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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 SEPTEMBER 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 October 31, 2003 was 100,522,836 shares of Class A Common Stock and
28,741,743 shares of Class B Common Stock.
TABLE OF CONTENTS
Page
PART I FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets at September 30, 2003 and
December 31, 2002 3
Condensed Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 2003 and 2002 4
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 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)
September 30, December 31,
2003 2002
--------- ---------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 206,937 $ 109,657
Fees receivable, net 221,347 283,068
Deferred commissions 23,267 25,016
Prepaid expenses and other current assets 24,729 30,425
--------- ---------
Total current assets 476,280 448,166
Property, equipment and leasehold improvements, net 61,451 71,006
Goodwill and other intangibles, net 227,777 226,114
Other assets 71,850 71,018
--------- ---------
TOTAL ASSETS $ 837,358 $ 816,304
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable and accrued liabilities $ 134,556 $ 140,891
Deferred revenues 301,681 305,887
--------- ---------
Total current liabilities 436,237 446,778
Convertible debt 367,625 351,539
Other liabilities 48,927 46,688
--------- ---------
TOTAL LIABILITIES 852,789 845,005
STOCKHOLDERS' DEFICIT
Preferred stock - -
Common stock 61 60
Additional paid-in capital 389,052 368,090
Unearned compensation, net (2,184) (3,069)
Accumulated other comprehensive loss, net (5,695) (11,392)
Accumulated earnings 167,059 150,243
Treasury stock, at cost (563,724) (532,633)
--------- ---------
TOTAL STOCKHOLDERS' DEFICIT (15,431) (28,701)
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 837,358 $ 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 Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
-------- -------- -------- --------
Revenues:
Research $115,830 $122,575 $349,347 $366,929
Consulting 62,998 79,457 191,302 217,961
Events 15,904 14,987 64,705 62,525
Other 2,172 3,508 9,150 10,364
-------- -------- -------- --------
Total revenues 196,904 220,527 614,504 657,779
Costs and expenses:
Cost of services and product development 94,378 93,503 300,151 287,889
Selling, general and administrative 79,169 85,745 243,403 256,189
Depreciation 9,046 11,659 27,835 32,580
Amortization of intangibles 320 499 1,063 1,447
Other charges - - 5,426 17,246
-------- -------- -------- --------
Total costs and expenses 182,913 191,406 577,878 595,351
-------- -------- -------- --------
Operating income 13,991 29,121 36,626 62,428
Gain (loss) on investments 102 5 5,624 (2,449)
Interest income 531 575 1,560 1,333
Interest expense (6,305) (5,893) (18,488) (17,264)
Other (expense) income, net (148) (178) 348 258
-------- -------- -------- --------
Income before income taxes 8,171 23,630 25,670 44,306
Provision for income taxes 2,697 8,034 8,854 14,771
-------- -------- -------- --------
Net income $ 5,474 $ 15,596 $ 16,816 $ 29,535
======== ======== ======== ========
Basic income per common share $ 0.07 $ 0.19 $ 0.21 $ 0.35
Diluted income per common share $ 0.07 $ 0.15 $ 0.21 $ 0.30
Weighted average shares outstanding:
Basic 78,026 82,130 79,251 83,487
Diluted 128,934 129,210 128,363 131,355
See the accompanying notes to the condensed consolidated financial statements.
4
GARTNER, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited, in thousands)
Nine Months Ended
September 30,
2003 2002
-------- --------
OPERATING ACTIVITIES:
Net income $ 16,816 $ 29,535
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of intangibles 28,898 34,027
Non-cash compensation 758 2,420
Tax benefit associated with employee exercise of stock options 1,423 1,778
Deferred taxes 88 3,244
(Gain) loss from investments and sales of assets, net (5,624) 1,956
Accretion of interest and amortization of debt issue costs 17,909 16,696
Non-cash charges associated with impairment of long-lived assets - 1,424
Changes in assets and liabilities:
Fees receivable, net 68,646 56,434
Deferred commissions 2,249 13,986
Prepaid expenses and other current assets 7,524 12,661
Other assets (2,014) 6,531
Deferred revenues (11,964) (27,576)
Accounts payable and accrued liabilities (8,781) (8,443)
-------- --------
CASH PROVIDED BY OPERATING ACTIVITIES 115,928 144,673
-------- --------
INVESTING ACTIVITIES:
Proceeds from insurance recovery 5,464 -
Purchases of businesses - (3,858)
Proceeds from sale of assets - 239
Investments (1,507) (1,508)
Additions to property, equipment and leasehold improvements (16,401) (15,258)
-------- --------
CASH USED IN INVESTING ACTIVITIES (12,444) (20,385)
-------- --------
FINANCING ACTIVITIES:
Proceeds from stock issued for stock plans 20,956 16,880
Payments for debt issuance costs (570) (238)
Purchase of treasury stock (32,380) (46,000)
-------- --------
CASH USED IN FINANCING ACTIVITIES (11,994) (29,358)
-------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS 91,490 94,930
EFFECTS OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS 5,790 2,432
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 109,657 27,431
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $206,937 $124,793
======== ========
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. These interim condensed consolidated financial statements 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 nine months ended September 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 Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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") Opinion 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 became 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 adoption of SFAS No. 149 had no impact
on the Company's 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 No. 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 No. 150
became effective on July 1, 2003. The adoption of SFAS 150 had no impact on the
Company's financial position, cash flows or results of operations.
Note 3 - Comprehensive Income
The components of comprehensive income for the three and nine months ended
September 30, 2003 and 2002 are as follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
-------- -------- -------- --------
Net income $ 5,474 $ 15,596 $ 16,816 $ 29,535
Other comprehensive (loss) income:
Foreign currency translation adjustments (259) 701 5,696 586
Net unrealized gains (losses) on investments, net
of tax 8 (48) 1 (393)
-------- -------- -------- --------
Other comprehensive (loss) income (251) 653 5,697 193
-------- -------- -------- --------
Comprehensive income $ 5,223 $ 16,249 $ 22,513 $ 29,728
======== ======== ======== ========
The balance of unrealized holding losses, net of tax, at September 30, 2003 was
$0.1 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 Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
-------- -------- -------- --------
NUMERATOR:
Net income used for calculating basic income per share $ 5,474 $ 15,596 $ 16,816 $ 29,535
After-tax interest on convertible long-term debt 3,341 3,149 9,908 9,339
-------- -------- -------- --------
Income used for calculating diluted income per share $ 8,815 $ 18,745 $ 26,724 $ 38,874
======== ======== ======== ========
DENOMINATOR:
Weighted average number of common shares used in
the calculation of basic income per share 78,026 82,130 79,251 83,487
Common stock equivalents associated with stock
compensation plans 1,878 750 797 2,215
Weighted average number of shares associated
with convertible long-term debt 49,030 46,330 48,315 45,653
-------- -------- -------- --------
Shares used in the calculation of diluted income per share 128,934 129,210 128,363 131,355
======== ======== ======== ========
Basic income per share $ 0.07 $ 0.19 $ 0.21 $ 0.35
======== ======== ======== ========
Diluted income per share $ 0.07 $ 0.15 $ 0.21 $ 0.30
======== ======== ======== ========
For the three and nine months ended September 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 September 30, 2003 and 2002, options to purchase 19.0 million and 26.5
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 nine months ended September 30, 2003 and 2002,
options to purchase 26.7 million and 14.2 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
No. 25 "Accounting for Stock Issued to Employees" in accounting for its employee
stock options and purchase rights and applies SFAS No. 123 "Accounting for Stock
Issued to Employees" for disclosure purposes only. Under APB No. 25, the
intrinsic value method is used to account for stock-based employee compensation
plans. The SFAS No. 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 No. 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 Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
--------- ---------- ---------- ----------
Net income as reported $ 5,474 $ 15,596 $ 16,816 $ 29,535
Add: Stock-based compensation expense
included in net income as reported, net of tax 161 1,186 493 1,573
Deduct: Pro forma employee stock-based
compensation cost, net of tax (4,314) (7,447) (13,614) (22,206)
--------- ---------- ---------- ----------
Pro forma net income $ 1,321 $ 9,335 $ 3,695 $ 8,902
========= ========== ========== ==========
Basic income per share:
As reported $ 0.07 $ 0.19 $ 0.21 $ 0.35
Pro forma $ 0.02 $ 0.11 $ 0.05 $ 0.11
Diluted income per share:
As reported $ 0.07 $ 0.15 $ 0.21 $ 0.30
Pro forma $ 0.02 $ 0.10 $ 0.05 $ 0.10
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 Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
---- ---- ---- ----
Expected dividend yield 0% 0% 0% 0%
Expected stock price volatility 43% 50% 43% 50%
Risk-free interest rate 2.2% 3.2% 1.9% 3.2%
Expected life in years 4.0 3.5 3.4 3.5
Note 6 - Gain on Investments
On September 1, 1998, the Company sold GartnerLearning, a division of the
Company that provided 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
9
research products. Consulting consists primarily of consulting and measurement
engagements. Events consists of various symposia, expositions and conferences.
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
SEPTEMBER 30, 2003:
Revenues $ 115,830 $ 62,998 $ 15,904 $ 2,172 $ 196,904
Gross Contribution 73,330 21,680 5,163 1,375 101,548
Corporate and other expenses (87,557)
---------
Operating income $ 13,991
=========
THREE MONTHS ENDED
SEPTEMBER 30, 2002:
Revenues $ 122,575 $ 79,457 $ 14,987 $ 3,508 $ 220,527
Gross Contribution 79,149 33,608 6,508 2,646 121,911
Corporate and other expenses (92,790)
---------
Operating income $ 29,121
=========
NINE MONTHS ENDED
SEPTEMBER 30, 2003:
Revenues $ 349,347 $ 191,302 $ 64,705 $ 9,150 $ 614,504
Gross Contribution 222,381 65,308 24,095 6,335 318,119
Corporate and other expenses (281,493)
---------
Operating income $ 36,626
=========
NINE MONTHS ENDED
SEPTEMBER 30, 2002:
Revenues $ 366,929 $ 217,961 $ 62,525 $ 10,364 $ 657,779
Gross Contribution 241,777 83,897 28,479 6,544 360,697
Corporate and other expenses (298,269)
---------
Operating income $ 62,428
=========
10
Note 8 - Intangible Assets
The following table presents the Company's intangible assets subject to
amortization (in thousands):
September 30, 2003 December 31, 2002
---------------------------------- ----------------------------------
Accumulated Accumulated
Gross Amortization Net Gross Amortization Net
-------- ------------ -------- -------- ------------ --------
Non-compete agreements $ 13,062 $(12,235) $ 827 $ 12,910 $(11,157) $ 1,753
Trademarks & tradenames 1,811 (1,444) 367 1,808 (1,307) 501
-------- -------- -------- -------- -------- --------
Total $ 14,873 $(13,679) $ 1,194 $ 14,718 $(12,464) $ 2,254
======== ======== ======== ======== ======== ========
Aggregate amortization expense for the three and nine-month periods ended
September 30, 2003 was $0.3 million and $1.1 million, respectively. Aggregate
amortization expense for the three and nine-month periods ended September 30,
2002 were $0.5 million and $1.4 million, respectively. The estimated future
amortization expense of purchased intangibles is as follows (in thousands):
2003 (remaining three months) $ 210
2004 709
2005 182
2006 69
2007 24
------
$1,194
======
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 $4.6 million during the nine months ended September 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 related to estimated 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. Approximately $18.9 million of these charges
were for employee termination severance payments and benefits associated
with a workforce reduction, which resulted in the termination of 175
employees initiated during that period. During the nine months ended
September 30, 2003, the Company paid $10.3 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. Approximately $5.8 million of these charges
were associated with the Company's workforce reduction initiated during
that period and were for related employee termination severance payments
and benefits. This workforce reduction resulted in the elimination of
approximately 100 positions. The remaining $1.4 million related 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 were
associated with the Company's workforce reduction, which resulted in the
elimination of 383 positions, initiated in April 2001. During the nine
months ended September 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 were
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 nine months ended
September 30, 2002 5,808 10,014 1,424 17,246
Non-cash charges (120) (2,663) (1,424) (4,207)
Payments (7,919) (3,263) - (11,182)
--------- ------- ------- -------
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 nine months ended
September 30, 2003 5,426 - - 5,426
Payments (15,038) (5,158) - (20,196)
--------- ------- ------- -------
Accrued Liability at September 30, 2003 $ 2,111 $10,778 $ - $12,889
========= ======= ======= =======
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 17, 2001, the Company's Board of Directors approved the repurchase of up
to $75 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 additional increase of $75 million in the stock repurchase program
bringing the total authorization to date to $200 million. During the nine months
ended September 30, 2003, the Company repurchased 3,018,240 shares of its Class
A Common Stock and 1,040,785 shares of its Class B Common Stock at an aggregate
cost of $32.4 million under this program. On a cumulative basis at September 30,
2003, the Company has purchased $116.1 million of its stock under this stock
repurchase program.
12
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 September 30, 2003, management was not aware of any indemnification
agreements that would require material payments.
Note 12 - Subsequent Event
As announced on October 9, 2003, the Company converted into common stock the
$300 million original face amount, 6% convertible subordinated notes held by
Silver Lake Partners ("SLP") and other noteholders. The notes were converted,
based upon a $7.45 conversion price, into 49,441,122 shares of Gartner Class A
common stock, representing approximately 49.5% of Gartner Class A Common Stock
outstanding and 38.4% of the total of Class A Common Stock and Class B Common
Stock, based upon shares outstanding as of September 30, 2003 and giving effect
to this conversion as if it had occurred on that date. The conversion was in
accordance with the original terms of the notes.
The transaction during October of 2003 resulted in converting the original face
amount of $300 million plus accrued interest of $68.3 million into equity. The
unamortized balances of debt issue costs of $2.8 million and debt discount of
$0.3 million as of the conversion date will be netted against the outstanding
principal and interest balances, resulting in a $365.2 million increase to
stockholders' equity. Additionally, certain costs directly associated with the
conversion will be charged to equity.
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.
14
CLIENT RETENTION RATE represents a measure of client
satisfaction and renewed business relationships at a
specific point in time. 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 committed business to
be derived from in-process consulting, measurement
and strategic advisory services engagements, for
which future revenue is expected.
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.
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 $40.8 million and $29.3 million at September 30, 2003
and December 31, 2002, respectively. In addition, at September 30, 2003 and
December 31, 2002, the Company had not recognized uncollected receivables or
deferred revenues, relating to government contracts that permit termination, of
$6.8 million and $4.7 million, respectively.
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
15
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 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 September 30, 2003 were
$228.3 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 $11.5 million and $10.7 million at
September 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 requires an annual assessment for goodwill
impairment. 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
value of a reporting unit is less than its carrying amount, we must recognize an
impairment of our goodwill associated with such reporting unit in our financial
statements. The carrying amount of goodwill at September 30, 2003 was $225.5
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
16
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.
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 11% in the third quarter of 2003 to $196.9 million
compared to $220.5 million for the third quarter of 2002 and decreased 7%, or
$43.3 million, when comparing the first nine months of 2003 to the first nine
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
exchange rates. Excluding the effects of foreign currency translation, revenues
would have decreased 13% for the quarter and 10% for the nine-month period. The
decrease in revenues for the third quarter of 2003 as compared to the third
quarter of 2002 was due to a larger decrease in consulting revenues when
comparing the quarterly periods as compared to the decrease on a year-to-date
basis. 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 increased $0.9 million, or 1%, to $94.4
million in the third quarter of 2003 from $93.5 million in the third quarter of
2002 and increased 4%, or $12.3 million, when comparing the first nine months of
2003 to the first nine months of 2002. Excluding the effects of foreign currency
translation, cost of services and product development would have decreased by 2%
for the quarter and been relatively consistent when comparing the nine-month
periods. The increase in cost of services and product development as a
percentage of sales during 2003 resulted primarily from investments in Gartner
EXP, Gartner G2, membership programs, product development and database
management, higher conference related expenses, and lower utilization rates for
our consulting practice.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES decreased $6.5 million, or 8%, to
$79.2 million in the third quarter of 2003 from $85.7 million in the third
quarter of 2002. SG&A expenses also decreased 5%, or $12.8 million, when
comparing the first nine months of 2003 to the first nine months of 2002. The
effects of foreign currency translation had minimal impact on the quarterly
comparison, but SG&A would have decreased by 8% had it not been for the negative
effect of foreign currency translation when comparing the nine-month periods.
The decrease in SG&A was primarily the result of lower headcount and lower
commission expenses, partially offset by the effects of foreign currency
translation exchange rates.
DEPRECIATION EXPENSE for the third quarter of 2003 decreased 22% to $9.0
million, compared to $11.7 million for the third quarter of 2002 and decreased
15%, or $4.7 million, when comparing the first nine months of 2003 to the first
nine months of 2002. The decrease was due to a reduction in capital spending
during 2002 and 2003 relative to the capital spending during 2000 and 2001,
which has led to a decrease
17
in depreciation expense. In addition, costs capitalized during 2000 associated
with the initial launch of the gartner.com web site in January 2001 have been
fully depreciated as of the beginning of 2003.
AMORTIZATION OF INTANGIBLES decreased when comparing the quarterly and nine
month period ending September 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 nine 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 nine 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 termination of 92 employees, or approximately 2% of
the Company's workforce at that time. We expect the payments associated with the
workforce reduction to be completed by the end of the first quarter of 2004. The
remaining $1.4 million of expenses recorded as other charges during 2003 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 nine-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 nine months ended September 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 nine month period ended September 30, 2002 was
caused primarily by the recognition of impairment losses related to equity
securities owned by us through two limited partnerships, 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 third quarter and the first nine months of
2003 consists primarily of net foreign exchange losses and gains. Other
(expense) income, net for the third quarter of 2002 also consists primarily of
net foreign exchange gains. For the nine months ended September 30, 2002, other
(expense) income, net includes a $0.5 million gain from the sale of certain
assets during the first quarter of 2002, partially offset by net foreign
exchange losses.
PROVISION FOR INCOME TAXES was 33.0% and 34.5% of income before income taxes for
the three and nine months ended September 30, 2003, respectively. Excluding the
effect of the insurance recovery, the tax rate for the nine months ended
September 30, 2003 was approximately 33% as compared to 34% for the nine months
ended September 30, 2002. The reduction in the effective tax rate for the 2003
year, as compared to the 2002 year, reflects the implementation of tax planning
strategies.
BASIC AND DILUTED INCOME PER COMMON SHARE was $0.07 for the third quarter of
2003, compared to $0.19 and $0.15, respectively, for the third quarter of 2002.
Basic and diluted income per common share was $0.21 for the nine months ended
September 30, 2003, and was $0.35 and $0.30, respectively, for the nine months
ended September 30, 2002. For the first nine months of 2003, the insurance
recovery received during the second quarter had a favorable impact of $0.03. Our
restructuring costs recorded as other charges offset the favorable impact of the
insurance recovery by unfavorably impacting diluted
18
income per share by $0.03. During the first nine months of 2002, the impairment
of investments had an unfavorable impact of $0.01, and the restructuring charges
during the first nine months of 2002 impacted diluted income per share by $0.09
unfavorably.
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 6% when comparing the third quarters of 2003 and
2002 and decreased 5% when comparing the first nine months of 2003 with the same
period of 2002. Foreign currency exchange rates favorably impacted research
revenues by 2% when comparing the quarterly periods and 4% when comparing the
nine month periods. The decrease in research revenues was due to the overall
weakness in the economy and the impact of this weakness on corporate information
technology spending causing lower demand throughout the entire technology
sector.
Research gross contribution of $73.3 million for the third quarter of 2003
decreased 7% from $79.1 million for the third quarter of 2002, while gross
contribution margin for the third quarter of 2003 decreased to 63% from 65% in
the prior year period. For the nine months ended September 30, 2003, gross
contribution decreased to $222.4 million, or a 64% contribution margin, from
$241.8 million, or a 66% 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 was $469.6 million at September 30, 2003, a decrease of
5% from $496.0 million at September 30, 2002; however, contract value increased
sequentially from $468.5 million at June 30, 2003. At September 30, 2003, our
client retention rates increased 1% to 76% as compared to the same measure at
the end of the second quarter of 2003 and has increased 2% as compared to the
same measure at the end of the first quarter of 2003. The decrease in contract
value as compared to the prior year 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 21% for the third quarter of 2003 and decreased
12% for the first nine months of 2003 as compared to the same periods of 2002.
Foreign currency exchange rates had a positive impact of 3% on the quarterly
comparison and 5% on the nine-month comparison. The decrease in revenues was
caused by lower demand, which has resulted in lower billable headcount and lower
utilization. Workforce reductions over the past year have resulted in reduced
billable headcount in response to the lower demand in the technology sector.
Billable headcount for our consulting business as of September 30, 2003 has
decreased approximately 14% as compared to September 30, 2003.
Consulting gross contribution of $21.7 million for the third quarter of 2003
decreased 35% from $33.6 million for the third quarter of 2002, and contribution
margin for the third quarter of 2003 decreased to 34% from 42% in the prior year
quarter. Gross contribution of $65.3 million for the first nine months of 2003
decreased 22% from $83.9 million for the same period of 2002, with contribution
margin for the
19
period decreasing to 34% from 38%. The decrease in the gross contribution margin
was primarily attributable to lower consultant utilization rates.
Consulting backlog, which represents future revenues to be recognized from
in-process consulting, measurement and strategic advisory services engagements
decreased 14% to $92.8 million at September 30, 2003, compared to $107.6 million
at September 30, 2002, but increased as compared to the June 30, 2003 backlog of
91.0 million. Consulting backlog decreased as compared to the prior year due to
the decline in demand throughout the entire technology sector, as technology
customers continue to constrain spending.
EVENTS
Events revenues increased 6% to $15.9 million for the third quarter of 2003,
compared to $15.0 million for the third quarter of 2002, and increased 3% when
comparing the first nine months of each year. Changes in foreign currency
exchange rates had a 3% favorable impact on revenues when comparing both the
quarterly and nine-month periods on a year over year basis. Revenues have
increased slightly despite having three fewer events during the third quarter of
2003 as compared to the third quarter of 2002 and ten fewer on a year-to-date
basis in 2003 as compared to 2002. The average revenue per event has increased
during 2003 due to the strong performance of new events added during 2003 as
compared to the events that were discontinued.
Gross contribution of $5.2 million, or 32% of revenues, for the third quarter of
2003 decreased from $6.5 million, or 43% of revenues, for the third quarter of
2002. Gross contribution of $24.1 million, or 37% of revenues, for the first
nine months of 2003 decreased from $28.5 million, or 46% of revenues, for the
first nine months of 2002. The decrease in gross contribution margin was due
primarily to increased personnel expenses and increased event marketing costs.
During 2003, we have invested more in marketing and promoting our events to
maintain our attendance levels during a weak economy, especially in the
technology sector.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities totaled $115.9 million for the nine months
ended September 30, 2003 compared to $144.7 million for the nine months ended
September 30, 2002. The net decrease in cash flow from operating activities of
$28.8 million was due primarily to lower operating income during 2003.
Additionally, we incurred $9.0 million of higher payments relating to our
restructuring programs during the first nine months of 2003 as compared to the
first nine months of 2002. Partially offsetting these decreases in operating
cash flow was improved working capital management, including improved
collections of receivables.
Cash used in investing activities was $12.4 million for the nine months ended
September 30, 2003, compared to $20.4 million for the nine months ended
September 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 in 2000.
Additionally, during 2002 we spent $4.0 million to purchase the remaining 49.9%
of People 3, Inc. not previously owned by us. During each of the first nine
months of 2003 and 2002, we funded $1.5 million of our investment commitment to
SI II, reducing our remaining commitment as of September 30, 2003 to $4.4
million. Spending on property and equipment increased $1.1 million to $16.4
million during the first nine months of 2003 as compared to $15.3 million during
the same period of 2002.
20
Cash used in financing activities totaled $12.0 million for the nine months
ended September 30, 2003, compared to $29.4 million for the nine months ended
September 30, 2002. We purchased $32.4 million of common stock for treasury
during the first nine months of 2003 as compared to $46.0 million during the
same period in the prior year. We received proceeds of $21.0 million from the
exercise of stock options and the purchase of stock by employees participating
in the employee stock purchase plan during the first nine months of 2003 as
compared to $16.9 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 September 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 September 30, 2003 was $46.9 million.
As discussed in the following paragraph, during October 2003 our convertible
debt was converted into shares of Class A common stock. Upon conversion of our
convertible debt, our borrowing availability under this credit facility is
$200.0 million.
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. ("SLP") and
other noteholders. Interest accrued semi-annually by a corresponding increase in
the face amount of the convertible notes. Accordingly, $68.0 million has been
added to the face amount of the convertible notes' balance outstanding at
September 30, 2003, resulting in a balance outstanding of $368.0 million on that
date, before reducing this balance for unamortized debt discount of $0.4
million. These notes were due and payable on April 17, 2005.
On October 7, 2003, we converted into common stock the 6% convertible
subordinated notes held by SLP and other noteholders. The notes were converted
based upon a $7.45 conversion price into 49,441,122 shares of Gartner Class A
common stock. After the conversion, the noteholders own, in the aggregate,
approximately 49.5% of Gartner Class A Common Stock outstanding and 38.4% of the
total of Class A Common Stock and Class B Common Stock outstanding, based upon
shares outstanding as of September 30, 2003 and giving effect of this conversion
as if it had occurred on that date.
The conversion resulted in converting the original face amount of $300 million
plus accrued interest of $68.3 million to equity. The unamortized balances of
debt issue costs of $2.8 million and debt discount of $0.3 million as of the
conversion date will be netted with the debt balances, resulting in a net credit
of $365.2 million dollars recorded as an increase to stockholders' equity.
Additionally, costs directly associated with the conversion will be charged to
equity.
Class A Common Stock and Class B Common Stock stockholders are entitled to one
vote per share on all matters to be voted by stockholders, other than the
election of directors. Class A Common Stock stockholders are entitled to one
vote per share on the election of Class A directors, which constitute not more
than 20% of the directors, and Class B Common Stock stockholders are entitled to
one vote per share on the election of Class B directors, which constitute at
least 80% of the directors. In addition, any Class B Common Stock holder who
owns more than 15% of the outstanding Class B Common Stock, will not be able to
vote all of his or her Class B Common Stock in the election of directors unless
such holder owns an equivalent percentage of Class A Common Stock.
We also issue letters of credit in the ordinary course of business. As of
September 30, 2003, we had letters of credit outstanding with JPMorgan Chase
Bank for $1.4 million, The Bank of New York for $2.0 million, and others for
$0.1 million.
21
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, there can be
no assurances that such capital will be available to us or will be available on
commercially reasonable terms.
Stock Repurchase Program
On July 17, 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
additional increase of $75 million in the stock repurchase program bringing the
total authorization to date to $200 million. During the nine months ended
September 30, 2003, we repurchased 3,018,240 shares of our Class A Common Stock
and 1,040,785 shares of our Class B Common Stock at an aggregate cost of $32.4
million under this program. On a cumulative basis at September 30, 2003, the
Company has purchased $116.1 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 fourth 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. 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 Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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
22
is effective for fiscal years ending after December 15, 2002. We continue to
account for stock-based compensation according to Accounting Principles Board
("APB") Opinion 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 us
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, 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 adoption of SFAS No. 149 had no 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
adoption of SFAS 150 had no impact on our 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
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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. 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.
Renewal of Research Business by Existing Clients. Some of our success depends on
renewals of our subscription-based research products and services, which
constituted 57% of total revenues for the first nine 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 76% and 75% for the third quarters of 2003 and 2002,
respectively. 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 33% of total revenues for the first nine 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.
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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 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 a $200.0 million senior revolving credit facility under
which we can incur significant additional indebtedness, although there were no
amounts outstanding at September 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
September 30, 2003 was $46.9 million, and subsequent to the conversion of our
convertible debt in October 2003, our borrowing availability is $200.0 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.
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.
25
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.
Significant Stockholder. Silver Lake Partners, L.P. ("SLP") and their affiliates
own approximately 46.7% of our Class A Common Stock and approximately 36.3% on a
combined basis with our Class B Common Stock. Currently, the owners of our Class
A Common Stock are only entitled to vote for two of the 10 members of our board
of directors and vote together with the holders of the Class B Common Stock as a
single class on all other matters coming before the stockholders. SLP is
restricted from purchasing additional stock without our consent pursuant to the
terms of a Securityholders' Agreement. This Securityholders' Agreement also
provides that we cannot take certain actions, including acquisitions and sales
of stock and/or assets without SLP's consent. While SLP does not hold a majority
of our outstanding shares, it may be able to exercise significant influence over
matters requiring stockholder approval, including the election of directors and
the approval of mergers, consolidations and sales of our assets. SLP's interests
may differ from the interests of other stockholders.
Anti-takeover Protections. Provisions our certificate of incorporation and
bylaws and Delaware law may make it difficult for any party to acquire control
of us in a transaction not approved by the requisite number of directors. These
provisions include:
- the presence of a classified board of directors;
- the existence of two classes of common stock with our Class B Common
Stock having the ability to elect 80% of our Board of Directors
- the ability of the board of directors to issue and determine the terms
of preferred stock;
26
- advance notice requirements for inclusion of stockholder proposals at
stockholder meetings; and
- the anti-takeover provisions of Delaware law.
These provisions could delay or prevent a change of control or change in
management that might provide stockholders with a premium to the market price of
their Common Stock.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
As of September 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 $368.0 million of 6% convertible subordinated notes. At September 30,
2003, there were no amounts outstanding under the revolving credit facility and
our borrowing availability was $46.9 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. Since our convertible debt has been
converted to shares of our Class A Common Stock during October of 2003, a
decrease in market interest rates would no longer have an associated opportunity
cost. 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
September 30, 2003, we had investments in equity securities totaling $11.5
million. Unrealized gains and losses net of deferred taxes are recorded as a
separate component of accumulated other comprehensive 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 September
30, 2003, this would result in a non-cash impairment charge of $11.6 million.
Additionally, we have a commitment to fund an additional $4.5 million of
investments with SI I and SI II. 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 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
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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 September 30, 2003, we had
one foreign currency forward contract 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
contract outstanding as of September 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 $ 4.4 0.6051 October 27, 2003
The gains and losses on this contract at September 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 September 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.
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PART II OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------- -------------------------------------------------------------
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 July 31, 2003 to furnish
the Company's press release issued July 31, 2003, with respect to financial
results for Gartner, Inc. for the quarter ended June 30, 2003.
The Company filed a Report on Form 8-K dated September 23, 2003 to
furnish the Company's press release issued September 19, 2003, with respect to
the Company's receipt of notice from holders holding $300 million of original
aggregate principal amount of 6% convertible subordinated notes of their
decision to convert 100% of the outstanding notes into approximately 49 million
shares of Gartner's Class A Common Stock.
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 November 14, 2003 /s/ Christopher Lafond
---------------------------------
Christopher Lafond
Executive Vice President
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
30