ITEM 1. BUSINESS
Since our founding 75 years ago, Young & Rubicam Inc. ("Y&R" or the "Company") has evolved from a single New York-based advertising agency to the sixth largest consolidated marketing and communications organization in the world based upon 1998 revenues. We currently operate through recognized market leaders, including:
o Young & Rubicam Advertising (full-service advertising);
o Dentsu, Young & Rubicam (full-service advertising in the Asia/Pacific region);
o Y&R 2.1 (full-service on-line and off-line advertising and marketing services);
o The Bravo Group and Kang & Lee (multi-cultural marketing and communications);
o impiric (customer relationship management, direct marketing and sales promotion);
o KnowledgeBase Marketing (customer relationship marketing);
o Brand Dialogue (digital interactive branding and digital commerce);
o The Media Edge (media planning, buying and placement services);
o The Digital Edge (internet media planning, buying and placement services);
o Burson-Marsteller (perception management and public relations);
o Cohn & Wolfe (full-service public relations);
o Robinson Lerer & Montgomery (strategic corporate public relations);
o Landor Associates (branding consultation and design services); and
o Sudler & Hennessey (healthcare communications).
In late 1992, we created the Key Corporate Account, or KCA, program to enhance the coordination of services sought by clients from both a global coverage as well as an integrated solutions perspective. KCAs are large global client accounts that, as a group, contribute the greatest share of our revenues and profits, and are served on a multinational basis by two or more of our businesses. Revenues from the ten largest KCAs, as a group, accounted for approximately 37% of our consolidated revenues in 1999. As part of our client focus, members of our senior management team retain ongoing responsibilities for individual KCAs in addition to their managerial roles.
INDUSTRY OVERVIEW
The marketing and communications industry encompasses a wide range of services used to develop and deliver messages to both broad and targeted audiences through multiple communication channels. The industry includes traditional advertising services as well as other marketing and communications services such as direct marketing and sales promotion, public relations, branding consultation and design services, new media marketing and other specialized services.
Traditional advertising services include the development and planning of marketing and branding campaigns; the creative design and production of advertisements; the planning and buying of time and/or space in a variety of media, including broadcast and cable television, radio, newspapers, general interest/specialty magazines, billboards and the Internet; and the provision of consumer, product and other market research to clients on an ongoing basis.
Customer relationship management, direct marketing and sales promotion incorporate a broad range of services, including consulting, direct mail and direct response television advertising (using toll-free 800 numbers), inbound and outbound telemarketing, database marketing and online marketing. Sales promotion includes the planning, design and implementation of merchandising and sales promotions as well as design and implementation of targeted interactive campaigns.
Perception management and public relations address clients' external corporate or brand positioning, public image and relations with key external constituencies. Functions provided by public relations firms include corporate communications, public affairs, lobbying, crisis management, issue advertising and internal, consumer grassroots communications.
Branding consultation and design services encompass a range of services to create, build and revitalize clients' brands. Among these services are corporate identity, package design, retail design and branded environments, verbal branding and nomenclature systems, corporate literature and interactive branding.
New media marketing services include interactive marketing campaigns and strategic consulting services, the design of Internet websites, banners and home pages, the development of corporate intranets and digital commerce applications.
OPERATIONS
The following section contains a brief description of the Company's main service offerings.
Young & Rubicam Advertising. Young & Rubicam Advertising is one of the world's leading full-service consumer advertising agencies, offering expertise in strategic and creative development, consumer research and marketing, and media buying and planning. Young & Rubicam Advertising ranks as one of the ten largest advertising agencies based in the United States.
Young & Rubicam Advertising operates in the Americas, Europe and Africa. Young & Rubicam Advertising services clients through the Dentsu, Young & Rubicam Partnerships across the Asia/Pacific region.
Dentsu, Young & Rubicam Partnerships. The Dentsu, Young & Rubicam Partnerships ("DY&R") are a network of full-service advertising agencies that provide Young & Rubicam Advertising with access to major markets across the Asia/Pacific region. DY&R was created as a joint venture between Y&R and Dentsu, Inc. ("Dentsu") in 1991. In 1998, Dentsu ranked as the fifth largest marketing and communications organization in the world and the largest marketing and communications organization based in the Asia/Pacific region. DY&R is a series of local ventures in which Y&R typically has a majority interest in principal markets, except in Japan in which Dentsu has a majority interest, and is jointly managed and operated by Y&R and Dentsu. To maximize local brand equity and minimize conflicts, DY&R operates under different brand names and management in each of its three regions -- Asia, Australia/New Zealand and the United States.
Y&R 2.1. Y&R 2.1 integrates on-line and off-line advertising and marketing services in support of client brands around the world.
The Bravo Group and Kang & Lee. The Bravo Group ("Bravo") and Kang & Lee create multi-cultural marketing and communications programs targeted to the fast-growing U.S. Hispanic and Asian communities, respectively. Their multi-disciplinary services include advertising, promotion and event marketing, public relations, research and direct marketing.
impiric. impiric, formerly known as Wunderman Cato Johnson, is a leading behavior-driven marketing and communications company. Behavior-driven marketing and communications are designed to assist clients in producing immediate sales and building brand and customer equity. impiric addresses its clients' marketing objectives through customer relationship management, consulting, direct marketing, sales promotion, television commercials and infomercials, telemarketing, customer loyalty programs, relationship marketing programs, database development and management, merchandising, entertainment and sports marketing, lead generation and new product launches.
Headquartered in New York, impiric operates in North America, Latin America, the Asia/Pacific region, Europe, the Middle East and Africa. impiric also has significant database facilities in Europe and Latin America.
KnowledgeBase Marketing. KnowledgeBase Marketing ("KBM") is a single source provider of integrated information-based marketing solutions to businesses in targeted high-growth industries. KBM delivers its integrated business solutions services by creating consolidated databases, and then designing, implementing and evaluating database marketing programs for clients. KBM's capabilities include data warehousing, data mining, information services and data analysis. Y&R acquired KBM in May 1999.
Brand Dialogue. Brand Dialogue specializes in digital interactive branding and digital commerce. Brand Dialogue's primary offerings consist of web advertising, including the design, creation and production of websites, banners, home pages and comprehensive interactive campaigns; digital commerce applications; the development of corporate intranets to improve communications and productivity within and among a defined set of users; and interactive marketing consulting services.
The Media Edge. The Media Edge provides integrated media planning, buying and placement services for both Young & Rubicam Advertising and impiric. In addition, The Media Edge provides planning and buying of both traditional and direct response media, and offers a range of media-related services to clients other than those of Young & Rubicam Advertising and impiric, as well as to smaller independent advertising and communications agencies.
The Digital Edge. The Digital Edge provides internet media planning, buying and placement services on behalf of clients of The Media Edge and its own clients. It provides services for clients' digital convergence, e-commerce and technology activities. In addition to internet opportunities, The Digital Edge provides clients with resources in areas such as addressable advertising, information-enhanced television programming and video-on-demand.
Burson-Marsteller. Burson-Marsteller is a leading perception management, public relations and public affairs company. It provides a comprehensive range of perception management capabilities to its clients, including issues analysis, crisis management, consumer and business marketing and research, corporate communications, investor relations and public affairs advocacy. The perception management process begins with a statement of the desired business results and then identifies current and targeted perceptions, as well as different approaches to create the desired mindset with key audiences.
Burson-Marsteller is headquartered in New York and operates in the United States, Latin America, the Asia/Pacific region and Europe.
Cohn & Wolfe. Cohn & Wolfe is a full-service public relations firm that provides creative, results-driven services to its clients. Cohn & Wolfe helps its clients establish and communicate corporate and brand identity, launch new products and expand sales. Areas of expertise include consumer marketing, sports publicity and issues management, as well as healthcare, information technology and business-to-business communications.
Cohn & Wolfe was founded in 1970 and was acquired by Burson-Marsteller in 1984. Cohn & Wolfe operates in North America, Europe and Australia.
Robinson Lerer & Montgomery. Robinson Lerer & Montgomery ("RLM") specializes in working with the senior management of companies to develop and implement strategies for corporate image-building, financial transactions, crisis management, litigation support and media and investor programs. RLM was founded in 1986 and was acquired by Y&R in March 2000.
Landor Associates. Landor Associates ("Landor") is a leading branding consultancy and strategic design firm. Landor creates, builds and revitalizes clients' brands and helps position these brands for continued success. Landor's branding and identity consultants, designers and researchers work with clients on a full range of branding and identity projects, including corporate identity, packaging and brand identity systems, retail design and branded environments, interactive branding and design, verbal branding and nomenclature systems, corporate literature, brand extensions and new brand development.
Landor was founded in 1941 and was acquired by Y&R in 1989. Landor is headquartered in San Francisco and operates in the Americas, Asia/Pacific and Australia, Europe and the Middle East, including multidisciplinary consulting and design studios in New York, Seattle, Mexico City, Hamburg, London, Paris, Hong Kong and Tokyo.
Sudler & Hennessey. Sudler & Hennessey ("S&H") is a leading healthcare communications firm that develops strategic promotional and educational programs for a wide spectrum of healthcare brands. S&H creates advertising, direct marketing and sales promotion programs for prescription drugs and over-the-counter medications. In addition, S&H provides strategic consultancy and communications support in the areas of managed care, medical devices and equipment, nutrition, veterinary medicine and general healthcare. Communications programs produced by S&H on behalf of its largely pharmaceutical industry client base are directed to a wide range of healthcare professionals as well as patients and their support networks.
S&H was founded in 1941 and was acquired by Y&R in 1973. S&H is headquartered in New York and operates in North America, Europe and the Asia/Pacific region.
CLIENTS
We represent clients in various industries, including automotive, consumer packaged goods, financial services, food and beverages, government services, telecommunications and the internet. Among our approximately 5,500 client accounts are a number of large multinational organizations, including AT&T, Citibank, Colgate-Palmolive, Ford Motor Company, Philip Morris and Sony. Our ten largest clients accounted for approximately 37% of consolidated revenues in 1999; our three largest clients accounted for approximately 22% of consolidated revenues in 1999 and our largest client, Ford Motor Company, accounted for approximately 13% of consolidated revenues in 1999.
OTHER INFORMATION
For information concerning revenues and assets on a geographical basis for each of the last three years, reference is made to Note 10 -- "Worldwide Operations" of the Notes to the Consolidated Financial Statements beginning on page.
DEVELOPMENTS IN 1999
The Company completed secondary public offerings of Common Stock on May 28, 1999 pursuant to which certain selling stockholders sold an aggregate of 17,250,000 shares of Common Stock to the public, and on November 23, 1999 pursuant to which certain selling stockholders sold an aggregate of 5,515,443 shares of Common Stock to the public.
The Company did not receive any proceeds from the sale of shares of Common Stock by the selling stockholders in either of such offerings.
COMPETITION
The marketing and communications industry is highly competitive, and we expect it to remain so. Our principal competitors in the advertising, direct marketing and perception management and public relations businesses are large multinational marketing and communications companies, as well as numerous smaller agencies that operate only in the United States or in one or more countries or local markets. We must compete with these other companies and agencies to maintain existing client relationships and to obtain new clients and assignments. Some clients, such as U.S. governmental agencies, require agencies to compete for business at mandatory periodic intervals. We compete principally on the basis of the following factors:
o creative reputation;
o knowledge of media;
o quality and breadth of services;
o geographical coverage and diversity;
o relationships with clients; and
o financial controls.
Recently, traditional advertising agencies also have been competing with major consulting firms that have developed practices in marketing and communications. New competitors also include smaller companies such as systems integrators, database marketing and modeling companies and telemarketers, which offer technological solutions to marketing and communications issues faced by clients. In addition, the trend towards consolidation of global accounts requires companies seeking to compete effectively in the international marketing and communications industry to make significant investments. These investments include additional offices and personnel around the world and new and improved technology for linking these offices and people.
United States clients typically may cancel contracts with agencies upon 90 days' notice, and non-U.S. clients typically also may cancel contracts with agencies on 90 to 180 days' notice. In addition, clients generally remain able to move from one agency to another with relative ease. However, we believe that clients may find it increasingly difficult to terminate relationships with agencies that represent their brands on a global basis because of the complexity of coordinating creative, media and non-media services. As is typical in the marketing and communications industry, we have lost or resigned client accounts and assignments, including The Clorox Company and Blockbuster Video, for a variety of reasons, including conflicts with newly acquired clients. Although typically we have replaced these losses with new clients and assignments, we may not be successful in replacing clients that may leave Y&R or in replacing revenues when a client significantly reduces the amount of work given to Y&R. A significant reduction in the marketing and communications spending by, or the loss of, one or more of our largest clients, if not replaced by new client accounts or an increase in business from existing clients, would have a material adverse effect on our prospects, business, financial condition and results of operations.
When we represent a client, we do not always handle all advertising, public relations or other marketing and communications services for that client. Many large multinational companies are served by a number of agencies within the marketing and communications industry. In many cases, clients' policies on conflicts of interest or desires to be served by multiple agencies result in one or more global agency networks representing a client only for a portion of its marketing and communications needs or only in particular geographic areas. In addition, the ability of agencies within marketing and communications organizations to acquire new clients or additional assignments from existing clients may be limited by the conflicts policy followed by many clients. This conflicts policy typically prohibits agencies from performing similar services for competing products or companies. Our principal international competitors are holding companies for more than one global advertising agency network. As a result, in some situations, separate agency networks within these holding companies may be able to perform services for competing products or for products of competing companies. We have one global advertising agency network. Accordingly, our ability to compete for new advertising assignments and, to a lesser extent, other marketing and communications assignments, may be limited by these conflicts policies.
Industry practices in other areas of the marketing and communications business reflect similar concerns with respect to client relationships.
REGULATION
The regulation of advertising takes several forms. The primary source of governmental regulation in the United States is the Federal Trade Commission ("FTC") which is charged with administering the Federal Trade Commission Act (the "FTC Act"). The FTC Act covers a wide range of practices involving false, misleading and unfair advertising. In the event of violations of federal laws or regulations, the FTC may seek cease and desist orders, may impose monetary penalties and may require other remedies. The Federal Food and Drug Administration, the Federal Communications
Commission and other agencies also have regulatory authority that affects the advertising business. In addition, many state and local governments have adopted laws and regulations similar in scope to the FTC Act and the regulations thereunder.
Self-regulatory activities have become significant in the advertising business. The Council of Better Business Bureaus has created the National Advertising Division and the National Advertising Review Board, which review and process possible violations of proper business conduct through advertising. The national television networks and various other media have also adopted strict and extensive regulations governing the advertising that they will accept for broadcast or publication. Trade associations in certain industries publish advertising guidelines for their members and, in addition, various consumer groups have been and continue to be powerful advocates of increased regulation of advertising.
Advertising is also subject to regulation in countries other than the United States in which we and our affiliates do business. We have developed internal review procedures to help ensure that our work product, as well as that of our affiliates, is in compliance with standards of accuracy, fair disclosure and ethical proprieties, including those established by federal, state and local laws and regulations and the pre-clearance procedures of the broadcast media.
In addition, as an international organization we are subject to the Foreign Corrupt Practices Act, which imposes civil and criminal fines and penalties on companies and individuals that violate its anti-bribery and other provisions.
EMPLOYEES
We are highly dependent upon the skills of our creative, research, media and account personnel and practice group specialists, and their relationships with our clients. Employees generally are not subject to employment contracts and are, therefore, typically able to move within the industry with relative ease. Competition among the Company and its competitors for qualified personnel is substantial, and the Company, like its principal competitors, is vulnerable to the potentially adverse consequences that would arise from the inability to attract or retain qualified personnel. We have approximately 15,000 employees (including part-time employees) worldwide, including approximately 6,000 employed in the United States. Our U.S. employees are not covered by collective bargaining agreements. We believe that our relations with employees are satisfactory.
ITEM 2.
ITEM 2. PROPERTIES
We own our headquarters office building at 285 Madison Avenue, New York, New York. We lease other offices and space for our facilities in New York City and elsewhere throughout the world. The following table sets forth certain information relating to our principal properties:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are involved from time to time in various claims and legal actions incident to our operations, both as plaintiff and defendant. In the opinion of management, these existing claims, in the aggregate, are not expected to have a material adverse effect on the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the last quarter of 1999.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed on the New York Stock Exchange under the symbol "YNR." The table below shows the range of reported last sale prices on the New York Stock Exchange Composite Tape for the Company's Common Stock for the periods indicated and dividends paid during such periods; the reported last sale price on March 24, 1999 was $49.25. As of March 24, 1999, there were approximately 1,038 holders of record of Common Stock.
On March 15, 2000, Y&R paid a quarterly cash dividend of $0.025 per common share to all stockholders of record as of March 1, 2000. The decision whether to apply legally available funds to the payment of dividends on the Common Stock in the future will be made at the discretion of the Board of Directors and will depend upon, among other factors, our results of operations, financial condition, capital requirements and contractual restrictions under our credit facilities. Our credit facilities contain financial and operating restrictions and covenant requirements and permit the payment of cash dividends except in the event of a continuing default under the credit agreements governing those facilities.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data set forth below has been derived from and should be read in conjunction with Young & Rubicam Inc.'s ("Y&R") audited consolidated financial statements and notes thereto (the "consolidated financial statements") and Management's Discussion and Analysis of Financial Condition and Results of Operations presented herein.
SELECTED STATEMENT OF OPERATIONS IS AS FOLLOWS:
- - ------------------ (1) For a discussion of charges included in compensation expense, including employee benefits, general and administrative expenses, and other operating charges, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the heading "Results of Operations."
(2) Represents charges, primarily related to compensation, recorded in connection with Y&R's recapitalization in 1996 (the "Recapitalization").
(3) Net income in 1999 includes the aggregate after-tax effect of approximately $51 million ($0.62 per share) in connection with the net gain recognized on the sale of certain assets of Brand Dialogue in exchange for an ownership interest in Luminant Worldwide Corporation and additional consideration received as a result of achieving certain revenue and operating profit performance targets of the Brand Dialogue contributed assets. Net loss in 1998 includes an extraordinary loss on the retirement of debt of $4.4 million ($0.08 per share). Earnings per share for 1996 and 1995 cannot be computed because Y&R's capital structure prior to its Recapitalization consisted of both common stock and limited partnership units in predecessor entities.
SELECTED BALANCE SHEET DATA
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated Financial Statements beginning on page.
RESULTS OF OPERATIONS
The following table sets forth, for the years indicated, certain items derived from our consolidated statements of operations and the percentages of revenue represented by such items. References to years are to years ended December 31. Totals may not add due to rounding.
1999 COMPARED TO 1998
Revenues for 1999 increased by $194.7 million, or 12.8%, to $1,717.2 million compared to 1998. Organic worldwide revenue growth, excluding the effect of acquisitions and foreign currency fluctuations, was 10.4% due to the growth of existing businesses, including net new business gains and net higher spending from existing clients. Acquisitions contributed 5.0% of revenue growth, or $82.2 million. Domestic revenues increased by 16.0%, or 11.7% excluding acquisitions, to $899.8 million for 1999 compared to 1998. International revenues increased by 9.5% to $817.4 million. Excluding the effect of foreign currency fluctuations and acquisitions, international revenues increased 9.1% for 1999 compared to 1998.
Compensation expense increased by $90.2 million to $994.1 million for 1999 compared to 1998. This increase in compensation expense was primarily due to additional salary expense to support an increased revenue base and compensation expense attributable to acquired entities, partially offset by the favorable impact of a decrease in employee benefit expenses as a percentage of total compensation. Compensation expense in 1999 decreased as a percentage of revenues to 57.9% from 59.4% in 1998, principally reflecting the savings in employee benefit expenses as a percentage of total compensation, and improved productivity.
General and administrative expenses increased by $59.4 million to $515.0 million for 1999 compared to 1998. This increase was primarily due to additional operating expenses to support revenue growth, amortization of goodwill and other intangible assets attributable to acquired entities and incremental facilities costs associated with the expansion and relocation of certain domestic and international offices, partially offset by ongoing cost containment initiatives. General and administrative expenses for 1999 as a percentage of revenues were 30.0% as compared to 29.9% for 1998.
Operating profit was $208.1 million for 1999. As a result of the $234.4 million of other operating charges associated with our initial public offering in 1998, operating loss was $71.5 million for 1998. Excluding the other operating charges in 1998, operating profit increased $45.1 million, or 27.7%, in 1999 compared to 1998. This increase was primarily due to net new business gains in 1999 combined with improved operating margins. The operating profit margin for 1999 was 12.1%, a 140 basis point improvement over 1998, excluding the effect of the other operating charges.
Net interest expense decreased by $2.8 million to $14.8 million for 1999 compared to 1998. The decline was principally due to lower average borrowing rates during 1999 compared to 1998.
Other income of $85.0 million in 1999 represented the net pre-tax gain on the sale of certain assets of our Brand Dialogue operations in exchange for an ownership interest in Luminant Worldwide Corporation ("Luminant") and additional consideration received in the fourth quarter of 1999 as a result of achieving revenue and operating profit performance targets of the Brand Dialogue contributed assets.
Income tax expense was $111.3 million for 1999 compared to an income tax benefit of $2.6 million for 1998. In 1998, an income tax benefit of $64.6 million was attributable to the other operating charges of $234.4 million incurred in connection with our initial public offering and reflected the anticipated federal, state and foreign tax effect of these charges after consideration of valuation allowances for certain non-U.S. deductions, partially offset by income tax expense of $62.0 million. The effective tax rate for 1999 was 40.0% compared to 42.0% in 1998, after excluding the benefit derived from the other operating charges. The decrease in the effective tax rate resulted from various tax planning initiatives and a shift in foreign income to jurisdictions taxed at rates lower than the U.S. statutory rate.
Equity in net income of unconsolidated affiliates was $4.5 million for 1999 compared to $4.7 million in 1998, reflecting improved operating results of these companies offset by the effect of the step up to majority ownership in Dentsu, Young & Rubicam companies throughout principal markets in Asia, with the exception of Japan, resulting in the consolidation of these entities from August 2, 1999.
Minority interest in net income of consolidated companies was $4.3 million for 1999 compared to $2.0 million in 1998, primarily reflecting the effect of the acquisition on August 2, 1999 of incremental ownership interests in Dentsu, Young & Rubicam companies throughout principal markets in Asia, with the exception of Japan.
In 1998, we incurred an extraordinary charge of $4.4 million, net of a tax benefit of $2.8 million, due to the write-off of unamortized deferred financing costs related to a previous credit facility.
Net income for 1999 was $167.1 million. As a result of the other operating charges incurred in connection with our initial public offering in 1998, net loss was $86.1 million for 1998. Excluding the other operating charges in 1998 of $234.4 million and other income of $85.0 million in 1999, net income increased $32.3 million, or 38.5%, in 1999 compared to 1998. This increase was principally due to revenue growth, acquisition activity, improved operating margins, lower net borrowing costs and a reduced effective tax rate.
1998 COMPARED TO 1997
Revenues for 1998 increased by $139.8 million, or 10.1%, to $1,522.5 million compared to 1997. Organic worldwide revenue growth, excluding the effect of acquisitions and foreign currency fluctuations, was 12.2% due to growth of existing businesses, including net new business gains and net higher spending from existing clients. Domestic revenues increased by 17.3% to $775.7 million for 1998 compared to 1997. International revenues increased by 3.5% to $746.8 million. Excluding the effect of foreign currency fluctuations, international revenues increased 7.9% for 1998 compared to 1997.
Compensation expense increased by $67.7 million to $903.9 million for 1998 compared to 1997. The growth in compensation expense was primarily attributable to additional staffing to support business growth and salary increases. Compensation expense in 1997 also included a $12.3 million charge primarily for deferred compensation awards granted to senior executives. Excluding the effect of the 1997 deferred compensation awards, compensation expense in 1998 decreased as a percentage of revenues to 59.4% from 59.6% in 1997.
General and administrative expenses decreased by $8.3 million to $455.6 million for 1998 compared to 1997. This decrease was primarily due to a $25.5 million write-off in 1997 of accounts receivable, costs billable to clients and other capitalized costs with respect to the operations of Burson-Marsteller in Europe and Asia, which was partially offset in 1998 by additional operating expenses to support business growth. Excluding the effect of the Burson-Marsteller write-off, general and administrative expenses in 1998 decreased as a percentage of revenues to 29.9% from 31.7% in 1997.
Effective upon the completion of our initial public offering in 1998, we recognized other operating charges of $234.4 million. These other operating charges consisted of non-recurring, non-cash compensation charges resulting from the vesting of shares of restricted stock allocated to employees. In 1997, we recognized $11.9 million of other operating charges for non-cash asset impairment write-downs principally related to operations in the United States, Africa, Latin America and Europe.
As a result of the $234.4 million in other operating charges in 1998, we reported an operating loss of $71.5 million for 1998. Excluding the other operating charges described above for both 1998 and 1997, and the Burson-Marsteller write-off and deferred compensation charge in 1997, operating profit in 1998 increased by $42.4 million, or 35.2%, compared to 1997.
Net interest expense decreased by $16.7 million to $17.7 million for 1998 compared to 1997. The decline was due to lower average borrowing levels and lower average borrowing rates during 1998 compared to 1997.
We recognized an income tax benefit of $2.6 million for 1998 compared to income tax expense of $58.3 million for 1997. Included in 1998 is an income tax benefit of $64.6 million attributable to the other operating charges of $234.4 million described above, which reflects the anticipated federal, state and foreign tax effect of these charges after consideration of valuation allowances for certain non-U.S. deductions. The effective income tax rate was a benefit of 3.0% for 1998. Excluding the benefit derived from the other operating charges, the effective tax rate was 42% for 1998, a decrease from the 160.6% effective tax rate for 1997. The effective tax rate in 1997 includes the effect of incremental foreign taxes arising from losses outside the United States, which provided little or no tax benefit.
Equity in net income of unconsolidated affiliates was $4.7 million for 1998 compared to $0.3 million in 1997, reflecting improved worldwide operating results by advertising agency affiliates.
Minority interest in net income of consolidated companies was $2.0 million for 1998 compared to $2.3 million in 1997, primarily due to lower earnings from a Latin American operation.
We incurred an extraordinary charge of $4.4 million in 1998, which is net of a tax benefit of $2.8 million, due to the write-off of unamortized deferred financing costs related to a credit facility which was replaced in May 1998 in connection with our initial public offering.
Net loss for 1998 was $86.1 million compared to a net loss of $23.9 million for 1997. Excluding the after-tax effect of the other operating charges associated with our initial public offering and the extraordinary charge in 1998, and the other operating charges, the Burson-Marsteller write-off and the deferred compensation charge in 1997, net income increased by $86.3 million in 1998 compared to 1997. This increase was primarily the result of revenue growth, improved operating margins, lower net borrowing costs and a reduced effective tax rate.
LIQUIDITY AND CAPITAL RESOURCES
We generally finance our working capital, capital expenditures, acquisitions and equity repurchases from cash generated from operations and third-party borrowings.
Cash and cash equivalents were $144.5 million and $122.1 million at December 31, 1999 and 1998, respectively. Cash provided by operating activities in 1999 was $326.9 million compared to $195.6 million in 1998, reflecting revenue and net income growth, improved operating margins and a significant improvement in working investment. Operating cash flows are significantly impacted by seasonal media spending patterns of advertisers, including the timing of payments made to media and other suppliers on behalf of clients as well as the timing of cash collections from clients to fund these expenditures. Our practice, where possible, is to bill and collect from our clients in sufficient time to pay the amounts due the media.
Free cash flow, which is defined as cash provided by operating activities less capital expenditures, totaled $240.8 million in 1999, a 100% increase from 1998.
Cash used in investing activities in 1999 was $301.3 million and included $86.2 million in capital expenditures and $216.1 million for investments and acquisitions, net of cash acquired. In 1998, cash used in investing activities was $99.7 million, principally consisting of $76.4 million in capital expenditures. The majority of capital expenditures in 1999 were for leasehold improvements and information technology-related purchases. Acquisitions and investments in 1999 included the purchase of KnowledgeBase Marketing, Inc., the contribution of cash and certain net assets of our Brand Dialogue operations in exchange for an ownership interest in Luminant, the purchase of an incremental ownership interest in the Dentsu, Young & Rubicam companies throughout principal markets in Asia, with the exception of Japan, and an investment in DigitalConvergence.com Inc.
Cash provided by financing activities in 1999 was $8.6 million and included net borrowings of $127.1 million. In 1998, our Board of Directors approved a plan to repurchase an aggregate of up to 8.0 million shares of our common stock in the open market or in private transactions. In 1999, our Board of Directors approved an increase of 4.0 million shares to our authorized share repurchase program, bringing the total shares we can repurchase through August 2001 under the repurchase program to 12.0 million. During 1999, we repurchased 3.5 million shares of our common stock on the open market and in other transactions at an average price of $41.70 per share for an aggregate cost of $146.0 million. From January 1, 2000 through March 15, 2000, we repurchased an additional approximately 1.7 million shares of common stock at an average price of $51.15 per share on the open market and in other transactions. This brings the total to 7.1 million shares repurchased under our authorized repurchase program. In 1998, cash used in financing activities was $136.2 million, reflecting the repayment of our previous credit facility, offset in part by the proceeds received from the consummation of our initial public offering and borrowings under our current credit facility.
During 1999, we increased our borrowing capacity by entering into an additional $200 million credit facility. At December 31, 1999, we had approximately $123.5 million in outstanding indebtedness under our aggregate $600 million credit facilities. We expect to fund payments of principal and interest under these credit facilities with cash from operations. During the first quarter of 1999, all interest rate protection agreements to which we were party either matured or were retired. Accordingly, at December 31, 1999, we had no such agreements outstanding.
Our credit facilities contain financial and operating restrictions and covenant requirements, including maximum leverage ratio and minimum interest coverage requirements, and permit the payment of cash dividends except in the event of a continuing default under the credit agreements. On June 15, 1999, September 15, 1999 and December 15, 1999, we paid a quarterly cash dividend of $0.025 per share of common stock to all shareholders of record as of June 1, 1999, September 1, 1999 and December 1, 1999, respectively. The payment of additional dividends in the future will be at the discretion of our Board of Directors and will depend upon, among other factors, our results of operations, financial condition, capital requirements and contractual restrictions in our credit facilities.
On January 20, 2000, we completed the placement of $287.5 million of 3% convertible subordinated notes due January 15, 2005. At the option of the holder, the notes are convertible into
shares of our common stock at a conversion price of $73.36 per share, subject to adjustment. We used the net proceeds of the offering to repay outstanding debt under our existing bank credit facilities and to fund operations.
We may, from time to time, pursue acquisition opportunities that would strengthen or enhance existing capabilities or expand the geographic scope of our operations.
At December 31, 1999, our net deferred tax assets were $85.2 million consisting primarily of federal, state and foreign net operating loss carryforwards and deferred tax assets resulting from prior period compensation payments made in connection with our initial public offering in 1998 and our recapitalization in 1996, partially offset by deferred tax liabilities related to the Luminant net gain and unrealized appreciation in equity securities.
We believe that cash provided by operations and funds available under our credit facilities will be sufficient to meet our anticipated cash requirements as presently contemplated.
MARKET RISK MANAGEMENT
Our market risks primarily consist of the impact of changes in currency exchange rates on assets and liabilities of non-U.S. operations, the impact of changes in interest rates on debt and the impact of changes in market prices on publicly traded equity securities held by us. At December 31, 1999 and 1998, the carrying value of our financial instruments approximated fair value in all material respects.
INTEREST RATE RISK
At December 31, 1999, we had $159.3 million in outstanding indebtedness as compared to $63.9 million at December 31, 1998, consisting primarily of floating rate debt. For floating rate debt, interest rate changes generally do not affect the fair market value but do impact future earnings and cash flows, assuming other factors are held constant. Based on outstanding indebtedness as of December 31, 1999, the annual after-tax earnings impact resulting from a one-percentage point increase or decrease in interest rates would be approximately $1.0 million, holding other variables constant.
At December 31, 1998, we had interest rate protection agreements with respect to $31.5 million of our indebtedness. The fair value approximated the notional amount at December 31, 1998. During the first quarter of 1999, all interest rate protection agreements to which we were party either matured or were retired. Accordingly, at December 31, 1999, we had no such agreements outstanding.
MARKET RISK
On September 21, 1999, we received equity securities in Luminant, an internet and e-commerce services firm, in exchange for cash and certain net assets of our Brand Dialogue operations. During 1999, Y&R also made strategic investments in marketable equity securities of certain other entities and received certain marketable equity securities in exchange for services rendered. We account for our investments in equity securities with readily determinable fair values under Statement of Financial Accounting Standards ("SFAS") No. 115, which requires that certain equity securities be adjusted to market value at the end of each accounting period. The values of these securities have since appreciated significantly. However, the value of equity securities may fluctuate based on the volatility of the respective company's stock price and other general market conditions. All of these equity securities have been classified as available-for-sale securities and, as such, are carried net of tax as a separate component of stockholder's equity in the consolidated balance sheet caption "Unrealized appreciation in equity securities."
FOREIGN EXCHANGE RATE RISK
Our consolidated financial statements are denominated in U.S. dollars. In 1999, we derived approximately 48% of our revenues from operations outside of the United States. Significant strengthening of the U.S. dollar against other major foreign currencies could have a material adverse
effect on our results of operations. Substantially all of our revenues are billed in the same currency as the costs incurred to support the revenues, thereby reducing exposure to transaction gains and losses. We typically do not hedge foreign currency profits into U.S. dollars, believing that over time the costs of a hedging program would outweigh any benefit of greater predictability in our U.S. dollar-denominated profits. However, we selectively hedge some positions where management believes it is economically beneficial to do so, and base our foreign subsidiary capitalization, debt and dividend policies on minimizing currency risk. We also seek, through pricing and other means, to anticipate and avoid economic currency losses.
We enter into forward foreign exchange contracts to hedge certain assets and liabilities, which are recorded in a currency different from that in which they will be settled. These contracts are generally entered into in order to hedge intercompany transactions. Gains and losses on these contracts generally offset losses and gains on the related foreign currency denominated intercompany transactions. The gains and losses on these positions are deferred and included in the basis of the transaction upon settlement. The terms of these contracts are generally a one-month maturity. At December 31, 1999, Y&R had contracts for the sale of $26.1 million and the purchase of $11.9 million of foreign currencies at fixed rates, compared to contracts for the sale of $19.4 million and the purchase of $6.1 million of foreign currencies at fixed rates at December 31, 1998.
Management believes that any losses resulting from market risk would not have a material adverse impact on Y&R's consolidated financial position, results of operations or cash flows.
CONVERSION TO EURO
On January 1, 1999, 11 of the member countries of the European Union established fixed conversion rates between their existing currencies and the European Union's common currency, the euro. The transition period for the introduction of the euro began on January 1, 1999. Beginning January 1, 2002, the participating countries will issue new euro-denominated bills and coins for use in cash transactions. No later than July 1, 2002, the participating countries will withdraw all bills and coins denominated in the legacy currencies, so that the legacy currencies no longer will be legal tender for any transactions, making the conversion to the euro complete. We are addressing the issues involved with the introduction of the euro, including converting information technology systems, reassessing currency risk and negotiating and amending agreements. Based on progress to date, we believe that the use of the euro will not have a significant impact on the manner in which we conduct our business. Accordingly, conversion to the euro is not expected to have a material effect on our consolidated financial condition, results of operations or cash flows.
YEAR 2000 COMPLIANCE
We continue to monitor the potential impact of the year 2000 on the ability of our computer systems to accurately process information with dates later than December 31, 1999, or to process date-sensitive information accurately after the turn of the century. We have modified or replaced all significant systems necessary for us to operate our business that we have identified as requiring year 2000 remediation. We are also dependent in part on third-party computer systems and applications, particularly with respect to such critical tasks as accounting, billing and buying, planning and paying for media, as well as on our own computer systems.
Since January 1, 2000, we have experienced no material impact on our computer systems or operations as a result of the year 2000 issue. While we believe our efforts have been successful to date, because of the complexity of the year 2000 issue and the interdependence of organizations using computer systems, it is possible that our efforts, or those of third parties with whom we interact, may not be sufficient to prevent all year 2000 issues that may arise in the future. Our failure to satisfactorily and completely address the year 2000 issue could have a material adverse effect on our prospects, business, financial condition and results of operations.
The out-of-pocket costs incurred in 1999 in respect of the year 2000 issue were not material. We have funded all remedial projects in connection with our program.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"), which provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. In June 1999, the FASB issued Statement No. 137, "Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133", which delays implementation of SFAS No. 133 until fiscal years beginning after June 15, 2000. We do not anticipate that the adoption of SFAS No. 133 will have a significant effect on our financial condition.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information required in response to this Item 7A, reference is made to Management's Discussion and Analysis of Financial Condition and Results of Operations under the heading "Market Risk Management" and to Notes 1 and 13 of Notes to the Consolidated Financial Statements.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required in response to this Item 8 appear beginning on page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to the executive officers and directors of the Company and compliance with Section 16(a) of the Securities Exchange Act of 1934 and the rules thereunder is incorporated by reference to the Company's definitive proxy statement for its 2000 Annual Meeting of Stockholders (the "Proxy Statement") expected to be filed by April 14, 2000.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference to the Proxy Statement expected to be filed by April 14, 2000. Such incorporation shall not be deemed to incorporate specifically by reference the information referred to in Item 402(a)(8) of Regulation S-K.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference to the Proxy Statement expected to be filed by April 14, 2000.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference to the Proxy Statement expected to be filed by April 14, 2000. Such incorporation shall not be deemed to incorporate specifically by reference the information referred to in Item 402(a)(8) of Regulation S-K.
PART IV
ITEM 14.
ITEM 14. EXHIBITS; FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)1. Financial Statements:
2. Financial Statement Schedules:
All other schedules are omitted because they are not applicable.
3. Exhibits:
- - ---------- * Filed herewith.
+ This exhibit is a management contract or a compensatory plan or arrangement.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the fourth quarter of the year ended December 31, 1999.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF MANAGEMENT
The management of Young & Rubicam Inc. ("Y&R") and its subsidiaries is responsible for the integrity of the financial data reported by Y&R. Management uses its best judgment to ensure that the financial statements present fairly, in all material respects, the consolidated financial position and results of operations of Y&R. These financial statements have been prepared in accordance with generally accepted accounting principles.
The system of internal controls of Y&R is designed to provide reasonable assurance that assets are safeguarded, that transactions are executed in accordance with management's authorization and are properly recorded, and that accounting records may be relied upon for the preparation of financial statements and other financial information. Underlying this concept of reasonable assurance is the premise that the cost of control should not exceed the benefits derived and that the evaluation of those factors requires estimates and judgments by management. Further, because of inherent limitations in any system of internal accounting control, errors or irregularities may occur and not be detected. Nevertheless, management believes that a high level of internal control is maintained by Y&R through the selection and training of qualified personnel, the establishment and communication of accounting and business policies, and its internal audit program.
The financial statements have been audited by independent accountants. Their report expresses an independent informed judgment as to the fairness of management's reported operating results and financial position. This judgment is based on the procedures described in their report.
The Audit Committee of the Board of Directors, which is comprised solely of directors who are not officers or employees of Y&R, meets regularly with corporate management, Y&R's internal auditors and legal counsel, and the independent accountants to review the activities of each and to satisfy itself that each is properly discharging its responsibility. In addition, the Audit Committee meets on a scheduled basis with the independent accountants, without management's presence, to discuss the audit of the financial statements as well as other auditing and financial reporting matters.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Young & Rubicam Inc.
In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) on page 21 present fairly, in all material respects, the financial position of Young & Rubicam Inc. and its subsidiaries (the "Company") at December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 14(a)(2) on page 21 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP New York, New York February 11, 2000
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these consolidated financial statements.
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these consolidated financial statements.
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (DEFICIT)
The accompanying notes are an integral part of these consolidated financial statements.
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES QUARTERLY FINANCIAL INFORMATION (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- - ---------- (1) Operating profit (loss) for the third quarter of 1999 includes $70.8 million of net pre-tax gain on the sale of certain assets of our Brand Dialogue operations in exchange for an ownership interest in Luminant Worldwide Corporation.
(2) Operating profit (loss) for the second quarter of 1998 includes $234.4 million of non-recurring, non-cash, pre-tax compensation charges recognized upon the consummation of our initial public offering resulting from the vesting of shares of restricted stock allocated to employees. Net income for the second quarter of 1998 also includes an extraordinary charge of $4.4 million, which is net of a tax benefit of $2.8 million, due to the write-off of unamortized deferred financing costs related to Y&R's replaced credit facility.
(3) The high and low prices of common stock reflect amounts from the period commencing upon the consummation of our initial public offering on May 12, 1998, the first day of public trading, through June 30, 1998.
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
NOTE 1 -- DESCRIPTION OF THE BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS: Young & Rubicam Inc. ("Y&R") is a global marketing and communications company which offers clients integrated services in the creation and production of advertising, strategic media planning and buying, direct marketing and customer relationship management, perception management and public relations, branding consultancy and design services, and healthcare communications. Y&R operates through wholly owned subsidiaries, joint ventures and non-equity affiliations worldwide. Operations cover the major geographic regions of North America, Europe, Latin America, the Far East, Australia, New Zealand, the Middle East and Africa.
PRINCIPLES OF CONSOLIDATION: The accompanying consolidated financial statements include the accounts of Y&R and its majority owned subsidiaries. The equity in net income attributable to minority shareholder interests are shown separately in the consolidated balance sheets and consolidated statements of operations. Investments in entities owned 20% or more, but less than majority owned and not otherwise controlled by Y&R are accounted for under the equity method. All significant intercompany transactions are eliminated.
CASH EQUIVALENTS: Y&R considers all highly liquid instruments with an initial maturity of three months or less to be cash equivalents at the time of purchase. Y&R records book overdrafts in accounts payable. Accounts payable included $88.6 million and $51.8 million of book overdrafts as of December 31, 1999 and 1998, respectively.
REVENUE RECOGNITION: Substantially all revenues are derived from commissions for placement of advertisements in various media and from fees for manpower and for production of advertisements and other marketing and communications services. Commission revenue is recognized when media is placed and when labor and production costs are billed. Fee revenue is recognized when services are rendered.
COSTS BILLABLE TO CLIENTS: Costs billable to clients consist principally of costs incurred in providing communication services to clients. Such amounts are generally billed to clients when manpower is used, when costs are incurred for production and when print production is completed.
DEPRECIATION AND AMORTIZATION: Depreciation charges are computed using the straight-line method over the estimated useful life of the respective asset up to 25 years. Leasehold improvements are amortized on a straight-line basis over the lesser of the term of the related lease or the estimated useful life of these assets.
INTANGIBLES: Intangibles, including goodwill, are carried at cost less accumulated amortization which is being provided on a straight line basis over the economic lives of the respective assets with a maximum life of 40 years. Each year, the intangibles are written down if, and to the extent they are determined to be impaired. Intangibles are determined to be impaired if the future anticipated undiscounted cash flows arising from the use of the intangibles is less than the net unamortized cost of the intangibles.
INCOME TAXES: In accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," deferred tax assets and liabilities are determined based on differences between the financial reporting and the tax basis of assets and liabilities and are measured by applying enacted tax rates and laws to taxable years in which such differences are expected to reverse. Y&R's practice is to provide currently for taxes that will be payable upon remittance of foreign earnings of subsidiaries and affiliates to the extent that such earnings are not considered to be reinvested indefinitely.
STOCK-BASED COMPENSATION: SFAS No. 123, "Accounting for Stock-Based Compensation," encourages entities to account for employee stock options or similar equity instruments using a fair value approach. However, it also allows an entity to continue to measure compensation costs using
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - (CONTINUED )
the method prescribed by Accounting Principles Bulletin ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." Y&R has elected to continue to account for such plans under the provisions of APB Opinion No. 25 and has included, in Note 15, the required SFAS No. 123 pro forma disclosures of net income (loss) and earnings (loss) per share as if the fair value-based method of accounting had been applied.
TREASURY STOCK: Y&R accounts for treasury share purchases at cost. The reissuance of treasury shares is accounted for at the average cost. Gains or losses on the reissuance of treasury shares are accounted for as capital surplus.
FOREIGN CURRENCY TRANSLATION: Y&R's financial statements were prepared in accordance with the requirements of SFAS No. 52, "Foreign Currency Translation." Under this method, net foreign currency transaction gains of $0.5 million and net losses of $1.3 million were recorded in 1999 and 1997, respectively. Net losses in 1998 were immaterial.
DERIVATIVE FINANCIAL INSTRUMENTS: Derivative financial instruments are used by Y&R principally in the management of its interest rate and foreign currency exposures. Y&R does not hold or issue derivative financial instruments for trading purposes. Gains and losses on hedges of existing assets and liabilities are included in the carrying amounts of those assets and liabilities and are ultimately recognized in income as part of those carrying amounts. Gains and losses related to hedges of firm commitments are also deferred and included in the basis of the transaction when it is completed.
INVESTMENTS IN EQUITY SECURITIES: Y&R accounts for its investments in publicly traded equity securities under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." In accordance with SFAS No. 115, unrealized gains on securities owned by Y&R, which are classified as available-for-sale securities, are carried net of tax as a separate component of stockholders' equity under the consolidated balance sheet caption "Unrealized appreciation in equity securities." Unrealized appreciation in equity securities included in stockholders' equity at December 31, 1999, was $145.0 million, net of $92.7 million of related income taxes. Investments which are not publicly traded are accounted for at cost.
CONCENTRATIONS OF CREDIT RISK: Y&R's clients are engaged in various businesses located primarily in North America, Europe, Latin America and the Asia/Pacific region. Y&R performs ongoing credit evaluations of its clients. Allowances for credit losses are maintained at levels considered adequate by management. Y&R invests its excess cash in deposits with major banks and in money market securities. These securities typically mature within 90 days and are highly rated instruments. Y&R's top 10 clients accounted for approximately 37%, 36% and 31% of consolidated revenues in 1999, 1998 and 1997, respectively. Y&R's largest client accounted for approximately 13%, 10% and 10% of consolidated revenues for the years ended December 31, 1999, 1998 and 1997, respectively.
USE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
RECENT ACCOUNTING PRONOUNCEMENTS: In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"), which provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. In June 1999, the FASB issued Statement No. 137, "Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133", which delays implementation of SFAS No. 133 until fiscal years beginning after June 15, 2000. We do not anticipate that the adoption of SFAS No. 133 will have a significant effect on our financial condition.
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - (CONTINUED )
RECLASSIFICATIONS: Certain reclassifications have been made to the prior years' financial statements to conform to the 1999 presentation.
NOTE 2 -- EARNINGS PER SHARE
Basic earnings (loss) per share are calculated by dividing net income (loss) by the weighted average shares of common stock outstanding during the years ended December 31, 1999, 1998 and 1997. Diluted earnings per share reflect the dilutive effect of stock options, primarily stock options granted to employees under stock-based compensation plans, and other dilutive securities.
Shares used in computing basic and diluted earnings per share were as follows:
In the years ended December 31, 1998 and 1997, basic and diluted weighted average shares used in the calculation were the same since the inclusion of the effect of stock options on loss per share would have been antidilutive.
In computing basic loss per share for the year ended December 31, 1997, Y&R's 11.1 million shares of restricted stock were excluded from the weighted average number of common shares outstanding. Such shares vested upon the consummation of Y&R's initial public offering on May 15, 1998, a condition which was not satisfied at December 31, 1997 (see Note 3).
NOTE 3 -- INITIAL PUBLIC OFFERING
On May 15, 1998, Y&R closed an initial public offering of its common stock (the "Offering"). An aggregate of 19,090,000 shares of Y&R's common stock was offered to the public, of which 6,912,730 shares were sold by Y&R and 12,177,270 shares were sold by certain selling shareholders. Y&R used the net proceeds of $158.6 million, together with $155 million of borrowings under a new credit facility to repay all of the outstanding borrowings under its then existing $700 million senior secured credit facility.
The completion of the Offering gave rise to non-recurring, non-cash, pre-tax compensation charges of $234.4 million, or $169.8 million net of the related tax benefit, from the vesting of an aggregate of 9,231,105 shares of restricted stock allocated to employees as of the date of the completion of the Offering. These charges have been reflected as other operating charges in Y&R's consolidated statement of operations for the year ended December 31, 1998. Y&R redeemed the remaining 1,855,845 shares of restricted stock held in the restricted stock trust upon the consummation of the Offering.
NOTE 4 -- COMMON STOCK DIVIDEND
On April 6, 1998, the Board of Directors declared a stock dividend of 14 shares of common stock payable for each share of common stock outstanding, which became effective and was paid on May 11, 1998. Y&R's historical financial statements have been presented to give retroactive effect to this stock dividend.
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - (CONTINUED )
NOTE 5 -- EQUITY IN NET ASSETS OF UNCONSOLIDATED AFFILIATES
Effective August 2, 1999, the ownership and management structure of Dentsu, Young & Rubicam ("DY&R") was amended. The agreement resulted in Y&R acquiring majority ownership in and operational control of all DY&R companies throughout principal markets in Asia, with the exception of Japan. In Japan, Dentsu has acquired a majority share. Effective August 2, 1999, Y&R commenced consolidating the results of DY&R for those markets where it holds a majority ownership interest. For periods prior to August 2, 1999, the financial information reflects the DY&R partnerships in which Y&R held a minority equity ownership interest.
The summarized unaudited financial information below represents an aggregation of Y&R's unconsolidated affiliates.
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - (CONTINUED )
NOTE 6 -- INVESTMENTS IN EQUITY SECURITIES
On September 21, 1999, Y&R contributed $15 million and certain net assets of its Brand Dialogue operations (the "Brand Dialogue Contributed Assets") in exchange for an ownership interest in Luminant Worldwide Corporation ("Luminant"), an internet and e-commerce services firm that provides strategic consulting, content development and systems integration capabilities to its clients. Y&R recognized a net after-tax gain of approximately $42 million on the sale of the Brand Dialogue Contributed Assets in the third quarter of 1999. Y&R accounts for its investment in Luminant equity securities at fair value under SFAS No. 115. Since September 1999, the value of these equity securities has appreciated significantly. However, the value of the equity securities may fluctuate based on the volatility of Luminant's stock price and other general market conditions. We have classified the Luminant securities as available-for-sale securities. At December 31, 1999, the cost basis of these securities was $91.5 million. The securities are carried at their fair value of $306.5 million and are included in other investments on the balance sheet. The difference between cost and fair value of $215.0 million is carried net of $83.9 million of related income taxes as a separate component of stockholders' equity under the consolidated balance sheet caption "Unrealized appreciation in equity securities." Under the terms of the contribution agreement between Luminant and Y&R, Y&R recorded a net after-tax gain of approximately $9 million in the fourth quarter of 1999 reflecting the realization of contingent consideration as a result of achieving certain revenue and operating profit performance targets of the Brand Dialogue Contributed Assets, and is eligible to receive, in 2000, future contingent consideration from Luminant, in the form of cash and/or non-voting shares of Luminant common stock, at Luminant's discretion, based on the consolidated performance of Luminant for the first six months of 2000.
During 1999, Y&R also made strategic investments in marketable equity securities of certain other entities for an aggregate cost of approximately $45 million and also received certain marketable equity securities in exchange for services rendered. Y&R accounts for its investments in equity securities with readily determinable fair values under SFAS No. 115. At December 31, 1999, all equity securities covered by SFAS No. 115 were designated as available-for-sale. Accordingly, these securities are stated at fair value, with unrealized holding gains, net of taxes, reported in a separate component of shareholders' equity. Such equity securities at December 31, 1999, excluding Luminant, had an aggregate cost basis of $14.7 million. These securities are carried at their fair value of $37.3 million and are included in investments in equity securities on the balance sheet. Differences between cost and fair value of $22.6 million are carried net of $8.8 million of related income tax as a separate component of stockholders' equity under the consolidated balance sheet caption "Unrealized appreciation in equity securities."
When readily determinable fair values are not available, marketable securities are carried on the balance sheet at cost, except in cases where it is determined that a decline in the estimated fair value of the investment is other than temporary. At December 31, 1999, the carrying value of such cost investments was $22.8 million, which includes our investment in DigitalConvergence.com Inc. of approximately $20 million.
NOTE 7 -- ACQUISITIONS
Effective August 2, 1999, the ownership and management structure of DY&R was amended. The agreement resulted in Y&R acquiring majority ownership in and operational control of all DY&R companies throughout principal markets in Asia, with the exception of Japan. In Japan, Dentsu has acquired a majority share. Effective August 2, 1999, Y&R commenced consolidating the results of DY&R for those markets where it holds a majority ownership interest. Y&R paid approximately $6 million for the incremental ownership interest and will pay $4 million in the first quarter of 2001. This transaction has been accounted for under the purchase method of accounting for business combinations. A preliminary allocation of the cost to acquire the additional interest in DY&R has been made based upon the fair value of DY&R's net assets.
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - (CONTINUED )
On May 21, 1999, Y&R acquired KnowledgeBase Marketing, Inc. ("KBM"), a provider of database and analytical services, in a stock and cash transaction valued at approximately $175 million. This transaction has been accounted for under the purchase method of accounting for business combinations. A preliminary allocation of the cost to acquire KBM has been made based upon the fair value of KBM's net assets.
Also during 1999, Y&R acquired The Direct Impact Company, a company specializing in grassroots issues management; Rainey, Kelly, Campbell, Roalfe, a London-based advertising agency; a majority ownership interest in The Banner Corporation, a European marketing and communications firm specializing in the technology sector, and made several other acquisitions and equity investments for which the aggregate purchase price was approximately $80 million. All of these acquisitions were accounted for under the purchase method of accounting and a preliminary allocation of the costs to acquire these entities has been made based on the fair value of the net assets.
During 1998 and 1997, Y&R acquired full or partial interests in certain domestic and international entities and obtained additional interests in certain partially owned entities for an aggregate purchase price of $17.6 million and $14.7 million, respectively. In 1998, acquisitions included Y&R's purchase of a multi-cultural advertising agency and certain other assets located in the United States. In 1997, Y&R acquired an additional 37.5% equity interest in the DY&R companies in Australia and New Zealand. In consideration for this additional equity interest, Y&R contributed to Dentsu 12.5% of its equity interest in its advertising and direct marketing agencies in Australia and New Zealand. All of these acquisitions were accounted for under the purchase method of accounting. During 1997, Y&R also recorded $11.9 million in other operating charges for certain asset impairment writedowns.
Certain acquisitions completed in 1999 and prior years require payments in future years if certain results are achieved by the companies that were acquired. Formulas for these contingent future payments differ from acquisition to acquisition. Contingent future payments are not expected to be material to Y&R's results of operations or financial position.
NOTE 8 -- PROPERTY, LEASEHOLD IMPROVEMENTS AND EQUIPMENT
Property, leasehold improvements and equipment are recorded at cost and are comprised of the following:
During 1999, 1998 and 1997, depreciation expense amounted to $53.6 million, $49.2 million and $47.6 million, respectively.
NOTE 9 -- INCOME TAXES
Income (loss) before income taxes consisted of the amounts shown below:
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - (CONTINUED )
The following summarizes the provision (benefit) for income taxes:
Y&R's effective income tax rate varied from the statutory federal income tax rate as a result of the following factors:
Y&R's share of the undistributed earnings of foreign subsidiaries not included in its consolidated Federal income tax return that could be subject to additional income taxes if remitted was approximately $102.9 million and $59.1 million at December 31, 1999 and 1998, respectively. No provision has been recorded for the United States in respect of foreign taxes that could result from the remittance of such undistributed earnings since the earnings are permanently reinvested outside the United States and it is not practicable to estimate the amount of such taxes. Withholding taxes of approximately $5.1 million and $8.1 million would be payable upon remittance of all previously unremitted earnings at December 31, 1999 and 1998, respectively.
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - (CONTINUED )
The components of Y&R's net deferred income tax assets are:
Y&R's net deferred income tax assets arise from temporary differences which represent the cumulative deductible or taxable amounts recorded in the financial statements in different years than recognized in the tax returns. The majority of the temporary differences result from expenses accrued for financial reporting purposes which are not deductible for tax purposes until actually paid and net operating losses.
The net operating loss ("NOL") carryforwards represent the benefit recorded for federal, state and local, and foreign NOLs. At December 31, 1999 and 1998, Y&R had approximately $251.3 million and $258.3 million, respectively, of NOL carryforwards for U.S. tax purposes which expire in the year 2018 and approximately $111.9 million and $91.4 million, respectively, of NOL carryforwards for foreign tax purposes with carryforward periods ranging from one year to an indefinite time. At December 31, 1999 and 1998, Y&R had approximately $3.4 million and $3.2 million, respectively, of alternative minimum tax credits which are not subject to expiration and $0.4 million of foreign tax credits which expire in the year 2001.
Furthermore, Y&R, under its stock option plans, has a significant number of non-qualified stock options issued to employees that remain outstanding at December 31, 1999. These options, if exercised, would create additional tax deductions that would further reduce Y&R's domestic and international taxable income. The tax deduction has no impact on Y&R's consolidated results of operations, in accordance with APB Opinion No. 25, except for payroll taxes imposed by certain taxing jurisdictions upon exercise. It is impractical to quantify the future deduction as it is dependent upon, among other factors, the fair market value of Y&R stock at the time of exercise.
Y&R is required to provide a valuation allowance against deferred income tax assets when it is more likely than not that some or all of the deferred tax assets will not be realized. Valuation allowances of $20.7 million and $22.0 million were recorded at December 31, 1999 and 1998, respectively. The valuation allowances represent a provision for uncertainty as to the realization of certain deferred tax assets, including NOL carryforwards in certain jurisdictions. Y&R has concluded that based upon expected future results, it is more likely than not that the net deferred tax asset balance will be realized.
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - (CONTINUED )
NOTE 10 -- WORLDWIDE OPERATIONS
Y&R's wholly owned and partially owned businesses and affiliates operate in the global marketing and communications operating segment. These businesses provide marketing and communications services to clients on an integrated basis, where appropriate, through several worldwide, regional and national networks and brands. Y&R's financial information by geographic area as of December 31, 1999, 1998 and 1997 and for the years then ended is presented below.
NOTE 11 -- EMPLOYEE BENEFITS
Y&R provides retirement benefits for their U.S. full-time employees primarily through a defined benefit pension plan ("the Plan"). Contributions to the Plan are based upon current costs and prior service costs which are actuarially computed, with the latter being amortized over the average remaining service period.
During 1999, there were no contributions made to the Plan. Total contributions to the Plan made in 1998 were $10.0 million. Pursuant to an agreement with the Pension Benefit Guaranty Corporation, Y&R has also agreed to make contributions to the Plan in an amount required to cause the credit balance at the end of each Plan year to be at least equal to $12.5 million plus interest. Y&R is not required to make any payment that would not be deductible under Internal Revenue Code section 404. Y&R's credit balance maintenance requirement terminates when Y&R's indebtedness obtains specified rating levels (or, if there are no such ratings from certain major ratings agencies, when Y&R meets a fixed charge coverage ratio test), but in no event earlier than December 31, 2001. In addition, such credit balance maintenance requirements terminate if the Plan's unfunded benefit liabilities are zero at the end of two consecutive Plan years.
Y&R also contributes to government mandated plans and maintains various noncontributory retirement plans at certain foreign subsidiaries, some of which are considered to be defined benefit plans for accounting purposes. Plans are funded in accordance with the laws of the countries where the plans are in effect and, in accordance with such local statutory requirements, may have no plan assets.
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - (CONTINUED )
A summary of the components of net periodic pension cost for the defined benefit plans are as follows:
Changes in the benefit obligation and plan assets are as follows:
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - (CONTINUED )
Assumptions used were:
Y&R recorded liabilities of $0.8 million and $1.2 million at December 31, 1999 and 1998, respectively, for the portion of its unfunded pension liabilities that had not been recognized as expense with corresponding adjustments to equity.
Contributions to foreign defined contribution plans were $9.9 million, $9.0 million and $8.4 million in 1999, 1998 and 1997, respectively.
Y&R also has an employee savings plan that qualifies as a deferred salary arrangement under section 401(k) of the Internal Revenue Code. Under the plan, participating U.S. employees may defer a portion of their pre-tax earnings up to the Internal Revenue Service annual contribution limit. Y&R currently matches 100% of each employee's contribution up to a maximum of 5% of the employee's earnings up to $160,000. Amounts expensed by Y&R for its contributions to the plan were $9.1 million, $8.4 million and $7.8 million in 1999, 1998 and 1997, respectively.
At December 31, 1999 and 1998, other noncurrent liabilities include $10.2 million and $8.6 million, respectively, relating to postretirement and postemployment benefits other than pensions.
Y&R maintains certain deferred cash incentive plans which are either tied to operating performance or contractual deferred compensation agreements. The costs of these compensation plans were expensed over the applicable service period. At December 31, 1999 and 1998, Y&R recorded deferred compensation liabilities of $31.3 million and $30.6 million, respectively.
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - (CONTINUED )
NOTE 12 -- DEBT
Y&R's short-term debt consists principally of advances under bank lines of credit and generally bears interest at prevailing market rates. Y&R's short-term debt of $31.7 million and $32.0 million include short-term portions of long-term debt of $2.0 million and $0.5 million at December 31, 1999 and 1998, respectively.
Long-term debt is comprised of the following:
On June 30, 1999, Y&R increased its borrowing capacity by entering into a $200 million 364-day unsecured revolving credit facility. On May 15, 1998, Y&R entered into a $400 million, five-year unsecured multicurrency revolving credit facility and used the net proceeds from the Offering together with $155 million of borrowings under this credit facility to repay all outstanding borrowings outstanding under its then existing $700 million senior secured credit facility. Approximately $7.3 million of unamortized deferred financing costs related to the replaced credit facility were charged to expense and have been reflected as an extraordinary charge, net of an applicable tax benefit of approximately $2.8 million, in Y&R's consolidated statement of operations for the year ended December 31, 1998. Amounts due under the credit facility are required to be repaid on May 15, 2003. Y&R is required to pay varying rates of interest on outstanding borrowings, generally based on LIBOR plus an applicable margin ranging from 0.275% to 0.70%, depending on the leverage ratio, or the Federal Funds Rate plus 0.5%. Y&R is also required to pay a facility fee ranging from 0.10% to 0.20% and, if the outstanding advances exceed 50% of the aggregate facility, a utilization fee will be charged ranging from 0.075% to 0.125%. In 1999 and 1998, the total facility fees under the credit facilities were $0.6 million and $0.4 million, respectively. Our credit facilities contain financial and operating restrictions and covenant requirements, including maximum leverage ratio and minimum interest coverage requirements, and permit the payment of cash dividends except in the event of a continuing default under the credit agreements.
At December 31, 1999, the current portion of long-term debt includes installment notes payable to management investors of $0.7 million. At December 31, 1998, short-term and long-term debt includes installment notes payable to management investors of $0.7 million and $0.4 million, respectively.
The weighted-average interest rate on outstanding debt was 5.71% for the year ended December 31, 1999. The weighted-average interest rate on outstanding debt, including the effect of interest rate swap contracts, was 6.27% for the year ended December 31, 1998. At December 31, 1998, Y&R had interest rate protection agreements with respect to $31.5 million of its indebtedness. During the first quarter of 1999, all interest rate protection agreements to which we were party either matured or were retired. Accordingly, at December 31, 1999, we had no such agreements outstanding.
At December 31, 1999 and 1998, Y&R had $760 million and $543 million, respectively, in availability under its commercial lines of credit ($635 million and $435 million, respectively, in the United States and $125 million and $108 million, respectively, outside the United States). Unused commercial lines of credit at December 31, 1999 and 1998 were $600 million and $480 million, respectively. Y&R has no obligation to pay commitment fees on our current credit facilities. During 1998, Y&R paid commitment fees of approximately $0.1 million on the unused portion of the replaced credit facility.
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - (CONTINUED )
NOTE 13 -- FAIR VALUE OF FINANCIAL INSTRUMENTS AND HEDGING ACTIVITY
At December 31, 1999 and 1998, the carrying value of Y&R's financial instruments approximated fair value in all material respects.
At December 31, 1999, Y&R had $159.3 million in outstanding indebtedness as compared to $63.9 million at December 31, 1998, consisting primarily of floating rate debt. For floating rate debt, interest rate changes generally do not affect the fair market value but do impact future earnings and cash flows, assuming other factors are held constant. Based on outstanding indebtedness as of December 31, 1999, the annual after-tax earnings impact resulting from a one-percentage point increase or decrease in interest rates would be approximately $1.0 million, holding other variables constant.
Y&R enters into forward foreign exchange contracts to hedge certain assets and liabilities which are recorded in a currency different from that in which they settle. The purpose of these contracts is almost exclusively to hedge intercompany transactions. Gains and losses on these contracts generally offset losses and gains on the related foreign currency denominated intercompany transactions. The gains and losses on these positions are deferred and included in the basis of the transaction upon settlement. The terms of these contracts are generally a one-month maturity. At December 31, 1999, Y&R had contracts for the sale of $26.1 million and the purchase of $11.9 million of foreign currencies at fixed rates, compared to contracts for the sale of $19.4 million and the purchase of $6.1 million of foreign currencies at fixed rates at December 31, 1998.
At December 31, 1998, Y&R had entered into interest rate protection agreements with respect to $31.5 million of its indebtedness. The fair value approximated the notional amount at December 31, 1998. During the first quarter of 1999, all interest rate protection agreements to which we were party either matured or were retired. Accordingly, at December 31, 1999, we had no such agreements outstanding.
Management believes that any losses resulting from market risk would not have a material adverse impact on the consolidated financial position, results of operations or cash flows of Y&R.
NOTE 14 -- EQUITY
The following schedule summarizes the changes in the number of outstanding shares of common stock and treasury stock:
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - (CONTINUED )
In 1997, payments of $247.8 million were made to U.S.-based equity holders for options and other equity holdings tendered in connection with Y&R's recapitalization in 1996 (the "Recapitalization").
In connection with the consummation of the Recapitalization, Y&R created a class of preferred stock designated as Money Market Preferred Stock (the "Money Market Preferred"). The Money Market Preferred carries a variable rate dividend and is redeemable at Y&R's election for $115.00 per share following the fifth anniversary of the issuance thereof. At December 31, 1999 and 1998, 50,000 shares of Money Market Preferred were authorized and 87 shares were issued and outstanding.
NOTE 15 -- OPTIONS
The Young & Rubicam Inc. 1997 Incentive Compensation Plan (the "ICP") provides for grants of stock options, stock appreciation rights ("SARS"), restricted stock, deferred stock, other stock-related awards, and performance or annual incentive awards that may be settled in cash, stock or other property ("Awards"). Under the ICP, the total number of shares of Y&R common stock reserved and available for delivery to participants in connection with Awards is 19,125,000, plus the number of shares of Y&R common stock subject to awards under pre-existing plans that become available (generally due to cancellation or forfeiture) after the effective date of the ICP; provided, however, that the total number of shares of Y&R common stock with respect to which incentive stock options may be granted shall not exceed 1,000,000. Any shares of Y&R common stock delivered under the ICP may consist of authorized and unissued shares or treasury shares.
The Board of Directors is authorized to grant stock options, including incentive stock options, non-qualified stock options, and SARS entitling the participant to receive the excess of the fair market value of a share of common stock on the date of exercise over the grant price of the SAR. The exercise price per share subject to an option and the grant price of a SAR is determined by the Board of Directors, but must not be less than the fair market value of a share of common stock on the date of grant. The maximum term of each option or SAR, the times at which each option or SAR will be exercisable, and provisions requiring forfeiture of unexercised options or SARS at or following termination of employment generally is fixed by the Board of Directors, except no option or SAR may have a term exceeding ten years.
Generally, options granted prior to 1999 under the ICP become exercisable over a three-year vesting period beginning on the third anniversary of the date of grant and expire ten years from the date of grant. The three-year vesting period for options granted in 1999 generally begins on the first anniversary of the date of grant. However, the Board of Directors may, at its discretion, accelerate the exercisability, the lapsing of restrictions, or the expiration of deferral or vesting periods of any award, and such accelerated exercisability, lapse, expiration and vesting shall occur automatically in the case of a "change in control" of Y&R except to the extent otherwise provided in the award agreement. In addition, the Board of Directors may provide that the performance goals relating to any performance-based awards will be deemed to have been met upon the occurrence of any change in control.
At the closing of the Recapitalization in 1996, the Board of Directors granted the Rollover Options, which were immediately vested and exercisable. Each Rollover Option has an exercise price of $1.92 per share, with certain limited exceptions outside of the United States. Of the Rollover Options, 50% have a term of five years and the remaining 50% have a term of seven years.
At the closing of the Recapitalization, the Board of Directors also granted to employees options to purchase 5,200,590 shares of Y&R common stock at $7.67 per share and, in 1997, additional options to purchase 1,891,200 shares of Y&R common stock at $7.67 per share (the "Additional Options"). As a result of the granting of the Additional Options in 1997, Y&R recognized a compensation charge of $1.3 million reflecting the difference between the estimated fair market value of Y&R common stock on the
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - (CONTINUED )
date of grant and the exercise price of the Additional Options. All options granted to employees in connection with the Recapitalization were pursuant to and are governed by the stock option plan in existence prior to the effective date of the ICP.
Additionally, at the closing of the Recapitalization, Y&R granted to Hellman & Friedman Capital Partners III, L.P. ("HFCP") and certain other investors options to purchase 2,598,105 shares of Y&R common stock at $7.67 per share which were exercisable immediately and expire on the seventh anniversary of the closing. Substantially all of the HFCP options were exercised in 1999.
Y&R has adopted SFAS No. 123 (see Note 1). In accordance with the provisions of SFAS No. 123, Y&R applies APB Opinion No. 25, and related interpretations, in accounting for its plans. If Y&R had elected to recognize compensation expense based upon the fair value at the grant date for awards under its plans consistent with the methodology prescribed by SFAS No. 123, Y&R's net income in 1999 would be decreased by $8.3 million and the net income per common share would be decreased by $0.12 and $0.10, for basic and diluted earnings per share, respectively. Y&R's net loss would be increased by $7.8 million and $6.3 million for the years ended December 31, 1998 and 1997, respectively, and the net basic and diluted loss per common share would be increased by $0.13 for each of the years ended December 31, 1998 and 1997.
These SFAS No. 123 pro forma amounts may not be representative of future disclosures since the estimated fair value of stock options is amortized to expense over the vesting period, and additional options may be granted in future years. The fair value for these options was estimated at the date of grant using the Black-Scholes option-pricing model with the following assumptions for the period ended December 31, 1999, 1998 and 1997, respectively:
Since Y&R's common stock was publicly traded for the first time in 1998 as a result of the Offering, we did not have sufficient historical information to make a reasonable assumption as to the expected volatility of our common stock price in the future. As a result, the assumption in the table above reflects the expected volatility of stock prices of entities similar to Y&R. In addition, the decrease in the expected term of options for 1998 as compared to 1997 is due to the creation of an active, liquid market for Y&R's common stock resulting from the Offering.
The weighted-average fair value and weighted-average exercise price of options granted on and subsequent to the Recapitalization for which the exercise price equals the fair value of Y&R common stock on the grant date was $12.30 and $38.76 in 1999, respectively, $7.80 and $22.59 in 1998, respectively, and $5.28 and $12.33 in 1997, respectively.
In 1997, Y&R granted options to certain executives at exercise prices below the fair value of Y&R common stock on the date of grant. The weighted-average fair value and weighted-average exercise price of these options was $6.76 and $7.67 in 1997, respectively.
The Black-Scholes option valuation model was developed for use in estimating the weighted-average fair value of traded options, which have no vesting restrictions and are fully transferable. Because Y&R's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - (CONTINUED )
Transactions involving options are summarized as follows:
At December 31, 1999, 1998 and 1997, Y&R had exercisable options of 8,494,699, 14,963,354, and 17,242,995, respectively.
The following information is as of December 31, 1999:
NOTE 16 -- LITIGATION, COMMITMENTS AND CONTINGENT LIABILITIES
Y&R is involved in various legal proceedings incident to the ordinary course of business. Y&R's practice is to attempt to minimize potential liabilities through insurance coverage and/or indemnification provisions in its agreements with clients and others. Y&R believes that the outcome of all pending legal proceedings and unasserted claims in the aggregate will not have a material adverse effect on its results of operations, consolidated financial position or liquidity.
At December 31, 1999, Y&R was committed under operating leases, principally for office space. Certain leases contain renewal options calling for increased rentals. Others contain certain escalation clauses relating to taxes and other operating expenses.
YOUNG & RUBICAM INC. AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - (CONTINUED )
Net rental expense was $85.1 million, $75.5 million, and $74.4 million in 1999, 1998 and 1997, respectively. Future minimum rental commitments as of December 31, 1999 are as follows:
Y&R had outstanding guarantees of $4.5 million and $8.6 million at December 31, 1999 and 1998, respectively, primarily in support of credit lines of unconsolidated affiliates.
NOTE 17 -- SUBSEQUENT EVENTS (UNAUDITED)
On January 20, 2000, Y&R completed the placement of $287.5 million of 3% convertible subordinated notes due January 15, 2005, which includes $37.5 million of notes issued pursuant to the exercise by the initial purchasers of their over-allotment option. At the option of the holder, the notes are convertible into shares of Y&R's common stock at a conversion price of $73.36 per share, subject to adjustment. Y&R used the net proceeds of the offering to repay outstanding debt under Y&R's existing bank credit facilities and to fund operations.
In January 2000, Y&R contributed cash and certain assets and rights known as Y&R TeamSpace, a proprietary software tool, to eMotion Inc., a firm that provides digital media management solutions that facilitate the creative workflow, sale, distribution and management of media rich broadband content. In exchange for an ownership interest in eMotion Inc. Y&R expects to record a gain in the first quarter of 2000 in connection with this transaction.
In the first quarter of 2000, Y&R acquired 100% of Robinson Lerer Montgomery, LLC and also made strategic investments in certain other entities. Cash payments made in connection with these transactions amounted to approximately $45 million.
YOUNG AND RUBICAM INC. AND SUBSIDIARY COMPANIES SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (IN THOUSANDS) - - --------------------------------------------------------------------------------
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