Omnicom Group Inc. (OMC) Q2 2013 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Omnicom Second Quarter 2013 Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. At this time, I'd like to introduce today's conference call host, Executive Vice President, Chief Financial Officer of Omnicom Group, Mr. Randall Weisenburger. Please go ahead.

Good morning. Thank you for taking the time to listen to our second quarter 2013 earnings call. We hope everyone had a chance to review our earnings release. We have posted to our website both the press release and the presentation covering the information that we'll be presenting 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's 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'd also like to remind you that during the course of the call, we'll 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're going to begin the call with some brief remarks from John Wren. Following John's remarks, we'll review our financial performance for the quarter, and then both John and I will be happy to take questions.

Good morning. Thank you for joining us on the call. We're now half way through 2013, and I'm pleased to say that our performance continues to demonstrate the strength, diversity and stability of our business. On a global basis, our top and bottom line was consistent with our internal forecast. And as you can see in our deck, organic growth was 2.8%, and margins increased during the quarter. Regionally, our performance broadly reflected the different macroeconomic conditions in global markets. Our business in the United States continues to grow at a steady pace that is slightly faster than the overall economy. In Asia and Latin America, we're experiencing stronger growth. And as you might expect, the Eurozone remains a key geographic challenge. Before discussing the highlights of our second quarter performance, let me start by providing an update on the progress we're making on our key strategic initiatives. More than at any time in our history, our company and agencies are aligned around the common set of strategies that are essential to our growth. These strategies share a goal of helping us meet the rapidly changing needs of our clients by giving them access to the best people and the latest technologies, where and when they need it: first is attracting, retaining and developing top talent; next is expanding our global footprint and moving into new service areas; third is building upon our digital and analytical capabilities by investing in our agencies and partnering with innovative technology companies in key markets around the world; and finally, by delivering innovative solutions using meaningful consumer insights across systems and platforms for the benefit of our clients. Our progress is really a reflection of the caliber and contributions of our people. I'm happy to report our agencies continue the tradition of creativity and…

Thank you, John. As John said, our agencies had an excellent performance in Q2, benefiting from their continuous focus on delivering new, innovative and insightful ideas and services to their clients, while relentlessly driving their own cost efficiencies. As a result, revenue came in right on track at $3.6 billion, and our EBITA margin for the quarter increased almost 20 basis points to 15.1%, bringing EBITA for the quarter up to $548 million. Operating income or EBIT for the quarter increased 3.3% to $523 million, and the resulting operating margin was 14.4%, also a year-over-year improvement of about 20 basis points. Looking at the items below operating income, net interest expense for the quarter was $40.7 million, up $5.8 million from Q2 of last year and just about flat with the first quarter. The year-over-year increase is primarily due to the interest cost on the $1.25 billion of 10-year notes we issued last year. If you remember, the first tranche of $750 million was issued early in Q2, and the second tranche of $500 million was issued mid-Q3. Together, they have a blended interest rate of about 3.4%. On the tax front, our reported rate for the quarter was 33.9%. While the rate was down slightly from last year, there were a few ups and downs in the quarter from discrete items that pushed the rate up just a bit. For the full year, we still expect our operating tax rate to be around 33.6%, which is about where we are for the first 6 months. Net income for the quarter was $289.5 million, which was a solid increase of 2.4%. And on Slide 3, we show the computation of diluted EPS. The increase in net income, combined with the year-over-year reduction in our diluted share count of 4.6%, resulted…

[Operator Instructions] We'll go to the line of James Dix with Wedbush.

Just 3 things. I guess, when you look at the growth within the advertising discipline, are there any longer-term trends you think worth pointing out in terms of organic growth, and I guess also, margin trends between your media agencies as opposed to the other agencies within that category? Just curious on that. And then secondly, just your thoughts on what the amount of pending large pitches is in the market at the moment, and in particular, what's your outlook for picking up some auto business to take advantage of your resources there. And then finally, there's a couple -- there's been some trade press on some renewed push by procurement, which I assume is ever present, or changes in some types of payment terms, in particular, how quickly they will be paying for certain types of services. Just wondering how we should be thinking about developments there. Is there anything really new there? And is there anything we should be thinking about in terms of modeling cash flow going forward?

That was long enough, I forgot the first question.

I've got them written down, Randy, so...

I'm kidding. I'll let John go.

Let's start from the bottom up. In terms of procurement, there's always been pressure, there continues to be pressure to drive efficiencies. With respect to balance sheet cash flow, we've turned down and not accepted clients that we could have won because we weren't prepared to accept the terms that they were offering. We're not a bank. I think if you speak to my competitors, they'll both -- or all 3 agree with that concept. That's not what we're here for. And anybody who wants to treat us like a bank can go to a bank. The second thing, part, pending large pitches, there's a couple around. We don't try to aggregate them. We just believe in ourselves, and we believe that if we get up to the plate, we'll score well. There's no -- not to my knowledge -- big car pitches up at the moment, but I have great confidence in the capabilities of the people who were on the Chevy business, that when one does come up, we'll have a very good chance at it. And then your first question...

And on the car front, we have a excellent roster of auto clients already, 3 major global accounts, so it's not like we're short of auto.

But we always accept the next one if we can handle it. And then in terms of your first question, which was the distinction in margins between the media agencies and the advertising disciplines, I think?

Yes.

They're roughly the same. I'll let Randy...

The media agencies have strong margins. There's a lot -- there's more investment in the systems and technology, especially with some of the new areas of programmatic trading and I'll say digital marketing, behavioral marketing. So I think we get a pretty comparable return on capital in both areas. Yes, that's probably all there is to really say about it. On an absolute reported margin basis, the media business are a little bit higher. You also asked about growth in advertising, the strong growth in advertising. The way we operate the business, I think a lot of that is being driven by digital, or what other people might break out as digital. We operate our businesses on a much more integrated basis, and we're certainly seeing strong growth with providing services to utilize new technologies.

Our next question would come from the line of John Janedis with UBS.

Randy, there's been some concern in the market that the tone of business in the emerging markets slowed a bit in both Asia and Latin America. I know you spoke to it briefly, but did you see any sign of that trend in China, India or Brazil as you exited the quarter or at the start of the third quarter?

China and India were very strong for us. Brazil is not growing as fast as China and India right now. Brazil is a much more developed market in many ways.

But there are -- the balance of this year, who knows, next year, you start with a lot of major global events that will run through 2016, so we're very bullish about Brazil in the near term.

Okay. And then separately, you had accelerating growth in the U.K. in a period where you mentioned the Olympics comp. And the European, I guess, money looks like it stabilized. Are you guys feeling a little bit more comfortable about the region going forward?

Well, the U.K. was benefited a little bit by switching a packaged goods company, which we were handling out of our French office last year at this time. And we switched to our London office. That, plus the Olympics. So France wasn't as down as much as the reported numbers would have you believe. And the U.K., which was very strong, was still very strong, but not as strong as the reported numbers. Southern -- Spain and Southern Europe seems to be bottoming out. I think you still have concerns, and we still have some concerns in the very short term about France and Germany until after the election, but nothing dramatic. It's just -- it's a bit of a headwind.

It does feel like it's stabilizing. It's not -- it's just not necessarily rebounding yet, but one step at a time.

And we'll go to the line of Craig Huber with Huber Research Partners.

A few questions, one at a time, if I could. Typically, you'll give us what your net billings number was in the quarter. I think your goal was generally about $1 billion per quarter. What was it this last quarter, please?

We were right about $800 million with the -- with Chevy and a couple other things, like Gillette. As I've always said, if -- a couple big moves, big changes up or down can affect the quarter, so I think our base was very strong, came in pretty much as we would expect, but with the Gillette loss, it just pushed us down below $1 billion.

Okay. Then switching over to the U.K., just a little bit further on this, if we could, Randy or John. The 7.4% organic number there, how much was that impacted on a year-over-year basis organically from the Olympics revenue about a year ago? And also, can you just talk a little bit further about this switch of the business booked in France over to London. That just basically started at the beginning of the second quarter. It's the first time I've heard you talk about it.

I think the Olympics was around $15 million to $20 million in the U.K. I don't have the number at my fingertips, but I think it's in that category.

And I've seen the number for the second quarter of that move, but I don't have it sitting in front of me. But it was just we changed personnel and where the lead on that global piece of business was from, at the clients' request, and so it was neutral to the overall Omnicom. But if you're examining microscopically the countries, it had an impact on -- to the benefit of the U.K. and to the detriment of France.

We've talked about these things a few times. There's a handful of places in the world that are really global centers that you can really handle global pieces of business out of. I think last year or maybe it was the year before, we had it where a piece of business moved from the Netherlands to the United States. And when you deal in some of those international markets on these global pieces of business, when you have a move, either in or out, it can look pretty impactful in that market. If it happens to go into a place like the United States, it tends to get blended away a little bit because it's just the size of the market. But as John points out, it's net neutral for overall Omnicom revenues. It just makes these country numbers look different than what the actual market economy is. Many times, I think when we talk about revenue growth in a country, people take that as to the strength of the country or the strength of the market in that country, and that's certainly one aspect of it. But wins and losses are, at times, an overwhelming aspect of it, especially as we get to the smaller markets.

But just -- I'm sorry, just for the timing of this switch between the countries, that basically started at the beginning of this second quarter?

I don't know if it was late in the first quarter, and just probably we didn't have an impact.

Yes, I think...

When I spoke of it in the last call.

I think the move started in the first quarter, but again, it takes a little while to move a sizable piece of business.

And then my final question, please. When you think about your Southeast Asian markets, China and maybe Australia, is the rate of growth in those markets for Omnicom -- is the rate of growth slowing there, given the economic slowness we hearing over there?

I don't think China is. Australia probably is. Last year, we benefited -- we finally consolidated Clemenger. And with that, quite a bit of activity was going on around it, where we were able to expand the business, probably a little bit faster than normal, so that's steady. But China still remains a very strong double-digit growth market.

And you're not seeing it slow at all, in a material level?

Not for our business, no.

Our next question will come from the line of Alexia Quadrani with JPMorgan. Townsend Buckles - JP Morgan Chase & Co, Research Division: It's Townsend Buckles for Alexia. Can you say how much of an impact the recent account losses had on the quarter, specifically Chevy and Gillette, as you called out, and what we should expect in coming quarters?

No, that's not something that we really break out client by client. Townsend Buckles - JP Morgan Chase & Co, Research Division: Okay. I guess, as we look at the U.S. growth, it slowed a bit from Q1. I mean, would you say that most of that would reflect those losses, if you can say?

The problem with the question is, if I -- I can take any bad thing or I can take any good thing and probably account a quarter to any one of them, but there's 100 of them every quarter. So it's -- to try to isolate and say that the quarter is down because of a Gillette -- the Gillette move or I can also say it was up because of this move. This stuff balances out. So we don't really look at it quite that way, we prefer to never have any account losses. We prefer to only have account wins, but unfortunately, both happens. Townsend Buckles - JP Morgan Chase & Co, Research Division: Got it. And your sale of Hodes, I think that's been a bit of a drag on the business in the past. Should we expect this to have a positive impact on organic growth and profitability going forward? Will that be meaningful at all?

It will definitely be positive on organic growth and margins going forward. It's got -- 3 years ago, it had a bigger impact. But right now, the impact because of the business, while it was not positive, was starting -- was stabilizing at a very low number. So it was -- the benefits of losing this headwind on organic growth, again, will be positive but not significantly positive. And kind of the same thing with margins, it will be positive but not noticeably.

Right. I mean, if you recall, we didn't call it out specifically, but implied in what we said in 2010 of the agencies that we felt were no longer strategic to the business, and we wanted to, in an orderly fashion, dispose of them. Hodes was probably the largest of the remaining items on that list, and it just took us until now to dispose of it in an orderly fashion. Townsend Buckles - JP Morgan Chase & Co, Research Division: Got it. And then just lastly, if you can talk just generally about how you're seeing the second half of the year in terms of client sentiment and spending plans?

Right now, we're in the process of re-forecasting for the second half, and we're not quite done with that process, but we haven't seen any major swift swings in attitude from what we previously had forecasted.

Yes. And we're certainly comfortable with what we've been talking about if you go on along. I mean, this quarter, the margins were up. Our agencies have done an extremely good job of pressing their own efficiencies. So I think we're certainly more comfortable with the full year than we were -- well, I mean, I guess, we've always been comfortable with it, but it's certainly encouraging to see how this quarter came out.

Our next question comes from the line of William Bird with Lazard.

Yes, as a follow-up, just as you look at kind of the second half and you think about kind of how some of your leading clients are behaving, would you expect kind of the growth profile to be consistent with the first half or somewhat different?

We have -- we've got a little bit less headwind in the -- certainly at least in the third quarter. We've had, as we've talked about a couple times, some specific Olympic revenue in the first half as a headwind. We're not going to have that in the second half. And I think all the client conversations that I've heard remain pretty consistent with what we thought at the beginning of the year. So at this point, I think we think we feel pretty positive about the year.

And as you alluded to earlier, there's some natural chop in the business from quarter-to-quarter. Is there anything to read into the moderation in U.S. growth in Q2?

I don't think so.

And finally, can you talk a bit about just your strategy around programmatic buying and Accuen?

I'm going to let John do that. I want to go back to your other point about the U.S. I mentioned the Olympics spending. The Olympics happened to be in London. All the work that we did wasn't in London, so a piece of it was there, but frankly, more -- much more of it was in the United States.

Digital buying of media is done by machines as if you're standing on the floor of the NASDAQ as opposed to in a traditional media shop. Increasingly, the capabilities of what we can do, we -- I hold the long-term belief that, eventually, traditional media or a lot of traditional media will get purchased that way. So where we have a client need, we've been expanding the service and opening up the capability country -- major country by major country. And it improves every day because with more volume, more activity, it just expands, and it can probably continue to expand for the foreseeable future in terms of what it can do.

And the labor in that space is really in developing the technology and developing the insights. So as of right now, while the buying uses a lot more technology, the development of that technology, the programming and insights that we give from one client to the next is still obviously very labor intensive.

And as you can imagine, the publishers are changing their algorithms constantly, so we're changing our algorithms constantly.

And just a final question. Based on the numbers you gave, Randy, just on the acquisition headwind from the Hodes sale, is it roughly a $100 million business and annualized? And I'm just curious what the organic growth was on that business.

That's -- you got the number about right, about $100 million, and it was costing us $2 million to $5 million a quarter in negative organic growth.

Our next question comes from the line of Anthony DiClemente from Barclays.

I have one for Randy and one for John. Randy, just looking at this -- the auto number being down 11%, and I know a lot of that is owing to the Chevy move, and maybe you can't quantify the exact impact of that. But I just wanted to hear if there's anything organic going on in automotive. We heard that in the TV upfront that some of the tone of business was maybe slightly slower, so I just wanted to hear if there's anything that we can isolate at auto. And then the second question for John, I appreciate your comment about growing your digital capabilities at your agencies. I'm always trying to figure out, there are these independent ad technology firms that pop up and that have material or legitimate businesses and business models. And did you think that the digital capabilities at your agencies are taking share from the independents or not? And so I just also want to ask that question in the context of your need to build digital via acquisition as digital matures. I guess the hope would be that more of your growth is organic as digital matures and the need for those bolt-on acquisitions actually sort of diminishes.

Sure. I may take a stab at both of them, and John can correct me on the second one. So in auto, our major auto clients are doing quite well. I think the bulk of the change this quarter really was the Chevy move. But we have a lot of different auto businesses. Our 3 major accounts are doing quite well. And the rest of it is probably -- if there's anything else, it's probably project business. On the media technology front, there's a very interesting ecosystem that's being developed, where there are a number of companies that are being established to hopefully sort of knock down roadblocks in the development of the space. As the space evolves, issues pop up, and people try to attack those issues. Many of those technologies, the better ones we're partnering with, we're maybe even buying some of their services. I think that will continue to go on for quite some time, because frankly, as the space evolves, more and more little roadblocks pop up as people move forward. Our people are obviously also developing solutions around those issues, and we're happy to find the best answer for our clients. And it's inevitably going to be a combination of utilizing solutions developed by third parties, developing some of our own solutions and there will inevitably be some places, at least as of right now, that haven't appeared yet, that we're going to find solutions necessary to keep moving forward.

And the only thing I would add to that is with all the digital channels that are now available to reach the desired audiences, clients understand the complexity, and they're actually looking for partners that can holistically handle both their digital requirements and their traditional requirements. And whilst small, very successful startups, when you compare them to the size of a company like Omnicom, may win $20 million, which may turn to be 10% growth for them, that's not much of a challenge to us. And we think the long-term trend is clients looking for people they can depend on to provide insights and to reach those audiences holistically.

Our next question comes from the line of Tim Nollen with Macquarie.

Two questions, please. First, nice to see a bit of margin expansion in the quarter after you hadn't really promised any necessarily this year. I just wonder if there's any updated thoughts on what we could expect for margins, particularly having seen you attain your margin target last year. And then secondly, it might be a little bit philosophical, but seeing that the moderation in economies in emerging markets, I'm wondering if you can gauge whether emerging market ad spending might follow the typical cyclical patterns that we see in the U.S. and Europe, or if by contrast, and I get the sense this is what's happening, at least in China, just the structural growth in consumer spending means there just remains strong demand for your services.

I'll say...

Yes. I should've written down the question, sorry.

Well, in -- on margins, we had a really good quarter. Our agencies are making great progress and are very focused on finding internal efficiencies. I don't think, at this point, we're making promises on margins any different than we said before, but we're very happy with the work that's been done in the quarter and are going to continue to put all the focus we can on finding every efficiency possible.

The only thing I might add to that is, as we look to the third and the fourth quarter, we're not internally forecasting margin improvement, but we're not -- when you compare just those quarters, but we're not forecasting that they'll be down. So the gains we've had in the first 6 months will flow through. And your second philosophical question?

Should I repeat the second one? Maybe I shouldn't have said philosophical. It's a scary word. It's just understanding kind of the cyclical versus the structural growth trends in emerging markets. So whether we get moderation in economies in China, Brazil, India, whatever the countries may be, does that lead to moderation in ad spending, as we typically see in the U.S. and Europe? Or by contrast, is there just enough strong structural growth and consumer spending growth in these markets that your business could remain just fine?

If you -- I think in our situation, it's slightly different. In the United States, we're very large, so we are impacted by GDP and track it. In some of those other markets, we don't have as much market share, and we still have the opportunity to get -- gain new clients, as well as be impacted by their economic situation. So we haven't tried to drill down and understand every nuance about the difference between 7.5% and 8.5% growth in China because, for instance, we still have the opportunity to win new business. So philosophically, we haven't spent the energy just trying to gauge that impact because we haven't reached 100% market share yet.

Our client -- depends on the market as well, but our client base, I think, at this point, is largely focused on getting themselves more and more entrenched and established in those markets. So I would think that their spending patterns won't exactly follow the economy, which is good for us. It basically is saying that the structural growth kind of outweighs the cyclical growth.

Yes.

Or cyclical patterns.

And I've never said this before, but I'm sure one of my competitors is prepared to tell the Chinese what their growth will be for the next year, so you might ask the question of them.

I think we have one -- time for one more question.

And that will be from the line of Matt Chesler with Deutsche Bank.

So you're more comfortable with the full year but are still reviewing the plan. You spoke a little bit about how you're coming in slightly ahead year-to-date on the margins. What's your level of comfort and increased confidence in terms of the top line momentum? Or is it really just the conversion of that into profitability?

I think we had the toughest headwinds in the first half of the year, so if I go through and if we're right about those headwinds and that they just disappear, and it wasn't shift -- money shifted around, I think we feel pretty good with where we're at through the first 6 months. So that gives us more confidence in the numbers that we were talking about for the full year.

But you know just from following us, we're constantly doing bottoms up and then looking at what we're doing. So whilst confident, we're not ones to overpromise at this point.

Yes, I definitely appreciate that. We still have a half of year to go. I'm just trying to understand, I mean, things seem to be certainly on track through this first 6 months, and some of the parts of the business are de-risked, and you're executing well. Just trying to understand what you think the risks are through the back half of the year and what could prevent a situation where we're not sitting here in January and you're telling us that you came in slightly ahead of what your formal plan had been?

There's always the fairly big number every year in Q4 -- at the very end of Q4. It's very difficult for us to predict if it -- if that spending pattern follows, I'll say, historic patterns, then we're going to be in -- we're going to have a very -- we're going to have a good year. We're going to certainly be able to achieve our targets and all the numbers that we've talked about. But it always makes us nervous, because frankly, those numbers don't start to solidify until late in the fourth quarter. So could that -- could something affect that? Sure, it could. We don't expect it will, because frankly, the historic patterns are fairly consistent, but it's difficult to forecast.

Okay. You also had mentioned the strong performance of your specialty health care practice. Is that -- how much of that is related to agency performance as opposed to -- I'm just trying to get color on whether you think that, broadly speaking, health care marketing has reached the point where you're seeing overall growth industry-wide at this point.

Well, I mean, we have had some new business wins. I think when you get outside the United States, especially in emerging markets, I think there's a lot of potential growth for health care and health care spending, especially as people move up into the middle class or what they call the middle class. The limitation on our side will be, can we find the talent and train people to take that business, not whether it's healthier. It's not healthier. I believe it's very healthy, and it's an opportunity if we can execute against it in the correct marketplace.

We also won some very good pieces of new business last year, some pitches that were out there. And the revenue didn't really come through. The spending didn't come through to drive it. I think we're starting to see some of that now. Looking at some of our peers' numbers, they are mentioning that health care is strong for them as well. I'm not sure if it's as strong as ours or not. I haven't compared the relative numbers, but they're talking about health care positively. So I would guess, hearing that market commentary, that the health care category is picking up in spending, which makes some sense when I tie together some of the wins we had last year and the numbers sort of not showing up then but they're showing up now and the overall backdrop. So it has traditionally been a very good space. It seems like we're back on that track. Thank you all for taking the time to listen to our call. Have a great day.

Thank you. And ladies and gentlemen, that does conclude your conference call for today. Thank you for your participation and for using AT&T Executive TeleConference Service. You may now disconnect.