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

Good afternoon. I'm Alex Hess, an associate on the Business and Information Services Equity Research team led by Andrew Steinerman here at JPMorgan. We are pleased to have with us today, Gartner CFO, Craig Safian, who has been with the company since 2002 and has been its CFO since 2014. Welcome to Ultimate Services, Craig.

Great to be here. Thanks for having us.

So maybe to lead off with, I would like to start with an overview for maybe those who might be new to Gartner. Could you tell us a bit about what Gartner does and the company's client value proposition?

Sure, absolutely. And thanks, everyone, for joining us. So our mission is to help senior executives and their teams accomplish their most important or mission-critical priorities. And we do that through a combination of insights, tools, templates, et cetera, to basically help them be better at their jobs and help their teams again accomplish those mission-critical priorities. If you think about the Gartner business, we've been around since 1979. Our heritage is in technology research. That's where we started out and where we played for several decades in 2009 or 2010, we actually got into covering and supporting supply chain leaders. In 2012, we got into marketing. And then in 2017 through the acquisition of a company called CEB, we actually got into covering all the other functional areas across the C-suite. So today, we help executives and leaders across the entire C-suite, whether it's technology, HR, supply chain, marketing, finance, legal, sales, et cetera. And again, our research business is really focused on helping those executives accomplish their mission-critical priorities. Our core business is research. It makes up 80% to 85% of our total revenues. We also have a consulting business and a conferences business. But think about each of those businesses, their reason for exist, they're great businesses, but the reason we have them is to complement and essentially accentuate our research business. So conferences, we get to bring our research to life. Our clients get to experience it, great from a branding perspective, great from a prospect conversion perspective and great from a client engagement perspective. And our consulting business really exists to help our largest technology clients who have the biggest IT budgets and along with that, probably the thorniest IT problems, with on-the-ground help when interacting with our research platform, they want a little bit more than that. So that's the business.

Great. Great. So I mean let's talk about research. You -- Gartner use an annualized contract value measure, which is a key metric for the business, and you expect both contract value and research revenue to grow by 12% to 16% annually over the medium term. What gives you confidence you can sustain double-digit growth on contract side?

Yes. So CV contract value or CV is our #1 metric. It's a great forward-looking measure for future revenue, for future cash flow for future profitability. And we have a high degree of confidence that we can drive sustained double-digit growth, 12% to 16% growth in research for a few reasons. Probably first and foremost is the market opportunity. And so we've done a lot of work on this, and we estimate the total addressable market in each of the functions that we serve to be around $200 billion. $55 billion of that is in technology. And then the remainder, $145 billion of it is in the other functional areas we talked about a moment ago. And we've got about $4.4 billion or $4.5 billion of that. And so a lot of runway. And so that's sort of point #1 on the confidence. Point #2 is that we've been consistently delivering sustained double-digit growth for a long period of time. And that doesn't happen by accident. Lots of companies with large market opportunities don't grow at double-digit growth rates. We feel like we've got great products and great assets that drive tremendous value for our clients. We feel like we've got a selling machine that can get out there and both renew and grow the accounts that we have or the clients that we have. And we've got an organization that's just tuned to continue to do that over and over and over again.

Awesome. Awesome. So Gartner separate contract value out into global technology sales. That's called GTS and which includes sales to users and providers of technology. And then you have global business sales, which is supply chain marketing, all the sort of functions, you do guys brought it on the CEB. Maybe in GTS and tech, how does Gartner think about future growth opportunities there, especially given the mine share you already possess?

Yes. No. I mean we obviously operate from a position of strength with our brand and the brand recognition and brand awareness in the market. What's fascinating about that, though, is that a lot of times, prospects, so people who aren't Gartner clients, they know Gartner, but they know us for a really thin sliver of what we actually do. So I've been in too many conversations to count where a prospect will say, yes, of course, I know Gartner. You're the Magic Quadrant people. And I'll say, yes, we're the Magic Quadrant people. And they'll say, well, that's awesome, but I'm not buying anything this year. And so I don't see why I would need Gartner. And our salespeople do this much better than I do mind you, but just go with me for a second here. And I'll say, but are you worried about cybersecurity? Yes, of course. Are you migrating your data centers to the cloud? yes, of course. Are you trying to scale up a data and analytics function? Yes, of course. And like we can help you with that. And a lot of times, blush you. And a lot of times, they don't know that we have that depth and breadth of coverage that we can help them with. And so part of our challenge is we need salespeople to go in and connect with a prospect. We can get those meetings because of the brand, but then we need to actually map our value proposition to what's important to them. And this is actually a critical part of our selling process. And so we talk about helping clients with their mission-critical priorities. So if we understand what's most important to a client, we can then map all of our assets to that and essentially create a value plan on how we're going to help them with that over the life of their contract. And ultimately, that's what matters. And I think the cool thing about the Gartner service, the Gartner subscription is mission critical priorities and initiatives can change, right? And so even if today, you say these are my 3 mission-critical priorities, something like a global pandemic or a recession or whatever could happen and your priorities change. You don't need to do anything or buy anything different from Gartner, you essentially change the channel and go after all our deep broad research in whatever area that is. And so there's inherent flexibility, but fundamentally, the biggest challenge we have is people know us, but they only know us for thin sliver of what we actually do.

Got it. Got it. And so as we think about the growth on the GBS side, that's supply chain, legal, marketing, HR, sales, finance, all these sort of great leadership functions where you've grown quite robustly. How does that go-to-market approach, let's say, helping see clients with an action plan, feed into that 20-plus percent growth you guys have been having in GBS?

Yes. I mean, obviously, the GBS business, which, as you point out, isn't really just one business, it's actually several businesses underneath where we're selling to servicing and delivering value for chief human resource officers and their teams, Chief Financial Officers and their teams and so on. It's the same go-to-market function and process and flow. It's the same retention flow. It's the same research creation and engagement flow. So one of the bets we made when we bought CEB back in 2017 was that the operational best practices that we had developed over a decade plus in heritage Gartner would be portable over to the other functions like finance and HR. And I think what we're seeing with that supercharge 20-plus percent growth is they absolutely are portable over. And so we've driven significant improvements in sales productivity in GBS. We've driven significant improvements in the retention rates in GBS. The HR leaders have problems, just like IT leaders have. They're different, right? But think about what an HR leader is dealing with in this environment, whether it's managing a hybrid workforce, that's part virtual, part in-office, dealing with diversity, equity and inclusion challenges, dealing with a highly competitive labor market where turnover is spiking or dealing with a great resignation or whatever you want to call it. And so each of the leaders in each of the functions has a unique set of challenges just like that. I won't bore you with the CFO's challenges, but I can later, if you like, but it's the same sort of thing. And again, we have assets and insights and tools and templates that actually help those leaders and their teams deal with those things.

Got it. So I want to talk about the cyclicality of research as a whole. Recession, prospects for recession whether in the U.S. or globally are surely on investors' minds right now as well as sort of the recent pullback in the tech sector. How would you expect the research business to perform in a U.S. recession? And then how sensitive would that GTS piece be to a pullback in the text sector?

Yes. So it's definitely something that's on everybody's minds, as you mentioned, across the board. So just a couple of thoughts, and I probably should have mentioned this upfront. So the Gartner business is actually a very diversified business, diversified from a geography perspective. About 60% of our revenues are in North America, which means 40% are outside of North America. We're very diverse from an industry perspective. Every industry relies on IT. Every industry has HR and so on and so on. And we are very diversified from a client size perspective. So we sell to the largest companies in the world, companies, Gartner size and small companies as well. And so that sort of diversification is actually to our benefit, right? So unless there's like a global thing, we have pockets where we can -- the economy and the market is still really, really strong. So that's one point. The second point I'd say is in our research business, we are selling minimum 1-year contracts. A majority of our contracts are actually multiyear in nature. And what that means is when there is a short-term or even medium-term disruption, a lot of our contracts actually never even come up for renewal, right? And so we're a little bit insulated from the wins of the market on a day-to-day basis. And then the third thing I'd say is even in tough times, leaders still have the same or perhaps even more acute challenges that they need help with. And we know that we help clients, and we have grown clients that are in real trouble, and we help clients that are doing great. And the way I think about it is with our diversified client base, we typically, at a given point in time, have a, call it, normal distribution of our clients in terms of how well they're performing. So let's say, 25% are doing great, 25% are challenged, 50% if I'm doing my math right, or kind of in the middle. I am doing the math, right? When a recession happens, what happens is the sort of distribution just squeezes left. And so instead of 25% of companies having challenges, 40% have challenges. And so for us, it's not like it's going from 0 to 40%. It's going from 25% to 40%. And we've proven that we can be super successful and grow clients even if they are having challenges. And one of the other things that we do there is we have a significant amount of cost optimization and cost reduction assets. And so when companies are in distress, we very quickly pivot to the cost reduction play, and we can justify our spend multiple times over by helping them accomplish their cost reduction and cost optimization goals.

Got it. That's a good point. So I just want to highlight though something cited on the third quarter call. You asked about this a while on the call as well. New business was down 5% year-on-year in GTS, and then slowed to being up 1% year-on-year on the GBS side. So what drove those decelerations in both sides? Was that more of a product of a less tenured sales force? And we're going to get on that one.

Yes, okay. So a couple of things there. So one is on an absolute dollar basis, we sold a significant amount of new business in both the second quarter and third quarter of 2022 against really tough comparison in 2021. And I'd say there are 2 or 3 reasons why those compares were so tough against '21. First reason is in 2021, we actually had a decent amount of win back activity. So clients that either canceled or decreased spend in 2020 came back roaring in '21, which obviously helped us on the new business side. The bigger thing that probably drove a tough compare in '21, which you alluded to, is the tenure of our sales force. So because we didn't hire a lot of people in 2020, we, in 2021, had the most seasoned sales force we've ever had. And obviously, we were hiring in earnest in the back half of '21 and through the first 3 quarters of '22 to catch up. And so now we have essentially the least tenured sales force we've ever had. And so we -- as we entered this year, we knew this dynamic was going to be happening, and we actually signaled it and called it out a bunch of times. And so again, it's a super tough compare. It's -- we're still generating huge amounts of dollar new business, but the biggest driver is the tenure of the sales force, which, again, as we roll into '23, we should have, in our words, in average tenured sales force. So I know this sounds a little bit like a 3 bearer story, but it's sort of last year, highest -- most tenured we'd ever had. This year, least tenured, next year, average tenured.

Right, right. And so going back all the way to 2019 when you had an Investor Day, you actually flagged that it takes 3 years to basically ramp to full productivity for somebody in the sales force. That seems like a while. Can you explain what is driving that?

Yes. So a couple of bots there. So one is we're selling an intangible. And we're selling that intangible predominantly to C-level execs and their direct reports. And it takes time for sellers even if they've been really successful in software or in services or other areas to really understand the nuances and best practices around selling that intangible to the C level. We do see a pretty nice ramp from year to year to year though. So if you think about it, it takes about 3 years to get to full productivity, year 1 being the lowest. Year 2, we kind of close half that gap. And then by year 3, they're up to full productivity. And when I talk about sort of the average tenure that we're going to have heading into '23, that sort of contemplates people moving up the maturity curve and us having a "normal level" of people with less than 1-year experience, normal level with 1 to 2 years of experience, a normal level with 2-plus experience, which would be those that are tenured and are at "full productivity."

Got it. That's very helpful. So I want to talk a bit about the retention rates in -- on both sides GTS, GBS. This will be the last question on research pivot. So we know your wallet retention is consistently north of 100%. And 91% of research revenues are subscription-based, so contracted 1 year more, presumably. So -- but client retention rates are in the high 80s. So what's driving that attrition?

Yes. So the bulk of the attrition on the client retention side, are small clients. And so they take a chance with 1 license or 2, it either works or it doesn't and they churn it out. So that's the bulk of what you're seeing in that the 14%-ish or 15% that is trued away. There are other pieces in there, too. So corporate restructuring impacts the client retention rate, probably 5, 6 points a year. And so that's M&A, bankruptcies, things like that, that's sort of unavoidable. That's not us, but the gap between that and the 85% or 86% is just clients didn't get the value they thought they were going to get out of the product. Now the good news is we've seen a nice increase in client retention over the last several years. And so historically, we ran in the low 80s. Now we're running in the mid-80s, right, and pretty consistently. And I would argue the more important metric is the wallet retention, right? So that client retention doesn't take into account what a client is spending with us. And essentially, what the wallet means and there's roughly a 20-point gap between client retention and wallet retention, which basically means when a client stays with us, they increase their spend on average, but a nice amount each and every year. And so that's been a significant source of growth, consistent growth for us on the GTS business.

That's very helpful. So stepping back, you've described that there's complementary role in your conferences and consulting play. So maybe we'll highlight the conferences business briefly. And you'll correct me if my numbers are wrong here, I hope, but I believe that you have announced 41 destination conferences this year in 2022, and that's a mixture of live and hybrid or virtual...

Virtual, yes, yes.

And then for next year, presently on your website, 45 have been announced. I believe those are all live or mostly live.

Yes.

You were at 70 in 2019. How should investors think about when conferences will get back to 2019 levels in terms of either the count, the revenue and things like that?

Yes. So conferences are a critical piece of our business for all the reasons I detailed earlier in terms of being an extension of our Research business. Our goal is to have in-person destination conferences for every major role we serve in every major region in which we operate, right? So that is the strategy. That said, when we went from running only virtual in 2021, and actually virtual for the first 4 months of 2022. When we flip back to in-person, we led with our largest conferences, right, and most profitable conferences. And so that was what we wanted to get back into first, and they've done fantastically well since we launched -- started relaunching them in Q2. And Q3 was really strong, and we talked a little bit on our last earnings call about a couple of the conferences that we held in October, which were absolutely phenomenal from both an attendee perspective and from a exhibit perspective. As we roll forward, we want to continue to expand to make sure that we hit that strategic point of -- for every major role we have, we want a destination conference in every region in which we operate. We can't snap our fingers and put them all back at once. It does take time. It takes years of planning to get it right. We also want to make sure that when we do relaunch, they actually meet our economic goals. And I'd argue we've raised the bar a little bit in terms of our economic goals. And so one of the things that investors actually often ask about is what about virtual? Are you going to still run virtual conferences? And I think what I'd say is, number one, wherever we can run in-person destination and it's economically viable, we want to do that. But in places where it's not, then virtual might make sense. And so an example might be in the Middle East, we used to run a Middle East symposium. It was not a highly profitable conference for us. We'll send people to Barcelona, send people potentially to Australia, maybe invite people over to the U.S. and also potentially have a virtual offering that kind of fills that gap. But over time, we want to make sure that we fill out our portfolio the way I described. And the place where we probably have the biggest opportunity to fill out that portfolio is on the GBS side. So the statement I made is not just a GTS point, it's a GBS point too. So today, we have 3 global conferences for HR leaders, but we only have one for finance leaders. And we only have one for marketing leaders. And so again, as we build those businesses out, we want to expand the conference portfolio to support those businesses as well.

Got it. That makes sense. Touching briefly on the consulting business. And this is pretty small relative to, obviously, research. But it doesn't have the popular awareness either that the conferences or the research business have. But what sort of use cases -- or when does people go to a Gartner -- when does one go to a Gartner for a consulting arrangement rather than one of the many other consulting for instance?

Yes. So our consulting business is really targeted, as I mentioned earlier, at our largest clients in key geographies. And we don't want to do little small engagements wherever we actually want to keep it really focused. The type of work that we predominantly do, I put into probably 3 or 4 categories. So category 1 is classic IT strategy work. So I want to think about my cloud and infrastructure strategy moving forward. I need help doing that. We hire Gartner to do that. Second big topic would be large program support. We're running a large transformation program. We need program office support from somebody to help keep all the various vendors that we are working on this in line. And so will hire us. They hire Gartner to do that. Third would be like security benchmarks and security frameworks. I need to really make sure that my cybersecurity function is as strong as my board or my CEO wants to be, hire Gartner to come in and do a security assessment with recommendations out there. And then the fourth piece would be helping them save money on sourcing and procurement. And one of the businesses within the consulting business is something we call our Contract Optimization business. And that contract optimization business is a contingency fee-based business where if we save our clients a lot of money on procurement of software, services, whatever, we take a cut of the savings, and we only take a cut if we actually save the money.

Got it. That's very helpful. And then I want to talk briefly on margins. So you guys speak to contribution, we're going to speak to EBITDA margin, if that's all right. So Gartner's guidance implies a mid-20s percent EBITDA margin for 2022. That's down from 27% last year perhaps. The way you frame your guidance is always at least so let's say perhaps, but that's well above the 16% to 17% range of the company pre-pandemic. So I want to think maybe help investors understand about that change over time. And then I'm going to highlight something that your CEO, Gene Hall said on your earnings call at the start of the month, which is that underlying margins are in the low 20s, which are comfortably above pre-pandemic levels, but rising modestly over time. So maybe help investors think about how to bridge those 2?

A lot of numbers there.

I'm sorry.

No, no, no. It's -- this is obviously something that's on most investors' minds. So the way I'd frame it is this, which is in the most recent year prior to the pandemic, our EBITDA margin was 16.1%. And we had been heavily investing behind the business for a couple of years, especially as a result of the CEB acquisition to get that GBS business ready to really accelerate and grow and investing in lots of other areas as well. And that put pressure on the overall operating margins. Obviously, 2020 and 2021 were, I would say, somewhat anomalous years for a variety of reasons. And we're able to drive really strong EBITDA margins and profitability largely because we were able to avoid a lot of expenses that we now have coming back into the P&L as things get back closer to normal. If you look at 2022 as an example, we've been catching up on hiring quite a bit. So as growth really exploded in 2021, both GTS and GBS and conferences coming back and consulting is starting to grow at double-digit growth rates as well, we fell behind in our hiring. And we need the staff to basically serve and support the growth we've been selling. So we've been catching up in earnest over the course of 2022. And a lot of that hiring has been back-end loaded to this year. And so obviously, we have the rollover challenge of next year. But again, this is why when Gene said the underlying margins, it's taking that into account. We're also getting back to more normal levels of travel. Now we're going to travel a lot less than we did in 2019, but we're going to travel a lot more than we did in 2020 and 2021, just because we're actually traveling again. And so the way to think about the business sort of overall, taking it down the margin level is as we talked about earlier, we believe over the medium term, we can drive sustained top line double-digit growth. We can modestly expand margins from that underlying margin of the low 20s each and every year, which implies EBITDA grows a little bit faster than revenue. Our free cash flow, which we didn't get a chance to talk about, will grow as fast or potentially a little bit faster than EBITDA because of the great working capital model that we have in the business. And we want to deploy that free cash flow on shareholder-enhancing initiatives, most notably with a bias towards buybacks. And so kind of flow that all the way through, that's the best summation of at least our economic algorithm that I can give.

Got it. That's great. So let's talk about buybacks. So the last 2 years, you've done about $2.7 billion in buybacks. That's since the start of 2021. And then that was against $2.2 billion over the preceding decade. So 2020 to -- 2010 to 2020, $2.2 billion, so more in the last 2 years than the prior 10. What drove that change in capital allocation philosophy?

Two things, significant step-up in our free cash flow generation. And after CEB, we did not see any really large acquisition opportunities. And so from an M&A perspective, we believe the opportunities will be small, medium-sized tuck-in deals. And we want to put our free cash flow to work. And we did put our free cash flow to work, and we're committed to continuing to put our free cash flow to work.

Great. Well, thank you so much for your time today.

My pleasure. Thank you. Thanks, everyone.