<PAGE> 1
GREY
GREY ADVERTISING INC.
1997 FINANCIAL REPORT
GREY ADVERTISING INC.
777 THIRD AVENUE
NEW YORK, NEW YORK 10017
212-546-2000
<PAGE> 2
WHO WE ARE AND WHAT WE DO
Grey Advertising Inc. and its subsidiaries (collectively with Grey, the
"Company") have been engaged in the planning, creation, supervision and placing
of advertising since the Company's formation in 1917. Grey was incorporated in
New York in 1925 and changed its state of incorporation to Delaware in 1974.
The Company's principal business activity consists of providing a full
range of advertising and related services to its clients. Typically, this
involves developing an advertising and/or marketing plan after study of a
client's business, the distribution or utilization of the client's products or
services and the use of various media (e.g., television, radio, newspapers,
magazines, direct mail, outdoor billboards and the Internet) by which desired
market performance can best be achieved. The Company then creates advertising,
prepares media recommendations and places advertising in the media. The
Company's business also involves it in allied areas such as marketing
consultation, audio-visual production, co-marketing programs, direct marketing,
interactive consulting and production, media research, planning and buying,
package and other design, product publicity, public affairs, public relations,
research and sales promotion.
The Company does business in only one industry segment, and no separate
class of similar services contributed 10% or more of the Company's gross income
or net income during 1997, 1996 or 1995. While the Company operates on a
worldwide basis, for the purposes of presenting certain financial information in
accordance with Securities and Exchange Commission rules, the Company's
operations are deemed to be conducted in three geographic areas. Related
information appears in Note M to the Consolidated Financial Statements.
BID PRICES* AND
DIVIDEND HISTORY 1996-1997
<TABLE>
<CAPTION>
DOLLARS PER SHARE
----------------- DIVIDENDS
HIGH LOW PER SHARE
----- ---- ---------
<S> <C> <C> <C>
1996
First Quarter............................................. 223 190 .9375
Second Quarter............................................ 233 219 .9375
Third Quarter............................................. 240 204 .9375
Fourth Quarter............................................ 251 230 1.00
1997
First Quarter............................................. 278 253 1.00
Second Quarter............................................ 322 250 1.00
Third Quarter............................................. 341 292 1.00
Fourth Quarter............................................ 360 328 1.00
</TABLE>
- ---------------
* Such over-the-counter market quotations reflect inter-dealer prices, without
retail mark-up, mark-down or commission and may not necessarily represent
actual transactions.
Note: Stockholders of Record -- Common Stock 556 (6/1/98);
Limited Duration Class B Common Stock 285 (6/1/98).
<PAGE> 3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Income from commissions and fees ("gross income") increased 12.2% in 1997
and 11.2% in 1996 as compared to the respective prior years. Absent exchange
rate fluctuations, gross income increased 16.9% in 1997 and 11.6% in 1996. In
1997, 1996 and 1995, respectively, 44.5%, 44.2% and 44.1% of consolidated gross
income was attributable to domestic operations and 55.5%, 55.8% and 55.9%,
respectively, to international operations. In 1997, gross income from domestic
operations increased 12.9% versus 1996 and was up 11.4% in 1996 versus 1995.
Gross income from international operations increased 11.6% (20.0% absent
exchange rate fluctuations) in 1997 when compared to 1996 and 11.1% (11.8%
absent exchange rate fluctuations) in 1996 when compared to 1995. The increases
in gross income in both years primarily resulted from expanded activities from
existing clients, and the continued growth of the Company's general agency and
specialized communications operations.
Salaries and employee-related expenses increased 11.6% in 1997 and 9.8% in
1996 as compared to the respective prior years. Office and general expenses
increased 13.6% in 1997 and 12.9% in 1996 versus respective prior years. The
increases in expenses are generally in line with the increases in gross income
in such years.
Inflation did not have a material effect on revenue or expenses in 1997,
1996 or 1995.
Other income decreased in 1997 by $2,789,000 and increased in 1996 by
$3,073,000 as compared to the comparable prior periods. Both the 1997 decrease
and the 1996 increase result primarily from a 1996 non-recurring, non-operating
pre-tax income amount of approximately $4,000,000 primarily related to gains on
the sale of the Company's equity position in a nonconsolidated subsidiary and
the liquidation of a non-marketable investment security.
The effective tax rate remained relatively constant at 48.7% in 1997 as
compared to 48.1% in 1996. The tax rate in 1995 was 49.6%. The decrease in the
effective tax rate in 1996 as compared to 1995 is due, in large part, to a lower
effective foreign tax rate in 1996.
Minority interest increased $80,000 in 1997 and $390,000 in 1996 as
compared to the respective prior years. The changes in 1997 and in 1996 were
primarily due to changes in the level of profits of majority-owned companies.
Equity in earnings of nonconsolidated companies increased $438,000 in 1997
and decreased $1,166,000 in 1996 as compared to the respective prior years.
These changes are due primarily to changes in the level of profits attributable
to the nonconsolidated companies.
The Company reported net income of $30,451,000 for 1997 as compared to
$28,602,000 in 1996 and $23,438,000 in 1995. Diluted earnings per common share
was $21.89 in 1997 as compared to $20.45 in 1996 and $16.32 in 1995. Absent
non-recurring, non-operating pre-tax income recognized in 1996, net income for
1997 and 1996 was up 15.0% and 13.0%, respectively, and diluted earnings per
common share was up 15.5% and 16.1% versus the respective prior periods.
For purposes of computing basic earnings per common share, the Company's
net income was adjusted by (i) dividends paid on the Company's preferred stock
and (ii) by the change in redemption value of the Company's preferred stock. For
the purposes of computing diluted earnings per common share, net income was also
adjusted by the interest savings, net of tax, on the assumed conversion of the
Company's 8.5% convertible subordinated debentures.
The Company's results may be affected by currency exchange rate
fluctuations given the Company's extensive non-United States operations.
Generally, the foreign currency exchange risk is limited to net income because
the Company's revenues and expenses, by country, are almost exclusively
denominated in the local currency of each respective country with both revenue
and expense items matched. Occasionally, the Company enters into foreign
currency contracts for known cash flows related to repatriation of earnings from
2
<PAGE> 4
its international subsidiaries. The term of each such foreign currency contract
entered into in 1997 was for less than three months. At December 31, 1997, there
were no foreign currency contract transactions open. In addition, the Company
had no derivative contracts outstanding at December 31, 1997 and did not enter
into any derivative contracts during 1997.
Some of the Company's older computer programs were written using a two
digit year. As a result, those computer programs may be unable to process
time-sensitive information beyond the year 2000. This situation, which is not
uncommon, is frequently referred to as the Year 2000 Issue and can cause a
temporary disruption of the ordinary course of business. The Company has
completed an assessment of its computer programs and those of its third party
software vendors and has undertaken what it believes to be the appropriate steps
to modify or replace software as necessary. The Company anticipates having a
significant portion of the modifications to existing software and conversions to
new software be completed by December 31, 1998 and that the Year 2000 Issue
should not pose significant operational problems for its computer network. The
estimated cost of the project has been determined and is not expected to have a
material adverse effect on the Company. The project is being funded through
operating cash and is being expensed as incurred. The cost and time of
completion are based on management's best estimates which were derived utilizing
numerous assumptions of future events, including the continued availability of
certain resources and other factors. There can, however, be no guarantee that
these estimates will be achieved and actual results could differ materially from
those anticipated. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area, the ability to locate and correct all relevant computer codes, the
timely receipt and installation of upgrades from third party software vendors,
compliance of third party vendors with whom the Company interacts and similar
circumstances.
LIQUIDITY AND CAPITAL RESOURCES
The Company continues to be highly liquid by maintaining significant levels
of cash, cash equivalents and investments in highly liquid marketable
securities, a majority of which are United States government securities and
corporate bonds. Cash and cash equivalents were $150,553,000 and $112,485,000 at
December 31, 1997 and 1996, respectively, and the Company's investment in
marketable securities was $72,741,000 and $96,107,000 at December 31, 1997 and
1996, respectively. The continued high level of liquidity reflects the Company's
ongoing focus on its cash management process. Working capital increased by
$46,683,000 from $3,843,000 at December 31, 1996 to $50,526,000 at December 31,
1997. The increase in working capital is largely attributable to the investment,
in cash equivalents, of the net proceeds from the refinancing of a term loan.
Domestically, the Company maintains committed bank lines of credit totaling
$51,000,000. These lines of credit were partially utilized during both 1997 and
1996 to secure obligations of selected foreign subsidiaries in the amounts of
$3,000,000 and $26,000,000 at December 31, 1997 and 1996, respectively.
Other lines of credit are available to the Company in foreign countries in
connection with short-term borrowings and bank overdrafts used in the normal
course of business. Amounts outstanding under such facilities at December 31,
1997 and 1996 were $19,455,000 and $60,004,000, respectively. The decrease in
the borrowings is largely attributable to the Company's paydown of short-term
borrowings in Europe.
Historically, funds from operations and short-term bank borrowings have
been sufficient to meet the Company's dividend, capital expenditure and working
capital needs. The Company expects that such sources will be sufficient to meet
its short-term cash requirements in the future. While the Company has not
utilized long-term borrowing to fund its operating needs, in 1997 it refinanced
its borrowings with the Prudential Insurance Company of America. Pursuant to the
refinancing, the Company repaid the 7.68% $30,000,000 loan it had taken down in
early 1993 and, in turn, borrowed $75,000,000 in December 1997. The new loan
bears an interest at the rate of 6.94% and is repayable in three equal annual
installments, commencing in December 2003. The Company does not anticipate any
material increased requirement for capital or other expenditures which will
adversely affect its liquidity.
The Company's business generally has been seasonal with greater gross
income earned in the second and fourth quarters, particularly the fourth
quarter. As a result, cash, accounts receivable, accounts payable and accrued
expenses are typically higher on the Company's year-end balance sheet than at
the end of any of the preceding three quarters.
3
<PAGE> 5
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------------
1997 1996
-------------- --------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 150,553,000 $ 112,485,000
Marketable securities (Notes A and E)..................... 15,401,000 28,688,000
Accounts receivable....................................... 647,524,000 590,002,000
Expenditures billable to clients.......................... 54,687,000 52,285,000
Other current assets (Note K)............................. 56,225,000 52,982,000
-------------- --------------
Total current assets.................................... 924,390,000 836,442,000
Investments in and advances to nonconsolidated affiliated
companies (Notes A and B)................................. 18,386,000 17,723,000
Fixed assets -- net (Note D)................................ 88,006,000 78,223,000
Marketable securities (Notes A and E)....................... 57,340,000 67,419,000
Intangibles and other assets -- including loans to executive
officers of $5,572,000 in 1997 and $5,822,000 in 1996
(Notes A, F, G, K and L(2))............................... 111,865,000 89,587,000
-------------- --------------
Total assets....................................... $1,199,987,000 $1,089,394,000
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 709,959,000 $ 619,003,000
Notes payable to banks (Note F)........................... 22,455,000 86,004,000
Accrued expenses and other................................ 122,269,000 107,368,000
Income taxes payable...................................... 19,181,000 20,224,000
-------------- --------------
Total current liabilities............................... 873,864,000 832,599,000
Other liabilities -- including deferred compensation of
$36,481,000 in 1997 and $28,738,000 in 1996 (Note L(1))... 61,723,000 55,217,000
Long-term debt (Note F)..................................... 78,025,000 33,025,000
Minority interest........................................... 13,309,000 10,533,000
Redeemable preferred stock -- at redemption value; par value
$1 per share; authorized 500,000 shares; issued and
outstanding 32,000 shares in 1997 and 1996 (Note G)....... 10,760,000 10,098,000
Common stockholders' equity:
Common Stock -- par value $1 per share; authorized
10,000,000 shares; issued 1,124,324 in 1997 and
1,110,918 shares in 1996................................ 1,124,000 1,111,000
Limited Duration Class B Common Stock -- par value $1 per
share; authorized 2,000,000 shares; issued 307,460 in
1997 and 320,866 shares in 1996......................... 308,000 321,000
Paid-in additional capital................................ 44,349,000 42,814,000
Retained earnings......................................... 169,214,000 144,789,000
Cumulative translation adjustment......................... (9,422,000) 2,579,000
Unrealized gain (loss) on marketable securities (Notes A
and E).................................................. 189,000 (870,000)
Loans to officer used to purchase Common Stock and Limited
Duration Class B Common Stock (Note L(2))............... (4,726,000) (4,726,000)
-------------- --------------
201,036,000 186,018,000
Less -- cost of 222,098 and 222,810 shares of Common Stock
and 26,762 and 26,759 shares of Limited Duration Class B
Common Stock held in treasury at December 31, 1997 and
1996, respectively...................................... 38,730,000 38,096,000
-------------- --------------
Total common stockholders equity............................ 162,306,000 147,922,000
Retirement plans, leases and contingencies (Note L).........
-------------- --------------
Total liabilities and stockholders' equity......... $1,199,987,000 $1,089,394,000
============== ==============
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 6
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Commissions and fees............................. $858,752,000 $765,498,000 $688,219,000
Expenses:
Salaries and employee related expenses (Note
L(1))....................................... 529,863,000 474,686,000 432,311,000
Office and general expenses (Note L(3))........ 263,969,000 232,279,000 205,668,000
------------ ------------ ------------
793,832,000 706,965,000 637,979,000
------------ ------------ ------------
64,920,000 58,533,000 50,240,000
Other income -- net (Note C)..................... 4,371,000 7,160,000 4,087,000
------------ ------------ ------------
Income of consolidated companies before taxes on
income......................................... 69,291,000 65,693,000 54,327,000
Provision for taxes on income (Note K)........... 33,719,000 31,612,000 26,966,000
------------ ------------ ------------
Income of consolidated companies................. 35,572,000 34,081,000 27,361,000
Minority interest applicable to consolidated
companies...................................... (6,743,000) (6,663,000) (6,273,000)
Equity in earnings of nonconsolidated affiliated
companies...................................... 1,622,000 1,184,000 2,350,000
------------ ------------ ------------
Net income....................................... $ 30,451,000 $ 28,602,000 $ 23,438,000
============ ============ ============
Earnings per Common Share (Note J):
Basic.......................................... $25.03 $22.98 $18.19
Diluted........................................ $21.89 $20.45 $16.32
</TABLE>
See notes to consolidated financial statements.
5
<PAGE> 7
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
COMMON STOCK
PAID-IN HELD IN TREASURY OTHER
COMMON ADDITIONAL RETAINED ---------------------- EQUITY
STOCK CAPITAL EARNINGS SHARES AMOUNT ACCOUNTS TOTAL
---------- ----------- ------------ ------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994..... $1,432,000 $31,895,000 $105,123,000 188,133 $(22,799,000) $ (6,946,000) $108,705,000
Net Income...................... 23,438,000 23,438,000
Cash dividends -- Common Shares
$3.5625 per share............. (4,333,000) (4,333,000)
Cash dividends -- Redeemable
Preferred Stock -- $7.125 per
share......................... (228,000) (228,000)
Common Shares acquired -- at
cost.......................... 77,001 (14,434,000) (14,434,000)
Dividends Payable in Company
Stock pursuant to Senior
Management Incentive Plan
(Note L)...................... 185,000 (185,000)
Increase in redemption value of
Redeemable Preferred Stock
(Note G)...................... (1,470,000) (1,470,000)
Restricted stock activity (Note
I)............................ 133,000 133,000
Tax benefit from restricted
stock (Note K)................ 164,000 164,000
Common Shares issued upon
exercise of stock options..... (287,000) (25,535) 2,733,000 2,446,000
Tax benefit from exercise of
stock options (Note K)........ 959,000 959,000
Senior Management Incentive Plan
activity (Note L)............. 4,849,000 4,849,000
Translation adjustment.......... 5,392,000 5,392,000
Unrealized gain on marketable
securities (Notes A and E).... 2,042,000 2,042,000
---------- ----------- ------------ ------- ------------ ------------ ------------
Balance at December 31, 1995..... 1,432,000 37,898,000 122,345,000 239,599 (34,500,000) 488,000 127,663,000
Net income...................... 28,602,000 28,602,000
Cash dividends -- Common
Shares -- $3.8125 per share... (4,527,000) (4,527,000)
Cash dividends -- Redeemable
Preferred Stock -- $7.625 per
share......................... (244,000) (244,000)
Common Shares acquired -- at
cost.......................... 20,818 (4,733,000) (4,733,000)
Dividends Payable in Company
Stock pursuant to Senior
Management Incentive Plan
(Note L)...................... 275,000 (275,000)
Increase in redemption value of
Redeemable Preferred Stock
(Note G)...................... (1,112,000) (1,112,000)
Restricted stock activity (Note
I)............................ 43,000 (250) 14,000 57,000
Tax benefit from restricted
stock (Note K)................ 3,000 3,000
Common Shares issued upon
exercise of stock options..... 250,000 (10,598) 1,123,000 1,373,000
Tax benefit from exercise of
stock options (Note K)........ 483,000 483,000
Senior Management Incentive Plan
activity (Note L)............. 3,862,000 3,862,000
Translation adjustment.......... (2,085,000) (2,085,000)
Unrealized loss on marketable
securities (Notes A and E).... (1,420,000) (1,420,000)
---------- ----------- ------------ ------- ------------ ------------ ------------
Balance at December 31, 1996..... 1,432,000 42,814,000 144,789,000 249,569 (38,096,000) (3,017,000) 147,922,000
Net income...................... 30,451,000 30,451,000
Cash dividends -- Common
Shares -- $4.00 per share..... (4,738,000) (4,738,000)
Cash dividends -- Redeemable
Preferred Stock $8.00 per
share......................... (256,000) (256,000)
Common Shares acquired -- at
cost.......................... 3,007 (962,000) (962,000)
Dividends Payable in Cash
pursuant to Senior Management
Incentive Plan (Note L)....... (370,000) (370,000)
Increase in redemption value of
Redeemable Preferred Stock
(Note G)...................... (662,000) (662,000)
Restricted stock activity
(Note I).................... (143,000) (3,000) 309,000 166,000
Tax benefit from restricted
stock (Note K)................ 8,000 8,000
Common Shares issued upon
exercise of stock options..... 52,000 (716) 19,000 71,000
Senior Management Incentive Plan
activity (Note L)............. 1,618,000 1,618,000
Translation adjustment.......... (12,001,000) (12,001,000)
Unrealized gain on marketable
securities (Notes A and E).... 1,059,000 1,059,000
---------- ----------- ------------ ------- ------------ ------------ ------------
Balance at December 31, 1997..... $1,432,000 $44,349,000 $169,214,000 248,860 $(38,730,000) $(13,959,000) $162,306,000
========== =========== ============ ======= ============ ============ ============
</TABLE>
See notes to consolidated financial statements.
6
<PAGE> 8
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income................................................ $ 30,451,000 $ 28,602,000 $ 23,438,000
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization of fixed assets........... 25,866,000 22,880,000 17,388,000
Amortization of intangibles............................. 6,160,000 4,976,000 4,146,000
Deferred compensation................................... 14,002,000 16,217,000 15,162,000
Equity in earnings of nonconsolidated affiliated
companies, net of dividends received of $658,000,
$441,000 and $483,000................................ (964,000) (743,000) (1,867,000)
Gains from the sale of marketable securities............ (599,000) (378,000)
Gains from the sale of a nonconsolidated affiliated
company and a non-marketable investment security..... (4,533,000)
Minority interest applicable to consolidated
companies............................................ 6,743,000 6,663,000 6,273,000
Amortization of restricted stock expense................ 140,000 33,000 133,000
Deferred income taxes................................... (7,366,000) (7,085,000) (2,999,000)
Changes in operating assets and liabilities:
Increase in accounts receivable......................... (89,556,000) (103,252,000) (79,612,000)
Increase in expenditures billable to clients............ (6,103,000) (7,229,000) (14,109,000)
(Increase) decrease in other current assets............. (5,314,000) (4,782,000) 4,351,000
(Increase) decrease in other assets..................... (652,000) (2,741,000) 3,680,000
Increase in accounts payable............................ 121,303,000 78,157,000 61,846,000
Increase in accrued expenses and other.................. 14,473,000 8,611,000 3,180,000
Increase in income taxes payable........................ 480,000 2,419,000 2,431,000
Increase (decrease) in other liabilities................ 1,380,000 (2,592,000) (2,509,000)
------------ ------------ ------------
Net cash provided by operating activities................. 110,444,000 35,223,000 40,932,000
INVESTING ACTIVITIES
Purchases of fixed assets................................. (39,718,000) (27,896,000) (29,136,000)
Trust fund deposits....................................... (2,974,000) (2,833,000) (2,426,000)
Increase in investments in and advances to
non-consolidated affiliated companies................... (1,142,000) (320,000) (1,686,000)
Purchases of marketable securities........................ (25,038,000) (129,491,000) (68,500,000)
Proceeds from the sales of marketable securities.......... 49,613,000 101,012,000 26,957,000
Proceeds from the sale of a nonconsolidated affiliated
company and a non-marketable investment security........ 8,568,000
Increase in intangibles, primarily goodwill............... (19,912,000) (13,103,000) (6,183,000)
------------ ------------ ------------
Net cash used in investing activities..................... (39,171,000) (64,063,000) (80,974,000)
</TABLE>
7
<PAGE> 9
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
FINANCING ACTIVITIES
Net (repayments of) proceeds from short-term borrowings... (60,895,000) 18,180,000 4,834,000
Proceeds from term loan................................... 75,000,000
Repayment of term loan.................................... (30,000,000)
Common Shares acquired for treasury....................... (962,000) (4,733,000) (14,434,000)
Cash dividends paid on Common Shares...................... (4,738,000) (4,527,000) (4,333,000)
Cash dividends paid on Redeemable Preferred Stock......... (256,000) (244,000) (228,000)
Proceeds from the issuance of Restricted Stock............ 27,000 24,000
Proceeds from exercise of stock options................... 71,000 1,373,000 2,446,000
Borrowings under life insurance policies.................. 450,000 464,000 11,779,000
------------ ------------ ------------
Net cash (used in) provided by financing activities....... (21,303,000) 10,537,000 64,000
Effect of exchange rate changes on cash................... (11,902,000) (3,525,000) 4,214,000
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents.......... 38,068,000 (21,828,000) (35,764,000)
Cash and cash equivalents at beginning of year............ 112,485,000 134,313,000 170,077,000
------------ ------------ ------------
Cash and cash equivalents at end of year.................. $150,553,000 $112,485,000 $134,313,000
============ ============ ============
</TABLE>
See notes to consolidated financial statements.
8
<PAGE> 10
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its majority owned subsidiaries. Material intercompany balances and
transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company 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. Estimates also affect the reported amounts of revenue and expenses
during the reporting period. Actual results could differ from those estimates.
Commissions and Fees and Accounts Receivable
Income derived from advertising placed with media is generally recognized
based upon the publication or broadcast dates. Income resulting from
expenditures billable to clients is generally recognized when billed. Payroll
costs are expensed as incurred. Accounts receivable include both the income
recognized as well as the actual media and production costs which are paid for
by the Company and rebilled to clients at the Company's cost.
Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less from the purchase date to be cash equivalents. The carrying
amount of cash equivalents approximates fair value because of the short
maturities of those instruments.
Investments in and Advances to Nonconsolidated Affiliated Companies
The Company generally carries its investments in nonconsolidated affiliated
companies on the equity method. Certain investments which are not material in
the aggregate are carried on the cost method.
Fixed Assets
Depreciation of furniture, fixtures and equipment is provided for over
their estimated useful lives ranging from three to ten years and has been
computed principally by the straight-line method. Amortization of leaseholds and
leasehold improvements is provided for principally over the terms of the related
leases, which are not in excess of the lives of the assets.
Foreign Currency Translation
Primarily all balance sheet accounts of the Company's foreign operations
are translated at the exchange rate in effect at each year end and statement of
income accounts are translated at the average exchange rates prevailing during
the year. Resulting translation adjustments are made directly to a separate
component of stockholders' equity. Foreign currency transaction gains and losses
are reported in income. During 1997, 1996 and 1995, foreign currency transaction
gains and losses were not material.
Intangibles
The excess of purchase price over underlying net equity of certain
consolidated subsidiaries and nonconsolidated affiliated companies at the date
of acquisition ("goodwill") is amortized by the straight-line
9
<PAGE> 11
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
method over periods of up to twenty years. The amounts of goodwill, net of
accumulated amortization, associated with consolidated subsidiaries (included in
Other Assets) and nonconsolidated investments (included in Investments in and
Advances to Nonconsolidated Affiliated Companies) were $59,851,000 and
$3,685,000 in 1997, and $46,084,000 and $5,592,000 in 1996, respectively.
Annually, the Company assesses the carrying value of its goodwill and the
respective periods of amortization. As part of the evaluation, the Company
considers a number of factors including actual operating results, the impact of
gains and losses of major local clients, the impact of any loss of key local
management staff and any changes in general economic conditions. The Company
quantifies the recoverability of goodwill based on each agency's estimated
future non-discounted cash flows over the applicable remaining amortization
periods. This requires management to make certain specific assumptions with
respect to future revenue and expense levels. Where multiple investments had
been made in a single company, a weighted average amortization period is used.
Charges to reflect permanent impairment are recorded to the extent that the
unamortized book value of the goodwill exceeds the future cumulative discounted
cash flows.
Income Taxes
The Company uses the liability method of accounting for income taxes. Under
this method, deferred tax assets and liabilities are determined based on
differences between financial reporting and tax basis of assets and liabilities
and are measured using enacted tax rates and laws that will be in effect when
the differences are expected to reverse. The Company provides appropriate
foreign withholding taxes on unremitted earnings of consolidated and
nonconsolidated foreign companies.
Marketable Securities
The Company considers all its investments in marketable securities as
available-for-sale. Available-for-sale securities are carried at fair value,
based on publicly quoted market prices, with unrealized gains and losses
reported as a separate component of stockholders' equity.
Stock-Based Compensation
As permitted by Financial Accounting Standards Statement No. 123,
Accounting for Stock-Based Compensation, the Company accounts for stock-based
awards in accordance with APB Opinion No. 25, Accounting For Stock Issued to
Employees. No compensation expense is recorded for options granted at fair
market value at the date of grant. The excess of the fair market value of
Restricted Stock over the cash consideration received is amortized, as
compensation, over the period of restriction. The future obligation to issue
stock, pursuant to the Company's Senior Management Incentive Plan, is included
in Paid-In Additional Capital and results in periodic charges to compensation.
Earnings Per Share
In 1997, the Company adopted Financial Accounting Standards Statement No.
128, Earnings Per Share and, accordingly, has restated the earnings per share
amount for all prior periods, including pro forma information. The computation
of basic earnings per common share is based on the weighted average number of
common shares outstanding and for diluted earnings per common share includes
adjustments for the effect of the assumed exercise of dilutive stock options,
shares issuable pursuant to the Company's Senior Management Incentive Plan (see
Note L(1)) and the assumed conversion of the 8 1/2% Convertible Subordinated
Debentures. Also, for the purpose of computing earnings per common share, the
Company's net income is adjusted by dividends on the Preferred Stock and by the
increase or decrease in redemption value of the Preferred Stock.
10
<PAGE> 12
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
B. FOREIGN OPERATIONS
The following financial data is applicable to consolidated foreign
subsidiaries:
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Current assets........................... $489,242,000 $429,863,000 $395,016,000
Current liabilities...................... 480,514,000 452,220,000 408,541,000
Other assets -- net of other
liabilities............................ 79,391,000 62,363,000 56,312,000
Net income............................... 8,921,000 9,276,000 9,384,000
</TABLE>
Consolidated retained earnings at December 31, 1997 includes equity in
unremitted earnings of nonconsolidated foreign companies of approximately
$10,488,000.
C. OTHER INCOME -- NET
Details of other income -- net are:
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ -----------
<S> <C> <C> <C>
Interest income........................... $ 13,826,000 $ 12,211,000 $12,183,000
Interest expense.......................... (11,095,000) (10,065,000) (8,928,000)
Gains from the sale of a non-consolidated
affiliated company, a non-marketable
investment security and marketable
securities.............................. 599,000 4,911,000
Dividends from affiliates................. 83,000 151,000 217,000
Income (expense) -- net................... 958,000 (48,000) 615,000
------------ ------------ -----------
$ 4,371,000 $ 7,160,000 $ 4,087,000
============ ============ ===========
</TABLE>
D. FIXED ASSETS
Components of fixed assets -- at cost are:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Furniture, fixtures and equipment............. $ 145,116,000 $ 131,329,000
Leaseholds and leasehold improvements......... 59,333,000 51,705,000
------------- -------------
204,449,000 183,034,000
Accumulated depreciation and amortization..... (116,443,000) (104,811,000)
------------- -------------
$ 88,006,000 $ 78,223,000
============= =============
</TABLE>
11
<PAGE> 13
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
E. MARKETABLE SECURITIES
The marketable securities, by type of investment, held by the Company at
December 31, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Maturities of one year or less:
U.S. Treasury Securities........................ $ 995,000 $ 2,506,000
Money market funds.............................. 14,406,000 22,556,000
Corporate bonds................................. 3,626,000
----------- -----------
15,401,000 28,688,000
----------- -----------
Maturities greater than one year:
U.S. Treasury Securities........................ 32,310,000 49,355,000
Government National Mortgage Association
Securities................................... 1,622,000 4,920,000
Corporate bonds................................. 23,408,000 13,144,000
----------- -----------
57,340,000 67,419,000
----------- -----------
$72,741,000 $96,107,000
=========== ===========
</TABLE>
At December 31, 1997, the Company had unrealized gains of $748,000 related
primarily to investments in corporate bonds and unrealized losses of $559,000
primarily related to investments in U.S. Treasury Securities and Money Market
Funds. At December 31, 1996 the Company had unrealized losses of $870,000,
principally related to the investments in U.S. Treasury Securities. At December
31, 1997 and 1996, the Company's investments in marketable securities,
classified as non-current, had an average maturity of approximately 7 and 6
years, respectively.
F. CREDIT ARRANGEMENTS AND LONG-TERM DEBT
The Company maintains committed lines of credit of $51,000,000 with various
domestic banks and may draw against the lines on unsecured demand notes at rates
below the applicable bank's prime interest rate. These lines of credit, which
are renewable annually, were partially utilized during both 1997 and 1996 by
selected foreign subsidiaries in the amount of $3,000,000 and $26,000,000 at the
end of each respective year. The weighted average interest rate related to the
debt associated with the committed lines of credit was 6.92% and 7.11% at
December 31, 1997 and 1996, respectively. The Company had $19,455,000 and
$60,004,000 outstanding under other uncommitted lines of credit at December 31,
1997 and 1996, respectively. The weighted average interest rate for the
borrowings under the uncommitted lines of credit was 6.64% and 6.94% at December
31, 1997 and 1996, respectively. The carrying amount of the debt outstanding
under both the committed and uncommitted lines of credit approximates fair value
because of the short maturities of the underlying notes. Occasionally, the
Company enters into foreign currency contracts for known cash flows related to
the repatriation of earnings from its international subsidiaries. The term of
each foreign currency contract entered into in 1997 was for less than three
months. At December 31, 1997, there were no foreign currency contract
transactions open. In addition, the Company had no derivative contracts
outstanding at December 31, 1997, and did not enter into any derivative
contracts during 1997.
12
<PAGE> 14
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Long-term debt at December 31, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Term loans........................................ $75,000,000 $30,000,000
Convertible debentures............................ 3,025,000 3,025,000
----------- -----------
Long-term debt.................................... $78,025,000 $33,025,000
=========== ===========
</TABLE>
During 1997, the Company repaid the 7.68%, $30,000,000 loan it had taken
down in 1993 from the Prudential Insurance Company ("Prudential") and, in turn,
borrowed $75,000,000 in December 1997 at a fixed interest rate of 6.94% with
principal repayable in equal installments of $25,000,000 in December 2003, 2004
and 2005. The terms of the loan agreement require, inter alia, that the Company
meet certain cash flow requirements and limit its incurrence of additional
indebtedness to certain specified amounts. At December 31, 1997, the Company was
in compliance with all of these covenants. The fair value of the Prudential debt
is estimated to be $75,000,000 and $30,275,000 at December 31, 1997 and 1996,
respectively. This estimate was determined using a discounted cash flow analysis
using current interest rates for debt having similar terms and remaining
maturities.
The remaining portion of long-term debt consists of 8 1/2% Convertible
Subordinated Debentures, due December 31, 2003, which are currently convertible
into 8.50 shares of Common Stock and an equal number of shares of Limited
Duration Class B Common Stock (Class B Common Stock), subject to certain
adjustments, for each $1,000 principal amount of such debentures. The debentures
were issued in exchange for cash and a $3,000,000, 9% promissory note from the
Chairman and Chief Executive Officer of the Company, payable on December 31,
2004 (included in Other Assets at December 31, 1997 and 1996). During each of
the years 1997, 1996 and 1995, the Company paid to the officer interest of
$257,000 pursuant to the terms of the debentures and the officer paid to the
Company interest of $270,000 pursuant to the terms of the 9% promissory note.
The scheduled repayment of long-term debt is as follows:
<TABLE>
<CAPTION>
YEARS ENDING
DECEMBER 31 AMOUNT
------------ -----------
<S> <C>
2003.................................. $28,025,000
2004.................................. 25,000,000
2005.................................. 25,000,000
-----------
$78,025,000
===========
</TABLE>
During 1997 and 1996, the Company borrowed against the cash surrender value
of the life insurance policies that it owns on the life of its Chairman and
Chief Executive Officer. The amounts borrowed at December 31, 1997 and 1996 are
$16,428,000 and $14,733,000, respectively, with an interest rate 7.30% in each
year, and are carried as a reduction of the related cash surrender value that is
included in Other Assets. Of the amounts borrowed in 1997 and 1996, the Company
received $450,000 and $464,000 in cash, respectively, and $1,245,000 was used in
each year to pay premiums on the underlying life insurance policies.
For the years 1997, 1996 and 1995, the Company made interest payments of
$11,969,000, $10,065,000 and $8,934,000, respectively.
G. REDEEMABLE PREFERRED STOCK
As of December 31, 1997 and 1996, the Company had outstanding 20,000 shares
of Series I Preferred Stock, 5,000 shares each of Series II and Series III
Preferred Stock, and 2,000 shares of Series 1 Preferred Stock. The holder of the
Series I, Series II and Series III Preferred Stock is the Chairman and Chief
13
<PAGE> 15
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Executive Officer of the Company, and the Series 1 Preferred Stock is held by a
former employee. The terms of each class of Preferred Stock, including the basic
economic terms relating thereto, are essentially the same, except with respect
to the redemption date of each series. The redemption date for the Series I,
Series II and Series III Preferred Stock is fixed at April 7, 2004, unless
redeemed earlier under circumstances described below. The terms of the Series I,
Series II and Series III Preferred Stock also give the holder, his estate or
legal representative, as the case may be, the option to require the Company to
redeem his Preferred Stock for a period of 12 months following his (i) death,
(ii) permanent disability or permanent mental disability, (iii) termination of
full-time employment for good reason or (iv) termination of full-time employment
by the Company without cause. The Company is obligated to redeem the Series 1
Preferred Stock in 1998.
Each share of Preferred Stock is to be redeemed by the Company at a price
equal to the book value per share attributable to one share of Common Stock and
one share of Class B Common Stock (subject to certain adjustments) upon
redemption, less a fixed discount established upon the issuance of the Preferred
Stock. The holders of each class of Preferred Stock are entitled to receive
cumulative preferential dividends at the annual rate of $.25 per share, and to
participate in dividends on one share of the Common Stock and one share of the
Class B Common Stock to the extent such dividends exceed the per share
preferential dividend. In connection with his ownership of the Series I, Series
II and Series III Preferred Stock, the holder issued to the Company full
recourse promissory notes totaling $763,000 (included in Other Assets at
December 31, 1997 and 1996) with a maturity date of April 2004. The interest
paid by the senior executive to the Company in 1997, 1996 and 1995 pursuant to
the terms of these notes was approximately $70,000 in each year.
In accordance with the terms of the respective Certificates of Designation
and Terms of each Series of Preferred Stock ("Certificates"), the Board of
Directors determined the change in redemption value would not reflect a 1994
write-off of goodwill but rather reflect amortization as if the Company had
continued to write-off goodwill in accordance with historical amortization
schedules.
Following the distribution of Class B Common Stock, the holders of the
Preferred Stock became entitled to eleven votes per share on all matters
submitted to the vote of stockholders. The holder of the Series I Preferred
Stock is entitled, as well, to vote as a single class to elect or remove
one-quarter of the Board of Directors, to approve the merger or consolidation of
the Company or the sale by it of all or substantially all of its assets, and to
approve the authorization or issuance of any other class of Preferred Stock
having equivalent voting rights.
In the event of the liquidation of the Company, holders of Preferred Stock
are entitled to a preferential liquidation distribution of $1.00 per share in
addition to all accrued and unpaid preferential dividends.
The total carrying value of the Preferred Stock (applicable to those shares
outstanding at each respective year end) increased by $662,000, $1,112,000 and
$1,470,000 in 1997, 1996 and 1995, respectively. The change in carrying value
represents the change in aggregate redemption value during those periods. This
change is referred to as "Additional Capital Applicable to Redeemable Preferred
Stock" in the respective Certificates.
H. COMMON STOCK
The Company has authorized and outstanding two classes of common stock,
Common Stock and Class B Common Stock, each having a $1 par value per share. The
Class B Common Stock has the same dividend and liquidation rights as the Common
Stock, and a holder of each share of Class B Common Stock is entitled to ten
votes on all matters submitted to stockholders. The shares of Class B Common
Stock are restricted as to transferability and upon transfer, except to
specified limited classes of transferees, will convert into shares of Common
Stock which have one vote per share. The Class B Common Stock will automatically
convert to Common Stock on April 3, 2006.
14
<PAGE> 16
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
I. RESTRICTED STOCK AND STOCK OPTION PLANS
The Company's 1994 Stock Incentive Plan ("Stock Incentive Plan") is the
Company's active restricted stock and stock option plan. The Stock Incentive
Plan replaced the Restricted Stock Plan, the Executive Growth Plan, the
Incentive Stock Option Plan and the Nonqualified Stock Option Plan
(collectively, the "Prior Plans"), and any shares available for granting of
awards under the Prior Plans are no longer available for such awards. Options
granted pursuant to the Prior Plans remain outstanding and in full force, and
shares reserved thereunder remain so for such purposes.
STOCK INCENTIVE PLAN
Under the Stock Incentive Plan, awards in the form of incentive or
nonqualified stock options or restricted stock are available to be granted
through June 2003 to officers and other key employees. A maximum of 250,000
shares of Common Stock are available for grant under the Stock Incentive Plan.
Stock options cannot be granted at a price less than 100% of the fair market
value of the shares on the date of grant. A committee of the Board of Directors
("Committee") determines the terms and conditions under which the awards may be
granted, vest or are exercisable. Options must be exercised within ten years of
the date of grant. Shares of restricted stock may be sold to participants at a
purchase price determined by the Committee (which may be less than fair market
value per share).
Under the Prior Plans, nonqualified and incentive stock options were
granted to employees eligible to receive options at prices not less than 100% of
the fair market value of the shares on the date of grant. Options must be
exercised within ten years of grant and for only specified limited periods
beyond termination of employment. There were 1,200 shares reserved for issuance
under the Prior Plans at December 31, 1997.
NONQUALIFIED OPTIONS
Transactions involving nonqualified options under the Stock Incentive and
Prior Plans were:
<TABLE>
<CAPTION>
NUMBER WEIGHTED AVERAGE
OF SHARES EXERCISE PRICE
--------- ----------------
<S> <C> <C>
Outstanding, December 31, 1994............................. 36,399 $112
Granted.................................................... 84,174 151
Exercised.................................................. (21,965) 95
Forfeited.................................................. (284) 165
------- ----
Outstanding, December 31, 1995............................. 98,324 149
Granted.................................................... 47,100 229
Exercised.................................................. (9,884) 130
Forfeited.................................................. (66) 118
------- ----
Outstanding, December 31, 1996............................. 135,474 178
Granted.................................................... 8,450 260
Exercised.................................................. 0 0
Forfeited.................................................. (1,500) 189
------- ----
Outstanding, December 31, 1997............................. 142,424 $183
======= ====
</TABLE>
There were 50,133, 33,400 and 23,283 options exercisable at December 31,
1997, 1996 and 1995, respectively. The weighted average fair value of the
options granted during 1997, 1996 and 1995 was $101, $77 and $51, respectively.
15
<PAGE> 17
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The remaining weighted average contractual life of options outstanding as
of December 31, 1997 and the weighted average exercise price for options
exercisable at December 31, 1997 are as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
RANGE OF NUMBER OF AVERAGE AVERAGE NUMBER OF AVERAGE
EXERCISE SHARES REMAINING EXERCISE SHARES EXERCISE
PRICES OUTSTANDING CONTRACTUAL LIFE PRICE EXERCISABLE PRICE
-------- ----------- ---------------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$131-142......................... 1,200 2.2 years $133 133 $141
149-171......................... 85,974 6.6 years 157 40,000 149
188-196......................... 7,400 8.0 years 195 0 0
235............................. 39,400 8.8 years 235 10,000 235
251-290......................... 8,450 9.6 years 260 0 0
------- ------
Total............................ 142,424 50,133
======= ======
</TABLE>
Incentive Stock Options
Transactions involving outstanding incentive stock options under the plans
were:
<TABLE>
<CAPTION>
NUMBER OF SHARES OF WEIGHTED AVERAGE
COMMON STOCK EXERCISE PRICE
------------------- ----------------
<S> <C> <C>
Outstanding, December 31, 1994............................. 5,000 $99
Exercised.................................................. (3,570) 99
------
Outstanding, December 31, 1995............................. 1,430 99
Exercised.................................................. (714) 99
------
Outstanding, December 31, 1996............................. 716 99
Exercised.................................................. (716) 99
------
Outstanding, December 31, 1997............................. 0
======
</TABLE>
As of December 31, 1996, there were no incentive stock options which were
exercisable. As of December 31, 1995, options to acquire 714 shares of Common
Stock were exercisable.
Restricted Stock
In 1997, 3,000 shares of Restricted Stock were issued at prices between $1
and $93.50 per share. In 1996, 250 shares of Restricted Stock were issued at a
price of $97.75 per share. All stock is issued with restrictions as to
transferability expiring after five years. No shares of Restricted Stock were
issued in 1995. During 1995, the restrictions lapsed on 5,000 shares of Common
Stock. No restrictions lapsed in either 1997 or 1996.
Compensation to employees under the Stock Incentive and Prior Plans of
$756,000 in 1997, $98,000 in 1996 and $106,000 in 1995, representing the
unamortized excess of the market value of restricted stock over any cash
consideration received, is carried as a reduction of Paid-In Additional Capital
and is charged to income ($140,000 in 1997, $33,000 in 1996, and $133,000 in
1995) over the related required period of service of the respective employees.
Pro Forma Information
Pro forma information regarding net income and earnings per share has been
determined as if the Company had accounted for its employee stock options under
the fair value method. The approximate fair value for these options was
estimated at the date of grant using a Black-Scholes option valuation model with
the following weighted average assumptions for the years 1997, 1996 and 1995,
respectively; risk-free interest
16
<PAGE> 18
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
rates of 6.70%, 6.16% and 7.85%; dividend yields of 1.40%, 1.73% and 2.37%;
volatility factors of the expected market price of the Company's Common Stock of
.19, .17 and .17; and a weighted-average expected life for the options of 10.0,
10.0 and 9.4 years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restriction
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company'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. For purposes of
pro forma disclosures, the estimated fair value of the options is amortized to
expense over the options' vesting period. The Company's pro forma information
follows:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Pro forma net income........................ $29,689,000 $27,861,000 $22,493,000
Pro forma earnings per share:
Basic..................................... $24.41 $22.38 $17.44
Diluted................................... $21.39 $19.87 $15.72
</TABLE>
The pro forma information for 1997, 1996 and 1995 is not necessarily
indicative of future year calculations because options issued prior to 1995 have
not been valued for purposes of the pro forma calculation.
17
<PAGE> 19
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
J. COMPUTATION OF EARNINGS PER COMMON SHARE
The following table shows the amounts used in computing earnings per share
and the effect on income and the weighted average number of shares of dilutive
potential common stock.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31
-----------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
BASIC EARNINGS PER SHARE
Weighted-average shares............................. 1,180,146 1,185,841 1,195,314
----------- ----------- -----------
Net Income.......................................... $30,451,000 $28,602,000 $23,438,000
Effect of dividend requirements and the change in
redemption value of redeemable preferred stock.... (917,000) (1,356,000) (1,698,000)
----------- ----------- -----------
Net earnings used in computation.................... $29,534,000 $27,246,000 $21,740,000
----------- ----------- -----------
Per share amount.................................... $ 25.03 $ 22.98 $ 18.19
=========== =========== ===========
DILUTED EARNINGS PER SHARE
Weighted-average shares used in Basic............... 1,180,146 1,185,841 1,195,314
Net effect of dilutive stock options and stock
incentive plans(1)................................ 124,289 102,378 93,947
Assumed conversion of 8.5% convertible subordinated
debentures issued December 1983................... 51,017 50,892 51,000
----------- ----------- -----------
Adjusted weighted-average shares.................... 1,355,452 1,339,111 1,340,261
----------- ----------- -----------
Net Income used in Basic............................ $29,534,000 $27,246,000 $21,740,000
8.5% convertible subordinated debentures interest
net of income tax effect.......................... 139,000 139,000 139,000
----------- ----------- -----------
Net earnings used in computation.................... $29,673,000 $27,385,000 $21,879,000
----------- ----------- -----------
Per share amount.................................... $21.89 $20.45 $16.32
=========== =========== ===========
</TABLE>
- ---------------
(1) Includes 92,391, 85,350 and 69,260 shares for 1997, 1996 and 1995,
respectively, expected to be issued pursuant to the terms of the Senior
Management Incentive Plan.
18
<PAGE> 20
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
K. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and amounts used for income tax purposes. At December 31, 1997 and
1996, the Company had deferred tax assets and deferred tax liabilities as
follows:
<TABLE>
<CAPTION>
DEFERRED TAX ASSETS (LIABILITIES)
----------------------------------
1997 1996
--------------- ---------------
<S> <C> <C>
Deferred compensation..................................... $27,966,000 $23,056,000
Accrued expenses.......................................... 3,315,000 2,613,000
Safe harbor lease and depreciation........................ (1,225,000) (3,415,000)
Tax on unremitted foreign earnings and other.............. (3,414,000) (2,978,000)
----------- -----------
Net deferred tax assets................................... $26,642,000 $19,276,000
=========== ===========
Included in:
Other current assets.................................... $ 6,779,000 $ 4,426,000
Intangibles and other assets............................ 19,863,000 14,850,000
----------- -----------
$26,642,000 $19,276,000
=========== ===========
</TABLE>
The components of income of consolidated companies before taxes on income
are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Domestic.................................... $40,476,000 $36,553,000 $26,704,000
Foreign..................................... 28,815,000 29,140,000 27,623,000
----------- ----------- -----------
$69,291,000 $65,693,000 $54,327,000
=========== =========== ===========
</TABLE>
Provisions (benefits) for Federal, foreign, state and local income taxes
consisted of the following:
<TABLE>
<CAPTION>
1997 1996 1995
------------------------- ------------------------- -------------------------
CURRENT DEFERRED CURRENT DEFERRED CURRENT DEFERRED
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Federal.............. $16,763,000 $(3,989,000) $16,285,000 $(3,890,000) $13,607,000 $(4,248,000)
Foreign.............. 15,171,000 (1,204,000) 13,677,000 (280,000) 10,167,000 2,888,000
State and local...... 9,151,000 (2,173,000) 8,735,000 (2,915,000) 6,191,000 (1,639,000)
----------- ----------- ----------- ----------- ----------- -----------
$41,085,000 $(7,366,000) $38,697,000 $(7,085,000) $29,965,000 $(2,999,000)
=========== =========== =========== =========== =========== ===========
</TABLE>
The effective tax rate varied from the statutory Federal income tax rate as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Statutory Federal tax rate.................................. 35.0% 35.0% 35.0%
State and local income taxes, net of Federal income tax
benefits.................................................. 6.6 5.8 5.4
Difference in foreign tax rates............................. 4.7 4.3 6.5
Withholding tax on unremitted foreign earnings.............. 0.9 0.6 0.5
Other -- net................................................ 1.5 2.4 2.2
---- ---- ----
48.7% 48.1% 49.6%
==== ==== ====
</TABLE>
During the years 1997, 1996 and 1995, the Company made income tax payments
of $39,689,000, $36,513,000 and $21,368,000, respectively.
19
<PAGE> 21
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The tax benefit resulting from the difference between compensation expense
deducted for tax purposes and compensation expense charged to income for
restricted stock and nonqualified stock options is recorded as an increase to
Paid-In Additional Capital.
L. RETIREMENT PLANS, DEFERRED COMPENSATION, EXECUTIVE OFFICER LOANS, LEASES AND
CONTINGENCIES
1. The Company's Profit Sharing Plan is available to employees of the
Company and qualifying subsidiaries meeting certain eligibility requirements.
This plan provides for contributions by the Company at the discretion of the
Board of Directors, subject to maximum limitations. The Company also maintains a
noncontributory Employee Stock Ownership Plan covering eligible employees of the
Company and specified, qualifying subsidiaries, under which the Company may make
contributions (in stock or cash) to an Employee Stock Ownership Trust (ESOT) in
amounts each year as determined at the discretion of the Board of Directors. The
Company made only cash contributions to the ESOT in 1997, 1996 and 1995. The
Company and the ESOT have certain rights to purchase shares from participants
whose employment has terminated. In addition to the two plans noted above, a
number of subsidiaries maintain separate profit sharing and retirement
arrangements. Furthermore, the Company also provides additional retirement and
deferred compensation benefits to certain officers and employees.
The Company maintains a Senior Management Incentive Plan ("Plan") in which
deferred compensation is granted to senior executive or management employees
deemed important to the continued success of the Company. The Plan operates as
an ongoing series of individual five year plans. The latest plan in the series
commenced in 1993 and ended on December 31, 1997. Individuals with 5 years of
participation in the current plan are vested in their awards. Those participants
who commenced participation after 1993 will vest in their awards five years from
the year of their initial participation. The amount recorded as an expense
related to the Plan amounted to $8,377,000, $8,211,000 and $6,873,000 in 1997,
1996 and 1995, respectively. Approximately $1,113,000, $5,634,000 and $5,223,000
of plan expense incurred in 1997, 1996 and 1995, respectively, will be payable
in Common Stock in accordance with the terms of the plan. The awards payable in
Common Stock were converted at the fair value of the Common Stock on the date of
grant into an equivalent number of shares of Common Stock. The future obligation
to issue Common Stock related to these stock awards has been reflected as an
increase to Paid-In Additional Capital. At December 31, 1997, approximately
96,000 shares are payable in Common Stock pursuant to the Plan of which
approximately 87,000 shares are vested. Stock and cash awards which are vested
under the Plan will be distributed in 1998.
In 1995, the Company and its Chairman and Chief Executive Officer entered
into an agreement extending the term of his employment agreement with the
Company through December 31, 2002. This agreement further provides for the
deferral of certain compensation otherwise payable to the Chairman and Chief
Executive pursuant to his employment agreement and the payment of such deferred
compensation into a trust, commonly referred to as a rabbi trust, established
with United States Trust Company of New York. The purpose of the trust
arrangement is to ensure the Company's ability to deduct compensation paid to
the Chairman and Chief Executive Officer without the application of Section
162(m) of the Internal Revenue Code ("Section"). The Section, under certain
circumstances, denies a tax deduction to an employer for certain compensation
expenses in excess of $1,000,000 per year paid by a publicly-held corporation to
certain of its executives. Amounts deferred and paid into the trust, as adjusted
for the earnings and gains or losses on the trust assets, will be paid to the
Chairman and Chief Executive Officer or to his estate, as the case may be, upon
the expiration of his employment agreement, or the termination of his employment
by reason of death or disability.
At December 31, 1997 and 1996, the value of the trust was $10,400,000 and
$5,648,000, respectively, and is included in Other Assets and the Company's
related deferred compensation obligation for the same amount is included in
Other Liabilities.
20
<PAGE> 22
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Expenses related to the foregoing plans and benefits aggregated $33,230,000
in 1997, $36,140,000 in 1996 and $29,307,000 in 1995.
2. Pursuant to an employment agreement, dated December 21, 1990, an
executive officer of the Company borrowed $1,000,000 from the Company. One-fifth
of the principal amount of the loan was forgiven by the Company each December
31, beginning with December 31, 1991, as the officer continued to be employed by
the Company on those dates. In 1994, the executive officer entered into a new
employment agreement. Pursuant to that agreement, the executive officer borrowed
an additional $600,000 from the Company repayable at December 31, 1998, except
that one-third of the principal amount of the loan is forgiven by the Company
each December 31, beginning with December 31, 1996, provided that the officer
continues to be employed by the Company on those dates. In 1997, 1996 and 1995,
the Company has included in each year $200,000 of compensation expense,
representing the amount of loan forgiven each year. As of December 31, 1997 and
1996, the remaining loan balance was $200,000 and $400,000, respectively, and is
included in Other Assets.
In addition, a second executive officer has outstanding loans with the
Company totaling $825,000 and $875,000 as of December 31, 1997 and 1996,
respectively, which are reflected in Other Assets. The first of these loans,
granted in 1994, was for $50,000 and was forgiven on December 31, 1997. Two
other loans for $125,000 and $200,000 were made in 1995 and are repayable with
accrued interest in December 1999 and May 1999, respectively. The loan for
$125,000 is forgivable on December 31, 1999 provided that the executive officer
is employed by the Company on that date. During 1996, the Company made two
additional loans to this executive officer for $175,000 and $325,000 which are
repayable with accrued interest in December 2003.
In connection with a 1992 exercise of the stock options, the Company
received a cash payment of $67,000 and a note from the Chairman and Chief
Executive Officer of the Company in the amount of $3,170,000, due in December
2001, at a fixed interest rate of 6.06%. In addition, and in accordance with the
terms of the option agreement, the holder of the options issued to the Company a
promissory note in the principal amount of $2,340,000 bearing interest at the
rate of 6.06%, payable in December 2001, to settle his obligation to provide the
Company with funds necessary to pay the required withholding taxes due upon the
exercise of the options. A portion of the second note ($1,556,000) equal to the
tax benefit received by the Company upon exercise and the full amount of the
note for $3,170,000 are reflected in a separate component of stockholders'
equity. The interest paid to the Company by the holder pursuant to the terms of
the two notes issued in connection with the option exercise was $334,000 in
1997, 1996 and 1995.
3. Rental expense amounted to approximately $41,239,000 in 1997,
$41,104,000 in 1996 and $36,445,000 in 1995. Approximate minimum rental
commitments, excluding escalations, under noncancellable operating leases are as
follows:
<TABLE>
<S> <C>
1998........................................... $ 34,929,000
1999........................................... 34,328,000
2000........................................... 38,371,000
2001........................................... 36,641,000
2002........................................... 35,600,000
Beyond 2002.................................... 135,179,000
------------
$315,048,000
============
</TABLE>
4. The Company is not involved in any pending legal proceedings not
covered by insurance or by adequate indemnification or which, if decided
adversely, would have a material effect on the results of operations, liquidity
or financial position of the Company.
21
<PAGE> 23
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
M. INDUSTRY SEGMENT AND RELATED INFORMATION
Commissions and fees and operating profit by geographic area for the years
ended December 31, 1997, 1996 and 1995, and related identifiable assets at
December 31, 1997, 1996 and 1995 are summarized below (000s omitted):
<TABLE>
<CAPTION>
UNITED STATES WESTERN EUROPE OTHER
------------------------------ ------------------------------ ----------------------------
1997 1996 1995 1997 1996 1995 1997 1996 1995
-------- -------- -------- -------- -------- -------- -------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commissions and fees........ $382,288 $338,496 $303,826 $380,675 $370,888 $337,726 $ 95,789 $56,114 $46,667
======== ======== ======== ======== ======== ======== ======== ======= =======
Operating profit............ $ 32,570 $ 26,174 $ 21,368 $ 30,534 $ 30,279 $ 27,212 $ 1,816 $ 2,080 $ 1,660
======== ======== ======== ======== ======== ======== ======== ======= =======
Other income-net............
Income of consolidated
companies before taxes on
income.....................
Identifiable assets......... $581,557 $549,160 $464,067 $457,099 $445,038 $406,757 $142,945 $77,473 $71,916
======== ======== ======== ======== ======== ======== ======== ======= =======
Investments in and advances
to nonconsolidated
affiliated companies.......
Total assets.........
<CAPTION>
CONSOLIDATED
----------------------------------
1997 1996 1995
---------- ---------- --------
<S> <C> <C> <C>
Commissions and fees........ $ 858,752 $ 765,498 $688,219
========== ========== ========
Operating profit............ $ 64,920 $ 58,533 $ 50,240
Other income-net............ 4,371 7,160 4,087
---------- ---------- --------
Income of consolidated
companies before taxes on
income..................... $ 69,291 $ 65,693 $ 54,327
========== ========== ========
Identifiable assets......... $1,181,601 $1,071,671 $942,740
Investments in and advances
to nonconsolidated
affiliated companies....... 18,386 17,723 20,693
---------- ---------- --------
Total assets......... $1,199,987 $1,089,394 $963,433
========== ========== ========
</TABLE>
Commissions and fees from one client amounted to 12.8%, 13.2% and 13.8% of
the consolidated total in 1997, 1996 and 1995, respectively.
22
<PAGE> 24
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Grey Advertising Inc.
We have audited the accompanying consolidated balance sheets of Grey
Advertising Inc. and consolidated subsidiary companies as of December 31, 1997
and 1996, and the related consolidated statements of income, common
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Grey Advertising Inc. and consolidated subsidiary companies at December 31, 1997
and 1996, and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 1997 in conformity
with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
ERNST & YOUNG LLP
New York, New York
February 8, 1998
23
