Gartner, Inc. (IT) Earnings Call Transcript & Summary

All right. Good morning. I'm Jeff Meuler, Baird's Information Solutions analyst. The next presenting company in this room will be Gartner, the leading provider of syndicated research across all major corporate functions as well as related consulting and conferences. With us from the company is CFO and EVP, Craig Safian, who's been with Gartner since 2002 holding a number of finance and strategy, leadership positions with the company prior to being promoted to CFO in 2014. Also with us doing meetings throughout the today is the IR team of David Cohen and Kathleen Persaud. With that, I'll hand it over to Craig, who's going to show some slides, go through a quick company overview, and then we'll launch into Q&A. Investors, you have the option to e-mail me questions during the session. We also will have a breakout immediately following the session. But with that, over to you, Craig.

Thank you. Thanks, Jeff, and good morning, everyone. Thanks for joining us this morning. As Jeff mentioned, we'll do a very brief overview of the company, and then we'll dive into some -- I'm sure, some hard-hitting questions from Jeff and others. So a quick reminder, as I have to do, we will be discussing some forward-looking statements. And the other thing I would mention is basically all of our non-GAAP reconciliations can be found on our Investor Relations website. So with the formalities behind us, Gartner, we are a free cash flow growth compounder, and we believe we have a really long runway to continue to be a cash flow growth compounder from a top line perspective, bottom line perspective and a free cash flow perspective. So we've got a great long-standing financial model that is consistent with our medium-term guidance. Our medium-term guidance essentially includes double-digit top line revenue growth, modest margin expansion from a normalized 2021 level and free cash flow growth at least as fast as EBITDA. So that's sort of the high-level view from a financial perspective of the company. In terms of what we do, we deliver actionable objective insight to executives and their teams. And the way to think about it is our insight expert guidance and tools enable better decision-making across every major enterprise function, including IT, HR, supply chain, finance, legal, sales and all the others. And we deliver this insight through individual subscriptions that have a minimum term of at least 1 year. We have, Gartner, around 16,000 associates around the world, serving more than 14,000 client enterprises globally. We do business in about 100 countries, and we're just in about every major country you would imagine. We deliver that research through a variety of methods from our highly visible best practices, hype cycles, magic quadrants, to our tools and templates, to being able to speak within one of our analysts, one-on-one, where essentially, we're hoping every individual subscriber address their specific priorities, whether they are -- whatever they are and as they evolve. And I think one of the underappreciated aspects of our research is our ability to quickly pivot to quickly match our client needs. So priorities are fixed for a very short period of time and then often they change. And with a Gartner subscription, you're able to essentially pivot or change the channel as your priorities change, and it's not an incremental sale. It's all included in what you get. And so just to wrap it up and again, to reiterate the first slide, we believe we are a free cash flow growth compounder with a very long runway. And our free cash flow, after our investing activities, reflect the benefit of our business model, which is a large portion of our business. We bill upfront and collect the cash and then recognize the revenue and deliver services over time. We have a very strong balance sheet, and we expect to use our free cash flow going forward to return capital to shareholders through our repurchase programs and through opportunistic strategy informed tuck-in acquisitions. So with that, Jeff, happy to now launch into Q&A.

Thank you, and I appreciate the overview. So you didn't get into this level of granularity, but tech research is the majority of the research business, but I want to start with GBS. It's been a long time coming. I know it's been a lot of work on your end to the point where we're talking about GBS actually leading growth. And just to recap some of the metrics. Obviously, contract value growth really strong, but behind that, 87% new business growth last quarter, really strong wallet retention, 104.5%. Those are numbers that I almost didn't think were even possible, not too long ago. So I guess, on the magnitude of the strength and the fact that GBS is ahead of GTS, like what's driving that? Is it about sales capacity? Is it about an even less penetrated TAM? Just are there other factors in terms of how its contract because -- why is GBS, I guess, as strong as it is?

Yes. Well, first, I'd say, Jeff, we told you this for a number of years, and now the metrics are bearing out. Look, I think it's a number of things. So first off, it's all about the compelling client value proposition, and that really resonating with both prospects and clients. And again, it's the same value prop that you've seen from our tech side of our business. And we're just doing it in HR, in finance, in sales, in marketing, in supply chain, et cetera. And essentially, again, you go back to the way I talked about the value proposition, we're providing actionable objective insight to help leaders and their teams make better decisions. And that's critical, whether you're in finance or IT, quite honestly. We're obviously very excited about the GPS opportunity, and it had been accelerating, prepandemic. We took a couple of quarter hit there and then started to reaccelerate in the second half of 2020. And look, I think there's a couple of things we could talk about. First, we are seeing the benefits of all the building blocks and investments that we put in place in the 2017 to 2018 and early part of 2019 time frame. So we invested in building out our analyst and adviser team. We grew and train the sales force on new products with a new value proposition. We introduced subscription products for individual leaders and their teams. And we rolled out dedicated service capability to drive engagement, which, in turn, drives retention. And then so I'd say it's really almost all about that. And then obviously, the second element, which you alluded to, is the enormous market opportunity. So we always talk about the vast untapped market in GTS. And that remains absolutely 100% true, but it's even more true in GBS. So we feel like we can grow both of these businesses at double-digit growth rates. And again, that's reflected in our medium-term guidance as well.

And I guess, we have the historical Gartner metrics that apply to GTS. Are they fully applicable to GBS? Or are there some nuances? And I guess, in a way, GTS has a lot of different geographies and a lot of different sales forces, client sizes that all roll up. For GBS, you're also rolling up a few different business functions. So does that have an impact on, I don't know, new sales or on wallet retention and maybe do I just need to reorient on what's possible on some of those metrics within GBS?

Yes. I mean, you're right in that structurally, we are in GBS, unlike GTS, we are selling to multiple functions within a single enterprise. And so if you pick an enterprise, so enterprise X, we could sell to HR, finance, legal, sales, customer service, et cetera. And that would be one enterprise. And so if we are able to do that really successfully over time with penetrating a new enterprise, a new function each year, the enterprise count will remain the same. And while retention would continue to expand each and every year. And so as we grow within that enterprise, you're right, the wallet retention over time, it could be structurally higher than what we see in GTS, which is essentially a one function sale. Now obviously, within tech, you can penetrate different organizations, different geographic regions, slightly different buying centers. And again, that's been part of the recipe for GTS for a really long time. But if you think about the addressable market within an enterprise, there are obviously many more functions under GBS than there are under GTS. And again, I think we will have to reorient or think about the metrics a little bit differently. So structurally, there is more potential upside on that wallet retention number for sure within GBS.

And what's left to be done in GBS? So as you said, you have the CEB-based products. I don't think you quite have them for the full tail of all of the functions and smaller functions. You have the dedicated service. Obviously, it's -- the business is performing incredibly well right now even through the pandemic. How many more CEB-based products do you have to roll out? Where are you in terms of the content and transitioning it from best practices, research or maybe amplifying like the analyst insights as part of it or building out the conferences business? Like what's yet to be done?

Yes. There's still -- I mean, we've obviously made great progress. And the nicest thing we see is that the current product set and current product architecture we have in the market is clearly resonating in the market. And you can see that both from a new business perspective and from a retention perspective. But if you think about the full Gartner portfolio, whether that be the product stack within research or the conference portfolio, we still have a long way to go. And again, it would only help our growth rate. It's not that we're struggling because we don't have that full portfolio. But if you think about the product stack within tech, which, again, we've been at for 30-plus years, we've got products, multiple products for the C-level within IT. And then we've got products for their direct reports and their teams and front line professionals. And again, this is why the tech market is bigger than any -- market opportunity is larger than any of the other markets we serve because of that full product stack. And because we know there are users that go from the top to the bottom of the organization. And so over time, we have the opportunity to potentially build out that product stack within the GBS functions. Maybe not all of them, but in the GBS functions where it's relevant to look more like the GTS product stack. And similarly, on the conference side, I think we have that opportunity as well. Obviously, the pandemic gotten away a little bit of rollout plans of conferences. But we, within the IT portfolio, the GTS portfolio, we essentially have conferences in every major region where we do business. And we're not there yet with the GBS Conference portfolio, but Conferences are a core part of the way that we go-to-market broadly and are obviously very complementary to the research business. And so you can definitely see us over time filling out that Conference portfolio as well.

And I know you said earlier, like, hey, we told you we're going to get to this 12% to 16% growth in GBS, and we're there. You've also told us you're going to get back there in GTS, and that's been the long-term trend. Help us understand like what does the recovery look like in GTS? During and coming out of the last downturn, it only took like 4 quarters to go from declining to double-digit growth. Any -- is that the right framework? Or are there differences about this recession or just anything in terms of like why GTS is maybe lagging the recovery?

Yes. So I think looking at the last major recession is instructive in a number of ways, both in terms of time to trough and time to rebound. I would be remiss if I didn't point out that, the trough was a lot less deep. This recession for GTS than it was in the prior recession, where I think our trough was a 4% decline in contract value growth. And this time around, we're looking at a trough of around 4%, a positive. And again, we do start lapping tough compares or getting into the easy compare territory, which, again, is always helpful when you're coming out of an environment with a trough. So look, I mean, we feel very good about where we are from a GTS perspective. If you look at stand-alone Q4 and stand-alone Q1, they're pretty good quarters from a new business perspective, from a retention perspective. And the outlook in the pipeline remains pretty strong. And we get the benefit of "easy compares" rolling into Q2, where on the rolling 4-quarter metrics, we lose a really challenging Q2, which was Q2 of last year, and we gain. Even if it's an average Q2, things will look a lot better. So we feel like we're on a really good path again with both GBS and GTS. And I think looking at the rebound time of the last turnaround can be an instructive way to look at the GTS acceleration moving forward as well.

Yes. You talk a lot about, and I think investors are oriented around like looking at the year-over-year growth in contract value, and there is some seasonality. But the GTS contract value performance sequentially was also really strong in Q1 relative to what it normally is Q4 to Q1. We got an investor question, and it's, I guess, related to your margins being temporarily inflated in 2021, and you referenced that there's an underlying 18% to 19% margin in 2021. And it's trying to get at the bridging to the double-digit EBITDA growth. So does -- do margins have to be -- does the double-digit EBITDA growth guidance imply that margins will be significantly better than 18% to 19% in 2022? Or can you just help bridge maybe those 2 metrics?

Yes. So the way we think about the business is, first, given the market opportunity and given the medium-term guidance levels for the top lines on each of our businesses. And again, this is not specific to 2022, we can double-click on that if you want. In a moment, we can obviously drive double-digit top line growth. To deliver modest margin expansion from whatever baseline you want, whether it's a normalized level of the 18% to 19% that we talked about or what have you, essentially, we're growing EBITDA just a little bit faster than the top line. And again, importantly, we believe we can grow free cash flow at same rate or potentially even a little bit faster than EBITDA. And so again, we have a very firm belief that we will get the business as it rebounds and comes out of this downturn, and we get back to in-person conferences and GTS starts to reaccelerate and all the other great stuff that we will get this business back to being a double-digit top line performer. And then from there, we will manage our expense base and investments so that we are poised to continue to grow into the future. So we'll continue to invest in growing our sales force. We'll continue to invest in great products. We'll continue to invest in initiatives that drive sales productivity. We'll continue to do all that. We'll just do so at an expense growth clip that is modestly lower than the top line clip. And again, that's how we drive the margin expansion moving forward.

And I guess, once you come to agree with the management view around the TAM being there and untapped and you have the products, I think your competitively advantaged. A lot of the model does get down to sales headcount and sales productivity. To get to margin expansion, do you need to grow contract value faster than sales headcount? And just help us understand like the productivity levers, especially to the extent to which the labor market seems like it's starting to tighten. And I think in GTS, like the sequential headcount in GTS sales -- quota-bearing sales headcount was a little bit weaker this quarter. So just talk through turnover, talk through the ability to achieve those things in a potentially tightening labor market?

Yes. I mean -- so a couple of thoughts. If you think about the growth algorithm for us, the primary element to the sort of in-year growth algorithm is the amount of -- are the retention levels and the amount of new business we can drive, right? And essentially, the headcount investment we make in a given year is really about seeding investment for future years' growth, right? So the growth that we want to invest in 2021 won't have much of an impact on contract value growth and virtually no impact on revenue growth in-year, it's all about making sure that we've got a slightly larger army heading into next year to be able to continue to drive growth. But again, it's all about that retention and new business, which comes together to generate that contract value growth or net contract value increase and then looking at that on a per AE basis gives you our overall productivity level. We've tweaked our algorithm a little bit in the way we think about supporting the growth. And this is with a combination of sustained long-term double-digit growth and that modest margin expansion that we have now committed to. And the way we want to do that is we believe that we can drive the top line growth we need year after year after year after year by essentially investing in growing the sales force, call it, 3 points lower than contract value. And the reason we do it that way is so that essentially notional cost of sale or sales cost as a percent of CV or percent of revenue remains flat, right? So does it dilute the margin overall and does it help the margin? And then we get a little bit of gross margin expansion and a little bit of G&A leverage. And that's where the overall EBITDA margin, modest EBITDA margin expansion comes from. But we do believe that, let's just say, we were growing CV at 14%, we would grow headcount at 11%. And 11% is really nice headcount growth. And again, it's all about what it then delivers for us in the future years. So that is the slight tweak we've made strategically and to our overall sort of economic algorithm going forward. And again, the way we can keep up the contract value growth rate is through those adding headcount so that in the following year, we've got more feet on the street to sell and a very modest improvement in the NCVI productivity that we track, that can keep that growth rate sustained. If we can get more than a little bit of a modest uptick in productivity that can accelerate the growth rate. And again, we're tuned so that if we see an increase in the contract value growth rate, we will increase the headcount as well. So in my example, if we went from 14% to 15% or 16%, we would also turn them out, turn the dials a little bit so that headcount growth grew a couple of points quicker as well.

And the other offset, just to bridge all this math, you get about 3 points roughly of price. So when you say 3 points slower headcount to maintain selling expense as a percentage of revenue or CV, that's the other kind of piece to get there, right?

That's right. And again, and we sort of blend that all in with our overall sort of selling metrics. It happens every year. So it's not an incremental improvement from year to year, but you're right. That is baked into the way our sales force goes to market and the way we retain business. And structurally, we do take our prices up in the 3-plus percent range each year.

So we alluded to this earlier that the 2021 margins are temporarily inflated. You just referenced getting some gross margin expansion over time. The research gross margins look like they're running hot, at least relative to your prior target. Do they remain above your prior target because there's more remote interaction and webinars and things that came out of the pandemic that could be lasting? Or are they part of the over-earning margin in 2021 that needs to normalize lower?

It's a little bit of both, Jeff. So clearly, we have not had any travel over the last 12 to 15 months. And the gross margin line on research has benefited from that really, really nicely. That said, when we get back to "normal" whenever that is and whatever that is, we don't believe we'll need to travel as much as we did historically. So there's a little bit of leverage there. The gross margin leverage I alluded to really comes from continued shift in mix. So as research continues to become a bigger and bigger piece of the pie. It being the highest gross margin business that we have, just naturally based on math, even without any gross margin leverage in the research business, just based on the math, you can see some modest gross margin leverage from that.

Got it. So as we get back to traveling again, your conferences have been getting facilitated digitally for the last few quarters. Operationally, you're planning to get back to in-person conferences this fall. So just talk us through like the decision window. So when do you make the go or no-go decision on if these are going to be happening or not, and your guidance assumes that they're going to be digital? And then what are the financial implications if you actually are doing them in-person, like to what extent you need to bring back costs that you had taken out or just help us understand what the indications are and when you make the decisions?

Yes. No, no, happy to. So just to level set. So our current guidance, as you mentioned, assumes virtual-only, right, from a top line perspective. Baked into that, our EBITDA guidance does assume, we've got the headcount in place to go either way, right? So we've kept -- we did an action last year to sort of rightsize the Conferences business. And then we've been building back up modestly so that we had the optionality to go either way. And again, as you mentioned, we are operationally planning to start running conferences in the mid- to late September time frame, but predominantly fourth quarter. And we needed certain staff on board to have that optionality. I think, obviously, in terms of the go, no-go, there's not going to be one answer. There will be 20 or 25 different answers depending on the jurisdiction that we're operating in, what's happening there from a COVID perspective, what is allowed, what clients want to do, what our exhibitors want to do, et cetera. But if it's safe and permitted, and we feel like we can attract a large enough in-person audience to run a profitable conference, we will do that. And so if you sort of look at in the U.S. given where we are today that seems like that could happen, right? If you were to ask me, are conferences in India in the fourth quarter? That is unlikely to happen, right? Europe? We'll see. But clearly here in the U.S. or in Australia are places that look good from a numbers perspective, from a COVID -- through the COVID lens, we have a higher likelihood of being able to run those versus an Indian conference or something on the continent in Europe. In terms of the go, no-go, obviously, the closer we get to the conference, the more costs we start to commit to, right? So to date that is relatively minimal other than marketing costs and the fixed headcount costs we talked about earlier, starting in July, though, as we get closer to September and October. In November, we do start incurring some fixed costs and/or contractual commitments with sites and things of that nature. And so over the course of the next, really 2 to 3 months, where we're making those -- getting to those cost decision points, we're going to be making calls on whether we proceed or pull back and go with virtual. The other thing I'd mention, which is obviously an important piece of this in addition to the local regulations, is we are keeping a very, very, very tight view on the pulse of what our potential clients and attendees want to do and what our sponsor exhibitors want to do. And if they are able to travel or not. And the response has been generally very positive. People want to get back to in-person conferences. And if they are able to, they will want to, but we're continuing to watch that very closely, and that will go into our ultimate decision-making over the next couple of months as well. Once we report Q2 earnings in early August, we'll have a lot more visibility on what our likelihood is of holding some in-person destination conferences. And we'll update it accordingly. But the way to think about it, just to close out on your question, Jeff, economically, obviously, there's a lot more revenue to be generated in an in-person scenario. There's also a lot of costs, right? So the site costs, food and beverage, getting our teams down there, all that stuff. And so it does flow through a nice gross margin, but it's not like you'll see 100% flow through on that upside, you'll probably see in the neighborhood of 40%, 50% flow through on that upside, potentially a little bit more depending on the specific conference. So that's the way we're thinking about it. And we do look forward to updating everybody in August once we're closer to those conferences and have better line of sight to which ones do have a higher likelihood of being in person.

Awesome. And then we only have a minute, so hopefully, we can get this quickly. But you talked about being a free cash flow compounder. To me, GBS, magnitude of strength was one surprise. In the last couple of quarters, the other surprise to some investors was just how strong free cash flow has been and how strong it's going to be in guidance. What's the right benchmark? You used to talk about conversion as a percentage of adjusted net income or GAAP net income. Now it seems like you're talking free cash flow margins. So what benchmark should investors be using?

Yes. I personally like the free cash flow margin a little bit better. And so the way to think about it is the -- our normalized free cash flow margin should run about 3 to 4 points lower than our EBITDA margins. So if we say normalized EBITDA margins of 18% to 19% that implies free cash flow margins in the roughly 14% to 16% range going forward, which, again, is back to historical levels back in the early part of last decade, but a lot stronger than what we've been able to drive over the last few years.

It's good summary. So unfortunately, we're out of time in this room. As I said at the beginning, we do have Gartner for a breakout session. If investors want to follow us over, we'll get that going in the next few minutes. The next presenting company at the conference are Shake Shack, Ansys, Sykes, Bandwidth, Sun Communities, SEMRush and NV5 Global. So with that, thanks to Craig and the Gartner team, and thanks to all the investors who have attended. We'll see you shortly.

Thank you, Jeff. Thanks, everyone.