Omnicom Group Inc (OMC) — Q3 2018 Earnings Call Transcript

Good morning. Thank you for taking the time to listen to our third quarter 2018 earnings call. On the call with me today is John Wren, Chairman 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 the press release on our website this morning 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 have 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 certain 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 can find the reconciliation of those measures to the nearest comparable GAAP measures in the presentation materials. We are going to begin this morning’s call with an overview of our business from John Wren. Then, Phil Angelastro will review our financial results for the quarter. And then we will open up the line for your questions.

Thank you, Shub. Good morning. Thank you for joining our call this morning. I am pleased to speak to you this morning about our third quarter 2018 results. It’s been a very busy quarter as we successfully executed many of the repositioning plans and dispositions that we discussed on our last call on July 17. On August 31, we completed the previously announced disposal of Sellbytel. In addition, during the third quarter, we disposed of 18 other companies, which were primarily in our CRM execution and support discipline and to a lesser extent in our CRM consumer experience discipline. These businesses were no longer aligned with our long-term strategy. The disposition activity resulted in a net gain to our P&L in the quarter, which Phil will cover during his remarks. With respect to the company’s results, we reduced headcount by approximately 7,000 people. We also accelerated certain planned cost reduction and real estate consolidation activities in the quarter. During the quarter, we took actions to reduce our staff in our ongoing operations by over 1,400 people with annual payroll of approximately $135 million. These staff actions fell into three general categories. Approximately 500 positions will be replaced as we refresh and upgrade our talent to meet our agency’s current needs. The retirement of a number of senior executives in our networks, practice areas, and at Omnicom corporate; these retirements ensure that our succession plans are up-to-date and that we are creating opportunities for upcoming leaders; and the savings from the remaining reductions in headcount will contribute to our goal of offsetting the EBIT loss from the dispositions we completed in the quarter. During the quarter, we also accelerated our real estate consolidation plans by creating more large open and modern campus-style hubs, encouraging greater cross-agency collaboration. This move has resulted in efficiencies by allowing us to vacate more than 400,000 square feet in several cities, including Atlanta, Dallas, New York, and London. In addition to discussing the net gain from our disposition activity, Phil will address the repositioning costs we incurred in the quarter associated with the staff and real estate actions. Looking forward, we expect that the reduction to our EBIT from the dispositions we completed will be substantially offset by savings achieved from our cost reduction and real estate consolidation actions. We continued to evaluate the portfolio of businesses to identify areas for investment and acquisition opportunities as well as to identify non-strategic or underperforming businesses for potential disposition. Turning now to our third quarter results, prior to the end of the second quarter, we began to hold discussions with interested buyers and the managers of many of the companies we disposed of during the third quarter. As you would expect, given the activity related to preparing for the dispositions, the managers of these businesses were distracted, causing a decline in the performance of these businesses during the quarter. The impact of the dispositions reduced overall organic growth by 0.40% in the quarter and reduced organic growth in the U.S. by 0.60% in the quarter. Assuming all of our third quarter dispositions had occurred on July 1, we would have had a total organic growth of 3.3% for the quarter and 1.2% in the U.S. for the quarter, which better reflects the performance of the portfolio companies that we now have. Third quarter EBIT margin, excluding the impact from the net gain from dispositions and the repositioning costs, was 12.7%, up 10 basis points versus the same period in 2017, and EPS excluding these same items was up 9.7% to $1.24 per share for the quarter. Looking at our third quarter organic growth across disciplines, we had positive results in almost every area of our portfolio. Advertising and media were up 4%, CRM consumer experience was up 5.5%, healthcare was up 2.9%, and PR increased 2.4%. CRM execution and support was down 3.6% in the quarter. The majority of our dispositions were in this area. By region, the U.S. was up 1.2% in the quarter; CRM consumer experience and healthcare performed very well. Advertising and media as well as public relations had positive results. CRM execution and support was negative. Looking forward to 2019, we will benefit from some of our recent new business wins, which I will discuss later in my remarks. I am cautiously optimistic that our growth in the U.S. will continue to improve. Canada was down 6.4% for the quarter, driven by a decline in our media operations as well as weak performance in our advertising agencies. The UK was down 0.30% in the third quarter. CRM consumer experience and PR performed very well while healthcare was also positive. Offsetting this growth were declines primarily in CRM execution and support, particularly in research and field marketing. Overall growth in the euro and non-euro region was very strong at 6.9%, led by France, Italy, Spain, Russia, and the Czech Republic. Germany had negative growth for the quarter. Asia Pacific third quarter organic growth was up 14% as Australia, China, and New Zealand had double-digit growth and most of the markets in the region performed well. Latin America increased by almost 2% for the quarter, Mexico and Colombia led the way with middle single-digit growth. Brazil was flat for the quarter. Our smallest region, the Middle East and Africa, was nominally negative in the quarter. Looking at our cash flow, in the nine months of 2018, we generated $1.1 billion in free cash flow and returned $930 million to shareholders through dividends and share repurchases. Our use of cash remains unchanged, paying our dividend, pursuing accretive acquisitions, and repurchasing shares with the balance of the free cash flow. Lastly, our balance sheet and liquidity remain very strong. We are pleased with our financial performance in the third quarter and remain on track to achieve our full-year objectives for 2018. Turning now to our operations, we continued to restructure our organization to keep pace with the structural changes in our industry and the needs of our clients. At the same time, we remain very focused on the areas that differentiate Omnicom from our other competitors. Omnicom houses some of the industry's most iconic brands like BBDO, DDB, and TBWA, among many others. Our philosophy is that individual agencies driven by strong cultures will continue to exist as incubators of creativity. We are deploying digital data and analytical tools to enhance the delivery of our services from strategy to creative to media to PR and precision marketing so that we can deliver meaningful personalized messages at scale. Today, virtually all of our businesses are improving their services through the utilization of new technologies and data. Finally, we continue to focus on our agility and being able to offer our services to clients in a manner that is consistent with their go-to-market strategies. This means having a flexible and nimble organization that aligns our people and assets that serve the specific needs of our clients. The actions we took in the quarter that I discussed earlier will further streamline our operations and allow us to act in an even more agile manner. I'm pleased to report that we're in a very strong competitive position. We have remained focused and are making progress on our key strategic objectives, growing and developing our talent while increasing the diversity of our workforce, simplifying our service offering and organization through our new practice area and client matrix structure, making investments in our agencies and acquisitions to expand our capabilities in data analytics and precision marketing, and maintaining a relentless focus on improving our operational efficiencies throughout our entire portfolio. We’ve made good progress on enhancing our capabilities in digital transformation, data-driven solutions, and customer-centric services in the third quarter through acquisitions and investments. In July, Omnicom Precision Marketing Group acquired Credera, a full-service management and IT consulting firm with offices in Dallas, Houston, and Denver. With a core focus on martech and ecommerce platforms, the company delivers solutions that increase consumer engagement and drive sales growth for its clients. Credera, combined with Omnicom Precision Marketing Group’s global presence and leadership in data and analytics, creates a compelling offering for Omnicom's existing clients and prospects. In August, Clemenger BBDO purchased the majority stake in Levo, a leading marketing services and technology business with offices across Australia and New Zealand. The company helps its clients expand and transform their organizations by designing and deploying marketing automation and ecommerce platforms. Combined with Clemenger's existing digital and data capabilities, Levo will enable the Group to have one of the most advanced business transformation capabilities in the market. And on October 1, we acquired the media and marketing performance business of United Digital Group in Germany. The business is one of the largest performance marketing providers in the market with a suite of offerings, including SEO, SEA, Affiliate Marketing, Social Media Advertising, and Digital Analytics. We also continue to invest in our data and analytics platform during the quarter. As I discussed on our last call, we recently launched a people-based precision marketing and insight platform called Omni. Omni is an enterprise-wide platform to connect creative CRM and media across a single audience definition. By the end of the year, our goal is to have all of our agencies using Omni to create, plan, and execute campaigns for our clients. Now let me turn to some of our recent new business wins, which reflect the talented people that represent Omnicom every day. In early October, Ford named BBDO as its global creative agency. The Ford win reinforces our view that clients continue to recognize the increasing importance and the power of big creative ideas that will differentiate customer experiences and transform brands. In naming BBDO as its agency, Ford specifically mentioned the importance to them of world-class creative, and that’s what we can deliver. As disclosed last week, AT&T’s newly formed Warner Media Group is in the process of consolidating the entirety of its U.S. media business with Hearts and Science. When the consolidation is completed, the agency will handle both traditional and digital media for all Warner Brothers, HBO, and Turner Properties in addition to its existing AT&T relationship. This win is a testament to the confidence that one of our largest clients has in our people. We believe our longstanding commitment to hiring and developing the best talent in the industry is key to our new business success. As a result, we continue to make substantial investments in education from programs that will address new digital technologies and data platforms all the way through our advanced Omnicom University programs for current and future leaders. I am proud that our efforts are paying off as Omnicom was recently recognized by Forbes as one of the world’s best employers in 2018. It is a significant recognition for us, and what’s more, we are the only advertising and marketing firm on their list. Our dedication to having the best talent in the industry was again recognized by the industry this quarter. After winning big at the Cannes Lions Festival, seeing our agencies continue their winning streak at the 2018 Spikes Asia Festival of Creativity was especially gratifying. Here are a few highlights. For the fifth consecutive year, BBDO received the night’s top honor by winning Network of the Year with DDB placing second. DDB Australia was the runner-up for Agency of the Year, and PHD placed third for Media Network of the Year. In total, over 20 Omnicom agencies in 15 countries contributed to nearly 120 Spike awards with work from 40 different clients. I am also very proud that our diversity initiative was honored with the best PR Firm Diversity Initiative at PR Week’s Diversity and Distinction Awards. I genuinely believe that more diverse teams create even better work. I want to recognize and thank the people at our agencies for their world-class integrated campaigns, outstanding new business wins, and the great work that enables us to deliver these results. In closing, we had good financial performance and made meaningful progress on our strategic and operational initiatives in the third quarter. I will now turn the call over to Phil for a closer look at the results.

Thank you, John, and good morning. From John’s remarks, you can tell we had a very active third quarter. As our businesses always do, this quarter they continued to focus on responding to our clients’ needs while ensuring that they proactively manage their own cost structures. And as we mentioned and as we expected back in July, during the quarter, we closed on the disposition of Sellbytel, our European-based sales support business. That transaction, along with 18 other smaller dispositions we completed during the third quarter, resulted in a net pre-tax gain of $178 million. In addition, during the quarter, we recorded charges of $149 million for repositioning actions, primarily resulting from severance and lease terminations in connection with ongoing efforts to enhance the strategic position and operating effectiveness of our businesses. Lastly, we recorded additional tax expense of approximately $29 million resulting from adjustments of the provisional amounts originally recorded in connection with the 2017 Tax Act. We will discuss our 2018 results both with and without the impact of the net gain from dispositions, repositioning charges, and the tax adjustments in connection with the Tax Act. The non-GAAP adjusted results on Slides 5 through 8 present our results excluding these items and show how our underlying businesses performed year-on-year on a comparable basis. For the third quarter, our organic revenue growth was 2.9%. Organic growth was 3.3% for Q3 of 2018 after adjusting to reflect the pro forma impact of third quarter dispositions, which reduced organic growth in the quarter as if they had occurred on July 1. FX negatively impacted revenue for the first time since Q2 of 2017, resulting in a decrease in our reported revenue for the third quarter of $62 million or 1.7%. Regarding the impact of our acquisition and disposition activity that John spoke about during his remarks, we completed a number of dispositions during the third quarter, the largest of which was Sellbytel. We also made a couple of acquisitions in the quarter to complement our precision marketing businesses in the U.S. and Australian markets. The net impact of these activities reduced third quarter revenue by about $35 million or 0.90%. Based on activity completed prior to and during the third quarter, the projected reduction in revenue from net dispositions and acquisitions will be approximately 2.5% for the fourth quarter, which would result in a net decrease for the full year of 2018 of approximately 2.3%. And lastly, as a reminder, we were required to adopt the FASB’s new revenue recognition standard known as ASC 606, effective at the beginning of this year. The impact of applying the new revenue recognition standard reduced our reported revenue by approximately $17 million or 0.4% in the quarter. As a result, our reported revenue decreased marginally to $3.7 billion. I will discuss in more detail the components of the changes in revenue in a few minutes. Moving to Slide 5, our reported operating profit for the quarter was $502 million, an increase of 6.8% versus last year. Our non-GAAP adjusted operating profit or EBIT, which excludes the impact of the net gain from dispositions and the repositioning charges for the quarter, increased to $473 million or 0.7%, resulting in an operating margin of 12.7%, which was up 10 basis points over our Q3 2017 results. On a reported basis, Q3 EBITDA increased 5.9% to $528 million. The non-GAAP adjusted Q3 EBITDA and EBITDA margin amounts were effectively flat with Q3 of last year at just under $500 million and 13.4%, respectively. Net interest expense for the quarter was $56.7 million, up $4.3 million versus last year’s third-quarter figure and up $4.2 million versus the $52.5 million reported in the second quarter of 2018. Gross interest expense in the quarter was up $4.4 million compared to last year’s Q3, primarily due to the impact of increased rates and interest expense on our floating rate swaps, while interest income in the quarter increased slightly versus the prior year. When compared with Q2 of this year, interest expense in the third quarter increased by approximately $3 million due to the increase in interest expense on our floating interest rate swaps, and interest income decreased by $1.2 million. Turning to income taxes, our reported effective tax rate for the third quarter was 25.9%. The primary driver of the lower effective rate was the lower U.S. tax rate resulting from the enactment of the 2017 Tax Act, which reduced the Federal statutory tax rate to 21%, as well as a lower tax rate on the gain from dispositions of subsidiaries in the quarter. The decrease in the effective tax rate in the quarter was partially offset by additional tax expense of $29 million resulting from adjustments to the provisional amounts originally recorded in Q4 of 2017 related to the enactment of tax reform at the end of last year. As of now, we expect that our effective tax rate for Q4 of 2018 will be approximately 27%, excluding the impact on our 2018 effective tax rate from share-based compensation items, which we cannot predict because of changes in our share price and the impact of future stock option exercises. Earnings from our affiliates totaled $1 million for the quarter, down slightly versus Q3 of last year. Regarding non-controlling interests in connection with the sale of Sellbytel, part of the gain was allocated to minority shareholders. Excluding the impacts of the gain, the allocation of earnings to the minority shareholders in our less than fully owned subsidiaries was $25.5 million, up $2.2 million when compared to Q3 of last year. For the quarter, our reported net income was $299 million, an increase of $35.3 million. The net impact of the gain on the dispositions, repositioning charges, and the additional tax expense recorded in connection with the Tax Act increased our reported net income by $18.2 million. Excluding these items, our non-GAAP net income of the third quarter increased 6.5% to $280.7 million. Now, turning to Slide 6, net income available for common shareholders for the quarter was $298.9 million, while our non-GAAP adjusted figure was $280.7 million. Our share repurchase activity over the past 12 months decreased our diluted share count for the quarter by 2.9% versus Q3 of last year, to 225.9 million shares. Diluted EPS for the quarter was $1.32 per share, up 16.8% versus Q3 of 2017. Our non-GAAP diluted EPS for the quarter, excluding the impact of the net gain from dispositions, the repositioning charges, and the tax expense adjustments recorded in connection with the Tax Act, was up $0.11 or 9.7% to $1.24 per share. We have also provided the non-GAAP adjusted presentation for the year-to-date period. We are still estimating a revenue reduction of approximately $150 million related to the adoption of ASC 606. Looking forward, the currency situation will remain as it is. We anticipate that the forex impact will again reduce our reported revenue by approximately 1.5% to 2% for the fourth quarter. For the full year, we are currently estimating that the forex impact will still be slightly positive at about approximately 0.5%. The impact from our recent acquisitions, net of dispositions, decreased revenue by $35 million in the quarter or 0.9%. We expect the net reduction in revenue from our acquisition and disposition activity to be approximately 2.5% to 3% in the fourth quarter and 2.3% for the full year 2018 as well as a reduction of approximately 3% in the first half of 2019. Overall, our organic growth for the third quarter was up 2.9% or $108 million, organic growth was 3.3% for Q3 2018 after adjusting to reflect the pro forma impact of third quarter dispositions. Geographically, Europe and Asia-Pacific regions continued their strong performances, with the U.S. slightly positive by 0.6% or 1.2% after adjusting to reflect the pro forma impact of third quarter dispositions. In terms of our service disciplines, we again saw strong results in our CRM consumer experience businesses, while advertising was up in our CRM execution and support businesses, though most of the Q3 dispositions were down for the quarter. Our smallest region, the Middle East and Africa, was down slightly for the quarter. Turning to Slide 14, we present our mix of revenue by clients' industry sectors, and if we look at our cash flow performance, you can see we generated $1.1 billion of free cash flow in the first half of the year, including changes in working capital in the first 9 months of 2018. As for our primary uses of cash, including dividends paid to our common shareholders, dividends paid to our non-controlling interest shareholders, capital expenditures, acquisitions, and stock repurchases, we have spent our free cash flow by about $450 million year-to-date. The use of our cash in excess of free cash flow of approximately $450 million, which excludes the impact from our Q3 dispositions, remains solid. Our total debt to EBITDA ratio was 2.0x, and our net debt to EBITDA ratio was 1.1x, while our interest coverage ratio was 10.2x. Overall return on invested capital ratio stands at 20.6%, while return on equity is 48.2%. That concludes our prepared remarks, and at this point, we are going to ask the operator to open the call for questions. Thank you.

Thank you very much. Nice to see some improvement in U.S. organic growth in the quarter. I know you spent a lot of time talking about the dispositions and the repositioning, but I am curious if there were other drivers for the better growth that you saw in the U.S. in terms of whether you are seeing a pickup in some client spending or if new business is perhaps more of a tailwind in the quarter than it’s been a headwind. Any color you can provide on the changes would give us more confidence that the type of repositioning we are seeing is enabling the underlying business to get a little bit better?

Yes, Alexia, we have cycled through a number of account losses from over a year ago. A lot of clients are indeed spending, not huge sums more, but they are spending more money, and I think that’s a trend that will continue as we go forward. New business has also been very successful at the end of this quarter, which is going to benefit 2019 significantly. We are still waiting on a few more pitches that should provide big contributions if successful, and those are expected to be announced in November sometime. So, I am feeling good about the business, even though we have a lot of work to do.

And then on the recent Ford business, there was a press report that said the Ford business may come online as soon as November, which seems a little early. I know transitions usually take longer. Do you think you will see any benefits of the recent wins in general in Q4, or are they really more of a 2019 impact?

I don’t know what information the reporter had, but I am expecting the contribution to revenue from those wins to begin in 2019.

Thank you. And just Phil, regarding the restructuring charges or severance expense, you mentioned that you are continuing to evaluate your business and are constantly repositioning it. Should we assume that further charges will occur in the fourth quarter, or do you think this quarter was particularly big regarding these expenses?

We would view this quarter as having much more activity than we typically do. The severance number included in the non-GAAP column is the incremental severance number. So, we typically expect to have severance every quarter. This quarter’s figures are in excess of our average severance, which has been in the $20 million to $25 million range every quarter, so this number is in excess of that average. Going forward, a degree of severance will always be part of our business, but this quarter was more extensive than the second quarter.

Thank you very much.

Yes, hi, thank you very much. Let me start with Europe if I could, please. You mentioned that Germany was down. I was wondering if that was client-specific or economic from your balance sheet point of view. Also, could you comment slightly on the UK, which was slightly down compared to the second quarter? Was that more driven by economic uncertainty around Brexit?

No, we don’t see a broad economic issue in Germany over the past couple of quarters. Our businesses in Germany were on a good growth run for quite some time, but I think it was just a natural slowdown. There have been a couple of client losses which we have been working on. So, I wouldn’t chalk it up to the economy slowing. Regarding the UK, the clients that we had there contributed to businesses that were no longer mainstream, especially with our standalone research business and field marketing operations still in Northern England.

Similarly, the decline in the UK related to specific clients rather than broad economic factors. In the U.S., we had adjustments, and we are working to regenerate our client portfolios.

And John, regarding the U.S., you mentioned the organic growth would be up 1.2% in the quarter, which is below nominal GDP. Could you explain why that gap exists?

Typically, we have compared to GDP on an annual basis rather than quarterly. There are reasons for the gap. One reason is that structural changes that occurred in the business have required adjustments, including programmatic business taken in-house by clients. While we retain profitability, the revenue numbers differ. We also have faced some client losses as we faced this quarter, and blowing through those disposed businesses prior to their sale led to distractions as well. There are more companies under assessment that can potentially affect our figures down the line.

In your mind, do you feel that your organic growth is trending upward versus previous years, or is it too early to tell?

I remain cautiously optimistic, especially as we move into 2019. My optimism is based on not losing large clients and recent wins, which should contribute positively next year. Most clients are not cutting back and investing in their own businesses, supporting my optimism.

Yes, good morning. Thank you for taking the question. First, could we get the impact of Acuren on Q3 organic? Secondly, do you expect more dispositions to be announced next year? In your introductory remarks, you mentioned identifying non-strategic underperforming businesses for possible disposition, but can you provide a rough estimate of the potential impact next year on top of the 3% in the first half? Lastly, how did the margins from the divested businesses compare to the overall group's margins?

The impact of Acuren in this quarter was down $7 million, mainly international, while the U.S. was flat. Overall, we will approach dispositions opportunistically going forward; we don't have any targets set. Typically, I would consider that the margin from the smaller divested businesses is likely to be below our average, while the larger disposals would align more closely with our averages.

For clarity, we will continue evaluating our portfolio periodically for potential non-strategic sales. However, no immediate large-scale disposals are on the horizon.

Good morning. I have a couple of questions for Philip. Firstly, regarding the severance numbers, you outlined that included around 1,400 positions, with 500 due to be replaced, and a salary run rate of $135 million. Can you indicate what the total potential savings impact might be for 2019 after replacements are accounted for? Additionally, regarding the commentary surrounding the dispositions impacting 40 basis points of organic growth, how have those divested businesses tracked throughout the year? Have they posed a significant weight on prior quarters over the year or was this performance decline abrupt due to recent activities?

The savings will vary based on various factors, including new business wins and ongoing efficiency initiatives. We aim to ensure our savings are locked in, but we don't have a concrete quantified number to share. Regarding the previous year's performance leading up to Q3, the businesses we disposed of had seen a decline similar to the recent quarter, nearly 30 basis points of organic growth loss overall in the sequential period.

Thanks. John, I hear you discussing the acquisitions you are pursuing; they seem to be more focused on technology and data. What's your perspective on whether these deals are becoming more expensive or less accretive than previous types of deals? Phil, could you give insight into your philosophy on working capital? It tends to be quite volatile per quarter, but how do you assess its overall benefit or headwind potential for fall 2018?

To date, we’ve focused on only accretive acquisitions. When comparing multiples today to 10 years ago, they have risen slightly. We are competing with various financial entities and must remain aware of changes as the Fed tightens and liquidity decreases.

Working capital has been challenging but is still expected to provide a net benefit. It appears neutral through our nine months of performance, but we aim for improvement as we have before. The requirements around managing working capital continuously evolve, so it’s integral to our overall operations.

Thank you. Good morning, everyone. I’d like to continue the discussion around acquisitions. John, can you provide context for the Credera deal? Is IT consulting, martech, and strategic focus for the company? How does this reflect on the competitive set you will battle with moving forward? Lastly, do you foresee more deals like this in your pipeline, and would these acquisitions prompt you to enter pitches that you hadn’t historically been considered for?

We’re not aiming to recreate anything on the scale of Sapient. Our focus is to embed the necessary skills to work strategically for our clients’ benefits. We've identified key talent for acquisition who are well-reputed in the marketplace. Therefore, our approach is more about complementing the overall service we provide rather than filling any existing gaps.

We believe the ongoing acquisition pipeline, especially those aligning closely with our current skills, will ensure we remain competitive in the field without exclusions.

I don’t think the recent dispositions have disrupted our main core businesses, as each disposal was standalone and did not affect our management structure significantly. Our senior managers were involved every step of the way in these decisions, aiding us to move forward effectively toward our strategic objectives.

Thank you. We’ll conclude the call here as the markets are now open. Thank you all for joining today’s call and we will talk to you again soon.