Gartner, Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Gartner provides research, consulting, events and talent-assessment services. Results include CEB from its April 5 acquisition date and L2 from March 9; segment reporting was revised following the CEB acquisition.
Financial performance and liquidity
| Metric | Q2 2017 | Six months 2017 |
|---|---|---|
| Revenue | $843.7 million, up 38% year over year | $1.469 billion, up 26% |
| Operating income (loss) | $(98.4) million; prior year $83.3 million | $(44.9) million; prior year $147.7 million |
| Net income (loss) | $(92.3) million; diluted EPS $(1.03) | $(55.8) million; diluted EPS $(0.65) |
| Interest expense, net | $44.0 million | $49.9 million |
| Cash from operations | Not stated separately for the quarter | $82.7 million, versus $161.8 million |
Q2 revenue growth was 40% excluding foreign-exchange effects, according to management. Research revenue was $613.7 million (+34%), Consulting $91.7 million (+6%), Events $91.2 million (+37%), and Talent Assessment & Other $47.1 million. CEB contributed $152.6 million of revenue in the quarter and six-month results.
Q2 cost of services and product development was 42% of revenue, compared with 38% a year earlier. Research gross contribution margin fell to 65% from 70%; management attributed about three percentage points of the decline to the acquisition-related fair-value adjustment to CEB deferred revenue. Consulting margin was 34% versus 33%, and Events margin 55% versus 54%. Consolidated operating margin was approximately negative 11.7% in Q2, versus positive 13.7% a year earlier.
At June 30, cash and equivalents were $589.3 million; principal debt was $3.468 billion (balance-sheet carrying amount $3.418 billion). Available revolving credit capacity was $675.0 million. Current assets were $1.760 billion and current liabilities $2.244 billion. Management said liquidity was adequate for anticipated needs. Approximately 94% of cash was held overseas. The company was in compliance with debt covenants.
Material changes and notable items
- Gartner acquired CEB for aggregate consideration of approximately $3.519 billion and L2 for $134.2 million. The preliminary purchase-price allocation included $2.428 billion of goodwill and $1.590 billion of finite-lived intangibles. Purchase accounting remained preliminary.
- The acquisitions materially increased leverage and interest costs. Debt included $800 million of 5.125% senior notes due 2025, term loans, revolver borrowings and a bridge loan; $200 million remained outstanding on the bridge facility at quarter-end, maturing April 2018.
- Acquisition and integration charges were $98.3 million in Q2 and $111.6 million year to date, versus $8.0 million and $16.4 million in the comparable 2016 periods. They included professional fees, severance, stock compensation and a $20.8 million accrual for Arlington office space the company does not plan to occupy.
- Amortization of intangibles was $65.5 million in Q2, versus $6.2 million; six-month expense was $71.8 million, versus $12.4 million. Higher acquisition-related costs, amortization and interest, together with the CEB deferred-revenue fair-value adjustment, contributed to the reported losses.
- Operating cash flow declined year over year, reflecting the net loss, higher bonus, commission and acquisition-cost payments, and working-capital timing. Investing cash use was $2.664 billion, primarily for acquisitions; financing provided $2.686 billion, largely from borrowings.
- Traditional Gartner research contract value increased 14% year over year to approximately $2.0 billion; client retention was 83% and wallet retention 105%. Consulting backlog was $91.0 million, down 2% year over year.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management stated that interim results may not indicate results for the rest of 2017 or beyond. It cited seasonality, demand, contract generation, foreign exchange, event timing, compensation and competition as factors that can cause results to fluctuate.
Key risks include integrating CEB and L2, realizing expected acquisition synergies, managing the new Talent Assessment & Other business and public-sector offerings, and subleasing acquired Arlington office space. Failure to sublease space or a subtenant default could lead to lost rental income or additional charges. Approximately $2.7 billion of debt was floating-rate; management estimated a 25-basis-point rate change could alter annual pretax interest expense by about $3.3 million. The company also identified foreign-exchange exposure and potential tax uncertainty. Ordinary-course litigation was not expected by management to have a material effect; no material indemnification payment obligations were reported.
Gartner was integrating the acquired businesses’ controls and planned to implement its internal control structure over them in 2018; the acquisitions were excluded from the 2017 Section 404 assessment under SEC guidance.
Important facts for investors to verify
- Whether CEB integration, synergies and acquired businesses’ operating performance support the acquisition price and preliminary goodwill and intangible valuations.
- How recurring acquisition, integration, amortization and deferred-revenue purchase-accounting effects influence margins and earnings in subsequent periods.
- Debt repayment, refinancing of the bridge facility, interest-rate exposure, covenant headroom and the extent to which offshore cash is available for U.S. needs.
- Trends in contract value, client and wallet retention, Consulting utilization and backlog, and Events attendance and monetization.
- Progress in subleasing Arlington office space and any resulting occupancy charges, along with integration of acquired controls and resolution of tax uncertainties.