Item 1. Business....................................................... 1 Item 2.
Item 2. Properties..................................................... 3 Item 3.
Item 3. Legal Proceedings.............................................. 4 Item 4.
Item 4. Submission of Matters to a Vote of Security Holders............ 4
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.......................................... 5 Item 6.
Item 6. Selected Financial Data........................................ 6 Items 7/7A. Management's Discussion and Analysis of Financial Condition and Results of Operations: Critical Accounting Policies; and Quantitative and Qualitative Disclosures about Market Risk................................ 8 Item 8. Financial Statements and Supplementary Data.................... 24 Item 9. Changes and Disagreements with Accountants on Accounting and Financial Disclosure..................................... 24 Item 9A. Controls and Disclosure........................................ 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................. *
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 ........................................................ Independent Auditors' Report................................................ Consolidated Financial Statements........................................... Notes to Consolidated Financial Statements.................................. Certifications of Senior Executive Officers................................. S-7
- ---------- * The information called for by Items 10, 11, 12 and 13, 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 23, 2004.
PART I
Introduction
This report is both our 2003 annual report to shareholders and our 2003 annual report on Form 10-K required under federal securities laws.
We are a holding company. Our business is conducted through subsidiaries. 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 3 and 7 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: We are one of the largest advertising, marketing and corporate communications companies in the world. Our company was formed through a 1986 combination of three advertising, marketing and corporate communications networks, BBDO, Doyle Dane Bernbach and Needham Harper.
Since then, we have grown our strategic holdings to over 1,500 subsidiary agencies operating in all major markets worldwide. Our agencies provide an extensive range of advertising, marketing and corporate communications services, including:
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
Advertising, marketing and corporate communications services are provided to clients through global, pan-regional and national independent agency brands. Our brands include:
BBDO Worldwide DDB Worldwide TBWA Worldwide OMD Worldwide Adelphi Group AGENCY.COM Alcone Marketing Group Anderson DDB ARA Group Arnell Group Atmosphere BBDO Auditoire BDDP & Fils Bernard Hodes Group Brand Architecture International Brodeur Worldwide Carlson and Partners Carre Bleu Marine Changing Our World Clark & Weinstock Claydon Heeley Jones Mason Clemenger Communications Limited Cline, Davis & Mann Cone Corbett Accel Healthcare Group CPM Creative Juice Davie-Brown Entertainment del Rivero Messianu Dieste, Harmel & Partners Direct Partners Doremus Eigen Fabrikaat Element 79 Partners Etcetera Groep European Communication Consultants FitzGerald Communications FKGB Fleishman-Hillard Full Circle Entertainment G1 Gavin Anderson & Company Goodby, Silverstein & Partners Grizzard Communications GSD&M Hall & Partners Group Harrison & Star Business Group Health Science Communications Heye & Partner Horrow Sports Ventures ICON Integrated Merchandising Services Integer Group Interbrand InterScreen i\tec Jump Kaleidoscope Ketchum Ketchum Directory Advertising KPR Lieber Levett Koenig Farese Babcock Lyons Lavey Nickel Swift M/A/R/C Research Marketing Advantage MarketStar Martin/Williams Matthews Media Group MBA Mercury Public Affairs Merkley & Partners MicroMedia Millsport Moss Dragoti Multi-M National In-Store New Solutions Nouveau Monde Novus Organic Paris Venise Design Pentamark PGC Advertising PhD Porter Novelli International Proximity Worldwide Radiate Sports & Entertainment Group Rapp Collins Worldwide Russ Reid Company Salesforce Screen Sellbytel Serino Coyne Siegel & Gale Spike DDB Spot Plus Staniforth Steiner Sports Marketing Targetbase TARGIS Tequila Textuel The Ant Farm The Designory The Marketing Arm The Promotion Network TPG Tracy Locke Partnership Tribal DDB Washington Speakers Bureau Wolff Olins Zimmerman & Partners Advertising
The various components of our business and material factors that affected us in 2003 are discussed in our "Management's Discussion and Analysis of Financial Conditions and Results of Operations" of this report. None of our acquisitions in 2003, 2002 or 2001 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: We had over 5,000 clients in 2003, many of which were served by more than one of our agency brands. Our 10 largest and 250 largest clients in the aggregate accounted for 18.7% and 53.8%, respectively, of our 2003 consolidated revenue. Our largest client was served by 50 of our agency brands. This client accounted for 4.7% of our 2003 consolidated revenue. No other client accounted for more than 2.9% of our 2003 consolidated revenue.
Our Employees: We employed approximately 58,500 people at December 31, 2003. We are not party to any significant collective bargaining agreements. See our management discussion and analysis beginning on page 7 of this report for a discussion of the effect of salary and service 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 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 as discussed in our management's discussion and analysis starting on page 7. 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, with the key competitive considerations for keeping existing business and winning new business being the quality and effectiveness of the services offered, including 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 services and public and corporate communications businesses 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 could be adversely affected.
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. In addition, an important aspect of our competitiveness is our ability to retain key employee and management 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 communication 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 beginning on page 7 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 through regulations and other governmental action. We believe the total volume of advertising, marketing and corporate communications services will not be materially affected by future legislation or regulation, however the scope, content and manner of presentation may continue to change.
2. Properties
We maintain office space in many major cities around the world. 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 and is in suitable and well-maintained condition for our current operations. 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. In addition, leases are denominated in the local currency of the operating entity and are therefore subject to changes in foreign exchange rates. Our consolidated rent expense was $335.5 million in 2003, $311.3 million in 2002 and $305.4 million in 2001, after reduction for rents received from subleases of $17.3 million, $15.5 million and $8.0 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 -------- 2004 ................................................. $435.9 2005 ................................................. 362.7 2006 ................................................. 288.4 2007 ................................................. 231.3 2008 ................................................. 190.9 Thereafter............................................ 949.3
See note 10 to our consolidated financial statements of this report for a discussion of our lease commitments and our management discussion and analysis 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 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 our behalf, alleging breaches of fiduciary duty, disclosure failures, abuse of control and gross mismanagement in connection with the formation of Seneca Investments LLC.
Management presently expects to defend these cases 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 2003.
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters
Our common shares are listed on the New York Stock Exchange under the symbol "OMC". On March 1, 2004, we had 3,633 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 2002......................... $96.30 $82.76 $0.20 Q2 2002......................... 94.10 36.27 0.20 Q3 2002......................... 65.61 38.54 0.20 Q4 2002......................... 70.29 48.10 0.20
Q1 2003......................... $68.25 $46.50 $0.20 Q2 2003......................... 76.43 53.15 0.20 Q3 2003......................... 81.18 69.61 0.20 Q4 2003......................... 87.60 71.80 0.20
Q1 2004*........................ $88.50 $76.85 $0.20
* through March 1, 2004
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, as well as our management's discussion and analysis which begins on page 7 of this report.
As discussed in footnote 13 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 due to a change in generally accepted accounting principles ("GAAP") are not amortized. 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.
The following is a reconciliation of the "as reported" to "as adjusted" Net Income per share on a basic and diluted basis.
7/7A. Management's Discussion and Analysis of Financial Condition and Results of Operations; Critical Accounting Policies; and Quantitative and Qualitative Information about Market Risk
Executive Summary
We are a holding company. We own industry-leading advertising, marketing and corporate communications companies that span more than 30 marketing disciplines, 100 countries, 1,500 subsidiary agencies and 5,000 clients. On a global, pan-regional and local basis, our agencies provide traditional media advertising services as well as marketing services including customer relationship management, public relations and specialty communications. We continually seek to grow our business with our existing clients by maintaining a 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 either currently serve or have the ability to serve our existing client base.
During the past few years, overall industry and margin growth 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. Our diversified portfolio of companies, both from a geographical and a service offerings perspective, has allowed us to perform ahead of the industry in general. 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 companies to deal with the changing economic circumstances.
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.
Although the overall 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. However, as a result of changes in our business mix, increased severance costs incurred, under-utilization of staff, increased professional fees and increased amortization of other intangible assets, our margins were lower in 2003 and in 2002 than our historical performance. We are hopeful that with continuing improvements in the U.S. economy, combined with the cost-reduction actions taken by our companies, margins should begin to stabilize.
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 2003, our overall revenue growth was 14.4%, of which 6.2% was related to changes in foreign exchange rates and 3.6% was related to acquired entities. The remainder, 4.6%, was organic growth.
In 2003, traditional media advertising represented about 44% of the total revenue and grew by 14.1%. Marketing services represented about 56% of total revenue and grew by 14.6% over the previous year.
We believe that our ability to increase revenues as a result of our client-centered approach to the business is demonstrated most clearly in our relationships with our largest clients. While consolidated revenues on a U.S. dollar basis increased 14.4% in 2003, revenue from our ten largest clients increased 19.3%. By expanding the breadth of our relationships with these clients we not only increase revenues, but we also enhance the overall consistency and stability of our operations, which in turn drives our financial performance.
We measure operating expenses in two distinct cost categories, salary and service costs, and office and general expenses. 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 revenues increase because a
significant portion of these expenses are relatively fixed in nature. Over the past three years, salary and service costs have grown from 64.2% of revenue to 67.7% of revenue, while office and general expenses have declined from 21.8% of revenue to 18.8% of revenue.
Our net income for 2003 increased by 5.0% to $675.9 million from $643.5 million in 2002 and our diluted EPS increased by 4.4% to $3.59 from $3.44.
The following year-over-year analysis gives further details and insight into the changes in our financial performance.
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 .................. 5,839.0 4,952.9 Office and general expenses ............... 1,617.7 1,479.3 --------- --------- 7,456.7 6,432.2 --------- ---------
Operating profit ............................. 1,164.7 1,104.1
Net interest expense: Interest expense .......................... 57.9 45.5 Interest income ........................... (15.1) (15.0) --------- --------- 42.8 30.5 --------- ---------
Income before income taxes ................... 1,121.9 1,073.6
Income taxes ................................. 380.9 375.6 --------- ---------
Income after income taxes .................... 741.0 698.0
Equity in earnings of affiliates ............. 15.1 13.8 Minority interests ........................... (80.2) (68.3) --------- --------- Net income ................................ $ 675.9 $ 643.5 ========= =========
Net Income Per Common Share: Basic ..................................... $ 3.61 $ 3.46 Diluted ................................... 3.59 3.44
Dividends Declared Per Common Share .......... $ 0.80 $ 0.80
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 2003 consolidated worldwide revenue increased 14.4% to $8,621.4 million from $7,536.3 million in 2002. The effect of acquisitions, net of disposals, increased 2003 worldwide revenue by $271.7 million. Organic growth increased worldwide revenue by $347.8 million, and foreign exchange impacts increased worldwide revenue by $465.6 million. The components of total 2003 revenue growth in the U.S. ("domestic") and the remainder of the world ("international") are summarized below ($ in millions):
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.
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 $7,536.3 million for the Total column in the table).
During the past few years, geopolitical unrest, lagging economic conditions, lack of consumer confidence and cautious client spending have continued to affect overall industry growth. However, our diversified portfolio of companies, both from a geographical and service offerings perspective, has allowed us to perform ahead of the industry in general and we have continued to grow our revenues.
The components of revenue and revenue growth for 2003 compared to 2002, in our primary geographic markets are summarized below ($ 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, and historically each year for Omnicom as a whole, was an overall gain in new business. Due to our multiple independent agency structure and the breadth of our service offerings and
geographic reach, our agencies have more than 5,000 active client relationships in the aggregate. Revenue from our single largest client in 2003 increased by 7.9%. This 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. Revenue from our ten largest and 250 largest clients grew by more than 19.0% and 15.0%, respectively. 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.
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.
Operating Expenses: Our 2003 worldwide operating expense increased $1,024.5 million, or 15.9%, to $7,456.7 million from $6,432.2 million in 2002, as shown below.
Salary and service costs represent the largest part of operating expenses. During 2003, we have continued to invest in our businesses and their personnel, and have taken action to reduce costs at some of our companies to deal with the changing economic circumstances. As a percentage of operating expenses, salary and service costs were 78.3% in 2003 and 77.0% in 2002. These costs are comprised of direct service costs and salary and related costs. Most, or 86.5%, of the $1,024.5 million increase in operating expenses in 2003 resulted from increases in salary and service costs. The $886.1 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 65.7% in 2002 to 67.7% in 2003.
Office and general expenses represented 21.7% and 23.0% of our operating expenses in 2003 and 2002, respectively. These costs are comprised of office and equipment rent, depreciation and amortization of other 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, as well as changes in our business mix, our operating margin decreased from 14.7% in 2002 to 13.5% in 2003.
We expect our efforts to control operating expenses will continue, but we anticipate that it will remain difficult. Accordingly, we continue to 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 companies, margins should begin to stabilize.
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 the additional interest costs associated with our payments on February 21, 2003, of $30 per $1,000 principal amount of our Liquid Yield Option Notes due 2031 and, on August 6, 2003, of $7.50 per $1,000 principal amount of our Zero Coupon Zero Yield Convertible Notes due 2032 as incentives to the holders not to exercise their put rights. These payments to qualified noteholders amounted to $25.4 million and $6.7 million, respectively, and are being amortized ratably over 12-month periods. 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 marginally lower short-term interest rates and cash management efforts during the course of the year.
The amortization of the February and August 2003 payments increased interest expense by $25.4 million for the full-year 2003 compared to 2002. These payments will also impact 2004 by approximately $6.7 million.
See "Liquidity and Capital Resources" for a discussion of our indebtedness and related matters.
Income Taxes: Our consolidated effective income tax rate was 34.0% in 2003 as compared to 35.0% in 2002. This reduction reflects the realization of our ongoing focus on tax planning initiatives including a reduction of the inefficiencies of our international and state tax structures.
Financial Results from Operations -- 2002 Compared with 2001
Certain reclassifications have been made to the 2002 and 2001 reported amounts to conform them to the 2003 presentation. In addition, as discussed in footnote 13 of the notes to our consolidated financial statements, as required by SFAS 142, beginning with our 2002 results goodwill and other intangible assets that have indefinite lives are not amortized. In addition to discussing 2002 and 2001 on a reported basis and to make the discussion of periods comparable, our 2001 income statement information in the discussion that follows has been adjusted to eliminate goodwill amortization as presented in the following table. As a result of these adjustments, this presentation is a non-GAAP financial measure. We believe that the table below presents selected financial data that is more comparable year-to-year and thus more meaningful for purposes of analysis.
- ---------- (a) Excludes amortization of goodwill and related tax impact.
Revenue: Our 2002 consolidated worldwide revenue increased 9.4% to $7,536.3 million from $6,889.4 million in 2001. The effect of acquisitions, net of disposals, increased 2002 worldwide revenue by $362.5 million. Internal/organic growth increased worldwide revenue by $193.1 million, and foreign exchange impacts increased worldwide revenue by $91.3 million. The components of total 2002 revenue growth in the U.S. ("domestic") and the remainder of the world ("international") are summarized below ($ in millions):
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 $7,445.0 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 $7,536.3 million less $7,445.0 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 $6,889.4 million for the Total column in the table).
The components of revenue and revenue growth for 2002 compared to 2001, in our primary geographic markets are summarized below ($ in millions):
$ Revenue % Growth --------- -------- United States ........................... $4,284.6 15.3% Euro Markets ............................ 1,458.6 3.2% United Kingdom .......................... 814.1 1.1% Other ................................... 979.0 2.7% -------- ------ Total ................................... $7,536.3 9.4% ======== ======
As indicated, foreign exchange impacts increased our international revenue by $91.3 million for 2002. The most significant impacts resulted from the 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. This was partially offset by the strengthening of the U.S. dollar against the Brazilian Real. Additional geographic information relating to our business is contained in note 5 to our consolidated financial statements at page of this report.
Comparisons of 2002 results to the prior year needs to be made in the context of the events of September 11, 2001, which had a significant adverse impact on our business in the third quarter of 2001. The adverse impact of September 11, 2001, was less significant in the fourth quarter of 2001 and management believes that the fourth quarter of 2001 also benefited from other short-term economic stimuli and delayed spending from the third quarter of 2001. The impact of these factors on our business and our 2002 and 2001 results of operations is more fully discussed below.
Due to our multiple independent agency structure and the breadth of our service offerings and geographic reach, our agencies have more than 5,000 active client relationships in the aggregate. Revenue from our single largest client in 2002 increased by 2.4%. This client represented 5.0% of worldwide revenue in 2002 and 5.4% in 2001 and no other client represented more than 2.5% in 2002 and 2001. Our ten largest and 250 largest clients represented 17.9% and 53.4% of our 2002 worldwide revenue, respectively and 17.0% and 50.6% of our 2001 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.
Operating Expenses: Our 2002 worldwide operating expense increased $511.0 million, or 8.6% to $6,432.2 million from $5,921.2 million, or on an as adjusted basis by $605.8 million, or 10.4%, from $5,826.4 million in 2001, as described below.
Salary and service costs, which are comprised of direct service costs and salary related costs, increased by $532.0 million, or 12.0%, and represented 77.0% of total operating expenses in 2002 versus 74.7% in 2001. These expenses increased as a percentage of revenue to 65.7% in 2002 from 64.2% in 2001. Salaries and incentive compensation costs, which include bonuses, decreased as a percentage of revenue in 2002 primarily as a result of continuing efforts to align permanent staffing with current work levels on a location-by-location basis, as well as our attempts to increase the variability of our cost structure by relying more upon freelance labor for project work as necessary. This was offset by increased direct service costs resulting in greater utilization of freelance labor, changes in the mix of our revenues and increased severance related costs.
Office and general expenses decreased by $21.0 million, or 1.4%, in 2002. Office and general expenses represented 23.0% of our total operating costs in 2002 versus 25.3% in 2001. Additionally, as a percentage of revenue, office and general expenses decreased in 2002 to 19.6% from 21.8%. This decrease was the result of our efforts to better align costs with business levels on a location-by-location basis and the elimination of goodwill amortization in 2002, as a result of adopting SFAS 142 which represented $94.8 million in 2001.
On an as adjusted, non-GAAP basis, office and general expenses increased by $73.8 million, or 5.3%, in 2002. Office and general expenses represented 23.0% of our total operating costs in 2002 versus 24.1% in 2001. Additionally, as a percentage of revenue, office and general expenses decreased in 2002 to 19.6% from 20.4%. These decreases were primarily the result of our efforts to better align costs with business levels on a location-by-location basis.
For the foregoing reasons, our operating margin increased to 14.7% in 2002, from 14.1% on an as reported basis in 2001. However, on an as adjusted, non-GAAP basis, excluding goodwill amortization expense in 2001 our margins decreased from 15.4%.
Net Interest Expense: Our net interest expense decreased in 2002 to $30.5 million, as compared to $72.8 million in 2001. Our gross interest expense decreased by $45.4 million to $45.5 million. Of this decrease in gross interest expense, $12.4 million was attributable to the conversion of our $230.0 million aggregate
principal amount 2.25% convertible notes in December of 2001. The balance of the reduction was attributable to generally lower short-term interest rates as compared to the prior year, the issuance in February 2001 of $850.0 million Liquid Yield Option notes as to which substantially all of the related debt issuance costs were amortized in prior periods and the issuance in March 2002 of the $900.0 million aggregate principal amount of Zero Coupon Zero Yield Convertible notes of which $530.0 million was used to reduce existing interest bearing bank debt thereby reducing interest expense. The reduction in gross interest expense was partially offset by increased daily average outstanding debt levels resulting from our repurchase of common stock in the first quarter of 2002.
See "Liquidity and Capital Resources" for a discussion of our indebtedness and related matters.
Income Taxes: Our consolidated effective income tax rate was 35.0% in 2002 as compared to 39.3% in 2001. The rate declined by 2.4% directly as a result of the cessation of the amortization of goodwill in 2002. The remainder of reduction in the tax rate reflects the realization of our ongoing focus on tax planning initiatives.
Earnings Per Share (EPS): For the foregoing reasons, our net income for 2002 increased by 27.9% to $643.5 million from $503.1 million in 2001 and our diluted EPS increased by 27.4% to $3.44 from $2.70. While our net income in 2002 was positively impacted by the conversion of the 2.25% Convertible Subordinated Debentures at the end of 2001, the conversion of these debentures were included in computing basic and diluted EPS in 2002 and diluted EPS in 2001.
On an as adjusted, non-GAAP basis, our net income for 2002 increased by 9.8% to $643.5 million from $586.2 million in 2001 and our diluted EPS increased by 9.9% to $3.44 from $3.13.
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 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 service offerings, competitive position, reputation and geographic coverage, as well as our prior experience and judgment. The amount we paid for acquisitions, including cash, stock and assumption of net liabilities totaled $472.3 million in 2003 and $680.1 million in 2002.
Our acquisition strategy is to continue to build upon the core capabilities of our various strategic business platforms and agency brands through the expansion of their service capabilities and/or their geographic reach. 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. As a result, a significant portion of an acquired company's revenues are often derived from existing clients. Additional key factors we consider include the competitive position, reputation and specialized know-how of acquisition targets. In addition, due to the nature of advertising, marketing and corporate communications services companies, the companies we acquire frequently have minimal tangible net assets and identifiable intangible assets which primarily consist of customer relationships. Accordingly, a substantial portion of the purchase price is allocated to goodwill. We perform an annual impairment test in order to assess that the fair value of our reporting units exceeds their carrying value, inclusive of goodwill.
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 contingent purchase price obligations 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 and information about changes in GAAP relative to accounting for acquisitions and goodwill is described below in the "New Accounting Pronouncements" section and in note 13 to our consolidated financial statements.
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 by clients.
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" (SFAS 123), we have elected to account for employee stock option grants in accordance with Accounting Principles Board Opinion 25 -- "Accounting for Stock Issued to Employees" ("APB 25") and make annual pro forma disclosures (see note 7 to our consolidated financial statements) of the effect on our reported net income and earnings per share as if we adopted the fair value method of accounting for stock options for the relevant periods. Also in accordance with APB 25 we issue stock option awards with an exercise price equal to the quoted market price on the grant date and therefore we historically have not recorded any expense in our income statement.
SFAS 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure -- An Amendment of FASB Statement No. 123" ("SFAS 148"), was issued as an amendment to FASB No. 123, and provides alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. We continue to apply the accounting provisions of APB 25.
We adopted the quarterly disclosure requirement as required under SFAS 148 as set forth in our Form 10-Q filings during the 2003 year. Adopting this disclosure requirement did not have an impact on our consolidated results of operations or financial position. The FASB recently concluded that the fair value of stock options will need to be expensed and indicated that they will limit the transition methods for implementing SFAS 123 to the modified prospective method. The FASB is also considering alternative valuation methodologies. We will continue to monitor the progress of the FASB with regard to their guidance and the adoption of these standards.
We plan to adopt the fair value method of accounting for stock-based compensation during the first quarter of 2004 utilizing the modified prospective method and the restatement approach. We expect the effect will be to reduce net income and earnings per share in future periods. The impact on our net income and earnings per share for prior periods will be consistent with the pro forma disclosures included in note 7 to our financial statements.
New Accounting Pronouncements:
SFAS 146 -- Accounting for Costs Associated with Exit or Disposal Activities requires costs associated with exit or disposal activities be recognized and measured initially at fair value only when the liability is incurred. SFAS 146 is effective for exit or disposal costs that are initiated after December 31, 2002. We adopted SFAS 146 effective January 1, 2003. The adoption did not have a significant impact on our consolidated results of operations or financial position.
SFAS 150 -- Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). The provisions of SFAS 150 are effective for instruments entered into or modified after May 31, 2003 and pre-existing instruments as of July 1, 2003. On October 29, 2003, the FASB voted to indefinitely defer the effective date of SFAS 150 through the issuance FASB Staff Position 150-3 for mandatorily redeemable instruments as they relate to minority interests in consolidated entities. We adopted SFAS 150 in the third quarter of 2003, as modified by FSP 150-3. The adoption did not have a material impact on our consolidated results of operations or financial position. We will continue to closely monitor developments in the area of accounting for certain financial investments with characteristics of both liabilities and equity.
FASB Interpretation No. 45 -- Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others (FIN 45). FIN 45 sets forth the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. FIN 45 also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of FIN 45 are applicable to guarantees issued or modified after December 31, 2002. If the initial recognition and measurement issues were in effect at December 31, 2002, we would have recorded both an asset and a liability equal to $11.3 million related to certain real estate lease guarantees and letters of credit. Additional information appears in note 11 to our consolidated financial statements.
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. The effective date of FIN 46R applies 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 are not expected to 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 also released interpretive guidance covering several topics that impact our financial statements. These topics include revenue arrangements with multiple deliverables (EITF 00-21), customer relationship intangible assets acquired (EITF 02-17) and vendor rebates (EITF 02-16). The application of this guidance did not have a material impact on our consolidated results of operations or financial position.
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, purchases of treasury stock, payments for strategic acquisitions and capital expenditures. In 2003 and 2002, 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 funding available 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 difference being approximately $1.0 billion during these periods in 2003 and 2002. 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 about certain of our obligations as of December 31, 2003 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.
As more fully described on pages 21 and 22, 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, $1,739.3 million of the convertible notes could be due in less than one year, and $600.0 million could be due in the "1 to 5 Years" category above.
Due in Due in Due Less than 1 1 to 5 after 5 Total Year Years Years Due ----------- ------ ------- ----- Other Commercial Commitments at December 31, 2003 (in millions) Lines of Credit ................ $ -- $ -- $ -- $ -- Guarantees and letters of credit 0.1 0.7 0.1 0.9 ---- ---- ---- ---- Total .......................... $0.1 $0.7 $0.1 $0.9 ==== ==== ==== ====
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 any potential losses.
Contingent Acquisition Obligations
Certain of our acquisitions are structured with additional contingent purchase price obligations. 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. The amount of future contingent purchase price payments that we would be required to pay for prior acquisitions, assuming that the acquired businesses perform over the relevant future periods at their current profit levels, is approximately $462 million as of December 31, 2003. The ultimate amounts payable cannot be predicted with reasonable certainty because they are dependent upon future results and are subject to changes in foreign currency exchange rates. In accordance with GAAP, we have not recorded a liability for these items on our balance sheet since the definitive amount is not determinable or distributable. Actual results can differ from these estimates and the actual amounts that we pay are likely to be different from these estimates. Our obligations change from period to period as a result of payments made during the current period, changes in the previous estimate of the acquired entities' performance, changes in foreign currency exchange rates and other factors. These differences could be significant. The contingent purchase price obligations as of December 31, 2003, calculated assuming that the acquired businesses perform over the relevant future periods at their current profit levels, are as follows:
($ in millions) - ------------------------------------------------------------------------------ There- 2004 2005 2006 2007 after Total - ------ ------ ------ ------ ------- ------- $175 $152 $54 $37 $44 $462
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 these subsidiaries or affiliates. 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 $294 million, $178 million of which relate to obligations that are currently exercisable. The ultimate amount payable in the future relating to these transactions will vary because it is dependent on the future results of operations of the subject businesses, the timing of when these rights are exercised and changes in foreign currency exchange rates and other factors. The actual amounts that we pay are likely to be different from these estimates. These differences could be significant. The obligations that exist for these agreements as of December 31, 2003, calculated using the assumptions above, are as follows:
($ in millions) ---------------------------------------- Currently Not Currently Exercisable Exercisable Total ----------- ----------- ----- Subsidiary agencies ........... $154 $105 $259 Affiliated agencies ........... 24 11 35 ---- ---- ---- Total ......................... $178 $116 $294 ==== ==== ====
If these rights are exercised, there would likely be an increase in our net income as a result of our increased ownership and the reduction of minority interest expense.
Sources and Uses of Cash
Although our cash requirements in 2003 and 2002 were funded by operating cash flow, during the past three 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 purchase of treasury shares and the funding of selected investing activities.
At year-end 2003, we had $1,528.7 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 our control. Additionally, liquidity could be impaired by short and long-term debt ratings assigned by independent rating agencies, which are based on our performance as measured by credit ratios.
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 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.
Our committed bank facilities, described in detail in note 3, contain only two financial covenants, relating to cash flow and interest coverage, which the company met by a significant margin as of December 31, 2003.
We believe that our financial condition is strong and that our cash balances, 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.
Cash Management
We manage our cash and liquidity centrally through treasury centers in North America, Europe and Asia/Pacific. 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 all 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 our 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.
While our cash on hand balance at December 31, 2003 increased $861.8 million from the prior year, we manage our net debt position, which we define as total debt outstanding less cash on hand, centrally through our treasury centers as discussed above. Our net debt outstanding at December 31, 2003 decreased $292.2 million as compared to the prior year-end.
Debt Instruments, Guarantees and Related Covenants
We maintain two revolving credit facilities with two consortia of banks totaling $2,035.0 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. We fund our daily borrowing needs by issuing commercial paper. During 2003, we issued and redeemed $19.6 billion and the average term was 5.9 days. As of December 31, 2003, we had no commercial paper or bank loans outstanding under these credit facilities. We had short-term bank loans of $42.4 million at December 31, 2003, 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. The credit facilities contain financial covenants limiting 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 3.0 times. In addition, we are required to maintain a minimum ratio of EBITDA to interest expense of 5.0 times. At December 31, 2003, we were in compliance with these covenants, as our ratio of debt to EBITDA was 2.0 times and our ratio of EBITDA to interest expense was 22.9 times.
At December 31, 2003, 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. 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 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 is being 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 dues 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 is being 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 February 6, 2004, we repurchased for cash, notes from holders who exercised their put right for $0.006 million principal amount of Liquid Yield Option Notes due 2031.
At December 31, 2003, we had Euro-denominated bonds outstanding of (Euro)152.4 million or $192.0 million. The bonds pay a fixed rate of 5.2% to maturity in June 2005. The bonds serve as a hedge of our investment in Euro-denominated net assets. While an increase in the value of the euro against the dollar will result in a greater liability for interest and principal, there will be a corresponding increase in the dollar value of our Euro-denominated net assets.
Our outstanding debt and amounts available under these facilities as of December 31, 2003 ($ in millions) were as follows:
Debt Available Outstanding Credit ----------- -------- Bank loans (due in less than 1 year) ..................... $ 42.4 -- $835.0 million revolver -- due November 14, 2005 ......... -- $ 835.0 Commercial paper issued under 364-day facility ........... -- 1,200.0 (euro)152.4 million 5.20% Euro notes -- due June 24, 2005 192.0 -- 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 2012 ............ 17.7 -- -------- -------- Total .................................................... $2,591.4 $2,035.0 ======== ========
Additional information about our indebtedness is included in notes 3 and 4 of our consolidated financial statements.
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 profit margins.
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. Outside of major markets, our subsidiaries generally borrow funds directly in their local currency. 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, 2003, we had foreign exchange contracts outstanding with an aggregate notional principal of $1,251.0 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, 2003 we had cross-currency interest rate swaps in place with an aggregate notional principal amount of 19,100.0 million 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, 2003 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, including issuances of commercial paper. We currently have a 364-day facility with a one-year term out option and a 3-year facility. Accordingly we classify outstanding borrowings 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. We also plan to renew the 3-year facility with a new multi-year facility with similar terms. Our ability to obtain the required bank syndication commitments depends in part on conditions in the bank market at the time of syndication.
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, Fleet, 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, 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 to cause us to repurchase up to the entire aggregate face amount. We may offer the holders of our notes a cash payment or other incentives, such as extending the no-call period of the note to induce them to not put the notes to us in advance of a put date. If we were to decide to pay a cash incentive, our interest expense could increase based on market factors at the time.
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 one-time payments made in 2003 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. We can also preserve liquidity by satisfying some of or the entire put obligation with common equity, provided we notify the noteholders in advance of their put that we intend to do so. If a put were to be satisfied in cash, we expect to have sufficient 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 then evaluate all funding alternatives available to us to restore our credit capacity and liquidity to the level prior to any such put. We believe the funding alternatives would include substantially all forms of debt, equity and convertible instruments available to us by accessing the public or private capital markets. Our evaluation would likely include the expected cash flows from the normal course of our business operations and the credit capacity to fund additional potential puts on the remaining outstanding convertible notes.
If we were to replace the convertible notes with another form of debt on a dollar-for-dollar basis, it would have no impact on either our debt to capital ratios or our debt to EBITDA ratio. However, an increase in interest expense would negatively impact our coverage ratios, such as EBITDA to interest expense, if the replacement debt were to be interest bearing. Currently our coverage ratios applicable to our current rating levels are well above the thresholds since the majority of our long-term debt does not pay or accrue interest. Based on present expectations of our future operating cash flows and expected access to debt and equity capital markets, we believe any increase in interest expense and reduction in coverage ratios would still place us comfortably within an acceptable range. Thus, we do not expect any negative impact on our credit ratings if the convertible notes are put in the near future.
8. Financial Statements and Supplementary Data
Our financial statements and supplementary data are included at the end of this report beginning on page of this report. See the index appearing on page 26 of this report.
9. Changes and Disagreements with Accountants on Accounting and Financial Disclosure
None.
9A. Controls and Disclosure
We maintain disclosure controls and procedures designed to ensure that information required to be included in our SEC reports is recorded, analyzed and reported within applicable time periods. During the 90-day period prior to the filing of this report, we conducted an evaluation, under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of our disclosure controls and procedures. Based on that evaluation, our CEO and CFO concluded that they believe that our disclosure controls and procedures are effective to ensure recording, analysis and reporting of information required to be included in our SEC reports on a timely basis. There have been no significant changes in our internal controls or others factors that could be reasonably expected to significantly affect the effectiveness of these controls since the date that evaluation was completed.
PART III
10. Executive Officers
The executive officers of Omnicom Group Inc. as of March 1, 2004 are:
All of the executive officers have held their present positions at Omnicom for at least five years except as specified below.
Philip Angelastro was promoted to Senior Vice President of Finance in January 2002 and was appointed Controller on February 1, 1999. Mr. Angelastro joined the Company in June 1997 as Vice President of Finance of Diversified Agency Services after being a Partner at Coopers & Lybrand LLP.
Jean-Marie Dru was appointed President and Chief Executive Officer of TBWA Worldwide in March 2001. He had previously been President International of TBWA Worldwide. Mr. Dru was co-founder and Chairman of BDDP Group, which merged with TBWA in 1998.
Ken Kaess has been Chief Executive Officer and President of DDB Worldwide since January 2001, and President since December 1999. Prior to that he was President of DDB North America.
Peter Mead was appointed Vice Chairman on May 16, 2000. He had previously been Group Chief Executive of Abbot Mead Vickers plc and Joint Chairman of AMV BBDO.
Michael O'Brien joined Omnicom in November 2003 and was appointed Senior Vice President, General Counsel and Secretary in December 2003. Prior to that, he was a partner in the law firm of Goodwin Procter LLP (since April 2002). Prior to that, he was a partner in the law firm of O'Sullivan LLP.
Additional information about our directors and executive officers appears under the captions "Election of Directors", "Stock Ownership", "Director Compensation" and "Executive Compensation" in our 2004 proxy statement.
PART IV
15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) Financial Statements: Page ---- Management Report .............................................. Report of Independent Public Accountants ....................... Consolidated Statements of Income for the Three Years Ended December 31, 2003 ......................... Consolidated Balance Sheets at December 31, 2003 and 2002 ...... Consolidated Statements of Shareholders' Equity for the Three Years Ended December 31, 2003 ......................... Consolidated Statements of Cash Flows for the Three Years Ended December 31, 2003 ..................................... Notes to Consolidated Financial Statements ..................... Quarterly Results of Operations (Unaudited) ....................
(a)(2) Financial Statement Schedules: Schedule II -- Valuation and Qualifying Accounts (for the three years ended December 31, 2003)................ S-1
All other schedules are omitted because they are not applicable.
(a)(3) Exhibits:
Exhibit Numbers Description ------- ----------- (3)(i) Restated Certificate of Incorporation (Exhibit 3.1 to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2003 and incorporated by reference).
(ii) By-laws (Exhibit 3.2 to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2003) and incorporated by reference (File No. 1-10551).
4.1 Fiscal Agency Agreement, dated June 24, 1998, in connection with our issuance of 1,000,000,000 5.20% Notes due 2005 (the "5.20% Notes") (Exhibit 4.1 to our Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (the "6-30-98 10-Q") (File No. 1-10551) and incorporated herein by reference).
4.2 Subscription Agreement, dated June 22, 1998, in connection with our issuance of the 5.20% notes (Exhibit 4.2 to our 6-30-98 10-Q and incorporated by reference).
4.3 Deed of Covenant, dated June 24, 1998, in connection with our issuance of the 5.20% notes (Exhibit 4.3 to the 6-30-98 10-Q and incorporated by reference).
4.4 Indenture, dated February 7, 2001, between JPMorgan Chase Manhattan Bank, as trustee, and us in connection with our issuance of $850,000,000 Liquid Yield Option notes due 2031 (the "2031 Indenture") (Exhibit 4.1 to our Registration Statement on Form S-3) (Registration Statement No. 333-55386 and incorporated by reference).
4.5 Form of Liquid Yield Option notes due 2031 (included in Exhibit 4.4 above).
4.6 First Supplemental Indenture to the 2031 Indenture, dated as of February 13, 2004, between us, Omnicom Capital Inc., Omnicom Finance Inc. and JPMorgan Chase Bank (Exhibit 4.3 to our Registration Statement on Form S-3 (File No. 112840) and incorporated herein by reference).
4.7 Indenture, dated March 6, 2002, between JPMorgan Chase Bank as trustee and us in connection with our issuance of $900,000,000 Zero Coupon Zero Yield Convertible notes due 2032 (the "2032 Indenture") (Exhibit 4.6 to our Annual Report on Form 10-K for the year ended December 31, 2001 and incorporated by reference).
4.8 Form of Zero Coupon Zero Yield Convertible notes due 2032 (included in Exhibit 4.7).
4.9 First Supplemental Indenture to the 2032 Indenture, dated as of February 13, 2004, between us, Omnicom Capital Inc., Omnicom Finance Inc. and JPMorgan Chase Bank (Exhibit 4.3 to our Registration Statement on Form S-3 (File No. 112841) and incorporated herein by reference).
4.10 Indenture, dated as of June 30, 2003, between JPMorgan Chase Bank, as trustee, and us in connection with our issuance of $600,000,000 Zero Coupon Zero Yield Convertible Notes due 2033 (the "2033 Indenture") (Exhibit 4.1 to Registration Statement 333-108611 and incorporated by reference).
4.11 Form of the Zero Coupon Zero Yield Convertible Notes due 2033 (included in 4.10 above).
4.12 First Supplemental Indenture, to the 2033 Indenture, dated as of November 5, 2003, between JPMorgan Chase Bank, as trustee, and us, Omnicom Capital Inc. and Omnicom Finance Inc. (Exhibit 4.4 to Registration Statement 333-108611 and incorporated by reference).
10.1 Credit Agreement, dated November 14, 2002, among Omnicom Finance Inc., Omnicom Capital Inc., Omnicom Finance PLC, us, Salomon Smith Barney Inc. and ABN AMRO Incorporated, as lead arrangers for the institutions party thereto (Exhibit 10.1 to our Annual Report on Form 10-K for the year ended December 31, 2002 and incorporated by reference).
10.2 364-day Credit Agreement, dated November 13, 2003, among Omnicom Finance Inc., Omnicom Capital Inc., Omnicom Finance PLC, the financial institutions party thereto, Citibank, N.A., as Administrative Agent and Salomon Smith Barney Inc., as Lead Arranger, ABN AMRO Bank N.V., as syndication agent, HSBC Bank USA, Wachovia Bank, National Association and Societe Generale, as documentation agents (Exhibit 10.1 to our Periodic Report on Form 8-K filed on December 2, 2003 and incorporated by reference).
10.3 Amendment to the Credit Agreement, dated as of April 30, 2003, among Omnicom Finance Inc., Omnicom Capital Inc., Omnicom Finance PLC, collectively as borrowers, us, as guarantor and UBS AG as lender (Exhibit 10.1 to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2003).
10.4 Amended and Restated 1998 Incentive Compensation Plan (Exhibit B to our Proxy Statement filed on April 10, 2000 and incorporated by reference).
10.5 Restricted Stock Plan for Non-employee Directors (Exhibit 10.10 to our Annual Report on Form 10-K for the year ended December 31, 1999 and incorporated by reference).
10.6 Standard form of our Executive Salary Continuation Plan Agreement (Exhibit 10.24 to our Annual Report on Form 10-K for the year ended December 31, 1998 and incorporated by reference).
10.7 Standard form of the Director Indemnification Agreement (Exhibit 10.25 to our Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated by reference).
10.8 Severance Agreement, dated July 6, 1993, between Keith Reinhard and DDB Worldwide Communications Group, Inc. (Exhibit 10.11 to our Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated by reference).
10.9 Long-Term Shareholder Value Plan (Exhibit 4.4 to our Registration Statement on Form S-8 dated March 19, 2002, (File No. 333-84498) and incorporated by reference).
10.10 Executive Salary Continuation Plan Agreement -- Thomas Harrison (Exhibit 10.7A to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2002 (the "6-30-02 10-Q") and incorporated by reference).
10.11 Executive Salary Continuation Plan Agreement -- Peter Mead (Exhibit 10.7B to our 6-30-02 10-Q and incorporated by reference).
10.12 Executive Salary Continuation Plan Agreement -- Keith L. Reinhard (Exhibit 10.7C to our 6-30-02 10-Q and incorporated by reference).
10.13 Executive Salary Continuation Plan Severance Compensation Agreement -- Allen Rosenshine (Exhibit 10.7D to our 6-30-02 10-Q and incorporated by reference).
10.14 Executive Salary Continuation Plan Agreement -- John Wren (Exhibit 10.7E to our 6-30-02 10-Q and incorporated by reference).
10.15 Equity Incentive Plan (Exhibit 4.3 to our Registration Statement on Form S-8 dated August 18, 2003 (File No. 333-108063) and incorporated by reference).
12.1 Ratio of Earnings to Fixed Charges.
21.1 Subsidiaries of the Registrant.
23.1 Consent of KPMG LLP.
31.1 Certification of Chief Executive Officer and President required by Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
31.2 Certification of Executive Vice President and Chief Financial Officer required by Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.
32.1 Certification of the Chief Executive Officer and President and the Executive Vice President and Chief Financial Officer required by Rule 13a-14(b) under the Securities Exchange Act of 1934, as amended and 18 U.S.C ss.1350.
(b) Reports on Form 8-K
On October 28, 2003, we filed a Current Report on Form 8-K to furnish under Item 9 (Regulation FD Disclosure) and Item 12 (Results of Operations and Financial Condition) our press release announcing our operating results for the third quarter of 2003 and the text of materials used in the related call at which such results were discussed.
On December 2, 2003, we filed a Current Report on Form 8-K to file under Item 5 and Item 7