 2004 vs 2003
------------------------------- -------------------------------- -------------------
% of % of
% of Total Op. % of Total Op. $ %
Revenue Revenue Costs Revenue Revenue Costs Growth Growth
-------- -------- -------- -------- -------- -------- -------- --------
Revenue .............................. $9,747.2 $8,621.4 $1,125.8 13.1%
Operating expenses:
Salary and service costs .......... 6,846.8 70.2% 80.3% 5,911.8 68.6% 78.5% 935.0 15.8%
Office and general expenses ....... 1,685.0 17.3% 19.7% 1,617.7 18.8% 21.5% 67.3 4.2%
-------- -------- -------- -------- -------- -------- -------- --------
Total Operating Costs ................ 8,531.8 87.5% 7,529.5 87.3% 1,002.3 13.3%
Operating profit ..................... $1,215.4 12.5% $1,091.9 12.7% $ 123.5 11.3%
======== ======== ========
Salary and service costs represent the largest part of operating expenses.
During 2004, we continued to invest in our businesses and their personnel. As a
percentage of operating expenses, salary and service costs
11
were 80.3% in 2004 and 78.5% in 2003. These costs are comprised of direct
service costs and salary and related costs. Most, or $935.0 million and 93.3%,
of the $1,002.3 million increase in operating expenses in 2004 resulted from
increases in salary and service costs. This increase was attributable to
increased revenue levels and the required increases in direct salary and salary
related costs necessary to deliver our services, including increases in
incentive compensation costs, increases in freelance labor costs and increases
in costs relating to new business initiatives and recruiting. This was partially
offset by a reduction in severance costs and the expected positive impact in
2004 of previous cost actions. As a result, salary and service costs as a
percentage of revenues increased year-to-year from 68.6% in 2003 to 70.2% in
2004.
Office and general expenses represented 19.7% and 21.5% of our operating
expenses in 2004 and 2003, respectively. These costs are comprised of office and
equipment rent, technology costs and depreciation, amortization of identifiable
intangibles, professional fees and other overhead expenses. As a percentage of
revenue, office and general expenses decreased in 2004 from 18.8% to 17.3%
because these costs are relatively fixed in nature and decrease as a percentage
of revenue as revenue increases. In addition, this year-over-year decrease
resulted from our continuing efforts to better align these costs with business
levels on a location-by-location basis. This decrease was partially offset by
increased costs incurred in connection with the implementation of Sarbanes-Oxley
Section 404 and $9.9 million of costs incurred in connection with the disposal
of two non-strategic businesses early in 2004.
We expect our efforts to control operating expenses will continue as we
continuously look for ways to increase the variability of our cost structure. We
are hopeful that with the continuing improvements in the U.S. economy combined
with the cost reduction actions taken by our agencies, margins will continue to
stabilize.
Included in office and general expense was a net gain of $13.1 million
related to investment activity during the first quarter of 2004. In March 2004,
in connection with Seneca LLC's recapitalization, we agreed to exchange our
remaining preferred stock in Seneca for a $24.0 million senior secured note and
40% of Seneca's outstanding common stock. The note, which is due in March 2007,
bears interest at a rate of 6.25% per annum. The recapitalization transaction
was required to be recorded at fair value and, accordingly, we recorded a
pre-tax net gain of $24.0 million. This gain was partially offset by losses of
$10.9 million on other cost-based investments unrelated to our investment in
Seneca. Additional information appears in note 6 to our consolidated financial
statements.
Excluding the net gain of $13.1 million from investment activity, office
and general expenses were 17.4% of revenue in 2004, compared to 18.8% of revenue
in 2003, and operating margin decreased to 12.3% of revenue from 12.7% of
revenue.
Net Interest Expense: Our net interest expense decreased in 2004 to $36.6
million, as compared to $42.8 million in 2003. Our gross interest expense
decreased by $6.8 million to $51.1 million. This decrease is attributed to a
reduction of $5.1 million in the amortization of interest related payments on
our convertible notes from $28.1 million in 2003 to $23.0 million in 2004 and
reductions resulting from cash management efforts during the course of the year.
This reduction was partially offset by an increase in interest expense relative
to the (euro)152.4 million 5.20% Euro note due to the foreign currency change of
the Euro relative to the U.S. dollar in 2004.
As a result of interest related payments made in the second half of 2004
related to our convertible notes, we expect interest expense to increase by
$10.4 million in 2005 compared to 2004, as these payments are amortized ratably
through their next put dates.
See "Liquidity and Capital Resources" for a discussion of our indebtedness
and related matters.
Income Taxes: Our 2004 consolidated effective income tax rate of 33.6% was
unchanged from 2003. The FASB issued two staff proposals on accounting for
income taxes to address recent changes enacted by the United States Congress.
Proposed Staff Position FAS 109-a, Application of FASB Statement No. 109,
Accounting for Income Taxes, for the Tax Deduction Provided to U.S. Based
Manufacturers by the American Jobs Creation Act of 2004, and Proposed Staff
Position FAS 109-b, Accounting and Disclosure Guidance for the Foreign Earnings
Repatriation Provisions within the American Jobs Creation Act of 2004. We
believe that Proposed Staff Position FAS 109-a does not apply to our business.
We are currently assessing the impact of Proposed Staff Position FAS 109-b,
however, we do not believe it will have a material impact on our consolidated
results of operations or financial position.
12
Financial Results from Operations -- 2003 Compared with 2002
(Dollars in millions,
except per share amounts)
--------------------------
Twelve Months Ended December 31, 2003 2002
--------- ---------
Revenue ...................................... $ 8,621.4 $ 7,536.3
Operating expenses:
Salary and service costs .................. 5,911.8 5,071.9
Office and general expenses ............... 1,617.7 1,479.3
--------- ---------
7,529.5 6,551.2
--------- ---------
Operating profit ............................. 1,091.9 985.1
Net interest expense:
Interest expense .......................... 57.9 45.5
Interest income ........................... (15.1) (15.0)
--------- ---------
42.8 30.5
--------- ---------
Income before income taxes ................... 1,049.1 954.6
Income taxes ................................. 353.0 329.6
--------- ---------
Income after income taxes .................... 696.1 625.0
Equity in earnings of affiliates ............. 15.1 13.8
Minority interests ........................... (80.2) (68.3)
--------- ---------
Net income ................................ $ 631.0 $ 570.5
========= =========
Net Income Per Common Share:
Basic ..................................... $ 3.37 $ 3.07
Diluted ................................... 3.37 3.07
Dividends Declared Per Common Share .......... $ 0.80 $ 0.80
The following year-over-year analysis gives further details and insight
into the changes in our financial performance.
Revenue: Our 2003 consolidated worldwide revenue increased 14.4% to
$8,621.4 million from $7,536.3 million in 2002. Foreign exchange impacts
increased worldwide revenue by $465.6 million. The effect of acquisitions, net
of disposals, increased 2003 worldwide revenue by $271.7 million. Organic growth
increased worldwide revenue by $347.8 million. The components of total 2003
revenue growth in the U.S. ("domestic") and the remainder of the world
("international") are summarized below ($ in millions):
Total Domestic International
-------------------- -------------------- --------------------
$ % $ % $ %
-------- ---- -------- ---- -------- ----
December 31, 2002 ........................... $7,536.3 -- $4,284.6 -- $3,251.7 --
Components of Revenue Changes:
Foreign exchange impact ..................... 465.6 6.2% -- -- 465.6 14.3%
Acquisitions ................................ 271.7 3.6% 174.7 4.1% 97.0 3.0%
Organic ..................................... 347.8 4.6% 261.6 6.1% 86.2 2.7%
-------- ---- -------- ---- -------- ----
December 31, 2003 ........................... $8,621.4 14.4% $4,720.9 10.2% $3,900.5 20.0%
======== ==== ======== ==== ======== ====
The components and percentages are calculated as follows:
o The foreign exchange impact component shown in the table is
calculated by first converting the current period's local currency
revenue using the average exchange rates from the equivalent prior
period to arrive at a constant currency revenue (in this case
$8,155.8 million for the Total column in the table). The foreign
exchange impact equals the difference between the current period
revenue in U.S. dollars and the current period revenue in constant
currency (in this case $8,621.4 million less $8,155.8 million for
the Total column in the table).
o The acquisition component shown in the table is calculated by
aggregating the applicable prior period revenue of the acquired
businesses. Netted against this number is the revenue of any
business included in the prior period reported revenue that was
disposed of subsequent to the prior period.
13
o The organic component shown in the table is calculated by
subtracting both the foreign exchange and acquisition revenue
components from total revenue growth.
o The percentage change shown in the table of each component is
calculated by dividing the individual component amount by the prior
period revenue base of that component (in this case $7,536.3 million
for the Total column in the table).
The components of revenue and revenue growth for 2003 compared to 2002, in
our primary geographic markets are summarized below ($ in millions):
$ Revenue % Growth
--------- --------
United States ..................... $4,720.9 10.2%
Euro Markets ...................... 1,789.9 22.6%
United Kingdom .................... 941.9 15.9%
Other ............................. 1,168.7 19.4%
-------- ----
Total ............................. $8,621.4 14.4%
======== ====
As indicated, foreign exchange impacts increased our international revenue
by $465.6 million for 2003. The most significant impacts resulted from the
continued strengthening of the Euro and the British Pound against the U.S.
dollar, as our operations in these markets represented approximately 70.0% of
our international revenue. Additional geographic information relating to our
business is contained in note 5 to our consolidated financial statements.
Due to a variety of factors, in the normal course, our agencies both gain
and lose business from clients each year. The net result in 2003 for us as a
whole was an overall gain in new business. Under our client-centric approach, we
seek to broaden our relationships with our largest clients. Revenue from our
single largest client represented 4.7% of worldwide revenue in 2003 and 5.0% in
2002 and no other client represented more than 2.9% in 2003 or 2002. Our ten
largest and 250 largest clients represented 18.7% and 53.8% of our 2003
worldwide revenue, respectively and 17.9% and 53.4% of our 2002 worldwide
revenue.
In an effort to monitor the changing needs of our clients and to further
expand the scope of our services to key clients, we monitor revenue across a
broad range of disciplines and group them into the following four categories:
traditional media advertising, customer relationship management, referred to as
CRM, public relations and specialty communications as summarized below.
(Dollars in millions)
----------------------------------------------------------------------------
Twelve Months Ended December 31,
2003 2002 2003 vs 2002
-------------------- --------------------- ------------------
% of % of $ %
Revenue Revenue Revenue Revenue Growth Growth
------- ------- ------- ------- ------ ------
Traditional media advertising ............... $3,775.7 43.8% $3,377.1 44.8% $ 398.6 11.8%
CRM ......................................... 2,953.4 34.2% 2,423.5 32.2% 529.9 21.9%
Public relations ............................ 928.6 10.8% 898.4 11.9% 30.2 3.4%
Specialty communications .................... 963.7 11.2% 837.3 11.1% 126.4 15.1%
-------- -------- --------
$8,621.4 $7,536.3 $1,085.1 14.4%
======== ======== ========
Certain reclassifications have been made to the 2003 and 2002 amounts in
the tables above to conform the numbers to the 2004 presentation.
14
Operating Expenses: Our 2003 worldwide operating expenses increased $978.3
million, or 14.9%, to $7,529.5 million from $6,551.2 million in 2002, as shown
below.
(Dollars in millions)
---------------------------------------------------------------------------------------
2003 2002 2003 vs 2002
------------------------------- ------------------------------ ---------------
% of % of
% of Total Op. % of Total Op. $ %
Revenue Revenue Costs Revenue Revenue Costs Growth Growth
------- ------- --------- ------- ------- --------- ------ ------
Revenue ............................ $8,621.4 $7,536.3 $1,085.1 14.4%
Operating expenses:
Salary and service costs ........ 5,911.8 68.6% 78.5% 5,071.9 67.3% 77.4% 839.9 16.6%
Office and general expenses ..... 1,617.7 18.7% 21.5% 1,479.3 19.6% 22.6% 138.4 9.4%
-------- ---- ---- -------- ---- ---- -------- ----
Total Operating Costs .............. 7,529.5 87.3% 6,551.2 86.9% 978.3 14.9%
Operating profit ................... $1,091.9 12.7% $ 985.1 13.1% $ 106.8 10.8%
======== ======== =======
Salary and service costs represent the largest part of operating expenses.
During 2003, we continued to invest in our businesses and their personnel, and
took actions to reduce costs at some of our agencies to deal with the changing
economic circumstances. As a percentage of operating expenses, salary and
service costs were 78.5% in 2003 and 77.4% in 2002. These costs are comprised of
direct service costs and salary and related costs. Most, or $839.9 million and
85.9%, of the $978.3 million increase in operating expenses in 2003 resulted
from increases in salary and service costs. The $839.9 million increase in
salary and service costs was attributable to increased revenue levels, including
changes in the mix of our revenues which resulted in greater utilization of
freelance labor. In addition, although we incurred increased severance costs and
did not reach optimal utilization levels for our staff, we continued to make
investments in new key personnel. Furthermore, we increased incentive
compensation where performance dictated. As a result, salary and service costs
as a percentage of revenues increased year-to-year from 67.3% in 2002 to 68.6%
in 2003.
Office and general expenses represented 21.5% and 22.6% of our operating
expenses in 2003 and 2002, respectively. These costs are comprised of office and
equipment rent, technology costs and depreciation, amortization of identifiable
intangibles, professional fees and other overhead expenses. As a percentage of
revenue, office and general expenses decreased in 2003 from 19.6% to 18.8%. This
year-over-year decrease, which was offset by increases in professional fees and
amortization of other intangible assets, resulted from our continuing efforts to
better align these costs with business levels on a location-by-location basis,
as well as from increased revenue levels.
For the foregoing reasons, our operating margin decreased from 13.1% in
2002 to 12.7% in 2003.
Net Interest Expense: Our net interest expense increased in 2003 to $42.8
million, as compared to $30.5 million in 2002. Our gross interest expense
increased by $12.4 million to $57.9 million. This increase resulted from $25.4
million of additional interest costs associated with the amortization of our
payments to qualified holders of our convertible notes as incentives to the
noteholders not to exercise their put rights. In February 2003, we paid $25.4
million to holders of our Liquid Yield Option Notes due 2031 and, in August
2003, we paid $6.7 million to holders of our Zero Coupon Zero Yield Convertible
Notes due 2032. These payments are being amortized ratably over 12-month
periods. No such payments were made in 2002. In addition, interest expense
relative to the (euro)152.4 million 5.20% Euro note increased by $2.2 million
due to the change in the value of the Euro relative to the U.S. dollar in 2003.
These increases were partially offset by lower short-term interest rates and
cash management efforts during the course of the year.
Income Taxes: Our consolidated effective income tax rate was 33.6% in 2003
as compared to 34.5% in 2002. This reduction reflects the realization of our
ongoing focus on tax planning initiatives including increasing the efficiencies
of our international tax structures.
15
7A. Critical Accounting Policies and New Accounting Pronouncements
Critical Accounting Policies: We have prepared the following supplemental
summary of accounting policies to assist in better understanding our financial
statements and the related management discussion and analysis. Readers are
encouraged to consider this supplement together with our consolidated financial
statements and the related notes to our consolidated financial statements,
including our discussion in note 1 setting forth our accounting policies in
greater detail, for a more complete understanding of accounting policies
discussed below.
Estimates: The preparation of our financial statements in conformity with
generally accepted accounting principles in the United States of America, or
"GAAP", requires management to make estimates and assumptions. These estimates
and assumptions affect the reported amounts of assets and liabilities including
valuation allowances for receivables and deferred tax assets, accruals for bonus
compensation and the disclosure of contingent liabilities at the date of the
financial statements, as well as the reported amounts of revenue and expenses
during a reporting period. We evaluate these estimates on an ongoing basis and
we base our estimates on historical experience, current conditions and various
other assumptions we believe are reasonable under the circumstances. Actual
results can differ from those estimates, and it is possible that the differences
could be material.
A fair value approach is used in testing goodwill for impairment under
SFAS 142 and when evaluating cost based investments, which consist of ownership
interests in non-public companies, to determine if an other than temporary
impairment has occurred. The primary approach utilized to determine fair values
is a discounted cash flow methodology. When available and as appropriate, we
also use comparative market multiples to supplement the discounted cash flow
analysis. Numerous estimates and assumptions necessarily have to be made when
completing a discounted cash flow valuation, including estimates and assumptions
regarding interest rates, appropriate discount rates and capital structure.
Additionally, estimates must be made regarding revenue growth, operating
margins, tax rates, working capital requirements and capital expenditures.
Estimates and assumptions also need to be made when determining the appropriate
comparative market multiples to be used. Actual results of operations, cash
flows and other factors used in a discounted cash flow valuation will likely
differ from the estimates used and it is possible that differences and changes
could be material. Additional information about impairment testing under SFAS
142 and valuation of cost based investments appears in notes 2 and 13, and notes
1 and 6, respectively, to our consolidated financial statements.
Acquisitions and Goodwill: We have historically made and expect to
continue to make selective acquisitions. In making acquisitions, the price we
pay is determined by various factors, including specialized know-how,
reputation, competitive position, geographic coverage and service offerings, as
well as our experience and judgment. The amount we paid for acquisitions,
including cash, stock and assumption of net liabilities totaled $378.1 million
in 2004 and $472.3 million in 2003.
Our acquisition strategy has been 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 and/or their service capabilities to better serve our
clients. Accordingly, like most service businesses, a substantial portion of the
intangible asset value that we acquire is the know-how of the people, which is
treated as part of goodwill and, in accordance with SFAS 141, is not valued
separately. For each of our acquisitions we undertake a detailed review to
identify other intangible assets and a valuation is performed for all such
assets identified. The majority of the value of the identifiable intangible
assets that we acquire is derived from customer relationships. In executing our
acquisition strategy, one of the primary drivers in identifying and executing a
specific transaction is the existence of, or the ability to, expand our existing
client relationships. Additional key factors we consider include the competitive
position and specialized know-how of the acquisition targets. When executing our
acquisition strategy, a significant portion of an acquired company's revenues is
often derived from existing clients. The expected benefits of our acquisitions
are typically shared across multiple agencies as they work together to integrate
the acquired agency into our client service strategy.
A summary of our contingent purchase price obligations, sometimes referred
to as earn-outs, and obligations to purchase additional interests in certain
subsidiary and affiliate companies is set forth in the "Liquidity and Capital
Resources" section of this report. The amount of contingent purchase price
obligations
16
and obligations to purchase additional interests in certain subsidiary and
affiliate companies are based on future performance. Contingent purchase price
obligations are accrued, in accordance with GAAP, when the contingency is
resolved and payment is certain.
Additional information about acquisitions and goodwill appears in notes 1
and 2 to our consolidated financial statements of this report.
Revenue: Substantially all revenue is derived from fees for services.
Additionally, we earn commissions based upon the placement of advertisements in
various media. Revenue is realized when the service is performed, in accordance
with terms of the arrangement with our clients and upon completion of the
earnings process. This includes when services are rendered, generally upon
presentation date for media, when costs are incurred for radio and television
production and when print production is completed and collection is reasonably
assured.
In the majority of our businesses, we record revenue at the net amount
retained when the fee or commission is earned. In the delivery of certain
services to our clients, we incur costs on their behalf for which we are
reimbursed. Substantially all of our reimbursed costs relate to purchases on
behalf of our clients of media and production services. We normally have no
latitude in establishing the reimbursement price for these expenses and invoice
our clients for these expenses in an amount equal to the amount of costs
incurred. These reimbursed costs, which are a multiple of our revenue, are
significant. However, the majority of these costs are incurred on behalf of our
largest clients and we have not historically experienced significant losses in
connection with the reimbursement of these costs.
A small portion of our contractual arrangements with clients includes
performance incentive provisions designed to link a portion of our revenue to
our performance relative to both quantitative and qualitative goals. We
recognize this portion of revenue when the specific quantitative goals are
achieved, or when our performance against qualitative goals is determined by our
clients. Additional information about revenue appears in note 1 to our
consolidated financial statements.
Employee Stock-based Compensation: In accordance with SFAS No. 123,
"Accounting for Stock Based Compensation", as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation -- Transition and Disclosure, an
amendment of FASB Statement No. 123", we elected, effective January 1, 2004, to
account for stock-based employee compensation using the fair value method. As a
result, the fair value of stock-based employee compensation, including unvested
employee stock options issued and outstanding, were recorded as an expense in
the current period utilizing the retroactive restatement method as set forth in
SFAS 148. Accordingly, our results for the prior periods have been restated as
if we had used the fair value method to account for stock-based employee
compensation. Pre-tax stock-based employee compensation costs for the years
ended December 31, 2004, 2003 and 2002, were $117.2 million, $131.1 million and
$173.5 million, respectively. Also in connection with the restatement, our
December 31, 2003 balance sheet presented reflects an increase in the deferred
tax benefit of $120.5 million, an increase in additional paid-in capital of
$434.7 million, an increase in unamortized stock compensation of $92.6 million
and a decrease in retained earnings of $221.6 million. Additional disclosures
are included in note 7 to our financial statements.
In December 2004, the FASB issued SFAS No. 123 (Revised 2004) --
Share-Based Payment ("SFAS 123R") which is effective for reporting periods
beginning after June 15, 2005 and generally applies to grants made after
adoption. SFAS 123R is a revision of FASB No. 123, Accounting for Stock-Based
Compensation. As a result of our adoption of SFAS 123 on January 1, 2004, we
believe that the adoption of SFAS 123R will not have a material impact on our
consolidated results of operations or financial position. However, we are in the
process of assessing the full impact of this revision.
New Accounting Pronouncements:
In addition to those discussed previously, the following pronouncements
were either issued by the FASB or adopted by us in 2004 and impact our financial
statements as discussed below.
SFAS No. 153, "Exchanges of Nonmonetary Assets, an amendment of APB
Opinion No. 29 ("SFAS 153"). SFAS 153 amends APB Opinion No. 29, Accounting for
Nonmonetary Transactions, to eliminate the exception from having to apply the
fair value accounting provisions of APB 29 for non-monetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of
non-monetary assets that
17
do not have commercial substance. SFAS 153 is effective for the first reporting
period beginning after June 15, 2005. We believe that the adoption of SFAS 153
will not have a material impact on our consolidated results of operations or
financial position. However, we are in the process of assessing the full impact
of this amendment.
FASB Interpretation No. 46 -- Consolidation of Variable Interest Entities
("FIN 46"). FIN 46 addresses the consolidation by business enterprises of
variable interest entities, as defined in FIN 46, and is based on the concept
that companies that control another entity through interests, other than voting
interests, should consolidate the controlled entity. The consolidation
requirements apply immediately to FIN 46 interests held in variable interest
entities created after January 31, 2003, and to interests held in variable
interest entities that existed prior to February 1, 2003 and remain in existence
as of July 1, 2003. The FASB subsequently issued FIN 46R in December 2003 which
modified certain provisions of FIN 46. FIN 46R applied to the first reporting
period after March 15, 2004. The application of FIN 46 as originally issued and
as revised by the issuance of FIN 46R did not have an impact on, or result in,
additional disclosure in our consolidated results of operations or financial
position.
The Emerging Issues Task Force ("EITF") of the FASB reached a consensus
and released interpretive guidance in 2004 covering several topics that impact
our financial statements.
EITF No. 03-6, "Participating Securities and the Two-Class Method under
FASB Statement No. 128, Earnings Per Share" is required to be adopted in
financial periods beginning after March 31, 2004. The adoption of EITF No. 03-6
did not have an impact on our consolidated results of operation or financial
position.
EITF No. 04-8, "The Effect of Contingently Convertible Instruments on
Diluted Earnings per Share" was required to be adopted on December 31, 2004. The
adoption did not impact our historical results and our December 31, 2004
quarter-to-date and full-year diluted earnings per share as we amended our
Convertible Notes due 2031, 2032 and 2033 prior to December 31, 2004. The
amendments require us, upon conversion, to settle the principal of our
Convertible Notes in cash and any accretion in shares of our common stock. For
additional information, see note 4 to our consolidated financial statements. The
amendments made the notes compliant with EITF 90-19 "Instrument C" treatment.
Compliance with "Instrument C" treatment does not result in additional dilution
to our Diluted EPS because our weighted average share price was less than the
conversion price of the notes for the periods set forth above. In accordance
with the transition provisions of EITF 04-8, it is assumed that "Instrument C"
treatment occurred at the beginning of the first period presented.
Liquidity and Capital Resources
Cash Requirements, including contractual obligations
Our principal non-discretionary funding requirement is our working capital
requirement. In addition, as discussed below, we have contractual obligations
related to our debt and convertible notes, our recurring business operations
primarily related to lease obligations, as well as certain contingent
acquisition obligations related to acquisitions made in prior years.
Historically, substantially all of our non-discretionary cash requirements have
been funded from operating cash flow.
Our principal discretionary cash requirements include dividend payments to
our shareholders, repurchases of our stock, payments for strategic acquisitions
and capital expenditures. In 2004 and 2003, our discretionary spending was
funded from operating cash flow. However, in any given year, depending on the
level of discretionary activity, we may use other sources of available funding
to finance these activities.
We have a seasonal working capital cycle. Working capital requirements are
lowest at year-end and highest during the second and third quarters. The
fluctuation in working capital requirements between the lowest and highest
periods was approximately $1.0 billion in 2004 and 2003. This occurs because in
the majority of our businesses we act as agent on behalf of our clients,
including when we place media and incur production costs on their behalf. We
generally require collection from our clients prior to our payment for the media
and production cost obligations and these obligations are greatest at the end of
the year. This pattern was similar during the past three years. During the year
we manage liquidity through our credit facilities as discussed below under "Cash
Management."
Contractual Obligations and Other Commercial Commitments: We enter into
numerous contractual and commercial undertakings in the normal course of our
business. The following table summarizes information
18
about certain of our obligations as of December 31, 2004 and should be read
together with note 3 (bank loans and lines of credit), note 4 (long-term debt
and convertible notes), note 10 (commitments and contingent liabilities), note
11 (fair value of financial instruments) and note 12 (financial instruments and
market risk) to our consolidated financial statements.
Due in Due in Due
Less than 1 to 5 after 5 Total
1 Year Years Years Due
--------- -------- -------- --------
Contractual Obligations at
December 31, 2004 (in millions)
------------------------------------------------
Long-term debt ........... $ 209.2 $ 18.9 $ 0.2 $ 228.3
Convertible notes ........ -- -- 2,339.3 2,339.3
Lease obligations ........ 401.2 1,054.6 884.2 2,340.0
Other .................... 2.2 6.6 -- 8.8
-------- -------- -------- --------
Total .................... $ 612.6 $1,080.1 $3,223.7 $4,916.4
======== ======== ======== ========
As more fully described in the discussion below under the heading "Debt
Instruments, Guarantees and Related Covenants", the holders of the convertible
notes included in the table above have the right to cause us to repurchase up to
the entire aggregate face amount of the notes then outstanding for par value at
certain dates in the future. If these rights were exercised at the earliest
possible future date, as set forth in note 4 to our consolidated financial
statements, $892.3 million of the convertible notes could be due in less than
one year, and $1,447.0 million could be due in the "1 to 5 Years" category
above.
Due in Due in Due
Less than 1 to 5 after 5 Total
1 Year Years Years Due
--------- -------- -------- --------
Other Commercial Commitments at
December 31, 2004 (in millions)
------------------------------------------
Lines of credit .................... $ -- $ -- $ -- $ --
Guarantees and letters
of credit ....................... 0.1 0.1 0.0 0.2
-------- -------- -------- --------
Total .............................. $ 0.1 $ 0.1 $ 0.0 $ 0.2
======== ======== ======== ========
In the normal course of business, our agencies enter into various
contractual media commitments on behalf of our clients at levels substantially
exceeding our revenue. These commitments are included in our accounts payable
balance when the media services are delivered by the providers. Historically, we
have not experienced significant losses for media commitments entered into on
behalf of our clients and we believe that we do not have any substantial
exposure to potential losses of this nature in the future as we receive payment
in advance and we monitor the credit worthiness of our clients. In the event
that we are committed to the media services and our client has not paid us, we
believe that the risk of material loss is minimal because we believe that we
have reasonable options available to substantially mitigate potential losses.
Contingent Acquisition Obligations
Certain of our acquisitions are structured with contingent purchase price
obligations, often referred to as earn-outs. We utilize contingent purchase
price structures in an effort to minimize the risk to us associated with
potential future negative changes in the performance of the acquired entity
during the post-acquisition transition period. These payments are not contingent
upon future employment. The amount of future contingent purchase price payments
that we would be required to pay for prior acquisitions, assuming that the
businesses perform over the relevant future periods at their current profit
levels, is approximately $458 million as of December 31, 2004. The ultimate
amounts payable cannot be predicted with reasonable certainty because it is
dependent upon future results of operations of subject businesses and is subject
to changes in foreign currency exchange rates. In accordance with GAAP, we have
not recorded a liability for these items on our balance sheet since the
definitive amount is not determinable or distributable. Actual results can
differ from these estimates and the actual amounts that we pay are likely to be
different from these estimates. Our obligations change from period to period
primarily as a result of payments made during the current period, changes in the
acquired entities' performance
19
and changes in foreign currency exchange rates. These differences could be
significant. The contingent purchase price obligations as of December 31, 2004,
calculated assuming that the acquired businesses perform over the relevant
future periods at their current profit levels, are as follows:
($ in millions)
- --------------------------------------------------------------------------------
There-
2005 2006 2007 2008 after Total
- ---- ---- ---- ---- ------ -----
$225 $82 $81 $47 $23 $458
In addition, owners of interests in certain of our subsidiaries or
affiliates have the right in certain circumstances to require us to purchase
additional ownership stakes in those companies. Assuming that the subsidiaries
and affiliates perform over the relevant periods at their current profit levels,
the aggregate amount we could be required to pay in future periods is
approximately $274 million, $163 million of which relate to obligations that are
currently exercisable. If these rights are exercised, there would be an increase
in our net income as a result of our increased ownership and the reduction of
minority interest expense. The ultimate amount payable relating to these
transactions will vary because it is primarily dependent on the future results
of operations of the subject businesses, the timing of the exercise of these
rights and changes in foreign currency exchange rates. The actual amount that we
pay is likely to be different from this estimate and the difference could be
significant. The obligations that exist for these agreements as of December 31,
2004, calculated using the assumptions above, are as follows:
($ in millions)
---------------------------------------
Currently Not Currently
Exercisable Exercisable Total
----------- ------------- -----
Subsidiary agencies ............ $139 $ 99 $238
Affiliated agencies ............ 24 12 36
---- ---- ----
Total .......................... $163 $111 $274
==== ==== ====
Sources and Uses of Cash
Although our cash requirements in 2004 and 2003 were funded by operating
cash flow, during 2003 and prior years, we have opportunistically accessed the
capital markets by issuing convertible debt of $600 million, $900 million and
$850 million in 2003, 2002 and 2001, respectively. The proceeds were used for
general corporate purposes, including the repayment of maturing debt, the
repurchase of our shares and the funding of selected investing activities.
At year-end 2004, we had $1,165.6 million in cash and cash equivalents. In
addition, we had $2.0 billion in unused committed credit facilities available
for immediate use to fund our cash needs. These credit facilities are more fully
described in note 3 in the accompanying financial statements.
Our operating cash flow and access to the capital markets could be
impacted by macroeconomic factors outside of our control. Additionally,
liquidity could be impaired by short and long-term debt ratings assigned by
independent rating agencies.
Standard and Poor's Rating Service currently rates our long-term debt A-,
Moody's Investor Service rates our long-term debt Baa1 and Fitch Rating rates
our long-term debt A-. Our short-term ratings are A2, P2 and F2 by the
respective agencies. Neither our outstanding convertible bonds nor our bank
credit facilities contain provisions that require acceleration of cash payments
should our ratings be downgraded. The interest rates and fees on our bank credit
facilities, however, will increase if our long-term debt rating is downgraded.
Our committed bank facilities, described in detail in note 3, contain two
financial covenants, relating to cash flow and interest coverage, which we met
by a significant margin as of December 31, 2004.
We believe that our financial condition is strong and that our cash
balances, liquidity of short-term investments, operational cash flows, unused
committed borrowing capacity and access to capital markets, taken together, are
sufficient to support our foreseeable cash requirements, including working
capital, capital expenditures, dividends and acquisitions.
20
Cash Management
We manage our cash and liquidity centrally through treasury centers in
North America and Europe. Each day, operations with excess funds invest these
funds with their regional treasury center. Likewise, operations that require
funding will borrow funds from their regional treasury center. The treasury
centers then aggregate the net position of our operating companies. The net
position is either invested with or borrowed from third party providers. To the
extent that our treasury centers require liquidity, they have the ability to
access local currency lines of credit, our $2.0 billion committed bank
facilities, or issue U.S. dollar-denominated commercial paper. This enables us
to reduce our consolidated debt levels and minimize interest expense as well as
centrally manage our exposure to foreign exchange.
Our cash balance at December 31, 2004 decreased by $77.9 million from the
prior year, while our short-term investments at market increased $268.6 million
from the prior year. Short-term investments include investments of our excess
cash which we expect to convert into cash in our current operating cycle,
generally within one year.
We manage our net debt position, which we define as total debt outstanding
less cash and short-term investments, centrally through our treasury centers as
discussed above. Our net debt outstanding at December 31, 2004 decreased $198.0
million as compared to the prior year-end.
Debt Instruments, Guarantees and Related Covenants
We maintain two revolving credit facilities with a consortium of banks
totaling $2,000.0 million as described in note 3 to our consolidated financial
statements. These credit facilities are available to provide credit support for
issuances under our $1,500.0 million commercial paper program, as well as to
provide back-up liquidity in case any of our convertible bond issues are put
back to us. We fund our daily borrowing needs by issuing commercial paper or
drawing down on our revolving credit facilities. During 2004, we issued and
redeemed $27.2 billion and the average term was 2.3 days. As of December 31,
2004, we had no commercial paper or bank loans outstanding under these credit
facilities. We had short-term bank loans of $17.5 million at December 31, 2004,
primarily comprised of bank overdrafts by our international subsidiaries, which
are treated as unsecured loans pursuant to the subsidiaries' bank agreements.
Our credit facilities contain financial covenants that restrict our
ability to incur indebtedness as defined in the agreements. These financial
covenants limit the ratio of total consolidated indebtedness to total
consolidated EBITDA (EBITDA for these purposes being defined as earnings before
interest, taxes, depreciation and amortization) to no more than 3.0 times. In
addition, they require us to maintain a minimum ratio of EBITDA to interest
expense of at least 5.0 times. At December 31, 2004, we were in compliance with
these covenants, as our ratio of debt to EBITDA was 1.9 times and our ratio of
EBITDA to interest expense was 27.1 times.
At December 31, 2004, we had a total of $2,339.3 million aggregate
principal amount of convertible notes outstanding, including $847.0 million
Liquid Yield Option Notes due 2031, which were issued in February 2001, $892.3
million Zero Coupon Zero Yield Convertible Notes due 2032, which were issued in
March 2002 and $600.0 million Zero Coupon Zero Yield Convertible Notes dues
2033, which were issued in June 2003.
The holders of our Liquid Yield Option Notes due 2031 have the right to
cause us to repurchase up to the entire aggregate face amount of the notes then
outstanding for par value in February of each year beginning in 2006. The
holders of our Zero Coupon Zero Yield Convertible Notes due 2032 have the right
to cause us to repurchase up to the entire aggregate face amount of the notes
then outstanding for par value in August of each year. The holders of our Zero
Coupon Zero Yield Convertible Notes due 2033 have the right to cause us to
repurchase up to the entire aggregate face amount of the notes then outstanding
for par value on June 15, 2006, 2008, 2010, 2013, 2018, 2023 and on each June 15
annually thereafter through June 15, 2032. The Liquid Yield Option Notes due
2031, the Zero Coupon Zero Yield Convertible Notes due 2032 and the Zero Coupon
Zero Yield Convertible Notes due 2033 are convertible, at specified ratios, only
upon the occurrence of certain events, including if our common shares trade
above certain levels, if we effect extraordinary transactions or, in the case of
the Liquid Yield Option Notes due 2031 and the Zero Coupon Zero Yield
Convertible Notes due 2032, if our long-term debt ratings are downgraded to BBB
or lower by Standard & Poor's Ratings Services, or Baa3 or lower by Moody's
Investors Services, Inc. or in the case of the Zero Coupon Zero Yield
Convertible Notes due 2033, to BBB- or lower by S&P, and Ba1 or lower by
Moody's. These events would not, however, result in an
21
adjustment of the number of shares issuable upon conversion and would not
accelerate the holder's right to cause us to repurchase the notes. For
additional information about the terms of these notes, see note 4 to our
consolidated financial statements.
On February 21, 2003, we paid $25.4 million to qualified noteholders of
our Liquid Yield Option Notes due 2031, equal to $30 per $1,000 principal amount
of notes, as an incentive to the holders not to exercise their put right. This
payment was amortized over the 12-month period ended February 2004. On February
7, 2003, we repurchased for cash, notes from holders who exercised their put
right for $2.9 million, reducing the aggregate amount outstanding of the notes
due 2031 to $847.0 million.
On August 6, 2003, we paid $6.7 million to qualified noteholders of our
Zero Coupon Zero Yield Convertible Notes due 2032, equal to $7.50 per $1,000
principal amount of notes, as an incentive to the holders not to exercise their
put right. This payment was amortized over the 12-month period ended August
2004. On August 1, 2003, we repurchased for cash, notes from holders who
exercised their put right for $7.7 million, reducing the aggregate amount
outstanding of the notes due 2032 to $892.3 million.
On August 12, 2004, we paid $25.4 million to qualified noteholders of our
Zero Coupon Zero Yield Convertible Notes due 2032, equal to $27.50 per $1,000
principal amount of notes, as an incentive to the holders not to exercise their
put right and to consent to an amendment to the indenture. This payment is being
amortized over the 12-month period ended August 2005. Under the amendment, we
will pay cash to noteholders for the initial principal amount of the notes
surrendered for conversion. The remainder of the conversion value would be paid
in cash or shares at our option. We have also amended the method by which we
will pay contingent interest.
On November 16, 2004, we paid $1.2 million to qualified noteholders of our
Zero Coupon Zero Yield Convertible Notes due 2033 as an incentive to the holders
to consent to an amendment to the indenture. At later dates in November and
December 2004, we paid an additional $0.3 million to the remaining qualified
noteholders. These payments are being amortized ratably through the next put
date of June 2006. Under the amendment, we will pay cash to noteholders for the
initial principal amount of the notes surrendered for conversion. The remainder
of the conversion value would be paid in cash or shares at our option.
On November 30, 2004, we paid $14.8 million to qualified noteholders of
our Liquid Yield Option Notes due 2031 as an incentive to the holders not to
exercise their February 2005 put right and to consent to an amendment to the
indenture. This payment is being amortized ratably through the next put date of
February 2006. Under the amendment, we will pay cash to noteholders for the
initial principal amount of the notes surrendered for conversion. The remainder
of the conversion value would be paid in cash or shares at our option. We also
amended the method by which we will pay contingent interest.
At December 31, 2004, we had Euro-denominated bonds outstanding of
(euro)152.4 million or $206.6 million. The bonds pay a fixed rate of 5.2% to
maturity in June 2005. The bonds serve as a hedge of our investment in
Euro-denominated net assets. While an increase in the value of the euro against
the dollar will result in a greater liability, there will be a corresponding
increase in the dollar value of our Euro-denominated net assets. We intend to
redeem these Euro-denominated bonds in 2005 utilizing our available cash, our
credit facilities or a combination of both.
Our outstanding debt and amounts available under these facilities as of
December 31, 2004 ($ in millions) were as follows:
Debt Available
Outstanding Credit
----------- ---------
Bank loans (due in less than 1 year) ................... $ 17.5 --
$1,500.0 million revolver -- due May 24, 2009 .......... -- $1,500.0
$500.0 million -- due May 23, 2005 ..................... -- 500.0
(euro)152.4 million 5.20% Euro notes -- due
June 24, 2005 ........................................ 206.6 --
Convertible notes -- due February 7, 2031 .............. 847.0 --
Convertible notes -- due July 31, 2032 ................. 892.3 --
Convertible notes -- due June 15, 2033 ................. 600.0 --
Loan notes and sundry -- various through 2010 .......... 21.7 --
-------- --------
Total .................................................. $2,585.1 $2,000.0
======== ========
Additional information about our indebtedness is included in notes 3 and 4
of our consolidated financial statements.
22
Quantitative and Qualitative Disclosures Regarding Market Risk
Foreign Exchange: Our results of operations are subject to risk from the
translation to the U.S. dollar of the revenue and expenses of our foreign
operations, which are generally denominated in the local currency. The effects
of currency exchange rate fluctuation on the translation of our results of
operations are discussed in note 12 of our consolidated financial statements.
For the most part, our revenues and the expenses incurred related to those
revenues are denominated in the same currency. This minimizes the impact that
fluctuations in exchange rates will have on our net income.
While our agencies conduct business in more than 70 different currencies,
our major-non-U.S. currency markets are the European Monetary Union (EMU), the
United Kingdom, Japan, Brazil and Canada. As an integral part of our treasury
operations, we enter into short-term forward foreign exchange contracts which
hedge the intercompany cash movements between subsidiaries operating in
different currency markets from that of our treasury centers from which they
borrow or invest. In the limited number of instances where operating expenses
and revenues are not denominated in the same currency, amounts are promptly
settled or hedged in the foreign currency market with forward contracts. At
December 31, 2004, we had foreign exchange contracts outstanding with an
aggregate notional principal of $1,453.1 million, most of which were denominated
in our major international market currencies with maturities ranging from 2 to
365 days with an average duration of less than 30 days.
Additionally, at December 31, 2004 we had cross-currency interest rate
swaps in place with an aggregate notional principal amount of 19.1 billion Yen
maturing in 2005. See note 12 to our consolidated financial statements for
information about the fair value of each type of derivative instrument.
The forward foreign exchange and swap contracts discussed above were
entered into for the purpose of hedging certain specific currency risks. As a
result of these financial instruments, we reduced financial risk in exchange for
foregoing any gain (reward) which might have occurred if the markets moved
favorably. In using these contracts, we exchanged the risks of the financial
markets for counterparty risk. To minimize counterparty risk, we only enter into
these contracts with major well-known banks and financial institutions that have
credit ratings equal to or better than our credit rating.
These hedging activities are confined to risk management activities
related to our international operations. We have established a centralized
reporting system to evaluate the effects of changes in interest rates, currency
exchange rates and other relevant market risks. We periodically determine the
potential loss from market risk by performing a value-at-risk computation.
Value-at-risk analysis is a statistical model that utilizes historic currency
exchange and interest rate data to measure the potential impact on future
earnings of our existing portfolio of derivative financial instruments. The
value-at-risk analysis we performed on our December 31, 2004 portfolio of
derivative financial instruments indicated that the risk of loss was immaterial.
This overall system is designed to enable us to initiate remedial action, if
appropriate.
Debt Instruments: Our bank credit facilities mentioned above are available
to provide credit support for issuances of commercial paper, as well as to
provide back-up liquidity in case any of our convertible bond issues are put
back to us. We currently have a $500.0 million 364-day facility with a one-year
term out option expiring on May 23, 2005 and a $1,500.0 million 5-year facility
expiring on May 24, 2009. Accordingly, we classify outstanding borrowings, if
any, under these facilities as long-term debt. We normally replace our 364-day
facility each year with a new 364-day facility with similar provisions.
Our bank syndicates typically include large global banks such as Citibank,
JP Morgan Chase, HSBC, ABN Amro, Societe Generale, Barclays, Bank of America and
BBVA. We also include large regional banks in the U.S. such as Wachovia, US
Bancorp, Northern Trust, PNC and Wells Fargo. We also include banks that have a
major presence in countries where we conduct business such as Sumitomo in Japan,
Fortis in Belgium, San Paolo in Italy, Scotia in Canada and Westpac in
Australia.
Our other long-term debt consists principally of convertible notes. The
holders of these convertible notes have the right on specific dates to cause us
to repurchase up to the entire aggregate face amount as previously discussed. We
may offer the holders of our notes a cash payment or other incentives to induce
them not to put the notes to us in advance of a put date. If we were to decide
to pay a cash incentive, the amount of interest expense incurred will be based
on market factors.
23
Since our existing convertible notes do not pay or accrue interest, our
interest expense could increase if notes are put. The extent, if any, of the
increase in interest expense will depend on the portion of the amount
repurchased that was refinanced, when we refinance, the type of instrument we
use to refinance and the term of the instrument.
The incentive payments made in 2003 and 2004 to qualified noteholders, as
described above under "Debt Instruments, Guarantees and Related Covenants", are
one method of keeping the convertible notes outstanding and preserving our
liquidity. If we are required to satisfy a put, we expect to have sufficient
available cash and unused credit commitments to fund the put, while still
preserving ample capacity under these commitments to meet cash requirements for
the normal course of our business operations after the put event.
Our credit commitments support either the issuance of commercial paper or
bank loans, and we would likely fund the put initially using some combination of
these instruments. We would