ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Introduction

Certain Non GAAP measures included in this operating and financial review and prospects have been derived from amounts calculated in accordance with IFRS but are not themselves IFRS measures. They should not be viewed in isolation as alternatives to the equivalent IFRS measure, rather they should be read in conjunction with the equivalent IFRS measure. These include constant currency, pro-forma (‘like-for-like’), headline PBIT (Profit Before Interest and Taxation), headline PBIT margin, headline PBIT margin on gross profit, headline PBT (Profit Before Taxation), headline EBITDA (Earnings before Interest, Taxation, Depreciation and Amortisation), billings, estimated net new billings, free cash flow and net and average net debt, which we define, explain the use of and reconcile to the nearest IFRS measure on pages 28 to 31.

A. Operating Results

Overview

The Company is one of the world’s most comprehensive marketing communications groups. It operates through a large number of established national, multinational and global advertising and marketing services companies. The Company offers services in four reportable segments:

In 2012, approximately 41% of the Company’s consolidated revenues were derived from Advertising and Media Investment Management, with the remaining 59% of its revenues being derived from the remaining three segments.

The following objectives represent the Group’s key performance indicators.

16

Table of Contents

The following discussion is based on the Company’s audited Consolidated Financial Statements beginning on page F-1 of this report. The Group’s consolidated financial statements have been prepared in accordance with IFRS as issued by the IASB.

2012, our twenty-seventh year, was another record one, with revenue, profitability, headline PBIT margin and earnings per share all reaching new highs and, for the second year running, the Company was awarded a Cannes Lion for Creative Holding Company of the Year, in recognition of the Company’s collective creative excellence. These record results were achieved against a backdrop of economic uncertainty and fragile client confidence.

The share price rose sharply in 2012 – an increase of over 31% to 888.0p at year end. Dividends were increased by almost 16% to 28.51p, a record level.

Reported billings were down slightly at £44.4 billion, but up well over 1% in constant currencies. Revenues were up 3.5% to £10.4 billion and up almost 6% in constant currencies. Our revenues exceeded all our competitors for the fifth consecutive year and by an increasing amount.

Reported profit before interest and taxation rose over 4% to £1.311 billion from £1.258 billion. Headline PBIT was up over 7% to £1.531 billion against £1.429 billion in 2011 and up over 11% in constant currencies. Headline PBIT margin was 14.8% in 2012 against 14.3% last year, in line with target and also surpassing the historical pro- forma high of 14.3% in 2008. On gross profit, the headline PBIT margin was 16.1%, up 0.6 margin points on 2011.

Profit for the year decreased by 2% to £0.895 billion. Headline EBITDA increased by 7% to £1.756 billion. Headline profit before tax was up over 7% to £1.317 billion and reported profit before tax was up over 8% to £1.092 billion. Diluted earnings per share decreased by over 2% to 62.8p, reflecting the release of prior year tax provisions in 2011.

Net cash inflow from operating activities strengthened to £0.908 billion in the year. Free cash flow strengthened to £1.094 billion in the year, over £1 billion for the second consecutive year. Net debt averaged £3.2 billion in 2012, up £0.4 billion at 2012 exchange rates, and net debt at 31 December 2012 was £2.8 billion, £0.3 billion higher than 2011, reflecting increased spending on acquisitions (chiefly AKQA) and higher dividends.

Estimated net new business billings of £3.9 billion ($6.2 billion) were won in 2012, up almost 21% on 2011.

Segment performance

Performance of the Group’s businesses is reviewed by management based on headline PBIT. A table showing these amounts by operating sector and geographical area for each of the three years ended 31 December 2012, 2011 and 2010 is presented in note 2 to the Consolidated Financial Statements. To supplement the reportable currency segment information presented in note 2 to the Consolidated Financial Statements, the following tables give details of revenue growth by geographical area and operating sector on a reported, constant currency, and like-for-like basis.

17

Table of Contents

Geographical area

Like-for-like revenue growth in North America declined as the year progressed, from over 1% in the first quarter to down -0.6% in quarter four. Relatively strong growth in the Group’s Advertising and Media Investment Management businesses was more than offset by parts of the Group’s Consumer Insight, Public Relations & Public Affairs and Branding & Identity, Healthcare and Specialist Communications businesses. This seems to be indicative of continued pressure on discretionary client spending. In constant currencies, full year revenue growth was well over 3%, while like-for-like revenues were down marginally at -0.1%.

Conversely, and against market trends, the UK showed an improving rate of quarterly like-for-like revenue growth as the year progressed, from 2.5% in the first quarter to over 5% in quarter four. In the last quarter, particularly strong growth in Advertising and Media Investment Management was partly offset by slower growth in Consumer Insight, Branding & Identity and Healthcare Communications. Full year revenue growth in constant currencies was well over 7% and like-for-like growth was 4%.

Western Continental Europe, although relatively more difficult, actually showed some improvement in the fourth quarter, with growth in Italy, Turkey and (surprisingly) Greece, but Spain, Portugal, Scandinavia, France, the Netherlands and Switzerland were tougher, with the continuing effects of the Eurozone crisis impacting parts of the region. Full year revenue growth in constant currencies was well over 3%, while like-for-like growth was only slightly positive at 0.1%.

Our strongest region in 2012 was again Asia Pacific, Latin America, Africa & Middle East and Central & Eastern Europe, with constant currency growth of over 9% and like-for-like growth of over 8%, principally driven by Latin America and the BRICs ¹ .

Latin America showed the strongest growth of all of our sub-regions in the year, with constant currency revenues up almost 13% and like-for-like revenues up well over 11%. The Middle East & Africa showed the strongest growth of our sub-regions in the fourth quarter, with like-for-like revenues up almost 10% and with all sectors improving. Full year revenue growth was almost 9%. Central and Eastern Europe, after a difficult third quarter, improved significantly in the final quarter, with like-for-like growth of over 12% in Russia. Full year like-for-like growth in this sub-region was 0.7%.

18

Table of Contents

Full year revenues for the BRICs, which account for almost $2 billion of revenue, were up over 11% on a like-for-like basis. In 2012, 30% of the Group’s revenues came from Asia Pacific, Latin America, Africa & Middle East and Central & Eastern Europe, 0.6 percentage points more compared with the previous year and against the Group’s strategic objective of 35-40% over the next two to three years. Markets outside North America now account for 66% of our revenues.

Advertising and Media Investment Management remained the strongest-performing sector with full year revenues up 5.2% in constant currencies and 5.1% like-for-like. In the final quarter, constant currency revenues were up 4.0% and like-for-like revenues were up 5.4%, considerably stronger than the third quarter like-for-like growth of 2.9%.

Of the Group’s advertising networks, Ogilvy & Mather, which was named Network of the Year at Cannes, performed especially well in North America, the UK and Latin America, with Grey in North America even stronger. However, the Group’s advertising businesses in Western Continental Europe generally remained under pressure with like-for-like revenues down. Growth in the Group’s Media Investment Management businesses has been very consistent throughout the year, with constant currency revenues up over 12% for the year and like-for-like growth of 11.0%. tenthavenue, the ‘engagement’ network focused on out-of-home media, was established towards the end of 2010 and in 2012 showed strong revenue growth, with like-for-like revenues up over 7% following growth of over 14% in 2011. The strong revenue growth across most of the Group’s businesses, together with good cost control, resulted in the combined headline PBIT margin of this sector improving by 1.6 margin points to 17.7%.

In 2012, Ogilvy & Mather, JWT, Y&R, Grey and United generated estimated net new business billings of £1.087 billion ($1.740 billion). GroupM (the Group’s Media Investment Management arm, which includes Mindshare, MEC, MediaCom, Maxus, GroupM Search and Xaxis), together with tenthavenue, generated estimated net new business billings of £2.148 billion ($3.437 billion).

Consumer Insight revenues grew 2.8% on a constant currency basis, with gross profit up 0.8% on the same basis. On a like-for-like basis revenues were up 0.8% with gross profit down 1.1% on the same basis. The pattern of revenue growth seen in the first nine months continued into the final quarter, with the mature markets of North America and Continental Europe difficult but counterbalanced by strong growth in the faster growing markets of Asia Pacific, Latin America, Africa & the Middle East. In the fourth quarter, the UK also slowed. Headline PBIT margins fell 0.5 margin points to 10.0%, while headline PBIT margins on gross profit fell 0.4 margin points to 13.9%. The central issue continues to be like-for-like revenue growth in the custom businesses in mature markets, where discretionary spending remains under review by clients. Custom businesses in faster-growth markets, and syndicated and semi-syndicated businesses in all markets, remain robust, with strong like-for-like revenue growth.

19

Table of Contents

The Group’s Public Relations & Public Affairs businesses had a more difficult year with full-year growth in constant currencies of 4.2% and like-for-like revenues down 1.0%, with continuing pressure in North America and Continental Europe across most of the Group’s brands, only partly offset by strong growth in the UK, Latin America and the Middle East & Africa. Headline PBIT margins fell by 1.2 margin points to 14.9%.

At the Group’s Branding & Identity, Healthcare and Specialist Communications businesses (including direct, digital and interactive), constant currency revenues grew strongly at 10.2% with like-for-like growth of 2.6%. Like-for-like revenue growth slipped slightly in quarter four, due primarily to slower growth in parts of the Group’s Branding & Identity and Healthcare Communications businesses, but remained close to 2%. AKQA, the leading digital agency acquired in July 2012, performed well with full year like-for-like revenues up 10%. Headline PBIT margins for the sector as a whole improved slightly, up 0.1 margin points to 14.4%.

Over 32% of the Group’s 2012 revenues came from direct, digital and interactive, up over 1.0 percentage point from the previous year and growing 6.7% like-for-like over 2011. Marketing services comprised almost 60% of our revenues in 2012, a similar proportion to 2011.

2012 compared with 2011

Revenues

Reported revenue growth for the year of 3.5% was impacted by the strength of sterling, primarily against the Euro. On a constant currency basis, which excludes the impact of currency movements, revenues were up almost 6%. On a like-for-like basis, which excludes the impact of currency and acquisitions, revenues were up 2.9%, with like- for-like gross profit up 2.4%, reflecting pressure on gross profit in the Group’s Consumer Insight custom businesses in the mature markets of North America, the UK and Western Continental Europe. In the fourth quarter, like-for-like revenues were up 2.5%, an improvement on the third quarter of 1.9%, due to stronger growth in all regions except North America. This reflects a reversal of the declining quarterly like-for-like revenue growth trend which went from 4% in quarter one, to 3% in quarter two and to 2% in quarter three.

Operating costs

Operating costs increased by 2.8% in 2012 to £8,273.7 million from £8,046.3 million in 2011 on a reported basis and by 4.7% on a constant currency basis. During 2012, the Group continued to reap the benefits of containing operating costs, with improvements across most cost categories, particularly property, commercial and office costs.

On a like-for-like basis the average number of people in the Group increased by 1.6% in 2012. On the same basis, the number of people in the Group at 31 December 2012 was 0.4% lower than at the end of 2011. This point-to-point decrease reflects the adjustments in staff costs made in the second half of 2012, following the slowdown in revenue growth after the first quarter of the year. Also on a like-for-like basis, revenues increased by 2.9% and gross profit 2.4%.

Reported staff costs, excluding incentives, rose by over 5% and by over 7% in constant currency. Incentive payments amounted to £291 million (or over $465 million) which was well over 16% of headline PBIT before incentives and income from associates compared with £338 million or almost 20% in 2011. Performance in parts of the Group’s custom research, public relations and public affairs, healthcare and direct, digital and interactive businesses fell short of the maximum performance objectives agreed for 2012, as the like-for-like revenue growth rate slowed in quarters two and three in 2012. This followed the record profit and margin performance in 2011, when most of the Group’s operating companies achieved maximum incentive levels. Headline PBIT margins, before all incentives and income from associates, were 16.9%, down 0.1 margin points, compared with 17.0% last year. The Group’s staff cost to revenue ratio, including incentives, increased by 0.3 margin points to 58.9% compared with 58.6% in 2011. Following intentional reductions in 2009 and 2010 after the Lehman crisis, the Group increased its investment in people, particularly in the latter part of 2011 and in early 2012, mainly in the faster-growing geographic and functional markets (such as media investment management and digital) as like-for-like revenues and gross profit increased.

20

Table of Contents

In 2012, the ratio of variable staff costs (incentives, freelance and consultants costs) to total staff costs was 11.4%, compared with 12.2% in 2011. As a proportion of revenue, variable staff costs were 6.7% in 2012 compared with 7.2% in 2011.

In the second half of 2012, the Group received the proceeds from the sale of the stake in Buddy Media and also completed the sale of the freehold of 285 Madison Avenue, the New York headquarters of Young & Rubicam Inc. These two transactions combined resulted in a gain of £102 million. Offsetting this gain, are restructuring costs of £93.4 million which include £62.9 million of severance cost arising from a structural reassessment of certain of the Group’s operations, primarily in Western Continental Europe; and £30.5 million of other costs, primarily accelerated depreciation of IT assets in the US and Europe, arising from an overhaul of its centralised IT infrastructure.

Profit before interest and taxation

As a result of the above, reported PBIT rose over 4% to £1.311 billion from £1.258 billion, up over 8% in constant currencies. Headline PBIT rose over 7% to £1.531 billion from £1.429 billion, up over 11% in constant currencies.

Finance income, finance costs and revaluation of financial instruments

Finance income decreased to £85.9 million in 2012 from £97.3 million in 2011. Finance costs increased to £299.8 million in 2012 from £297.2 million in 2011. Therefore, net finance costs were £213.9 million, up from £199.9 million last year, reflecting higher average net debt, offset by lower funding costs. Revaluation of financial instruments resulted in a charge of £4.7 million in 2012 and a charge of £50.0 million in 2011.

Taxation

The Company’s effective tax rate on reported profit before tax in 2012 was 18.1%, compared to 9.1% in 2011. The difference in the reported tax rate is primarily due to the release in 2011 of prior year corporate tax provisions following the resolution of a number of open tax matters.

Profit for the year

Profit for the year decreased by 2.4% to £894.7 million in 2012 from £916.5 million in 2011 on a reported basis and increased by 2.4% in constant currency, reflecting a higher effective tax rate, which is only partially offset by the higher revenue and lower charges for revaluation of financial instruments. In 2012, £822.7 million of profit for the year was attributable to equity holders of the parent and £72.0 million attributable to non-controlling interests. Diluted earnings per share decreased by over 2% (increased by almost 2% in constant currencies) to 62.8p, again reflecting the release of prior year tax provisions in 2011.

2011 compared with 2010

Revenues

Reported revenues were up 7.4% in 2011 to £10,021.8 million from £9,331.0 million in 2010. The Group’s reported revenue growth for the year of over 7% reflected the strength of sterling, primarily against the US dollar. On a constant currency basis, which excludes the impact of currency movements, revenues were up over 8%. On a like-for-like basis, excluding the impact of acquisitions and currency, revenues were up 5.3%, with gross profit up 5.9%. In the fourth quarter, like-for-like revenues were up 4.5%, down slightly on the third quarter, primarily due to stronger comparatives.

Despite the slowdown in economic activity resulting from the uncertainty triggered by the Eurozone crisis, advertising and marketing services expenditures continued to rise and there seem to have been some significant changes, particularly in corporate behaviour, to explain why. In 2009, post-Lehman, all bets were off. Consumers

21

Table of Contents

and corporates were focused almost totally on rapidly reducing costs and de-leveraging. In 2010 and 2011, however, the situation seemed to change. The financial world did not come to an end as some had predicted. Western-based multinational companies, which today are reputed to be sitting on as much as $2 trillion net cash with relatively un-leveraged balance sheets, were still fearful of making mistakes but prepared to invest in capacity and behind brands in fast-growing markets. At the same time, they were also prepared to invest in brands to maintain or increase market share even in slow-growth Western markets, such as the US and Western Europe. This approach has the virtue of not increasing fixed costs, although we in the communications services business naturally regard brand spending as a fixed investment and not a discretionary cost.

On a combined basis, over the last two years, there has been a sequential improvement in like-for-like quarterly revenue growth, with 6.7% for the first quarter, 10.3% in the second, 12.2% for the third and 13.1% for the fourth. This two-year combined sequential quarterly growth continues to reflect increased client advertising and promotional spending – with the former tending to grow faster than the latter, which from our point of view is more positive – across most of the Group’s major geographic markets and functional sectors despite tougher comparatives. Nonetheless, clients understandably continue to demand increased effectiveness and efficiency, i.e. better value for money.

Operating costs

Operating costs increased by 6.0% in 2011 to £8,046.3 million from £7,587.5 million in 2010 on a reported basis and by 7.1% on a constant currency basis. During 2011, the Group continued to reap the benefits of containing operating costs, with improvements across most cost categories, particularly direct, property, commercial and office costs.

On a like-for-like basis the average number of people in the Group increased by 4.6% in 2011. On the same basis, the number of people in the Group at 31 December 2011 was 4.3% higher than at the end of 2010. Also on a like-for-like basis, revenues increased by 5.3% and gross profit 5.9%.

Reported staff costs, excluding incentives, rose by 8.6% and by 9.6% in constant currency. Incentive payments amounted to £338 million (or over $500 million) which was almost 20% of headline PBIT before incentives and income from associates and represented close to maximum achievement of agreed performance targets. The Group’s reported staff cost to revenue ratio, including incentives, increased by 0.3 margin points to 58.6% compared with 58.3% in 2010. Following intentional containment in 2009 and 2010 post-Lehman, the Group continued to increase its investment in human capital in 2011, particularly in the faster-growing geographic and functional markets as like-for-like revenues and gross profit increased significantly. However, the Group’s more representative staff costs to gross profit ratio remained flat at 63.6% compared with the prior year, as gross profit grew faster than revenues.

In 2011, the ratio of variable staff costs (incentives, freelance and consultants costs) to total staff costs was 12.2%, compared with 13.4% in 2010. As a proportion of revenue, variable staff costs were 7.2% in 2011 compared with 7.8% in 2010.

In 2011 we were able to reduce our core property portfolio. Although square footage rose by 1.7% from 22.8 million sq ft to 23.2 million sq ft at the end of the year, this increase was less than the 3.1% of revenue growth attributable to acquisitions and considerably less than constant currency revenue growth of 8.4%, meaning our core portfolio (excluding the impact of acquisitions) reduced. As a result of this improvement in space utilisation the establishment cost-to-revenue ratio in 2011 dropped to 6.7% (in spite of a 3% increase in cost per square foot) from 7.1% in 2010.

Profit before interest and taxation

As a result of the above, reported PBIT rose over 22% to £1.258 billion from £1.028 billion, up over 23% in constant currencies. Headline PBIT rose over 16% to £1.429 billion from £1.229 billion, up over 17% in constant currencies.

22

Table of Contents

Finance income, finance costs and revaluation of financial instruments

Finance income increased to £97.3 million in 2011 from £81.7 million in 2010. Finance costs increased to £297.2 million in 2011 from £276.8 million in 2010. Therefore, net finance costs were £199.9 million, up from £195.1 million last year, reflecting lower average net debt, offset by higher funding costs. Revaluation of financial instruments resulted in a charge of £50.0 million in 2011 and income of £18.2 million in 2010. The 2011 charge is predominantly attributable to revaluation of put options over non-controlling interests.

Taxation

The Company’s effective tax rate on reported profit before tax in 2011 was 9.1%, compared to 22.4% in 2010. The difference was primarily due to the release of prior year corporate tax provisions following the resolution of a number of open tax matters, together with deferred tax credits in relation to amortisation of acquired intangible assets.

Profit for the year

Profit for the year increased by 38.7% to £916.5 million in 2011 from £661.0 million in 2010 on a reported basis and increased by 40.2% in constant currency, reflecting higher profit margins and a lower effective tax rate. In 2011, £840.1 million of profit for the year was attributable to equity holders of the parent and £76.4 million attributable to non-controlling interests.

Inflation

As in 2011, in management’s opinion inflation did not have a material impact on the Company’s results for the year or financial position at 31 December 2012.

Foreign currency fluctuations

See Item 11 for a discussion of the impact of currency exchange rate fluctuations on the Group’s consolidated results.