Omnicom Group Inc (OMC) — Q3 2016 Earnings Call Transcript

Good morning. Thank you for taking the time to listen to our third quarter 2016 earnings call. On the call with me today is John Wren, President and Chief Executive Officer; and Phil Angelastro, Chief Financial Officer. We hope everyone has had a chance to review our earnings release. We have posted on our website, this morning's press release, along with the presentation covering the information that we will review this morning. This call is also being simulcast and will be archived on our website. Before we start, I've been asked to remind everyone to read the forward-looking statements and other information that we have included at the end of our investor presentation. And to point out that several of the statements made today may constitute forward-looking statements, and that these statements are our present expectations, and that actual events or results may differ materially. I would also like to remind you that during the course of the call, we will discuss some non-GAAP measures in talking about Omnicom's performance. You will find the reconciliation of those measures to the nearest comparable GAAP measures in the presentation material. We're going to begin this morning's call with an overview of our business from John Wren. Then Phil Angelastro will provide our financial results for the quarter. And then we will open up the line for your questions.

Thank you, Shub. Good morning everyone and thank you for joining our call. I'm pleased to speak to you this morning about our third quarter 2016 business results. Organic revenue growth for the third quarter was 3.2%, which is in line with our internal targets. For the nine months ended September 30th, organic growth is 3.4%. Our EBITA margins exceeded our expectations and increased 40 basis points for the third quarter and are up 40 basis points for the nine months ended September 30th. Based on our year-to-date results, we are on track to meet our internal revenue and margin targets for the year. As we have discussed, foreign exchange continued to have a negative impact on our earnings during the quarter, although the effect of currencies has significantly declined compared to what we experienced in 2015. At this point, the biggest movement is the decline of the British pound versus the U.S. dollar. Phil will provide more details on our margin improvement and currency outlook during his remarks. Turning to our organic growth, it was broad based across our major regions and disciplines. This growth highlights the consistency and diversity of our operations, even in the face of tepid economic conditions and the uncertainty created by events in our two largest markets; the Presidential Election in the United States and Brexit in the U.K. Our performance underscores the strong competitive position of our agencies across the spectrum of advertising and marketing disciplines and key geographic markets, as well as our digital and analytical expertise. Looking at organic growth by region, North America was up 1.7%. This was in the face of difficult comps when compared to the third quarter 2015. North American growth was driven by strong performance in media and public relations. Our U.K. organic growth was 5.2%, reflecting very solid performance from our portfolio of agencies in the market. The situation in the U.K. is clearly something we're monitoring closely. At this point, we're not able to fully assess the effect Brexit could have on our operations in either the U.K. or the rest of Europe. In Europe, we experienced growth of 2%. The Eurozone markets were essentially flat for the quarter, as very strong growth in Italy and Spain was offset by a difficult quarter in Germany and declines in France and the Netherlands. Outside the Euro markets, growth was in the low teens, with the Czech Republic, Russia and Sweden outperforming during the quarter. Turning to Asia, third quarter organic growth was 8%. Australia, India, Japan and New Zealand all had strong results, and growth in Greater China moderated to just over 4%. Latin America was up 11.9%, driven by very strong performance in Mexico. Brazil was also positive for the quarter, helped in part by Olympic activity. EBITA for the quarter increased $27.4 million or 6% to $482.1 million. Our EBITA margin increased to 12.7% versus 12.3% in the third quarter of 2015. Looking at our bottom-line, net income available for common shares for the third quarter of 2016 increased $15.8 million or 6.7% to $252.6 million. And our average share count was down 2.3% from the prior year. The combined result was an increase in EPS of 9.3% to $1.06 per share for the quarter versus $0.97 per share for the same quarter a year ago. For the nine months ended September 30th, our cash flow balance sheet and liquidity remained very strong. We generated $1.1 billion in free cash flow and returned approximately $800 million to shareholders through dividends and share purchases. Looking at the rest of the year, there are a couple of factors that result in less visibility as we plan for Q4. As has consistently been the case over a number of years, there's quite a bit of project work in the fourth quarter that can impact revenue. Each year, we found this year-end project work is between $200 million and $250 million. Client spending on these projects is not easily forecast and typically is based on individual client circumstance and general economic conditions. This year is further complicated by the upcoming U.S. Presidential Election, the increasing likelihood that the Fed will raise rates before year-end and the potential effects of Brexit. Partially offsetting these unknowns is our recent new business success. Some of these wins, like AT&T, will start generating incremental revenue in the fourth quarter and others, like Volkswagen Media and McDonald's, will not contribute to incremental revenue until January 2017. Let me now discuss what we're seeing in the industry and how our strategies allow us to achieve consistent financial results. During the third quarter, we stayed focused on executing our strategies for growth; attracting, retaining, and developing top talent; extending our capabilities around the world and moving into new service areas, building our digital and analytical competencies by investing in platforms and agencies and partnering with innovative technology companies; and collaborating to deliver big ideas and results based upon meaningful consumer insights across all channels. The significant wins I just mentioned prove Omnicom has the brightest talent, using the latest digital and analytical tools in the marketplace.

Thank you, John and good morning. As John said, our business has once again met the financial and strategic objectives we set for them. They also performed well in meeting the objectives of their clients, as well as winning new business. For the third quarter, organic growth was 3.2%, and for the year-to-date period, it was 3.4%. FX continues to represent a headwind to our revenue, driven in large part by the weakening of the British pound year-over-year. For the third quarter, the FX impact reduced revenue 1.3% or about $50 million. Including the positive impact of 0.4% from our net acquisition activity, total revenue for the quarter was just under $3.8 billion, an increase of 2.3% versus Q3 of last year. I'll review our revenue growth in detail in a few minutes. Moving down the income statement to the items below revenue, our Q3 EBITDA increased 6.0% to $482 million. And the resulting EBITDA margin of 12.7% represents a 40 basis point increase over Q3 of last year. The increase, which exceeded our targeted 30 basis point improvement for the full year of 2016, is mainly the result of our ongoing initiatives to leverage scale and enhance efficiency on a companywide basis, as well as a change in business mix for the quarter. Operating income, or EBIT, for the quarter increased 5.8% to $453 million, with operating margin improving to 12.0%, in line with the EBITA margin improvement. Now, turning to the items below operating income. Net interest expense for the quarter was $42 million, down $2.8 million versus the second quarter of 2016 and up $6.1 million versus Q3 of 2015. Gross interest expense was down slightly compared to Q2 2016. As you know, when our $1 billion in 2016 senior notes reached maturity back in April, we issued $1.4 billion of 10-year senior notes due in 2026. We also entered into a fixed-to-floating interest rate swap on $500 million of the 2026 notes. Although we incrementally added $400 million in debt, the net effect of the reduction in rates on the new notes, combined with the rate swaps, reduced our gross interest expense. The third quarter had the benefit of this reduction for the full quarter, compared to only a partial benefit in Q2, resulting in a reduction compared to Q2 of approximately $1.5 million in interest expense. As compared to Q3 of last year, the increase in gross interest expense of $7.3 million, primarily resulted from the termination of the fixed-to-floating rate swaps on our 2022 notes. Interest income earned in Q3 of 2016 was a bit higher when compared to both Q2 of 2016 and Q3 of 2015, resulting from higher interest earned on the cash held by our international treasury centers. Our effective tax rate for the third quarter was 32.7%, which is in line with our current expectations for our annual rate. Earnings from our affiliates totaled $1.4 million for the quarter, down a little versus Q3 last year. The allocation of earnings to the minority shareholders in our less than fully owned subsidiaries decreased $3 million to $24.4 million. The decrease is the result of purchase in minority interest in certain subsidiaries over the past year, operational changes in a few agencies, and the negative effect of FX because a large portion of our less-than-fully-owned subsidiaries are located outside the U.S. As a result, net income was $253.8 million. That's an increase of $14.5 million or 6.1% versus Q3 of last year. Turning to slide three, the remaining net income available for common shareholders for the quarter after allocation of $1.2 million of net income to participating securities was $252.6 million, up $15.8 million or 6.7% when compared to last year's Q3. You can also see that our diluted share count for the quarter was $238.7 million, which is down 2.3% versus last year as a result of repurchases of shares over the past year. As a result, diluted EPS for the quarter was $1.06, up $0.09 or 9.3% versus Q3 2015.

For the nine months ended September 30th, our cash flow balance sheet and liquidity remained very strong. We generated $1.1 billion in free cash flow and returned approximately $800 million to shareholders through dividends and share purchases. Looking at the rest of the year, there are a couple of factors that result in less visibility as we plan for Q4. As has consistently been the case over a number of years, there's quite a bit of project work in the fourth quarter that can impact revenue. Each year, we found this year-end project work is between $200 million and $250 million. Client spending on these projects is not easily forecast and typically is based on individual client circumstance and general economic conditions. This year is further complicated by the upcoming U.S. Presidential Election, the increasing likelihood that the Fed will raise rates before year-end and the potential effects of Brexit. Partially offsetting these unknowns is our recent new business success. Some of these wins, like AT&T, will start generating incremental revenue in the fourth quarter and others, like Volkswagen Media and McDonald's, will not contribute to incremental revenue until January 2017. Let me now discuss what we're seeing in the industry and how our strategies allow us to achieve consistent financial results. During the third quarter, we stayed focused on executing our strategies for growth; attracting, retaining, and developing top talent; extending our capabilities around the world and moving into new service areas, building our digital and analytical competencies by investing in platforms and agencies and partnering with innovative technology companies; and collaborating to deliver big ideas and results based upon meaningful consumer insights across all channels. The significant wins I just mentioned prove Omnicom has the brightest talent, using the latest digital and analytical tools in the marketplace.

Thank you, John and good morning. As John said, our business has once again met the financial and strategic objectives we set for them. They also performed well in meeting the objectives of their clients, as well as winning new business. For the third quarter, organic growth was 3.2%, and for the year-to-date period, it was 3.4%. FX continues to represent a headwind to our revenue, driven in large part by the weakening of the British pound year-over-year. For the third quarter, the FX impact reduced revenue 1.3% or about $50 million. Including the positive impact of 0.4% from our net acquisition activity, total revenue for the quarter was just under $3.8 billion, an increase of 2.3% versus Q3 of last year.

The client feedback from these wins highlights two major themes. First, we have outstanding talent that can truly work together. And second, we have the ability to leverage superior data and analytics that drive sharper insights, more relevant and resonant creative work, and more efficient and effective media delivery. Effective collaboration among our agencies and with our clients and outside partners is part of the culture we have worked to organically build at Omnicom. It's gratifying to see that it is being recognized by clients. We believe the ability of our people to effectively and actively coordinate will be increasingly important as marketers use data-driven insights to inform creative and media planning.

Operator, we will now open the line for questions.

Hi, thank you, and good morning. John, could you provide some insights on the overall health of the advertising business and the trends you're observing? I understand that projecting Q4 is challenging. You mentioned the project business, which I completely grasp. I'm looking to understand if you believe the underlying revenue trends are consistent with what you've experienced year-to-date. Specifically regarding the U.S., I know the comparisons were tough this quarter. Are there any other factors impacting the U.S. that we should consider for the remainder of the year? Additionally, did P&G have any impact on the quarter in Q3, or will we see more of that in Q4?

I believe this is my 80th call as CEO. Over the past 20 years, I've mentioned that in the third quarter, results typically range from $200 to $250 million, particularly regarding our project business, which is challenging to forecast at this time. We will have to see how it plays out as we progress through the quarter. In the last two decades, there has only been one year where this did not hold true, likely 2008. While I am cautious, we are reviewing everything and do not observe any fundamental shifts in the trends we have been seeing. Some of our new business wins will not contribute to additional revenue until 2017, and while we are pleased to have them, we are currently working on staffing for these projects. There will not be a substantial immediate boost in the fourth quarter, but looking beyond that, the trends appear positive and it's business as usual. The unpredictability surrounding the general election has made this fourth quarter somewhat chaotic, as clients who have the ability to pause projects are waiting to see the outcome. I hope we can move past this soon. That summarizes the situation, Alexia. The U.S. remains the largest segment of our business, and while we have a strong presence there, the ongoing uncertainty is not benefiting us.

Yes. Aside from a small consulting business in the political sector, we haven’t observed any significant impact from the national elections on our third quarter performance. We do not anticipate it will affect our fourth quarter either. Regarding P&G, there was a benefit in this quarter, but we prefer not to disclose revenue specifics for individual clients. Overall, while there is a minor benefit, it is not substantial in relation to Omnicom as a whole.

Okay. And just one more question, just sort of broader question. I mean, you've won some; you've pulled in some big high profile accounts consolidated to your benefit lately. I know as the headlines and you always have sort of the engine right that we don't necessarily see. But talking about sort of these big headline wins, is there anything I guess different in the new business environment that is sort of clearly to your benefit? Or is it still maybe one competitor still a little bit losing more share than others? Is it more of the same? I guess any color on those bigger wins that we've seen? Thank you.

I believe we are experiencing an improvement in our ability to work better, more cost-effectively, and more efficiently through enhanced coordination and collaboration across various disciplines, particularly in media and advertising. However, I don't want to confine it to just that area, as the benefits extend throughout the entire company. We demonstrated this strongly during the third quarter, especially in light of the challenges and successes we faced.

Yes, good morning. A few housekeeping questions to start. Thank you. In the third quarter, I'm just curious what was the net new billings, assuming you typically try to get about $1 billion of net new billings basis. What was it?

The number was about $1.9 billion, so just under $2 billion.

Okay. And then what's going on with Germany? You said obviously did there's good strong market for you relative to the rest of Europe for a number of years. All of a sudden, now it's turned down year-over-year, is it local economy there or something else going on in the account front?

From our perspective, Craig, the third quarter is just one quarter and is relatively small compared to the second and fourth quarters. Last year, during the third quarter of 2015, we saw about 8% organic growth in Germany, making it a significant quarter. The comparisons this year were challenging. We do not view the third quarter of 2016 as an indicator of future trends, and we anticipate facing some challenges with our agencies in Germany as we approach the fourth quarter of 2017. Therefore, we wouldn't interpret this as a trend moving forward for Germany. We expect some tough comparisons, and a part of it may be related to timing quarter-over-quarter. Overall, we are not particularly worried about our performance in Germany.

And then back on North America, please, the 1.7% organic number in the third quarter, are you feeling right now the fourth quarter is setting up to be similar to growth rate that you saw in the third quarter? Or can it rebound potentially block out in the first half or is that too optimistic?

I think, John, can add on my comments. But I think it's still a little bit early to tell. We don't think there's anything fundamentally that's an issue in the U.S. and North America for us and our agencies. We think there's some uncertainty out there in the overall environment that could have something to do with it. We certainly have some challenging comps in the third quarter versus Q3 of 2015. And we'll have much better perspective on that as we go through our planning process over the next few weeks.

Hey, good morning everyone. John, we just went through Advertising Week and one of the dominant themes continues to be around transparency. And I wanted to ask a little bit about Accuen, in particular. We know that business has used the principal base model at times. And just curious how you see that business evolving as client needs evolve? And then secondly, if you could spend a little bit of time on where you're doing programmatic ad buying outside of Accuen? I think sometimes it's lost on the outside community vendors, investors alike that this is a discipline that is increasingly embedded right at OMG's various agencies at Hearts & Science, PHD and OMD. And just if you could remind us a little bit about how programmatic buying is spreading down for those agencies that would be helpful as well.

The programmatic business has been evolving rapidly over the last couple of years. It's primarily focused on ROI and effectively targeting audiences. We offer clients a bundled product with guarantees on price and expected outcomes. Additionally, our three media groups can provide unbundled products for greater transparency, depending on client objectives and preferences. We are prepared to offer either solution to the brands we serve, as different clients have varying goals. One approach may suit one client's objectives while another may work better for someone else, resulting in more choices than commonly perceived. A crucial aspect to consider is the measurement used to determine if clients are receiving the value they expect. It's essential to remember that if you're providing the service, you can't evaluate your own performance.

Yes, I think, one other comments on the win. So, while we do have some work to do in terms of our planning process to get better handle on the actual numbers in terms of the impact as we look at 2017, certainly, we look at the wins as bigger in the perspective that Hearts & Science really has a big strong base now in addition to P&G. And PHD is a network with the global Volkswagen win certainly has more halves than many of the markets, where they were smaller player in the past. So, as far as our media networks go, we feel really good that we've got three very strong platforms to grow off. And I think the other comment John had touched on this earlier, the investments we made in our data analytics business, you really see them come to bear some fruit, especially when you look at some of these more recent wins. So, we think the benefits to the foundation for growth in the future are as important, if not more important, than the actual revenues that the first few client wins here that we've had will give us in 2017.

During the quarter, we didn't mention it, but Hearts & Science, in addition to their operations in the U.S. and Canada, launched in the U.K. They are currently seeking business in Germany, and with the AT&T win, Hearts & Science has opened in Mexico. This network, which is just a year old, includes the first and second largest advertisers in the U.S., and we are beginning to expand and secure business in other markets. Phil’s remarks about PHD are crucial. We have had PHD for quite a while, primarily serving Anglo markets in Northern Europe and the U.S. The Volkswagen win enables us to compete in many more markets, which was a necessary development for the company, and we anticipate more opportunities from both of these avenues moving forward. Another vital point, although intangible, is the level of collaboration and coordination among the accounts we secured, which was exceptional. We have always emphasized this culturally within Omnicom, but it seems to have really paid off this time with significant wins. I am very optimistic about the positive indicators we see and what we can expect moving forward due to the strength we have built.

Great. Thank you.

I think we have time for one more call operator.

Thank you. Phil, your margin expansion in the quarter was the best. I'm thinking about five years for the third quarter, and I was wondering if you could talk a little more about the drivers and is there any benefits from business either rolling on or off? And I guess the implication that there'll be more investment in the fourth quarter given your margin growth year-to-date?

We are pleased with our performance in the third quarter, although it's a smaller quarter overall. While a 10 basis point increase may not seem significant in isolation, we observed several positive factors this quarter. We continued to benefit from our efforts to enhance scale and efficiency across the organization, saw a reduction in freelance labor usage, and experienced improved performance from some of our previously underperforming agencies compared to last year. Most of the year-to-date margin gains stem from these efficiency initiatives, which we believe will sustain going forward. Looking ahead to the fourth quarter, we remain cautious due to less visibility than in previous years. Therefore, similar to past years, we are not adjusting our expectation for a 30 basis point improvement in Q4. However, we will keep advancing the initiatives we have implemented.

No, we are currently in the process of hiring a significant number of people every week. However, we expect it will take about two months to be fully staffed for the business we have in-house today. This is an ongoing process.

Okay. Thank you everybody for listening in.