<PAGE> 1
GREY
GREY ADVERTISING INC.
1998 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") is the sixth largest United States-headquartered, worldwide cohesive
marketing communications services company in the world according to Advertising
Age, a respected trade publication. The Company was founded in 1917,
incorporated in New York in 1925 and changed its state of incorporation to
Delaware in 1974.
The Company has evolved from a traditional advertising agency to a
full-service, marketing communications company operating through equity-owned
and non-equity affiliates in 158 cities in 90 countries worldwide. Its primary
business is to create marketing communications for its clients across every
channel of the media spectrum. The Company offers full-service advertising
through Grey Advertising, one of the largest global agency networks. In
addition, it provides a broad array of specialized communications and integrated
marketing services including: public relations/public affairs (GCI/APCO); direct
marketing (Grey Direct); strategic co-marketing (J. Brown/LMC Group);
interactive communications and e-commerce (Grey New Technologies; Grey
Interactive, MediaCom Digital Technologies, KPE); healthcare marketing (Grey
Healthcare Group); entertainment marketing (Grey Entertainment, Grey Alliance);
Hispanic marketing (FOVA); Yellow Pages advertising (Grey Directory Marketing);
youth marketing (G-Whiz! Youth Marketing); business, marketing and sales
communications (Great! Communications); corporate identity and sales promotion
(Grey Design & Promotion); financial services multimedia communications (Visual
Communications); media research buying and planning services (MediaCom); and
brand planning (Grey Brand Planning and Research). The Company's client roster
includes major national and international advertisers of consumer and commercial
goods and services.
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 1998, 1997 or 1996. 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 N to the Consolidated Financial Statements.
BID PRICES* AND
DIVIDEND HISTORY 1997-1998
<TABLE>
<CAPTION>
DOLLARS PER SHARE
----------------- DIVIDENDS
HIGH LOW PER SHARE
----- ---- ---------
<S> <C> <C> <C>
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
1998
First Quarter............................................. 370 325 1.00
Second Quarter............................................ 455 360 1.00
Third Quarter............................................. 417 312 1.00
Fourth Quarter............................................ 369 262 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 505 (7/7/99);
Limited Duration Class B Common Stock 259 (7/7/99).
<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 8.9% in 1998
and 12.2% in 1997 as compared to the respective prior years. Absent exchange
rate fluctuations, gross income increased 11.7% in 1998 and 16.9% in 1997. In
1998, 1997 and 1996, respectively, 44.9%, 44.5% and 44.2% of consolidated gross
income was attributable to domestic operations and 55.1%, 55.5% and 55.8%,
respectively, to international operations. In 1998, gross income from domestic
operations increased 9.7% versus 1997 and was up 12.9% in 1997 versus 1996.
Gross income from international operations increased 8.2% (13.3% absent exchange
rate fluctuations) in 1998 when compared to 1997 and 11.6% (20.0% absent
exchange rate fluctuations) in 1997 when compared to 1996. 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 13.2% in 1998 and 11.6% in
1997 as compared to the respective prior years. Office and general expenses
increased 7.2% in 1998 and 13.6% in 1997 versus respective prior years. The 1998
increases reflect the general growth of the business and an increased investment
in staffing to better serve our multinational clients and their businesses in
developing markets. The 1997 increases in expenses are generally in line with
the increases in gross income in that year.
Inflation did not have a material effect on revenue or expenses in 1998,
1997 or 1996.
Other income increased in 1998 by $2,124,000 and decreased in 1997 by
$2,789,000 as compared to the comparable prior periods. The 1998 increase is due
primarily to increased interest income generated from higher average invested
balances, in part due to the proceeds from the long-term borrowing in December
1997. The 1997 decrease resulted primarily from the absence of a 1996
non-recurring, non-operating pre-tax income amount of approximately $4,000,000
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 increased to 50.5% in 1998 as compared to 48.7% in
1997. The tax rate in 1996 was 48.1%. The change in the effective tax rates in
1998 and 1997, as compared to their respective prior periods, was due to higher
effective state and local tax rates and higher effective foreign tax rates,
largely dependent upon where the Company generates profits.
Minority interest decreased $2,602,000 in 1998 and increased $80,000 in
1997 as compared to the respective prior years. The changes in 1998 and in 1997
were primarily due to changes in the level of profits of majority-owned
companies.
Equity in earnings of nonconsolidated affiliated companies decreased
$900,000 in 1998 and increased $438,000 in 1997 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 $25,877,000 for 1998 as compared to
$30,451,000 in 1997 and $28,602,000 in 1996. Diluted earnings per common share
was $18.98 in 1998 as compared to $21.89 in 1997 and $20.45 in 1996. Net income
for 1998 was off from 1997 by 15.0%, and absent non-recurring, non-operating
pre-tax income recognized in 1996, net income for 1997 was up 15.0% from 1996.
Diluted earnings per common share was down 13.3% for 1998 while 1997 diluted
earnings per common share was up 15.5% absent the 1996 non-recurring,
non-operating pre-tax income.
For purpose 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
purpose 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 1/2% convertible subordinated debentures.
2
<PAGE> 4
The Company's 1998 results were adversely affected by software
development-related losses in the Internet division of one of its international
subsidiaries. In addition, the results were impacted by significant decreases in
client expenditures in emerging markets. The Company has invested in these
markets in support of its multinational clients and their businesses, and
remains committed to the long-term growth potential of these developing markets.
It is expected that the losses incurred in such Internet unit will be reduced
significantly in 1999. Equally, the Company believes that the losses in the
economically-troubled emerging markets will be less in 1999 than in 1998 but it
does foresee its operations in those countries negatively impacting 1999
results.
During 1998, the Company's principal advertising agency business lost a
number of pieces of business, the impact of which will be felt mostly in 1999.
The Company has not yet replaced the lost business and its absence will put
pressure on the gross income, and resulting profitability, of the Company in
1999. The Company is committed to growing this revenue base and has done so in
the past in the face of client losses. It has also reduced expenses at the
operations which have suffered the gross income declines. At the same time, a
number of the Company's units, most notably in the healthcare, Internet
services, public relations and media sectors, are growing rapidly. The Company
will continue to seek to propel the global growth of these operations by
continuing its investment program in their support. On balance, however, until
the lost business is fully replaced, the Company will likely operate at lower
profitability levels than in the recent past.
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.
The Year 2000 issue is the result of computer programs being written using
two digits rather than four digits to define the applicable year. Accordingly,
computer equipment, software and other devices with embedded technology that are
time-sensitive may not be able to distinguish between the year 1900 and the year
2000 and may encounter other difficulties as a result. This could result in
system failures or miscalculations causing a temporary disruption of the
ordinary course of business.
Grey and its operating subsidiaries have completed an assessment of their
computer programs, those of its third party software vendors and those of
mission critical business partners. The Company's assessment process included
formal communications, via questionnaire, with third parties regarding their own
Year 2000 status and testing of relevant equipment, systems and interfaces.
Based on this assessment along with normal recurring upgrades and replacement of
outdated systems, the Company has undertaken, or is in the process of
undertaking, what it believes to be the appropriate steps to modify or replace
hardware and software as necessary.
These steps included an inventory of systems, both domestically and
internationally, for Year 2000 compliance and a remediation strategy to ensure
substantial completion of upgrades and replacement where necessary. Given the
decentralized nature of the Company's information technology environment,
software for financial and non-financial applications can vary from operation to
operation and range from complete reliance on third party software to use of all
in-house applications. Moreover, as a result of its decentralized environment,
the Company's systems tend to be more limited in their effect and easier to
correct. The remediation strategy, therefore, can be unique from operation to
operation and includes a combination of conversions of all in-house systems and
upgrades to Year 2000 compliant third party systems. The majority of operations,
including all entities in the larger markets, are in various stages of
implementation which should be completed by mid-year. The Company envisages
final testing to be completed well in advance of year end and does not expect
the Year 2000 issue to pose significant operational problems for its computer
network.
The Company is also dependent in various ways, both domestically and
internationally, on the Year 2000 readiness of broadcasters, governments,
financial institutions, utilities, communications suppliers and building
services, other infrastructure suppliers and other parties with whom it does
business. The effects of failures in the systems utilized by these third party
suppliers can not be estimated or anticipated. Given the reliance on third party
information as it relates to compliance programs and the difficulty of
determining potential errors
3
<PAGE> 5
on the part of external service suppliers, no assurance can be given that the
Company's information systems or operations will not be affected by mistakes, if
any, of third parties or third party failures to complete the Year 2000 projects
on a timely basis. There can be no assurance that the systems of other companies
on which the Company relies will be converted on a timely basis or that any such
failure to convert by another company would not have an adverse effect on the
Company's systems. However, with respect to operations under the Company's
control, the Company does not expect, in light of its Year 2000 readiness
efforts and the diversity of its suppliers and customers, that occurrences of
Year 2000 failures will have a material adverse effect on the financial position
or results of operations of the Company.
Grey and its subsidiaries are utilizing both internal and external
resources to reprogram, replace, implement and test the software modifications
necessary for Year 2000 compliance. The cost of the project has been estimated
to be approximately $4,000,000 and will not have a material effect on the
Company. Costs include the purchase of third party software, hardware and
related internal payroll costs associated with the information technology group.
A substantial portion of these estimated costs relate to systems and
applications that were previously planned and budgeted. The project is being
funded through operating cash; costs specifically identified with the Year 2000
remediation are being expensed as incurred. Other hardware and purchased
software costs have been capitalized. 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. Since there is no guarantee that these estimates will be
achieved, 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 parties with whom the Company interacts and similar circumstances.
The Company believes it has an effective program in place to resolve the
Year 2000 issue. However, due to the magnitude and complexity of the problem it
is difficult to identify all possible contingencies. The Company believes that a
worst case scenario would involve its temporary inability to process media,
collect payments or invoice customers at a significant number of its
subsidiaries. In addition, disruptions in the economy generally resulting from
Year 2000 issues could also affect the Company. The Company could, for example,
be subject to litigation for computer system product failure, equipment shutdown
or failure to properly date business records. The amount of potential liability
and lost revenue cannot be reasonably estimated at this time. Current
contingency plans call for manual workarounds and staffing strategies that
provide a prompt response time in the event of problems. The development of the
Company's contingency plans is ongoing and will be amended as appropriate.
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, most of which are money market funds and corporate bonds. Cash and
cash equivalents were $153,816,000 and $150,553,000 at December 31, 1998 and
1997, respectively, and the Company's investment in marketable securities was
$85,957,000 and $72,741,000 at December 31, 1998 and 1997, respectively. The
continued high level of liquidity reflects the Company's ongoing focus on its
cash management process. Working capital decreased by $47,062,000 from
$50,526,000 at December 31, 1997 to $3,464,000 at December 31, 1998. The
decrease in working capital is largely attributable to an increased investment
in majority-owned subsidiaries and an increase in short-term financing of the
Company's international subsidiaries.
Domestically, the Company maintains committed bank lines of credit totaling
$51,000,000. These lines of credit were partially utilized during both 1998 and
1997 to secure obligations of selected foreign subsidiaries in the amounts of
$18,700,000 and $3,000,000 at December 31, 1998 and 1997, 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
4
<PAGE> 6
facilities at December 31, 1998 and 1997 were $52,211,000 and $19,455,000,
respectively. The increase in borrowings is largely attributable to the
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 borrowings 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 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.
FASB STATEMENT 130
As of January 1, 1998, the Company adopted the Financial Accounting
Standards Board Statement No. 130, Reporting Comprehensive Income ("FAS 130").
FAS 130 establishes standards for reporting and display of comprehensive income
and its components in the financial statements. FAS 130 requires unrealized
gains or losses on the Company's available for sale securities and foreign
currency translation adjustments, which prior to adoption were reported
separately in stockholders' equity, to be included in other comprehensive income
(loss). Prior period financial statements have been reclassified to conform to
the requirements of FAS 130. The adoption of this standard has no impact on the
Company's net income or stockholders' equity.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Occasionally, the Company enters into foreign currency contracts for known
cash flows related to repatriation of earnings from its international
subsidiaries. The term of each such foreign currency contract entered into in
1998 was for less than three months. At December 31, 1998, there were no foreign
currency contracts open. The Company did take advantage of an inverted yield
curve in the United Kingdom and entered into an interest rate swap agreement as
a hedge against rising interest rates by exchanging the cash flow on borrowings
of L5,000,000 at a variable interest rate for the cash flow from a similar
borrowing at a fixed interest rate of 5.67%. The Company had no other derivative
contracts outstanding at December 31, 1998 and did not enter into any other
derivative contracts during 1998.
FORWARD LOOKING STATEMENTS
In connection with the provisions of the Private Securities Litigation
Reform Act of 1995 (the "Reform Act"), the Company may include Forward Looking
Statements (as defined in the Reform Act) in oral or written public statements
issued by or on behalf of the Company. These Forward Looking Statements may
include, among other things, plans, objectives, projections, anticipated future
economic performance or assumptions and the like that are subject to risks and
uncertainties. Actual results or outcomes may differ materially from those
discussed in the Forward Looking Statements. Important factors which may cause
actual results to differ, include but are not limited to, the following: the
unanticipated loss of a material client or key personnel, delays or reductions
in client budgets, shifts in industry rates of compensation, government
compliance costs or litigation, unanticipated natural disasters, changes in the
general economic conditions that affect interest rates and/or consumer spending
both in the U.S. and the international markets in which the Company operates,
unanticipated expenses, client preferences which can be affected by competition,
the inability to implement upgrades for certain computer programs which are not
year 2000 compliant and the ability to project risk factors which may vary.
5
<PAGE> 7
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------------
1998 1997
-------------- --------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 153,816,000 $ 150,553,000
Marketable securities..................................... 55,130,000 15,401,000
Accounts receivable....................................... 797,474,000 647,524,000
Expenditures billable to clients.......................... 66,681,000 54,687,000
Other current assets...................................... 75,481,000 56,225,000
-------------- --------------
Total current assets.................................... 1,148,582,000 924,390,000
Investments in and advances to nonconsolidated affiliated
companies................................................. 16,705,000 18,386,000
Fixed assets-net............................................ 113,084,000 88,006,000
Marketable securities....................................... 30,827,000 57,340,000
Goodwill-net of accumulated amortization of $31,466,000 in
1998 and $23,509,000 in 1997.............................. 116,499,000 59,851,000
Other assets-including loans to executive officers of
$5,572,000 in 1998 and 1997............................... 63,956,000 52,014,000
-------------- --------------
Total assets....................................... $1,489,653,000 $1,199,987,000
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 865,427,000 $ 709,959,000
Notes payable to banks.................................... 70,911,000 22,455,000
Accrued expenses and other................................ 184,497,000 122,269,000
Income taxes payable...................................... 24,283,000 19,181,000
-------------- --------------
Total current liabilities............................... 1,145,118,000 873,864,000
Other liabilities-including deferred compensation of
$41,871,000 in 1998 and $36,481,000 in 1997............... 68,676,000 61,723,000
Long-term debt.............................................. 78,025,000 78,025,000
Minority interest........................................... 14,112,000 13,309,000
Redeemable preferred stock -- at redemption value; par value
$1 per share; authorized 500,000 shares; issued and
outstanding 30,000 shares in 1998 and 32,000 shares in
1997...................................................... 10,333,000 10,760,000
Common stockholders' equity:
Common Stock -- par value $1 per share; authorized
10,000,000 shares; issued 1,205,041 shares in 1998 and
1,124,324 shares in 1997................................ 1,205,000 1,124,000
Limited Duration Class B Common Stock -- par value $1 per
share; authorized 2,000,000 shares; issued 282,765
shares in 1998 and 307,460 shares in 1997............... 283,000 308,000
Paid-in additional capital................................ 38,832,000 44,349,000
Retained earnings......................................... 189,714,000 169,214,000
Accumulated other comprehensive loss:
Cumulative translation adjustment....................... (11,716,000) (9,422,000)
Unrealized (loss) gain on marketable securities......... (1,307,000) 189,000
-------------- --------------
Total accumulated other comprehensive loss.................. (13,023,000) (9,233,000)
-------------- --------------
Loans to officer used to purchase Common Stock and Limited
Duration Class B Common Stock............................. (4,726,000) (4,726,000)
-------------- --------------
212,285,000 201,036,000
Less -- cost of 222,950 and 222,098 shares of Common Stock
and 26,762 and 26,762 shares of Limited Duration Class B
Common Stock held in treasury at December 31, 1998 and
1997, respectively...................................... 38,896,000 38,730,000
-------------- --------------
Total common stockholders' equity.................. 173,389,000 162,306,000
Retirement plans, leases and contingencies................
-------------- --------------
Total liabilities and stockholders' equity......... $1,489,653,000 $1,199,987,000
============== ==============
</TABLE>
See notes to consolidated financial statements.
6
<PAGE> 8
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Commissions and fees............................. $935,181,000 $858,752,000 $765,498,000
Expenses:
Salaries and employee related expenses......... 599,681,000 529,863,000 474,686,000
Office and general expenses.................... 282,843,000 263,969,000 232,279,000
------------ ------------ ------------
882,524,000 793,832,000 706,965,000
------------ ------------ ------------
52,657,000 64,920,000 58,533,000
Other income -- net.............................. 6,495,000 4,371,000 7,160,000
------------ ------------ ------------
Income of consolidated companies before taxes on
income......................................... 59,152,000 69,291,000 65,693,000
Provision for taxes on income.................... 29,856,000 33,719,000 31,612,000
------------ ------------ ------------
Income of consolidated companies................. 29,296,000 35,572,000 34,081,000
Minority interest applicable to consolidated
companies...................................... (4,141,000) (6,743,000) (6,663,000)
Equity in earnings of nonconsolidated affiliated
companies...................................... 722,000 1,622,000 1,184,000
------------ ------------ ------------
Net income....................................... $ 25,877,000 $ 30,451,000 $ 28,602,000
============ ============ ============
Earnings per Common Share:
Basic.......................................... $20.81 $25.03 $22.98
Diluted........................................ $18.98 $21.89 $20.45
</TABLE>
See notes to consolidated financial statements.
7
<PAGE> 9
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
COMMON STOCK
PAID-IN HELD IN TREASURY
COMMON ADDITIONAL COMPREHENSIVE RETAINED ----------------------
STOCK CAPITAL INCOME EARNINGS SHARES AMOUNT
---------- ------------ ------------- ------------ ------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995....... $1,432,000 $ 37,898,000 $122,345,000 239,599 $(34,500,000)
Comprehensive income:
Net income........................ $28,602,000 28,602,000
Other comprehensive loss:
Translation adjustment.......... (2,085,000)
Unrealized loss on marketable
securities, net of
reclassification adjustment for
gains included in net income of
$378,000....................... (1,420,000)
-----------
Other comprehensive loss.......... (3,505,000)
-----------
Total comprehensive income........ $25,097,000
===========
Cash dividends -- Common Shares
$3.8125 per share............... (4,527,000)
Cash dividends -- Redeemable
Preferred Stock -- $7.625 per
share........................... (244,000)
Common Shares acquired -- at
cost............................ 20,818 (4,733,000)
Dividends payable in common shares
pursuant to the Senior
Management Incentive Plan....... 275,000 (275,000)
Increase in redemption value of
Redeemable Preferred Stock...... (1,112,000)
Restricted stock activity......... 43,000 (250) 14,000
Tax benefit from restricted
stock........................... 3,000
Common Shares issued upon exercise
of stock options................ 250,000 (10,598) 1,123,000
Tax benefit from exercise of stock
options......................... 483,000
Senior Management Incentive Plan
activity........................ 3,862,000
---------- ------------ ------------ ------- ------------
Balance at December 31, 1996....... 1,432,000 42,814,000 144,789,000 249,569 (38,096,000)
Comprehensive income:
Net income........................ $30,451,000 30,451,000
Other comprehensive loss:
Translation adjustment.......... (12,001,000)
Unrealized gain on marketable
securities, net of
reclassification adjustment for
gains included in net income of
$215,000....................... 1,059,000
-----------
Other comprehensive loss.......... (10,942,000)
-----------
Total comprehensive Income........ $19,509,000
===========
Cash dividends -- Common
Shares -- $4.00 per share....... (4,738,000)
Cash dividends -- Redeemable
Preferred Stock -- $8.00 per
share........................... (256,000)
Common Shares acquired -- at
cost............................ 3,007 (962,000)
Dividends Payable in common shares
pursuant to the Senior
Management Incentive Plan....... (370,000)
Increase in redemption value of
Redeemable Preferred Stock...... (662,000)
Restricted stock activity......... (143,000) (3,000) 309,000
Tax benefit from restricted
stock........................... 8,000
Common Shares issued upon exercise
of stock options................ 52,000 (716) 19,000
Senior Management Incentive Plan
activity........................ 1,618,000
---------- ------------ ------------ ------- ------------
Balance at December 31, 1997....... $1,432,000 $ 44,349,000 $169,214,000 248,860 $(38,730,000)
Comprehensive income:
Net income........................ $25,877,000 25,877,000
Other comprehensive loss:
Translation adjustment.......... (2,294,000)
Unrealized loss on marketable
securities, net of
reclassification adjustment for
gains included in net income of
$256,000....................... (1,496,000)
-----------
Other comprehensive loss.......... (3,790,000)
-----------
Total comprehensive income........ $22,087,000
===========
Cash dividends -- Common
Shares -- $4.00 per share....... (4,895,000)
Cash dividends -- Redeemable
Preferred Stock $8.00 per
share........................... (244,000)
Common Shares acquired -- at
cost............................ 427 (168,000)
Dividends payable in cash pursuant
to the Senior Management
Incentive Plan.................. (14,000)
Increase in redemption value of
Redeemable Preferred Stock...... (224,000)
Restricted stock activity......... 81,000 625 (21,000)
Tax benefit from restricted
stock........................... 8,000
Common Shares issued upon exercise
of stock options................ 5,000 (200) 23,000
Senior Management Incentive Plan
activity........................ 56,000 (5,611,000)
---------- ------------ ------------ ------- ------------
Balance at December 31, 1998....... $1,488,000 $ 38,832,000 $189,714,000 249,712 $(38,896,000)
========== ============ ============ ======= ============
<CAPTION>
ACCUMULATED
OTHER
LOANS TO COMPREHENSIVE
OFFICERS INCOME TOTAL
----------- ------------- ------------
<S> <C> <C> <C>
Balance at December 31, 1995....... $(4,726,000) $ 5,214,000 $127,663,000
Comprehensive income:
Net income........................ 28,602,000
Other comprehensive loss:
Translation adjustment..........
Unrealized loss on marketable
securities, net of
reclassification adjustment for
gains included in net income of
$378,000.......................
Other comprehensive loss.......... (3,505,000) (3,505,000)
Total comprehensive income........
Cash dividends -- Common Shares
$3.8125 per share............... (4,527,000)
Cash dividends -- Redeemable
Preferred Stock -- $7.625 per
share........................... (244,000)
Common Shares acquired -- at
cost............................ (4,733,000)
Dividends payable in common shares
pursuant to the Senior
Management Incentive Plan.......
Increase in redemption value of
Redeemable Preferred Stock...... (1,112,000)
Restricted stock activity......... 57,000
Tax benefit from restricted
stock........................... 3,000
Common Shares issued upon exercise
of stock options................ 1,373,000
Tax benefit from exercise of stock
options......................... 483,000
Senior Management Incentive Plan
activity........................ 3,862,000
----------- ------------ ------------
Balance at December 31, 1996....... (4,726,000) 1,709,000 147,922,000
Comprehensive income:
Net income........................ 30,451,000
Other comprehensive loss:
Translation adjustment..........
Unrealized gain on marketable
securities, net of
reclassification adjustment for
gains included in net income of
$215,000.......................
Other comprehensive loss.......... (10,942,000) (10,942,000)
Total comprehensive Income........
Cash dividends -- Common
Shares -- $4.00 per share....... (4,738,000)
Cash dividends -- Redeemable
Preferred Stock -- $8.00 per
share........................... (256,000)
Common Shares acquired -- at
cost............................ (962,000)
Dividends Payable in common shares
pursuant to the Senior
Management Incentive Plan....... (370,000)
Increase in redemption value of
Redeemable Preferred Stock...... (662,000)
Restricted stock activity......... 166,000
Tax benefit from restricted
stock........................... 8,000
Common Shares issued upon exercise
of stock options................ 71,000
Senior Management Incentive Plan
activity........................ 1,618,000
----------- ------------ ------------
Balance at December 31, 1997....... $(4,726,000) $ (9,233,000) $162,306,000
Comprehensive income:
Net income........................ 25,877,000
Other comprehensive loss:
Translation adjustment..........
Unrealized loss on marketable
securities, net of
reclassification adjustment for
gains included in net income of
$256,000.......................
Other comprehensive loss.......... (3,790,000) (3,790,000)
Total comprehensive income........
Cash dividends -- Common
Shares -- $4.00 per share....... (4,895,000)
Cash dividends -- Redeemable
Preferred Stock $8.00 per
share........................... (244,000)
Common Shares acquired -- at
cost............................ (168,000)
Dividends payable in cash pursuant
to the Senior Management
Incentive Plan.................. (14,000)
Increase in redemption value of
Redeemable Preferred Stock...... (224,000)
Restricted stock activity......... 60,000
Tax benefit from restricted
stock........................... 8,000
Common Shares issued upon exercise
of stock options................ 28,000
Senior Management Incentive Plan
activity........................ (5,555,000)
----------- ------------ ------------
Balance at December 31, 1998....... $(4,726,000) $(13,023,000) $173,389,000
=========== ============ ============
</TABLE>
See notes to consolidated financial statements.
8
<PAGE> 10
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------------------
1998 1997 1996
------------- ------------ -------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income.............................................. $ 25,877,000 $ 30,451,000 $ 28,602,000
Adjustments to reconcile net income to net cash provided
by operating activities, net of acquisitions:
Depreciation and amortization of fixed assets......... 27,992,000 25,866,000 22,880,000
Amortization of intangibles........................... 7,957,000 6,160,000 4,976,000
Deferred compensation................................. 12,366,000 14,002,000 16,217,000
Equity in earnings of nonconsolidated affiliated
companies, net of dividends received of $856,000 in
1998, $658,000 in 1997, and $441,000 in 1996....... 134,000 (964,000) (743,000)
Gains from the sale of marketable securities.......... (256,000) (215,000) (378,000)
Gains from the sale of a nonconsolidated affiliated
company and a non-marketable investment security... (336,000) (384,000) (4,533,000)
Minority interest applicable to consolidated
companies.......................................... 4,141,000 6,743,000 6,663,000
Amortization of restricted stock expense.............. 84,000 140,000 33,000
Deferred income taxes................................. (4,793,000) (7,366,000) (7,085,000)
Changes in operating assets and liabilities:
Increase in accounts receivable....................... (106,600,000) (89,556,000) (103,252,000)
Increase in expenditures billable to clients.......... (9,644,000) (6,103,000) (7,229,000)
Increase in other current assets...................... (9,590,000) (5,314,000) (4,782,000)
Increase in other assets.............................. (7,264,000) (652,000) (2,741,000)
Increase in accounts payable.......................... 110,878,000 121,303,000 78,157,000
(Decrease) increase in accrued expenses and other..... (1,721,000) 14,473,000 8,611,000
Increase in income taxes payable...................... 7,656,000 480,000 2,419,000
Increase (decrease) in other liabilities.............. 35,000 1,380,000 (2,592,000)
------------- ------------ -------------
Net cash provided by operating activities............... 56,916,000 110,444,000 35,223,000
INVESTING ACTIVITIES
Purchases of fixed assets............................... (47,068,000) (39,718,000) (27,896,000)
Trust fund deposits..................................... (5,306,000) (2,974,000) (2,833,000)
Increase in investments in and advances to
non-consolidated affiliated companies................. (840,000) (1,142,000) (320,000)
Purchases of marketable securities...................... (41,088,000) (25,038,000) (129,491,000)
Proceeds from the sales of marketable securities........ 26,684,000 49,613,000 101,012,000
Proceeds from the sale of a nonconsolidated affiliated
company and a non-marketable investment security...... -- -- 8,568,000
Increase in intangibles, primarily goodwill............. (24,839,000) (19,912,000) (13,103,000)
------------- ------------ -------------
Net cash used in investing activities................... $ (92,457,000) $(39,171,000) $ (64,063,000)
</TABLE>
9
<PAGE> 11
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
FINANCING ACTIVITIES
Net proceeds from (repayments of) short-term borrowings... 45,694,000 (60,895,000) 18,180,000
Proceeds from term loan................................... -- 75,000,000 --
Repayment of term loan.................................... -- (30,000,000) --
Common Shares acquired for treasury....................... (168,000) (962,000) (4,733,000)
Preferred Shares redeemed to treasury..................... (651,000) -- --
Cash dividends paid on Common Shares...................... (4,895,000) (4,738,000) (4,527,000)
Cash dividends paid on Redeemable Preferred Stock......... (244,000) (256,000) (244,000)
Net (payments for repurchase of) proceeds from issuance of
Restricted Stock........................................ (18,000) 27,000 24,000
Proceeds from exercise of stock options................... 28,000 71,000 1,373,000
Borrowings under life insurance policies.................. 510,000 450,000 464,000
------------ ------------ ------------
Net cash provided by (used in) financing activities....... 40,256,000 (21,303,000) 10,537,000
Effect of exchange rate changes on cash................... (1,452,000) (11,902,000) (3,525,000)
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents.......... 3,263,000 38,068,000 (21,828,000)
Cash and cash equivalents at beginning of year............ 150,553,000 112,485,000 134,313,000
------------ ------------ ------------
Cash and cash equivalents at end of year.................. $153,816,000 $150,553,000 $112,485,000
============ ============ ============
</TABLE>
See notes to consolidated financial statements.
10
<PAGE> 12
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 other
comprehensive income (loss). Foreign currency transaction gains and losses are
reported in income. During 1998, 1997 and 1996, 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
11
<PAGE> 13
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 and
nonconsolidated investments (included in Investments in and Advances to
Nonconsolidated Affiliated Companies) were $116,499,000 and $3,394,000 in 1998,
and $59,851,000 and $3,685,000 in 1997, 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. When multiple investments are 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 bases 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 other comprehensive income (loss).
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
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 M(1)) and the assumed conversion of the 8 1/2%
Convertible Subordinated Debentures. For the purpose of computing basic 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 during the relevant period. For the purpose of computing diluted
earnings per common share, net income is also adjusted by the interest savings,
net of tax, on the assumed conversion of the Company's 8 1/2% convertible
subordinated debentures.
12
<PAGE> 14
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>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Current assets........................... $610,767,000 $489,242,000 $429,863,000
Current liabilities...................... 621,164,000 480,514,000 452,220,000
Other assets -- net of other
liabilities............................ 161,619,000 79,391,000 62,363,000
Net income............................... 745,000 8,921,000 9,276,000
</TABLE>
Consolidated retained earnings at December 31, 1998 includes equity in
unremitted earnings of nonconsolidated foreign companies of approximately
$9,712,000.
C. OTHER INCOME -- NET
Details of other income -- net are:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Interest income.......................... $ 16,113,000 $ 13,826,000 $ 12,211,000
Interest expense......................... (11,506,000) (11,095,000) (10,065,000)
Gains from the sale of marketable
securities and in 1996 a
nonconsolidated affiliated company and
a nonmarketable investment security.... 592,000 599,000 4,911,000
Dividends from affiliates................ 93,000 83,000 151,000
Other income (expense) -- net............ 1,203,000 958,000 (48,000)
------------ ------------ ------------
$ 6,495,000 $ 4,371,000 $ 7,160,000
============ ============ ============
</TABLE>
D. FIXED ASSETS
Components of fixed assets -- at cost are:
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Furniture, fixtures and equipment............. $ 180,657,000 $ 145,116,000
Leaseholds and leasehold improvements......... 69,961,000 59,333,000
------------- -------------
250,618,000 204,449,000
Accumulated depreciation and amortization..... (137,534,000) (116,443,000)
------------- -------------
$ 113,084,000 $ 88,006,000
============= =============
</TABLE>
E. ACQUISITIONS AND RELATED COSTS
In December 1998, pursuant to a cash tender offer, the common and preferred
shareholders of TMBG Media Co. ("TMBG"), a United Kingdom company, agreed to be
acquired by the Company. In January 1999, the Company distributed cash in the
amount of $47,006,000 in exchange for 100% of TMBG's voting common stock and 90%
of its preferred stock. The acquisition was funded out of operating cash and has
been accounted for using the purchase method. Results of operations of TMBG for
the period December 23, 1998 to December 31, 1998 were not material and thus
were not included in the Consolidated Statement of Income for the year ended
December 31, 1998. TMBG's net assets of $8,007,000, including $14,158,000 of
cash, have been included in the Consolidated Balance Sheet at December 31, 1998.
Additionally, the liability related to the tendered shares of TMBG has been
included in Accrued Expenses and Other at December 31,
13
<PAGE> 15
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1998. The excess of purchase price over the underlying net equity of TMBG was
recorded as goodwill and will be amortized in accordance with the Company's
accounting policy.
F. MARKETABLE SECURITIES
The marketable securities, by type of investment, held by the Company at
December 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Maturities of one year or less:
Money market funds.............................. $55,130,000 $14,406,000
U.S. Treasury Securities........................ -- 995,000
----------- -----------
55,130,000 15,401,000
----------- -----------
Maturities greater than one year:
Corporate bonds................................. 30,827,000 23,408,000
U.S. Treasury Securities........................ -- 32,310,000
Government National Mortgage Association
Securities................................... -- 1,622,000
----------- -----------
30,827,000 57,340,000
----------- -----------
$85,957,000 $72,741,000
=========== ===========
</TABLE>
At December 31, 1998, the Company had unrealized gains of $5,412,000 and
unrealized losses of $6,719,000 related primarily to investments in both U.S.
and non-U.S. dollar-denominated corporate bonds; all such bonds are denominated
in U.S. dollars. 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, principally related to the investments in U.S. treasury
securities and money market funds. At December 31, 1998 and 1997, the Company's
investments in marketable securities, classified as non-current, had an average
maturity of approximately six and seven years, respectively.
G. 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 1998 and 1997 by
selected foreign subsidiaries in the amount of $18,700,000 and $3,000,000 at the
end of each respective year. The weighted average interest rate related to the
debt associated with the committed lines of credit was 7.43% and 6.92% at
December 31, 1998 and 1997, respectively. The Company had $52,211,000 and
$19,455,000 outstanding under other uncommitted lines of credit at December 31,
1998 and 1997, respectively. The weighted average interest rate for the
borrowings under the uncommitted lines of credit was 6.24% and 6.64% at December
31, 1998 and 1997, 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 terms of
each foreign currency contract entered into in 1998 and 1997 were for less than
three months. At December 31, 1998, there were no foreign currency contract
transactions open. In December 1998, the Company did take advantage of an
inverted yield curve in the United Kingdom and entered into a two year interest
rate swap agreement as a hedge against rising interest rates by exchanging the
cash flow on borrowings of L5,000,000 at a variable interest rate under the
uncommitted lines of credit, for the cash flow from a similar borrowing at a
fixed interest rate of 5.67%. The fair value of the swap agreement is not
material. This estimate was determined
14
<PAGE> 16
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
using a discounted cash flow analysis using current interest rates for debt
having similar terms and remaining maturities.
Long-term debt at December 31, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Term loans........................................ $75,000,000 $75,000,000
Convertible debentures............................ 3,025,000 3,025,000
----------- -----------
Long-term debt.................................... $78,025,000 $78,025,000
=========== ===========
</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, 1998 and 1997, the
Company was in compliance with all of these covenants. The fair value of the
Prudential debt is estimated to be $79,105,000 and $75,000,000 at December 31,
1998 and 1997, 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 8.44 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, 1998 and 1997). During each of
the years 1998, 1997 and 1996, 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 1998 and 1997, 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, 1998 and 1997 are
$18,184,000 and $16,428,000, respectively, with an interest rate of 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 1998 and 1997, the
Company received $510,000 and $450,000 in cash, respectively, and $1,245,000 was
used in each year to pay premiums on the underlying life insurance policies.
For the years 1998, 1997 and 1996, the Company made interest payments of
$11,673,000, $11,969,000 and $10,065,000, respectively.
15
<PAGE> 17
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
H. REDEEMABLE PREFERRED STOCK
As of December 31, 1998, the Company had outstanding 20,000 shares of
Series I Preferred Stock, 5,000 shares each of Series II and Series III
Preferred Stock. In 1997, 2,000 shares of Series I Preferred Stock were
outstanding which were redeemed in 1998. The holder of the Series I, Series II
and Series III Preferred Stock is the Chairman and Chief Executive Office of the
Company, and the Series I Preferred Stock was 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.
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 holder of each class of Preferred Stock is 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, 1998 and 1997) with a maturity date of April 2004. The interest
paid by the senior executive to the Company in 1998, 1997 and 1996 pursuant to
the terms of these notes was approximately $69,000 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 holder 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, the holder of the Preferred
Stock is 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 $224,000, $662,000 and
$1,112,000 in 1998, 1997 and 1996, 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.
I. 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
16
<PAGE> 18
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
J. 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 1,000 shares reserved for issuance
under the Prior Plans at December 31, 1998.
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, 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
Granted................................................... 45,400 333
Exercised................................................. (200) 141
Forfeited................................................. (8,675) 209
------- ----
Outstanding, December 31, 1998............................ 178,949 220
======= ====
</TABLE>
17
<PAGE> 19
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
There were 76,750, 50,133, and 33,400 options exercisable at December 31,
1998, 1997 and 1996, respectively. The weighted average fair value of the
options granted during 1998, 1997 and 1996 was $108, $101 and $77, respectively.
The remaining weighted average contractual life of options outstanding as
of December 31, 1998 and the weighted average exercise price for options
exercisable at December 31, 1998 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............................. 1,000 1.2 years $131 666 $131
149-171......................... 83,299 5.3 years 151 46,000 151
187-196......................... 6,900 7.0 years 195 84 187
235............................. 34,100 7.3 years 235 20,000 235
259-282......................... 8,450 8.3 years 260 0 0
268-393......................... 45,200 7.1 years 333 10,000 333
-------- ------
Total............................ 178,949 76,750
======== ======
</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 and exercisable, December 31, 1995............. 1,430 $99
Exercised.................................................. (714) 99
-----
Outstanding and exercisable, December 31, 1996............. 716 99
Exercised.................................................. (716) 99
-----
Outstanding, December 31, 1997............................. 0
=====
</TABLE>
RESTRICTED STOCK
In 1998, 1,375 shares of Restricted Stock were issued at a price of $1.00
per share. In 1997, 3,000 shares of Restricted Stock were issued at prices
between $1.00 and $93.50 per share. All stock is issued with restrictions as to
transferability expiring after five years. No restrictions lapsed in 1998, 1997
or 1996. In 1998, 2,000 shares were forfeited and held in treasury.
Compensation to employees under the Stock Incentive and Prior Plans of
$671,000 in 1998, $756,000 in 1997 and $98,000 in 1996, representing the 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
($166,000 in 1998, $140,000 in 1997 and $33,000 in 1996) over the related
required period of service of the respective employees. In 1998, accumulated
amortization of $82,000 was added back into income resulting from the forfeiture
of Restricted Stock.
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
18
<PAGE> 20
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the following weighted average assumptions for the years 1998, 1997 and 1996,
respectively; risk-free interest rates of 6.78%, 6.70% and 6.16%; dividend
yields of 1.86%, 1.40% and 1.73%; volatility factors of the expected market
price of the Company's Common Stock of .18, .19 and .17; and a weighted-average
expected life for the options of 9.6, 10.0, and 10.0 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>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Pro forma net income........................ $24,450,000 $29,689,000 $27,861,000
Pro forma earnings per share:
Basic..................................... $19.67 $24.41 $22.38
Diluted................................... $17.95 $21.39 $19.87
</TABLE>
The pro forma information for 1998, 1997 and 1996 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.
19
<PAGE> 21
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
K. 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
-----------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
BASIC EARNINGS PER SHARE
Weighted-average shares............................. 1,220,767 1,180,146 1,185,841
----------- ----------- -----------
Net Income.......................................... $25,877,000 $30,451,000 $28,602,000
Effect of dividend requirements and the change in
redemption value of redeemable preferred stock.... (468,000) (917,000) (1,356,000)
----------- ----------- -----------
Net earnings used in computation.................... $25,409,000 $29,534,000 $27,246,000
----------- ----------- -----------
Per share amount.................................... $20.81 $25.03 $22.98
=========== =========== ===========
DILUTED EARNINGS PER SHARE
Weighted-average shares used in Basic............... 1,220,767 1,180,146 1,185,841
Net effect of dilutive stock options and stock
incentive plans(1)................................ 74,121 124,289 102,378
Assumed conversion of 8.5% convertible subordinated
debentures issued December 1983................... 51,040 51,017 50,892
----------- ----------- -----------
Adjusted weighted-average shares.................... 1,345,928 1,355,452 1,339,111
----------- ----------- -----------
Net Income used in Basic............................ $25,409,000 $29,534,000 $27,246,000
8.5% convertible subordinated debentures interest
net of income tax effect.......................... 137,000 139,000 139,000
----------- ----------- -----------
Net earnings used in computation.................... $25,546,000 $29,673,000 $27,385,000
----------- ----------- -----------
Per share amount.................................... $18.98 $21.89 $20.45
=========== =========== ===========
</TABLE>
- ---------------
(1) Includes 31,481, 92,391, and 85,350 shares for 1998, 1997 and 1996,
respectively, expected to be issued pursuant to the terms of the Senior
Management Incentive Plan.
20
<PAGE> 22
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
L. 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, 1998 and
1997, the Company had deferred tax assets and deferred tax liabilities as
follows:
<TABLE>
<CAPTION>
DEFERRED TAX ASSETS (LIABILITIES)
---------------------------------
1998 1997
--------------- --------------
<S> <C> <C>
Deferred compensation.................................... $ 24,485,000 $27,966,000
Accrued expenses......................................... 3,649,000 3,315,000
Safe harbor lease and depreciation....................... 749,000 (1,225,000)
Foreign net operating losses............................. 14,517,000 8,140,000
Tax on unremitted foreign earnings and other............. (1,477,000) (3,414,000)
------------ -----------
41,923,000 34,782,000
Valuation allowance...................................... (10,488,000) (8,140,000)
------------ -----------
Net deferred tax assets.................................. $ 31,435,000 $26,642,000
============ ===========
Included in:
Other current assets................................... $ 10,914,000 $ 6,779,000
Other assets........................................... 20,521,000 19,863,000
------------ -----------
$ 31,435,000 $26,642,000
============ ===========
</TABLE>
The components of income of consolidated companies before taxes on income
are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Domestic.................................... $44,600,000 $40,476,000 $36,553,000
Foreign..................................... 14,552,000 28,815,000 29,140,000
----------- ----------- -----------
$59,152,000 $69,291,000 $65,693,000
=========== =========== ===========
</TABLE>
Provisions (benefits) for Federal, foreign, state and local income taxes
consisted of the following:
<TABLE>
<CAPTION>
1998 1997 1996
------------------------- ------------------------- -------------------------
CURRENT DEFERRED CURRENT DEFERRED CURRENT DEFERRED
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Federal.............. $11,382,000 $ 1,526,000 $16,763,000 $(3,989,000) $16,285,000 $(3,890,000)
Foreign.............. 16,010,000 (6,886,000) 15,171,000 (1,204,000) 13,677,000 (280,000)
State and local...... 7,257,000 567,000 9,151,000 (2,173,000) 8,735,000 (2,915,000)
----------- ----------- ----------- ----------- ----------- -----------
$34,649,000 $(4,793,000) $41,085,000 $(7,366,000) $38,697,000 $(7,085,000)
=========== =========== =========== =========== =========== ===========
</TABLE>
The effective tax rate varied from the statutory Federal income tax rate as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<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.................................................. 8.6 6.6 5.8
Difference in foreign tax rates............................. 6.8 4.7 4.3
Withholding tax on unremitted foreign earnings.............. 0.1 0.9 0.6
Other -- net................................................ 0.0 1.5 2.4
---- ---- ----
50.5% 48.7% 48.1%
==== ==== ====
</TABLE>
21
<PAGE> 23
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During the years 1998, 1997 and 1996, the Company made income tax payments
of $31,104,000 $39,689,000, and $36,513,000 respectively.
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.
At December 31, 1998, the Company had cumulative net operating losses
attributable to foreign subsidiaries of approximately $44,000,000. The duration
over which the tax benefits attributable to these losses may be realized varies
on a country by country basis, but in no instance will any of the benefits
expire before 2003. Since a portion of the benefits may fail to be realized, a
valuation allowance has been reflected.
M. RETIREMENT PLANS, DEFERRED COMPENSATION, EXECUTIVE OFFICER LOANS, LEASES AND
CONTINGENCIES
1. The Company's Profit Sharing Plan is available to employees of Grey 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 as well as employee pre-tax
contributions. The Company also maintains a noncontributory Employee Stock
Ownership Plan covering eligible employees of the Company and 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 1998, 1997 and 1996. 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 executive 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 1998. Awards will vest to
individuals achieving five years of participation in the current plan. Those
participants who commence participation after 1998 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 $7,600,000, $8,377,000 and $8,211,000
in 1998, 1997 and 1996, respectively. Approximately $2,295,000, $1,113,000 and
$5,634,000 of plan expense incurred in 1998, 1997 and 1996, respectively, will
be payable in Common Stock in accordance with the terms of the Plan. The awards
payable in Common Stock were converted into an equivalent number of shares of
Common Stock, based on the average of the market values on the last 15 business
days of the calendar year. The 1998 Plan activity includes increases to Paid-In
Additional Capital of $1,899,000 related to the future obligation to issue
Common Stock and $3,648,000 related to the tax benefit resulting from the
issuance of shares in settlement of the previous plan's awards offset by a
decrease of $11,158,000 related to the repurchase of shares to satisfy statutory
minimum tax withholding requirements. At December 31, 1998, approximately 14,000
shares are payable in Common Stock pursuant to the Plan of which approximately
3,000 shares were vested.
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
22
<PAGE> 24
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, following the
expiration of his employment agreement, or the termination of his employment by
reason of death or disability. In 1998, the Company made payments to the rabbi
trust which are to be used to fund a pension obligation to be payable to the
Chairman and Chief Executive Officer over the eleven year period following the
normal expiration of his current employment agreement ("pension period"). The
initial pension deposit was for $1,040,000 with annual pension deposits of
$360,000 ratably payable from 1998 through 2002, inclusive. The amount of the
pension to be paid to the Chairman and Chief Executive Officer will depend on,
and be limited to, the funds in the rabbi trust during the pension period. In
addition, upon termination of his employment prior to the commencement of the
pension period or upon his death, any undistributed funds in the rabbi trust
would be paid to his estate, as the case may be, in satisfaction of any future
obligations with respect to this pension.
At December 31, 1998 and 1997, the value of the trust was $15,706,000 and
$10,400,000, respectively, and is included in Other Assets and the Company's
related deferred compensation obligation for the same amount is included in
Other Liabilities.
Expenses related to the foregoing plans and benefits aggregated $32,266,000
in 1998, $33,230,000 in 1997 and $36,140,000 in 1996.
2. Pursuant to an employment agreement, dated January 1, 1994, an
executive officer of the Company borrowed $600,000 from the Company. One-third
of the principal amount of the loan was forgiven by the Company on December 31,
1996 and 1997, as the officer continued to be employed by the Company on those
dates. In 1997 and 1996, the Company has included in each year $200,000 of
compensation expense, representing the amount of loan forgiven each year. The
forgiveness date for the remaining $200,000 loan balance is in 1999 and is to be
forgiven contingent upon the officer's continued employment by the Company. As
of December 31, 1998 and 1997, the remaining loan balance was $200,000 and is
included in Other Assets.
In addition, a second executive officer has outstanding loans with the
Company totaling $825,000 as of December 31, 1998 and 1997 which are reflected
in Other Assets. The first loan for $125,000 was made in 1995 and is forgivable
on December 31, 1999 provided that the executive officer is employed by the
Company on that date. During 1996, the Company made an additional loan to this
executive officer for $700,000, $200,000 of which is forgivable by the Company
assuming his continued employment through 2003 and $500,000 of which is
forgivable by the Company assuming his continued employment through 2004.
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, bearing interest at the 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 1998, 1997 and 1996.
23
<PAGE> 25
GREY ADVERTISING INC. AND CONSOLIDATED SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. Rental expense amounted to approximately $44,364,000 in 1998,
$41,239,000 in 1997 and $41,104,000 in 1996. Approximate minimum rental
commitments, excluding escalations, under noncancellable operating leases are as
follows:
<TABLE>
<S> <C>
1999........................................... $ 43,809,000
2000........................................... 41,940,000
2001........................................... 39,822,000
2002........................................... 36,933,000
2003........................................... 32,503,000
Beyond 2003.................................... 124,030,000
------------
$319,037,000
============
</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.
N. INDUSTRY SEGMENT AND RELATED INFORMATION
The Company is not engaged in more than one industry segment. The Company
evaluates performance by geographic region based on profit or loss before income
taxes. Commissions and fees are attributed to the geographic region that
generates billings. Commissions and fees, operating profit, interest
income/expense, and related identifiable assets at December 31, 1998, 1997 and
1996, are summarized below according to geographic region (000s omitted):
<TABLE>
<CAPTION>
UNITED STATES EUROPE OTHER
------------------------------ ------------------------------ -----------------------------
1998 1997 1996 1998 1997 1996 1998 1997 1996
-------- -------- -------- -------- -------- -------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commissions and fees..... $419,469 $382,288 $338,496 $415,685 $380,675 $370,888 $100,027 $ 95,789 $56,114
-------- -------- -------- -------- -------- -------- -------- -------- -------
Operating profit
(loss).................. 38,501 32,570 26,174 27,509 30,534 30,279 (13,353) 1,816 2,080
Interest income
(expense) -- net........ 4,677 6,366 4,910 853 (2,501) (2,634) (923) (1,135) (130)
Other income (expense)... 1,422 1,540 5,470 785 194 (765) (319) (93) 309
-------- -------- -------- -------- -------- -------- -------- -------- -------
Income of consolidated
companies before taxes
on income............... 44,600 40,476 36,554 29,147 28,227 26,880 (14,595) 588 2,259
======== ======== ======== ======== ======== ======== ======== ======== =======
Equity in earnings of
nonconsolidated
affiliated companies....
Identifiable assets...... 608,880 581,557 549,160 699,637 457,099 445,038 164,431 142,945 77,473
Investments in and
advances to
nonconsolidated
affiliated companies....
Total assets......
<CAPTION>
CONSOLIDATED
------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Commissions and fees..... $ 935,181 $ 858,752 $ 765,498
---------- ---------- ----------
Operating profit
(loss).................. $ 52,657 $ 64,920 $ 58,533
Interest income
(expense) -- net........ 4,607 2,730 2,146
Other income (expense)... 1,888 1,641 5,014
---------- ---------- ----------
Income of consolidated
companies before taxes
on income............... 59,152 69,291 65,693
========== ========== ==========
Equity in earnings of
nonconsolidated
affiliated companies.... 722 1,622 1,184
========== ========== ==========
Identifiable assets...... 1,472,948 1,181,601 1,071,671
Investments in and
advances to
nonconsolidated
affiliated companies.... 16,705 18,386 17,723
---------- ---------- ----------
Total assets...... $1,489,653 $1,199,987 $1,089,394
========== ========== ==========
</TABLE>
Commissions and fees from one client amounted to 13.4%, 12.8% and 13.2% of
the consolidated total in 1998, 1997 and 1996, respectively.
24
<PAGE> 26
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, 1998
and 1997, 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, 1998. 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, 1998
and 1997, and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 1998 in conformity
with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
ERNST & YOUNG LLP
New York, New York
February 18, 1999
25
