1
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 QUARTER ENDED MARCH 31, 1999
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 GROUP, 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)
P.O. Box 10212 06904-2212
56 Top Gallant Road (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 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 .
--- ---
The number of shares outstanding of the Registrant's capital stock as of
March 31, 1999 was 103,748,743 shares of Common Stock, Class A.
2
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS Page
Condensed Consolidated Balance Sheets at March 31, 1999
and September 30, 1998 3
Condensed Consolidated Statements of Operations for the
Three and Six Months ended March 31, 1999 and 1998 4
Condensed Consolidated Statements of Cash Flows for the
Six Months ended March 31, 1999 and 1998 5
Notes to Condensed Consolidated Financial Statements 6
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 8
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISKS 15
PART II OTHER INFORMATION
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS 15
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K 15
2
3
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
GARTNER GROUP, INC.
Condensed Consolidated Balance Sheets
(In thousands)
March 31, September 30,
1999 1998
---- ----
ASSETS
Current assets:
Cash and cash equivalents $ 185,113 $ 157,744
Marketable securities 71,364 60,940
Fees receivable, net 248,328 239,243
Deferred commissions 22,070 28,287
Prepaid expenses and other current assets 22,680 24,865
--------- ---------
Total current assets 549,555 511,079
Long-term marketable securities 14,231 43,610
Property, equipment and leasehold improvements, net
56,068 50,801
Intangible assets, net 199,745 155,786
Other assets 76,799 71,595
--------- ---------
Total assets $ 896,398 $ 832,871
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 85,764 $ 106,400
Commissions payable 10,699 20,422
Deferred revenues 300,021 288,013
--------- ---------
Total current liabilities 396,484 414,835
Long-term deferred revenues 909 3,098
Commitments and contingencies
Stockholders' equity:
Preferred stock -- --
Common stock 58 57
Additional paid-in capital 302,746 262,776
Unearned compensation (12,333) --
Cumulative translation adjustment (3,492) (2,155)
Accumulated earnings 252,413 193,485
Treasury stock, at cost (40,387) (39,225)
--------- ---------
Total stockholders' equity 499,005 414,938
--------- ---------
Total liabilities and stockholders' equity $ 896,398 $ 832,871
========= =========
See accompanying notes
3
4
GARTNER GROUP, INC.
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
For the three months ended For the six months ended
March 31, March 31,
--------------------------- ---------------------------
1999 1998 1999 1998
-------- -------- -------- --------
Revenues:
Advisory and measurement $132,499 $121,533 $265,622 $237,522
Learning -- 4,980 -- 9,943
Other, principally consulting and conferences 38,829 23,052 96,086 64,767
-------- -------- -------- --------
Total revenues 171,328 149,565 361,708 312,232
-------- -------- -------- --------
Costs and expenses:
Cost of services and product development 60,377 52,158 139,727 118,561
Selling, general and administrative 59,132 50,526 116,984 99,521
Acquisition-related charge -- 6,294 -- 6,294
Nonrecurring charges 4,426 2,819 4,426 2,819
Depreciation 5,284 4,264 10,517 8,204
Amortization of intangibles 2,499 2,421 4,702 4,605
-------- -------- -------- --------
Total costs and expenses 131,718 118,482 276,356 240,004
-------- -------- -------- --------
Operating income 39,610 31,083 85,352 72,228
Interest income, net 2,600 2,449 5,076 4,651
-------- -------- -------- --------
Income before provision for income taxes 42,210 33,532 90,428 76,879
Provision for income taxes 13,369 13,433 31,499 31,136
-------- -------- -------- --------
Net income $ 28,841 $ 20,099 $ 58,929 $ 45,743
======== ======== ======== ========
Earnings per common share:
Basic $ 0.28 $ 0.20 $ 0.57 $ 0.46
Diluted $ 0.27 $ 0.19 $ 0.56 $ 0.43
Weighted average common shares outstanding:
Basic 103,535 99,516 102,641 98,996
Diluted 106,805 105,486 105,706 105,209
See accompanying notes
4
5
GARTNER GROUP, INC.
Condensed Consolidated Statements of Cash Flows
(In thousands)
For the six months ended
March 31,
--------------------------------
1999 1998
--------- ---------
Operating activities:
Net income $ 58,929 $ 45,743
Adjustments to reconcile net income to cash provided by
operating activities:
Depreciation and amortization 15,219 12,809
Provision for doubtful accounts 2,028 701
Equity losses of minority owned companies 617 472
Acquisition related charges -- 6,294
Deferred revenues 4,474 15,705
Deferred tax benefit (1,203) (12,224)
Changes in assets and liabilities, net of effects of acquisitions:
Increase in fees receivable (7,614) (37,988)
Decrease in deferred commissions 6,060 5,399
Decrease (increase) in prepaid expenses and other current assets 4,768 (3,004)
Increase in other assets (1,962) (2,827)
Decrease in accounts payable and accrued liabilities (31,453) (13,151)
Decrease in commissions payable (9,730) (5,625)
--------- ---------
Cash provided by operating activities 40,133 12,304
--------- ---------
Investing activities:
Payment for businesses acquired (excluding cash acquired) (26,245) (16,398)
Additions of property, equipment and leasehold improvements, net (13,634) (11,309)
Marketable securities sale (purchase), net 18,955 (31,960)
Investments in unconsolidated subsidiaries (2,775) (17,024)
Loans to officers -- (2,475)
--------- ---------
Cash used in investing activities (23,699) (79,166)
--------- ---------
Financing activities:
Issuance of common stock 9,873 25,713
Proceeds from employee stock purchase plan offering 2,469 3,204
Net cash settlement on forward purchase agreement (8,438) --
Purchase of treasury stock (1,177) --
Tax benefits of stock transactions with employees 8,467 34,912
--------- ---------
Cash provided by financing activities 11,194 63,829
--------- ---------
Net increase (decrease) in cash and cash equivalents 27,628 (3,033)
Effects of foreign exchange rates on cash and cash equivalents (259) (688)
Cash and cash equivalents, beginning of period 157,744 142,415
--------- ---------
Cash and cash equivalents, end of period $ 185,113 $ 138,694
========= =========
See accompanying notes
5
6
GARTNER GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Interim Condensed Consolidated Financial Statements
These interim condensed consolidated financial statements have been prepared in
accordance with generally accepted accounting principles 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
Gartner Group, Inc. (the "Company") on Form 10-K for the fiscal year ended
September 30, 1998. 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 month periods ended March 31, 1999 may not be indicative of the
results of operations for the remainder of fiscal 1999.
Note 2 - Nonrecurring Charges and One-Time Income Tax Benefit
In the second quarter of fiscal 1999, the Company recorded pre-tax, nonrecurring
charges totaling approximately $4.4 million related to the Company's recent
reorganization and planned recapitalization. Approximately one-half of the
charge relates to severance benefits as a result of certain job eliminations
associated with the reorganization. The remainder of the charge pertains to
legal and advisory fees associated with the planned recapitalization of the
Company (see Management's Discussion and Analysis of Financial Condition and
Results of Operations). In addition, the Company recorded a one-time income tax
benefit of $2.5 million primarily as a result of the settlement of certain
Federal income tax examinations through fiscal 1997. The benefit was recorded as
a reduction in the provision for income taxes in the Condensed Consolidated
Statements of Operations.
Note 3 - Acquisitions
In January 1999, the Company acquired all of the assets and assumed the
liabilities of G2R, Inc. ("G2R") for $7.8 million in cash and 358,333 shares of
Class A Common Stock of the Company which had an approximate fair market value
of $7.8 million. G2R is a provider of research and consulting services to IT
product vendors and professional services and outsourcing firms. The acquisition
was accounted for by the purchase method, and the purchase price has been
allocated to the assets acquired and the liabilities assumed, based upon
estimated fair values at the date of acquisition. The excess purchase price over
the fair value of amounts assigned to the net tangible assets acquired was
approximately $13.1 million. The resulting goodwill will be amortized by the
Company over 30 years.
In addition, in March 1999 the Company acquired all of the outstanding shares of
Inteco Corporation ("Inteco") for $4.8 million in cash. Inteco is a research and
advisory services company offering subscription products focused on Internet
technology and e-commerce used by consumers. Through surveys of U.S. and
European households, Inteco's primary demand-side research helps clients track
consumers' uses of interactive products. Inteco provides in-depth customized
research in the following technology areas: Internet delivery and content, PCs,
cable and satellite, electronic commerce, telephone and wireless, and consumer
electronics. The acquisition was accounted for by the purchase method, and the
purchase price has been allocated to the assets acquired and the liabilities
assumed, based upon estimated fair values at the date of acquisition. The excess
purchase price over the fair value of amounts assigned to the net tangible
assets acquired was approximately $6.5 million. The resulting goodwill will be
amortized by the Company over 30 years.
6
7
Note 4 - Computations of Earnings per Share of Common Stock
The following table sets forth the reconciliation of the basic and diluted net
earnings per share computations.
For the three months ended For the six months ended
March 31, March 31,
-------------------------------------------------------
1999 1998 1999 1998
-------- -------- -------- --------
Numerator:
Net income $ 28,841 $ 20,099 $ 58,929 $ 45,743
======== ======== ======== ========
Denominator
Denominator for basic earnings per share - weighted average
number of common shares outstanding 103,535 99,516 102,641 98,996
Effect of dilutive securities:
Weighted average number of common shares under warrant
outstanding 167 328 144 301
Weighted average number of option shares outstanding 3,103 5,642 2,921 5,912
-------- -------- -------- --------
Dilutive potential common shares 3,270 5,970 3,065 6,213
-------- -------- -------- --------
Denominator for diluted earnings per share - adjusted
weighted average number of common shares outstanding 106,805 105,486 105,706 105,209
======== ======== ======== ========
Basic earnings per common share $ 0.28 $ 0.20 $ 0.57 $ 0.46
======== ======== ======== ========
Diluted earnings per common share $ 0.27 $ 0.19 $ 0.56 $ 0.43
======== ======== ======== ========
Note 5 - Comprehensive Income
In June 1997, Statement of Financial Standards No. 130, "Reporting Comprehensive
Income" ("FAS 130"), was issued. FAS 130 establishes standards for reporting and
disclosure of comprehensive income and its components in a full set of
general-purpose financial statements. This statement requires that all items
that are required to be recognized under generally accepted accounting
principles as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. FAS 130 requires certain adjustments, including foreign currency
translation adjustments, which are reported separately in stockholders' equity,
to be included in comprehensive income. The Company has adopted the disclosure
provisions of FAS 130 effective October 1, 1998. Comprehensive income for the
three and six months ended March 31, 1999 and 1998 are as follows:
For the three months ended For the six months ended
March 31, March 31,
--------------------------------------------------------------------
1999 1998 1999 1998
-------- -------- -------- --------
Net income $ 28,841 $ 20,099 $ 58,929 $ 45,743
Foreign currency translation adjustments (2,270) (442) (1,337) (1,638)
======== ======== ======== ========
Comprehensive income $ 26,571 $ 19,657 $ 57,592 $ 44,110
======== ======== ======== ========
7
8
Note 6 - Restricted Stock Awards and Stock Option Grants
In January 1999, the Company granted restricted stock awards and stock options
under the 1991 Stock Option Plan and the 1998 Long Term Stock Option Plan. The
restricted stock awards will vest in six equal installments with the first
installment vesting two years after the grant and then annually thereafter.
Recipients are not required to provide consideration to the Company other than
rendering service and have the right to vote the shares and to receive
dividends. A total of 504,500 restricted shares were issued at a weighted
average market value of $23.25 per share. In addition, the Company granted
35,000 stock options with an exercise price of $1.00 per share that vest on the
same basis as the restricted stock awards. Such stock options had a fair market
value of $23.25 per stock option on the date of grant. The aggregate market
value of the restricted stock awards and stock option grants was $12.5 million.
Initially, the total market value of the restricted shares and stock options was
recorded as an increase in additional paid-in capital and unearned compensation
in stockholders' equity. Unearned compensation will be reduced by charges to
expense over the vesting period of the restricted stock and options.
Compensation expense for the restricted stock awards and option grants was
approximately $0.2 million for the quarter ended March 31, 1999.
ITEM 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations
The discussion and analysis below contains trend analysis and other
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. Actual results could differ materially from those projected in the
forward-looking statements as a result of the risk factors set forth below under
"Quarterly Operating Income Trends," "Other Factors That May Affect Future
Performance", "Year 2000 Issues" and elsewhere in this report.
RESULTS OF OPERATIONS
The following table sets forth certain results of operations as a percentage of
total revenues:
For the three months ended For the six months ended
March 31, March 31,
------------------------------------------------------------
1999 1998 1999 1998
------ ------ ------ ------
Revenues:
Advisory and measurement 77.3% 81.3% 73.4% 76.1%
Learning -- 3.3 -- 3.2
Other, principally consulting and conferences 22.7 15.4 26.6 20.7
------ ------ ------ ------
Total revenues 100.0 100.0 100.0 100.0
------ ------ ------ ------
Costs and expenses:
Cost of services and product development 35.2 34.8 38.7 38.0
Selling, general and administrative 34.5 33.8 32.3 31.9
Acquisition-related charge -- 4.2 -- 2.0
Nonrecurring charges 2.6 1.9 1.2 0.9
Depreciation 3.1 2.9 2.9 2.6
Amortization of intangibles 1.5 1.6 1.3 1.5
------ ------ ------ ------
Total costs and expenses 76.9 79.2 76.4 76.9
------ ------ ------ ------
8
9
Operating income 23.1 20.8 23.6 23.1
Interest income, net 1.5 1.6 1.4 1.5
------ ------ ------ ------
Income before provision for income taxes 24.6 22.4 25.0 24.6
Provision for income taxes 7.8 9.0 8.7 10.0
------ ------ ------ ------
Net income
16.8% 13.4% 16.3% 14.6%
====== ====== ====== ======
TOTAL REVENUES increased 15% to $171.3 million for the second quarter of fiscal
1999 from $149.6 million for the second quarter of fiscal 1998. For the six
months ended March 31, 1999, total revenues were $361.7 million, up 16% from
$312.2 million for the same period last fiscal year. Excluding revenues from the
Company's learning business, GartnerLearning, which was sold in September 1998,
ongoing business revenue increased 18% for the second quarter of fiscal year
1999 and 20% for the six months ended March 31, 1999 as compared to the same
periods in the prior fiscal year. The Company enters into annual renewable
contracts for advisory (excluding consulting) and measurement services. Advisory
and measurement services encompass services which, on an ongoing basis,
highlight industry developments, review new products and technologies, provide
quantitative market research, analyze industry trends within a particular
technology or market sector and provide comparative analysis of the information
technology operations of organizations. Revenues from advisory and measurement
services are recognized as services and products are delivered, and as the
Company's obligation to the client is completed over the contract period.
Revenues from advisory and measurement services increased by 9% to $132.5
million from $121.5 million for the second quarter of fiscal 1998. Revenues from
advisory and measurement services increased 12% to $265.6 million for the six
months ended March 31, 1999, compared to $237.5 million for the same period in
the prior fiscal year. The increase in revenues from advisory and measurement
services reflects continuing client acceptance of new products and services,
sales penetration into new and existing clients and incremental revenue from
current and prior year acquisitions.
Contract value increased 18% to $603.1 million at March 31, 1999 versus $512.4
million at March 31, 1998. The Company believes that contract value, which is
calculated as the annualized value of all advisory and measurement contracts in
effect at a given point in time, without regard to the duration of the contracts
outstanding at such time, is a significant measure of the Company's volume of
business. Historically, a substantial portion of client companies have renewed
these services and products for an equal or higher level of total value each
year, and annual revenues from these services in any fiscal year have
approximated contract value at the beginning of the fiscal year. As of March 31,
1999, approximately 85% of the Company's clients had renewed one or more
services in the last twelve months. However, this renewal rate is not
necessarily indicative of the rate of retention of the Company's revenue base,
and contract value at any time may not be indicative of future advisory and
measurement revenues or cash flows if the rate of renewal of contracts, or the
timing of new business, were to significantly change during the following twelve
months compared to historic patterns. Total deferred revenues of $300.9 million
and $291.1 million at March 31, 1999 and September 30, 1998, respectively, as
presented in the Company's Consolidated Balance Sheets, represent unamortized
revenues from advisory and measurement services and products plus unamortized
revenues of certain other business products and services not included in
advisory and measurement services and products. Deferred revenues do not
directly correlate to contract value as of the same date, since contract value
represents an annualized value of all outstanding contracts without regard to
the duration of such contracts, and deferred revenue represents unamortized
revenue remaining on all outstanding contracts including advisory and
measurement and certain other services and products not included in advisory and
measurement revenue.
9
10
Other revenues for the second quarter of fiscal 1999 increased 68% to $38.8
million compared to $23.1 million for the second quarter of fiscal 1998. For the
six months ended March 31, 1999, other revenues were $96.1 million, up 48% from
$64.8 million for the same period in the prior fiscal year. Other revenues
consist principally of revenues from consulting engagements and conferences. The
increase of $15.7 million for the second quarter of fiscal 1999 over the second
quarter of fiscal 1998 was primarily a result of the expansion of consulting
services to new geographic regions and incremental revenue from current and
prior year acquisitions as well as revenue from the Company's spring Symposia
event. Revenues from the Company's Symposia conferences and ITxpo exhibition
events held annually during the first quarter of the fiscal year also
contributed to the growth of other revenues for the six months ended March 31,
1999.
OPERATING INCOME increased 27% to $39.6 million, or 23.1% of total revenues, for
the second quarter of fiscal 1999, from $31.1 million, or 20.8% of total
revenues, for the second quarter of fiscal 1998. Operating income was $85.4
million for the six months ended March 31, 1999, an increase of 18% over the
$72.2 million for the same period in the prior fiscal year. The effect of
fluctuations in foreign exchange rates did not have a significant impact on
operating income during the second quarter of either fiscal 1999 or 1998.
Excluding acquisition-related and nonrecurring charges incurred in the
respective periods presented (collectively the "special charges"), operating
income for the three months and six months ended March 31, 1999 increased by
approximately 10% over the same periods in the prior fiscal year.
Costs and expenses, excluding the special charges, increased to $127.3 million
in the second quarter of fiscal 1999 from $109.4 million in the second quarter
of fiscal 1998. Year to date total costs and expenses, excluding the special
charges, were $271.9 million compared to $230.9 million for the same period in
the prior fiscal year. The increase in costs and expenses over the prior fiscal
year for both the three and six month periods ended March 31, 1999 primarily
reflects an increase in staffing to support the advisory, measurement and
consulting services, incremental costs associated with conferences and
additional costs associated with acquisitions. Cost of services and product
development expenses were $60.4 million and $52.2 million for the second quarter
of fiscal 1999 and 1998, respectively, and $139.7 million and $118.6 million for
the six months ended March 31, 1999 and 1998, respectively. Costs related to the
delivery of advisory and measurement services are treated as period costs which
are expensed as incurred. The increase in expenses over the prior fiscal year
reflects the need to provide additional support to the growing client base,
costs associated with acquired businesses and continued product development
costs. Selling, general and administrative expenses, which were $59.1 million
and $50.5 million for the second quarter of fiscal 1999 and 1998, respectively,
and $117 million and $99.5 million for the six months ended March 31, 1999 and
1998, respectively, increased as a result of the Company's continuing expansion
of worldwide distribution channels and additional general and administrative
resources needed to support the growing revenue base and the impact of
acquisitions. Although the Company has added general and administrative
resources to support the growing revenue base, selling, general and
administrative expenses have remained relatively unchanged as a percentage of
total revenues at 35% and 34% for the second quarter of fiscal 1999 and 1998,
respectively, and flat as a percentage of total revenues at 32% for the six
months ended March 31, 1999 and 1998, respectively.
In the second quarter of fiscal 1999, the Company recorded pre-tax, nonrecurring
charges totaling approximately $4.4 million related to the Company's recent
reorganization and planned recapitalization. Approximately one-half of the
charge relates to severance benefits as a result of certain job eliminations
associated with the Company's recent reorganization. The remainder of the charge
pertains to legal and advisory fees associated with the planned recapitalization
of the Company. In the second quarter of fiscal 1998, the Company recorded
pre-tax, nonrecurring charges, primarily consisting of relocation and severance
costs, totaling approximately $2.8 million related to the Company's relocation
of certain accounting and order processing operations from Stamford, Connecticut
to a new financial services center
10
11
in Fort Myers, Florida. Also in the same quarter of fiscal 1998, the Company
incurred an acquisition-related charge from a $6.3 million write-off of
purchased in-process research and development costs in connection with the
acquisition of Interpose, Inc. On December 10, 1998, the amount of the write-off
was reduced to $4.5 million (which was recognized in fiscal 1998 results) in
response to new guidance from the Securities and Exchange Commission.
Depreciation expense for the second quarter of fiscal 1999 increased to $5.3
million compared to $4.3 million for the second quarter of fiscal 1998. For the
six months ended March 31, 1999 depreciation expense increased to $10.5 million
compared to $8.2 million for the same period in the prior fiscal year. The
increases were the result of capital spending required to support business
growth.
Amortization expense remained flat as a result of increased amortization expense
related to recent acquisitions offset by the reduction of amortization expense
resulting from the sale of GartnerLearning in September 1998. Amortization
expense for the second quarter of fiscal 1999 increased to $2.5 million compared
to $2.4 million for the second quarter of fiscal 1998. For the six months ended
March 31, 1999 amortization expense increased to $4.7 million compared to $4.6
million for the same period in the prior fiscal year.
INTEREST INCOME, NET was $2.6 million for the second quarter of fiscal 1999, up
from $2.4 million for the second quarter of fiscal 1998. For the six months
ended March 31, 1999 and 1998, interest income, net was $5.1 million and $4.7
million, respectively. This increase was attributable to a higher balance of
investable funds during the second quarter of 1999 as compared to the same
period in the prior fiscal year, partially offset by changes in the mix of
investable funds to principally tax-free and tax-advantaged investments which
generally have lower interest rates compared to taxable investments.
PROVISION FOR INCOME TAXES was approximately $13.4 million in the second quarter
of both fiscal 1999 and fiscal 1998. The effective tax rate for the second
quarter and year to date fiscal 1999 was approximately 32% and 35%,
respectively. During the second quarter of fiscal 1999, the Company recognized a
one-time tax benefit of $2.5 million resulting from the settlement of certain
Federal income tax examinations through fiscal 1997. Excluding the one-time tax
benefit, the effective tax rate for the six months ended March 31,1999 was 38%
which is a decrease of approximately three percentage points from fiscal 1998.
This decrease is primarily the result of on-going tax planning initiatives.
DILUTED EARNINGS PER COMMON SHARE increased 42% to 27 cents per common share for
the second quarter of fiscal 1999, compared to 19 cents per common share for the
second quarter of fiscal 1998. For the six months ended March 31, 1999 and 1998,
diluted earnings per common share were 56 cents per common share and 43 cents
per common share, respectively, an increase of 30%. Excluding the impact of
non-recurring charges, diluted earnings per share were 27 cents per common share
for the second quarter and 56 cents per common share for the six months ended
March 31, 1999. Basic earnings per common share increased to 28 cents for the
second quarter of fiscal 1999 from 20 cents for the same period a year ago.
Basic earnings per common share was 57 cents for the six months ended March 31,
1999 compared to 46 cents for the same period last year.
PROPOSED RECAPITALIZATION, SPECIAL CASH DIVIDEND AND SHARE REPURCHASE In
November 1998, the Company's Board of Directors approved an agreement in
principle with IMS Health Inc. ("IMS Health"), which owns approximately 47.6
million shares or 46% of the Company's Class A Common Stock, to undertake a
recapitalization of the Company and facilitate a tax-free spin-off by IMS Health
to its shareholders of its equity position in the Company. As part of the
recapitalization, IMS Health will exchange 40.7 million shares of Class A Common
Stock for an equal number of shares of new Class B Common Stock of the Company
prior to the spin-off. This new class of common stock will be entitled to elect
at least 80% of the Company's Board of Directors, but will otherwise be
substantially
11
12
identical to existing Class A Common Stock. All Class B Common Stock will be
distributed to IMS Health shareholders in a tax-free distribution. IMS Health is
required by Internal Revenue Service ("IRS") regulations to monetize its
remaining interest in the Company as quickly as feasible after the spin-off,
subject to certain restrictions agreed to by both companies. IMS Health's
remaining interest will include 6.9 million shares and a warrant for an
additional 599,400 shares. In May 1999, the Company's Board of Directors
approved an amendment to certain terms of the transaction as announced by the
Company in November. The Company has agreed to repurchase 19.9% of its
outstanding shares following completion of the spin-off, instead of the lesser
of $300 million or 20% of its outstanding shares. The Company intends to conduct
a Dutch Auction tender offer, as soon as feasible after the spin-off, for 15% of
its outstanding shares. The remaining 4.9% of the shares are expected to be
repurchased in the open market. In addition, the Company has agreed to
reallocate $175 million of the previously planned $300 million cash dividend to
the share repurchase, resulting in a cash dividend of $125 million to the
Company's shareholders and ensuring sufficient funding for the share repurchase.
A favorable IRS tax ruling regarding the tax-free nature of the spin-off has
been previously received. In light of the restructured transaction, a
supplemental ruling from the IRS is being sought. The recapitalization plan
remains subject to SEC clearance of the proxy statement, additional regulatory
approvals and approval by the majority of non-IMS Health shareholders of the
Company voting at a special shareholder meeting.
QUARTERLY OPERATING INCOME TRENDS. Historically, the Company has realized
significant renewals and growth in contract value at the end of quarters. The
fourth quarter of the fiscal year typically is the fastest growth quarter for
contract value and the first quarter of the fiscal year typically represents the
slowest growth quarter as it is the quarter in which the largest amount of
contract renewals are due. As a result of the quarterly trends in contract value
and overall business volume, fees receivable, deferred revenues, deferred
commissions and commissions payable reflect this activity and typically show
substantial increases at quarter end, particularly at fiscal year end. All
advisory and measurement contracts are billable upon signing, absent special
terms granted on a limited basis from time to time. All contracts are
non-cancelable and non-refundable, except for government contracts which have a
30-day cancellation clause, but which have not produced material cancellations
to date. The Company's policy is to record at the time of signing of an advisory
and measurement contract the portion of the contract that is billable as
deferred revenue and fees receivable. The Company also records the related
commission obligation upon the signing of the contract and amortizes the
corresponding deferred commission expense over the contract period in which the
related advisory and measurement revenues are earned and amortized to income.
Historically, total revenues have increased in the first quarter of the ensuing
fiscal year over the immediately preceding quarter due to annual conferences and
exhibition events held in the first quarter. Additionally, operating income
margin (operating income as a percentage of total revenues) typically improves
in the first quarter of the fiscal year versus the immediately preceding
quarter. The operating income margin improvement in the first quarter of the
fiscal year is due to the increase in operating income generated on the first
quarter Symposia and ITxpo exhibition events plus an increase in advisory and
measurement revenue upon which the Company is able to further leverage its
selling, general and administrative expenses. Operating income margin in the
second quarter is typically consistent with the first quarter. In the second
quarter of fiscal 1999, the spring symposium event and management's ability to
control discretionary spending and variable costs linked to financial
performance favorably impacted operating margin. Operating income margin
generally is not as high in the third and fourth quarters of the fiscal year
compared to the first and second quarters. Additionally, the Company
historically does not fully increase its level of spending until after the first
quarter of the fiscal year, when the rate of growth in revenues and contract
value becomes known. As a result, growth in operating expenses has typically
lagged behind growth in revenues within a given year, and operating income
margin has generally been higher in the earlier quarters of the fiscal year.
Therefore, the operating income for the first two quarters of fiscal 1999 may
not be indicative of the quarterly operating results for the remainder of the
fiscal year.
12
13
OTHER FACTORS THAT MAY AFFECT FUTURE PERFORMANCE. The Company's future operating
results will depend upon the Company's ability to continue to compete
successfully in the market for information products and services. The Company
faces competition from a significant number of independent providers of similar
services, as well as the internal marketing and planning organizations of the
Company's clients. The Company also competes indirectly against other
information providers, including electronic and print media companies and
consulting firms. In addition, there are limited barriers to entry into the
Company's market and additional new competitors could readily emerge. There can
be no assurance that the Company will be able to continue to provide the
products and services that meet client needs as the Information Technology
("IT") market rapidly evolves, or that the Company can otherwise continue to
compete successfully. In this regard, the Company's ability to compete is
largely dependent upon the quality of its personnel, including its senior
management team, sales staff and IT analysts. Competition for qualified
personnel is intense. There can be no assurance that the Company will be able to
attract and retain additional qualified personnel, including IT staff, as may be
required to support the evolving needs of customers or any growth in the
Company's business. Any failure to maintain a premier staff of IT analysts could
adversely affect the quality of the Company's products and services, and
therefore its future business and operating results. Additionally, there may be
increased credit risk and turnover of accounts as the Company expands product
and service offerings to smaller companies.
The Company's operating results are also subject to risks inherent in
international sales, including changes in market demand as a result of exchange
rate fluctuations, tariffs and other barriers, challenges in staffing and
managing foreign sales operations, and higher levels of taxation on foreign
income than domestic income. Further expansion would require additional
management attention and financial resources.
YEAR 2000 ISSUES The Year 2000 problem results from the fact that many
technology systems have been designed using only a two-digit representation of
the year portion of the date. This has the potential to cause errors or failures
in those systems that depend on correct interpretation of the year, but cannot
necessarily correctly interpret "00" as the year "2000". While the potential
ramifications of the Year 2000 issue are significant, the Company believes that
it is taking full advantage of its internal resources and all necessary external
resources to understand, identify and correct all Year 2000 issues within its
control. The Company recognizes that there are significant unknowns, hence
potential risks, that are outside its control and will take all reasonable steps
to minimize the impact of those exposures.
The Company is on target to have made all essential IT and non-IT systems Year
2000 ready before their known failure dates or January 1, 2000, whichever is
sooner. All products of the Company are, or are expected to be Year 2000 ready
before their known failure dates or by January 1, 2000, whichever is sooner.
Should any date-related problems be revealed after that point, they will be
fixed at no extra charge to the customer or replaced with a product of equal
value. Initial testing of the four business critical applications for product
delivery (GG Interactive, GG Lotus Notes, GG Intraweb, and GG CD) has shown
these applications to be compliant with certain Company identified key functions
with full Year 2000 internal validation expected to occur early in the next
quarter. Additionally, the Company expects to continue to take all prudent and
reasonable steps to validate the Year 2000-readiness of its direct supply chain
interfaces, but believes that this area does and will continue to represent a
significant level of uncertainty and business risk at least through the first
half of the year 2000.
The Company has established a separate Year 2000 account to budget and track
significant fiscal 1999 Year 2000 expenditures. All maintenance and modification
costs are expensed as incurred, while the cost of new systems is being
capitalized according to generally accepted accounting principles. Identified
Year 2000 expenses were $1.9 million for the six months ended March 31, 1999,
and are forecasted to be $3.3 million for the remaining six months of fiscal
1999. These costs are predominantly for the budgeted replacement or upgrades of
the IT and non-IT systems, but also include personnel standard unit costs.
13
14
The Company believes that the Year 2000 problem may result in an increased
percentage of IT department budgets being directed toward Year 2000 remediation
expenditures in the near term. If this occurs, changes in customer buying
practices could result in either an increase or decrease in the demand for the
Company's products and services and, therefore, have the potential of benefiting
or adversely impacting future Company revenues and revenue patterns. Additional
information on year 2000 issues can be found in the Company's Form 10-K for the
fiscal year ended September 30, 1998.
Liquidity and Capital Resources
The Company's continued focus on revenue and operating income increases has
contributed to its ability to continue building cash and utilizing it to make
strategic investments and acquisitions. As of March 31, 1999, total cash and
cash equivalents and marketable securities (including both current and long-term
maturities) increased to $270.7 million. Cash provided by operating activities
totaled $40.1 million for the six months ended March 31, 1999 (compared to $12.3
million provided by operating activities for the six months ended March 31,
1998) reflecting primarily the impact of increased revenues and related changes
in the balance sheet accounts. Cash used in investing activities was $23.7
million for the six months ended March 31, 1999 (compared to $79.2 million of
cash used in the first six months of fiscal 1998) due primarily to the net
effect of cash used in acquisitions and investments in consolidated and
unconsolidated subsidiaries of $29.0 million and $19.0 million of cash provided
by maturing marketable securities. Cash provided by financing activities totaled
$11.2 million for the six months ended March 31, 1999 (compared to $63.8 million
of cash provided for the six months ended March 31, 1998). The cash provided by
financing activities resulted primarily from $9.9 million received from the
issuance of common stock upon the exercise of employee stock options and, $8.5
million increase in additional paid-in capital for tax benefits received from
stock transactions with employees which were partially offset by $8.4 million of
cash used in the settlement of forward purchase agreements. The tax benefit of
stock transactions with employees is due to the reduction in the corporate
income tax liability based on an imputed compensation deduction equal to
employees' gain upon the exercise of stock options at an exercise price below
fair value. Forward purchase contracts on the Company's common stock were
originally established to facilitate the acquisition of 1,800,000 shares of
Class A Common Stock necessary to offset a portion of the shareholder dilution
that will be created by the exercise of stock options reserved for issuance and
granted under the Company's 1996 Long Term Stock Option Plan.
The effect of exchange rates increased cash and cash equivalents by $0.3 million
through the six months ended March 31, 1999, and was due to the strengthening of
certain European currencies versus the U.S. dollar. The Company has available
two unsecured credit lines, with Chase Manhattan Bank and The Bank of New York
for $25.0 million and $5.0 million, respectively. These lines may be canceled by
the banks at any time without prior notice or penalty. Additionally, the Company
issues letters of credit in the ordinary course of business. The Company had
outstanding letters of credit with Chase Manhattan Bank of approximately $4.0
million and $2.0 million with The Bank of New York at March 31, 1999. Except as
described below regarding the proposed recapitalization, the Company believes
that its current cash balances and maturing marketable debt securities, together
with cash anticipated to be provided by operating activities and borrowings
available under the existing lines of credit, will be sufficient for the
expected short-term and foreseeable long-term cash needs of the Company.
If completed, the Company's proposed recapitalization would require a
significant amount of cash to fund the payment of the special dividend and the
repurchase of common shares. The Company intends to fund the recapitalization
through borrowings beyond the current lines of credit and, in lesser part,
through existing cash balances and marketable securities and anticipated funds
from operations. The Company currently believes that it will need to borrow
between $300.0 million to $450.0 million in order to fund the payment of the
special dividend and the share repurchase. The Company is presently negotiating
with
14
15
several banks to provide the required borrowings and believes that lending
commitments will be finalized shortly. However, prior to finalizing such
commitments, there can be no assurance that such financing will be available to
the Company on commercially reasonable terms, or at all. If and when the Company
obtains such financing, there can also be no assurance that the Company's debt
service obligations will not have a material adverse effect on the Company's
business, results of operations and financial condition. The Company currently
has no other material capital commitments.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Amounts invested in the Company's foreign operations are translated into U.S.
dollars at the exchange rates in effect at quarter end. The resulting
translation adjustments are recorded as cumulative translation adjustment, a
component of stockholders' equity, in the Condensed Consolidated Balance Sheets.
PART II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
On January 7, 1999, the Company issued 358,333 shares of Class A Common Stock as
partial consideration for the assets of G2R, Inc., as more fully described in
Note 2 to the Notes for the Consolidated Financial Statements. The securities
were not registered under the Securities Act of 1933 as amended (the "Act"), in
reliance on the exemption from registration provided by Rule 506 under the Act
and Section 4(2) of the Act.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit Number Description of Document
10.7(1) Gartner Group, Inc. 1991 Stock Option Plan as amended and restated on
October 13, 1998
10.22(2) Gartner Group, Inc. 1998 Long Term Stock Option Plan
27.1 Financial Data Schedule
(1) Incorporated by reference from the Registrant's Registration Statement
on Form S-8 (File No. 333-77015) as filed on April 26, 1999.
(2) Incorporated by reference from the Registrant's Registration Statement
on Form S-8 (File No. 333-77013) as filed on April 26, 1999.
(b) No reports on Form 8-K were filed by the Registrant during the fiscal
quarter ended March 31, 1999.
Items 1, 3, 4 and 5 are not applicable and have been omitted.
15
16
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Gartner Group, Inc.
Date May 17, 1999 /s/ Michael D. Fleisher
------------ -------------------------------
Michael D. Fleisher
Executive Vice President
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
16
5
1,000
U.S. DOLLARS
6-MOS
SEP-30-1999
OCT-01-1998
MAR-31-1999
2
185,113
71,364
248,328
4,406
0
549,555
124,538
68,471
896,398
396,484
0
0
0
58
498,947
896,398
361,708
361,708
139,727
139,727
136,629
2,028
0
90,428
31,499
58,929
0
0
0
58,929
0.57
0.56
Amount reported is EPS-BASIC
