UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-14443
GARTNER, INC.
(Exact name of Registrant as specified in its charter)
Delaware 04-3099750
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
56 Top Gallant Road 06904-2212
P.O. Box 10212 (Zip Code)
Stamford, CT
(Address of principal executive offices)
Registrant's telephone number, including area code: (203) 316-1111
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ].
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2) YES [X] NO [ ].
The number of shares outstanding of the Registrant's capital stock as
of July 31, 2003 was 48,802,712 shares of Class A Common Stock and 28,903,643
shares of Class B Common Stock.
TABLE OF CONTENTS
Page
PART I FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets at June 30, 2003 and
December 31, 2002 3
Condensed Consolidated Statements of Operations for the
Three and Six Months Ended June 30, 2003 and 2002 4
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2003 and 2002 5
Notes to Condensed Consolidated Financial Statements 6
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 14
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 27
ITEM 4: CONTROLS AND PROCEDURES 28
PART II OTHER INFORMATION
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K 29
2
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GARTNER, INC.
Condensed Consolidated Balance Sheets
(In thousands)
June 30, December 31,
2003 2002
---------- ----------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 166,685 $ 109,657
Fees receivable, net 226,086 283,068
Deferred commissions 22,167 25,016
Prepaid expenses and other current assets 20,954 30,425
---------- ----------
Total current assets 435,892 448,166
Property, equipment and leasehold improvements, net 63,460 71,006
Goodwill and other intangibles, net 228,447 226,114
Other assets 72,000 71,018
---------- ----------
TOTAL ASSETS $ 799,799 $ 816,304
========== ==========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable and accrued liabilities $ 133,226 $ 140,891
Deferred revenues 287,645 305,887
---------- ----------
Total current liabilities 420,871 446,778
Long-term convertible debt 362,201 351,539
Other liabilities 48,556 46,688
---------- ----------
TOTAL LIABILITIES 831,628 845,005
STOCKHOLDERS' DEFICIT
Preferred stock - -
Common stock 60 60
Additional paid-in capital 370,047 368,090
Unearned compensation, net (2,430) (3,069)
Accumulated other comprehensive loss, net (5,444) (11,392)
Accumulated earnings 161,585 150,243
Treasury stock, at cost (555,647) (532,633)
---------- ----------
TOTAL STOCKHOLDERS' DEFICIT (31,829) (28,701)
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 799,799 $ 816,304
========== ==========
See the accompanying notes to the condensed consolidated financial statements.
3
GARTNER, INC.
Condensed Consolidated Statements of Operations
(Unaudited, in thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
--------- --------- --------- ---------
Revenues:
Research $ 117,793 $ 121,619 $ 233,517 $ 244,354
Consulting 66,525 72,611 128,304 138,504
Events 25,292 38,438 48,801 47,538
Other 3,708 3,489 6,978 6,856
--------- --------- --------- ---------
Total revenues 213,318 236,157 417,600 437,252
Costs and expenses:
Cost of services and product development 103,440 106,045 205,773 194,386
Selling, general and administrative 80,730 84,412 164,234 170,444
Depreciation 8,964 10,577 18,789 20,921
Amortization of intangibles 338 445 743 948
Other charges - - 5,426 17,246
--------- --------- --------- ---------
Total costs and expenses 193,472 201,479 394,965 403,945
--------- --------- --------- ---------
Operating income 19,846 34,678 22,635 33,307
Gain (loss) on investments 5,491 (2,532) 5,522 (2,454)
Interest income 594 458 1,029 758
Interest expense (6,136) (5,740) (12,183) (11,371)
Other (expense) income, net (39) 452 496 436
--------- --------- --------- ---------
Income before income taxes 19,756 27,316 17,499 20,676
Provision for income taxes 6,902 9,061 6,157 6,737
--------- --------- --------- ---------
Net income $ 12,854 $ 18,255 $ 11,342 $ 13,939
========= ========= ========= =========
Basic income per common share $ 0.16 $ 0.22 $ 0.14 $ 0.17
Diluted income per common share $ 0.13 $ 0.16 $ 0.14 $ 0.15
Weighted average shares outstanding:
Basic 79,234 83,719 79,863 84,166
Diluted 127,959 132,299 128,260 132,645
See the accompanying notes to the condensed consolidated financial statements.
4
GARTNER, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited, in thousands)
Six Months Ended
June 30,
2003 2002
--------- ---------
OPERATING ACTIVITIES:
Net income $ 11,342 $ 13,939
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization of intangibles 19,532 21,869
Non-cash compensation 511 595
Tax benefit associated with employee exercise of stock options - 1,338
Deferred taxes 68 (665)
(Gain) loss from investments and sales of assets, net (5,522) 1,961
Accretion of interest and amortization of debt issue costs 11,781 11,048
Non-cash charges associated with impairment of long-lived assets - 1,424
Changes in assets and liabilities:
Fees receivable, net 64,051 61,689
Deferred commissions 3,345 8,240
Prepaid expenses and other current assets 11,313 21,607
Other assets (1,543) 7,822
Deferred revenues (26,314) (30,990)
Accounts payable and accrued liabilities (10,390) (7,966)
--------- ---------
CASH PROVIDED BY OPERATING ACTIVITIES 78,174 111,911
--------- ---------
INVESTING ACTIVITIES:
Proceeds from insurance recovery 5,464 -
Purchases of businesses - (3,960)
Proceeds from sale of assets - 239
Investments (1,500) -
Additions to property, equipment and leasehold improvements (9,765) (9,320)
--------- ---------
CASH USED IN INVESTING ACTIVITIES (5,801) (13,041)
--------- ---------
FINANCING ACTIVITIES:
Proceeds from stock issued for stock plans 2,575 14,736
Payments for debt issuance costs (220) (238)
Purchase of treasury stock (23,504) (33,063)
--------- ---------
CASH USED IN FINANCING ACTIVITIES (21,149) (18,565)
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 51,224 80,305
EFFECTS OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS 5,804 2,152
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 109,657 27,431
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 166,685 $ 109,888
========= =========
See the accompanying notes to the condensed consolidated financial statements.
5
GARTNER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Basis of Presentation
On October 30, 2002, Gartner, Inc. (the "Company") announced that the Board of
Directors approved a change of the Company's fiscal year end from September 30
to December 31, effective January 1, 2003. This change resulted in a three-month
transitional period ending December 31, 2002. References to Transition 2002,
unless otherwise indicated, refer to the three-month transitional period ended
December 31, 2002. References to quarterly periods of 2002, unless otherwise
indicated, are to the calendar quarters of 2002. Certain prior year amounts have
been reclassified to conform to the current year presentation.
These interim condensed consolidated financial statements have been prepared in
accordance with generally accepted accounting principles in the United States of
America ("GAAP") for interim financial information and with the instructions to
Form 10-Q and should be read in conjunction with the consolidated financial
statements and related notes of the Company filed in our Transition Report on
Form 10-KT for the transition period from October 1, 2002 to December 31, 2002.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities, and
the reported amounts of operating revenues and expenses. These estimates are
based on management's knowledge and judgments. In the opinion of management, all
adjustments (consisting of normal recurring adjustments) considered necessary
for a fair presentation of financial position, results of operations and cash
flows at the dates and for the periods presented have been included. The results
of operations for the three and six months ended June 30, 2003 may not be
indicative of the results of operations for the remainder of 2003.
Note 2 - Recent Accounting Pronouncements
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment of SFAS No. 123." This
amendment provides alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
In addition, this statement amends the disclosure requirement of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. SFAS No. 148 is effective for
fiscal years ending after December 15, 2002. The Company continues to account
for stock-based compensation according to Accounting Principles Board ("APB")
No. 25, "Accounting for Stock Issued to Employees". The adoption of SFAS No. 148
in the first quarter of 2003 required the Company to provide prominent
disclosures about the effects of SFAS No. 123 on reported income and required it
to disclose these effects in the interim financial statements (see Note 5).
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. SFAS No. 149 is effective for contracts entered into or modified after
June 30, 2003, for hedging relationships designated after June 30, 2003, and to
certain preexisting contracts. The Company does not expect the adoption of SFAS
No. 149 will have a material impact on its financial position, cash flows or
results of operations.
6
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity" ("SFAS 150").
SFAS 150 changes the accounting for certain financial instruments that under
previous guidance issuers could account for as equity. It requires that those
instruments be classified as liabilities in balance sheets. The guidance in SFAS
150 is generally effective for all financial instruments entered into or
modified after May 31, 2003, and otherwise is effective on July 1, 2003. The
Company does not expect the adoption of SFAS 150 to have a material impact on
its financial position, cash flows or results of operations.
Note 3 - Comprehensive Income
The components of comprehensive income for the three and six months ended June
30, 2003 and 2002 are as follows (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
-------- -------- -------- --------
Net income $ 12,854 $ 18,255 $ 11,342 $ 13,939
Other comprehensive income (loss):
Foreign currency translation adjustments 5,756 1,684 5,955 (115)
Net unrealized losses on investments, net of tax (11) (26) (7) (345)
-------- -------- -------- --------
Other comprehensive income (loss) 5,745 1,658 5,948 (460)
-------- -------- -------- --------
Comprehensive income $ 18,599 $ 19,913 $ 17,290 $ 13,479
======== ======== ======== ========
The balance of unrealized holding losses, net of tax, at June 30, 2003 was $0.2
million.
7
Note 4 - Computations of Income per Share of Common Stock
The following table sets forth the reconciliation of the basic and diluted
income per share (in thousands, except per share data):
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
-------- -------- -------- --------
NUMERATOR:
Net income used for calculating basic income per share $ 12,854 $ 18,255 $ 11,342 $ 13,939
After-tax interest on convertible long-term debt 3,323 3,132 6,567 6,190
-------- -------- -------- --------
Income used for calculating diluted income per share $ 16,177 $ 21,387 $ 17,909 $ 20,129
======== ======== ======== ========
DENOMINATOR:
Weighted average number of common shares used in
the calculation of basic income per share 79,234 83,719 79,863 84,166
Common stock equivalents associated with stock
compensation plans 413 2,929 440 3,164
Weighted average number of shares associated
with convertible long-term debt 48,312 45,651 47,957 45,315
-------- -------- -------- --------
Shares used in the calculation of diluted income per share 127,959 132,299 128,260 132,645
======== ======== ======== ========
Basic income per share $ 0.16 $ 0.22 $ 0.14 $ 0.17
======== ======== ======== ========
Diluted income per share $ 0.13 $ 0.16 $ 0.14 $ 0.15
======== ======== ======== ========
For the three and six months ended June 30, 2003 and 2002, unvested restricted
stock awards were not included in the computation of diluted income per share
because the effect would have been anti-dilutive. For the three months ended
June 30, 2003 and 2002, options to purchase 31.9 million and 13.7 million
shares, respectively, of Class A Common Stock of the Company were not included
in the computation of diluted income per share because the effect would have
been anti-dilutive. For the six months ended June 30, 2003 and 2002, options to
purchase 32.2 million and 14.0 million shares, respectively, of Class A Common
Stock of the Company were not included in the computation of diluted income per
share because the effect would have been anti-dilutive.
Note 5 - Accounting for Stock-Based Compensation
The Company has several stock-based compensation plans. The Company applies APB
Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB 25") in
accounting for its employee stock options and purchase rights and applies
Statement of Financial Accounting Standards No. 123 "Accounting for Stock Issued
to Employees" ("SFAS 123") for disclosure purposes only. Under APB 25, the
intrinsic value method is used to account for stock-based employee compensation
plans. The SFAS 123 disclosures include pro forma net income and earnings per
share as if the fair value-based method of accounting had been used.
If compensation for employee options had been determined based on SFAS 123, the
Company's pro forma net income, and pro forma income per share would have been
as follows (in thousands, except per share data):
8
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net income as reported $ 12,854 $ 18,255 $ 11,342 $ 13,939
Add: Stock-based compensation expense
included in net income as reported, net of tax 169 193 332 387
Deduct: Pro forma employee stock-based
compensation cost, net of tax (3,603) (7,118) (9,300) (14,758)
---------- ---------- ---------- ----------
Pro forma net income (loss) $ 9,420 $ 11,330 $ 2,374 $ (432)
========== ========== ========== ==========
Basic income (loss) per share:
As reported $ 0.16 $ 0.22 $ 0.14 $ 0.17
Pro forma $ 0.12 $ 0.14 $ 0.03 $ (0.01)
Diluted income (loss) per share:
As reported $ 0.13 $ 0.16 $ 0.14 $ 0.15
Pro forma $ 0.10 $ 0.11 $ 0.03 $ (0.01)
The fair value of the Company's stock plans was estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted-average
assumptions for options granted in the following periods:
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
------ ------ ------ ----
Expected dividend yield 0% 0% 0% 0%
Expected stock price volatility 41% 50% 43% 50%
Risk-free interest rate 1.7% 3.2% 1.9% 3.2%
Expected life in years 3.4 3.5 3.4 3.5
Note 6 - Net Gain on Sale of Investments
On September 1, 1998, the Company sold GartnerLearning, a division of the
Company that provides technology based training and services for IT
professionals to NETg Inc. ("NETg"), a subsidiary of Harcourt, Inc. (formerly
Harcourt Brace & Company), and recorded a pre-tax loss of approximately $2.0
million. In addition, the Company recorded an additional loss of $6.7 million
during the twelve month period ended September 30, 2000 in connection with a
negotiated settlement of a claim arising from the sale of GartnerLearning. The
claim asserted that the Company had breached a contractual commitment under a
joint venture agreement to co-produce a product when GartnerLearning was sold.
During the second quarter of 2003, the Company received proceeds of
approximately $5.5 million on an insurance claim associated with the 2000
negotiated settlement.
Note 7 - Segment Information
The Company manages its business in three reportable segments organized on the
basis of differences in its products and services: Research, Consulting, and
Events. Research consists primarily of subscription-based research products.
Consulting consists primarily of consulting and measurement engagements. Events
consists of various symposia, expositions and conferences.
9
The Company evaluates reportable segment performance and allocates resources
based on gross contribution margin. Gross contribution, as presented below, is
the profit or loss from operations before interest income and expense, certain
selling, general and administrative costs, amortization, income taxes, other
expenses, and foreign exchange gains and losses. The accounting policies used by
the reportable segments are the same as those used by the Company.
The Company does not identify or allocate assets, including capital
expenditures, by operating segment. Accordingly, assets are not reported by
segment because the information is not available and is not reviewed in the
evaluation of segment performance.
The following tables present information about reportable segments (in
thousands). The "Other" column consists primarily of software sales and certain
other revenues and related expenses that do not meet the segment reporting
quantitative thresholds. There are no inter-segment revenues.
Research Consulting Events Other Consolidated
--------- --------- --------- --------- ------------
THREE MONTHS ENDED
JUNE 30, 2003:
Revenues $ 117,793 $ 66,525 $ 25,292 $ 3,708 $ 213,318
Gross Contribution 75,401 22,743 10,532 2,592 111,268
Corporate and other expenses (91,422)
---------
Operating income $ 19,846
=========
THREE MONTHS ENDED
JUNE 30, 2002:
Revenues $ 121,619 $ 72,611 $ 38,438 $ 3,489 $ 236,157
Gross Contribution 79,644 27,756 17,746 2,368 127,514
Corporate and other expenses (92,836)
---------
Operating income $ 34,678
=========
SIX MONTHS ENDED
JUNE 30, 2003:
Revenues $ 233,517 $ 128,304 $ 48,801 $ 6,978 $ 417,600
Gross Contribution 149,051 43,628 18,932 4,960 216,571
Corporate and other expenses (193,936)
---------
Operating income $ 22,635
=========
SIX MONTHS ENDED
JUNE 30, 2002:
Revenues $ 244,354 $ 138,504 $ 47,538 $ 6,856 $ 437,252
Gross Contribution 162,628 50,289 21,971 3,898 238,786
Corporate and other expenses (205,479)
---------
Operating income $ 33,307
=========
10
Note 8 - Intangible Assets
The following table presents the Company's intangible assets subject to
amortization (in thousands):
June 30, 2003 December 31, 2002
----------------------------------- -----------------------------------
Accumulated Accumulated
Gross Amortization Net Gross Amortization Net
-------- ------------ -------- -------- ------------ --------
Non-compete agreements $ 13,079 $(11,977) $ 1,102 $ 12,910 $(11,157) $ 1,753
Trademarks & tradenames 1,808 (1,395) 413 1,808 (1,307) 501
-------- -------- -------- -------- -------- --------
Total $ 14,887 $(13,372) $ 1,515 $ 14,718 $(12,464) $ 2,254
======== ======== ======== ======== ======== ========
Aggregate amortization expense for the three and six month periods ended June
30, 2003 was $0.3 million and $0.7 million, respectively. Aggregate amortization
expense for the three and six month periods ended June 30, 2002 was $0.4 million
and $0.9 million, respectively. The estimated future amortization expense of
purchased intangibles is as follows (in thousands):
2003 (remaining six months) $ 853
2004 470
2005 107
2006 63
2007 22
--------
$ 1,515
========
Note 9 - Other Charges
During the first quarter of 2003, the Company recorded other charges of $5.4
million associated with workforce reductions initiated during that quarter. The
charge was for costs for employee termination severance payments and related
benefits. This workforce reduction resulted in the termination of 92 employees
and the payment of $3.4 million during the six months ended June 30, 2003.
Other charges recorded in prior periods included:
- - During Transition 2002, the Company recorded other charges of $32.2
million. Of these charges, $13.3 million relates to costs and losses
associated with the elimination and reduction of excess facilities,
principally leased facilities and ongoing lease costs and losses associated
with sub-lease arrangements. In addition, approximately $18.9 million of
these charges are associated with the Company's workforce reduction, the
elimination of 175 positions, initiated during that period and are for
employee termination severance payments and related benefits. During the
six months ended June 30, 2003, the Company paid $9.1 million of
termination benefits associated with this workforce reduction.
- - During the three months ended March 31, 2002, the Company recorded other
charges of $17.2 million. Of these charges, $10.0 million relates to costs
and losses associated with the elimination of excess facilities,
principally leased facilities and ongoing lease costs and losses associated
with sub-lease arrangements. In addition, approximately $5.8 million of
these charges are associated with the Company's workforce reduction
initiated during that period and are for related employee termination
severance payments and related benefits. This workforce reduction resulted
in the elimination of approximately 100 positions. The remaining $1.4
million relates to the impairment of certain database-related assets.
11
- - During the twelve months ended September 30, 2001, the Company recorded
other charges of $46.6 million. Of these charges, $24.8 million are
associated with the Company's workforce reduction, the elimination of 383
positions, initiated in April 2001. During the six months ended June 30,
2003, the Company paid $0.1 million of termination severance payments and
related benefits associated with this workforce reduction. Approximately
$14.3 million of the other charges are associated with the write-down of
goodwill and other long-lived assets to net realizable value as a result of
the Company's decision to discontinue certain unprofitable products, and
$7.5 million of the charge is associated primarily with the write-off of
internally developed systems in connection with the launch of gartner.com
and seat-based pricing.
The following table summarizes the activity related to the liability for the
restructuring programs recorded as other charges (in thousands):
Workforce Excess
Reduction Facilities Asset
Costs Costs Impairments Total
--------- ---------- ----------- --------
Accrued Liability at December 31, 2001 $ 2,889 $ - $ - $ 2,889
Charges during six months ended
June 30, 2002 5,808 10,014 1,424 17,246
Non-cash charges (120) (2,663) (1,424) (4,207)
Payments (7,144) (2,529) - (9,673)
-------- -------- -------- --------
Accrued Liability at June 30, 2002 1,433 4,822 - 6,255
Payments during remainder of fiscal 2002 (775) (734) - (1,509)
-------- -------- -------- --------
Accrued Liability at September 30, 2002 658 4,088 - 4,746
Charges during Transition 2002 18,899 13,267 - 32,166
Non-cash charges (601) (659) - (1,260)
Payments (7,233) (760) - (7,993)
-------- -------- -------- --------
Accrued Liability at December 31, 2002 11,723 15,936 - 27,659
Charges during six months ended
June 30, 2003 5,426 - - 5,426
Payments (12,627) (3,882) - (16,509)
-------- -------- -------- --------
Accrued Liability at June 30, 2003 $ 4,522 $ 12,054 $ - $ 16,576
======== ======== ======== ========
The non-cash charges for workforce reductions result from the establishment of a
new measurement date for certain stock options upon the modification of the
exercise term. The Company expects to pay the remaining workforce reduction
costs by the end of the first quarter of 2004.
Note 10 - Stock Repurchase Program
On July 19, 2001, the Company's Board of Directors approved the repurchase of up
to $75.0 million of Class A and Class B Common Stock. On July 25, 2002, the
Company's Board of Directors increased the authorized stock repurchase program
from the previously approved $75 million to up to $125 million of its Class A
and Class B Common Stock. On July 24, 2003, the Company's Board of Directors
authorized an increase of $75 million in the stock repurchase program bringing
the total authorization to date to $200 million. During the six months ended
June 30, 2003, the Company repurchased 2,303,104 shares of its Class A Common
Stock and 803,450 shares of its Class B Common Stock at an aggregate cost of
$23.5
12
million under this program. On a cumulative basis at June 30, 2003, the Company
has purchased $107.2 million of its stock under this stock repurchase program.
Note 11 - Contingencies
The Company is involved in legal proceedings and litigation arising in the
ordinary course of business. The Company believes the outcome of all current
proceedings, claims and litigation will not have a material effect on the
Company's financial position or results of operations when resolved in a future
period.
The Company has various agreements in which it may be obligated to indemnify the
other party with respect to certain matters. Generally, these indemnification
clauses are included in contracts arising in the normal course of business under
which the Company customarily agrees to hold the other party harmless against
losses arising from a breach of representations related to such matters as title
to assets sold and licensed or certain intellectual property rights. It is not
possible to predict the maximum potential amount of future payments under these
indemnification agreements due to the conditional nature of the Company's
obligations and the unique facts of each particular agreement. Historically,
payments made by the Company under these agreements have not been material. As
of June 30, 2003, management was not aware of any indemnification agreements
that would require material payments.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The purpose of the following Management's Discussion and Analysis (MD&A) is to
help facilitate the understanding of significant factors influencing the
operating results, financial condition and cash flows of Gartner, Inc.
Additionally, the MD&A also conveys our expectations of the potential impact of
known trends, events or uncertainties that may impact future results. You should
read this discussion in conjunction with our condensed consolidated financial
statements and related notes included in this report and our consolidated
financial statements and related notes in our Transition Report on Form 10-KT
for the three month transition period ended December 31, 2002. Historical
results and percentage relationships are not necessarily indicative of operating
results for future periods.
References to "the Company," "we," "our," and "us" are to Gartner, Inc. and its
subsidiaries.
On October 30, 2002, the Company announced that the Board of Directors approved
a change of the Company's fiscal year end from September 30 to December 31,
effective January 1, 2003. This change resulted in a three-month transitional
period ending December 31, 2002. References to Transition 2002, unless otherwise
indicated, refer to the three-month transitional period ended December 31, 2002.
References to the quarters of 2002 are to the calendar quarters of 2002.
FORWARD-LOOKING STATEMENTS
In addition to historical information, this Quarterly Report contains
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Forward-looking statements are any statements other than statements
of historical fact, including statements regarding our expectations, beliefs,
hopes, intentions or strategies regarding the future. In some cases,
forward-looking statements can be identified by the use of words such as "may,"
"will," "expects," "should," "believes," "plans," "anticipates," "estimates,"
"predicts," "potential," "continue," or other words of similar meaning.
Forward-looking statements are subject to risks and uncertainties that could
cause actual results to differ materially from those discussed in, or implied
by, the forward-looking statements. Factors that might cause such a difference
include, but are not limited to, those discussed in "Factors That May Affect
Future Results," "Euro Conversion," and elsewhere in this report and in our
Transition Report on Form 10-KT for the three month transition period ended
December 31, 2002. Readers should not place undue reliance on these
forward-looking statements, which reflect management's opinion only as of the
date on which they were made. Except as required by law, we disclaim any
obligation to review or update these forward-looking statements to reflect
events or circumstances as they occur. Readers also should review carefully any
risk factors described in other reports filed by us with the Securities and
Exchange Commission.
BUSINESS MEASURES
We believe the following business measurements are important performance
indicators for our business segments.
REVENUE CATEGORY BUSINESS MEASUREMENTS
- ---------------- ----------------------------------------
Research CONTRACT VALUE represents the value
attributable to all of our
subscription-related research products
that recognize revenue on a ratable
basis. Contract value is calculated as
the annualized value of all subscription
research contracts in effect at a
specific point in time, without regard
to the duration of the contract.
CLIENT RETENTION RATE represents a
measure of client satisfaction and
renewed business relationships at a
specific point in time.
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Client retention is calculated on a
percentage basis by dividing our
current clients, who were also
clients a year ago, by all clients
from a year ago.
- ---------------- ----------------------------------------
Consulting CONSULTING BACKLOG represents future
revenue to be derived from in-process
consulting, measurement and strategic
advisory services engagements.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements requires the application of appropriate
accounting policies. The policies discussed below are considered by management
to be critical to an understanding of Gartner's financial statements because
their application requires the most significant management judgments. Specific
risks for these critical accounting policies are described below.
REVENUE RECOGNITION - We recognize revenue in accordance with SEC Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB
101"). Revenue by significant source is accounted for as follows:
- - Research revenues are derived from subscription contracts for research
products. Revenues from research products are deferred and recognized
ratably over the applicable contract term;
- - Consulting revenues are based primarily on fixed fees or time and materials
for discrete projects. Revenues for such projects are recognized as work is
delivered and/or services are provided and are evaluated on a contract by
contract basis;
- - Events revenues are deferred and recognized upon the completion of the
related symposium, conference or exhibition; and
- - Other revenues, principally software licensing fees, are recognized when a
signed non-cancelable software license exists, delivery has occurred,
collection is probable, and the fees are fixed or determinable. Revenue
from software maintenance is deferred and recognized ratably over the term
of the maintenance agreement, which is typically twelve months.
The majority of research contracts are billable upon signing, absent special
terms granted on a limited basis from time to time. All research contracts are
non-cancelable and non-refundable, except for government contracts that have a
30-day cancellation clause, but have not produced material cancellations to
date. It is our policy to record the entire amount of the contract that is
billable as a fee receivable at the time the contract is signed with a
corresponding amount as deferred revenue, since the contract represents a
legally enforceable claim. For those government contracts that permit
termination, the Company bills the client the full amount billable under the
contract but only records a receivable equal to the earned portion of the
contract. In addition, the Company only records deferred revenue on these
government contracts when cash is received. Deferred revenues attributable to
government contracts were $27.2 million and $29.3 million at June 30, 2003 and
December 31, 2002, respectively. In addition, at June 30, 2003 and December 31,
2002, the Company had not recognized uncollected receivables or deferred
revenues, relating to government contracts that permit termination, of $4.7
million in both periods.
UNCOLLECTIBLE ACCOUNTS RECEIVABLE - Provisions for bad debts are recognized as
incurred. The measurement of likely and probable losses and the allowance for
uncollectible accounts receivable is based on historical loss experience, aging
of outstanding receivables, an assessment of current economic conditions and the
financial health of specific clients. This evaluation is inherently judgmental
and requires material estimates. These valuation reserves are periodically
re-evaluated and adjusted as more information about the ultimate collectibility
of accounts receivable becomes available. Circumstances that
15
could cause our valuation reserves to increase include changes in our clients'
liquidity and credit quality, other factors negatively impacting our clients'
ability to pay their obligations as they come due, and the quality of our
collection efforts. Total trade receivables at June 30, 2003 were $233.1
million, against which an allowance for losses of approximately $7.0 million was
provided. Total trade receivables at December 31, 2002 were $290.1 million,
against which an allowance for losses of approximately $7.0 million was
provided.
IMPAIRMENT OF INVESTMENT SECURITIES - A charge to earnings is made when a market
decline below cost is other than temporary. Management regularly reviews each
investment security for impairment based on criteria that include: the length of
time and the extent to which market value has been less than cost, the financial
condition and near-term prospects of the issuer, the valuation of comparable
companies, and our intent and ability to retain the investment for a period of
time sufficient to allow for any anticipated recovery in market value. Future
adverse changes in market conditions or poor operating results of underlying
investments could result in losses or an inability to recover the carrying value
of the investments that may not be reflected in an investment's current carrying
value, thereby possibly requiring an impairment charge in the future. Total
investments in equity securities were $11.6 million and $10.7 million at June
30, 2003 and December 31, 2002, respectively.
IMPAIRMENT OF GOODWILL AND OTHER INTANGIBLE ASSETS - The evaluation of goodwill
is performed in accordance with SFAS No. 142, "Goodwill and Other Intangible
Assets." Among other requirements, this standard eliminated goodwill
amortization upon adoption and required an initial assessment for goodwill
impairment within six months of adoption and at least annually thereafter. The
evaluation of other intangible assets is performed on a periodic basis. These
assessments require management to estimate the fair value of our reporting units
based on estimates of future business operations and market and economic
conditions in developing long-term forecasts. If we determine the fair values
are less than the carrying amount of goodwill recorded on our Consolidated
Balance Sheets, we must recognize an impairment in our financial statements. The
carrying amount of goodwill at June 30, 2003 was $226.9 million. Goodwill is
evaluated for impairment at least annually, or whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. Factors
we consider important in determining whether an impairment may exist include:
significant under-performance relative to historical or projected future
operating results, significant changes in the manner of our use of acquired
assets or the strategy for our overall business, and significant negative
industry or economic trends.
Due to the numerous variables associated with our judgments and assumptions
relating to the valuation of the reporting units and the effects of changes in
circumstances affecting these valuations, both the precision and reliability of
the resulting estimates are subject to uncertainty. As additional information
becomes known, we may change our estimates.
ACCOUNTING FOR INCOME TAXES - As we prepare our consolidated financial
statements, we estimate our income taxes in each of the jurisdictions where we
operate. This process involves estimating our current tax exposure together with
assessing temporary differences resulting from differing treatment of items for
tax and accounting purposes. These differences result in deferred tax assets and
liabilities, which are included within our consolidated balance sheet. We record
a valuation allowance to reduce our deferred tax assets when future realization
is in question. We consider future taxable income and ongoing prudent and
feasible tax planning strategies in assessing the need for the valuation
allowance. In the event we determine that we would be able to realize our
deferred tax assets in the future in excess of our net recorded amount, an
adjustment to the deferred tax asset would increase income in the period such
determination was made. Likewise, should we determine that we would not be able
to realize all or part of our net deferred tax asset in the future, an
adjustment to the deferred tax asset would be charged to income in the period
such determination was made.
16
CONTINGENCIES AND OTHER LOSS RESERVES - We establish reserves for severance
costs, lease costs associated with excess facilities, contract terminations and
asset impairments as a result of actions we undertake to streamline our
organization, reposition certain businesses and reduce ongoing costs. Estimates
of costs to be incurred to complete these actions, such as future lease
payments, sublease income, the fair value of assets, and severance and related
benefits, are based on assumptions at the time the actions are initiated. To the
extent actual costs differ from those estimates, reserve levels may need to be
adjusted. In addition, these actions may be revised due to changes in business
conditions that we did not foresee at the time such plans were approved.
RESULTS OF OPERATIONS
OVERALL RESULTS
TOTAL REVENUES decreased 10% in the second quarter of 2003 to $213.3 million
compared to $236.2 million for the second quarter of 2002 and decreased 4% when
comparing the first six months of 2003 to the first six months of 2002. The
decrease in total revenues was a result of a decline in demand throughout the
entire technology sector and the overall weakness in the economy generally,
partially offset by the positive effects of foreign currency. The decrease in
revenues for the second quarter of 2003 as compared to the second quarter of
2002 was larger than the year-to-date percentage decline due to the timing of
Spring Symposium, which was held in the first quarter of 2003 as compared to the
second quarter of 2002. Please refer to the section of this MD&A entitled
"Segment Results" for a further discussion of revenues by segment.
COST OF SERVICES AND PRODUCT DEVELOPMENT decreased $2.6 million, or 2%, to
$103.4 million in the second quarter of 2003 from $106.0 million in the second
quarter of 2002 and increased 6% when comparing the first six months of 2003 to
the first six months of 2002. The increase in cost of services and product
development for the first six months of 2003 resulted primarily from investments
in Gartner EXP, Gartner G2, membership programs, product development and
database management and higher conference related expenses. Additionally, cost
of services increased due to the effects of foreign currency translation. The
decrease in costs of services and product development when comparing the second
quarter of 2003 with the second quarter of 2002 was due to the timing of the
Spring Symposium, which was held in the first quarter of 2003 as compared to the
second quarter of 2002. The decrease in cost of services in the quarter
comparison caused by timing of events was partially offset by the factors
previously mentioned.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES decreased $3.7 million, or 4%, to
$80.7 million in the second quarter of 2003 from $84.4 million in the second
quarter of 2002. SG&A expenses also decreased 4% to $164.2 million from $170.4
million when comparing the first six months of 2003 to the first six months of
2002. The decrease was primarily the result of lower headcount and lower
commission expenses, partially offset by the effects of foreign currency
translation.
DEPRECIATION EXPENSE for the second quarter of 2003 decreased 15% to $9.0
million, compared to $10.6 million for the second quarter of 2002 and decreased
10% when comparing the first six months of 2003 to the first six months of 2002.
The decrease was due to a reduction in capital spending over the past several
quarters, which has led to a decrease in depreciation expense. In addition,
costs capitalized during 2000 associated with the launch of the gartner.com web
site in January 2001 have been fully depreciated as of the beginning of 2003.
17
AMORTIZATION OF INTANGIBLES decreased when comparing the quarterly and six month
period ending June 30, 2003 to the same period in 2002 due to certain intangible
assets having been fully amortized over the past year.
OTHER CHARGES of $5.4 million during the first six months of 2003 were for costs
for employee termination severance and benefits associated with workforce
reductions initiated during the first quarter of 2003. This workforce reduction
has resulted in the termination of 92 employees, or approximately 2% of the
Company's workforce. During the first six months of 2002, Other charges were
$17.2 million. Of these charges, $10.0 million related to costs and losses
associated with the elimination of excess facilities, principally leasehold
improvements and ongoing lease costs and losses associated with sub-lease
arrangements. In addition, approximately $5.8 million of these charges were
associated with our workforce reduction initiated during the first quarter of
2002 and were for employee termination severance and benefits. This workforce
reduction resulted in the elimination of approximately 100 positions, or
approximately 2% of the Company's workforce. Payments associated with the
workforce reduction are expected to be completed by the end of the first quarter
of 2004. The remaining $1.4 million relates to the impairment of certain
database-related assets. We are funding all of these costs out of operating cash
flows.
INTEREST EXPENSE increased when comparing the quarterly and six month periods of
2003 to the same periods in 2002 due to the compounding of interest on our
long-term convertible debt.
GAIN (LOSS) ON INVESTMENTS for the three and six months ended June 30, 2003
includes a $5.5 million insurance recovery received during the second quarter of
2003 associated with previously incurred losses arising from the sale of a
business. The loss on investments for the three and six month periods ended June
30, 2002 was caused primarily by the recognition of impairment losses related to
equity securities owned by us through SI I and SI II. SI I and SI II are venture
capital funds engaged in making investments in early to mid-stage IT-based or
Internet-enabled companies. We own 100% of SI I and 34% of SI II.
OTHER (EXPENSE) INCOME, NET for the second quarter and the first six months of
2003 primarily consist of net foreign exchange losses and gains. Other (expense)
income, net for the second quarter of 2002 also consists primarily of net
foreign exchange gains. For the six months ended June 30, 2002, other (expense)
income, net includes a $0.5 million gain from the sale of certain assets during
the first quarter of 2002. Net gains and losses from foreign exchange for the
first six months of 2002 were minimal.
PROVISION FOR INCOME TAXES was 34.9% and 35.2% of income before income taxes for
the three and six months ended June 30, 2003, respectively. Excluding the effect
of the insurance recovery, the tax rate for the 2003 periods was approximately
33%, consistent with the tax rate for the 2002 periods.
BASIC AND DILUTED INCOME PER COMMON SHARE was $0.16 and $0.13, respectively, for
the second quarter of 2003, compared to $0.22 and $0.16, respectively, for the
second quarter of 2002. The insurance recovery favorably impacted diluted income
per share by $0.03 during the second quarter of 2003, while the impairment of
investments unfavorably impacted diluted income per share by $0.01 during the
second quarter of 2002. Basic and diluted income per common share was $0.14 for
the six months ended June 30, 2003, and was $0.17 and $0.15, respectively, for
the six months ended June 30, 2002. For the first six months of 2003, the $0.03
favorable impact of the insurance recovery was offset by the restructuring
recorded as Other charges, which unfavorably impacted diluted income per share
by $0.03. In addition to the $0.01 unfavorable impact of the impairment of
investments, the restructuring charges during the first six months of 2002
impacted diluted income per share by $0.09 unfavorably.
18
SEGMENT RESULTS
We evaluate reportable segment performance and allocate resources based on gross
contribution margin. Gross contribution is defined as operating income excluding
certain selling, general and administrative expenses, depreciation, amortization
of intangibles and other charges. Gross contribution margin is defined as gross
contribution as a percentage of revenues.
RESEARCH
Research revenues decreased 3% when comparing the second quarters of 2003 and
2002 and decreased 4% when comparing the first six months of 2003 with the same
period of 2002. The decrease was due to lower demand throughout the entire
technology sector and to the overall weakness in the economy generally.
Research gross contribution of $75.4 million for the second quarter of 2003
decreased 5% from $79.6 million for the second quarter of 2002, while gross
contribution margin for the second quarter of 2003 decreased to 64% from 65% in
the prior year period. For the six months ended June 30, 2003, gross
contribution decreased to $149.1 million, or a 64% contribution margin, from
$162.6 million, or a 67% contribution margin. The decrease in gross contribution
and gross contribution margin is a result of the lower revenues and costs
associated with investments in Gartner EXP, Gartner G2, membership programs,
product development and marketing and database management.
Research contract value, which consists of the annualized value of all
subscription-based research products with ratable revenue recognition, was
$468.5 million at June 30, 2003, a decrease of 7% from $502.9 million at June
30, 2002. At June 30, 2003, our client retention rates increased 1% to 75% as
compared to the same measure at the end of the first quarter of 2003. The
decrease in contract value reflects a decline in demand throughout the entire
technology and finance industries as our large clients in these industries
continue to constrain their spending.
CONSULTING
Consulting revenues decreased 8% to $66.5 million for the second quarter of 2003
and decreased 7% to $128.3 million for the first six months of 2003 as compared
to the same periods of 2002. Lower billable headcount and lower utilization
caused the decrease in revenues. Workforce reductions over the past year have
resulted in reduced billable headcount in response to the lower demand in the
technology sector.
Consulting gross contribution of $22.7 million for the second quarter of 2003
decreased 18% from $27.8 million for the second quarter of 2002, and
contribution margin for the second quarter of 2003 decreased to 34% from 38% in
the prior year quarter. Gross contribution of $43.6 million for the first six
months of 2003 decreased 13% from $50.3 million for the same period of 2002,
with contribution margin for the period decreasing to 34% from 36%. The decrease
in the gross contribution margin was primarily attributable to lower consultant
utilization rates. We continue to focus on larger engagements and on a limited
set of practices and markets in which we can achieve significant penetration.
Consulting backlog, which represents future revenues to be recognized from
in-process consulting, measurement and strategic advisory services engagements
decreased 27% to $91.0 million at June 30, 2003, compared to $124.4 million at
June 30, 2002. Consulting backlog decreased due to the decline in demand
throughout the entire technology sector, as technology customers continue to
constrain spending.
19
EVENTS
Events revenues decreased 34% to $25.3 million for the second quarter of 2003,
compared to $38.4 million for the second quarter of 2002. The decrease was
primarily due to the timing of Spring Symposium and certain Vision events, which
were held in the first quarter of 2003 instead of the second quarter, as in
2002. The decrease in revenues due to the timing of these events was
approximately $11 million. For the six month period ended June 30, 2003 Events
revenues increased 3% to $48.8 million compared to $47.5 million during 2002,
due to the performance of new events added during 2003 and the favorable effects
of foreign currency translation.
Gross contribution of $10.5 million, or 42% of revenues, for the second quarter
of 2003 decreased from $17.7 million, or 46% of revenues, for the second quarter
of 2002. The decrease in gross contribution margin was due primarily to the
timing of Spring Symposium, which was an event that contributed higher margin
during 2002 relative to other events held in 2002. Gross contribution of $18.9
million, or 39% of revenues, for the first six months of 2003 decreased from
$22.0 million, or 46% of revenues, for the first six months of 2002. The
decrease in gross contribution margin was due primarily to increased personnel
expenses, increased event marketing costs, and higher costs for conferences due
to certain conferences increasing in size causing an upgrade in event hosting
facilities.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities totaled $78.2 million for the six months
ended June 30, 2003 compared to $111.9 million for the six months ended June 30,
2002. The net decrease in cash flow from operating activities of $33.7 million
was due primarily to receipt of tax refunds of $17.6 million during the first
six months of 2002 for capital loss and foreign tax credit carrybacks. We were a
taxpayer during the first six months of 2003. In addition, we incurred $6.8
million of higher payments relating to our restructuring programs during the
first six months of 2003 as compared to the first six months of 2002.
Cash used in investing activities was $5.8 million for the six months ended June
30, 2003, compared to $13.0 million for the six months ended June 30, 2002. The
decrease was due primarily to the proceeds received from an insurance recovery
of $5.5 million during 2003 associated with a previously incurred loss on a
claim resulting from the sale of a business. Additionally, during 2002 we spent
$4.0 million relating to the purchase of the remaining 49.9% of People3, Inc.
not previously owned by us. During the first six months of 2003, we funded $1.5
million of our investment commitment to SI II, reducing our remaining commitment
to $4.4 million. During the first six months of 2003, we spent $9.8 million on
additions to property and equipment compared with $9.3 million in the prior
year.
Cash used in financing activities totaled $21.1 million for the six months ended
June 30, 2003, compared to $18.6 million for the six months ended June 30, 2002.
We purchased $23.5 million of common stock for treasury during the first six
months of 2003 as compared to $33.1 million during the same period in the prior
year. We received proceeds from stock issued for stock plans of $2.6 million
during the first half of 2003 as compared to $14.7 million during the same
period in the prior year.
We have a $200.0 million unsecured senior revolving credit facility led by
JPMorgan Chase Bank. At June 30, 2003, there were no amounts outstanding under
the facility. We are subject to certain customary affirmative, negative and
financial covenants under this credit facility, and continued compliance with
these covenants preclude us from borrowing the maximum amount of the credit
facility from time to time. These covenants are primarily based on financial
results and other measures such as contract value. As a result of these
covenants, our borrowing availability at June 30, 2003 was $77.8 million.
20
On April 17, 2000, we issued, in a private placement transaction, $300.0 million
of 6% convertible subordinated notes to Silver Lake Partners, L.P. and certain
of Silver Lake's affiliates ("SLP"). Interest accrues semi-annually by a
corresponding increase in the face amount of the convertible notes. Accordingly,
$62.6 million has been added to the face amount of the convertible notes'
balance outstanding at June 30, 2003, resulting in a balance outstanding of
$362.6 million on that date, before reducing this balance for unamortized debt
discount of $0.4 million. These notes are due and payable on April 17, 2005.
On or after April 17, 2003, subject to satisfaction of certain customary
conditions, we may redeem all of the convertible notes for cash provided that:
(1) the average closing price of our Class A Common Stock for the twenty
consecutive trading days immediately preceding the date the redemption
notice is given equals or exceeds $11.175 (150% of the adjusted conversion
price of $7.45 per share); and
(2) the closing price of our Class A Common Stock on the trading day
immediately preceding the date the redemption notice is given also equals
or exceeds $11.175.
The redemption price is the face amount of the notes plus all accrued interest.
If we initiate the redemption, SLP has the option of receiving payment in cash,
Class A Common Stock (at a conversion price of $7.45 per share), or a
combination of cash and stock. We are under no obligation to initiate any such
redemption.
Under the terms of the notes, as of April 18, 2003, SLP may convert all or a
portion of the notes to Class A Common Stock. If SLP initiates a conversion, we
have the option of redeeming all the notes for cash at a price based on the
number of shares into which the notes would be converted (at a conversion price
of $7.45 per share) and the market price on the date the notice of conversion is
given. If we were to redeem all of the notes for cash in response to SLP's
election to convert the notes to Class A Common Stock, we would incur a
significant earnings charge at the time of the redemption equal to the
difference between the market value of our Class A Common Stock at the time of
redemption at the conversion price of $7.45 per share and the carrying value of
the notes. At June 30, 2003, the notes were convertible into 48.7 million shares
with a total market value of $368.9 million, using our June 30, 2003 Class A
Common Stock market price of $7.58 per share. On the maturity date, April 17,
2005, we must satisfy any remaining notes for cash equal to the face amount of
the notes plus accrued interest; if none of the notes have been redeemed or
converted on that date, such amount will be $403.2 million.
We also issue letters of credit in the ordinary course of business. As of June
30, 2003, we had letters of credit outstanding with JPMorgan Chase Bank for $1.2
million, The Bank of New York for $2.0 million, and others for $0.1 million.
We believe that our current cash balances, together with cash anticipated to be
provided by operating activities and borrowings available under the existing
credit facility, will be sufficient for our expected short-term and foreseeable
long-term cash needs in the ordinary course of business. If we were to require
substantial amounts of additional capital to pursue business opportunities that
may arise involving substantial investments of additional capital, or for the
possible redemption of the convertible notes, there can be no assurances that
such capital will be available to us or will be available on commercially
reasonable terms.
21
Stock Repurchase Program
On July 19, 2001, our Board of Directors approved the repurchase of up to $75.0
million of Class A and Class B Common Stock. On July 25, 2002, our Board of
Directors increased the authorized stock repurchase program from the previously
approved $75 million to up to $125 million of its Class A and Class B Common
Stock. On July 24, 2003, the Company's Board of Directors authorized an increase
of $75 million in the stock repurchase program bringing the total authorization
to date to $200 million. During the six months ended June 30, 2003, we
repurchased 2,303,104 shares of our Class A Common Stock and 803,450 shares of
our Class B Common Stock at an aggregate cost of $23.5 million under this
program. On a cumulative basis at June 30, 2003, the Company has purchased
$107.2 million of its stock under this program. We expect to make repurchases
from time to time over the next two years through open market purchases, block
trades or otherwise. Repurchases are subject to the availability of the stock,
prevailing market conditions, the trading price of the stock, and our financial
performance. Repurchases will be funded from cash flow from operations and
possible borrowings under our existing credit facility.
BUSINESS AND TRENDS
Our quarterly and annual revenue and operating income fluctuate as a result of
many factors, including the timing of the execution of research contracts, the
extent of completion of consulting engagements, the timing of Symposia and other
events, all of which occur to a greater extent in the quarter ended December 31,
the amount of new business generated, the mix of domestic and international
business, changes in market demand for our products and services, the timing of
the development, introduction and marketing of new products and services, and
competition in the industry. The potential fluctuations in our operating income
could cause period-to-period comparisons of operating results not to be
meaningful and could provide an unreliable indication of future operating
results.
Over the past couple of years, we have seen a decrease in overall technology
spending due to the economic environment. In response to the decrease in
technology spending, we have attempted to constrain spending and have
implemented cost reduction programs to reduce workforce and facilities costs.
The timing of the cost reductions does not necessarily coincide with the timing
of decreases in revenues, but is anticipated to provide future benefit in the
form of lower expenses. While we have reduced certain costs, we also plan to
maintain a level of spending sufficient for us to be in a position to grow if
and when economic conditions improve.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an amendment of SFAS No. 123." This
amendment provides alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
In addition, this statement amends the disclosure requirement of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. SFAS No. 148 is effective for
fiscal years ending after December 15, 2002. We continue to account for
stock-based compensation according to Accounting Principles Board ("APB") No.
25, "Accounting for Stock Issued to Employees". The adoption of SFAS No. 148 in
the first quarter of 2003 required us to provide prominent disclosures about the
effects of SFAS No. 123 on reported income and required it to disclose these
effects in the interim financial statements (see Note 5 to the Condensed
Consolidated Financial Statements).
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies accounting for derivative instruments,
22
including certain derivative instruments embedded in other contracts, and for
hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts
entered into or modified after June 30, 2003, for hedging relationships
designated after June 30, 2003, and to certain preexisting contracts. We do not
expect the adoption of SFAS No. 149 will have a material impact on our financial
position, cash flows or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity" ("SFAS 150").
SFAS 150 changes the accounting for certain financial instruments that under
previous guidance issuers could account for as equity. It requires that those
instruments be classified as liabilities in balance sheets. The guidance in SFAS
150 is generally effective for all financial instruments entered into or
modified after May 31, 2003, and otherwise is effective on July 1, 2003. The
Company does not expect the adoption of SFAS 150 to have a material impact on
its financial position, cash flows or results of operations.
FACTORS THAT MAY AFFECT FUTURE PERFORMANCE.
We operate in a very competitive and rapidly changing environment that involves
numerous risks and uncertainties, some of which are beyond our control. In
addition, our clients and we are affected by the economy. The following section
discusses many, but not all, of these risks and uncertainties.
Economic Conditions. Our revenues and results of operations are influenced by
economic conditions in general and more particularly by business conditions in
the IT industry. A general economic downturn or recession, anywhere in the
world, could negatively effect demand for our products and services and may
substantially reduce existing and potential client information
technology-related budgets. The current economic downturn in the United States
and globally has led to constrained IT spending which has impacted our business
and may materially and adversely affect our business, financial condition and
results of operations, including the ability to maintain continued customer
renewals and achieve contract value, backlog and deferred events revenue. To the
extent our clients are in the IT industry, the severe decline in that sector has
also had a significant impact on IT spending.
Acts of Terrorism or War. Acts of terrorism, acts of war and other unforeseen
events, may cause damage or disruption to our properties, business, employees,
suppliers, distributors and clients, which could have an adverse effect on our
business, financial condition and operating results. Such events may also result
in an economic slowdown in the United States or elsewhere, which could adversely
affect our business, financial condition and operating results.
Competitive Environment. We face direct competition from a significant number of
independent providers of information products and services. We also compete
indirectly against consulting firms and other information providers, including
electronic and print media companies, some of which may have greater financial,
information gathering and marketing resources than we do. These indirect
competitors could choose to compete directly with us in the future. In addition,
limited barriers to entry exist in the markets in which we do business. As a
result, additional new competitors may emerge and existing competitors may start
to provide additional or complementary services. Additionally, technological
advances may provide increased competition from a variety of sources. However,
we believe the breadth and depth of our research assets position us well versus
our competition. Although our market share has been increasing, increased
competition may result in loss of market share, diminished value in our products
and services, reduced pricing and increased marketing expenditures. We may not
be successful if we cannot compete effectively on quality of research and
analysis, timely delivery of information, customer service, the ability to offer
products to meet changing market needs for information and analysis, or price.
23
Renewal of Research Business by Existing Clients. Some of our success depends on
renewals of our subscription-based research products and services, which
constituted 56% of total revenues for the first six months of 2003 and 2002.
These research subscription agreements have terms that generally range from
twelve to thirty months. Our ability to maintain contract renewals is subject to
numerous factors, including those described in this Quarterly Report. Client
retention rates were 75% for both the second quarters of 2003 and 2002. Any
material decline in retention rates or the amount of spending by clients could
have an adverse impact on our revenues and our financial condition.
Non-Recurring Consulting Engagements. Consulting segment revenues constituted
31% and 32% of total revenues for the first six months of 2003 and 2002,
respectively. Such consulting engagements typically are project-based and
non-recurring. Our ability to replace consulting engagements is subject to
numerous factors, including those described in this Quarterly Report. Any
material decline in our ability to replace consulting arrangements could have an
adverse impact on our revenues and our financial condition.
Hiring and Retention of Employees. Our success depends heavily upon the quality
of our senior management, research analysts, consultants, sales and other key
personnel. We face competition for the limited pool of these qualified
professionals from, among others, technology companies, market research firms,
consulting firms, financial services companies and electronic and print media
companies, some of which have a greater ability to attract and compensate these
professionals. Some of the personnel that we attempt to hire are subject to
non-compete agreements that could impede our short-term recruitment efforts. Any
failure to retain key personnel or hire and train additional qualified
personnel, as required to support the evolving needs of clients or growth in our
business, could adversely affect the quality of our products and services, and
therefore, our future business and operating results.
Maintenance of Existing Products and Services. We operate in a rapidly evolving
market, and our success depends upon our ability to deliver high quality and
timely research and analysis to our clients. Any failure to continue to provide
credible and reliable information that is useful to our clients could have a
material adverse effect on future business and operating results. Further, if
our predictions prove to be wrong or are not substantiated by appropriate
research, our reputation may suffer and demand for our products and services may
decline. In addition, we must continue to improve our methods for delivering our
products and services in a cost-effective manner. Failure to increase and
improve our electronic delivery capabilities could adversely affect our future
business and operating results.
Introduction of New Products and Services. The market for our products and
services is characterized by rapidly changing needs for information and
analysis. To maintain our competitive position, we must continue to enhance and
improve our products and services, develop or acquire new products and services
in a timely manner, and appropriately position and price new products and
services relative to the marketplace and our costs of producing them. Any
failure to achieve successful client acceptance of new products and services
could have a material adverse effect on our business, results of operations or
financial position.
International Operations. A substantial portion of our revenues is derived from
sales outside of North America. As a result, our operating results are subject
to the risks inherent in international business activities, including general
political and economic conditions in each country, changes in market demand as a
result of exchange rate fluctuations and tariffs and other trade barriers,
challenges in staffing and managing foreign operations, changes in regulatory
requirements, compliance with numerous foreign laws and regulations, different
or overlapping tax structures, higher levels of United States taxation on
foreign income, and the difficulty of enforcing client agreements, collecting
accounts receivable and protecting intellectual property rights in international
jurisdictions. We rely on local distributors or sales agents in some
international locations. If any of these arrangements are terminated by our
agent or us, we may not
24
be able to replace the arrangement on beneficial terms or on a timely basis or
clients of the local distributor or sales agent may not want to continue to do
business with us or our new agent.
Branding. We believe that our "Gartner" brand is critical to our efforts to
attract and retain clients and that the importance of brand recognition will
increase as competition increases. We may expand our marketing activities to
promote and strengthen the Gartner brand and may need to increase our marketing
budget, hire additional marketing and public relations personnel, expend
additional sums to protect the brand and otherwise increase expenditures to
create and maintain client brand loyalty. If we fail to effectively promote and
maintain the Gartner brand, or incur excessive expenses in doing so, our future
business and operating results could be materially and adversely impacted.
Investment Activities. We maintain investments in equity securities in private
and publicly traded companies through direct ownership and through wholly and
partially owned venture capital funds. The companies we invest in are primarily
early to mid-stage IT-based and Internet-enabled businesses. There are numerous
risks related to such investments, due to their nature and the volatile public
markets, including significant delay or failure of anticipated returns. In
addition, these entities may require additional financing to meet their cash and
operational needs; however, there can be no assurance that such funds will be
available to the extent needed at terms acceptable to the entities, if at all.
Indebtedness. We have incurred significant indebtedness through our 6%
convertible notes, of which $362.6 million was outstanding at June 30, 2003,
before reducing this balance for unamortized debt discount of $0.4 million.
Additionally, we have a $200.0 million senior revolving credit facility under
which we can incur significant additional indebtedness, although there were no
amounts outstanding at June 30, 2003. The affirmative, negative and financial
covenants of these debt facilities could limit our future financial flexibility.
As a result of these covenants, our borrowing availability at June 30, 2003 was
$77.8 million. The associated debt service costs could impair future operating
results. Our outstanding debt may limit the amount of cash or additional credit
available to us, which could restrain our ability to expand or enhance products
and services, respond to competitive pressures or pursue future business
opportunities requiring substantial investments of additional capital. On the
maturity date of the 6% convertible notes, April 17, 2005, we must satisfy any
remaining notes for cash equal to the face amount of the notes plus accrued
interest; if none of the notes have been redeemed or converted by that date,
such amount will be $403.2 million. The payment of this amount could materially
adversely impact our future business and operating results.
Convertible Notes. Since April 18, 2003, the holders of our 6% convertible notes
(of which $362.6 million was outstanding at June 30, 2003) have the ability to
elect to convert all or a portion of the notes to shares of our Class A Common
Stock. If all or a substantial portion of the notes are converted, the note
holders will own a substantial number of shares of our Class A Common Stock. At
June 30, 2003, the notes were convertible into 48.7 million shares of our Class
A Common Stock, which would constitute 38% of our combined Class A and Class B
Common Stock outstanding on that date. This is based upon the conversion price
of $7.45 per share. If the holders elect to convert the notes, we may redeem
them. See "Indebtedness" above. If we do not redeem the notes and all or a
substantial portion of the notes are converted, the holder of the notes (SLP)
will become our largest shareholder (based upon our shareholder base as of June
30, 2003). This, in turn, may (1) give SLP the ability to exercise significant
control over the Company; (2) create significant dilution for other
shareholders; and (3) cause volatility in our stock price. If we want to redeem
the convertible notes in response to the note holders' election to convert, or
on our own under certain circumstances, there can be no assurance that we will
be able to obtain sufficient capital on a commercially reasonable basis, or at
all, in order to fund a redemption. Even if we could obtain sufficient capital
to fund a redemption, it could materially adversely impact our future business
and operating results.
25
Organizational and Product Integration Related to Acquisitions. We have made and
may continue to make acquisitions of, or significant investments in, businesses
that offer complementary products and services. The risks involved in each
acquisition or investment include the possibility of paying more than the value
we derive from the acquisition, dilution of the interests of our current
stockholders or decreased working capital, increased indebtedness, the
assumption of undisclosed liabilities and unknown and unforeseen risks, the
ability to integrate successfully the operations and personnel of the acquired
business, the ability to retain key personnel of the acquired company, the time
to train the sales force to market and sell the products of the acquired
company, the potential disruption of our ongoing business and the distraction of
management from our business. The realization of any of these risks could
adversely affect our business.
Enforcement of Our Intellectual Property Rights. We rely on a combination of
copyright, patent, trademark, trade secret, confidentiality, non-compete and
other contractual provisions to protect our intellectual property rights.
Despite our efforts to protect our intellectual property rights, unauthorized
third parties may obtain and use technology or other information that we regard
as proprietary. Our intellectual property rights may not survive a legal
challenge to their validity or provide significant protection for us. The laws
of certain countries do not protect our proprietary rights to the same extent as
the laws of the United States. Accordingly, we may not be able to protect our
intellectual property against unauthorized third-party copying or use, which
could adversely affect our competitive position. Our employees are subject to
non-compete agreements. When the non-competition period expires, former
employees may compete against us. If a former employee chooses to compete
against us prior to the expiration of the non-competition period, there is no
assurance that we will be successful in our efforts to enforce the non-compete
provision.
Possibility of Infringement Claims. Third parties may assert infringement claims
against us. Regardless of the merits, responding to any such claim could be time
consuming, result in costly litigation and require us to enter into royalty and
licensing agreements which may not be offered or available on reasonable terms.
If a successful claim is made against us and we fail to develop or license a
substitute technology, our business, results of operations or financial position
could be materially adversely affected.
Potential Fluctuations in Operating Results. Our quarterly and annual operating
income may fluctuate in the future as a result of many factors, including the
timing of the execution of research contracts, which typically occurs in the
fourth calendar quarter, the extent of completion of consulting engagements, the
timing of symposia and other events, which also occur to a greater extent in the
fourth calendar quarter, the amount of new business generated, the mix of
domestic and international business, changes in market demand for our products
and services, the timing of the development, introduction and marketing of new
products and services, and competition in the industry. An inability to generate
sufficient earnings and cash flow, and achieve our forecasts, may impact our
operating and other activities. The potential fluctuations in our operating
income could cause period-to-period comparisons of operating results not to be
meaningful and may provide an unreliable indication of future operating results.
26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
As of June 30, 2003, we have exposure to market risk for changes in interest
rates primarily from borrowings under long-term debt which consists of a $200.0
million unsecured senior revolving credit facility with JPMorgan Chase Bank and
$362.6 million of 6% convertible subordinated notes. At June 30, 2003, there
were no amounts outstanding under the revolving credit facility and our
borrowing availability was $77.8 million. Under the revolving credit facility,
the interest rate on borrowings is LIBOR plus an additional 100 to 200 basis
points based on our debt-to-EBITDA ratio. We believe that an increase or
decrease of 10% in the effective interest rate on available borrowings from our
senior revolving credit facility, if fully utilized, would not have a material
effect on our future results of operations. If markets were to decline, we could
be required to accrue interest on the 6% convertible debt that would exceed
those based on current market rates. Each 25 basis point decrease in interest
would have an associated annual opportunity cost of approximately $0.9 million
based on the June 30, 2003 balance. Each 25 basis point increase or decrease in
interest rates would have an approximate $0.5 million annual effect under the
revolving credit facility if fully utilized.
Investment Risk
We are exposed to market risk as it relates to changes in the market value of
our equity investments. We invest in equity securities of public and private
companies directly and through SI I, a wholly-owned affiliate, and SI II, of
which we own 34%. SI I and SI II are engaged in making venture capital
investments in early to mid-stage IT-based or Internet-enabled companies. As of
June 30, 2003, we had investments in equity securities totaling $11.6 million.
Unrealized gains and losses net of deferred taxes are recorded as a separate
component of accumulated other comprehensive income (loss) in the stockholders'
deficit section of the Consolidated Balance Sheets. These investments are
inherently risky as the businesses are typically in early development stages and
may never develop. Further, certain of these investments are in publicly traded
companies whose shares are subject to significant market price volatility.
Adverse changes in market conditions and poor operating results of the
underlying investments may result in us incurring additional losses or an
inability to recover the original carrying value of our investments. If there
were a 100% adverse change in the value of our equity portfolio as of June 30,
2003, this would result in a non-cash impairment charge of $11.8 million. We are
continuing efforts to sell all of our investments owned through SI I and SI II.
Foreign Currency Exchange Risk
We face two risks related to foreign currency exchange: translation risk and
transaction risk. Amounts invested in our foreign operations are translated into
U.S. dollars at the exchange rates in effect at the balance sheet date. The
resulting translation adjustments are recorded as a component of accumulated
other comprehensive income (loss) in the stockholders' deficit section of the
Consolidated Balance Sheets. Our foreign subsidiaries generally collect revenues
and pay expenses in currencies other than the United States dollar. Since the
functional currency of our foreign operations are generally denominated in the
local currency of our subsidiaries, the foreign currency translation adjustments
are reflected as a component of stockholders' equity and do not impact operating
results. Revenues and expenses in foreign currencies translate into higher or
lower revenues and expenses in U.S. dollars as the U.S. dollar weakens or
strengthens against other currencies. Therefore, changes in exchange rates may
negatively affect our consolidated revenues and expenses (as expressed in U.S.
dollars) from foreign operations. Currency transaction gains or losses arising
from transactions in currencies other than the functional currency are included
in results of operations.
From time to time we enter into foreign currency forward exchange contracts or
other derivative financial instruments to hedge the effects of adverse
fluctuations in foreign currency exchange rates. At June 30,
27
2003, we had two foreign currency forward contracts outstanding. Foreign
exchange forward contracts are reflected at fair value with gains and losses
recorded currently in earnings.
The following table presents information about our foreign currency forward
contracts outstanding as of June 30, 2003, expressed in millions of U.S. dollar
equivalents.
Currency Contract Forward
Currency Purchased Sold Amount Rate Expiration Date
- ------------------- ---------- -------- ------- ---------------
Great Britain Pound US Dollars $ 2.6 0.5982 July 24, 2003
Great Britain Pound Euro $ 2.4 0.6967 July 24, 2003
The gains and losses on these contracts at June 30, 2003 were not significant.
ITEM 4. CONTROLS AND PROCEDURES
We have established disclosure controls and procedures that are designed to
ensure that the information we are required to disclose in our reports filed
under the Securities Exchange Act of 1934, as amended (the "Act"), is recorded,
processed, summarized and reported in a timely manner. Specifically, these
controls and procedures ensure that the information is accumulated and
communicated to our executive management team, including our chief executive
officer and our chief financial officer, to allow timely decisions regarding
required disclosure.
Management conducted an evaluation, as of June 30, 2003, of the effectiveness
and design of our disclosure controls and procedures, under the supervision and
with the participation of our chief executive officer and chief financial
officer. Based upon that evaluation, our chief executive officer and chief
financial officer have concluded that the Company's disclosure controls and
procedures are effective in alerting them in a timely manner to material Company
information required to be disclosed by us in reports filed under the Act.
In addition, there have been no significant changes in the Company's internal
control over financial reporting that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
28
PART II OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------- ---------------------------------------------------------------------------------------------
4.4d Amendment No. 5 to the Amended and Restated Credit Agreement dated as of June 30, 2003.
10.5a 2002 Employee Stock Purchase Plan, As Amended and Restated February 5, 2003
31.1 Certification of chief executive officer under Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of chief financial officer under Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certification under Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
The Company filed a Report on Form 8-K dated May 6, 2003 to furnish the
Company's press release issued May 6, 2003, with respect to financial results
for Gartner, Inc. for the quarter ended March 31, 2003.
Items 1, 2, 3, 4, and 5 of Part II are not applicable and have been omitted.
29
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
Gartner, Inc.
Date August 14, 2003 /s/ Maureen E.O'Connell
---------------------------
Maureen E. O'Connell
Executive Vice President
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
30